Will Clean Energy ETFs Benefit From A Carbon Tax?

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Includes: GEX, ICLN, KWT
by: Zacks Funds

The Washington Post recently reported that the Trump administration is considering the imposition of two controversial taxes, a value added tax and a carbon tax. Shortly after the story surfaced, the White House declared that it was currently considering neither of the two.

A White House spokesperson said that the team is hearing inputs from multiple sources on how to fund the tax reform, as it prepares to get the bill passed in the Congress after the failure of the healthcare bill.

This indicates that the tax bill is still in the early stages of development, as Trump fights to keep his promise of individual and corporate tax cuts without harming the economy.

The carbon tax is likely to be aimed at industry emission of carbon dioxide and other greenhouse gases by burning fossil fuels. Though many Democrats supported the idea in the past, it has been opposed by the majority of Republicans, saying that it would be devastating for the economy. What's interesting is that such a tax, if implemented, would negate President Trump's ideologies on climate change, as it will penalize people who burn coal, oil and gas.

When you use fossil fuels to generate electricity, or to power your car, the energy or gasoline prices are reflected in the bill. What is not reflected is the price of negative externalities. An individual is not paying for the pollution caused by the car, even though it is impacting others who breathe the same air. A carbon tax is perhaps one of the better ways to promote the use of clean energy, as it will increase the price of electricity and gas, and therefore lead consumers to shift to hybrid cars and solar energy.

The impact of such a move on the economy in terms of unemployment and standard of living is still uncertain. However, assuming rational consumer behavior, if prices of regular commodities rise drastically and alternatives are developed and available at cheaper rates in the future, consumers are unlikely to shy away from clean energy.

Let's take a look at some ETFs that we think would be impacted if the tax is implemented:

VanEck Vectors Solar Energy ETF (NYSEARCA:KWT)

This fund offers exposure to solar energy companies and is appropriate for investors looking to diversify into the clean energy space.

It has AUM of $10.8 million and charges a fee of 65 basis points a year. The fund has around 20% exposure to the United States. A number of individual stocks in the fund saw gains on talks of a carbon tax. It has an 8.4% exposure to First Solar (NASDAQ:FSLR), up 1.86% (on April 4, 2017), a 7.1% allocation to Atlantica Yield Plc (ABY), up 0.91%, and 4.93% to Canadian Solar Inc. (NASDAQ:CSIQ), up 0.98%. It returned 4.32% in the year-to-date time frame and lost 24.97% in the past year (as of April 4, 2017).

VanEck Vectors Global Alternative Energy ETF (NYSEARCA:GEX)

This fund offers exposure to various alternative energy industries and is appropriate for investors who are bullish on the thriving clean energy space.

It has AUM of $68.4 million and charges a fee of 62 basis points a year. The fund has around 54% exposure to the United States. It has an 11.95% exposure to Tesla Inc. (NASDAQ:TSLA), up 1.74% (on April 4, 2017), which might be attributed to great sales data for its Model 3, a 9.59% allocation to Eaton Corp. Plc (NYSE:ETN), up 0.97%, and 4.87% to EnerSys (NYSE:ENS), up 0.87%. It returned 9.65% in the year-to-date time frame and 6.75% in the past one year (as of April 4, 2017).

iShares Global Clean Energy ETF (NASDAQ:ICLN)

This fund offers exposure to various alternative energy industries and seeks to invest in the global clean energy index.

It has AUM of $80.32 million and charges a fee of 47 basis points a year. The fund has around 26% exposure to the United States. It has over 5.7% exposure to Covanta Holding Corp. (NYSE:CVA), up 0.32% (on April 4, 2017), and over 4.8% allocation to First Solar. It returned 9.01% in the year-to-date time frame and lost 5.08% in the past one year (as of April 4, 2017).

To Conclude

All in all, there is growing uncertainty regarding the future of clean energy in the U.S. Though President Trump's stance on climate change does not present a bullish case for clean energy, the failure of his first major legislation might lead him to push harder for the clearance of the tax reform bill in the Congress. Further, demand for alternative energy and hybrid cars is on the rise with major players like Tesla increasingly focusing on electric cars and solar panels to change the market demographics.

Though the recent rumors have led to a surge in prices of alternative energy stocks, it is still not clear if such a tax will be implemented. Therefore, we believe it is best to remain on the sidelines for now.

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