Premier Miton Global Renewables Trust plc Manager
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What has been driving renewable company share prices over the past 12 months?
Back in January, I wrote a note considering some factors, both positive and negative, currently having a major influence on the share prices of renewable energy firms. Perhaps the key negative remains the increased interest rate environment, and the effect this has on company share prices through “discounting” future cash flows into present day values. This is a means of calculating how much an investment is theoretically worth today based on future anticipated returns; when interest rates are higher the discount rate used in the calculation will also be higher, resulting in a lower present-day value.
I am encouraged that while central banks, such as the US Federal Reserve and the Bank of England, may not quite have reached the end of their cycles of increasing interest rates. Interest rates in bond markets as reflected by the yields on government debt, appear to have levelled off. This should be positive for the renewable energy sector as the dampening effect that increasing interest rates have on company share valuations begins to ease, and possibly goes into reverse toward the end of 2023 or early 2024.
For our second negative
Politics remains difficult. On the one hand, Europe’s politicians talk a good game about wishing to see more renewable energy, but on the other, have imposed “windfall” taxes which have increased risk associated with investing and will take money out of the sector which could have been used to fund new development.
Given the recent falls in electricity prices, that we discuss below, the amounts collected through these taxes are likely to be well below initial expectations; their benefits being more than outweighed by the additional risks borne by companies who will in turn demand higher investment returns through higher power prices, to compensate them for the increased risk of windfall taxation.
The US has taken more of a ‘carrot’ rather than a ‘stick’ based approach to renewable energy development, offering tax credits rather than imposing windfall taxes. A tax credit is a financial benefit provided by the government that reduces the dollar amount of taxes owed. A migration of capital across the Atlantic and a realisation that windfall taxes are doing more harm than good, may hopefully lead to a change of heart among Europe’s politicians.
On the positive side
While investors have been quick to focus on the impact of higher interest rates on company share prices, the positive effects of higher inflation have been largely ignored in my view. For example, many renewable energy companies have government price guarantees, or subsidies in place for older assets, which are repriced annually to take account of inflation.
In addition, inflation adjustments may be written into electricity sales contracts between energy generators and energy users. In any event, with renewable generators having mainly fixed cost bases, inflation linkages on revenues can have a markedly positive benefit on the bottom line.
Finally, power prices. European power prices have reduced as gas prices have levelled off. Despite exceptionally mild weather in Europe and historically high levels of gas in storage as a result, power prices remain relatively high by historical standards.
The underlying economics of power generation, taking into account higher carbon credit prices, a fleet of ageing nuclear reactors with limited remaining lives, the high initial cost of building new nuclear capability, the need to close substantial coal capacity in Germany and throughout Central and Eastern Europe, and a reconfiguration of Europe’s gas system from piped imports to more expensive Liquid Natural Gas (LNG), have moved electricity prices to a permanently higher level going forward in my opinion. This is positive for renewable energy production.
Short term pain, long term gain
Considering all the above, it is easy to get sucked into a debate about what are mainly short-term trends and influences. This would be a mistake, and it is worth restating that an investment in renewables should be made primarily with the goal of investing in what may prove to be an almost unique growth story over the next 30 years.
As is widely accepted, the world needs to reduce its carbon emissions. To do this it will increasingly switch from fossil fuels to renewable energy, mainly consumed in the form of electricity, but also hydrogen and other synthetic fuels. I also believe that renewables, which already have a cost advantage in the electricity market (hence the windfall taxes), could eventually establish a cost advantage over fossil fuels in other sectors, but this is a matter for debate and another article.
For those not yet convinced, let’s look at some market data provided by Bloomberg, their New Energy Finance’s global renewable energy production data (unfortunately 2022 figures are not yet available), has shown since 2009, has grown at an average 15.0% per year.
Global Renewable Energy Production (excl. hydro)
Source: Bloomberg New Energy Finance 2009 – 2021.
It is worth remembering that the growth to date has been almost entirely within the electricity generation sector as renewables increase their market share. The potential impact of hydrogen produced from renewable electricity, or the increased electricity demand through the “electrification” of the global economy, will add to growth in future.
Further, looking at global renewable energy capacity additions, it could be expected that renewable energy production will, if anything, accelerate its growth to levels above that seen in recent years.
Global Utility Scale Wind and Solar PV Capacity Additions
Source: Bloomberg New Energy Finance 2010 – 2021.
In summary, current economic challenges will pass in time, while the growth in renewable energy production should continue. The world’s leading renewable energy companies are well placed to satisfy these fundamental changes in the way we both produce and consume energy.