Q&A: Investing in the Future of Energy
Summary: We have asked our Head of Equity Strategies, Peter Garnry, a range of questions about the future of energy and the industry, which constitutes the green energy transformation.
Green energy stocks
The green transformation is all around us and a big topic in markets as well. But how should you, as an investor, expose yourself to the green energy sector?
“I think the short answer is to get some diversification. Like any industry it’s quite difficult to not only pick the best technology, but also pick the long-term winner. It’s doable. but it requires a lot of work and sometimes you have to shift your opinion over time as sentiment change. You basically have two options to get a diversified portfolio within the sector: Either you go with an ETF, which covers renewable energy like the iShares Global Clean Energy. The other option is to get inspiration somewhere else like in e.g. our green transformation basket. The latter requires a bit more work and it’s worth noting that our definition of green transformation is a little bit broader than purely green energy.”
Speaking of, how do you define green stocks?
“The key definition is whether a stock has a net positive impact on the environment. We live in a world, where we’re moving towards a net zero carbon emission in around 2050/2060 depending on which country you look at. For a stock to be green, it needs to have a positive impact on this objective. In our green transformation basket, we also have companies, which work with what you could call environmental services. This could be companies that help clean water, recycle certain materials etc. which we think benefit the planet - and then we of course have the companies producing low-carbon intense energy production, like wind, solar etc.
Why has the green energy sector performed worse than fossil fuels in 2021?
“First and foremost, if you widen the lens a bit and look at the last two years, then green energy outperforms its black counterparts. The discrepancy that you in 2021 on one side have a big push for going green and on the other hand a green transformation sector, which is performing worse than traditional energy stocks should be seen as a short-term transitionary period more than as a trend. Last year was the major breakthrough for the green energy sector, which translated into higher valuations, whereas the COVID-19 crisis had a severe negative impact on especially the oil industry. This meant that going into 2021, you had an oil and gas industry, which was valued low and a green industry that was valued high. Add to that the increasing commodity prices here in 2021, which have affected the production of green energy infrastructure like wind mills and solar panels with higher input costs, then you have the recipe for black energy outperforming green even though there’s a big push to go green. These factors will even themselves out over time and thus this shouldn’t be seen for more than a short-term technical bump on the road.”
Should you still prioritise green energy stocks?
“As mentioned, there isn’t anything that suggests that the path to become greener is becoming less prevalent for the world around us, so this is a short-term thing and the green energy sector will still be one of the biggest drivers of financial growth in the foreseeable future.”
Generally speaking, what are the pros and cons of investing in green energy stocks?
“The historical advantage for the green energy sector is that every big leap in recent human history has been sparked by innovation that’s ended up with some of the biggest industries in the world. It’s our belief that in the future some of the largest companies in the world will be the ones solving the environmental challenges our planet is facing. Much like how today’s largest companies have been players and key innovators in information technology, mobile technology, energy and transportation industries. Whenever mankind has faced a challenge, someone has come up with solutions and made money off of it.
It becomes difficult to invest in the green energy sector, when you either want to go very technologically specific or if you have a short time horizon. There are a lot of different energy sources that could win the race, wind, solar, hydro or even nuclear or fusion energy, but it’s very hard to sit today and predict, which technologies will be the winners. At the same time we have seen green energy bubbles bursting, e.g. in 2007/2008 and that is bound to happen again. Therefore, the green energy sector really is an industry where diversification and a long time horizon will benefit investors.”
It also sounds like greenwashing is something to be aware of. What is it?
“To answer this question I’d like to quote Berkshire Hathaway’s vice chairman, Charlie Munger, who said “show me the incentive and I’ll show you the outcome”. It’s very clear that the incentive for companies these days is to be green. And that is of course a good thing. But it also comes with the risk that companies start calling themselves green even though they’re not - and the general governance setup around this aspect is still at a pretty early stage. That’s why the term greenwashing has come to life. It’s the act of companies stating they’re green without having true proof of it. This is something that investors and people in general need to be aware of.”
What should you be aware of when choosing green stocks?
“Much like I’ve said, I think investors should focus on diversification and a long-term strategyas well as trying to avoid companies that are greenwashing, if exposure to the green transformation is key.”
Which green transformation stocks have been the most successful in 2021?
“It has been a quite dramatic year for the green sector. Primarily due to the increase in commodity prices, solar power has been hit quite hard this year and it has in general taken its toll on energy-producing sectors. The most successful aspects of the green transformation in 2021 have been the green transformation services area as well as the battery and energy storage area, which makes sense as it’s connected to the electrical vehicle development.”
Electric vehicles as a popular trend and the next big thing
On that note, electric vehicle industry – and especially Telsa – has been a very popular subsector among investors. Why has Tesla and other electric vehicle companies been so popular with investors?
“Looking at surveys about holdings within retail investors, it’s evident that Tesla is usually in the top five of people’s holdings and then there’s a natural spill-over effect to other electrical carmakers. It’s quite remarkable to see how much the overall valuation of the car industry has gone up since electrical vehicles started to become a thing even though the output hasn’t followed suit. If the market is right, this means that car makers will be able to make larger profits creating electrical vehicles than petrol-fuelled ones.
What does the future hold for electric vehicle stocks and Tesla in the long run?
“If you only got your news from companies like Tesla and e.g. Volkswagen, who is also very engaged in the development of electrical vehicles, you would pretty quickly be able to conclude that fully electrical battery-based automobile development is the way forward. But interestingly, Toyota, the world’s largest carmaker, seems to be prioritising the development of hybrid-cars over purely electrical vehicles. Already today, 26% of the cars Toyota sells are hybrids. While we’re definitely moving towards more electrified vehicles, I think it’s fair to say that the jury is still out on how the mix of hybrids and electrical vehicles will be.”
“Toyota’s focus on hybrids instead of purely electrical vehicles has meant that their financial situation has been stronger than the companies, that have tried to go fully battery-loaded. And it seems like these companies will in general have to take a profit hit in the beginning, but at the same time Toyota is also being increasingly isolated as more and more carmakers move towards focusing on electrical vehicles. So to answer the question, we’re moving towards greener cars, but the split between hybrids and electrical vehicles is still unknown.
What alternatives to Tesla exist for those looking to invest in other electric vehicle category stocks?
“It’s a good question and to be totally honest, one of the reasons behind Tesla’s appeal among many investors is probably the pure play they offer on the electric vehicle industry, which you can’t get from the traditional car manufacturers. Another suggestion could be e.g. NIO, but if want to expose yourself to the industry and not be focused on which of the manufacturers win the arms race, you could look at battery producers. Traditionally, car manufacturers have owned the intellectual property on which a car has been built. But this is bound to change with electric vehicles gaining ground, because the battery technology will be owned by the battery producers and not the car makers. It’s important as an investor to be aware that there will probably only end up being three or four companies in the world that will produce these batteries, because the construction of them is extremely advanced and the entry barrier is really high. This will limit the number of companies that can take on this amount of complexity. We, therefore, believe that there’s a fair chance that it will be the battery producers that will extract the most value out of the electrical car industry.”
Does investing in a stock such as Tesla, of which much of their appeal is fuelled in the media by Elon Musk’s celebrity entrepreneur status, have more risk than security?
"In many ways, Elon Musk is a great showman. He captivates his audience and he’s telling a narrative that many young people can relate to, which are both the new buyers of electric vehicles and the new class of retail investors. Having said that, his company is a company of the future and there’s a reason why people buy into it, which goes beyond his ability to market it.”
Despite a big pivot to clean energy, it still seems like companies that work with fossil fuels such as mining, oil and gas are regarded as some of the best investments. Why is this?
"As mentioned earlier on, the correction we have seen in 2021 between fossil fuels and green energy should be seen as more of a technical transitory event rather than a trend going forward. Having said that, isn’t realistic to think that oil and gas will become obsolete in the near future. We need it as part of our everyday life for years to come.”
What do you predict will be the next big trend within green energy?
“I participated in a discussion with Vestas’ CEO, Henrik Andersen and our CIO Steen Jakobsen in the middle of August. Here, we discussed whether the size of windmills are close to reaching its limits. Henrik didn’t think so, and he knows the industry better than anyone, but at some point wind will reach its limits. The same goes for hydro power, where most of the best places in the world are already being utilised. When we look at solar energy, there’s huge opportunities to develop and the path to create more efficient solar panels is there and the potential is enormous even though the rise in commodity prices put pressure on it right now. I think nuclear is also gaining more traction and EU is starting to open up for using it as a green energy source because it doesn’t emit CO2. But I believe that even though it’s been under way for a long time, fusion power could be the code we need to crack. If we break that, then we get an energy source, with a lot of potential.
From a macro perspective, reducing the world’s carbon footprint is important, however could become a very expensive transition. How could this move affect governments and everyday people financially?
“On an overall level, the green transformation is structured around two pillars, the rapid growth in renewable energy sources and the electrification of society which has many sub-pillars, but the main part is currently electrical vehicles. Clearly these can impact the way we live, e.g. through electric vehicles. But from a financial perspective, I very much agree with CEO of BlackRock, Larry Fink, who said that the green energy transition is the area of economic development that puts the biggest upside pressure on inflation. So, in that sense, the transition can add to the general price increases in society. We’re already seeing inflation pick up, but the energy transition can move it upwards even further. I do, however, not think that the period in which we will see price increases due to a shift towards green will be that long. And at the same time, we have to remember that climate change in and of itself comes with a pretty hefty price tag. Droughts, floods, fires and other natural disasters caused by global warming aren’t cheap. So even though that calculation is difficult to make, we have to remember that it’s the relative cost between those two scenarios that reflects the true cost of the green energy transition.”
Should you as an investor be worried about investing in green energies that are being heavily subsidised by governments?
“Everything needs to be viable in the long run, but as an investor I would like at this the other way around. The places where governments subsidise are the areas they want to prioritise and thus it’s the place where there’s money to be made.”
Could the ‘green revolution’ fuel a boom in jobs. Could the UK be about to undergo a skilled jobs revolution, particularly in formerly industrial areas?
“Looking at the history of economics, it’s always changing and evolving and there’s no doubt that the switch in energy sources will cause people to be laid off in some industries and then moved to others. I believe that the green transformation will have a net positive effect on job creation. There will still be a need for people in the oil and gas industry as well for years to come and the skillset from such industries should be pretty transferable to the green energy industry. So there all the reason in the world to view the green transformation as an opportunity to create more skilled jobs.”
Peter Garnry joined Saxo Bank in 2010 and is Head of Equity Strategy. In 2016, he became responsible for the quantitative strategies team, which focuses on how to apply computer models to financial markets. He develops trading strategies and analyses of the equity markets as well as individual company stocks applying statistics and models.
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