Alt. Energy: More Technology Than Energy?

Energy security issues such as dwindling global oil supplies in the face of increased global demand, and political insecurity in oil rich countries, coupled with increased concern about the natural environment including global warming and local air quality issues are driving factors behind oil price movements. Rising oil prices should help spur greater demand and supply of alternative energy.

According to New Energy Finance, global investment in clean energy rose 35% in 2007 to close out the year at close to $120 billion. Investing in individual alternative energy companies can be challenging for the average investor, and in response, there are now a number of interesting alternative energy ETFs. The largest alternative energy ETF, by assets, is The PowerShares WilderHill Clean Energy ETF (PBW) with assets totaling $1.38 billion.

Despite the fact that the long term outlook for alternative energy looks promising, in the short term, investing in alternative energy has been a lot like riding a roller-coaster. There have been spectacular highs along with some gut wrenching lows. In fact, over the past several years, the performance of alternative energy has lagged conventional energy.

As an example of how rough this ride has been, consider a comparison between an alternative energy ETF (PBW) with a basic energy ETF (iShares Dow Jones US Energy ETF (IYE)). The one and three year total returns for PBW are 3.76% and 10.92% respectively and these returns are considerably less than the one and three year total returns of 24.39% and 20.79% posted by IYE.

In fact, the performance of PBW more closely resembles that of a technology index (consider, as an example, an old favorite like the QQQQ). The one and three year total returns of PBW and QQQQ are each well below the one and three year total returns of IYE. Companies engaged in alternative energy are very dependent upon technology to find new ways to increase energy efficiency and reduce carbon emissions.

Another interesting exercise is to compare the performance of basic energy with emerging markets. A comparison between basic energy (IYE) with the iShares MSCI Emerging Markets Index (EEM) shows that, compared to PBW or QQQQ, IYE and EEM each posted double digit gains over one and three years, while dropping less this year. The close relationship between IYE and EEM makes sense when considering that emerging economies are gobbling up huge amounts of oil as their economies expand.

A closer comparison of these ETFs can be made on a risk adjusted basis. PBW has an alpha of 7.4, a beta of 1.74 and a Sharpe ratio of 0.35. The high alpha value of PBW is attractive for those seeking alpha, but the high beta value means that PBW is 74% more risky than the US stock market. In terms of beta, PBW shares more in common with technology or emerging markets than it does with basic energy. The closer connection between alternative energy and technology becomes apparent when comparing Sharpe ratios. PBW has a slightly higher Sharpe ratio than the QQQQ but both have Sharpe ratios considerably below investments in either basic energy or emerging markets.

Alternative energy will play a huge role in our economies of the future. So far, however, basic energy and emerging markets have had higher alpha and Sharpe ratios.

Disclosure: Author holds long positions in PBW, IYE and EEM.

Comments

[rafael:]

Well, if you really want technology index, then look at the Cleantech Index CTIUS and the Cleantech ETF (PZD). Wilderhill aims to track the narrower alternative energy market and PZD seeks to track the the global cleantech growth trend across all industries (but still has a significant allocation to clean energy). For that matter look at AECOX as well. There are a lot of 'alternative energy' (though often not very clean) indexes out there. A few good ones and a lot of dubious ones. Investors should do as much research on the index as they do on the ETF. Remember, what does the Index track and how well does it reflect its intent, what is its exposure, quality, and criteria. An ETF can only be as good as the underlying index. Never better.

2008 Apr 16 06:46 PM

[gogreen:]

I see alternative energy as a medium to long term play. When oil production peaks and oil hits $180 a barrel alternative energy will become less alternative and more basic.

2008 Apr 16 08:58 PM

[Urbane Gori...:]

Geez! You would have thought that alt-energy would have really kicked in at $90 a barrel.... In particular it seems that solar and wind would have really ramped up... Look at all the ads for solar installations on homes .. Our local college is beginning a certified solar installation program next year ( and we're a little town..), solar is getting popular in many cities with rebates in effect, big businesses, (particularly like techies, such as Google) are loading up, Walmart has a program for energy efficiency... I just don't get it...

Thx jegan ;-)

2008 Apr 16 11:51 PM

[lntwo:]

John E. - while high oil increases awareness and development of alt energy, our cars will be ostensibly running on gas for the near future, so the link to oil price is less direct than one might think. Since wind and solar generate electricity the driving issue is coal use ( repeat after me: "would you like mercury with that") and CO2 production. I could go on about the need to limit CO2 and the revised forecasts on near term sea level rise and all the other cheerful consequences but I'm sure anyone reading this thread is familiar with these issues.

However a point that is frequently ignored with wind and solar is the benefit to developing countries; aside from the obvious there is the water conservation aspect - coal and nuclear power generation are very water intensive, and water availability is an increasing pinch point in the developing world. Not to mention that coal and nuclear are localized, infrastructure intensive technologies.

Long on PBW, GEX, and a variety of oil companies,

Cheers all.

2008 Apr 17 01:24 AM

[Tim Plaehn:]

Alt. energy companies reach insane (IMO) valuations late last year and the market has corrected accordingly. Longer term growth prospects for alt. energy are tremendous and I think ETFs are the way to go. Personal favorite: PBD.

2008 Apr 17 11:23 AM

[Nick Gogerty:]

a lot of grid related alt energy depends on Coal and natural gas prices, not much to do with oil directly. Here is a spreadsheet that may be of interest. nickgogerty.typepad.co...

2008 Apr 17 12:12 PM

[Thomas Smic...:]

Shorting Al Gore is a better idea than alternative energy plays at this time. Coal (with improved pollutant capture technology), nuclear and conservation are going to play a larger role than wind, solar and biofuel.
Shortage of oil? Hardly. Shortage of courage to get the billions of proven oil assets within our national boundary? You bet.

2008 Apr 18 01:14 AM

[darwin c:]

We are still in the stone age regarding solar energy.

Basically, the cost of installation/parts/lab... will take 12+ years to pay itself back, and yet, thats not counting bad weather/ or hail storm.

2008 Apr 18 02:54 PM