Published: 01/06/2013
A common theme for most ethical investors is the desire to support and participate in the growth of renewable energy companies. This is substantiated by the powerful trends occurring in our changing climate and our collective need to adopt cleaner energy sources. On the surface this should provide a wealth of exciting investment options offering strong growth profiles. Unfortunately this is far from the reality when considering the renewable energy options available to Australian investors.
The nature of renewable energy investments is still going through a classic hype cycle. Hype cycle theory explains how the uptake of new technologies moves through five phases. The first phase is the ‘technology trigger’, or the event that is a catalyst for significant interest (climate change). The second phase is the ‘peak of inflated expectations’, where the frenzy generates over-enthusiasm and unrealistic expectations. The third phase is the ‘trough of disillusionment’, where many expectations are not met, business model forecasts are not met and the media pays less attention. The fourth phase is the ‘slope of enlightenment’, where industry rationalisation takes place. Finally the fifth phase is the ‘plateau of productivity’, where the technology becomes widely accepted and stable business plans emerge.
Whilst hydropower reached the fifth phase (plateau of productivity) years ago, most other renewable energy investment options are still somewhere close to the third phase (trough of disillusionment). This ‘trough’ is demonstrated in the negative investment returns. The S&P Global Clean Energy Index returned -28.35% over the five years to June 30, whilst the broader MSCI World Index was +1.25%. The Australian CleanTech Index returned -14.84% over the same five years and the broader ASX All Ordinaries returned +2.19%.
These returns are backed up by data that shows a significant over capacity of wind and solar, being at roughly double the global demand. The over capacity is a result of renewable technology moving through the second phase of the hype cycle (inflated expectations), and has mostly come from vastly ramped up Chinese production. Whilst this is supportive of the uptake of renewable energy in general, it is not healthy for renewable energy investments. These characteristics place tremendous downward pressure on prices and business margins, and explain the vast underperformance of renewable energy investments.
Zooming in further, solar energy investment options in Australia again demonstrate the hype cycle. The majority of global solar panel production is now done in China (virtually all Australian solar manufacturers are now out of business), and companies still involved are import, sales and distribution companies. The industry has become saturated – the number of accredited installers has risen from 338 at the end of 2007 to 4,821 at the end of 2012. The heavy downward pressure on prices as well as unstable federal and state government policy has resulted in many players under serious financial stress, if not out of business already. This puts the industry somewhere near the ‘trough of disillusionment’.
The fundamental drivers supporting the growth of renewable energy are certainly still in place. The instability of policy and downward price pressure are signs of immaturity. This will change as technology moves through the hype cycle, but in the mean time many companies will go through significant restructuring and some rationalisation is still to occur. Thus far our reluctance to expose a material amount of our client investment capital to the risks of renewable energy investments has proven correct. Naturally we remain acutely tuned to the opportunities as renewable energy moves through the hype cycle.