New President and Renewable Energy

Writing under the famous pen name Mark Twain, Samuel Clemens coined the phrase “history doesn’t repeat itself, but it often rhymes.” “I’m not the first to apply that bit of country wisdom to investing. But it’s always worth revisiting in the aftermath of extraordinary market events”.

This year’s short squeeze in Gamestop GME (GME) and other formerly depressed stocks—allegedly triggered in large part by Robinhood.com investors—certainly qualifies as noteworthy. And it has implications for the equally dramatic action recently in stocks perceived as leveraged to adoption of renewable energy.

The ongoing rally in wind, solar and other related stocks has been building since early in the previous decade, when states began adopting renewable portfolio standards. It’s accelerated as the cost of deployment has plunged. And it’s jumped into hyper-drive since early November, once it became clear Joe Biden would be the next U.S. president.

Since Wednesday November 4, the Invesco Solar ETF (TAN) has surged nearly 77%. The Invesco Wilderhill Clean Energy ETF (PBW) has more than doubled. And the remainder of the 10 largest “clean energy” ETFs are up at least 50%.

Many of those dollars have flowed to companies with actual earnings and sustainable business plans. But some of the biggest gains have been in stocks backed by neither.

That doesn’t necessarily mean they’re about to plunge 90% from their highs, as Gamestop has since early February. Tesla Inc (TSLA), for example, has a cadre of investor believers who appear willing to defend even its extraordinary enterprise value of 160 times trailing 12 months EBITDA.

But it’s a lot harder to see the likes of FuelCell Energy (FCEL) and Plug Power (PLUG) indefinitely defending post-election gains of roughly 1100% and 300%, respectively. For one thing, neither company has generated positive cash flow or is close to turning a sustainable profit.

True, Biden Administration policies will be far more positive for renewable energy adoption than former President Trump’s. But investors also have a habit of giving presidents far too much credit when it comes to being able to shift the course of large industries like energy, which collectively generates trillions of dollars in revenue every year and employs millions of people.

Remember how Trump’s election four years ago supposedly meant the death of renewable energy and resurgence for coal? Despite his administration’s best efforts, results have been 180 degrees opposite. Going back further, former President Obama was predicted to be bad news for oil and gas. Instead, he oversaw the greatest building boom for US energy pipelines in decades.

President Biden has promised bold action to reduce America’s CO2 emissions. But the magnitude of new federal funding needed to meaningfully boost fortunes of small renewable energy companies will require Congressional approval. And with oil and gas state Democrats holding the balance of power—including Senate Energy Chairman Joe Manchin (D-WVA)—that’s highly unlikely.

Instead, Biden will rely on regulatory actions and executive orders to push policy, much as he’s done to date. And when the big dollars needed to keep financially floundering companies don’t arrive, share prices will come down hard, as will the renewable energy ETFs that own them.

There’s still a massive investment opportunity here, with trillions of dollars to be devoted to reaching “net zero CO2 by 2050.” But it’s never been more critical to pick your spots carefully. And that means largely avoiding stocks that Wall Street has already picked over.

For renewable energy, the ultimate difference maker is scale. Bloomberg New Energy Finance notes it took 18 years for wind and solar to go from 0.1% to 1% of U.S. power generation in 2008. But it took just 12 after that to get to 10.5% in 2020.

The key driver was rapidly falling deployment costs. And the primary reason for that was greatly improved scale economics, from manufacturing components to financing and connecting meaningful amounts of generating capacity to the grid.

The stock market action of the past three months once again demonstrates the power of whiz-bang technology tales to bewitch investors. But this sector has come of age. And the only reliable returns going forward will be from owing stocks of companies that can best put scale economics to work.

High flying stocks of companies with no earnings may not crash and burn right away. And some will wisely use their suddenly low cost of equity capital to sock away survival cash.

But sooner or later, stocks of companies with actual profits will overtake them as renewable energy sector favorites. And that’s where investors’ focus needs to be now.

In the February issue feature article of Conrad’s Utility Investor, I highlight two areas of renewable energy that have yet to really grab investors’ attention. One is U.S. offshore wind development, stymied since August 2019 as the Trump administration has blocked permits. The other is helping natural gas distribution utilities and midstream pipelines get to net zero CO₂ emissions by 2050.

Both will be turbo-charged by Biden Administration policies, even if Congress doesn’t allocate a dime. Mainly, the leading companies are ready to roll. All the government has to do is cut the red tape.

These financially strong companies enjoy a simple formula for growth: Their projects will earn a guaranteed regulated return on investment of around 10% under utility rate base, or a mid-teens percentage return from long-term contracts. Either means higher earnings, expanded ability to complete more projects and strong, reliable investor returns.

These are the stocks investors need to buy now to build positions in the global energy transition. And focusing on them will also avoid the risks of this currently overheated sector, where rumors have a far greater influence than actual facts on near-term market moves.