- The share of the world’s energy generated from renewable, zero-emission sources will likely more than triple over the next 30 years.
- Excitement around renewables has pushed up stock prices for onshore wind and utility-scale solar companies.
- Utilities, commodity, and natural gas producers may offer lower-priced alternatives to renewable energy stocks while benefitting from the same long-term changes in the energy sector.
- Looking to invest in the green energy revolution? Do your research. Or consider funds managed by professionals.
Since 1859 when Edwin Drake drilled the first commercial oil well on a Pennsylvania farm, fossil fuels have created wealth for investors and transformed life by bringing cheap, reliable heat, light, and mobility to people who previously dwelt in cold, darkness, and isolation.
Now, a second energy revolution is taking place. Research firm Bloomberg New Energy Finance predicts worldwide energy demand is predicted to increase 9% between 2019 and 2050. During that time, the share of the world's energy derived from solar, wind, and other renewable sources will rise from 4% today to 14%. In total, they expect zero-emission power sources, including nuclear and bioenergy, will grow to provide 27% of the world's primary energy, up from 17% today.
With wind, solar, and other technologies increasingly supplementing or even supplanting oil and gas, opportunities are appearing for investors who can identify companies that can thrive in the next era of energy.
Meanwhile, familiar companies in the oil, gas, and electric power sectors that long provided investors with capital appreciation and attractive dividends must adapt to meet new demands from regulators and competitors alike.
The question for investors is how to take advantage of these opportunities while avoiding the very real risks that come from investing in emerging industries where exuberance may be irrational, earnings unpredictable, and markets not the only forces determining success or failure.
Since 1979, the federal government has subsidized the growth of wind and solar technology to stimulate demand and lower costs, with considerable success. The US Energy Information Administration estimates that the cost of solar power has declined by 82% since 2010 and that the cost of wind power has declined by 43% since 2010. While solar and wind may now compete on cost with gas and oil, continued reliance on subsidies makes the long-term profit potential of these companies harder to assess as the industry matures and competition increases.
Finding opportunities, managing risks
In this exciting but uncertain environment, Fidelity's portfolio managers rely on rigorous fundamental research to make decisions about how to invest in the new era of energy. Says Kevin Walenta, manager of Fidelity® Select Environment and Alternative Energy Portfolio (FSLEX), "If you have power sources like onshore wind and utility-scale solar that are cost competitive with oil and natural gas, it just makes economic sense to make that investment. These industries have been able to take down costs, to innovate, and to invest in products that companies want. They're standing on their own two economic feet, so to speak."
Those circumstances have not gone unnoticed by investors who have poured money into renewable energy stocks and pushed valuations to levels that may seem unconnected to familiar measures such as price earnings (P/E) ratios.
Those high stock valuations further complicate the challenge of identifying which emerging companies have strong prospects for long-term viability. As Walenta puts it, "There are premium valuations for companies that perform well on environmental, social, and governance factors, whether they have strong earnings or not. There are hydrogen energy companies with $30 billion market caps that are just beginning to show revenues. Those are big numbers."
Walenta relies on fundamental research to identify firms he believes could have durable competitive advantages and generate significant free cash flow over time. "I want to know why they'll be around in 3, 4, or 5 years—or longer. The way I get more comfortable with that is looking at a company's balance sheet. I ask, 'can they make it through a bad spot in the market? Do they generate consistent cash flows in their business? Do they have a competitive advantage?'"
Walenta notes that because technology changes so quickly, there's a good chance that today's winners may not be on top in a few years. Hydrogen and offshore wind are newer entrants to the energy landscape. "They're perhaps as much as a decade behind where onshore wind and utility-scale solar are, but if they execute, they should be able to get their costs down to be much more competitive with more traditional energy sources," he says.
A commodity opportunity
If high-priced stocks of yet-unprofitable companies leave you cold, Jody Simes, manager of Fidelity® Select Materials Portfolio (FSDPX) says investing in producers of the raw materials used in renewable power hardware and electric vehicles (EVs) may offer an opportunity.
Around the world, governments are increasingly requiring manufacturers to phase out gasoline and diesel-powered vehicles in favor of those powered by batteries made of commodities, including lithium, cobalt, and nickel.
While most consumers continue to favor conventional cars over EVs, which are expensive and have limited range, producers of commodities such as lithium, cobalt, copper, and nickel should enjoy rising demand as policymakers mandate batteries rather than barrels.
Simes says while the near-term outlook for lithium and some other commodities is clouded by oversupply, there could be a supply crunch by the mid-2020s. In fact, robust demand for lithium-ion EV batteries means that overall demand for the metal is likely to enjoy double-digit annual growth.
Copper is also a major component of EVs, as it's used in electric motors, batteries, inverters, wiring, and charging stations.
New power generation
Investors who have long viewed electric power producers as recession-resistant investments and reliable dividend payers may now also look to them for exposure to the future of energy as they invest billions in cleaner or renewable fuels.
Many firms that are increasing their investments in renewables, such as NextEra Energy (NEE) and Clearway Energy (CWEN) have traded at P/E multiples notably above the sector average. However, Maurice FitzMaurice, manager of Fidelity Select® Energy Fund (FSENX) says he's "found a few firms that I think are underappreciated—especially if we see a faster shift toward greener power under the new presidential administration."
FitzMaurice is focused on cheaper stocks he thinks could possibly trade for a premium eventually, such as AES. The Virginia-based utility generates about a third of its earnings from renewable energy, and FitzMaurice expects a good majority of its profit to come from renewables by 2030.
Give gas a chance
While pricey stocks of zero-emission energy technology makers get all the attention, opportunities are appearing in a reliable and relatively low emission corner of the energy sector—natural gas.
Gas is expected to remain an important source of energy for the foreseeable future. FitzMaurice points to Cheniere Energy (LNG) as an example of companies that could benefit from the emphasis on cleaner power sources. "It's an attractively priced cleaner-energy play that is seeking to make natural gas an alternative to relatively dirtier coal and diesel,” he says.
Given its long-term role in the shift toward a cleaner energy future, gas is remarkably cheap right now, too. Peter Belisle, portfolio manager of Fidelity® Select Natural Gas Portfolio (FSNGX) says he "still sees historic values in the sector, even after a roughly 35% rally for energy stocks in the last two months of 2020.”
Besides bargain-priced gas company stocks, Alexandre Karam, co-manager of Fidelity® High Income Fund (SPHIX), sees opportunities in bonds of energy companies that have been pushed below investment grade. When bonds fall below investment grade, many bond funds must sell them, which may present opportunities for investors in high-yield bond funds.
Those who want to invest in the future of energy should consider professionally managed mutual funds and ETFs such as those mentioned in this article.
Fidelity® Select Environment and Alternative Energy Portfolio, Fidelity® Select Materials Portfolio, Fidelity® Select Energy Fund, Fidelity® Select Natural Gas Portfolio, and Fidelity® High Income Fund held securities mentioned in this article as of their most recent holdings disclosure. For specific fund information, including holdings, please click on the fund trading symbols above.