Renewable energy stands out as one of the main stock market success stories of 2020. The sector’s main benchmark, the S&P Global Clean Energy index, rose by over 140% in USD terms last year. This increase in value compares with an uptick of just over 16% for the MSCI World index and a contraction of over 30% for the energy sector in the same period.
Renewable energy is not an entirely new theme. Indeed, solar panels, wind turbines and other sources of renewable energy have been with us for years, if not decades.
Something must have shifted in investors’ minds over the last twelve months, some new considerations must have come into play that aren’t limited to the long-term secular trend towards clean energy which has been evident for a long time. What exactly could have caused this sudden appreciation and where will things go from here?
The first observation to make is that, in sharp contrast to all other fuels, renewables used for electricity generation are projected to have grown by nearly 7% in 2020, according to estimates by the US Energy Information Administration. This may not sound like an awful lot, but it becomes more significant when considering that global energy demand is expected to have declined by 5% last year. In other words, renewables’ share of the electricity generation market has increased substantially.
Moreover, between January and October 2020, renewables capacity traded at auctions was 15% above the levels achieved during the same 10 months in 2019, representing a new record.
There is widespread expectation that renewables’ traded capacity will increase further in years to come – albeit not necessarily at the same rate.
Even more importantly, the cost of solar and wind power, already in steady decline over the past few years, has fallen further, making the technologies more competitive compared with fossil fuels. This is crucial because, in the past, renewable energy generation was only viable thanks to substantial government subsidies. This is particularly true of solar energy which has seen its costs decrease by 80% over the last ten years, meaning that it can finally compete with fossil fuels on its own. This is instrumental for its long-term sustainability.
These economic developments have been buttressed by government policies, such as the EU’s recovery plan that plots a substantial shift towards green investments. Additionally, the EU has set an ambitious target for carbon neutrality by 2050 in the shape of the European Green Deal that will require a significant move towards renewable energy. The Deal’s proposals include reducing carbon emissions by 55% compared with 1990 levels, between now and the end of the decade.
Particularly significant may be the developments afoot in China, by far the world’s largest producer of carbon dioxide, accounting for 27% of global emissions. On 22 September, Chinese President Xi Jinping announced the government’s intention to have carbon emissions peak before 2030 and achieve carbon neutrality by 2060.
While the feasibility of such a far-reaching, long-term goal should be taken with a pinch of salt, this statement marks a fundamental shift in China’s attitude towards carbon emissions – and by implication towards renewable energy – that should not be dismissed out of hand.
Therefore, even though China is still building new coal-fired electricity plants, this statement at the very least signals the potential beginning of a more balanced approach between fossil fuels and clean energy.
Last but not least, the incoming US president issued an order to re-enter the Paris Agreement and is expected to translate climate policy into federal government action.
Under the new administration, investment in green energy may reach up to $2 trillion, targeted at obtaining a carbon-neutral power sector by 2035, decarbonising the transport industry through new fuel emissions standards and developing emerging technologies, such as green hydrogen power, with the last of these alone in line to receive some $400 billion in federal funding.
In light of these developments, it is unsurprising that some leading renewable energy stocks, such as the thirty companies represented in the S&P Global Clean Energy index, have seen their share prices appreciate substantially over the past twelve months.
For a number of renewable energy stocks, revenues are estimated to have grown by 29% in 2020 and are expected to go up by a further 24% in 2021.
On top of this, rising profit margins and improved long-term prospects can be expected.
Investors with long memories may well recall the debacle of the previous solar power cycle that ended in a string of bankruptcies, followed by seemingly endless years of poor profitability for the entire sector.
Compared with that experience, a few things have fundamentally changed for the better, most notably the fact that climate policy is at the top of the political agenda in most parts of the developed world, meaning that investment in renewables is due to increase. Moreover, the renewables industry has consolidated globally, putting the sector’s current players on a firmer financial footing than in previous years.
On the other hand, what hasn’t changed is the volatile nature of investment cycles and the struggle to protect profit margins over time, given the relatively low barriers to entry into the renewables sector.
All in all, 2020 has been a pivotal year for the renewables industry that marked the start of a new cycle, as well as a reassessment of how we produce energy. This development chimes with global efforts to decarbonise the power system that are already under way.
The shift to renewables has acquired a dynamic that goes beyond the technological and regulatory aspects that have been on investors’ minds in the past.