The parallel worlds of green transformation

The parallel worlds of green transformation

Equities 6 minutes to read
Peter Garnry

Chief Investment Strategist

Summary:  Politicians are all in on the green transformation and central banks support green bonds. As a result the green transformation does not lack available capital to be deployed, but the industry has been faced with terrible stock returns over the past year. It is almost as if the green transformation lives in different worlds. There is the world of what we want to achieve and then the harsh reality of higher interest rates, higher material costs, and higher grid system costs from more renewable energy, and there is no other stock represent the downfall of green transformation stocks than Orsted.


Key points in this equity note:

  • Green transformation related theme baskets are the worst performing theme baskets over the past year despite strong political and capital commitment from the financial industry.

  • Orsted has gone from being part of the bubble stocks cluster peaking in early 2022 at excessive valuation to a premium that is getting closer to the European utility sector as offshore wind projects are faced with multiple headwinds.

  • While the talk of energy crisis has disappeared this year German baseload electricity is still 140% the long-term average from before the pandemic highlighting that Europe still has a big energy problem.

Green transformation baskets are the worst momentum

The past year has marked a period of first panic in technology stocks as the Fed unleashed its aggressive rate hikes before optimism and exuberance took over catapulting technology stocks back into positive gains. As recession fears increasingly looked wrong and the AI hype accelerated so did returns in technology stocks, so much in fact, that semiconductors is our best performing theme basket this year.

If we look at the past year, which is the classic definition of momentum used in equities, then the best performing themes are defence (due to the war in Ukraine), construction (delivering on backlog and infrastructure spending), luxury (bet on China’s consumer) and travel (post pandemic growth). Despite massive political capital, funds flowing into alternative investment funds for the green transformation, and retail investors liking the ESG agenda, our three energy baskets (renewable energy, energy storage, and green transformation) have been part of the worst performing baskets.

So despite the commitment from governments and capital being made available for green investments, the returns across many green transformation stocks have been bad. The power point slides and hopes of the green transformation have certainly met a harsh reality in financial markets. If investors continue to bid down prices of green energy stocks then it will at one point begin to reduce available supply of capital because capital is always seeking the highest risk-adjusted returns.

Will Orsted’s complexity weigh on valuation?

There is no stock like Orsted that represent the downfall of the green transformation since early 2022. At its peak, Orsted was the largest stocks in many of the leading clean energy funds, and as our valuation chart below shows, its 2-year forward EV/EBITDA valuation hit 22.1x in January 2022 compared to 8.4x for the European utility sector. In other words, Orsted peaked at the same time as many bubble stocks peaked illustrated by Cathie Wood’s Ark Innovation ETF.

Since then Orsted has disappointed the market in terms of profitability as its EBITDA margin has declined from 24.6% in FY19 to 14% in the latest 12 months. Rising interest rates, higher material costs, and higher volatility in electricity prices have all contributed to the headwinds for Orsted, and as a result Orsted’s equity valuation has come back closer to the utility sector in Europe. When you observe the historical development in Orsted’s equity valuation is interesting to observe its volatility compared to the overall utility sector. This sector is significantly regulated and constrained making it typically a very predictable sector in terms of returns and growth, but the narrative around the green transformation, and especially offshore wind farms, catapulted Orsted to be valued like a technology company.

Our view is that the operating model of Orsted is quite complex and the timing of cash flows has a high degree of volatility. In addition, the operating model is constrained by many factors (as mentioned above) and with renewable energy, including offshore, becoming more expensive due to expensive storage needed over time to balance the grid, our view is that Orsted should not have a significant premium to the rest of the utility sector.

Orsted share price | Source: Saxo
Nvidia share price | Source: Saxo

Energy crisis in the short and long run

In one our recent equity notes Can European equities continue to ignore the bad news? we discussed the fact that Germany’s economic model is broken and that the industrial giant of Europe looks once again to become the sick man of Europe. A big part of the explanation is the energy crisis in Europe. It was a hot topic during the second half of 2022 with galloping natural gas prices as the ramifications of the war in Ukraine, and subsequent sanctions against Russia, played out across energy markets. Since the word energy crisis has been used less and less as German baseload electricity prices have fallen on average by around 60% from 2022 levels. However, this year’s German baseload electricity prices are still around 140% higher than the long-term average from 2009-2020 signalling a structural break from the past.

In the short-term (this winter and the next), depending on the weather, a severe energy crisis could come back to haunt Europe which in itself could be bad for European equities. Longer term the green transformation poses challenges for the input costs of Europe’s industry and inflation. As transportation, heating, and digitialization (data centers) will significantly increase electricity consumption over the years (something we have written extensively about in previous equity notes) the need for baseload electricity is important. Solar and wind can only meaningfully contribute over a certain threshold of overall electricity production if storage is added, but energy storage is expensive and thus over system costs go up with more renewable energy over a certain point.

Europe will need a lot of baseload electricity and the only viable options are coal, natural gas, and nuclear power. As coal is no go due to green ambitions, natural gas and nuclear power will play a significant role and especially natural gas. There is a real risk in Europe that electricity demand could grow faster than supply due to electrification keeping electricity prices high and thus putting a floor under inflation.

German 1-month baseload electricity price

Quarterly Outlook

01 /

  • Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Quarterly Outlook

    Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Althea Spinozzi

    Head of Fixed Income Strategy

  • Equity Outlook: Will lower rates lift all boats in equities?

    Quarterly Outlook

    Equity Outlook: Will lower rates lift all boats in equities?

    Peter Garnry

    Chief Investment Strategist

    After a period of historically high equity index concentration driven by the 'Magnificent Seven' sto...
  • FX Outlook: USD in limbo amid political and policy jitters

    Quarterly Outlook

    FX Outlook: USD in limbo amid political and policy jitters

    Charu Chanana

    Chief Investment Strategist

    As we enter the final quarter of 2024, currency markets are set for heightened turbulence due to US ...
  • Macro Outlook: The US rate cut cycle has begun

    Quarterly Outlook

    Macro Outlook: The US rate cut cycle has begun

    Peter Garnry

    Chief Investment Strategist

    The Fed started the US rate cut cycle in Q3 and in this macro outlook we will explore how the rate c...
  • Commodity Outlook: Gold and silver continue to shine bright

    Quarterly Outlook

    Commodity Outlook: Gold and silver continue to shine bright

    Ole Hansen

    Head of Commodity Strategy

  • FX: Risk-on currencies to surge against havens

    Quarterly Outlook

    FX: Risk-on currencies to surge against havens

    Charu Chanana

    Chief Investment Strategist

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperfo...
  • Equities: Are we blowing bubbles again

    Quarterly Outlook

    Equities: Are we blowing bubbles again

    Peter Garnry

    Chief Investment Strategist

    Explore key trends and opportunities in European equities and electrification theme as market dynami...
  • Macro: Sandcastle economics

    Quarterly Outlook

    Macro: Sandcastle economics

    Peter Garnry

    Chief Investment Strategist

    Explore the "two-lane economy," European equities, energy commodities, and the impact of US fiscal p...
  • Bonds: What to do until inflation stabilises

    Quarterly Outlook

    Bonds: What to do until inflation stabilises

    Althea Spinozzi

    Head of Fixed Income Strategy

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain ...
  • Commodities: Energy and grains in focus as metals pause

    Quarterly Outlook

    Commodities: Energy and grains in focus as metals pause

    Ole Hansen

    Head of Commodity Strategy

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities i...

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)

Saxo
40 Bank Street, 26th floor
E14 5DA
London
United Kingdom

Contact Saxo

Select region

United Kingdom
United Kingdom

Trade Responsibly
All trading carries risk. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more
Additional Key Information Documents are available in our trading platform.

Saxo is a registered Trading Name of Saxo Capital Markets UK Ltd (‘Saxo’). Saxo is authorised and regulated by the Financial Conduct Authority, Firm Reference Number 551422. Registered address: 26th Floor, 40 Bank Street, Canary Wharf, London E14 5DA. Company number 7413871. Registered in England & Wales.

This website, including the information and materials contained in it, are not directed at, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in the United States, Belgium or any other jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation.

It is important that you understand that with investments, your capital is at risk. Past performance is not a guide to future performance. It is your responsibility to ensure that you make an informed decision about whether or not to invest with us. If you are still unsure if investing is right for you, please seek independent advice. Saxo assumes no liability for any loss sustained from trading in accordance with a recommendation.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc. Android is a trademark of Google Inc.

©   since 1992