The surge in oil, gas, and coal prices is accelerating demand for solar, wind, batteries and electric vehicles as a means to combat inflation, establish energy independence, and reduce environmental impact. The relative weakness in Chinese renewable energy stocks this year presents an attractive entry point for long-term investors.
2022 has been a rough ride for many investors, unless of course you went all-in on oil and gas stocks at the start of the year. Economic activity has sharply rebounded as vaccines facilitate a return to normal, and it turns out that our cars and planes still use the same kind of fuel as before the pandemic. The supply side has struggled to catch up with demand as persistently low oil prices over the past decade caused many oil producers to curtail capital investment as they switched from growth to survival mode, culminating in a record $100 billion worth of North American oil and gas producers entering bankruptcy during the height of the coronavirus pandemic in 2020. To add more fuel to the fire, the Russian invasion of Ukraine and resulting political fallout constrained a significant source of oil and gas supply to Europe during a seasonal peak in heating demand. As oil ran to prices not seen since 2008 and subsequent inflation and rising interest rates weighed heavily on long-duration growth stocks in the technology sector, oil and gas stocks outperformed the broader S&P 500 by 70% through the first five months of the year.
While the market appears to be acting rationally on the surface, it is making one glaring oversight. Renewables have been left out of the rally in the energy sector, as they have been lumped in with other high-growth stocks that have taken a beating due to higher interest rates. This may have made sense in past cycles, as the renewable energy and electric vehicle industries existed on a relatively tiny scale to serve niche markets and were nowhere close to being cost-competitive with fossil fuels for mass consumption. However, this is rapidly changing as renewable technologies follow their learning (cost) curves, meaning they become cheaper to produce at a predictable rate as more units are produced, which drives a virtuous cycle of lower prices, more demand, and more production. Fossil fuels, on the other hand, do not benefit from a learning curve, in part due to the maturity of combustion engine and power plant technologies, as well as a rising cost of extraction over time as the world’s cheapest resources tend to be discovered and depleted first. Even before the recent surge in input prices, this dynamic led solar and wind to leapfrog fossil fuels to become the cheapest source of electricity from new power plants over the past decade:
Price declines for renewables have temporarily gone in reverse as the industry contends with rising prices of most input materials, such as polysilicon used for solar wafer production, the steel used for wind turbines, and various minerals that go into lithium-ion batteries. For solar and wind, prices are back to 2018 levels, while lithium-ion batteries have risen back to 2020 levels. As fossil fuel prices have now risen to 2x-4x 2018 levels, higher prices have not had any chilling effect on demand for renewables and electric vehicles. An updated LCOE (levelized cost of energy) analysis from Lazard in October 2021 concluded that unsubsidized new-build wind and solar projects have already fallen below the cost of operating existing coal plants, and are competitive with existing gas plants. Since then, the price of coal has risen 100% and oil and gas have risen approximately 50%, while the cost of solar modules has been relatively flat. The difference in cost is perhaps most apparent in the Australian power market, where customers of the coal-heavy New South Wales and Queensland grids are contending with larger price increases than in South Australia, where the renewable mix is higher.
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