Why Renewable Energy Stocks Are Underperforming
Here at Green Alpha ® Advisors, we keep our next economy portfolios well diversified among industries, sectors, sub-sectors, countries and capitalizations. We don’t manage just silos of the green economy, such as with a ‘green energy fund’ or a ‘solar fund,’ but rather strive to include all next economy economic sectors. We do this for two reasons. First, we have a goal of representing the entire next economy, meaning not just renewable energy but also green forms of agriculture, water management, transportation, commerce, communications, services, infrastructure, waste management and materials. In short, everything you need to run an economy, but as executed by companies who know how to plan for and thrive in a warming, increasingly populous and carbon-and-resource-constrained world. We seek the next economy wherever we can find it. The second reason for our portfolios’ diversity, of course, is to minimize the risk to investors should any one sector underperform for any time period. Unfortunately, though thankfully with some exceptions, underperformance has been the case recently with stocks of wind and solar companies.
So how come? I think in the case of the poor general market performance of these two primary renewables, wind and solar, there have been two distinct but inter-reinforcing phenomena going on. First is the historical economic case. Each of the two sectors has been so small in scale compared to fossil fuel industries that they have lacked the ability to provide power as cheaply. They just don’t have anything like the same global scale. Yes, there have been many early adopters buying these technologies over the past couple decades, either because they were concerned about emissions, toxins and warming, or because they wanted to increase energy security with their own independent systems (a la Google), or both. But still, even today, solar supplies less than 1% of world energy, and wind somewhat less than 2%. So the economies of scale have (until recently) been tough, especially in the estimation of the more moribund banks and analysts who fail to consider fossil fuel’s uncounted but very real externalities such as the expense of effects of global warming, costs of pollution-related health care, going to war in the oil patch, etc., etc. These costs have not been accounted for in the economics of fossil fuels, but if the international political economy is ultimately rational, sooner or later (preferably sooner) they will be. The second factor in renewables’ poor stock performance is disinformation. This is related to the first in that there’s a concentrated effort underway to convince folks that fossil fuels’ externalities need not be counted or are just plain false. That warming is false, that emissions are not especially dangerous, that drilling is safe, and even, I’m not making this up, that birth defects in Appalachia, ascribed by epidemiologists to the toxic effects of coal mining, are actually the result of local inbreeding.
Polls show that (in the U.S. anyway), this disinformation effort is working. Except for a very recent rebound in belief in global warming, the last two years have seen a general decline in belief in climate science among Americans, particularly among conservatives (and even more so among white, male conservatives). Moreover, the media by and large do a poor job of accurately representing climate issues. So, many of fossil fuel’s true costs aren’t being included in their price, and folks aren’t often being told the facts about why they should be.
It’s hard not to notice that this period of declining acceptance of climate change and even toxic pollution has approximately corresponded to the period of declining valuation of solar and wind companies (declines partly driven by a wave of increasing short interest among the stocks of renewables, more below). But emerging scale with its declining costs along with accurate pricing of fossil combustion’s externalities will inexorably reverse this trend. As Michael Bloomberg and Michael Brune wrote recently in a CNN article, “The truth is, we can’t afford not to quit coal. The cost consumers pay for power does not reflect the true cost of burning coal.” Yet today, most financial analysts deride renewables’ profitability on the grounds that their electricity is too expensive to be grid price competitive.
Unless they’re saying the opposite. Currently I’m amused to note, and here I’m especially referring to solar, that as the prices of renewable energy are declining to the point where they are finally becoming competitive with fossil fuels – a good example being coal vs. solar electricity – some of the same analysts who derided renewables’ expense now object to their inexpensiveness on the grounds of “commoditization” and “margin squeezing,” claiming solar companies can’t make much money going forward, as though manufacturing costs aren’t dropping equally rapidly as scale grows.
For me, these guys are missing the point that the rapid, large reductions in the price of solar, which show every sign of continuing, mean that solar will now begin to supplant coal far faster than anyone could have foreseen even five years ago. Now, I think these analysts are for the most part bright, well-trained professionals, so I have to assume that they’re missing the obvious economic points either deliberately and/or because they’re ideologically inclined to believe the worst about renewables due to current preferences for fossil fuels.
Because make no mistake, fossil fuel kingpins will not give up market share easily, and, since the companies they run are the richest and most profitable firms in history, they have the resources to bring both tooth and claw to bear, while renewable energy firms are still comparatively small and poor. But no degree of hegemony is forever secure, particularly when the competition becomes not only cleaner but also cheaper.
If you doubt that the fossil fuel industry will stop at nothing to defend its oligarchy, look no further than the case of Tim DeChristopher, or the fact that there’s evidence that strong, profitable companies like LDK Solar have recently been the targets of illegal naked short selling, most likely in an attempt to crush share prices and discredit companies. Some solar companies have had short interest as high as 30-63% of total float, and short selling transactions can account for as much as 70% of daily volume. I believe these short sales are likely ideologically motivated because no rational portfolio manager or trader would take a short position in a very profitable company already trading at a ridiculously low valuation. And by ‘ridiculously low’ I mean, in the case of LDK, price to earnings of 1.8, price to book of .65, price to sales of .30, and net 2011 earnings – not losses – of US$300 million.
Chart showing percentage of LDK Solar’s daily volume that takes the form of short sales; it’s been as high as 72% and rarely lower than 30%. Source: www.fearthevix.com
This is all embedded in big oil’s and Wall Street’s culture. For years, renewables were perceived as being so fringe that the establishment didn’t much notice or care. Now they see solar and wind as potentially disruptive and threatening, so the knives have come out. But presently (and already in the case of French oil giant Total, which has purchased a stake in U.S. solar company SunPower for US$1.37 billion), they’ll see the economic if not climate writing on the wall, and decide to go ahead and engage in the next economy. This progression has frequently been the case when the establishment is challenged by a powerful new paradigm.
Meaning eventually ideology – or inertia – is put aside in favor of better economics. When practical decision makers realize that solar generation has in just a few more years gone from being about the same price as new coal generation to half the price, it won’t matter anymore what they hear on TV or what their local coal rep tells them. Solar companies will more than make up in volume what they’re losing in pricing power. As a parallel, consider that semiconductor manufacturers have faced similar concerns as Moore’s law has meant that computer processing chips now deliver tens of thousands times more computing power for the price than they did in the 1990s, yet chips have become so ubiquitous that many manufacturers today enjoy good earnings and fair valuations. I don’t expect solar efficiency to grow as much as semiconductor efficiency has, so solar’s margins won’t be squeezed quite as much, but neither do I expect there to be as many billions of PV panels on earth as there are computer chips. Ultimately, as solar grows from providing less than one per cent of world electricity demand to 10%, 20% and beyond, its sales numbers will easily suffice to keep the industry nicely profitable. Evidence that this is already occurring is mounting. Solar is the fastest growing industry in the United States, and has been for this entire period of declining solar stock prices (where does that make sense?). How rapid is solar’s growth? Check out this excerpt from a recent blog post from the White House:
“The U.S. solar energy industry is booming.
In June, the Solar Energy Industries Association and GTM Research released the U.S. Solar Market Insight: 1st Quarter 2011 report showing that in the last three years the U.S. solar industry has gone from a start-up to a major industry that is creating well-paying jobs and growing the economy in all 50 states…[i]n the first quarter of 2011, the solar industry installed 252 megawatts of new solar electric capacity, a 66 percent growth from the same time frame in 2010. There are now almost 3,000 megawatts of solar electric energy installed in the U.S., enough to power 600,000 homes. In the manufacturing sector, solar panel production jumped 31 percent.”
Economy-leading growth, and as price competitiveness continues to improve, the pace will only accelerate.
Disclosure: we are long LDK Solar and SunPower, and have no position in Total.
Note: this post is to some extent an expansion on my responses to questions posed by www.altenergystocks.com editor Tom Konrad for his article “Are the Declines in Solar and Wind Stocks Structural, or Cyclical?”
Garvin Jabusch is the cofounder of Green Alpha Advisors, LLC and manages The Sierra Club Green Alpha Portfolio — a unique blend of Green Alpha Advisors’ Next Economy universe and the Sierra Club’s proprietary green-investment guidelines.
Green Alpha Advisors’ mission is to deliver shareholder value earned in the critical and necessary process of balancing the world economy and Earth’s environment. Driven by the transition to eco-efficiency required to provide economic, energy and environmental security, Green Alpha Advisors is a conduit of capital into companies representing the Next Economy™. Next Economy companies are market leaders responding to the challenges presented by a warming, increasingly populous, carbon-and-resource-constrained world. Through technology and innovation, carefully selected portfolios of these companies deliver strategic growth through opportunities in transportation, communications, commerce, infrastructure, materials, energy, agriculture and water. Articles l Homepage
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