With surges and slumps common among renewable energy investments, it’s no wonder many investors avoid them. But it is time to pay more attention to the highly volatile sector, particularly wind and solar.

The recent collapse in global oil prices has put pressure on green energy stocks, and meanwhile federal investment tax credits for solar projects are set to expire at the end of 2016. Even so, the industry’s long-term momentum is accelerating.

Concerns about energy security (the availability, reliability and affordability of energy supplies), climate change and the health toll of air pollution are boosting interest, as are steep declines in the cost of providing solar and wind energy.

Global investments in renewable energy, led by wind and solar, rose 17% last year to $270 billion—just 3% below the record high set in 2011—according to the 2015 annual trends report from the United Nations Environmental Programme (UNEP) and Bloomberg New Energy Finance.

China, which has ramped up its renewable energy policies, saw the biggest 2014 renewable energy investments, followed by the U.S. and Japan. Investment in developing nations jumped 36% in 2014 to $131 billion, nearly half the global total.

Europe also remains a strong force. Over the past decade, four-fifths of its investment in power generation went to renewables, with 60% to wind and solar photovoltaics, according to the International Energy Agency (IEA).

Impax Asset Management Group PLC—a $4.6 billion investment manager dedicated to investing in opportunities created by the scarcity of natural resources and growing demand for cleaner, more efficient products and services—has used the recent pullback in stock prices as an opportunity to boost its renewable energy holdings.

“There is a misperception in the market that lower oil prices are dampening prospects for renewables,” says David Richardson, a managing director and head of U.S. business development and client service for Impax, which has offices in London, New York, Portland, Ore., and Hong Kong. In reality, oil is more of a transportation fuel, he says, and most new electricity generation capacity is coming from renewable sources.

Impax anticipates numerous long-term drivers for renewable energy, including an extension of some tax credits and some new policy initiatives coming out of the U.N. climate talks in Paris later this year. Dramatic declines in the cost of solar and wind equipment and the energy they produce, which are expected to continue, will also help, he says.

“There is soon going to be this tipping point where renewables without legislation and government support are going to be less expensive than conventional sources,” says Richardson. “Then growth in renewables will really accelerate.”

There are several opportunity sets, he notes, to invest in the equipment-supply side of renewables. This includes original equipment manufacturers (OEMs) that make wind turbines and solar panels; firms that supply OEMs with components, such as gearboxes and generators for wind turbines and silicon wafers for solar panels; and producers of the sophisticated factory machinery used by OEMs.

“It’s easier to see earnings visibility through some of the second and third derivative companies involved in renewable energy,” he says. “We’re focused not so much on the miners, which would be the manufacturers, but on the pick suppliers.”

“All types of renewable energy will be important over decades to come,” he says, “but we see fewer investment opportunities for us in some areas such as geothermal, hydro and biofuels.” Fewer pure-play companies make components for geothermal and hydro, he says, and energy input costs for biofuels can be quite volatile. Longer term, this may become less important to the investment thesis for biofuels, he says.

 

Impax tends to favor global companies because they don’t face systemic risk if a utility or policy initiative slows development in a particular market. It shies away from new technologies—because it’s difficult to build a diversified portfolio with them—and prefers to invest in “proven technology that’s just riding the long-term growth curve of renewable project development,” he says.

Despite its enthusiasm for renewable energy, Impax limits its exposure to the sector because of its volatility. “It’s not because of the long-term growth themes,” says Richardson, “but just because investors don’t understand it very well and sentiment and mood can change pretty quickly.”

As of March 31, renewable and alternative energy constituted 6.6% of the assets in the Pax World Global Environmental Markets Fund, which Impax subadvises. Another 33.1% was allocated to energy efficiency. In late 2014, the fund (traded under the symbol “PGINX”) added positions in China-based Huaneng Renewables Corp. and Trina Solar Ltd. and in Italy-based Enel Green Power S.p.A.

Major Shifts
Ron Pernick, founder and managing director of Clean Edge, a 15-year-old Portland, Ore.-based research and advisory firm devoted to the clean-tech sector, has observed three major recent shifts regarding investing in renewable energy.

Corporate and institutional investors have begun to get more active here over the past three to five years, he says, and there has been a shift from equity investments in technology companies to debt finance for projects.

For example, Google has agreed to fund more than $2 billion in renewable energy projects and uses renewable energy to power 35% of its operations. Bank of America Merrill Lynch has teamed with SolarCity, the U.S.’s largest solar provider, to finance $600 million in residential and commercial solar projects.

The third shift in renewables, he says, is the debut over the past two years of more investment vehicles for retail investors. A dozen or so exchange-traded funds now focus on clean tech and renewable energy, including the seasoned Guggenheim Solar ETF, PowerShares WilderHill Clean Energy Portfolio and First Trust Nasdaq Clean Edge Green Energy Index Fund, which is based on the Nasdaq Clean Edge Green Energy Index (CELS).

Though still barred from master limited partnership structures, renewable energy assets are now permitted in REITs. Yieldcos are also becoming a popular financing mechanism, particularly for solar. Energy providers are establishing them in order to bundle operating assets that generate predictable cash flows. Yieldcos, traded on the major stock exchanges, offer yields in the 5% to 7% range, says Pernick.

The CELS index has five yieldcos, including Pattern Energy Group (PEGI), an independent power company that operates wind power facilities in the U.S., Canada and Chile. Hannon Armstrong Sustainable Infrastructure Capital (HASI), a REIT in the index, provides debt and equity financing to the energy efficiency and renewable energy markets.

Additional fixed-income inve stments in renewable energy are also emerging, he notes. In October, SolarCity launched the U.S.’s first registered public offering of solar bonds.

 

Meanwhile, more than a dozen states already source over 10% of their electricity from clean energy (Iowa and South Dakota receive over 25% from wind), California is targeting 50% from renewables by 2030, and “Americans of all political stripes are firmly behind renewables,” says Pernick. “China is choking on its emissions and Japan is post-Fukushima,” he adds, referring to the nuclear disaster.

He is closely watching energy storage, an area with recent announcements from Tesla Motors, SolarCity and Greensmith Energy Management Systems. “It’s one of the last great frontiers,” he says. “We’ll see consolidation, prices coming down and breakthroughs in energy storage that really complete the distributed grid equation.”

Stu Dalheim, vice president of shareholder advocacy at Calvert Investments in Bethesda, Md., says improvements in the grid and the ability for grid operators to have greater control over transmission will help address the geographic limitations and intermittency of renewables.

For example, Southern Company, which is making big investments in its smart grid, plans to send the wind it generates in Oklahoma to its utilities in the southeast, he says.

Going Greener
Dalheim notes that more than 40% of Fortune 500 companies have set targets for emissions reductions, energy efficiency or renewable energy. He thinks the EPA’s Clean Power Plan, now being debated, will push states to invest more in energy efficiency and renewable energy.

Already, “Calvert is seeing a huge appetite from its client base and from the public for renewables,” he says. Rebecca Henson, a senior sustainability analyst at Calvert, says the firm offers exposure to renewable energy through its Global Energy Solutions Fund, Global Water Fund and Green Bond Fund.

Included among the bond fund’s holdings, she says, are TerraForm Power—a SunEdison subsidiary and yieldco—and solar bonds from SolarCity.
TerraForm operates solar farms and teamed up last year with SunEdison to acquire First Wind. SolarCity works in the residential, corporate, government and school markets.

Colm O’Connor, co-portfolio manager of the Calvert Global Energy Solutions Fund (CGAEX) through Dublin-based subadvisor Kleinwort Benson Investors (KBI), thinks solar offers the most interesting near-term opportunities in renewable energy. Its rapid decline in costs and stepped-up adoption rate are attractive. He also anticipates a strong rush by developers to install solar projects before the federal investment tax credits expire at the end of 2016.

He expects the tax credits, now 30%, will be reinstated somewhere between 10% and 30% rather than killed because the solar industry creates many jobs.  In addition, “We think the environment has never been better for financing,” he says.

O’Connor’s top pick in the portfolio is Canadian Solar, a leading maker of solar cells and modules. It also installs projects globally and is active in the U.S., China and Japan. The company plans to launch a yieldco. “We think that’s a very attractive catalyst that should unlock the value of Canadian Solar shares,” he says.

Other solar holdings in the portfolio, which he also expects will benefit from their recently announced yieldcos, include SunPower Corp. and First Solar.
O’Connor’s current favorite wind stock, Huaneng Renewables Corp., gets most of its growth from China and emerging markets. China’s central bank is reducing rates, which should help improve the debt on the company’s balance sheet, and the expected return to normalized wind conditions should help Huaneng’s cash flow, O’Connor says. He also likes Gamesa, a Spain-based wind turbine manufacturer with a leading position in Mexico, Brazil and India.

O’Connor monitors offshore wind opportunities, but cautions it’s a more difficult technology in a less scalable market. Saltwater is corrosive to offshore wind turbines, which are harder to repair and connect to the grid. The fund holds a small position in Toronto-based Northland Power. It is part of a consortium that is building a large offshore wind park in the North Sea.

He expects energy storage to become a bigger part of the energy mix, but says there are still only a few listed pure plays in this area. “If we were to fast-forward maybe 10 years’ time,” he says, “I think we’d be having a very different conversation.”

To help manage the volatility of the renewable energy sector, the Calvert Global Energy Solutions Fund has stepped up investments tied to energy efficiency.

O’Connor predicts the sector will become less volatile. “We would strongly argue this is just the beginning,” he says. “The technology is slowly becoming mainstream and much more accepted by the investment community and consumers.”