Summarize in up to four sentences.: Clean energy is the future, but stocks aren't acting like it. Here's why.
Aruni Soni
Sun, November 5, 2023 at 4:15 p.m. GMT-5·5 min read
Wind turbines at London Array offshore wind park, North Sea, near England, United Kingdom.
Wind turbines at London Array offshore wind park, North Sea, near England, United Kingdom.Getty Images

    Clean energy stocks are some of the worst performing stocks this year, as high interest rates choke growth.

    The S&P Global Clean Energy ETF is down 34% year-to-date and companies like SolarEdge are down 70%.

    Still, clean energy investments continue to grow and investors expect performance to improve.

Despite growing calls for an accelerated global shift to clean energy, stocks in the sector vastly underperforming the broader market. In fact, they're some of the worst performers this year.

Funds that track clean energy stocks are down broadly in 2023. The S&P Global Clean Energy ETF and the iShares Global Clean Energy ETF are down more than 30% since January. Companies like SolarEdge and Enphase Energy, meanwhile, are down 73% and 67%, respectively.

The paradox here is that the clean energy sector is seeing a flurry of investment, supportive policies boosting new projects, and hype around sustainable ventures as a warming planet drives calls for less reliance on fossil fuels.

So what gives?

 
The impact of higher rates

Front and center this year, companies in the clean energy sector– like companies in every other sector— are being pressured by higher interest rates.

Although the Fed decided to pause rate hikes this week, the fed funds rate has been pushed up at a historic pace, from near zero in March last year to a range of 5.25%-5.50% currently.

This is particularly tough for clean energy companies, which often carry more substantial debt, making them even more sensitive to rising rates.

"The space tends to use an extraordinary amount of leverage," Julien Dumoulin-Smith, a research analyst from Bank of America, said. "That's not a surprise given how low-risk these assets tend to be."

Funding in the debt markets was a good move for most clean energy firms until rates began to soar.

In a note this month from Charles Schwab, analysts point out that higher rates are the biggest hurdle for many of these stocks, given that they are more leveraged than their peers in the traditional energy sector.

"Higher interest rates are impacting these companies' finances. The stocks in the MSCI World Alternative Energy Index have a leverage ratio of 3.8, based on debt-to-12-month earnings, compared with just 1.1 for the five biggest energy producers by market capitalization. That means higher financing costs are much more costly for these companies."

Red tape 

And then there are the bureaucratic hurdles to getting new projects done.

Clean energy projects like commercial and industrial solar or wind farms need to clear regulatory hurdles to be approved. And right now, sources say that permitting process is slow, burdening the build out of clean energy projects.

Also, projects that aim to supply renewable power to the grid have to wait for approval to do so. That list of requests to connect to the power grid is called the "interconnection queue." A study from the Lawrence Berkeley National Laboratory in April found that the queue was so long that it "approximately equals the installed capacity of the entire US power plant fleet."

"The poor performance is almost directly related to how long it takes for a project to get permitted," said Geoffrey Hebertson, a researcher at energy market intelligence firm Rystad Energy. "There's some serious, serious concerns, and what we're noticing is a lot of project delays because of interconnection queues and environmental impact studies, which are all incredibly important and needed, but just the way that things have been done in the past is not able to sustain all of this growth in the industry."

Some of the lagging performance of the sector can also be chalked up to bad timing.

After the pandemic, dizzying inflation and broken supply chains sent costs soaring for companies in the space. Just as firms began to recover from the supply shock, rates went up, putting another damper on profitability.

"Right when the inflation wave started to hit, these companies were very much hit by both steel and semiconductor inflation," Martin Frandsen, a portfolio manager at Principal Asset Management said.

"But then right when you're starting to catch up and you start to get up to where you can breathe again, then comes the quite material interest rate hikes on top of that," he added.
What's comes next?

So high interest rates, permitting constraints, and supply chain inflation are choking growth in the renewables space and weighing on stocks in the sector even as the broader market enjoys a relatively buoyant 2023.

"In general, alternative energy companies are what we call 'long duration' stocks, meaning they are expected to deliver a higher proportion of their cash flows in the more distant future," the Schwab analysts wrote in their note.

Sources say clean energy will bounce back, though it is tricky to know when.

"I think the difficult thing from an investor perspective is that we're not out of the woods yet," said Frandsen. "I think the elements which have negatively affected these green stocks, whether it be interest rates, whether it be inflation in terms of cost, these things are still persistent and there's no sort of clear sign that those negative effects are going to evaporate any time soon."

Complicating that is the fact that many clean energy companies are long-term investments. Rystad's Herbertson said that most projects turn a profit after 10 years.

But at the same time, money continues to pour into clean energy and investment is only expected to grow. According to BloombergNEF, global new investment in renewable energy skyrocketed to a record-breaking $358 billion in the first half of 2023.

"24 and 25 looks better," BofA's Dumoulin-Smith said. "I think the practical reality is we're looking at a pretty reasonable recovery trajectory over the next couple of years that I think is very much supported by the [Inflation Reduction Act]. And mind you, I think it's not even just the IRA, it is fundamentally that the demand is recovering."

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