Renewable energy firms have outpaced fossil fuel companies over the past decade, including during the recent pandemic crisis, generating higher returns and lower volatility. New research from Imperial College Business School shows that despite the advantages, institutional investors are failing to reap the rewards of renewables.
Renewable energy firms have outpaced fossil fuel companies over the past decade, including during the recent pandemic crisis, generating higher returns and lower volatility. New research from Imperial College Business School shows that despite the advantages, institutional investors are failing to reap the rewards of renewables.
“Our results show that renewable power is outperforming financially, but has still not attracted sizeable support from listed equity investors,” says Dr Charles Donovan, executive director of the Centre for Climate Finance and Investment at Imperial College Business School.
The researchers, in partnership with the International Energy Agency, compared three hypothetical portfolios of renewables companies against fossil fuels firms listed on the public markets in US, UK, Germany and France, that had a minimum market cap over GBP200 million.
In UK, in particular, the total return over five years for renewables, which included Ceres Power, Greencoat UK, and Nextenergy Solar Fund and stood at 75.4 per cent, versus 8.8 per cent for fossil fuels, whose constituents included BP, Petrofac, and Energean Oil and Gas. Meanwhile annualised volatility was at 25.6 per cent for fossil fuels, double that of renewables firms, at 10.6 per cent.
The reason why institutions have failed to take advantage so far, is a problem of liquidity and depth in the current market, says one of the report’s researchers and former Blackrock investment manager, Mili Fomicov.
Over the past decade, renewable energy hasn’t been “an investable universe for the large institutional investors”, because the vast majority of renewable energy securities in the market today do not have the size or daily traded volume to be deemed eligible investments.
“Large asset managers have to have ample liquidity because they are often obliged to buy a similar asset across all of their client’s portfolios,” explains Fomicov.
The researchers say investors can expect to see corporate changes in the coming years, such as spin-outs, carve-outs, and reorganisations of the type pioneered by Germany’s biggest utilities firm, Eon. Back in 2016, Eon dispensed with all of its coal and gas-fired power stations, housing them in a new entity called Uniper.
“If there’s now value being created in a particular subsegment, then things need to be reorganised along those lines,” says Donovan.
Across all geographies, their research found renewable energy outpacing fossil fuels. In France and Germany, the 10-year total return for renewables stood at 171 per cent, compared to -25 per cent for the fossil fuel portfolio. The European Union’s target of 32 per cent renewable energy by 2030, and the initial public offering of pure-play renewable developer Neoen, sparked a significant rally beginning in 2018.
Renewables also proved more resilient to the pandemic, with the US portfolio, which which included First Solar and Fuelcell, continuing to show higher returns than both fossil fuels and also the S&P 500 overall between January and April 2020.
So far, these high returns have only been enjoyed by the more nimble and opportunistic hedge-funds and family offices. Donovan says these are “important pockets of capital”, but they are “not the main dish” when it comes to trying to electrify the global economy.
“We’re getting well beyond the point where we can see renewable power as just an add-on. We’re talking about a fundamental shift in which any credible scenario towards climate stabilisation means a massive electrification of the global economy, and that’s a theme investors need to be paying attention to.”
An important thing that their findings show is the way that climate risk is already affecting returns for traditional energy companies.
The Imperial team notes the International Energy agency’s forecast that global oil demand is expected to fall by a record 8.6 mb/d year-on-year in 2020, with the recovery expected to be gradual. “Without the traditional balancing mechanism of increased consumption from lower prices, oil and gas companies have slashed capital expenditure guidance upwards of 25 per cent for the year, with potentially larger cuts on the horizon,” warns the report.
Donovan adds: “There are some real risks, going forward, for the energy industry: one is clearly around some form of carbon tax, which is looking increasingly attractive at this level of commodity prices, and the need to deal with huge holes in government budgets. When it comes to volumes, there’s a real possibility that we have seen peak demand.”
