By Michael Liebreich
Chairman & CEO
New Energy Finance
“April is the cruellest month”, claims the famous opening line of TS Eliot’s Wasteland. Maybe for poets, but not for investors: October 1907, October 1929, October 1987, October 2008.
As I write this, the NEX index of leading clean energy stocks is down two thirds from its peak of 462.48 on 8 November last year, languishing at 152.30. The drop in the NEX in October alone was a monstrous, incomprehensible 45%. Is there any rationality behind this sort of crash?
The NEX, or WilderHill New Energy Global Innovation Index to use its full name, was indexed to 100 at the start of 2003. It passed through the 152 mark at the beginning of January 2004. That’s before the ratification of Kyoto; before Hurricane Katrina; before the start of trading under the EU-ETS; before the Inconvenient Truth; before the Stern Review; before the German Renewable Energy Feed-In Law; before countless other pieces of legislation supporting the development of clean energy and the carbon markets.
I would be the first to admit that the value of the NEX cannot be expected to grow at 30% per annum year after year. Indeed those who have heard me speak over the past few years will recall I have stated categorically that it cannot do so, that we have not found a single example of an industry, however rapidly growing, which has achieved capital formation rates above 15% for extended periods, and that we should expect the NEX either to trade sideways or to undergo a significant correction. So here is the correction, and boy, is it ever painful.
The sector is being hit by a triple whammy. First, any sort of growth equity is being dumped by investors, and that hits the stocks of any earlier-stage company. Second, although utilities are usually a good defensive play, with relatively recession-proof earnings, the utility-type companies in the NEX are the ones with the largest project development pipelines, and therefore the biggest hunger for capital. And finally, all of this is happening against the backdrop of a crash in oil and gas prices, which not only makes the bar of competitiveness that much harder to reach, but also reduces the cash available to oil companies to plough into the sector. As a result, we have seen asset values in the clean energy sector hit far harder than the main markets.
And yet, and yet, rationality? I don’t think so. These are not dot-com stocks, touting vapour-ware to each other in a spiral of hype and an absence of real markets: these are companies that are generating clean electricity to meet mandated markets, producing low-cost biofuels in Brazil, developing technology and building equipment to serve the fastest-growing industrial market of our time.
Most importantly, the sector has enormous political weight behind it and this has been bulked up – not slimmed down – recently. The European Union has put forward a target of 20% of energy consumption from renewable sources by 2020, up from 6.4% in 2005. To reach this, many hundreds of billions of euros will have to be invested in the 27 member countries.
In the US, the Production Tax Credit and Investment Tax Credit have recently been extended, giving wind one year of additional support, geothermal two years and solar eight years. Although tax equity is currently in short supply because of the problems of the financial sector, this move ensures important medium term incentive for investment, particularly in solar.
The two Presidential candidates have also been committing themselves to renewable power. In his speech to the Democratic Convention in August, Barack Obama said: “And I’ll invest $150bn over the next decade in affordable, renewable sources of energy – wind power and solar power and the next generation of biofuels; an investment that will lead to new industries and five million new jobs that pay well and can’t ever be outsourced.” And on John McCain’s campaign website, there is support for making the US leader in “green energy” and for a national carbon cap-and-trade scheme.
Medium-sized economies such as Australia and the UK have been beefing up their own commitment to low-carbon energy recently, the former by moving towards the start of carbon trading and the latter with the formation of a separate energy and climate change department. Once the most intense phase of the financial crisis has passed, the meetings at Poznan in December and Copenhagen in 2009 should put climate change back on the front pages.
Does this mean I am calling the bottom of the NEX? I am far too wise to offer such a hostage to fortune. There may be a few more turns of the screw before all this is over: the CDS market has still not been sorted out; the crisis is spreading to the developing world (anyone for decoupling? Ho, ho, ho), which has borrowed a tidy few trillion from banks in the developed world; and there is still the chance of some nasty geopolitical shocks in the inter-regnum between the election and the swearing-in of the new US President.
But the fundamental drivers – climate change, energy security, oil depletion, new technologies and so on – are still there. Investment volume will be down in 2008 – that we already know, and it may or may not bounce back fully in 2009. But strong projects, developed by strong teams, with proven technologies, supported by well-capitalised players are still receiving backing. The price surges in solar silicon, wind turbines and agricultural commodities have hidden three years of fantastic progress on the underlying cost position of clean energy – progress that is about to be revealed as the strongest players emerge and the weak struggle.
There will be a period of consolidation, of that there can be no doubt. But it will leave the industry more focused, leaner, meaner, less starry-eyed and far more equipped to compete and fight dirty for its place in the energy mix. And some would say that is no bad thing. The recovery, whenever it starts, will be strong, and powerful, and long, and it will carry this industry a long way towards where it needs to be.
Shantih, Shantih, Shantih.
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