What's Wrong With Renewable Energy Stocks

...and why it won't last for all

America’s so-called culture war has spread to energy. Loud voices now viciously attack literally every available energy source on grounds ranging from basic economics and the environment to geopolitics. And there’s no shortage of misinformation and conspiracy theories that would been laughed off just a few years ago.

Unfortunately, one very real consequence is industry is having an increasingly difficult time making investment needed to ensure Americans have access to abundant, affordable, reliable and sustainable energy. And for investors, the challenge of separating hype from substance has become quite steep.

Rule number one: Management of any company you buy must be relentlessly focused on the bottom line. But what about when the business grows robustly and the stock still chronically underperforms?

That’s been the case for roughly two years with companies generating electricity from CO2-free sources under long-term contract. Leaders like Brookfield Renewable Partners (TSX: BEP-U, NYSE: BEP), Clearway Energy (NYSE: CWEN) and NextEra Energy (NYSE: NEE) are reliably boosting earnings by adding wind, solar and energy storage capacity, with their return on those investments basically locked in for decades.

The trio has also shared their growing income with investors as a rising stream of dividends. Brookfield and Clearway have been boosting 5 to 8 percent a year, NextEra by more than 10 percent. Yet these three stocks sell for 20 to 40 percent less than they did two years ago—and it’s fair for investors to ask why.

I see four reasons. First, the overall stock market is relatively flat since early 2021, with a big gain that year followed by losses in 2022 and a mostly flat Q1 in 2023. It’s difficult for any stock or sector to make real headway in this kind of environment.

Second, in early 2021, the renewable energy sector was clearly in bubble mode. In 2020, for example, earnings-less company FuelCell Energy (NSDQ: FCEL) was up 345 percent, while Tesla Inc (NSDQ: TSLA) returned 743 percent. Brookfield roughly doubled.

Investors didn’t bid up these stocks for their business promise. Rather it was all about trying to get exposure to expected energy policies of the incoming Biden Administration.

We’ve certainly seen this movie before, for example the hype surrounding the oil business when George W. Bush and Donald Trump each became president. And both times, post-inauguration reality paled miserably in relation to the post-election hype.

In a very real sense, the Biden Administration has been far more aggressive policy wise regarding energy than any of its predecessors. That starts with $1 trillion plus in infrastructure spending and then the Inflation Reduction Act’s (IRA) $347 billion. And the raw dollars have been at least matched by regulatory initiatives, such as the 180 degree turn on offshore wind permitting.

Even these actions, however, weren’t enough to keep inflating the bubble renewable energy stocks had reached in early 2021. And what’s happened since to these stocks has been pretty much deflation.

Ironically, the third reason renewable energy stocks have underperformed is the details of the IRA itself. The Dow Jones Utility Average outperformed the S&P 500 by 20 percentage points in 2022 in large part because of investor expectations for a capital spending boom on the back of IRA tax incentives. But that did not materialize in meaningful capital spending increases for 2023.

To be sure, there have been some boosts. NextEra Energy, for example, raised its 5-year solar and wind buildout projection by 15 percent from the prior year. But with the stock slumping on that news, investors were clearly expecting more. And the same thing happened to shares of rooftop solar leader Sunrun (NSDQ: RUN), which forecast mid-teens percentage deployment growth in 2023.

Holding back investment is the fact that the IRA is as much industrial policy as a plan to accelerate spending on renewable energy. NextEra management noted during its Q4 earnings call that the IRA has the potential to significantly cut the cost of its current deployment plans for solar, wind and energy storage. And Xcel Energy (NYSE: XEL) CFO Brian Van Abel attached numbers to that assertion, including cuts of 25 to 40 percent for solar projects and 50 to 65 percent for onshore wind.

But those IRA tax credits come with requirements for local content and labor attached. Those are designed to encourage manufacturing in the US. And whether you agree that’s a worthy goal or not, re-shoring means moving from lower to higher cost production areas. That means higher prices for key components, as well as potential supply chain disruption. And with tax credits extending to the next decade, you can’t blame companies for holding off until they can get a handle on where costs are going.

Also, the Biden Administration has been unable to date to deliver on energy infrastructure permit reform, the “side deal” that delivered Senator Joe Manchin’s (D-WVA) critical vote on IRA. That means renewable and fossil fuel projects are still encountering crippling delays on the federal level, in addition to numerous and growing state regulations.

The fourth reason renewable energy stocks are underperforming is the negative impact of rising costs. Federal Reserve attempts to squeeze inflation have dramatically increased the cost of borrowing. Construction costs have surged with higher prices for commodities and skilled labor. And a rush to build in the wake of Russia’s Ukraine invasion has set off a global competition for resources.

Spiking natural gas costs in theory increase competitiveness of renewable energy. And utilities pass them through automatically to consumers and businesses in rates. But ironically, by driving up the price of electricity short-term, rising gas has increased resistance to industry CAPEX, particularly from utility regulators.

Officials in New England, for example, have been unwilling to date to negotiate higher rates with offshore wind developers to offset recent spikes in building costs. As a result, many projects are now effectively on hold, decreasing odds we’ll see anything close to the 30 GW by 2030 as once promised by the Biden Administration.

Now for some good news. While there are still plenty of hyped up, earnings less renewable energy companies, there’s also a growing number of cheap sector stocks with actual earnings and dividends. Their management is figuring out the IRA, which can’t help but cut their cost of investment for new wind, solar and storage to power growth.

We may or may not see sensible energy permit reform. But just as with restrictions on oil and gas production and related infrastructure, limits on renewable energy development will restrict future supply relative to demand. And that means the companies that can build capacity now will be all the more prosperous down the road.

Renewable energy does have limitations, intermittency being the biggest. And government insistence on producing components and mining materials in the US and allied nations is driving up costs, as are inflation and rising interest rates. But the technology is established. Costs are a fraction of what they were a decade ago. And renewables’ performance and costs stacked up well against spiking natural gas and coal prices this past winter.

The world is going to need investment in oil, natural gas, nuclear and other sources of energy for decades to come. But there’s plenty of room for rapid growth in wind, solar, energy storage and someday maybe even hydrogen. And that means a major opportunity in suddenly cheap renewable energy stocks—at least those of companies with actual earnings.