The Acceleration of the Clean Energy Revolution
When the Great Financial Crisis shook the markets in 2008, it sent the energy sector into freefall and brought the positive momentum of the burgeoning renewable energy industry to a screeching halt. In contrast, the COVID-19 crisis appears to have accelerated the shift toward renewable sources of energy.
As the world went into lockdown in spring 2020, the global economy shuttered and the demand for fossil fuels suddenly collapsed. Even as oil prices plummeted below $20 per barrel and the demand shock caused widespread storage problems, renewable energy sources proved resilient as clean energy’s share of the world’s global electricity supply expanded. Meanwhile, governments around the world earmarked billions of dollars in COVID-19 relief packages for clean energy projects and investors continued a rotation away from fossil fuels in favor of renewables.
Against this backdrop of mass clean energy investment was a growing contingent of countries and corporations committing to carbon neutrality by 2050 via net zero pledges. In the U.S., a change in administration—coupled with an increased focus on renewables and a continued decline in technology and storage costs—lent additional support to the transition.
As the interests of the public and private sectors continue to align, we believe the renewable energy opportunity set will grow in kind, and should be an attractive complement to client portfolios.
In this Investment Perspective, we will explore energy transition trends, industry performance, the evolution of the energy industry, and the future role of fossil fuels, as well as the current opportunity set for investors in this area.
Multiple factors have created an environment ripe for rapid advancements in both technology and implementation of clean energy solutions.
Wind, solar, and battery storage are key growth areas, particularly in electricity production. Wind and solar have a long track record of reliability and resiliency, and are assets typically backed by long-term contracts (or power purchase agreements) frequently with credit-worthy companies, institutions, and government entities. Renewable and natural gas power plants have been replacing higher-cost coal and nuclear power plants in the U.S., Europe, and Asia at an accelerated rate. The U.S. Energy Information Administration (EIA) projects renewables will be the dominant energy source by 2050.
Economic and technological advancements, combined with expanding green mandates across municipalities, states, and corporate users, have increased demand. In the U.S., 33 states and territories have either legally binding or targeted renewable portfolio standards that require a percentage of a utility’s electricity to come from renewable energy sources.
Corporate users have increased demand. According to the Rocky Mountain Institute, two-thirds of the Fortune 100 and half of the Fortune 500 have public sustainability goals. In addition, 290 companies, including IKEA, Apple, and Google, have signed on to the RE100 Commitment, whereby companies pledge to take incremental steps toward 100% renewable-derived electricity by 2050.
Renewables—wind and solar, primarily—are now cost-competitive on an unsubsidized basis in many markets. The cost to produce a megawatt hour of electricity for wind ranges from $29–56 compared to $60–143 for coal. Rapid improvements in battery technology and natural gas assets are helping solve the challenges related to wind and solar intermittent production.
The mass adoption of renewable energy systems will be commodities-intensive, as silver, copper, and lithium require significant infrastructure. The World Bank estimated the production of metals could increase by nearly 500% to meet the demands of clean energy technology, prompting many investors to position for this anticipated demand.
Big Returns & Valuations in 2020
Renewable energy stocks sharply outperformed broad equity markets in 2020. The growth path and projected earnings appear to support higher valuations for many companies. However, the influx of capital has created frothy valuations for certain sub-sectors and companies with venture-like profiles and negative earnings.
For example, Plug Power was up more than 1,000% during 2020 and traded at 34x revenue at year-end (increasing to 55x by the end of February 2021). Plug has yet to turn a profit after two decades in existence. Meanwhile, many private renewable, electric vehicle, and other clean companies skipped venture funding and rode the SPAC wave in 2020. This trend has accelerated in 2021.
At March 1st, there were 29 active ESG, energy transition, or environmental services-oriented SPACs in search of a business combination target. That does not include the 15 related SPACs that have announced deals in the last 12 months or the 10 new SPACs that have filed to be raised, but have not yet priced an IPO.
In 1998, FPL Energy (formerly Florida Power & Light Energy) was a relatively small regional power utility company that invested only in its first windfarm in Oregon. Over the next 10 years, the company invested heavily in wind and solar. By 2010, the renamed NextEra Energy was the largest wind and solar producer in the United States. Still, the company’s roughly $20 billion market cap paled in comparison to $400 billion oil giants like Exxon.
Fast forward 10 years, and NextEra’s vision for the world’s long-term energy needs proved omniscient as it unseated Exxon as the country’s most valuable energy company in October 2020.Two months later—fueled by an activist shareholder with a nominal investment (Engine #1) and the backing of the country’s second-largest pension fund (CalSTRS)—Exxon announced its intent to achieve net-zero greenhouse gas emissions by 2050, joining European majors BP, Royal Dutch Shell, and Total in stated emission reduction goals. In March, the company announced activist investor Jeff Ubben joined its board of directors. Since that late October decline, Exxon’s stock has nearly doubled, and the company has regained its position as the country’s most valuable energy company.
While fellow oil giant Chevron has not committed to net-zero, it launched a $300 million fund focused on low-carbon technology in late February. In a recent interview with CNN, Chevron CEO Michael Wirth alluded that oil and gas might not be the company’s primary business in 20 years, noting carbon utilization and renewable natural gas technologies as potential areas of growth.
On March 1st, the Wall Street Journal reported the American Petroleum Institute (API)—one of the country’s most powerful lobbying groups—will endorse policy that would set a price on carbon emissions, calling it “the most economic path to achieve the ambitions of the Paris Agreement.”
Carbon pricing policy seeks to discourage greenhouse gas emissions by establishing a price on carbon emissions while providing regulatory certainty for producers. The API’s support is significant in that it is both an acknowledgment by the oil industry of the environmental threat and presents a path toward achieving the goals of the Biden administration and the Paris Agreement. Business Roundtable, a major association made up of some of the country’s most powerful CEOs, endorsed carbon pricing last year.
As utilities and traditional energy companies diversify in an attempt to address the changing energy environment, the line that distinguishes fossil fuel companies from clean energy companies is becoming less clear. This could potentially reduce the utility/impact of divestment from an investment standpoint.
Future of Fossil Fuels
While private and public consumption and production of renewable energy is trending upward, fossil fuels are likely to play a significant role in meeting the world’s energy needs for decades to come. Electric vehicles currently represent a meager 1% of the world’s total fleet and renewable energy sources currently only represent 20% of supply.
Potential underinvestment in the oil and gas sector as a result of poor trailing returns, divestment measures, and long-term investment concerns could create a supply squeeze and price spikes long before the world is ready to completely transition away from fossil fuels.
The EIA projects the world’s energy demands will increase by 50% by 2050 due in large part to rapid population growth in Asia. This all but ensures oil and gas will continue to play a significant role in supplying the world’s energy.
In the interim, traditional oil and gas producers could take a number of steps to materially improve their carbon footprints, including eliminating methane emissions and reducing flaring. The industry is also investing material capital into carbon capture and sequestration technologies. Other efforts are also underway. Pioneer Natural Resources CEO Scott Sheffield recently announced the company will deploy its first electric-powered drilling rig.
The universe of available options that seek to capitalize on these renewable energy trends is broad and expanding rapidly.
Overall, we believe that public opportunities have the potential to enhance portfolio returns and improve diversification. However, investors should be aware that the asset class has experienced higher volatility on the public side and, depending on the strategy, potentially higher overall risk on the private side.
The table below shows the potential benefits associated with pure-play public vehicles and private value-add vehicles for a broader diversified portfolio.
The number of investable pure-play public clean energy stocks has grown, but remains constrained and includes electric vehicle technology stocks, renewable technology companies, component manufacturers, developers, and clean energy utilities. Many clean energy ETFs are heavily weighted to these tech companies and have exposure to producing assets in the wind and solar space.
Some of the largest renewable production owners are conglomerates (such as Berkshire Hathaway), traditional utilities, or energy companies—including Next Era, which is largely split between natural gas and renewable power plants.
Many infrastructure indices and related products have significant exposures to these companies as do many non-pure play natural resources and energy strategies. The limited universe and the mixed asset base or tech profile of many listed companies makes investing in the public markets more challenging for those seeking pure-play exposure.
Special Purpose Acquisition Companies (SPACs)
Clean energy SPACs are proliferating, and many are providing less-mature, venture-like firms, with significant growth capital in one large funding, eliminating the need for additional venture capital rounds. While this dynamic may allow investors to gain exposure to this growth phase, it comes with venture-like risk. Further, there are many SPACs competing for a finite universe of clean energy-related companies, potentially leading to inflated valuations.
Some hedge funds have launched SPAC strategies that attempt to capitalize on arbitrage opportunities in the SPAC lifecycle (the time between a SPAC’s listing and its de-SPAC). While some of these strategies appear attractive, clean energy exposure may be limited.
Groups that sponsor SPACs, including private energy firms, receive advantaged economics, whereby at-risk capital is limited for the sponsor. However, upside potential is highly attractive as sponsors receive founders’ shares/warrants at no additional cost. Many traditional private energy funds, including some we recommend to clients, have taken advantage of this dynamic and appear well positioned to potentially earn outsized returns.
The number of private equity fund strategies has grown as the renewable (solar, wind, and battery storage) industry has matured. Many individual wind and solar projects have traded at low discount rates or bond-like yields (5–7%), given that they have had long-term contracts to sell their power to creditworthy or credit-rated entities. However, we believe there are opportunities to pursue strategies that have higher return potential with managers that are developing assets, aggregating portfolios, integrating battery storage systems, and executing other value-add initiatives.
As the energy sector continues on its path of perpetual evolution, so does the investment industry’s response to those changes. We maintain a robust pipeline of investment options. We encourage clients seeking more information about opportunities in the space to speak with their client service team to request manager information or discuss ideas.
Please do not hesitate to reach out with any questions or to share your experience/expertise.
Indices referenced are unmanaged and cannot be invested in directly. Index returns do not reflect any investment management fees or transaction expenses. All commentary contained within is the opinion of Prime Buchholz and is intended for informational purposes only; it does not constitute an offer, nor does it invite anyone to make an offer, to buy or sell securities. The content of this report is current as of the date indicated and is subject to change without notice. It does not take into account the specific investment objectives, financial situations, or needs of individual or institutional investors. Information obtained from third-party sources is believed to be reliable; however, the accuracy of the data is not guaranteed and may not have been independently verified. Performance returns are provided by third-party data sources. Past performance is not an indication of future results. © 2021 Prime Buchholz LLC