Pushed forward by the threat of climate change, the renewable industry, also called the green energy or clean energy industry, has attracted trillions of dollars in investments. It includes energy production from solar, wind, hydropower, and other sources like geothermal and biomass.
Until 2010, the large majority of low-carbon energy was made from hydropower and nuclear power. Since then, wind and solar have grown very rapidly, but still constitute less than 6% of the total world’s energy consumption.
The industry generated $692B in 2020 and grew at an annual rate of 8.9% between 2016 to 2020.
A range of very diverse technologies and capabilities have been shoehorned together under the “renewables” brand. It is important to understand the fundamental differences between them when assessing an investment in the sector.
This is the oldest and most established renewable energy technology. It is also the one least likely to see a dramatic improvement in yield or efficiency. It’s growing in total output, but mostly in developing countries. This is because hydropower is very reliant on geography. It needs high enough water debit and change in elevation to be productive. So there is only a limited number of sites per country where a dam can be built, usually around very large rivers.
The main quality of hydropower from an investor’s perspective is durability. Dams last centuries, with very low operating costs but enormous building costs. They have no “fuel”, so they can produce electricity at a very predictable cost.
There are risks in hydropower as well. Climate change has driven significant changes in rainfall patterns in some areas, which can affect hydropower, and dams can be affected by siltation. Always investigate a project thoroughly!
As long as the company operating the dam has reasonable debt or an old enough park of hydropower stations and small enough overhead and administrative costs, this makes for a very safe investment. Therefore the main focus should be to buy at a low enough price, with a long-term horizon in mind.
Wind power has benefited from the push toward renewable energy, as well as tremendous cost reductions. Offshore wind is generally less profitable, as it has to deal with higher initial costs, stronger storms, seawater corrosion, long-distance maintenance, and other factors, all of which produce shorter equipment lifespans. It does produce more stable output than onshore wind farms and is less likely to incur community resistance.
Wind power, like hydropower, depends heavily on site quality. Wind power facilities need to be built on sites exposed to reliable high-speed winds. This is especially true for onshore wind.
With the number of available ideal sites for wind power in decline, the higher flexibility of solar makes it the likely candidate to lead the future growth of renewable energy. The very frequent local opposition to new wind farms is also a limitation.
Investors in wind power will want to focus on the cost/kWh and the risk of the project stalling for years from local communities opposed to the project (especially onshore). A critical eye on the estimated lifespan of windmills (especially offshore projects) is also recommended.
Like wind power, solar power is very sensitive to weather variation. It is also highly seasonal, with high production in summer, and almost none in the darkest/snowy months in northern latitudes. Contrary to popular belief, hot temperatures (like in deserts) can harm photovoltaic efficiency, with the ideal conditions being cold but sunny weather.
Most of the installed and growing solar power capacity is photovoltaic. Another technology is concentrated solar power, which uses mirrors to generate heat and then electricity. Concentrated solar has historically been much less profitable and has led to several massive bankruptcies, and requires very thorough research before investing.
The main limitation of solar is there is no production at night and low production in winter when energy demand is at the highest. This means a world power by solar will also need massive energy storage (more on that below).
Geothermal power remains a very small part of renewable energy production. It has the potential to be a major energy source (up to 10% of total US consumption for example), but technology is still in very early stages. At the moment, it is confined to specific regions with very high geothermal activity, like Iceland.
Paradoxically, a way to bet on geothermal is through fossil fuel energy majors and oil service providers, mostly because of the extensive expertise of those firms in drilling to high depths. A sector to look out for is Enhanced Geothermal System, the latest and potentially the most promising sector in this industry.
The most important quality of geothermal energy is that it is renewable but also highly stable. It produces roughly the same output at all times, independently of the weather. Investors will need to triple-check how validated the technology is, and how scalable it is as well.
Biomass energy is derived directly from plants instead.
One form of biomass energy is biofuel, derived from corn or sugar, although it can be argued that the energy spent farming is at least equal to the energy “produced”. Raising crops for conversion to fuel also competes with food production, potentially raising prices of key food commodities.
A more promising version of this is biogas, which produces natural gas from waste from agriculture and forestry.
Another is good old-fashioned wood. While not a replacement for all the world’s energy, it can be an extra option, as properly managed forests can provide carbon-neutral energy.
Forest is actually a surprisingly profitable investment, for the investors willing to wait decades for a return on investment. You can read more about forests as an investment class in this publication. Liquidity and natural risks (forest fires, pests), as well as purchase price and low management fees, should be the focus of investors in the sector.
Other types of green energy exist, but most are very far from mature and have uncertain profitability. Tidal energy, sea currents, wave power, space-bound solar, and algae-based biofuels, are all potential new renewable energy technologies.
Judging by the history of investment in solar and wind, the first adopters and first innovators often do not make good investments. You’ll have to be careful here.
Other green energy investments or technology sold as such, like electric vehicles (EV), batteries, or “green” hydrogen should be taken with a critical eye. They are not per se sources of energy, but more of a way to store energy or to use it more efficiently or in a “greener” way. So they should be judged on those metrics, and not piggyback on the bandwagon of “green energy”.
Assessing Renewable Investments – Energy Producers
Energy producers are among the most visible and popular targets for renewable energy investment. Here are some factors to consider when assessing them.
I’ve mentioned this already in the industry sub-sectors sections. Each renewable project should be analyzed for its cost per kWh. It should be compared to the cost of a similar project using conventional energy sources (a good way to judge the quality of the project compared to its peers) and to the overall cost of energy in the country.
When comparing the cost to the country’s power price, it would be best to look at the pre-covid numbers to get some margin of safety. If competing fossil fuel prices stay elevated, the profit potential is higher. If not, the renewable project stays profitable and can still distribute profits to its shareholders.
Geography, Subsidies, and Common Sense
Most renewable projects make sense if the local natural resources are a good fit. Mountains and rivers for hydropower, abundant sunlight, or wind. In the rush to boost renewable production, quite a few projects have been made that made little sense in retrospect. Wind farms far from consumers, solar fields in rainy regions, etc…
Avoid investing in any company that depends on government subsidies. While subsidies made sense to boost the initial roll-out of renewable facilities, cost reductions in renewables should allow them to stand on their own legs by now. Subsidies are politically driven and could be revoked at any time.
Generally, a company counting on subsidies to stay afloat is a bad investment. And if a project looks like it might not make sense (solar in the north of Finland?) there’s a good chance that it does not.
Debt, Capital Cost, and Interest Rates
Renewable energy requires a lot of upfront capital but has little operating cost afterward. This is very true for hydropower, somewhat less so for wind, with solar sitting in the middle.
This means that new projects are very sensitive to capital costs. This should be kept in mind in an environment of rising interest rates. A lofty growth plan might be derailed by rising capital costs. Existing debt might not be easily rolled over. Moderate debt load and conservative assumptions regarding the cost of capital are a must in an uncertain macro environment.
Assessing Renewable Investments – Suppliers
Energy producers aren’t the only part of the renewable energy picture. Suppliers are also part of the industry and are also worth considering as investments.
Producers of Energy Systems or Parts
The renewable industry relies on a large and complex supply chain for solar panels, wind turbines, motors, alternators, gears, maintenance, etc. These supplies are often dominated by a few major players, with a lot of smaller specialized or local companies fighting over the industry’s scraps. When it comes to solar and wind, most of the panels and basic components are manufactured in China, but there are several publicly traded US and European companies in the market.
Grid, Energy Storage, and Batteries
One valid criticism against renewable energy sources as an alternative to fossil fuels is intermittency. Some renewable power generation is irregular and hard to forecast. Some is relatively predictable, like solar, but largely produced at the wrong moment of the day or year.
One big problem intermittency creates is that power grids have traditionally been designed around large and stable power sources like nuclear power plants or gas power plants. Fossil fuel-powered plants are also very quick to react to changes in demand from the grid.
The only long-term solution to this problem is a radical increase in electricity storage capacity. The current solution focuses on massive lithium-ion batteries, but countless other types of batteries are looking to become THE solution for utility-scale energy storage. Other people are pushing for hydrogen or even ammonia to be used for long-term energy storage.
This is a very technical field, and promises of “breakthrough technology” should be taken with a very skeptical stance. Nevertheless, for the green transition to happen, such very large-scale storage facilities will be needed. So ultimately, the success of renewable energy production is going to rely on storage technologies.
Given the amount of research and experimentation going into energy storage, we can expect that there will be breakthroughs and superior technology will emerge. Investors who make the right bets on the right technologies early on will stand to do very well. At the same time, trying to pick THE right technology in a very complex and quickly changing industry is a very challenging and very risky endeavor, especially if you don’t have relevant high-level technical knowledge.
An alternative would be to invest in well-established, profitable renewable energy producers. These companies will be the first ones to benefit from any storage breakthrough. In effect, you are betting that there will be a storage breakthrough, without the need to predict what it will be.
One last way for investors to bet on the renewable industry is to look at the raw resources needed. Lithium and copper are likely to stay at the center of the green revolution for decades. Battery metals like cobalt and nickel are also important but might fade away with new technologies taking the front seat. Rare earth metals are also very important. The entire supply chain is currently 90% controlled by China, but rare earth metals are widely found and new suppliers are emerging.
Investors in the sector will need to be familiar with investing in the mining sector. Low-cost production, large ore reserve, low debt load, and high-quality jurisdiction will make for the best picks in that sector.
Renewable energy has moved from emerging technology and a far away promise to a key component of our energy systems. With the worries about global warming getting more pressing, the industry is here to stay and will grow larger. It has also passed the period where it depended entirely on subsidies. This could make the industry attractive to long-term investors.
Both climate change and the rising cost of fossil fuel will power the green transition, and the political will to back the transition up is growing. We can look at the declaration of the UN Secretary-General to judge the mood of the political elite.
Recent geopolitical tensions have highlighted the risks of dependence on fossil exporters like Russia. China is an equally important supplier for the renewable industry, but once a solar panel is sold, it does not carry the same risk as dependence on a continuing pipeline of fuel supply.
As always, company quality and the price paid will play a big role in future returns, and just being green is not enough to ensure future returns. As with any future-focused industry, the challenge is to pick the winning sectors and the winning players within them.
The process of analyzing a company varies considerably from industry to industry. Many industries have their own vocabularies and specific concerns that investors need to consider. This series of articles looks at specific industries and at industry-specific factors that affect investments. The goals are to highlight specific risks, clarify confusing terminology and explain industry-specific metrics for valuation. These methods complement the usual evaluation process, they don’t replace it.