To What Extent Is Alternative Energy Performance Linked to Fossil Energy Prices?

The recent slump in the price of energy commodities that has accompanied slumps in the rest of the market has reignited an old debate: to what extent is the performance of alternative energy companies (and their stock prices) linked to fossil energy prices?

People who argue that the two are closely connected implicitly believe that policy-makers and other important economic actors view alternative energy mainly as a hedge against high energy prices, and therefore believe that a drop in fossil energy costs will result in a fall from grace for alternative energy (there is evidence that at least some firms view renewable energy as such, providing credence to this argument).

Those who, like myself, believe that the fundamental performance of firms in the sector is not connected to the price of fossil energy (considerations of input costs aside), argue that the policy commitment behind the growth of much of renewable energy for the past few years has had more to do with political positioning on the increasingly-salient environment file.  

In a simpler follow-up to an article I wrote in July, I decided to put together a chart looking at the performances of a few ETFs since early July, when the commodity bubble burst. I included the following: (a) the S&P 500, as a general benchmark of performance for equity markets; (b) the USO ETF, which tracks the price of crude oil; (c) the UNG ETF, which tracks the price of natural gas; (d) the PWND ETF, which I believe provides more direct exposure to the wind sector than does the other wind ETF, FAN; and (e) the KWT ETF for solar, for no particular reason.

Tom Konrad wrote a useful article on alternative energy and cleantech ETFs and mutual funds in July, for those who missed it. I apologize for the quality and look of the graph. I picked the background that made it easiest to see the lines.

 Click to enlarge

If we accept that current stock prices reflect expectations of future firm performance, looking at this chart certainly seems to indicate that investors believe the outlook for the wind and solar sectors is grim. Indeed, not only have wind and solar stocks fallen much further than the market as a whole (>30% for solar!), but investors have discounted them beyond the fundamental risk they see in falling fossil energy prices. This outcome is broadly in line with the efficient market hypothesis - alternative energy outperformed the market as a whole over the past couple of years because alternative energy investors took greater risks.   

For the solar sector, this drop can be explained by concerns over a perfect storm brewing over the industry in 2009, coupled with uncertainty over the sustainability of very generous subsidy regimes in key markets like Spain and Germany. For wind, which relies for its deployment on project finance - type of arrangements with high gearing ratios, concerns over rising debt costs have added to anxiety about declining natural gas prices, wind's main economic competitor in the US.

In light of this, what's the answer to the main question posed initially about the relations to fossil energy prices? It's not clear. It is still too early to draw conclusions about any clear relationship between the performance of solar and wind firms and the prices of oil and natural gas. It is also impossible at this stage to disentangle all of the headwinds facing solar and wind and assert that energy prices play a larger role than other factors.

In my view, if policy commitments to alternative energy are strengthened rather than weakened during this crisis, which looks like it might be the case, it would represent the clearest evidence yet that policy-makers pay little to no attention to energy prices in deciding on support measures for the sector. In any event, what policy-makers believe may not matter much if the IEA is right about global oil supplies. In either case, alternative energy investors win.

DISCLOSURE: Charles Morand does not have a position in any of the securities listed here.

Comments

[Steven Hansen:]

i offer two observations:

1) history will repeat. 1973 oil crisis. five years later you would not know it happened. the price of oil directly effects all other forms of energy which can be used interchangeably. low oil prices pretty much stop all other forms of energy.

2) smell the economic decline. any program which costs money, including military spending will be cut. what we want to do will be impacted by what we have to do. priorities govern.

2008 Nov 13 04:11 AM

[sieraromero:]

Most people don't seem to understand that until we finally get rid of our oil addiction and dependency, that our economy will only deteriate further and more rapidly than it has already. Obama must begin an immediate and massive energy program,rebuild the auto industry and institute an national health care system if we are going to survive as an independent nation!

2008 Nov 13 11:15 AM

[Rikiki:]

>The Hand

I totaly concur with your points above.

As long as the congress and president act again as if the oil spike is an aberration, we are condemned to the repeat of history as you suggested. Congress and President have never had the guts to put forth a true "alternative energy" program. They have repeatedly reneged on CAFE (especially for light trucks) standards and buried heads in sand as to an increase in federal tax on gasoline and diesel fuels which would make european size vehicles the norm here. Heavens, they stand the chance of not getting reelected by the mindless mobs who want cheap now and the hell with the future. We americans are guilty of "more for us now" and less for our kids and grandkids. Almost sounds unionesque.

We have F150 and F250 pickups getting an average of 12 MPG. Who really needs that big of a truck .... I know .. Dallas, TX commuters. Right... I pick on Ford because the F150 is the most popular vehicle throughout the US (especially Texas, my former abode) . Yes, I had a F150 for my business 10 years ago. And, I got at best 16 MPG on the highway.

Another area where the government is way behind on is the new clean diesel cars and trucks. Diesel vehicles get at least 20% better mileage than injected gasoline options. My F150 only got 16 at best... my neighbor's F250 (bigger truck) claims as much as 24 on the highway. Why is it that VW, Mercedes and other imports meet our stiff standards for emissions and there is no american car that can?

The congress and the mob that continually reelects them apparently do not believe in long term solutions. I guess that we here are all victims of our culture of " I want now". Is there hope? People tend to believe their elected officials who depend on the lobby wonks to provide them with information on our votes... their way, of course.

To move to alternatives to liquid fuels, a very long, high price spike in petroleum is needed to get the attention of the mobs an the elected "servants". A gasoline and diesel tax increase could do a lot, in the mean time, to forestall the inevitable disaster of extreem fuel shortages and the crippling effect on the economy of the US.

Rikiki
.

2008 Nov 13 11:26 AM

[jack kreg:]

oil prices are collapsing, demand is dropping, world use is down 5 million barrels per day, or 5%.
When gas returns to 1 or 2 per gallon, do we still want to continue turning food into ethanol at a cost of 3 dollars per gallon?
Alternative energy must cheapen the cost of energy, or it will stay in the university's, or we can apply a general tax to all say on income or wealth, and then use these funds to cheapen (subsidize) the cost of alternative energy.
Solar gen electricity has been invested in for 3 decades and still produces less than 1 percent of our power, and at a much higher cost than natural gas power plants.
When will solar be cheaper than natural gas?
BTW, we just discovered a massive find of natural gas frozen under ground at depths of 2000 feet.
The recession will necessitate that cheap fuels be used, people will not have money to do otherwise, make solar cheap or leave it in the university.

2008 Nov 13 11:29 AM

[Gone Green:]

HAVE PETROLUEM COMPANIES GONE GREEN?

By Jay Hitz

There are a small number of petroleum producers that are beginning to look at renewable energy/biofuels as a way of both committing to environmentalism but also as a hedge against a changing economic and political landscape. The company that is most visible in this regard has been BP [Ticker: BP]. BP has built quite a profile for themselves as a greener, if not totally green company. While some have called what is being done by the company as “greenwashing” most analysts paint a different picture.

Shell [Ticker: RDS] has also made an equally large investment into biofuels, along with BP, the companies have each committed $1 Billion. Shell’s Chief, Jeroen van der Veer, told Reuters in a March 19 interview that Shell was building the green energy businesses for the long term, and dismissed concerns about the short-term value of the operations to share prices.”It’s more basic than that … 50 years from now, we think about one third (of total energy use) will be from renewables,” he said. “You only build big businesses if you expect the profitability there.”

With Shell’s purely R&D cost/benefit focus and the amount of both companies’ investments it certainly gives lie to the idea that BP is simply indulging in a publicity stunt. In a 2006 interview with German newsmagazine Der Spiegel, BP Chief Lord Browne addressed this assertion directly,

SPIEGEL: BP earns its money primarily from the sale of fossil fuels, which are then burned and pollute the environment. But your advertising refers to BP almost exclusively as “Beyond Petroleum” — to cleaner energy sources beyond petroleum. How can such a company portray itself as an environmentally conscious business?

Browne: Because we simply are. This is a fact, not a ploy. We have put a great deal of store in being environmentally conscious for some time now. We have managed to reduce our internal CO2 consumption, we are investing in alternative energy sources like solar and wind, and we are very active in the development of biofuels.

SPIEGEL: Some see this public emphasis on the green side of BP as a way of diverting attention from a dirty reality.

Browne: I vehemently disagree! You can’t say that you either want oil and gas or a clean environment. There has to be a balance between both sides. Fossil fuels will continue to be a large part of the energy mix in the future, that’s the reality. It will take some time before technologies are available that reduce the importance of oil and gas. This is why the question we must ask is: Can we find an energy mix that affects the environment in a positive way while at the same time guaranteeing a reliable supply? I think we’re doing a great deal to make this happen.

Both companies have shown that their investments are more a pragmatic strategy than a public relations ploy. For many though biofuels and renewable power investment has been thought to be a long-term and speculative with few short-term profitable applications. Small firms that have moved into this sector are often seen as experimental startups that might not move into the black for a decade or more. With oil and gas becoming ever more scarce, a few smaller firms are looking at a greener approach to energy that can find profits in the current market.

One of these companies is Titan Oil and Gas, Inc. [Ticker: TNOG]. The company’s President, Brandon Toth has been looking at alternative energy sources as a way of offsetting a portion of the company’s carbon footprint as well as building in a bulwark for inevitable changes of energy supply and demand. In a phone interview he had some provocative perspectives on the topic. “I think that the narrow-minded way of thinking in regard to energy is getting in the way of innovation. Previous management were following a plan that had worked for companies for years, go and drill a hole and pray that you hit oil. Well in a few instances they hit so much water at the same time that the cost to extract was just prohibitive.

“We took a page out of the Budweiser playbook, in the eighties as aluminum prices were beginning to creep up they started one of the largest recycling companies in the world. BUD was not only saving money on their aluminum bill but also contributing to a cleaner environment. What is it that is on the bumper sticker, Recycle, Reuse and Reduce? We see our way of recovering oil and gas in the same way, in a way we step in others footprints to reduce Titan’s. We see reworking and recompletion as the oil and gas version of those original three R’s. Sure we looked at the BP approach and it looks great for a company of their size. From our point of view though, a small company with no research and development budget, we need something with cash value now, that will can also grow with each year. That’s how we have to approach environmentalism as a country too. I think, theories and a dime won’t buy you a cup of coffee.”

Toth continued, ”I see some advantages in getting involved in leasing not only the mineral rights under the land for energy production but the air above it too. Wouldn’t it be a good thing to put a wind turbine above every pumpjack in the country? If they are on producing food crop farms then they have to be plowed around right now anyway. Why not leverage that for higher profits? Put the turbine right next to the pumpjack and let the thing offset the wells carbon footprint and generate power to be sold into the grid as well.”

“We have leases in Kern County, California; the land in that area is desolate right now but for the pumpjacks. Kern does have sun and wind though, so why not throw solar and wind into the mix, Forbes magazine just named Kern County the number 1 place in the country to build solar. There is money to be made in building a greener company. You know the first 100% wind powered community in the country is in Missouri, not a place thought of as teaming with treehuggers. You think the good folks of Rock Port, Missouri moved to wind power because it was an economic loser?”

The Titan President went on to describe how BP has been using jatropha and camelina, plants that cultivate in poor soil conditions, because of their high oil content and their ability to be grown in arid climates. “These two crops can be grown in places that you just couldn’t grow food crops so the concern about biofuels spiking food prices is not an issue with them. What if we were to put these in on our Kern properties, right now we don’t have the rights to do this, but what if? The land is just sitting there now but it could be used to get us off of foreign oil as well. America needs to be thinking like this.”

Regarding some of the news about T. Boone Pickens’ Plan, “It is good to see someone like T. Boone Pickens say this because it will open people’s eyes a lot more than if I say it. His plan to redirect natural gas for transportation use and making up the difference with wind and solar is a good one. You put that together with using non petroleum fertilizers like biosolids that can grow biofuel crops like camelina or even corn with a much smaller carbon footprint than we are currently doing and you start to see some light at the end of the tunnel. We could use the biosolids in areas like Kern to grow these crops at the same time we are pumping oil and/or gas and generating electricity with wind, solar or both. The crops may not be as profitable as the oil, gas, wind or solar but it makes some money and that contributes to the bottom line. Then as the margins get better we are there first with the supply chain and the sales outlets.”

“Don’t get me wrong we want to make some money off of oil and gas and we will for a long time to come, but we don’t want to be holding the bag when demand drops significantly in a couple decades. Its like this, Nike is the most successful active wear company in the world but as their brand matured they understood that it was important to branch out. Now they own Cole Haan [a high end dress and leisure shoe brand] and Bauer [a hockey equipment company] and they are selling golf clubs too, it’s all the same business in a way and it gives their stockholders value. That is all we are doing is looking at giving our stockholders more for their hard earned money.”

For more information about BP Global log into www.bp.com and for more information about Titan Oil and Gas, Inc. log into www.titanoilandgas.com and for more information about Shell Global log into www.shell.com.

2008 Nov 13 12:46 PM

[frflyer:]

Jack kreg
Your assumptions are based on absolute disregard for the environmental impact of continuing to do what we are doing. You remind me of what Colbert said on his TV show, (jokingly- he is a critic of the free market religion) "Can't we just let the market decide which animal species go extinct?"
His comment (joke) is only slightly more absurd than the way some free marketeers think.
Solar is already at grid parity in some parts of the country which are very sunny and also have high electric rates. Nanosolar says they can now build a utility scale solar farm cheaper than you can build a coal fired plant. And the solar farm won't ever ever need any coal, or any other fuel. No fuel ever to prospect for, mine, transport, store, refine, burn, clean up the mess from, or fight wars over. Solar industry people say we are just a few years away from grid parity. The whole country will be at grid parity by 2018 at the latest. Has it ever occurred to those of you, who think the market should be the only determinant, that we have developed our industrialized technologically advanced civilization at the expense of the earth? And has it ever occurred to you that maybe we owe the earth a little? And even if you can't make that big a stretch, maybe you can understand the meaning of sustainability. What isn't sustainable, the earth cannot support. The earth is finite, not infinite. The way we are conducting business as usual on this planet is simply not sustainable, period. If changing to sustainablility costs us a little economically, so be it. There really is no other choice, we either do things sustainably or the earth will cease to support us, period. In other words, a little sacrificing on the part of humans is not a ridiculous idea.
The amount by which we subsidize renewable energy is miniscule compared with the amount of subsidies to oil, gas,coal and nuclear. So the argument that solar and wind are losers, because they need subsidies, is absurd. According to one estimate, we now give oil and gas companies about $84 billion annually in tax credits and subsidies. We are subsidizing the most profitable companies in the world and we are subsidizing the past instead of the future.
Think nuclear is the answer? Better read "The Lean Guide to Nuclear Energy" www.theleaneconomyconn...
and this:
www.cleanwisconsin.org...

www.sciam.com/article....
This proposal published by Scientific American would provide a 69% solar powered grid by 2050, spending less tax dollars over the next 35 years or so than the above oil company subsidies would amount to over 5 years.
And less tax dollars than were spent to build the internet over the past 35 years. It would use less land for solar power plants, in the southwest deserts, than we now use for coal mining.
Add wind and other renewables to what we can do with solar and we will be able to phase out fossil fuels, starting with older coal plants.
While oil and solar are not presently comparable, since we only get about 1% of our electricity from oil,(which brings up the question of- why are solar stocks seen as coupled to the price of oil?) a clean electric grid could power much of our transportation with the use of PHEVs and EVs..
For more on oil and gas subsidies and the hidden costs of oil see:
www.setamericafree.org...

2008 Nov 13 01:42 PM

[David Michael:]

Working in the energy industry, I have heard nothing about solar being anywhere close to what frflyer calls "grid parity". Efficiency and pricing on renewables of all types will keep them out of the market so long as natural gas prices are less than ~$10.

Note that I refer to natural gas. While our auto industry is addicted to oil, less than 1% of our electrical use is based on oil - indeed, the largest segment is driven by natural gas.

In order to have renewables generators running in a low-fossil-fuel price environment such as the current one, electricity rates would have to be raised in one form or another. It will take convincing the public that paying more for more environmentally-friend... generated electricity is worthwhile for the extensive subsidies that currently exist for the green energy industry to continue or be expanded.

2008 Nov 13 02:38 PM

[CLH:]

Solar and wind were cutting edge science in the 1500s. They will never compete with nuclear or oil.

2008 Nov 14 07:54 AM

[Matthew Bascom:]

The debate between the performance of alternative energy businesses to the price of fossil energy prices is an understandable result of not be acquainted with the point you make, at the end of the post, on new policy initiatives. It's very possible that short term correlations exist between the price of fossil fuel to performance in alt-e businesses. But new policy measures support renewable energy technology and infrastructure development because renewable energy is a national priority. There is an unprecedented emergence of new global players who consume a lot of energy. The general audience of mainstream media might even argue that the popular global recession would preclude a longterm global surge in energy demand, but there is no denying the momentum of the world's strongest economies, who waste no time in an international energy grab of their own.

2008 Nov 18 01:04 PM