Investment Adviser – Changing Environment for Renewables
30 October 2009
In the aftermath of the credit crunch, ethical investors will need to be even more discriminating to make money in the renewables sector.
For ethically minded investors, the impetus for choosing renewable energy stocks has arguably never been greater. The amount of high-profile environmental disasters is projected to keep rising, the oil price veers erratically from highs to lows, and fossil fuel supply is finite. Then there’s the need to ensure security of supply, by reducing dependence on imported utilities from politically unstable regions.
So it’s encouraging that many European companies are at the forefront of renewable energy development, blazing the trail in solar and wind energy particularly. In fact, as a region, Europe has the largest concentration of renewable energy companies in the world. Their development has been supported by favourable subsidy regimes, with well-funded centralised government policies that aim to tackle carbon dioxide emissions proactively.
Given the high up-front capital costs involved in new project development, the renewable energy sector has been hit hard by the credit crunch during 2009. The return of liquidity to the corporate credit market means that conditions are improving, and more projects are now seeing the light of day. However, the drivers behind this acceleration are not necessarily positive for the companies involved.
Few Rays of Hope in Solar Sector
The European solar industry, in particular, is facing an uncertain future. Germany, which still accounts for half of the global solar power market, has spawned the majority of Europe’s solar players. Indeed, it boasts the world’s largest solar cell manufacturer in Q-Cells. But the solar industry has attracted a huge amount of new entrants over the last few years, many of which are based in the Far East. Within this increasingly fragmented marketplace, competitive pressures have prompted a dramatic fall in the price of solar cells, modules and wafers (see graph). As prices have plummeted, profitability at the European producers has inevitably suffered (Q-Cells reported losses in its most recent quarterly results). It doesn’t bode well, therefore, that industry players expect the price of solar modules to continue to fall significantly throughout 2010.
Since subsidy levels were set prior to the collapse in module prices, for the rest of this year developers look set to lock in fantastic returns (in excess of 10% p.a.) on their current projects. This has led to a hefty spike in demand, while the imminent onset of winter has also sent customers scurrying to complete installations fairly soon. Looking forwards, the lower price environment creates an opportunity for politicians to accelerate future reductions in solar subsidies. Historic returns of 6-7% p.a. for new solar power projects will still be on offer, but at a lower cost to consumers and taxpayers.
The companies benefiting from this dynamic are the installers of solar systems along with some developers (such as Phoenix Solar) and firms providing ancillary equipment, such as market-leading SMA Solar Technology. However, the companies that have traditionally attracted most investor attention, including solar cell and module manufacturers, will struggle to maintain margins within the current environment. All in all, the sector offers little upside for stock market investors.
Sizing up Opportunities in Wind
The wind energy industry has also faced its fair share of problems, not least of which has been the curtailed availability of financing for project development, triggered by the dire macro-economic backdrop. In the US, the financing situation is currently exacerbated by the fact that low power prices, the result of recession, mean that some utility companies are reluctant to sign power purchase agreements. (These deals commit the utility firms to buy electricity at a fixed price for a considerable period of time.)
On the positive side, the US benefits from the introduction of more favourable regulatory regimes, such as the provision of Treasury Department grants towards a portion of new renewable energy projects. This scheme will allow developers to apply directly for government grants, rather than the traditional tax credits, which should provide an immediate leg-up to liquidity. Meanwhile, the extension of the production and investment tax credits until 2012, introduced as part of President Obama’s economic stimulus measures, have guaranteed more years of visibility than ever before.
Not all industry players are set to profit equally from the improving environment, however. So which companies will be able to take advantage of the situation?
The crucial point differentiating the winners is one of scale. Large wind developers, both in the US and Europe, are much better placed to access what financing is available, and indeed have mopped up most of the first phases of grant money in the US. As a result, companies such as Spain’s Iberdrola Renovables, Portugal’s EDP Renovaveis and US-based Florida Power & Light are pushing ahead with next year’s projects. Meanwhile, there are improving prospects for offshore wind, which enjoys a burgeoning amount of political support. This too favours the large developers, which have the resources necessary to back bigger and higher-risk offshore projects.
But where large wind developers look set to thrive, their smaller, independent counterparts are likely to struggle in comparison. The new grant system in the US prioritises those projects already completed (normally by the larger developers). This leaves independent developers out in the cold as project financing, needed to fund initial construction, remains difficult to access. This troubled situation for independents hampers overall industry demand – creating a detrimental domino effect for the turbine manufacturers, such as Vestas Wind Systems, who supply them. With demand for turbines showing a much slower recovery than the manufacturers had hoped for, pricing is under pressure – industry players report turbine prices down 10-15% in some of the most recent deals signed.
Taking Stock
Ethical investors can take heart from the ongoing progress being made in the field of renewable energy. Its elevation from the grassroots level to the top of the international political agenda has been reinforced recently both by government measures in the US and rhetoric surrounding the upcoming climate summit in Copenhagen. In our view, large wind farm developers are best placed to profit from these trends, while solar cell producers and wind turbine manufacturers are at risk from increasing competitive and pricing pressures. Stock market investors will need to be even more discerning than in the past to root out those companies with scope for investment success.
Chris Haimendorf is Manager of the European Ethical Equity Fund at Standard Life Investments.
This article was first published in Investment Adviser on Monday 9th November 2009.
