What Is Green Investing?
Over the past 20 years, green energy has shown high growth rates.
It has grown at an average annual rate of 3.2% since 2000, although from 1990 to 2000 the growth rate was 1.7%. Conventional energy has only grown 1.4% per year since 1990. And if we consider renewable energy segments such as solar and wind - growth rates of 37 and 23.4% per year, respectively - it is clear that the growth of these industries has been tremendous.
The reasons for this are both the climate agenda and the declining cost of such electricity. The volume of renewable energy generation is growing rapidly, but so is global energy consumption. Opponents of alternative energy speak of the inefficiency of transmission, the instability of obtaining such energy, and the cost of disposal of wind turbines and solar panels. There are debates about whether alternative energy can replace traditional energy.
As an investor, many are interested in what the future holds for this industry and whether they can make money from it. In this article, we will look into it.
Why Green Energy is Becoming Popular
The generation volumes of renewable energy sources (RES) and their market share have been growing steadily over the past few decades. Let's look at the reasons in more detail.
Environmental friendliness is one of the most important reasons for the rapid deployment of RES. Green energy is not accompanied by the emission of carbon dioxide, which contributes to global warming. A complete switch to RES would reduce pollution and improve public health. This, in turn, could reduce premature deaths from pollution and reduce medical costs.
Energy security. The use of RES greatly reduces countries' dependence on energy imports. Importers of fossil fuels - primarily in Europe and now Asia - are seeking to reduce critical dependence on energy imports and develop renewable energy at home. Rapid deployment, technological diversification, and independence from fossil fuel prices are good reasons for many countries to look at renewables in terms of energy independence.
Efficiency gains. As technology advances, the efficiency of green energy generation increases, and the cost goes down. Given the high availability of solar and wind energy, this makes the industry increasingly attractive for commercial use.
Social Factor. Renewable energy in 2017-2019 was more effective in creating jobs in the U.S. than coal or oil. Worldwide, about 11 million people are employed in renewable energy.
The Sustainable Development Scenario (SDS) is a scenario designed to transform the global energy system under the Paris Agreement, which aims to keep the global average temperature rise below 2 °C compared to the pre-industrial period and work to reduce it to 1.5 °C. The scenario describes what needs to be done to achieve these goals realistically and cost-effectively. If further energy development follows this scenario instead of the previously adopted scenario of approved policies (SPS), renewable energy will receive a lot of investment.
How COVID-19 and the Oil Crisis Impacted the Industry
The global oil market was hit hard in March 2020 due to a demand collapse caused by tight quarantines and a price war between Saudi Arabia, Russia, and the United States. Renewable energy looks like an industry that could insulate electricity markets and individual consumers from volatility.
The International Energy Agency said capacity growth is expected to fall 13 percent in 2020 from the record pace set in 2019. The agency says this is the first decline in renewable energy growth in two decades.
The slowdown is related to the COVID-19 pandemic, which has delayed the launch and financing of many projects. But it also reflects policy shifts that took place before the pandemic. For example, the end of subsidies, as many of the green technologies have become cost-effective enough in recent years that government support schemes have lost relevance. This is true even for China, the largest market for renewables, as well as the production center for much of their infrastructure.
The independence of renewables from fossil fuel prices is a market advantage. Frozen transportation and suspended industrial activity are slowing overall energy demand - oil demand is expected to fall by a record 12 million barrels in 2020. But the renewable energy market is still projected to grow, according to the IEA. Even with a steep decline, it's expected to grow at an annualized rate of 6%.
Renewable Energy Companies
Under the IEA's baseline scenario, renewable energy generation capacity will increase another 50% by 2024. The IEA predicts that solar power will account for most of this growth. With that in mind, companies focused on the solar sector have the best growth prospects.
We're interested in companies that generate free cash flow and have strong balance sheets. They have an advantage over financially weaker competitors: better access to the capital needed to fund growth. That's why investors should focus on the financially strong companies in this industry. But growth for growth's sake won't enrich shareholders either, so you have to look at the return on investment as well.
Globally, we divide all renewable energy companies into two types:
Companies that produce and distribute energy.
Companies dealing with the production of equipment and technological developments in the field of RES.
However, nothing prevents combining these approaches. Let's look briefly at the largest companies in the green energy sector.
NextEra Energy (NEE) is the largest energy company in terms of solar and wind energy. It is an energy holding company and operates two utilities in Florida - Florida Power & Light and Gulf Power - and an energy resources segment that invests in clean energy assets. In addition, NextEra is a global leader in battery storage.
In 2019, NextEra owned 15.1 GW of wind and 2.5 GW of solar power capacity, as well as 11 GW of new renewable energy projects.
NextEra Energy sells power to end users under long-term fixed-rate power purchase agreements and PPAs. This business model makes the company reliable for partners and investors alike. Fixed-price contracts provide predictable cash flow, which the company also has enough to reinvest in new developments to continue to grow.
NextEra complements its stable operations with one of the highest credit ratings among major electric utilities. The company has the financial capacity to invest tens of billions of dollars in developing new renewable energy projects, with much of that money going to solar power. These investments should generate revenue growth of at least 6-8% per year through 2022 while allowing the dividend to increase by about 10% annually during that period. These dual growth factors allow NextEra to outperform the market in the coming years.
First Solar (FSLR) specializes in thin-film solar modules that use cadmium telluride as a semiconductor instead of the crystalline silicon used in most other panels. First Solar modules are larger and more expensive, but they can produce more energy per panel, which makes their energy cheaper. Such panels are becoming a great solution for utility companies.
First Solar has invested heavily in research and manufacturing to stay one step ahead of the competition. The company launched its newest product, the Series 6 module, in 2018. It has invested more than a billion dollars in this product, including building manufacturing facilities in the U.S. and Asia.
Another driver of First Solar's growth in the solar sector is that the company has one of the best balance sheets in the industry: it ended 2019 with $2.1 billion in net cash on its balance sheet versus $600 million in debt. That gives it the ability to continue to invest in product development. That said, most competitors have a lot of debt, so they pay interest to third-party lenders. First Solar's strong balance sheet not only lowers costs but also allows it to further expand production capacity.
Brookfield Renewable Partners (BEP) is a leader in hydropower, created by Brookfield Asset Management to operate renewable energy worldwide. Originally focused on owning hydroelectric power plants, the company now operates wind and solar facilities as well as energy storage. In 2020, hydropower still generates 70% of the company's revenue.
Brookfield sells most of its energy under fixed-rate agreements. These agreements help insulate the company's cash flow from electricity rates, which can be highly volatile, especially in Colombia and Brazil, where the company also operates.
Because Brookfield Renewable Partners generates such predictable cash flow, the company returns money to investors through high dividends. The goal is to distribute 80% of its cash flow and invest the rest in projects. These projects, combined with contract rate increases, will allow the company to increase its cash flow by 6-11% per year through 2022, giving it a 5-9% per year dividend increase.
Brookfield Renewable is also in the process of acquiring financially weaker companies.
SolarEdge Technologies (SEDG) is dedicated to optimizing renewable energy. The company has developed an optimized inverter solution that has improved the process of converting DC power from solar panels into the alternating current used by the electric grid.
The company's smart inverter solution allows solar panels to maximize power generation while reducing the cost of power generation.
The company has also made several purchases outside the solar market. For example, SolarEdge made several deals in 2018 and 2019 to expand its capabilities in the energy storage market. This is a forward-thinking decision, given that energy storage is one of the industry's key drivers. SolarEdge has also acquired companies focused on battery recharging: aiming for the electric car market.
In a sense, SolarEdge aims to become a vertically integrated company - similar to Tesla. This will expand opportunities to cross-sell components to adjacent renewable energy markets.
Enphase Energy (ENPH) is a leader in the field of microinverters. The company specializes in the production of inverters that convert direct current from solar panels into alternating current. The Enphase approach differs from the SolarEdge approach: Enphase inverters convert solar energy directly, while SolarEdge optimizers require an additional component. The SolarEdge approach is slightly cheaper overall, but the Enphase Energy microinverters are more efficient.
Ormat Technologies (ORA) is a leader in geothermal energy. The company operates a portfolio of geothermal and power plants in the United States, Central America, Asia, and Africa. It also designs, manufactures, and sells power equipment and other products to third-party geothermal operators. Ormat gets 67% of its revenue from electricity sales, with the rest coming from product sales.
Like many energy companies, Ormat sells most of its electricity under long-term, fixed-price contracts. These contracts provide predictable cash flow. Although the company also uses these funds to pay dividends, it reinvests most of it in expanding operations.
Ormat's investments in new geothermal power generation capacity have allowed it to steadily increase profits. From 2014 to 2019, the company's adjusted EBITDA increased from $273 million to $384 million. The company expects growth to continue.
Ormat operates a combined generation capacity of more than 900 MW in 25 countries. The largest capacity, about 600 MW, is in the United States, with another about 150 MW in Kenya. The company plans to increase its capacity to 1,150 MW. To that end, it is already launching new geothermal projects in the US, Guadeloupe, and Kenya and solar power projects in the US. The facilities are planned to be operational this year. While geothermal power may not have the same growth potential as other renewable sources, Ormat Technologies is a leader in its niche.
Terraform Power (TERP) is focused on wind and solar power in North America and Western Europe. It is another renewable energy company run by Brookfield Asset Management.
Terraform Power sells most of its electricity under long-term fixed-rate contracts. These agreements provide the company with a predictable cash flow. 80% of the money is paid to shareholders through dividends. This keeps some of the money available for investment - for example, to retrofit some old wind farms.
NextEra Energy Partners (NEP) is a Master limited partnership created by NextEra Energy. The company was created for investors seeking high dividend income. NextEra Energy Partners acquires and owns wind, solar, and natural gas pipelines in North America. MLP will use the growing cash flow from these acquisitions to generate dividend growth, while NextEra, discussed above, reinvests the sales proceeds in new renewable energy projects.
Both companies typically make at least one major acquisition each year. In March 2019, for example, NextEra sold a portfolio of six wind energy projects to the partnership for $1.02 billion. The deal allowed NextEra Energy Partners to increase its dividend by 15 percent, giving the company a plan to increase its payout from 12 percent to 15 percent annually through 2024.
Atlantica Yield (AY) is a large infrastructure company that owns a portfolio of renewable energy assets as well as transmission infrastructure. In 2018, the company generated about 68% of its revenue from renewable energy. The portfolio consists of wind and solar farms in the United States, Spain, South Africa, and Uruguay, as well as a small hydro facility in Peru. In addition, the company operated a natural gas-fired power plant in Mexico, transmission lines in Peru and Chile, and desalination plants in Algeria.
Atlantica Yield has obtained long-term fixed contracts for all of its expected capacity. This strategy generates predictable cash flow, most of which the company returns to investors through high dividends. The company uses its remaining cash and its strong balance sheet to expand its portfolio. It plans to increase its dividend by 8-10% per year through 2022.
Oil Giants and Renewable Energy Sources
The major oil and gas giants are also keeping up with the trend of investment in clean energy.
Royal Dutch Shell (RDS) intends to cut up to 40% of its oil and gas production costs to save money for business restructuring and transition to renewable energy sources.
Shell's new cost-cutting program, known internally as Project Reshape, is expected to be finalized. The program will affect the company's three main divisions.
Cost reductions are critical to Shell's plans to switch to renewable energy, where margins are relatively low. The company is also likely to face increased competition from generators and competitors in the oil industry, including BP and Total, which are vying for market share as it transitions to a green economy.
Last year, Shell had total operating expenses of $38 billion and capital expenditures of $24 billion.
Shell is exploring ways to cut spending on oil and gas production, its largest division, by 30 percent to 40 percent by cutting operating costs and capital spending on new projects.
On the downstream side, the review focuses on cutting costs through Shell's network of 45,000 service stations, which is expected to play a key role in the transformation.
Shell is a leader among oil companies actively investing in clean energy projects. These include German energy storage company Sonnen, U.S. solar power producer Silicon Ranch and offshore wind power projects in Europe and the United States.
British Petroleum (BP) is also investing in renewables. Together with Bunge, BP Bunge Bioenergia has created a company that combines efforts in bioenergy and ethanol production from sugar cane. The company has a stake in wind generation in seven U.S. states, including Hawaii. British Petroleum increased its stake in Lightsource BP to 50% - the company deals with solar projects and plans to deploy 10 GW of capacity by 2023.
A separate interesting project of BP is the development of digital platforms for supplying clean energy to transport and households.
Total (TOT). The French energy giant has set a target of 25 GW of renewable power generation capacity by 2025. The company plans to significantly expand the share of renewables in its portfolio by 2035.
Total plans to benefit from the experience of its subsidiaries: Total Solar, Total Eren, Total Quadran, and SunPower. Through them, Total is strengthening its position in photovoltaic solar power, wind power, bioenergy, and hydropower.
Chevron (CVX). The U.S. oil producer is also expanding its use of renewable energy to power its operations. The company has already acquired capacity for 65 MW of wind power in West Texas and 29 MW of solar power in Southern California.
Chevron is also working with Pacific Ethanol, Waste Management, and CalBio on renewable transportation fuels.
With such courses of development, the oil and gas giants will become the world's largest energy companies with a solid share of renewables among their assets. And they will also become significant players in the green energy market. You could say that by investing in oil giants today, you are already investing in renewable energy.
Risks and Barriers to Green Energy
Capital Costs. The most obvious and widely publicized barrier to renewable energy is the cost, particularly the capital, and upfront costs of building and installing solar and wind power plants. Like most renewable energy sources, solar and wind power are extremely cheap to operate: their "fuel" is free and maintenance is minimal. Therefore, the bulk of the cost is the creation of the technology.
Higher construction costs can make it more likely that financial institutions will perceive renewables as risky and lend money at higher rates. For power plants powered by natural gas and other fossil fuels, the cost of the fuel can be passed on to the consumer, which reduces the risk associated with the initial investment - although it does increase the risk of unpredictable electricity bills. But when you consider the lifetime costs of energy projects, wind and solar utility power may be the least expensive.
Even more encouraging, capital costs for renewables have fallen dramatically since the early 2000s and are likely to decline further. For example, between 2006 and 2016, the average cost of PV modules themselves fell from $3.5 to $0.72 per watt - an 80% drop in just 10 years.
Power deployment and transmission. Nuclear power, coal, and natural gas are centralized sources, meaning you need a relatively small number of high-capacity power plants. Wind and solar, on the other hand, offer a decentralized model in which small generating plants spread over a large area work together.
Decentralization offers several key advantages - including grid stability - but it also creates barriers: site selection and transmission.
Site selection means the need for negotiations, contracts, and land permits, which can increase costs and delay projects.
Transmission refers to the transmission lines and infrastructure needed to move electricity from the point of production to the point of consumption. A 2014 study by the International Energy Agency shows that transmission costs for wind are about three times higher than those for coal or nuclear power.
Excess costs are rising as intermittent renewables get a larger share of the total.
Here are some of the reasons for the higher costs:
A disproportionate number of lines must be built for wind and solar because transmission lines need to be scaled to maximum capacity rather than average capacity. Power generation from wind is typically available 25-35% of the time, and from solar 10-25% of the time.
Generally, there is much more distance between where renewable energy is used and where it is consumed than with traditional generation.
Renewable energy and the ancillary equipment installed do not have the same level of control over aspects of the grid - current output, amplitude - as fossil fuel power plants. This requires additional costs.
Availability. The biggest problem with basic renewable energy is intermittency. Wind power is generated only when it's windy, and solar power only when it's sunny. This creates several fundamental difficulties, one of which is the need for energy redundancy, which leads to additional costs.
Once even a small percentage of solar power is added to the electric grid, batteries are needed to smooth out intermittent generation.
There are other problems as well. Severe storms can disrupt the power supply for several days at any time of year. For this reason, if the system is going to run only on renewable energy, a backup battery is necessary.
Fossil fuels are relatively inexpensive to store, while the costs of storing electricity are enormous. They include both the cost of the storage system and the loss of energy in the storage facilities.
There are a total of three main redundancy options:
- Natural gas or diesel-powered backup turbines.
- Hydropower units, hydraulic power.
- Batteries and other energy storage devices.
Production and disposal issues. Wind turbines, solar panels, and storage units do not disappear on their own at no cost when they reach the end of their useful life. Recycling is not free. Very often the energy costs of recycling materials are higher than when they are produced in their original form. This problem must be considered when analyzing the real cost of renewable energy.
In addition to the massive use of steel, concrete, and other industrial materials, the manufacturing process of wind turbines requires significant amounts of toxic heavy metals, such as neodymium and dysprosium for magnets. There is also the problem of recycling wind turbines, in particular, the magnets and massive blades. Disposal of waste solar panels is also an issue - including lead, cadmium, chromium, and other toxic metals that are released if the panels break down during disposal.
A large number of birds are also thought to die from wind turbines and the extreme temperatures of CSP solar power plants.
What an Investor Should Do
The question of whether wind and solar energy are justified requires careful analysis. Many say that if wind and solar energy were profitable, there would be no need for subsidies. On the other hand, as technology advances, we are seeing a steady decline in the cost of such energy - which could make it more economically viable to use than fossil fuels in the future.
Here are the options we see for investing in green energy:
For those who like to invest in growth stocks, technology and perspective, there is a great opportunity to invest in future technologies. If the solar industry maintains or increases its growth rate, products in this area and new technologies will be in high demand.
In this case, stocks of companies such as Enphase Energy, First Solar, and SolarEdge Technologies might be interesting. You can hardly expect dividends from them shortly; their best return to shareholders is to invest in technology, which can pay back many times over in the future.
If you bet on wind power, the largest equipment manufacturers here are Vestas, Siemens Gamesa, and General Electric. But there is less innovation in this direction.
Those who don't want to choose companies can take a closer look at alternative energy ETFs.
The largest fund in this area is the iShares Global Clean Energy ETF (ICLN). This fund from Blackrock has a diversified portfolio of 30 of the largest companies in various renewable energy sectors.
Invesco Solar ETF (TAN) is the largest fund specifically focused on solar energy.
Invesco WilderHill Clean Energy ETF (PBV) is another fund that is very diverse in scope. In addition to generation, the portfolio contains companies that develop alternative energy products and technologies.
First Trust NASDAQ Clean Edge Green Energy Index Fund (QCLN) is another good option. The fund holds an extensive portfolio of U.S. clean energy companies.
For lovers of stable and high dividends, companies that generate and sell electricity would be a good fit. This business model is highly stable because most often such companies have long-term fixed-price power supply contracts. Their cash flows in the medium term will remain stable - with the possibility of an increase if the renewable energy sector grows.
The downside may be the high debt burden of some of these companies, so they should be chosen with caution. These types of companies include Brookfield Renewable Partners, Terraform Power, NextEra Energy Partners, and Atlantica Yield. All of these companies pay steady and high dividends quarterly, essentially turning the stock into a bond-like stock. Transalta Renewable, for example, pays a monthly dividend in Canadian dollars.
Those who prefer large and reliable companies and do not want to concentrate on renewables can invest in green energy indirectly through energy giants: Shell, British Petroleum, Total. These companies say that the transition to clean energy is their long-term strategic goal, and either already has renewable energy projects or are starting to work on them.
Green Investing: Final Thoughts
Today, investments in green energy have high growth potential. The volume of clean energy production is growing every year, and the cost of renewable energy resources is decreasing due to the emergence of new technologies. All this leads to the fact that alternative sources will soon completely replace traditional ones. Of course, we are talking about the long-term perspective, but the growth of investment attractiveness in this direction is already evident today.
This is evidenced by the following facts:
The inflow of investment capital into the renewable energy industry. In 2020, investment in the green industry will total $281 billion. By comparison, the oil and gas sector attracted $322 billion and the coal industry $76 billion.
The COVID-19 pandemic and the 2020 oil crisis harmed clean energy generation. The growth rate of production declined by 13%. At the same time, shares of companies in the green sector showed very high results. For example, the value of the securities of Sunnova Energy International, a leader in solar panel production, rose from $11.5 to $21.91 apiece.
The main risks for private investors are the winding down of government support for green energy and the decline in fossil energy prices.