Clean Energy: Second Wind?

Anybody who has paid attention to the clean energy sector over the past couple of years knows that times haven’t been easy. Ironically, the sector itself has burgeoned, even as nearly every domestic company in the sector has suffered. Some have perished, and even companies that remain highly profitable have seen their stock prices drop by staggering percentages. The bankruptcy of government-subsidized solar-panel maker Solyndra has been widely held up by nay-sayers–and trumpeted repeatedly by Obama opponents–as the exemplar of clean-tech’s financial futility. But even solar market leader First Solar has seen its stock drop over 85% since 2008, all the while more than doubling its sales and booking a profit of about $600 million in 2011. Which brings us to the question, where does the clean energy sector go from here? Should sustainability-oriented investors be gobbling up these stocks on the cheap, or are there good reasons to avoid them? The answers, particularly short-term, are still partly cloudy.
For decades, clean energy was more an idea than an industry. Sure, one could find small wind-turbine manufacturers, solar companies, and fuel-cell producers to invest in, but their products were fringe, at best. None were profitable. That began to change in the mid-2000s. Technological advances brought down costs, growing concern about global warming emissions resulted in stepped-up government support, and soaring energy prices combined to make clean energy commercially viable for the first time.
Clean energy powered up and went mainstream as some leading companies attained significant profitability. Wind power accounted for about 35% of new U.S. electricity generating capacity from 2005-2011, ahead of coal and trailing only natural gas. Solar installations soared as well but still account for a tiny fraction of overall generating capacity. These trends were global. Cumulative wind power globally jumped from 59 gigawatts (GW) in 2005 to 238 GW at the end of 2011. That increased production from wind alone is equivalent to about 250 average-sized U.S. coal-fired power plants or 150 nuclear plants. Global solar capacity reached about 67 GW at the end of 2011.
While this momentum continued right through 2011, the economics of the sector rapidly deteriorated for both equipment producers and developers of clean energy power plants. With today’s rock-bottom natural gas prices, the hurdle for clean-energy alternatives to achieve price parity with conventional power generation is higher than ever. And the generous financial incentives to install clean energy in Europe have peaked and now face a bleak future given the debt crisis in the region. Germany, Italy, and Spain, all of which have been critical markets for clean energy, are slashing their subsidies. Part of the strength of the clean energy sector in 2011 was a rush to install projects before these incentives lapse. In the meantime, China ramped up its production of polysilicon (a raw material for most solar cells) and solar panels at an astonishing rate. The new supply grew faster than demand, and the inevitable occurred: prices of both polysilicon and solar panels plunged. This decimated the profits of solar cell and panel makers. The upside of these imbalances is that the cost of solar power is falling quickly. According to Solarbuzz, PV panel prices dropped 28% from January 2011 to January 2012. The Solyndra debacle was largely a result of these plunging prices, which made their panels comparatively unattractive.
With Europe tightening its spending on clean energy, the big question for the industry is whether increased demand in the developing world will make up for the slowdown. Europe has accounted for 75% of the solar market in recent years. China and India have ambitious clean energy goals that could go a long way toward making up for the falloff in Europe. China aims for 15 GW of solar and 100 GW of wind power by the end of 2015 (remember that global capacity stood at 67 GW of solar and 238 GW of wind at the end of 2011, so these are enormous numbers). India has a goal to install 20 GW of solar by 2020, up from less than 1/2 GW today. Given goals such as these, the global growth of clean energy will undoubtedly continue at a rapid pace despite the near-term headwind, as government policies shift our energy production away from fossil fuels.
Meanwhile, the bankruptcies that are now rippling through the industry are the natural market response to bring supply and demand back into equilibrium. We expect significant consolidation of the solar industry as demand growth slows in Europe. This should restore pricing to a level where manufacturers can again earn a decent profit on their sales. We believe that the strongest companies in the industry will weather this difficult period and come out in good shape on the other side. It is difficult to anticipate how long it will take to cross this Valley of Death and it is unclear how attractive the economics of the industry will be when we get there. But as long-term investors, we believe that industry leaders will create significant value, especially those companies that innovate to enable clean energy to compete in price with fossil fuels.
Five years ago, many people believed that some form of global warming treaty was likely that would place a price on carbon via a cap-and-trade system or a carbon tax. Such a carbon-pricing mechanism would stimulate clean energy development by raising the cost of burning fossil fuels. Those hopes were dashed at the UN climate conference in Copenhagen in 2009 and have been buried for the foreseeable future by congressional Republicans who have rejected the scientific consensus on global warming. Nevertheless, there is significant government support for clean energy via a variety of mechanisms, including feed-in tariffs, tax credits, and requirements that utilities generate a targeted amount of electricity from renewable sources. Despite near-term fiscal austerity measures in Europe and the looming expiration of the production tax credit in the U.S., the longer-term outlook is clearly positive.
While our patience has been tried and we’ve taken some lumps, we believe that we are still early in the immense shift away from burning fossil fuels. The science of global warming is clear and the impacts are rapidly becoming painfully apparent. But the head-in-the-sand attitude in some quarters is simply slowing, not stopping this shift. The supply/demand imbalances in the sector are short-term in nature and will work themselves out in the next year or two. Because of the rapid technological changes in the industry, as investors we like to stick with industry leaders with strong financials and the scale necessary to compete in global markets. We also continue to like the clean-energy exchange traded funds that give broad exposure to the growth of the sector. Investing in this sector is not for the faint of heart, as it remains risky and volatile. But for patient and risk-tolerant investors, there’s bright sunlight at the end of the tunnel.