Is it over and out for investing in renewable energy?
Rapid progress is being made in renewable energy. However, investing in this sector is currently anything but profitable. The share prices of ‘green' energy companies are deep in red territory. Why is it that companies that are desperately needed in the fight against global warming have seen their share prices wither away over the past two years? ‘The sector has been disproportionately affected by a perfect storm,’ argues Anthony Sandra, Portfolio Manager at KBC Asset Management. One bright spot in the story is that the business model for Alternative Energy remains intact. And more than that, an explosive increase in demand for energy, along with a growing desire for strategic independence, are fuelling optimism.
Investing in the sustainable transition is not just about a fine-sounding narrative, but is about a narrative of inevitability, which brings promising opportunities and growth prospects. But it requires a vision that can see beyond the present uncertainties.
Anthony Sandra, Portfolio Manager at KBC Asset Management
The global climate is changing, resulting in more extreme weather. Never before have there been so many heat waves, forest fires or devastating floods. The financial damage is huge. No price can be put on the human suffering.
The transition from fossil fuels to more renewable energy sources is and will continue to be vital, and offers opportunities for companies in the Alternative Energy sector. ‘Investors discovered the Alternative Energy theme in 2020. It’s a theme that had been lying dormant for years and which then, in a relatively short time, attracted large flows of new money from investors,’ says Anthony Sandra, Portfolio Manager at KBC Asset Management. ‘It happened fast. But in the past two years, this trend has clearly hit the buffers. It would seem that investing in Alternative Energy has had its day.’ But is that really the case? Or do the cheap valuations, partly due to the outflow of short-term investors who were attracted by the early hype, actually offer opportunities for those who take a long-term view?
Private Equity investors with deep pockets are currently combing the market in search of high-quality, cheaply valued prey.
Anthony Sandra, Portfolio Manager at KBC Asset Management
‘The growth prospects remain promising,’ insists Sandra. ‘This is also demonstrated by the numerous acquisitions of renewable energy producers - whose valuations are at their lowest point for five years - by Private Equity investors.’
A perfect storm
‘The start of the war in Ukraine acted as a catalyst for the Alternative Energy sector, driven by high fossil fuel prices and the need for greater energy independence. But over the past two years, the sector has been disproportionately affected by a perfect storm,’ Sandra says.
- Sky-high inflation in recent years has driven up development costs, while materials, personnel and transportation have all become more expensive. The influx of cheap competition from China has also put pressure on profit margins, as not all companies were able to pass on costs to their end customers. Makers of solar power equipment have been hit especially hard.
- The many - and rapid - increases in interest rates, intended to curb high inflation, also increased the cost of capital. Utility projects have high upfront costs and are highly sensitive to interest rates. They are long-term assets, financed using loans. Higher interest rates make these loans more expensive. Valuations and returns then take an immediate hit.
The same goes for operators of electricity networks; their stable cash flow makes them a bit like bonds, so they too suffered under rising interest rates. - Higher interest rates immediately put the brakes on private investment, for example driving up the cost of loans for installing solar panels. Energy-efficient investments in new construction and/or renovation were deferred.
- And then oil and gas prices fell, making fossil fuels more competitive again. Continuing high interest rates made for a longer payback period, and this weighed on demand. Overcapacity due to supply outstripping that demand, put an additional squeeze on profit margins.
Trump throws oil on the fire...
He makes no secret of it: Donald Trump thinks climate change is a hoax. ‘Sea levels are rising. Who the hell cares?’, he openly wondered at a campaign rally in Milwaukee. What does it mean for the green transition, now that Trump will be spending the next four years back in the White House?
‘Trump had already withdrawn the US from the Paris Agreement during his first term as president,’ says Sandra. ‘His successor Joe Biden signed back up again immediately, but it may be that Trump will now pull out again. And not only that: under the motto ‘drill, baby, drill’, he will probably look to put as much effort as possible into fossil energy extraction again: in other words coal, oil and gas.’
And then there is the question of what will happen to the 2022 Inflation Reduction Act (IRA), one of Biden's proudest climate achievements. The IRA was meant to encourage green investments. The huge package of loans and tax breaks - worth a whopping 370 billion USD - included support for solar and wind energy projects, as well as incentives for the purchase of heat pumps and electric cars. According to Trump, the IRA represents ‘the biggest tax increase in US history’.
... Though the reality may prove to be less extreme than the rhetoric
Trump will not determine the climate future of the US on his own. The individual states, each with their own climate legislation, will also play a part in that. ‘The IRA is proving to be a key driver of economic growth and job creation, which is why the Act enjoys broad support among both Republicans and Democrats,’ Sandra stresses. ‘Another salient point is that investing in homegrown green energy reduces US dependence on China as regards renewable energy equipment. If the US wants to compete with the rest of the world, it will have to persevere with its own transition to some extent.’
And we must be sure not to forget Elon Musk, Trump's 'First Buddy' and also the boss of Tesla, who will no doubt want to see the tax breaks for electric cars maintained.
Anthony Sandra, Portfolio Manager at KBC Asset Management
There are also the ‘laws of the market’ to consider. Solar or wind power remains the cheapest source of energy in several US states. ‘So it is equally possible that US companies will continue to invest in renewable energy - not necessarily because of climate awareness, but for the simple reason that it brings in money,’ says Sandra.
Last but not least: During this term of office, Trump will no longer be able to ignore reality. The US has experienced a deadly hurricane season, and there will undoubtedly be further climate disasters during his presidency. Continuing to pretend that nothing is wrong is not an option.
‘The world’s sustainable transition will continue. That's a certainty’, Sandra declares. ‘Which isn’t to deny the fact that the Alternative Energy sector is currently under additional pressure because of the uncertainty surrounding Trump's policies. Investors are adopting a wait-and-see approach. Project developers want more clarity.’
There are two simple reasons why investing in renewable energy is not dead:
1. Explosive increase in demand for energy
Electricity demand is growing, and will only continue to grow. Why? Artificial intelligence (AI). AI is playing an increasing role in our lives. ‘As AI continues its advance, its hunger for energy is becoming more and more apparent,’ Sandra stresses. ‘AI needs a huge amount of computing power and data storage, all of which consumes energy. In recent years, data centres worldwide have been consuming increasing amounts of energy. A search using ChatGPT, OpenAI's advanced chatbot, creates significantly more CO2 emissions than a regular search on Google.’
Artificial Intelligence is driving an explosive increase in demand for energy. Renewable energy has a place in a healthy energy mix.
Anthony Sandra, Portfolio Manager at KBC Asset Management
‘The big technology companies like Amazon, Meta, Google and Microsoft have not only pledged to reduce their net CO2 emissions to zero within a certain timeframe, but are also terrified of running out of energy,’ Sandra adds. ‘That creates a need for diversification.’ These companies plan to invest not only in nuclear power but also increasingly in renewable energy generated from solar, wind and water. Hydrogen and geothermal energy are also attracting growing interest. All these power sources can also be combined with battery storage.
It is becoming increasingly important for the big tech giants to take energy supply into their own hands, and to diversify their energy mix. It’s a form of risk management.
Anthony Sandra, Portfolio Manager at KBC Asset Management
And there’s another small but important nuance. AI not only poses a threat to the climate, but is also a potential - and potentially powerful - ally. ‘AI can improve our understanding of climate science,’ explains Sandra, ‘for example by predicting extreme weather events more accurately. AI can also help us optimise our existing electricity networks. It can also help us manage our energy production more efficiently. Production from wind and solar energy is less predictable. AI can facilitate a stable balance between supply and demand by accommodating any dips in supply using other energy sources. In its present form, AI is not a particularly sustainable technology. And its development is expensive. But if we find solutions that offset its drawbacks, AI can help us meet the challenge of climate change.’
2. The need for strategic independence in a geopolitical minefield
The world is witnessing an increasing pursuit of strategic independence. This is a geopolitical trend that has been going on for some time and was accelerated by Covid-19 and the Russian invasion of Ukraine. Both events demonstrated the vulnerability of global supply chains and provided the incentive to move towards greater self-reliance. Add in a few conflicts in the Middle East and it becomes very clear: energy is geopolitical.
Strategic independence requires innovation and diversification. It comes down to finding new balances. No longer relying blindly on one bottleneck in the production chain, or on one authoritarian, unpredictable regime.
Anthony Sandra, Portfolio Manager at KBC Asset Management
International conflicts have already disrupted the oil and gas trade several times. Renewable energy is usually generated locally and preferably also consumed locally. That makes it an ideal component in a healthy energy mix.
‘With the new Clean Industrial Deal, Europe is continuing to encourage investment in clean energy,’ Sandra observes. ‘Europe is not only seeking to reduce its dependence on fossil fuels that in many cases are imported from far outside Europe; it also wants to protect the competitiveness of European industry. Because let's be clear: decarbonisation is no longer just something that’s ‘nice to have’, but is an absolute necessity.’
Companies that invest in renewable energy now are securing their future. For companies, sustainability is not just about complying with legislation or enhancing their own reputation; it's about building self-reliance in uncertain times.
Anthony Sandra, Portfolio Manager at KBC Asset Management
Sticking to the sustainable mission as an investor
Investing in Alternative Energy requires financial courage. In an ideal scenario, the world will evolve towards an energy mix in which renewable energy becomes increasingly important. And even though we have not seen the energy transition reflected in stock-market performance over the last two years, the opportunities are still there for investors who have a long-term vision. ‘After several years of strong performance followed by two difficult years, the sector should be able to find its second wind once the uncertainty disappears from the market’, Sandra believes.
The Alternative Energy sector may have faced headwinds in the stock market, but its business model is holding its course in the storm.
Anthony Sandra, Portfolio Manager at KBC Asset Management
‘The biggest interest rate hikes are behind us,’ Sandra explains. ‘And not only that: We saw the first interest rate cuts in a long time on the financial markets in 2024. That will breathe new life into the Alternative Energy sector. The uncertainties surrounding ‘Trump 2.0’ are also likely to be in the spotlight less than initially thought. It’s really quite simple: the main factors that make Alternative Energy a growth market are the explosive increase in demand for energy and the need for a healthy energy mix to meet that demand. And renewable energy will also have a significant place in that energy mix. The business model remains intact.’
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The information contained in this publication is for information purposes only and should not be considered as investment advice.
