The clean energy contrarian trade is coming. Coal, natural gas and crude oil producers are gaining traction relative to their competitors within the renewable space.
Compare three ETFs: iShares Global Clean Energy ETF (ICLN, Financial), VanECK Vectors Coal ETF (KOL, Financial) and the SPDR S&P Oil & Gas Exploration & Production ETF (XOP, Financial).
Figure 1 Data shown is from Yahoo Finance. Daily closing prices are used for each fund.
There are four inflection points to note within the chart: 2008, 2011, 2014 and January of 2016. Since the start of 2016, traditional energy producers have gained ground relative to clean sources and this trend has been accelerated following the U.S. election. This "spread" between the traditional and clean sectors is now at $20 per share compared to an average spread of $35 per share between 2010 and 2014.
Figure 2 Data used is from Yahoo Finance. Own calculations based on the average closing price of XOP and KOL, less ICLN each trade day.
This spread will continue to grow during the Trump presidency for three reasons:
- Tax incentives for residential and utility-scale solar investment will be threatened.
- The U.S. commitment to clean energy initiatives moving forward will be questioned.
- Environmental legislation and cap and trade rhetoric will be scaled back in Washington.
As value investors, it is critical we ignore the political debate and focus on the underlying strength of individual companies and the sectors they represent. Clean energy producers will be an out-of-favor sector during a Trump presidency and be ripe for a buying opportunity.
This is especially true as the business catalyst clean energy sources need is on the horizon. Based on current advancements in solar technology, solar energy will be cheaper to produce on a per Kilowatt hour basis than coal and nuclear energy by roughly 2025[1]. If the economics of solar adoption are in place, the political argument is largely irrelevant.
Figure 3 Full credit for this chart goes to Farmer, D. and Lafond, F. (2016) How Predictable is Technological Progress? Research Policy. Volume 45, Issue 3, Pages 647-665.
With the S&P 500 index priced at 24.97 times earnings, there are a number of clean energy companies that provide value investment opportunities. Again – my expectation is for this conventional / renewable energy spread to widen in the coming months, providing a future entry point. This is a true contrarian trade, as a number of these companies currently have significant balance sheet and earning issues to resolve.
- First Solar (FSLR, Financial) with a P/E(ttm) of 6.82
- SunPower Corp. (SPWR, Financial) with a P/E(ttm) of -3.37
- Canadian Solar Inc. (CSIQ, Financial) with a P/E(ttm) of 5.21
Disclosure: I do not hold any positions related to this article.
[1] Farmer, D. and Lafond, F. (2016) How Predictable is Technological Progress? Research Policy. Volume 45, Issue 3, Pages 647-665.
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