Renewable energy was among the best-performing segments of the stock market last year as solar and wind saw large capacity additions despite the pandemic, indicating the industry was quite resilient to shocks. Yet there is such a thing as too successful, and now MSCI is warning that the state of affairs in renewable energy stocks may be taking the shape of a bubble.
The bubble is as big as it was in tech before the dotcom crisis, according to data from the index provider. The data shows that renewable energy stocks have become so popular that the portion MSCI refers to as ‘crowded’ has reached 8 percent of the respective thematic index. To compare, tech stock crowding before the dotcom bust was slightly over 8 percent of the MSCI tech index.
It is easy to see where this popularity comes from. Business media are bursting at the seams with report after report on ambitious government plans for the energy sector that invariably focus on wind and solar power.
The dominant narrative is unbendable: there is no other way forward for human civilization—at least the part of civilization that is loosely grouped in the OECD—but towards cleaner energy generation and greater reliance on electricity over fossil fuels.
With government support seen as key for the growth in wind and solar generation capacity, no wonder investors are becoming as upbeat as forecasters about this part of the energy industry and rushing to boost their exposure to it. However, in reality, things are not as unequivocal and certain as they tend to be in reports on the future of energy.
Take the chip shortage, for example. Earlier this month, solar stocks took a beating as the persistent shortage of semiconductors made investors worry that solar power companies would not be able to meet strong demand for their products. Over four weeks, the Invesco Solar ETF booked a decline of as much as 15 percent. One of the biggest players in the field, SolarEdge, reported first-quarter results that beat analyst expectations but warned that its margins were going to get slimmer on higher shipping costs.
These are just two examples of the shocks that could come to the renewable energy sector at any point in the future. Like every other industry, wind and solar power are vulnerable to various factors, including supply chain disruptions like the one we’re witnessing now with semiconductors and raw material availability, which could become a risk before long.
But add to these normal risks the crowding in renewable stocks, And according to the MSCI, in the event of an economic downturn, the sector could see a drop of as much as 42 percent. This compares with a drop of 31 percent for growth stocks under the same scenario and one of 20 percent for the global stock market as a whole.
In fairness, the MSCI notes in its report that the probability of such a scenario—dubbed severe economic headwind (stagflation)—is quite low compared to the other, more optimistic scenarios. However, it adds that “its severity is helpful to further understand the link between crowding and a sharp potential market sell-off.”
A selloff is always a risk, even under the most benign economic circumstances. Other industries have seen enough examples of that. Even renewables, as mentioned earlier, have gone through shocks and selloffs. In fact, the renewable energy section of the stock market has not been performing particularly strongly since the beginning of the year at all.
Since the beginning of May, investors have pulled $154 million from clean energy ETFs such as ICLN and TAN, Alex Kimani reported for Oilprice.com earlier this month. Assets in the category have dropped for the past three months in a row and now stand at $18.1 billion compared to their peak of $22.3 billion at the end of January. In other words, popular as they may be, renewable energy stocks are not immune to trader mood swings and change in sentiment.
There are more challenges on the way, too. For example, a storm brewing in the solar power sector that has to do with an incongruity. President Biden has big plans for solar—plans worth billions. Yet, the overwhelming majority of solar panels that will be required under those plans are made with polysilicon made in China, and China is being accused of using forced labor to make it and a lot of other things. If the U.S. decides to stop using Chinese polysilicon, solar panels will become more expensive. This will tarnish the reputation of solar as a low-cost energy source.
Or take wind power. Wind turbines need a lot of copper, and there is a supply shortage looming large on the horizon. A supply shortage invariably means higher prices. Higher prices are often offputting for investors as they would compromise the competitiveness of the technology—tax credits or no tax credits.
Speaking of tax credits, these won’t be around forever, either. All governments, even the most ambitious in green energy, plan to phase out their generous support for wind and solar at some point. For now, forecasters are certain that both wind and solar will be competitive enough by the time credits end to stand firmly on their own feet. Again, reality often proves forecasters wrong, so the only way to know if they will indeed stand on their feet is to wait and see.
There are many arguments in favor of those positive forecasts—solar panel technology is getting cheaper and so are wind turbines—but as the polysilicon and copper examples above show, nothing is ever certain. With crowding, every uncertainty’s potential for harm becomes stronger, which is something that aspiring renewable energy investors should bear in mind before they venture into the field.
By Irina Slav for Oilprice.com
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