Temporary Turbulence: Unpacking the 2023 dip in clean energy stocks
Nia Impact Capital
Investing with an eye toward racial equity and a gender lens for an inclusive and sustainable economy.
Written by: Sampurna Khasnabis, MA
Clean energy stocks have run into a rough patch that extended from what at first seemed to be a couple of quarters’ worth of headwinds to a full fiscal year and beyond. Solar and wind stocks, in particular, have caught the brunt of this downturn despite the regulatory and policy encouragement of Biden’s Infrastructure Reduction Act. In a year that has been marked by the warmest summer on record, numerous extreme climate events such as forest fires, flash floods, and increasing fossil fuel prices, why is one of the major keys to a sustainable economy not receiving the market’s favor? The answer lies in several factors including rising interest rates, inventory hurdles and wavering profit margins, that have compounded to create skepticism among investors.
Renewable energy has been growing and is projected to continue
Rising temperatures in the last decade have been accompanied by a rising societal awareness of the acute climate crisis that our planet is currently experiencing. As a consequence, more and more people as well as governments are consciously choosing to transition to green sources of energy. For instance, a Pew Research Center survey conducted in the summer of 2023 revealed that 67% of Americans prioritize the development of alternative energy sources over increasing the production of fossil fuels. Regulatory support in the form of tax incentives or energy transition mandates are helping drive this development further. With the increase in demand, there has been a proliferation of clean energy producers in the last decade which has led to technological advances in the production process as well as a rise in accessibility thanks to cheaper prices. Clean energy sources now also serve as a hedge against the price volatility of fossil fuels, particularly against the backdrop of global conflict and war. The expansion in renewables has been so rapid that an International Energy Agency (IEA) report found that clean energy sources would account for most of the world’s energy generation, overtaking coal by 2025.
However, 2023 witnessed a few roadblocks on this path to expansion, with renewable energy companies taking a hit in the stock market.
Rising interest rates create multiple challenges for solar
The first and most obvious answer to not just the question of why clean energy stocks have declined but to the larger woes of the market this year, is the Federal Reserve’s determination of the federal funds rate (the rate used by U.S. banks for overnight lending). The production of solar and wind energy relies on technological equipment and infrastructure built to harness unlimited natural resources (namely sunlight, wind and waves). Fossil fuels, on the other hand,? are limited in supply, and are categorized as commodities with prices being determined by demand and supply. One of the distinguishing factors between renewable energy and fossil fuel derived energy companies is that the former’s cost of operations is primarily influenced by the cost of building the necessary infrastructure while the latter’s cost is influenced by the price of fuel (which depends on the global demand and supply of fuel). This meant that when interest rates were low, renewable energy companies could build and scale their factory lines by borrowing money cheaply. This low cost of capital, along with technological advances in the field, led to several solar companies ramping up their facilities between 2020 and 2022. As a result, in 2023 global renewable energy capacity added 107 gigawatts, the highest ever absolute increase.?
This is good news right? Turns out, not so much. As it became cheaper to produce solar panels and barriers to entry into the industry lowered, more and more companies in the U.S. and especially in China added to their production capacity, leading to a race to the bottom with solar panel prices. As this price war was developing, the Fed started hiking interest rates. Now, not only were the prices of solar products declining, the cost to produce critical components like solar panels had suddenly increased as borrowing had become more expensive. It must be noted here that while the U.S. federal interest rate hikes did not impact Chinese solar producers significantly, the post-COVID surge in production did result in overcapacity.?
The rising interest rates also impacted the residential customer, who largely depends on personal financing to install solar energy systems at home. For context, according to a CNBC report, the national average for installing a 10 kilowatt home solar energy system in 2023 is $20,000 (after a 30% federal solar tax credit). The economics of residential solar is a complex game and without getting into too much detail, additional developments such as changes in California’s net metering laws exacerbated the impact of interest rates on residential demand for solar. By now, most U.S. solar companies have guided to overall lower residential demand for this year. This temporary drop in demand and falling prices have now led to an inventory build up that will take at least a couple of quarters for solar companies to work through. These factors have created pressure on narrow operating margins which in turn has attracted the concern of investors in earnings calls.
The headwinds creating a bouncy ride for wind energy producers
The macroeconomic landscape has been tumultuous for wind energy producers as well. In addition to the above challenges, turbine companies have been hit with a slew of manufacturing quality issues and policy roadblocks. Wind turbine manufacturing can be capital intensive both due to the level of infrastructure needed as well as the use of hardware in the turbines which depend on commodities such as steel and copper. These companies often rely on government subsidies, grants, and/or tax credits to help aid financing. Government subsidies can play a crucial role in accelerating our transition to the use of clean energy.?
Major wind turbine manufacturers such as Danish companies Vestas and Orsted have been locked into long term contracts with low prices that are no longer compatible with the cost of supplies in this now contentious macroeconomic environment. While these companies entered current contracts with the aim of lowering the prices of wind energy and competing with fossil fuels, subsequent increases in commodity prices and cost of capital have chipped away at profit margins. In an interview with CNBC, Vestas CEO Henrik Andersen stated that the sector was in a moment of reckoning and this would be the time to identify “winners and losers”. On that note, as a pleasant surprise, Vestas reported Q3 net income and order intake significantly higher than estimates.?
The current times (years 2022-2024) may indeed end up being a time of reckoning for the clean energy sector as a whole. With major climate conferences like COP 28 getting drawn into intense debates around wordplay and corresponding intention (“phase down” vs “phase out” of fossil fuels), investors and companies will be keeping a close eye on how climate friendly country regulators will be and where the investor money flows. What cannot be denied is the absolute inevitability of our collective need to completely transition out of fossil fuels sooner rather than later. As with any other relatively new sector, many companies are going through the process of figuring out the intricate challenges of scaling, technological advancements and pricing dynamics. Those who can translate these challenges into profitable balance sheets sooner rather than later will emerge as industry leaders. And, the victory will be collectively ours as we move toward an economy powered by cleaner energy sources.
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References:
-Cheryl Winokur Munk, “The homeowner basics of financing solar power for residential real estate”,https://www.cnbc.com/2023/05/21/homeowner-basics-of-financing-solar-power-for-residential-real-estate.html?
-U.S. Energy Information Administration, “Short Term Energy Outlook”,https://www.eia.gov/outlooks/steo/report/BTL/2023/02-genmix/article.php#:~:text=Renewables%27%20output%20tends%2
-International Renewable Energy Agency, “Record Growth in Renewables Achieved Despite Energy Crisis”,? https://www.irena.org/News/pressreleases/2023/Mar/Record-9-point-6-Percentage-Growth-in-Renewables-Achieved-Despite-Energy-Crisis
-International Energy Agency, “Renewable Energy Market Update June 2023”, https://www.iea.org/reports/renewable-energy-market-update-june-2023/executive-summary
-Brian Kennedy, Cary Funk and Alec Tyson (Pew Research Center), “Majorities of Americans Prioritize Renewable Energy,Back Steps to Address Climate Change”, https://www.pewresearch.org/science/2023/06/28/majorities-of-americans-prioritize-renewable-energy-back-steps-to-address-climate-change/
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