In our latest quarterly commentary, we took a close look at an investment theme that has much — we’d say too much —momentum behind it: Green energy. The full commentary is worth a read for anyone interested in the future of the energy sector, or those concerned about finding a truly achievable path to carbon emission reduction.
However, this blog highlights some of the good, the bad, and the ugly behind green investing and the potential path toward meaningful emission reduction. Since we prefer to be positive, we’ll save the good for last.
The Ugly: Rich Valuations
In terms of ugly, our commentary points out that valuations for stocks tied to the green energy theme are quite excessive. As we note in our commentary:
“Over the last 12 months, green energy momentum has exploded. Investor euphoria has now reached new heights bordering on mania. Renewable investments (as measured by the RENIXX, ICLN and QCLN ETFs) have advanced between two and three-fold since the start of 2020. Tesla is up ten-fold and sports a market capitalization of $800 bn. Hydrogen stocks have done even better: Plug Power is up 2000% since January 2020 resulting in a market capitalization of $31 bn (or 100 times revenue).
“Investors have taken notice and poured huge sums of capital into green ETFs. Shares outstanding of the four most prominent clean energy ETFs are all up between three-and six-fold. Traditional energy has been on the other side of this trade. Over the same period, shares outstanding of the XOP ETF (designed to track S&P exploration and production stocks) are down 25%.
“Stretched valuations leave investors vulnerable to any setback or delay in the green energy transition. The ICLN ETF holdings currently trade at 70x earnings, 6x sales and 6.25x book value, suggesting dramatic growth is already priced in. What would happen if the energy transition proved more challenging than anticipated?
“Green energy Special Purpose Acquisition Vehicles (SPACs) are also a troubling sign. Green SPACs have raised $40 bn in 2020 alone with a mandate to acquire as-of-yet unidentified clean energy assets. Oil and gas exploration and production companies on the other hand raised only $5.2 bn in 2020 to develop their existing proven asset bases. Given how challenging clean energy product development can be, we fear the bulk of these green SPACs will likely end up being written off entirely.”
The Bad: Rosy Projections
This brings us to the bad. In our view, even reports and projections from reputable sources such as the International Energy Association (IEA) seem overly optimistic about renewables and their ability to reduce carbon emissions. In other words, the energy transition may indeed be more challenging than many anticipate.
We delve into the topic more in our Q4 2020 commentary, but we believe the IEA’s World Energy Outlook has several flaws. The outlook projects a 60% reduction in the next 20 years, but uses a couple of assumptions we believe will prove faulty. First, the agency projects per capita energy demand will decrease by 25%. As we point out in the commentary:
“According to the BP statistical review, there has not been a single 20-year period since their data begins in 1965 where per capita demand has fallen by more than 0.1%, making this assumption untenable.”
The report’s projection that CO2 per unit of energy will drop by 50% also seems too optimistic. We delve into it more in the commentary, but countries such as Germany that have spent the better part of two decades aggressively pursuing renewable-centric energy plans have not come close to achieving such results.
The Good: Policy Makers are Thinking More Broadly, and Practically
To end on a positive note, we are encouraged that politicians are taking a much needed holistic view to solving the carbon emission problem. As we note:
“There are signs that perhaps investors and policy makers are beginning to appreciate the limitations of the current “green” transition. The Biden administration has taken the most favorable view on nuclear power in decades. Delaying nuclear closures (currently rumored) would be a huge step in the right direction. On the investment side, we are extremely impressed by the work being done at Breakthrough Energy Ventures. Founded by Bill Gates, BEV seems to understand the nuances of the energy transition. It is no surprise that BEV is heavily invested in nuclear power along with several of the technologies we discuss [in our commentary.]”
To read more of our thoughts on green investing, and what a feasible carbon emission reduction plan might entail, we encourage you to read our Q4 2020 commentary.