Our boardroom lunch series continued in February as we welcome Sam Reynolds, Managing Director of Octopus Investments Australia. As we highlighted previously, Octopus is a European fund manager, with around $15bn in assets under management, who implement an ethical focus for their investment decisions. They have a preference to supporting positive business in the areas of healthcare, renewable energy and venture capital. When it comes to renewable energy, their experience is unheard of in Australia with over $4.6bn in assets under management and having constructed or operated over 250 individual sites, primarily in solar and wind.

We invited Sam to present as we believe the renewable energy thematic is a potentially hugely profitable investment opportunity over the next few decades. Whilst our major political parties may continue to disagree on the appropriate action, businesses around the world and now in Australia, are talking with their wallets, entering landmark Power Purchase Agreements with renewable energy operators to appease the wishes of their customers.

The boardroom lunch was a deliberately relaxed affair, with Sam taking questions throughout, whilst explaining the core facets of his approach and clearing up a few fallacies impacting the sector.

Why Australia?

As one of the most experienced and successful renewable energy investors in the world, the first question asked of Sam, is why Australia? According to Octopus, Australia today looks like the UK and Europe over 10 years ago, when there was a lack of political will to move towards renewables. As part of the decision to bring their full team of 10 analysts and experts to Australia, Octopus reviewed the opportunities available in the US and parts of Asia, but decided Australia offered the best opportunity to replicate their current model and deliver outsized returns.

Further, Sam suggested that any expectation that the move to renewables from coal will be smooth, as many bureaucrats expect, may be delusional. Approximately 80% of Australia’s energy currently comes from oil and gas, however, forecasts suggest that 50% should be sourced from renewables by 2030. In 2030, 50% of Australia’s coal plants will be over 40 years old, with many projects actually being mothballed well in advance of this date, as Hazelwood was in Victoria recently.

One of the biggest reasons for Australia, is our expanding cohort of Generation Y and Millenials, who increasingly want action taken on climate change and are forcing business through their tweets or buying decisions to make the change.

What about costs?

Sam explained that there is a common misconception that new solar sites actually cost more than coal plants but that this is completely untrue. According to analysis, new solar is cheaper than both new and life extending coal fired plants even without the benefit of renewable energy subsidies that are provided.

Is Australia too different to Europe?

Sam noted during the presentation that the UK powered its entire country without coal energy for 2 full days in 2018. Whilst a portion was supported by nuclear energy, the reduced reliance on coal is obvious and it is actually estimated to be removed from the energy mix from 2025. Whilst it would be an important step for Australia to consider the benefits of nuclear energy, it doesn’t appear likely for the time being.

On the positive side for renewables in Australia, the team indicated that we actually have a more favourable climate than the likes of the UK. In the UK the peak demand for energy comes overnight, due to the cold and snowy nights, meaning heating is turned on throughout the country at the same time that most renewable energy sources cease production. This is opposed to Australia, where peak demand occurs in the middle of the day, when the temperature is at its hottest, which happens to be when solar and wind can produce the most power for the grid.

Is there any issue with our grid?

A number of questions were raised around both the quality of our electricity grid and the ability to gain access from the likes of Australian Super and Transgrid. Sam confirmed that a major part of their extensive due diligence into any project is in the fact assessing and reviewing the quality of the grid infrastructure in the area, noting that their recent $450m project, required around $25m in self paid upgrades to the local grid to ensure the project was as efficient as possible and energy loss was minimised. One attendee noted the issue of the interconnected grid in Europe, compared to our straight line grid on the East Coast, hence the importance of locating any sites in the most effective area.

There was some concern about accessing the grid given it is basically monopoly owned by a number of large institutions, with Sam indicating his is well versed in the negotiating tactics required to work with grid owners, and the importance of the demand-pull for clean energy that is occurring from consumers. Importantly, Octopus’ reputation and experience means they have extensive networks within Government and the power industry both here and around the world that can assist with connection and any other issues.

What to watch for?

With over 250 projects built in Europe in the last decade, Octopus has a unique understanding of the issues facing both the industry and new projects that seek to enter the market. Sam discussed a number of issues that concern him throughout the sector and which should be front of mind for investors seeking to add an exposure to the sector.

His first point was that subsidies do not always end up being in the best interests of the sector, as evidenced several years ago, when Government funding saw many inexperienced providers enter the sector and the quality of work reduce substantially.

Sam highlighted the now bankrupt RCR Tomlinson as a case in point for new entrants in the industry, as the engineering and construction group simply took on too many projects at the same time and did so without any real experience in the sector.

Sam warned against working with any engineering company, developer or investor that is only making its entry into the sector, as he has seen and experienced the issues come with misunderstandings and poor pricing models. He noted that even some of the world’s most experienced renewable consulting business can include poor assumptions in their models, hence Octopus undertake their own due diligence, including of the local electricity grid, for every project. They do not rely solely on an independent report, but noted many other investors do, which can cause substantially worse outcomes than expected should the real world be different to the assumptions (as it typically is).

Another issues the smaller players face is the lack of scale in both construction and energy generation. In some cases, a smaller solar farm may need to sign off its entire annual generation to a single business, effectively making it a price taker, or not be able to access the debt required to fund the projects. There is no such issue for Octopus and in fact they have been requested as preferential builder/operators by the lenders on various occasions.

Other questions

There were a number of other questions from the audience, including around improving technology in the solar panel sector, the importance of baseload power and whether Octopus had given any consideration to adding storage to their solar farms. Sam noted that the Snowy Hydro 2.0 proposal, which sees water pumped upstream using solar panel, to produce baseload power overnight, made sense for Australia and has been used overseas for some time. He noted that at this point battery storage, like that in South Australia, which combined millions of small batteries, is simply not cost effective enough for solar farms in this or any other country, hence they would continue to work on the basis of direct connections to the grid. That being said, Octopus were always seeking new opportunities and would add said storage capacity if and when it became both reliable and more appropriately priced.

What are the investments?

The Octopus investments are restricted to wholesale investors only at this point, meaning investors need to have at least $2.5m in assets to access any of these opportunities. Octopus is offering two options, one directly for wholesale investors, with a minimum of $300,000 per investor, and one for institutions and pension funds, with a minimum of $5.0m per investor. We are currently seeking expressions of interest for the second option at investment levels of at least $250,000, with the potential for these investments to be pooled together to access the asset.

The first option is the Early Stage Innovation Company (ESIC), with the fund aiming to raise $35m to construct 1 to 2 solar farms and on sell them within a 2 year period. Under the ESIC Fund, the unit trust will own the underlying property, construct and operate the assets for a short period of time. The forecast return is around 8% per annum over the holding period, however, similar strategies in Europe resulting in returns of closer to 10-12% with minimal volatility. The added benefit of this option for those not investing through superannuation is a 20% tax offset for the value of the investment and capital gains tax exemption which has been afforded by the managers obtaining a Private Binding Ruling from the ATO based on the use of new technology in the project. Of course, this investment must stack up without the need for a tax offset, which we believe it does. If you would like a copy of the Information Memorandum, please contact one of our advisory team.

The second option, is the $150m OASIS Fund, which is restricted to a total of 49 investors and a minimum investment of $5.0m. The fund is targeting an annual return of 9-10% over a three to five year holding period, with minimal income expected in the early years. They intend to sell the underlying assets via private sale or IPO at the end of the five year term. This fund will be diversified across states and in our view represents the more attractive long-term option. Given the minimum investment size, any investment would need to be pooled via a separate unit trust, which we are in the process of reviewing with a number of legal and accounting experts.