Headwinds for renewable energy

Rising costs for personnel, materials and higher financing rates dented European wind turbine makers such as Vestas and Siemens Energy. Solar technology players, for example Enphase Energy, are faced with higher inventory levels and weaker end demand.

Green-energy company Orsted was also hit hard. The company previously tried to renegotiate a deal, that had been signed with New York's local government years before, for the construction of a massive offshore wind farm off the coast. But as time progressed and market conditions, such as continuous supply-chain-related delays and rising financing costs, deteriorated further, the offshore-wind pioneer was forced to record a huge impairment related to the project.

Basically, renewable-energy companies are often mentioned as candidates to benefit from the energy transition. But following this news and recent share price developments, the question rises whether this is still the case. Often, these companies are in the utilities, industrial, materials or IT sectors.

In this article, we discuss, among other things, the utilities sector, the impact of rising interest rates, the importance of energy security and expectations for the future.

Before looking ahead, it is important to understand how the utilities sector has behaved in recent history. Low interest rates in general have been a major factor of the sector’s success in recent years. Utilities have large capital investment requirements in order to operate and therefore tend to have more debt on their balance sheets. Low interest rates gave the sector an important boost.

The sector was also attractive from an investment perspective. Utilities, which provide essential needs such as water, gas, electricity and waste services, are less dependent on the state of the economy. As a result, shares of these companies have a cushioning effect on the portfolio during periods of economic uncertainty. It is also helpful that many of these companies pay attractive dividends.

Although utilities are traditionally known for their predictable results, the sector has been shaken up several times in the past decade. First, because of the growing awareness to combat climate change. This has prompted governments around the world to set ambitious goals to reduce carbon emissions.

Most utilities are by the nature of their business activities responsible for high CO2 emissions, but they are also aware of the important role they play in the energy transition. As such, in recent years, they have stepped up their efforts to reduce CO2 emissions. Companies such as Orsted, Veolia, Iberdrola and American Water Works have set interim climate targets to achieve net-zero CO2 emissions, and these have been accompanied by hefty investments.

More recently, we see that the European energy crisis has left its mark on the sector. Following the war between Russia and Ukraine, gas and electricity prices shot up. Consumer bills also rose. Utilities benefited, but also faced increased political control and operational problems. With the energy crisis subsiding and gas supplies in Europe now at comfortable levels, the situation for European utilities has stabilised somewhat. However, this is not yet the case for forerunners in the energy transition.

So while low interest rates have long favoured the renewable energy sector, this tailwind has now turned and changed into a substantial headwind. Rising inflation has led to significantly higher construction costs for renewable energy projects, yet at the same time financing costs have risen. While this is true for all utility companies, these developments hit green project developers harder.

At the same time, governments are keen to score on their climate targets, but are facing opposition when it comes to costly renewable energy projects. In some cases, the political will to realise climate ambitions seems to have become even more fragile.

Nevertheless, there is no doubt that the energy transition is here to stay. The transition to clean energy is taking place worldwide and is unstoppable. The question is not ‘whether’, but rather ‘how fast’. The International Energy Agency estimates that USD 2.8 trillion will be invested in energy this year, of which more than USD 1.7 trillion is for renewable energy. The remaining USD 1 trillion will go to fossil fuels. In other words, for every USD 1 spent on fossil fuels over USD 1.7 is invested in renewable energy. This ratio was one to one five years ago¹. Also, these investments are rising sharply in the coming years.

We assume that in case long-term interest rates have peaked and would start to move south again, the worst headwind for renewable-energy companies may subside. Furthermore, we see that large oil companies, such as Shell and BP, are pulling out of renewable-energy development projects, resulting in less competition for tenders. This increases the opportunity for renewable-energy companies to achieve acceptable margins on projects.

The utilities sector as a whole can offer investment opportunities with its strong balance sheets, expected solid earnings growth and attractive dividend policies. A decrease in interest rates would also support the valuation of renewable energy companies. Supportive government policies, such as the Inflation Reduction Act in the US, can also act as a catalyst in this regard.

It remains important, however, to be selective and look at companies that are more at the core of the energy transition, or that can benefit indirectly. This includes, for example, industrial companies offering services and products in the field of energy and water efficiency and grid modernisation. In case you want to know more about this, please contact your investment advisor.

Arthur Boelman - Expert equity research and advice
Judith Sanders - Sustainable Investment Strategist

¹This was published by the IEA in its latest World Energy Investment Report