Pension funds harness wind power to drive returns

COPENHAGEN Tue Aug 14, 2012 9:58am EDT

A wind farm generates electricity near bales of hay in the foothills of the Rocky Mountains near the town of Pincher Creek, Alberta September 27, 2010. REUTERS/Todd Korol

A wind farm generates electricity near bales of hay in the foothills of the Rocky Mountains near the town of Pincher Creek, Alberta September 27, 2010.

Credit: Reuters/Todd Korol

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COPENHAGEN (Reuters) - Pension funds hunting for higher returns are buying direct equity stakes in wind power projects that are being shunned as too risky by banks and other investors.

It is a major change for the funds, which favored government bonds for years until the debt crisis gripping Europe turned this once low-risk strategy on its head and drove down interest rates elsewhere, leaving few alternatives.

Green power needs heavy investment if the European Union is to reach targets for boosting its share of total energy supply to 20 percent by 2020 and cut both carbon emissions and dependence on fossil fuels.

But a funding gap has emerged because banks are staying away, in compliance with new rules aimed at reducing risk.

Wind power plants, particularly offshore farms, are expensive to build and maintain. Regulation is seen to be uncertain and the plants can face logistical and technological problems connecting to the wider grid. Forecasting reliable returns is difficult.

Nonetheless, some pension funds are thinking longer-term, to steady cash flow over 20 to 30 years once projects are in place, and have decided to step in.

Denmark's state-owned DONG Energy, an oil, gas and electricity producer, has enlisted several investors as it builds wind power projects off Denmark, the UK and Germany. Danish pension providers PensionDanmark and PKA, Dutch pension group PGGM, and industrial investors including the private owners of Danish toymaker Lego and Japanese trading house Marubeni are just some investors it has brought in.

"I think this will...develop into a standard investment case for many pension funds because the alternative of investing in government bonds provides such bad returns that you are obliged to identify alternative investments," said Torben Moger, managing director of PensionDanmark, which has 618,000 members and 125 billion crowns ($21 billion) in assets under management.

PensionDanmark's total investment in DONG wind projects is 4.5 billion crowns and Pedersen said it will invest more in the future as it moves to a 10 percent allocation to energy and infrastructure from about 6 percent now.

"We have quite an expansive strategy in this area," Pedersen said. "In five years we will have 180 billion under management. So our total budget for these kind of investments will be 10-15 billion crowns over the next 10 years."

ATTRACTIVE RETURNS?

It is no surprise that Denmark, world leader in wind energy, should spearhead new project finance in the sector. The country built the world's first offshore wind farm in 1991 and now meets roughly a quarter of its electricity needs from wind energy.

Many other pension funds and insurers are still put off investing in wind power by perceptions of regulatory risk and lack of knowledge about the industry. In Germany in particular this is hampering growth and industry targets.

But this is expected to change.

The OECD estimated in a report published in September last year that less than 1 percent of pension funds worldwide were invested in infrastructure projects.

"Institutional investors such as pension funds may therefore play a more active role in bridging the infrastructure gap," the OECD said in its 2011 report.

Other early movers say there are plenty of factors to offset risk. Investing in wind farms is safer than negotiating unstable financial markets and there is a clear advantage for early movers who team up with reliable partners, they say.

Europe's biggest insurer, Allianz of Germany, has invested more than 1.3 billion euros ($1.59 billion) in renewable energy since 2005. Most of this is in wind farms in Germany and France, but also some solar power plants in France and Italy.

David Jones, CEO of Allianz Specialized Investment, said returns on wind and solar projects are now around 7 percent - much higher than many other asset classes - and are totally decoupled from the ups and downs of the financial markets.

By comparison, 30-year U.S. treasuries are now yielding less than 3 percent while yields on some shorter high-grade government bonds are negative and equities have been extremely volatile during the recent economic turmoil.

Pedersen at PensionDanmark agreed.

"We expect a return with a spread of between 300 and 500 basis points above a government bond, but with a risk profile very much less risky than listed equities," he said. "So the risk/return ratio is very attractive."

Dutch pension group PGGM altered its strategy two years ago to become a direct investor as well as a fund investor in energy projects, and has since taken a stake in DONG's Walney wind farm in the UK and in a large Mexico wind power project backed by Australian investment bank Macquarie.

"If you have a good partner, then the risk for joining in the development phase can be acceptable, and you get a premium for going in earlier," said Henk Huizing, head of infrastructure investment at PGGM, which has allocated 15-20 percent of its infrastructure portfolio to renewable energy.

DONG Energy's acting deputy CEO for wind power Morten Buchgreitz said he had seen "quite extensive interest" from insurance companies and thought others would also invest, with around 100 billion euros needed.

"I hope this will be a model that catches on because, just looking at the northern European offshore market, we expect that the capacity will have to go from 4 gigawatts (GW) now to 37 GW by 2020, 10 times as much as today," Buchgreitz said.

(Editing by Sophie Walker)

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