On December 12, 2015, ministers (and their teams) from 196 countries sat crammed together in a conference hall. They had gathered to sign the biggest and one the most significant diplomatic deals in recent times. I am referring to the Paris climate change agreement. In many ways, the deal marks the end of the fossil fuel era. It aims for zero emissions in the second half of the century and that would mean moving away from nonrenewable energy sources. From an investor’s point of view, knowing about renewables has become almost mandatory.
Energy has been at the center of financial and mainstream media lately. Oil has plummeted 60% in the last 18 months, coming down to under $40 from over $100. There is no hope for an immediate recovery as no one seems bothered about cutting supply. Much has been said about nonrenewable energy sources, their demand and price forecasts. And rightly so, because renewable energy forms a small part of the global energy market. Even though it’s small, you would be wrong to think renewables don’t provide good investment opportunities. The time couldn’t be more relevant to know more about renewables. They will serve the world’s future energy needs. This article aims to give readers a sense of the renewable market and investment opportunities to utilize.
Lay of the Land
According to the U.S. Energy Information Administration’s Annual Energy Outlook published in April 2015, the share of renewables (except liquid biofuels) is a little over 8% and is expected to rise up to 10% by 2040. Current global energy needs are met primarily by petroleum-related products and natural gas. That is not going to change in the near future but there are some interesting things to note about the global energy market:
- Market share of petroleum-related products (except natural gas) has been on the decline since the ‘90s (40% in the ‘90s to 33% in 2040).
- Coal’s market share has declined since the ‘90s but will continue to maintain its market share for the next 15 years.
- The biggest gains of the lost market share of coal and petroleum products are natural gas and renewables. Contribution from nuclear power has barely moved since the ‘90s and that is not expected to change.
What You Need to Know About Renewables
As mentioned before, no matter how you see things the Paris deal is massive for renewables. It does not mean companies and governments will switch overnight to clean energy. It only means there is now a legal framework for that to happen. Billions of dollars moving in one direction can’t suddenly be stopped just because there is a policy change. Technological innovation, the capacity build up and, more importantly, demand generation will take its own time.
The price of oil is going to be even more crucial than it was before. People change their habits only when they see substantial material gain in doing things in a new way. If the price of oil is low for the next few years, there is little incentive for people to switch to solar energy, for example.
Given above are some scenarios that were constructed by the U.S. Energy Information Administration earlier this year (high/low oil prices, high/low economic growth, high oil and gas resource and the current reference point projected to 2040). The following are some interesting observations:
- No matter what the scenario is, wind energy is likely to gain renewable market share.
- Low oil prices or a high supply of oil and gas resources will prove to be bad for solar power (shown in yellow in the chart). Given that oil prices are likely to be low, solar energy may not be the most attractive investment in the near future. This will change however if demand catches up at the end of 2016. The overall supply from non-OPEC countries is likely to go down next year and that might very well cause oil prices to increase to above $60 per barrel. If that happens, investments might start to flow into solar energy.
- Hydropower is likely to maintain its dominant position no matter what the scenario.
If we were to go by these scenarios, wind and hydropower seem to be the safest investments. The overall market share of renewables might very well increase beyond the 10% market share earlier predicted, given the recent Paris deal.
Another important observation is the role of natural gas in the new world of clean energy. Petroleum’s loss is not just renewable’s gain but also natural gas’ gain (see above chart). There will be an interesting battle for dominance between natural gas and renewables during the next 50 years. As governments shift to cleaner energy, natural gas is an attractive option. Natural gas is already a large part of our lives and has a far more relatable demand/supply equation than newer forms of energy sources like geothermal or solar. It is not pollution free, but it does have a lower carbon footprint compared to sources like gasoline and coal. Governments might find it easier and cheaper to increase natural gas usage in the short run before renewables become a mature and reliable option.
Indexes and ETFs to Consider
Renewable and clean energy stocks have been going against the tide in recent times. The S&P Global Energy Index has returned more than 30% and the RENIXX World Index has returned more than 150% in the last three years. If we take a closer look and compare some relevant indexes for the same period, we find an interesting picture.
The chart above compares the following S&P indexes: the S&P 500 Energy, the S&P Global Clean Energy, the S&P/TSX Renewable Energy & Clean Technology, the S&P GSCI All Crude and the S&P 500. While overall energy stocks have taken a beating, and crude oil even more so, clean energy and renewable indexes have beaten them comfortably. Clean energy crossed a 175% return earlier this year (compared to late 2012) before correcting back to above 125%.
ETFs worth considering while calling your investment shots include the ICLN S&P Global Clean Energy Index Fund (ICLN), which tracks the S&P Global Clean Energy Index and has returned more than 46% in three years, and the Global Clean Energy Portfolio (PBD), which replicates the WilderHill New Energy Global Innovation index.
Sector-specific ETFs to consider include the Solar ETF (TAN) and the ISE Global Wind Energy Index Fund (FAN).
The Bottom Line
Renewables were expected to play a larger role in our lives going forward even without any formal climate deals. The Paris deal offers a legal framework by which a global energy reform can be executed. This has put renewables right in the spotlight. Earlier projections of a 10% market share by 2040 might be broken, meaning investors should see this as a good area to utilize. Wind and hydropower are both likely to play an increasingly significant role in the near future, and solar energy may or may not prove to be a good investment. Investors can either pick their winners from the abundant number of energy companies or invest based on indexes.
