As climate change increases, the world economy has made increasing efforts to turn from fossil fuel emissions from greenhouse gases and towards clean, renewable energy sources. From 2012 to 2017, the world economy spent a staggering $ 1.5 trillion on adding 1 million megawatts (MW) of new renewable power capacity. As a result of the investment, there was enough renewable electricity generation capacity to cover 24% of the world's power needs in 2017.
That is just the tip of the proverbial iceberg. Developed countries must spend $ 11 trillion in the coming decades to be 100% driven by renewable energy. This is a massive market opportunity for companies that operate in renewable energy.
This guide aims to give investors a broad overview of the entire sector. In this way, these investors can better understand the different ways of investing in renewable energy stocks.
An overview of the renewable energy industry
The energy industry consists of three sectors: power, heat and transport.
The power sector produces and transmits power to end users, such as homes and businesses. It produces this power from a number of sources in two main categories:
- Non-renewable energy such as coal, natural gas, nuclear and oil.
- Renewable energy such as wind, solar, geothermal, biomass, energy from waste and hydroelectric.
The heating sector transfers either fuel or heated air to warm buildings. Several sources produce heat such as:
- Non-renewable energies such as natural gas, heating oil, kerosene and propane used to heat furnaces and boilers that heat homes.
- Renewable heat sources such as wood or wood burning stoves in furnaces and fireplaces, geothermal heating systems and electric heat powered by solar panels
Meanwhile, the transport sector provides fuel needed to operate vehicles. These fuels include:
- Non-renewable energy such as gasoline, natural gas, diesel and jet fuel
- Renewable energy such as biodiesel, ethanol, renewable natural gas and fully electric vehicles
The renewable energy industry aims to gradually displace all non-renewable energy. renewable sources. That's because most non-renewable energy releases greenhouse gases that heat the atmosphere and contribute to climate change that negatively affects the planet. On top of that, there is only a limited amount of non-renewable resources available, which means the world will eventually run out. The need to fight climate change and reduce the use of these final resources is driving significant investments in renewable energy sources.
Key Values for Renewable Industry
Every sector in the market has specialized terms or industry-specific metrics that investors need to know. Here are five of the most important to understand the renewable energy industry:
Megawatts (MW): A megawatt is a million watts of power. Renewable energy companies use this calculation to demonstrate how much power they can generate if a facility is running at full capacity. To put this metric into perspective, 1 MW of power can meet the power requirement of 1,000 homes.
Megawatt hours (MWh): While a renewable power plant may have the capacity to produce 1 MW of power, it does not mean that it will generate as much energy. That's because renewable power sources like wind and solar don't always produce energy, which is a question known as intermittency. So renewable companies use MWh to show how much electricity they generated over a period of time.
Cost per watt: This metric measures how much it costs to produce a watt of power. While renewable fuels (wind, solar and water) are free, solar panels and wind turbines cost money to build and maintain. Renewable energy companies normalize costs with this calculation, providing a better "apples-to-apples" comparison with fossil fuel sources like coal.
Efficiency: This term refers to how much of the sun's light a solar panel turns into electricity. In 2018, the average solar panel was about 16% efficient, while the best had efficiency ratings of around 23%. The higher the efficiency rating, the better a solar panel is by generating electricity from the sun.
Cash Available for Distribution (CAFD): This metric measures how much cash a renewable energy company produced during a period that it could have distributed to investors. It makes it look like free cash flow. Renewable energy companies focused on paying dividends will use this calculation so that investors can measure the sustainability of the payout.
Headwinds to the Renewable Energy Industry
One of the biggest headwinds that renewable energy faces is that the sun does not always shine and the wind does not move at a steady rate. This problem, known as intermittency, puts renewable energy at the disadvantage of fossil fuels, which can produce even power. During the first six months of 2019, for example, wind resources where leading renewable power generator NextEra Energy (NYSE: NEE) operated only 92% of the historical average. This wind drought had a negative impact on the cash flow of NextEra Energy and its peers of wind power. If problems with intermittency worsen, it will reduce the return on investment that companies can expect to make, which could slow growth.
Another problem that renewable energy faces is that they can be more expensive than fossil fuels such as natural gas when it comes to producing power. In 2019, a highly efficient natural gas plant could generate electricity at as low as $ 41 per megawatt hour (MWh) to as much as $ 70 a MWh, according to an estimate from Lazard's financial advisory firm. The unsubsidized cost of wind ranged between $ 29 and $ 56 per MWh while solar power was $ 40 to $ 46 per MWh. However, these costs do not include the extra cost of battery storage – which left $ 4 to $ 7 per MWh – to offset the intermittency problem. Although wind and solar may be cheaper than natural gas, this is not always the case, which can prevent renewable development.
Governments have played a significant role in helping to narrow the gap between fossil fuel and renewable energy by providing subsidies that stimulate investment in wind and solar projects. These subsidies are not as crucial to industry growth as they were once due to the significant reduction in the cost of installing renewable energy. However, they are still necessary in many cases, such as installing roof panels on residential buildings. If governments cut these incentives too deeply, it could reduce the growth rate for this part of the industry.
Another way governments can negatively impact the solar industry is through burdensome regulations and policies. In 2019, for example, the United States imposed tariffs on solar panel imports to put domestic manufacturers on equal terms with their foreign counterparts. The tariffs ended up increasing the cost of all solar panels, making them less competitive against other energy sources such as fossil fuels. If governments implement more policies that are detrimental to the renewable energy industry, it could reduce growth rates.
Lower energy prices can also affect renewable energy. If natural gas prices tumble, it can make gas power plants cheaper to operate than renewable energy. Meanwhile, if the economy slows down, it could affect electricity prices, which would hurt renewable development since it needs higher prices to thrive. Finally, falling oil prices can affect demand for biofuels at a higher cost.
Headwinds that drive renewable industries
Climate change issues play an important role in driving growth in the renewable sector. According to a Reuters poll in June 2019, nearly 70% of Americans wanted the country to take "aggressive" measures to combat climate change. The strong support means that the government is proposing solutions that will quickly transfer the economy away from fossil fuels. If concerns about climate change continue to grow, it could lead to more aggressive government incentives to invest in the renewable energy sector.
One of the main obstacles to the development of renewable energy had been the higher costs compared to fossil fuels. At the beginning of the 2000s, for example, the unsubsidized costs of generating wind and solar power were around $ 70 and $ 120 per MWh. However, these costs have fallen significantly. During 2019, renewable energy was cheaper than coal and natural gas, in many cases before including the extra costs of battery storage. Storage costs are also falling. Because of this, renewable energy is on track to be cheaper than all but the most efficient natural gas plants by 2023, even after putting in enough battery storage to overcome intermittency. When renewable energy closed at that inflection point, the industry's growth rate could accelerate.
Renewable Energy Industry Opportunities
Investors considering renewable energy stocks have five ways to potentially benefit from the expansion of:
1. Component Manufacturers and Installers: These companies build and install the mechanical equipment that needed to generate renewable energy. They include:
- Solar cell and panel manufacturers such as First Solar and SunPower
- Component and accessory manufacturers such as SolarEdge and Enphase
- Solar energy installers such as Sunrun and Vivint Solar
- Wind turbine and blade manufacturers such as General Electric Siemens Vestas Wind Systems and Arcosa
These companies make money selling a product or service to customers. As such, income has some variation. It may grow as demand expands or contracts due to competition or increased headwinds in the industry. It makes them a higher risk, but it can also make them a higher reward opportunity.
2. Tools: These companies produce power and sell it to end users. While most tools still produce a large portion of fossil fuel power, some invest heavily in renewable energy. For example, NextEra Energy generated more wind and solar power than any other company in the world in 2018. Meanwhile, Xcel Energy (NASDAQ: XEL) was the first tool that promised to generate 100% of its power from carbon-free sources. Although Xcel Energy does not expect to reach its bold target until 2050.
3. Independent power producers or renewable dividends: Tools runs an integrated business as most produce power and also distributes it directly to customers. However, some companies focus exclusively on the operation of renewable energy. They usually sell the power these plants generate under long-term, fixed rates for power purchase (PPA) to tools and other end users such as industrial plants and data centers. These contracts provide these companies with predictable cash flow, most of which pays out to their investors through high returns. Some of the largest return cards are Brookfield Renewable Partners (NYSE: BEP) TerraForm Power (NASDAQ: TERP) and Pattern Energy (NASDAQ: PEGI) . These companies are ideal alternatives for income-focused investors to consider.
4. Manufacturers of biofuels and biomass: These companies make renewable fuel products that they sell to customers as a replacement for fossil fuels. For example, produces Clean Energy Fuels (NASDAQ: CLNE) Redeem, which is a renewable natural gas made from organic waste coming from landfills and farms. This fuel is as much as 70% cleaner to burn than diesel and gasoline. Enviva Partners (NYSE: EVA) meanwhile, is a master limited partnership (MLP) that produces quality wood pellets. Tools can burn these pellets instead of coal, which can help reduce carbon footprint by about 80%. Because biofuels and biomass companies replace fossil fuels, they can be very sensitive to changes in commodity prices. This makes them more risky options for investors.
5. Electric Vehicle Manufacturers and Component Manufacturers: Companies such as Tesla (NASDAQ: TSLA) develop and manufacture electric vehicles to replace those fueled by gasoline. So they take a different approach from biofuel producers when they disrupt the transport-focused segment of the energy market. Tesla offers a potentially fully renewable electric vehicle since it also sells an integrated roof solar system that includes panels and battery storage.
Risks to the renewable energy industry
Despite the rapid growth of the renewable energy industry over the years, the sector has struggled to generate returns above the average for investors. One issue that has caused this underperformance is intense competition. While this competition has helped lower the price of components such as solar panels, it has also pushed the profit margins of companies operating in the sector. Because of that, many companies have struggled to make money in the industry. Several have even filed for bankruptcy, wiping out their investors in the process.
The investment needed to support growth in the renewable energy industry far surpasses the sector's ability to internally fund expansion with free cash flow. Because of this, the industry needs to issue equity and debt to finance growth. However, given the sector's financial struggles, investors do not donate as much money in what they had previously done. This forces many companies to change their financing strategies. For example, Yieldco's as Pattern Energy used to be able to issue new shares and debt with ease. However, Pattern Energy had to stop increasing its dividend for 2017. This allowed it to retain more of the CAFD to finance growth after it became too expensive to sell more stock. The company aims to come up with a more sustainable financing model by 2020 so that it can resume dividend growth.
The energy industry is constantly investing in research and development. It does so in the hope of finding new forms of energy that will help accelerate the world's energy producers' ability to reach the goal of one day being carbon-free. These investments have included the pursuit of progress that will reduce the cost of existing wind, solar and battery technologies, as well as the development of new commercially viable sources. Some of the more promising renewable energy technologies being developed are:
- Tidal energy and wave energy that generate electricity through subsea turbines.
- Algae-based fuel that uses the chemicals in seaweed to make a clean and renewable biofuel.  Nuclear fusion, which creates energy by fusing two atoms. In a sense, it is the opposite of current nuclear fission technology, which divides one atom into two to create energy.
If technologies like these advance to the point where they can produce cheap energy on a commercial scale, they can disrupt companies focused on more traditional renewable resources.
Ways to invest in renewable energy stocks
Investors can take many different paths to find potential stocks in the renewable energy sector.
One is to focus on companies that build or install renewable energy components or create renewable fuels. These companies offer higher rewards potential since they can grow just as fast or faster than the overall sector. The disadvantage, however, is that they are more sensitive to the sector's headwinds and risk factors, which is likely to make their shares much more unstable. As such, they are better options for investors seeking high growth opportunities.
Another way to invest in renewable energy is to focus on companies that run renewable energy producing assets and sell the power they produce in the long term, fixed rate agreements. This business model helps to reduce the risk as it allows these companies to produce relatively predictable cash flow. Because of this, most of these renewable energy companies usually pay a large portion of the money in dividends. This approach makes them ideal alternatives for retirees or other income-seeking investors.
Investors may also consider using exchange-traded funds (ETFs) that focus on owning renewable energy. ETFs are an ideal way to gain broad exposure to a sector as they typically have multiple shares in one industry. Invesco WilderHill Clean Energy ETF (NEWSKMT: PBW) for example, held nearly 40 renewable energy stores from mid-2019. Among the largest holdings at that time were solar component producers SolarEdge and Enphase, solar panel manufacturer SunPower, and renewable energy yield TerraForm Power. In addition, other ETFs enable investors to target one aspect of the renewable energy sector, such as solar or wind storage.
Given the enormous growth potential of the renewable energy industry, some of these trajectories may prove to be very profitable in the long run. However, investors can increase the likelihood of making money from renewable energy stocks by focusing on companies that have excellent financial profiles. Companies with a strong balance sheet will have greater flexibility to navigate the industry's headwinds and risks. This will give them a competitive advantage over weaker competitors in capturing the sector's growth opportunities.