GREEN energy firms, star stock-market performers over the past three years, got a further boost last week when the government unveiled its long-awaited review of the sector.

The report concluded that the amount of electricity generated from renewable sources such as wind, wave and solar power should increase fivefold by 2020 if Britain is to meet its goal of slashing carbon emissions from fossil fuels by 60% over the next few decades.

The government also backed a new generation of nuclear- power plants to reduce our dependence on oil and gas from politically unstable areas such as Russia and the Middle East.

Green energy firms had already been riding high as climate change moved up the political agenda, and record oil and gas prices encouraged firms to seek alternatives to fossil fuels.

The Impax Environmental Technology index (ET50), which tracks the world’s biggest alternative-energy companies as well as waste-management firms, has leapt 73% over the past three years and 19% over the past 12 months, compared with gains of 49% and 14% for the FTSE All Share.

Some funds investing in green energy firms have done even better than the index. The Merrill Lynch New Energy Technology investment trust has soared 189% over the past three years, and the Impax Environmental Markets trust is up 122%.

Charlie Thomas, manager of Jupiter Green investment trust and Ecology fund, said: “I’ve been managing green money for 17 years and the outlook for alternative energy is better than it has been for a long time.”

The sector is not for the fainthearted, however. Green energy firms are often small, immature and volatile. Shares in ITM Power, an Essex fuel-cell company, were listed on London’s Alternative Investment Market (AIM) at 50p in June 2004 and by April this year they had soared to 335p. But they have since plunged back to about 160p because the firm will not start earning until 2008.

Investors can reduce risk by investing in a fund rather than individual stocks, but even these can be volatile and they are essentially a bet on the oil price staying high, which makes renewable energy look more cost-effective.

Justin Modray of Bestinvest, an adviser, said: “The record oil price is one of the main reasons the alternative-energy sector has boomed over the past three years. If the oil price falls, green energy funds will be hit, although the very long-term prospects remain promising.”

He suggests investors have only a small part of their portfolio in the sector and be prepared to tie their money up for 10 or 15 years. By then, he said, renewable energy should be entering the mainstream.

The government said last week it wanted electricity suppliers to generate 20% of their energy from renewable sources by 2020, compared with only 4% today.

Commentators say onshore wind power is likely to provide the bulk of this, even though the energy review suggested shifting subsidies towards less- mature technologies such as offshore wind and tidal power.

Britain has several wind firms listed on AIM, including Clipper Windpower, whose shares cost 362½p on Friday, and Renewable Energy Holdings, at 37½p.

Thomas also likes SIG, a supplier of insulation to the building trade, which could benefit from the drive to make homes more energy-efficient.

Governments around the world are also pinning their hopes on fuels derived from plants — such as bioethanol from corn — to reduce oil dependency. The EU wants 5.75% of all transport to be powered by biofuels by 2010. America has similar targets.

This could benefit AIM firms such as D1 Oils, which produces biodiesel from vegetable oils, and Biofuels Corporation, which opened its first biodiesel- processing plant at Seal Sands, Middlesbrough, last month.

However, some analysts have warned that shares in many biofuel firms have run ahead of themselves, particularly American ethanol companies. For example, shares in Vera Sun, the second-biggest producer of corn-based ethanol, were trading at 200 times the company’s earnings per share when they were listed in America recently, while Google shares were trading at a mere 50 times earnings.

Investors who still want to put a small part of their portfolio into renewable-energy companies should look at Merrill Lynch New Energy, Impax Environmental Markets or Jupiter Green, said Modray.

The Carbon Trust, set up by the government to reduce carbon emissions, is launching a venture-capital fund that will invest in green-energy technology firms later this year. While the initial fundraising will be aimed at institutions, individual investors will be able to buy shares.

Alternatively, companies such as Ventus and Keydata sometimes launch venture- capital trusts that invest in wind farms and offer generous tax breaks to individuals.

Investors who want to back Labour’s new generation of nuclear power plants could look at British Energy, which owns most existing nuclear sites and provides about 20% of the country’s electricity.

Or you could invest in the raw material for nuclear energy: uranium. New City Investment Managers has just launched a fund that will invest in uranium miners such as Cameco of Canada and Areva of France.

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