‘Pre-accredited’ solar farms offer inflation-protected and secure returns and are viable alternatives to conventional annuities.
1, The government has fiercely cut support for large-scale PV farms, taking prospective returns to well below the levels required by financial investors.
2, However a small number of locations with ‘pre-accredited’ allocations of renewable obligation certificates (‘ROCs’) are still possibly financeable. These farms will receive 1.2 ROCs per megawatt hour produced, worth over £50, as well as the price for the power produced. Crucially, the value of ROCs inflates with retail price inflation, or RPI.
3, The 1.2 ROC regime for pre-accredited sites ends in March 2017. To benefit from the scheme, money will need to be committed by end-November 2016.
4, Working with Jonathan Thompson, the CEO of PV developer Green Nation, we have calculated that the remaining pre-accredited sites will typically produce a stream of cash that is twice the amount that would be returned to a person buying a conventional financial annuity, even under very cautious assumptions about costs and incomes.
5, A PV farm with ROC income for 20 years therefore presents an attractive investment opportunity for an annuity-seeking individual wishing to obtain protection against inflation.
6, Annuity rates are unprecedentedly low. In fact, for a person aged 65 buying an annuity with the payout linked to RPI, the amount paid out will not return the initial investment for an individual with a life expectancy of someone living in the UK’s longest-lived local government area.
7, Today’s RPI-linked annuity rates produce about £2,570 per year for each £100,000 invested for a 65 year old, with a 5 year guarantee and paid only until the death of the individual. (If inflation is zero, the total amount paid out will only exceed the amount invested if the individual lives 39 years). See http://www.ft.com/personal-finance/annuity-table?ft_site=falcon&desktop=true .
8, The average life expectancy of a 65 year old man in England and Wales is 18.8 years. For a woman, it is 21.2 years.
9, The typical person buying a conventional annuity is likely to live longer (partly because they are more prosperous than the average). For men in the longest-lived area (Kensington and Chelsea) life expectancy at age 65 is 21.6 years and for women 24.6 years (Camden).
10, For a man with 21.6 years more life, the total return in real terms from a £100,000 invested in annuities is just £55,600.
11, The reason that this number is so low is that annuity providers are obliged to buy index-linked government bonds (‘gilts’) to fund future payments. 20 year indexed bonds currently trade at a real interest rate of about minus 1.82%. All gilt yields are very low but index linked bonds cost substantial amounts of money to hold. Protecting future income against the effects of inflation is very, very expensive indeed. https://www.fixedincomeinvestor.co.uk/x/bondtable.html?groupid=3530
12, A saver can also buy an annuity that does not rise with inflation but instead stays constant. The FT’s annuity table suggests that such purchase returns about £4,528 each year for each £100,000 invested. Even if inflation is zero, the person of average life expectancy also does not receive his (or her) investment back during their lives.
Investment in solar farms as an alternative to annuities
13, The underlying reason why solar farms paid through the ROC system are competitors to annuities is that the subsidy payment is linked to RPI inflation. An investor buying a share in a solar farm is purchasing a right to income that will rise at the same rate as retail prices.
14, A stand-alone solar farm receives both ROCs and also sells the electricity that it generates in the wholesale markets. In the simple model we have prepared, based upon Green Nation’s solar farm evaluation spreadsheet, the price of electricity falls by 2% a year against the average price in the economy. (Therefore if RPI is rising at 3%, wholesale electricity will only increase 1% per year). Almost all forecasters see electricity prices rising faster than general inflation so this assumption will be seen as extremely cautious.
15, Based on a recent offer from one of the largest second-tier electricity retailers, Green Nation believes wholesale electricity is currently worth about £46 per megawatt hour for a two year fixed period deal. We believe this price is higher than can be sustained. So not only do we deflate electricity prices each year but we also switch to price below £40 for year 3 of the model. Again, this is a highly conservative choice.
16, Other assumptions in the model are the same as Green Nation conventionally uses. We calculate the free cash flow for each year of operation.
17, The yearly payments to the annuity investor are as seen in the chart below. (The figures assume 2% RPI inflation). The cash continues for 21 years, the average length of ROC payments are only made for 20 years, hence the sharp fall in payments from the solar farm in the final period.
18, The total payments to investors under different RPI assumptions are given in the table below for the whole 21 year average life and an initial investment of £100,000. At all inflation rates between 0% and 4%, the PV farm returns more than twice an RPI-linked annuity.
RPI inflation 0% 2% 4%
PV farm 'annuity' £128,430 £160,746 £202,764
RPI linked annuity £54,054 £66,366 £82,289
Flat annuity £95,088 £95,088 £95,088
19, What are the prospective difficulties for an investor? First, the PV farm is of a pre-determined duration. It will return cash for 21 years (or until its planning permission expires, probably after 25 years). So a very long lived investor will not gain as much. But even an investor living to 100 will generally be better off overall with a holding in a PV farm. Second, the cash return is partly dependent on the wholesale price of electricity. However if the wholesale price falls to 50% of current levels in 2019, and continues to decline at RPI-2% after that, the PV farm returns far more cash than an RPI-linked conventional annuity. Third, the investor also faces a small degree of operational risk because the farm may not work as well as expected. (Though most UK solar farms have actually outperformed their initial plans). This last risk can be mitigated by using a mixture of two or more farms to provide the annuity
20, Next steps. Although other groups have tried to make ‘solar annuities’ work, the returns have been limited by large intermediary fees. We seek discussions with financial institutions interested in exploring ways of developing the idea contained in this short paper. We should say that there is limited scope for earning high returns for either organising or retailing this scheme. The bulk of the cash will need to be provided to annuity holders.