At Australian Ethical, we get our fair share of questions from detractors about the merits of investing in renewable energy. We can’t speak on behalf of other investors, but we can share our thoughts and experience in the smart energy space. Australian Ethical’s International Share’s Portfolio Manager, Nathan Lim, illuminates the facts for the doubters.
Globally, energy policy is shifting towards a lower carbon economy. This growing change is clearest in the power generation sector, where most advanced nations are reducing the carbon intensity of their energy sectors. Admittedly, some nations are more advanced or ambitious than others, but broadly speaking the direction is the same.
The push towards net zero emissions in the power sector has unsurprisingly meant a similar shift in the transportation sector (typically the second largest source of emissions in a country). Think about the drive towards electric transport: more ‘motive’ energy will come from electricity instead of the direct combustion of fossil fuels. At the same time, with the power sector reducing its reliance on fossil fuels, zero-emission technologies are in the box seat to gain market share.
The role of renewables
One of the most potent ways the energy sector is changing is through the spread of distributed generation (DG) – that is, generating power on-site rather than centrally. DG cuts out the middlemen, and so the traditional role of who is the customer and who is the supplier is becoming increasingly blurred. Consider a household with rooftop solar: the homeowner is both a consumer of power (at night) and a supplier (during the day). In time, cheap energy storage might even allow the owner to become a mini-utility, outright providing energy to neighbours directly with stored power in a battery pack charged during the day. With the plummeting cost of solar, an increasing number of homes around the world today can partially supply their energy needs for less than buying the power from the grid without applying for a subsidy. As these homes install solar, they are future-proofing themselves for the day when there is a cost breakthrough on energy storage.
Energy storage is still too expensive for widespread adoption, but it is already finding niches where it makes sense economically. For example, for businesses looking to perform peak load shaving, a battery can cap daily usage spikes that can account for a disproportionate portion of the bill.
Renewable energy investing is cyclical
Renewable energy investing is cyclical. Just to clarify, we are talking about investing in listed equities but these comments could be broadly applied to debt instruments and unlisted ventures as well. Beyond normal macroeconomic considerations, government policy direction leads to regulatory-driven spending cycles. For example, the US Production Tax Credit (PTC) has created a boom/bust cycle for the US wind
industry. The PTC provides a cash credit for every kilowatt produced during the first 10 years of a turbine’s life. Since its creation in 1992, the PTC has expired or been within five months of expiration six times. Chart 1 shows annual new wind turbine builds and the arrow marks the six times the PTC expired/neared expiration.
Chart 1 – Annual US Wind Turbine Installations in Megawatts
Except from 2005 to 2009 when Congress was not tardy in renewing the PTC – they extended it early in 2006 and 2009 – the year following the expiration of the credit saw a dramatic decline in installations. Anticipating these policy changes are often a catalyst for a company’s fortunes and its share price.
In the short term, macroeconomic factors and policy-driven cycles can push a company’s share price up and down quite dramatically. Hence, we can see how a causal observer of renewable energy companies can say they are terrible investments. However, over the long term, one would expect a well-run company to have a share price higher than where it began.
As a quick aside, all figures for the rest of this essay have been converted to Australian dollars to facilitate direct comparisons and are up to 31 July 2015.
Since going public in April 1998 Vestas Wind Systems’ share price has increased annually on average 16%. However, over this period the share price has fallen over 90% – twice! Over the past 17 years, the shares made new highs but also new lows roughly in-line with the PTC expiration cycle. Notably, amongst all wind companies, their fortunes are not perfectly correlated. Let us look at the share price return of a group of wind companies as represented by the NYSE Bloomberg Global Wind Energy Index. Over the roughly past 10 years, they have produced an average annual return of 3% versus Vestas at 14%. Clearly, even amongst similar firms there are going to be winners and losers.
Extending this example to solar, we look at First Solar. Since it listed in November 2006, it has produced an average annual return of 8%. Its peer group, as represented by the Ardour Solar Index, has returned -15%. We would note that the solar industry is still in its infancy having only just recently advanced from being a science experiment to a commercial industry product in the past several years. We have written previously on why investors need to consider solar here. Solar is poised to change the commercial dynamics of the energy markets given the dramatic declines in its cost.
Australian Ethical’s renewable energy investment experience to date
Now, let us turn to the Australian Ethical International Shares Fund, which has our highest concentration of renewable energy investments and holds both Vestas and First Solar. Over the past three years, our solar stocks have returned 107% in total while our wind investments have returned 636%. Over the same period, the Ardour Solar Index has returned 172%, and the NSYE Bloomberg Global Wind Energy Index returned 232%. We were behind on solar but made up for it with our wind investments.
Wind and solar are just subsets of the overall International Shares Fund, which has now achieved an average annual return of 27.4% over the past three years.
Renewables continue to emerge from their last deep cycle, and we believe they remain a solid investment choice at this point in the cycle. We incorporate renewables into a portfolio of other progressive technology leaders in other industries like recycling, energy efficiency, and transportation. In this fashion we believe the International Shares Fund will continue to serve our investors regardless of where a specific industry is within its cycle.
So, to all the renewable energy sceptics and cynics out there that say renewable energy investing does not work; why not have a chat with one of our investors about that point of view? An open mind is something we can all afford to have.
Nathan Lim is a portfolio manager with Australian Ethical Investment.