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IF Insights: The Sticky affair between high interest rates & clean energy growth

Till October 2023, the World Economic Forum observed that renewable energy stocks performing worse than their fossil fuel counterparts due to higher interest rates

In the recently concluded 2023 chapter of the United Nations Climate Change Conference (COP28), the message from the politicians and industry stakeholders was clear: ‘The future is not in fossil fuels’.

However, if one carefully scans the ground situation, a different picture will emerge.

Till October 2023, the World Economic Forum observed that renewable energy stocks performing worse than their fossil fuel counterparts due to higher interest rates. The S&P Global Clean Energy Index dropped 20.2% in the last half of 2023.

In contrast, the oil and gas-heavy S&P 500 Energy Index saw a 6% increase. Despite governments around the world offering billions in tax credits and subsidies, the renewable energy sector is dealing with rising interest rates, which have made it difficult for stakeholders to manage long-term contracts and higher costs.

Understanding The Full Picture

Over USD 4 trillion a year in investment is needed over the next 30 years to meet the goal of net zero by 2050, International Energy Agency (IEA) told recently. While Arun Majumdar, dean of Stanford University’s School of Sustainability, described the estimation as the “defining investment challenge and opportunity of the 21st century”, Greg Jackson, chief executive of renewables pioneer Octopus Energy, batted for the formation of a revolutionary new global energy grid.

Even if the renewable energy sector grew in 2023, the pattern was not uniform across all the verticals.

“In a bifurcated renewable landscape, the solar market brightened in 2023, while wind faced sweeping challenges. The latter bore the brunt of project inputs, labour and capital cost pressures, interconnection and permitting delays, and transmission limitations. Meanwhile, supply chain constraints started easing as historic clean energy and climate laws took effect,” commented a Deloitte study.

While the central banks around the world kept on increasing their interest rates to tackle the skyrocketing inflation throughout 2023, it only made it harder for the renewable energy companies to meet their costs, causing these ventures to trim profit forecasts, reduce dividends and pull back expansion plans. All these moves resulted in a stock market selloff.

As per the Corporate Knights, the only saving grace here is the fact that the investors have shown strong interest in climate-related funds in 2023. While these stakeholders are still optimistic about the overall industry health, the IEA only sees a substantial pause in the rate hike cycles easing up things for the sector further, especially in emerging markets and in developing countries.

Finding The Positivity

Another good news is in the form of the resilience shown by the sustainable and climate funds. As per the investment information provider Morningstar, global assets of mutual funds and exchange-traded funds (ETFs) with a climate-related mandate surged by 30% to USD 534 billion between January 2022 and June 2023.

“The number of climate funds globally has grown from fewer than 200 in 2018 to more than 1,400 currently, which has been a key driver of rising investor interest. Most are equity funds, but they also include 125 green bond funds, which are expected to attract growing interest. Recently, BlackRock announced a major new private debt fund to help meet the fast-rising debt needs of climate-transition companies,” Morningstar observed.

Sustainable funds too have grown, stated Morningstar, which remarked further, “In the third quarter of 2023, these funds attracted USD 13.7 billion in net new investment, compared with the non-ESG mutual fund and ETF market, which had net redemptions of almost USD 3 billion.”

Europe has emerged as the largest sustainable fund market with 84% of total global assets. In the 2023 Q3, it saw net inflows of USD 15.3 billion, compared with net redemptions in the United States of USD 2.7 billion.

“In Canada, sustainable funds experienced net withdrawals of USD 52 million in the third quarter, but total assets declined by only 0.3%, half the rate of decline of conventional funds at 0.6%,” Morningstar noted further.

The share of Canada’s total sustainable investment market rose to 49% at the 2022 end from 47% in 2021, as per Canada’s Responsible Investment Association, which also noted that 93% of asset owners and managers surveyed were tracking greenhouse gas emissions.

Slowdown In The US

Talking about high interest rates killing the renewable energy sector, we have the United States’ case study, where the Federal Reserve’s monetary policy tightening throughout 2023 resulted in renewable energy investments getting hurt.

Clean energy projects require developers to borrow large amounts of capital upfront to build projects. As per the IEA, a 5% rise in interest rates increases the electricity cost from wind and solar by a full 33%, a significant rise, nonetheless.

“The Invesco Solar ETF has cratered -42.1% over the past 12 months compared to a much tamer -3.7% loss by the Energy Select Sector SPDR Fund. There’s a dark cloud hanging over green stocks,” Martin Frandsen, portfolio manager at Principal Asset Management, told the Financial Times.

The American solar sector enjoyed a lucrative year in 2023, with the overall installed capacity increasing to a record 33 GW.

However, talking about 2024, as per the Solar Energy Industries Association (SEIA) and Wood Mackenzie, the sector will see a more modest 10% growth in installed capacity in 2024, hampered by high interest rates and the net metering policy in California.

Add California’s new solar policy, dubbed as ‘Net Energy Metering 3.0’, which decreases the value of energy credits by a whopping 75%. The California Public Utilities Commission (CPUC) wants the state’s residents to store more of their excess solar energy instead of sending it to the power grid, which, as per the residents and solar equipment manufacturers, discourages the adoption of solar and makes it less affordable.

The Road Ahead

As per Bloomberg, global green stocks have lost USD 280 billion in value since they hit their peak of over USD 600 billion in August 2022. The value of the MSCI Global Alternative Energy Index has dropped by 41% from the beginning of 2023.

Central banks are not in the unanimous mood of easing down their monetary policies. Add the pressure of energy utilities and other purchasers pressurising the renewable energy companies to keep electricity prices low.

“The indebtedness ratio for the clean energy sector is 3.8 times debt to 12-month earnings, almost four times higher than the 1.1 ratio for large oil and gas companies,” states a recent research post by Charles Schwab Corporation.

“This is jeopardising the ability of the sector to survive at a time when it should be continuing its recent rapid expansion, spurred on by higher oil and gas prices driven by the wars in Ukraine and Gaza, as well as government programmes like the U.S. Inflation Reduction Act and the European Green Deal,” the financial services company stated further.

“Given all those trends, it would seem that alternative energy stocks should be thriving. Instead, they are among the world’s worst performers this year,” Charles Schwab concluded.

Will things improve in 2024? Let’s wait and watch.

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