Is Clean Energy REALLY the Future?
As a young investor, it is not out of the norm for me to remain hopeful of the future. After all, for the sake of my psyche, it is imperative to remain optimistic for tomorrow. By working and investing in yourself, there is an assumption that "tomorrow" is a given and that your life will improve. If not, what's the point of putting in the effort? Naturally, in a world afflicted by the disease that is climate change and global warming, many have put their hopes into clean/renewable energy. Indeed, it has become all the rage to invest in clean energy companies, evident from the exponential share price increases in the sector over the last few years. In fact, I fondly recall a period when ten year old me invested in SunPower using the Investopedia Stock Simulator.
As your average layperson, I love the concept of clean energy. But as an investor, I'm not too sure, which is why I'm writing this article in the first place. After all, profit-motivated companies and shareholders seek free cash flow generation. So if clean energy wants to take off in the investing world, it better show its hand and prove that it's a viable business model. Just so you know, in 2018, air pollution from fossil fuels caused $2.9 trillion in health and economic costs. That's $8 billion a day. It is no wonder that governments have the incentive to promote renewable energy. If we want Earth to continue to be habitable for generations to come, then we best be committed in our effort to reduce our carbon footprint and pollution.
To start off, is clean energy actually 'clean'? I know it sounds counterintuitive, but does replacing our current method of energy generation with 'clean' energy actually reduce our environmental impact? We must verify this claim since the entire investment thesis lies on the assumption that "clean energy is the future!" I found this article from "The Conversation" to be rather enlightening, shedding some light on the potential drawbacks of using renewable energy sources. Just to preface, when I talk about renewable energy, I'm talking about solar, hydro, and wind power.
The article mentions that solar cells are indeed as efficient as coal plants in terms of land usage, with the entire process of manufacturing, installation, and usage of solar cells being more environmentally friendly than mining and delivering coal to power plants alone in terms of carbon emissions. Fantastic. In fact, Photovoltaics only emit slightly less than one-tenth of carbon emissions compared to natural gas power plants. I think it's important to note that the manufacturing of solar panels does incur waste and uses rare precious materials such as cadmium and gallium. Hence, if we wanted to bet on solar being the future, developments regarding efficient waste treatment and mining operations must be made.
On the flip side, a slightly less rosy future is presented for wind and hydropower. The article presents the case that significant methane contributions may arise from the decomposition of dead wildlife attributed to death in reservoirs from costly environmental degradation. Not to mention, from an ethical standpoint, the carbon benefits may not outweigh the significant environmental impact caused by habitat destruction and direct death of fauna due to wind turbine and dam construction. This may pose some issues from a legal standpoint as activist groups may continue to push against such electricity generation from becoming normalised and widespread.
Okay, now that we've established our case that solar may be the way to go, is it even economically viable? I think you would have heard by now that China has a stranglehold on the solar panel market, and I think it's essential that we break down why that is and what that actually means...
Now, the reason why China solar panels are so prevalent in the market is primarily due to one reason: dumping. No, China didn't break up with any country or anything of the like, instead, heavy, and I do mean heavy subsidies are granted to domestic solar panel manufacturers, allowing them to export products at heavily suppressed prices below cost. It's no wonder solar panel prices have been steadily dumping, decreasing approximately 75% in the last decade, notwithstanding improvements in production processes. In response, countries such as the US have imposed tariffs to combat this artificial depression of solar panel costs, helping their exporters in the process. We cannot deny that such an ever-evolving situation results in investors erring on the side of caution, reducing fund inflows. However, it should be noted that there have been allegations of China using forced labour coupled with inefficient, non-automated processes, which may mean that the low price of solar panels may come to an end, given China's seemingly unsustainable production. Of course, you should take all this with a pinch of salt unless such allegations do indeed come to light. Could this serve as an impetus for solar panel manufacturer stocks to rise? Maybe.
Would I invest in manufacturer stocks? I don't think so, and the reason is the same as why I'm not interested in Electric Vehicle stocks.
The reason is: I adore recurring income. I look favourably upon businesses that generate a steady, growing cash flow. EVs and Manufacturing may require high capital expenditure on Research & Development (R&D) to maintain a competitive edge, which comes with the risk of not bearing any fruit at all. What I'm interested in, is renewable energy generation. I want businesses that operate solar farms to sell electricity. A simple business model indeed. We all know real estate has leases, which leads me to wonder: How long do solar panels last? From simple googling, it turns out that solar panels typically perform at standard capacity for the first 25-30 years, which eventually goes downhill from there. Assuming we want an average of 7% net annualised return, it would mean that an ROE of at least 11% is necessary.
Let's take a look at one of the most massive renewable energy farm operators that are publicly listed: Brookfield Renewables
As of right now, ROE for Brookfield Renewables is a staggering -0.66%, brilliant. Furthermore, the fact that its ROE is actually on a downtrend adds further insult to injury. Not exactly a convincing growth story. Of course, I acknowledge that they do distribute dividends based on FFO, but if depreciation of assets exceeds cash flow generation, I don't see the point. All you are doing is paying to lose money again and again in the long run. I don't like it when companies use positive FFO so as to excuse negative profits.
It's not as if energy prices are especially low, so if the company isn't turning a profit right now, then I don't foresee it becoming worth investing in for the near future. Even if such a company is able to serve the entire potential addressable market, I still have doubts that it can reach an ROE of 11%. Even if I were to suddenly pivot to solar panel manufacturers such as Enphase Energy, it is still trading at a PE ratio of 73. As clean energy becomes more prominent, I highly doubt that governments will continue to roll out subsidy after subsidy to support businesses, which may result in a negative material impact on operating expenses.
To end off this post, I believe that renewable energy at current prices is fully valued, even taking into account optimistic growth scenarios. I will be staying away from renewable energy as an investor for the foreseeable future unless there is a significant correction of around 40%. I think it is highly doubtful that most hyped-up renewable energy stocks will continue to survive in the long term. Additionally, I believe that the unreliability of renewable energy may serve to discredit its viability as the energy source of tomorrow. Regardless of my case presented here, I am interested to hear alternative opinions!
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