Green ETFs: Technology in Disguise ~ Barron’s

Originally published in Barron’s – October 3, 2105

Solar, wind and other green-energy stocks have fallen along with oil and natural gas.  But these companies are really tech firms.  Time to buy.

Article by Lewis Braham

Green-energy companies have been drowned in cheap oil, and the exchange-traded funds that own them have been punished along with the rest of the energy sector.  Guggenheim Solar (ticker: TAN) and PowerShares WilderHill Clean Energy (PBW) are both down in excess of 30% in the past year, about the same as the Vanguard Energy ETF’s (VDE) 32.6% tumble. But that’s a mistake—one that can prove to be very profitable for investors.

Oil dominates the energy sector—the Vanguard Energy ETF has a 22% stake in ExxonMobil (XOM), for instance. But oil is rarely used to generate electricity, which is the aim of most green-energy companies. What’s more, green-energy stocks are technology, not commodity, stocks: They sell the technology needed to harness and generate energy. “A solar panel is just like a computer chip—it’s a silicon wafer with integrated circuitry etched into it,” says Garvin Jabusch, co-founder of Green Alpha Advisors, a Boulder, Colo.–based asset-management firm specializing in green investing. “A more appropriate comparison for a solar company is [a chip maker like] Advanced Micro Devices [AMD] or Nvidia [NVDA].”

The solar business has grown at an annual rate of 30% over the past 20 years. Illo: Mick Wiggins for Barron’s

The disconnect between investors’ perceptions of green-energy companies and their actual business has created a buying opportunity. “Demand for alternative energy has been fairly robust recently despite declining fossil-fuel prices,” says Angelo Zino, a senior equity analyst who covers the sector for S&P Capital IQ. “There really is no correlation between it and traditional energy.”

In fact, after a 2011-12 shakeout, when Chinese manufacturers dumped a lot of cheap solar cells on the market, solar’s prospects are much brighter. “As of the second quarter of this year, 17 of the 25 stocks in our index are profitable,” says Richard Asplund, research director of Mac Solar Index, which created the benchmark the Guggenheim ETF tracks. “That’s as opposed to a couple of years ago when all of them were losing money because of China. The median trailing price/earnings ratio for our index is eight, compared to 17 for the S&P 500.”

CONSUMERS HAVE BEEN PAYING more for electricity, as conventional power companies are forced to charge more to transmit and distribute electricity over an aging grid. Yet natural gas and coal, which power the turbines utilities use to create electricity, have suffered steep price drops, as the hydraulic-fracturing revolution has caused a surplus in shale gas. According to a report by Deutsche Bank, natural-gas prices have fallen 86% over the past 10 years, while electricity prices have increased by 20%.

Green-energy prices have been falling rapidly, as well. The cost of the solar systems bought by consumers has declined 15% a year over the past eight years, and Deutsche Bank analysts expect costs to fall another 40% over the next four to five years. But while coal and natural-gas prices will rise again at some point, green energy is likely to just get cheaper. “As demand for fossil fuels goes up, they become more expensive to locate, refine, and transport,” Jabusch says. “But the more demand there is for solar cells, the cheaper they are to produce, because of economies of scale from manufacturing.”

The benefits of scale will increase dramatically in coming years. That’s because green-energy companies are starting from such a small base that there’s a lot of room for them to steal market share and further reduce their costs. According to Deutsche Bank, solar-power generation accounts for just 1% of the $2 trillion in annual electricity spending worldwide, despite the solar business having grown at annual rate of 30% for the past 20 years. “Over the next 20 years, we expect over 100 million new customers to deploy solar and roughly $4 trillion of value to be created during this time frame,” the report predicts.

Of course, there are risks: One of them is political. Globally, green-energy projects are the beneficiaries of government subsidies that can easily be revoked. In the U.S., for instance, a 30% tax credit for solar installation is due to decline to 10% in 2017. Yet solar prices are falling so rapidly that such subsidies will soon be unnecessary.

THE HOLY GRAIL for green-energy companies is “grid parity.” That occurs when it costs a consumer the same amount to generate electricity via, say, solar panels on their roof as it does to buy it from a traditional utility. Deutsche Bank estimates that grid parity for solar—even without the benefit of subsidies—has already occurred in 14 U.S. states and will reach 47 states by 2016.

Nor is solar the only low-cost green technology. Wind- electricity generation (although its potential applications are more limited) recently hit an all-time-low wholesale price of 2.35 cents per kilowatt-hour, according to the Department of Energy. That’s cheaper than the national average of 3.5 cents per kwh utilities typically pay for electricity. Those interested in wind power can buy the First Trust ISE Global Wind Energy ETF (FAN).

The other risk for green energy is something every tech company faces—obsolescence. Because the industry is young, there is no dominant technology yet, so diversification is key. Plus, a portfolio that incorporates solar, wind, and other green technologies also has advantages from a political perspective. Different technologies receive government subsidies at different times, so when one is out of the government’s favor, another may be in.

The available ETFs are tiny. The most diversified green-energy ETF in the sector is the $60 million PowerShares Global Clean Energy (PBD). It has 101 companies from around the world, and its largest position is only 2.6% of assets. It has fallen 10% so far this year. For a U.S.-focused ETF, there’s the 46-stock, $63 million First Trust NASDAQ Clean Edge Green Energy (QCLN). It’s down 20% year to date.

Important disclosures