It has been a tough year for the energy transition theme. In spite of considerable progress on the adoption of renewables – including government backing for large-scale renewable infrastructure projects and ongoing recognition of the urgency of climate action - investment performance has been weak.
Is this still a major structural theme for the future – and if so, should investors be looking at the sector afresh?
The S&P Global Clean Energy Index, the benchmark for performance in the energy transition sector, has dropped 31% for the year to date*. This compares to a rise of 11.6% for the MSCI World**. Clean energy has also performed worse than more general sustainability strategies. The MSCI ACWI Sustainable Impact Index is down 6.4% over the same period**. Clean energy has been one of the year’s major laggards.
The weakness can be attributed to a number of factors: the first is a normalisation after an astonishing period of performance from March 2020 to early 2021. The S&P Global Clean Energy index saw a rise of over 130% in 2020 alone***. Investors saw the direction of regulation and government spending and became over-excited about the prospects for the sector. This exuberance needed to come out of share prices.
There have also been some significant problems for some of the sector’s heavyweight companies. Danish offshore wind farm developer Ørsted, for example, was forced to pull out of two major developments in the US, causing its share price to drop over 50% from the start of this year****. Ørsted is a top ten constituent of many of the clean energy funds, with offshore wind one of the most important alternatives to fossil fuel.
Some of the solar companies have been hit by cheap alternatives from China and supply chain issues. Craig Bonthron, fund manager from the Artemis Positive Future team, said: “The de-rating of clean technology stocks was a response to the short-term over-supply of solar panels and electric vehicle chargers, following tightness in supply chains seen in 2022 and weaker residential construction."
Renewable energy has also had to move from a great idea to a successful implementation. This has come up against some roadblocks. The sun doesn’t always shine and the wind doesn’t always blow, so measures needed to be put in place to cope with intermittency of supply.
Electrical grids across the world need to be upgraded to be able to handle a greater volume of power, but also to connect new sources of electricity, such as wind farms or solar panels. They also need to incorporate battery storage to meet demand.
As these changes have brushed up against reality, there has been more political backlash against net zero targets. There have been concerns that the cost of transition will fall to an already hard-pressed consumer, while there are inevitably worries over where wind or solar farms will be located and the disruption they may cause to people’s homes or the natural environment.
However, most of these issues are short-term, and there is still a lot supporting the sector. Most importantly, the problems of climate change remain as pressing as ever. The UN predicts that greenhouse gas emissions will rise 9% by 2030 from 2010 levels****. While this is marginally better than last year’s assessment, it remains significantly below the 45% drop required to limit global warming to the 1.5 degrees laid out in the 2015 Paris Climate Change Agreement****.
There is significant investment around the world. The US Inflation Reduction Act (IRA) ear-marked $282bn for renewable energy projects^, while Europe’s ‘Fit for 55’ makes similar commitments. Craig says: “The US Inflation Reduction Act represents the single largest investment in clean energy in US history”. Even the UK government, which has backed away from some climate targets, reinstated its objective to attract “record levels of investment in renewable energy sources” in the recent King’s speech.
Craig has sought to lean into these spending commitments through holdings such as First Solar: “It is uniquely positioned to benefit from both tax credits in the Inflation Reduction Act that support the domestic manufacture of renewables in the US, and from legislation designed to avoid exposure to the issues with China mentioned above. Some analysts suggest First Solar could potentially be the biggest beneficiary of the IRA.”
Russia’s attack on Ukraine in 2022 continues to galvanise policymakers into action on renewable energy adoption. Europe proved particularly vulnerable, given its historic reliance on Russian fossil fuels. A mild winter helped it avoid an energy crisis last year, but there are no guarantees that it will be able to repeat the same trick this year.
Even without the Russia crisis, fossil fuels are often sourced from unstable and unfriendly nations, and there is significant price volatility. The oil price, for example, moved from below $70 a barrel in the summer to over $90 in September^^.
The costs of doing nothing are getting higher. Regulation is getting tougher, and disclosure requirements are increasing. Companies are increasingly scrutinising their supply chains to look at embedded emissions. Companies that are not tackling their environmental footprint are facing a higher cost of capital according to research at Cazenove Capital from Schroders. This is likely to weigh on their share prices and should encourage them to take action.
Against this backdrop, the status of energy transition as a major theme for the future is assured. Investors are now buying in at far more realistic valuations. Energy transition funds can also be a compelling source of income. For example, VT Gravis Clean Energy Income fund currently has a yield of 6%^^^.
For investors that are still nervous about the bumpiness of the energy transition theme, it may be worth investing in a fund that blends it with other themes, giving greater diversification.
The WS Montanaro Better World fund (formerly LF Montanaro Better World fund), for example, invests in six impact themes: environmental protection; green economy; healthcare; innovative technology; nutrition and well-being. The Artemis Positive Future includes environmental and social impact, while the Liontrust Sustainable Future Global Growth fund looks through the prism of three mega trends – better resource efficiency, improved health and greater safety and resilience.
Investors can make a real difference by investing in energy transition solutions. The Make My Money Matter campaign points out that making a pension green is 21x more powerful in cutting carbon than going veggie, giving up flying and switching energy provider^^^^.
Peter Michaelis, manager of Liontrust Sustainable Future Global Growth says: “Business has an essential role to play in innovating and refining solutions and extending the limits of what is possible. This emboldens governments to drive for further change. Over the years, this has led to safer roads, cleaner city air, clean drinking water, reduced childhood mortality and the acceleration that we have seen in renewable energy and in arresting the decline of the ozone hole. Investing in and supporting these businesses is where sustainable investing comes in.”
*Source: S&P Global Clean Energy Index, total returns in US dollars, 30 December 2022 to 14 November 2023
**Source: FE Analytics, total returns in sterling, 30 December 2022 to 14 November 2023
***Source: S&P Global Clean Energy Index, total returns in US dollars, 2 January 2020 to 31 December 2020
****Source: FT, 14 November 2023
^Source: Goldman Sachs, 31 October 2023
^^Source: Crude Oil WTI, as of 15 November 2023
^^^Source: fund factsheet, 30 September 2023
^^^^Source: Make My Money Matter, November 2023
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the author and fund managers and do not constitute financial advice.