It Ain't Easy Being Green

by: The ETF Authority

In the U.S., for the decade spanning from 2001 to 2011, the annual energy generation from renewable sources grew by approximately 80% while fossil fuel energy generation grew by only ~5%. That being said, in absolute terms, renewable energy still comprises a relatively limited share of total energy output, accounting for just 520B kilowatt hours of the roughly 4.1Tr output in 2011 (Source) or about 13%.

The future of renewable energy continues to be a politically charged topic as the U.S. strives for energy independence. Policymakers on the left generally favor "clean," renewable energy sources while those on the right generally support expanded use of fossil fuels. However, the infrastructure supporting the procurement and distribution of fossil fuels is aging. Therefore policymakers and investors face a critical decision: do we replace refineries, pipelines, and railways to encourage further use of fossil fuels or do we increase R&D expenditures to identify viable technologies for the mass distribution of renewable energy? For tangible evidence of the political influence on green energy investments, we can look to a chart of the green energy ETFs since President Obama's reelection in November 2012.

Chart of Green ETF Performance Since 11/2012 Election

Germany, led by the "Green Lady," Angela Merkel, seems to have made up its mind, expecting to generate 30% of its energy from renewable sources by 2030 (Source). As a consequence of this trajectory, German citizens face some of the highest energy costs in Europe, up 11% year over year as of January 1, 2013. While it is difficult to make a true apples-to-apples comparison of the unit cost associated with energy generation from different sources, the "Levelized Cost" metric can provide a good approximation. As the chart below demonstrates, renewable energy generation can be considerably more expensive than natural gas, for instance (Source).

Table 1. Estimated Levelized Cost of New Generation Resources

As governments and citizens in the developed world continue to struggle in the wake of the financial crisis, it becomes increasingly difficult to make the case for relatively expensive and unproven renewable energy sources over cheaper fossil fuels. The performance of ETFs focusing on the renewable energy sector seems to reflect the doubts of the investment community regarding the financial viability of green energy companies near term. Since the broad market indices bottomed in March 2009, many of the widely followed ETFs in the green energy space have delivered strongly negative returns, trailing the rallying equity markets by a wide margin.

Chart of Green Energy ETFs Performance Since Market Bottom 03/2009

Unfortunately for green energy investors, this picture seems unlikely to change in the foreseeable future. Companies grounded in the procurement of fossil fuels continue to innovate, keeping costs relatively low, and incentivizing consumers to prefer their products over the more expensive green alternatives. First Trust ETF Strategist, Ryan Issakainen, suggests that some investors looking for more promising near-term results should consider "Smart Grid ETFs." Prominent holdings in these ETFs include companies such as ABB and Schneider Electric that seek to improve the efficiency of energy storage and distribution. While the energy may not be derived from renewable sources, these companies are working to ensure they distribute energy safely and efficiently so that less coal, oil, and natural gas must be extracted from the ground.

Chart of Smart Grid ETF Compared Against Other Green ETFs

Longer term, renewable energy producers must continue to innovate in order to lower costs and compete with fossil fuels. They must also secure new lines of financing as they can no longer rely on subsidization from cash strapped governments to provide the capital needed to fund their projects. In the meantime, mainstream investors are likely to avoid this sector until return expectations improve.

Disclosure: The ETF Authority is a team comprised of two independent financial professionals, Kevin Prendergast and Nathan Rutz. This article was jointly written by Kevin and Nathan. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article. The opinions expressed in this article are those of the authors and do not constitute investment, tax, or legal advice. Please consider your specific risk tolerance and investment objectives carefully before investing.