Debate about the U.S. commitment to the Paris climate accord masks the disruptive impact of renewable energy on the energy, auto and utilities industries.
Renewable energy and climate change are commonly discussed in ideological terms, with opinions shaped by political leanings rather than reasoned analysis. Until recently, investment-related discussions about renewable energy and climate change were primarily confined to firms focused on sustainable or socially responsible investment strategies. However, mainstream investors such as BlackRock, Goldman Sachs and GMO now dedicate investment resources to renewable energy, and increasingly consider the impact of climate change as part of their research process.
A common narrative paints renewable energy as reliant on government subsidies. Government loan guarantees provided to failed solar panel manufacturer Solyndra remain controversial, and tax subsidies provided to buyers of electric cars are widely unpopular. However, technology advancements have dramatically reduced the costs of renewable energy. According to Lazard, wind costs are down approximately 66 percent over the past seven years and utility-scale solar costs have declined by 85 percent. Battery storage costs have been reduced by more than 75 percent.
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Renewables have become competitive with traditional sources of energy, able to compete without relying on government subsidies. The rapid pace of technological innovation makes it likely that cost gaps between renewables and traditional energy sources will further narrow.
Although debate about climate change remains heated in Washington, much of the world considers climate change a “real” issue that requires long-term solutions. India and China represent more than half of the worldwide growth in energy usage, much of which has been coal-fueled. Both countries are suffering from severe pollution challenges and have prioritized initiatives to increase their use of renewables in order to reduce reliance on coal.
Although renewables are a small portion of global energy supply today, renewable energy is expected to gain consequential market share in the coming decades regardless of U.S. involvement in the Paris climate agreement.
Global energy company BP (ticker: BP), despite earning virtually all its profits from fossil fuels, is among the forecasters projecting that renewables will be the fastest growing energy source over the next two decades. BP also projects that coal will decline in importance relative to gas, and expects gas is expected to overtake coal by 2035. Coal demand is expected to peak in the next decade, and coal’s share of primary energy is projected to be less than 25 percent by 2035, the lowest since the industrial revolution. The coal industry, contrary to assertions from prominent politicians, is under siege by economic and technological forces rather than an anti-coal political agenda.
The intermittent availability of wind and solar limit the degree to which it is possible to unplug from the traditional power grid, making diversified sources of energy necessary for the foreseeable future. Despite the rapid growth expected for renewables, BP projects that fossil fuels will represent more than 75 percent of energy production in 2035.
Although fossil fuels aren’t disappearing from the landscape, there is massive potential disruption of legacy business models, presenting opportunities and risks.
The coal industry is under siege from renewables and natural gas. Hydraulic fracking has revolutionized oil and gas exploration, opening up new sources of supply and changing the import-export balance for the U.S. Shale oil has dramatically changed the oil supply dynamic, with profound and seemingly long-lasting implications for oil prices.
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Given changing supply dynamics, it is likely that some of the higher-cost oil reserves may not ever be extracted from the ground. In February, Exxon Mobil Corp. ( XOM) reduced the value of its reserves, contributing to the fall in the company’s stock price. Utilities that are overly-reliant on coal may also be at risk, as competition from lower cost or cleaner sources of energy could jeopardize earnings streams previously thought to be low-risk and predictable.
Electric vehicle sales are growing rapidly, albeit from a very low base. Electric vehicles and car-sharing present challenges to incumbent automakers, with the recent firing of Ford Motor Co. ( F) CEO Mark Fields highlighting the pace of disruption and fear of being left behind. The stock market fortunes of Ford relative to Tesla ( TSLA) may have been a factor in the termination of Fields.
Renewable energy is in its infancy, presenting numerous opportunities but considerable risks. The performance of solar and wind investments highlights the risks inherent in renewable energy.
For example, the Guggenheim Solar ETF ( TAN) had steep losses in 2010-2012, most notably declining more than 60 percent in 2011 and more than 30 percent in 2012 before rebounding by more than 100 percent in 2013. 2016 was another difficult year for solar, and the Solar ETF declined by more than 40 percent.
Wind had a somewhat less turbulent ride, but still was quite volatile. The First Trust Global Wind Energy ETF ( FAN) declined more than 30 percent in 2010, then declined the following two years before rebounding more than 60 percent in 2013. Worth noting is the importance of valuation in investment decision-making, as price-earnings ratios for wind turbine manufacturers peaked at 93.4 times earnings in 2007, then bottomed at 6.2 times earnings in 2012, before the wind sector began rebounding.
There are considerable opportunities in companies that provide climate change mitigation and adaptation, including renewable power, batteries, energy efficiency, pollution control, and water treatment. However, many of the most compelling opportunities are in small and mid-sized companies that are vulnerable to rapid technological change, regulatory shifts and capital availability.
Consequently, given volatility and considerable business uncertainty, it’s important to seek diversification at the company, technology and business model level. The growing availability of climate-focused mutual funds and exchange-traded funds provide a wide variety of diversified choices for the climate-focused investor.
[See: Oil ETFs: 8 Ways to Invest in Black Gold.]
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How Climate Change Will Disrupt Markets originally appeared on usnews.com
