A sharp correction in technology and innovation stocks is hitting renewable energy companies again, fostering a new bout of whiplash for their share prices – and raising questions about investors’ recent emphasis on environmental, social and governance concerns, commonly known as ESG principles.
Renewable energy stocks first crashed last February when the market’s frothiest sectors sold off, and they are struggling again as investors turn on young technology companies and others in the broad innovation sector, including Zoom Video Communications Inc. , Netflix Inc. and Goodfood Market Corp.
Many of these innovative businesses thrived when people were stuck at home, because investors assumed the companies were seizing on a new way of living. The same applies to the renewable sector. Much of the optimism has faded in recent months and the once-popular Ark Innovation ETF, which used to embody the growth stock movement, has plummeted 43 per cent since Nov. 1.
So far, Canadian renewable energy companies haven’t been decimated to the same extent, but they have certainly struggled. The S&P/TSX Renewable Energy and Clean Technology Index, which includes 21 companies developing green technologies in a range of industries, had slid 18 per cent since the start of November, while the S&P/TSX Composite Index is down 1.4 per cent over the same time frame.
The recent selloff has hit giants such as Brookfield Renewable Partners LP as well as smaller but established producers with long-term contracts such as Innergex Renewable Energy Inc. and Boralex Inc. The correction has been particularly rough on companies that once traded like high-flying growth stocks, such as Burnaby, B.C.-based Ballard Power Systems Inc. The fuel cell producer’s shares have been on a roller coaster over the past two years, echoing their rise and fall during the dot-com boom. Ballard’s stock is down 48 per cent since Nov. 1.
Newly listed companies have also taken a beating. Montreal’s Lion Electric Co. , which is backed by the Desmarais family and hopes to electrify the heavy-duty vehicle industry, is one of the sector’s worst performing stocks, down 42 per cent since November. Shares of Burnaby-based fuel-cell producer Loop Energy Inc. , which is thought of as a baby Ballard and went public in early 2021, have tanked 79 per cent since listing on the TSX early last year.
Oddly enough, the sector’s reset is playing out following last fall’s COP26 summit, which was held after months of destructive and deadly weather that included floods, heatwaves and wildfires. Many countries have committed to reaching net-zero emissions by 2050 and their pledges should bode well for makers of electric vehicles and other renewable energy technology, but the market slide has only intensified since the climate summit ended. Meanwhile, share prices of fossil fuel producers have soared.
The recent selloff largely stems from investors cashing out profits in the technology and innovation sectors as the froth started to come out of the market. The same is true of the renewable industry. However, renewables are also reeling from fundamental issues – notably, cost inflation and the expectation of future interest rate hikes. On top of these forces, renewable energy – and wind power, in particular – proved to be a fickle energy source at various points in 2021.
The roots of the sector’s recent whiplash are best understood by zooming out. For many years, renewable power companies were treated as yield stocks, because many producers lock in long-term power supply contracts that deliver stable cash flows over time, much like bond interest payments.
How 2021 became the year of ESG investing
Over the first year of the pandemic, however, investors started to consider society’s other major vulnerabilities and in no time many renewable energy producers were treated as growth stocks based on their future potential, rather than their existing supply contracts. Ballard Power’s shares surged 306 per cent from March, 2020, to February, 2021.
U.S. President Joe Biden’s election in November, 2020, was another major catalyst, because he had preached the virtues of a green economy throughout his presidential campaign. After he won, “there was a massive inflow of money into ESG funds that drove through the whole sector,” Rupert Merer, an equity analyst at National Bank Financial who specializes in renewable power, said in an interview.
Much of this optimism faded over the past year, owing to dysfunction in the U.S. Senate and COVID-19 concerns in the United States. “As long as there’s uncertainty over the Biden legislation, there’s going to be uncertainty in the sector,” Mr. Merer said.
The renewable sector also faced a crisis last summer when wind all but disappeared for several weeks in parts of Britain and Europe, and more recently, cost inflation has weighed on the sector. The solar industry in particular is taking a hit, because its production relies on commodities such as copper and aluminum, whose prices have jumped. Wood Mackenzie, an energy consultancy, recently slashed its growth projections for utility-scale solar projects in the U.S. by one-third for 2022.
“There’s been a real change in how investors are perceiving these asset classes, because of inflation mostly,” Darryl McCoubrey, an analyst at Veritas Investment Research, said in an interview. Higher costs not only hurt profit margins on development projects, but a reliance on long-term supply contracts also means it can take years to reap the rewards from higher power prices.
Heavy inflation across the economy is also forcing central banks in Canada and the United States to suggest they will start raising interest rates in March. Renewable energy producers tend to have much higher debt levels than fossil fuel-fired generators and even oil producers, Mr. McCoubrey said, prompting investors to consider how much it will cost these companies to borrow in a higher rate environment.
None of this is to say that demand for green products and services will die off. Countries including Canada face massive investments in new and existing technology to achieve their Paris Agreement commitments to slash emissions. “We know that investments in the energy transition will need to triple in the next few years to meet our net-zero goals,” said John Bai, chief investment officer at sustainable investing firm NEI Investments.
Investors, though, will have to be more discerning about which companies are best equipped to capitalize on the transition.
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