One year ago, renewable energy companies and ETFs were on an upswing. There was an increase in the price of oil, and companies like Tesla were attracting more and more customers. Many people predicted that it would only be a matter of time before the oil and gas industry collapsed and alternative energy companies took over.
The story has now reversed. The price of a barrel of oil has fallen to around $45 a barrel, and the futures for natural gas are projected to sink to the lowest level since 2012. Sales of pick-up trucks rose 22% in October, and companies like GMC and Cadillac saw their sales increase by double-digits. On the other hand, Tesla saw its stock drop 9.3% in August, and analysts are waiting to see whether Tesla’s cheaper Model 3 will gain ground. Alternative energy ETFs like QCLN and GEX have slumped. This slow growth, and in some cases, decline in the alternative energy industry is worrisome to both investors and governments alike, since many governments have funneled billions of dollars to promote “green initiatives.”
According to an article written by Diane Cardwell of the New York Times, this effect is most prominent in renewable energy yieldcos. A yieldco is a subsidiary of a renewable energy company whose sole job is to operate power plants that generate electricity for households and corporations. These power plants are usually powered by natural gas or some other form of energy other than oil or gas. The companies operate their own power plants under yieldcos, and then either invest the money generated from the yieldcos or pay out some of the profit to investors.
Yieldcos are particularly interesting because they serve as a safe bet for alternative energy investors. In localities across the United States and in other industrialized countries like the United Kingdom, there is usually only one power provider in town. The local utility company has a pseudo-monopoly in its region, and provides steady returns because the demand for electricity rarely decreases. The sole revenue for a yieldco is the electricity bill customers and businesses pay each month. Prior to last year, investors were pooling more cash into yieldcos, because the probability of reaping a positive return was very high.
The plummet in oil prices produced a pessimistic response from many yieldco operators. SunEdison, one of the largest producers of renewable energy, has halted the development of more yieldco-managed power plants. These yieldcos are facing continued losses, and the company cannot afford to invest more money in alternative energy projects. SunEdison also announced that it would remove its yieldcos from the UK, which recently approved many oil drilling operations in the northern part of England.
Aside from power plant operators, other alternative energy companies are facing setbacks. West Windsor, NJ based NRG Energy, which primarily provides electricity to consumers across the US, also operates an electric vehicle charging network and a solar panel company for homeowners. According to Ms. Caldwell, NRG Energy announced it was spinning off these two units in order to prevent overwhelming losses to the main business. The resulting devaluation, as experienced by many other alternative energy providers, limited the company’s ability to invest in new projects.
Outside of market turmoil, governmental turmoil is also causing unease among alternative energy companies. Currently, the US government has been extending subsidies, rebates, and tax breaks to renewable energy companies like Tesla and SolarCity. However, due to budget fights in Congress, the future of these subsidies is on the line. According to an article in Bloomberg Business, the wind energy subsidy has already expired and the solar power subsidy will expire at the end of 2016. In total, the wind and solar energy subsidies have accounted for 24 billion dollars from 2008-2014. If the subsidies are annulled, then many alternative energy companies will have to close, since most companies are facing heavy losses. The same is holding true in the UK, where the government is taking steps to eliminate subsidies for solar and tidal power and increase tax breaks for oil and gas companies.
The long-term view of the parent companies is more optimistic. Many larger energy providers, like SunEdison, are cutting costs and streamlining operations. In addition, while many yieldcos are currently not turning a profit, some companies and investors are continuing to fund them, believing that once oil prices increase, the yieldcos will once again become viable alternatives. These investors are more inclined to wait 10 to 20 years for the renewable energy industry to pick up steam. In fact, some successful yieldcos have been spun off into their own public companies.
Unfortunately, one of the most basic laws in economics has driven the majority of yieldcos into bankruptcy. Prior to the fall in oil prices, energy companies created many yieldcos. Since the number of power plants in the US is relatively constant, the glut of yieldcos produced an increase in the competition to operate these plants. The number of bidders on power plant contracts went up, so eventually the winners ended up paying more than they did in the past to outbid their competitors. This high cost served as a barrier to entry for many fledgling yieldcos, and worried investors who recognized that the supply of power plants was fixed while the demand to operate them kept increasing. Many feared that eventually there would be no more new plants, and the leftover yieldcos would be forced to go out of business.
To compound this problem, the fall in oil prices triggered a reduction in share price for the surviving yieldcos. When a company’s share price plummets, it makes it harder for the company to borrow money. The financially-strapped yieldcos had to battle a lack of cash to invest in new projects, which in turn soured investor confidence and led to a drop in share prices.
According to Ms. Caldwell, there was also a mismatch between the investors and the alternative energy companies. Alternative energy companies in particular tend to be unprofitable at first, since acquiring a foothold in the energy sector requires owning several power plants. While the company suffers heavy losses in the beginning, over a period of about 10 years, the company will begin to turn a profit as the company uses the electricity fees from consumers to pay off any debt. This is a steady model notwithstanding a sharp increase in demand and supply for a competing energy source. While the energy company could return a reasonable profit in 10 or so years, the investors wanted profits almost immediately. Most significant investors in energy companies tend to be activist hedge funds that are looking to reap profits within a year or two. Prior to the fall in oil prices and the financial crisis, SunEdison reached a top share price of $88.49. The positive outlook on renewable energy was compounded by governments actively trying to replace coal and oil with alternative energy sources. At the rate renewable energy companies were skyrocketing, hedge funds and short-term investors believed that their investments would be recouped very quickly.
However, once all the yieldcos and energy companies lost value after 2008, it no longer seemed feasible that the companies would be able to supplant oil and coal in a very short time frame. The impatience of the investors led to a max exodus of investment from the companies as soon as the oil price began to plummet. In addition, hedge funds and portfolio managers with investments in alternative energy and oil companies preferred to drop the alternative energy companies because the oil companies are larger and would be more likely to provide a slim profit.
On a more positive note, several countries are exploring nuclear power as an alternative to fossil fuels. Countries like the UK are partnering up with China to develop nuclear power plants, which are more profitable than solar and wind energy companies. In addition, developing countries are starting to diversify their energy generation, and are trying to move away from coal and oil with the help of foreign aid. Pakistan, which is currently facing an energy shortage due to a growing population, has partnered with Denmark, which will provide funding for solar and wind energy infrastructure. Pakistan has large tracts of unused land and coastline that could serve as perfect locations to place solar panels and windmills.
Outside of governments, private companies and industry are pitching in to make alternative energy initiatives appealing. Apple for instance recently announced plans to construct more solar farms in China, and Google and Facebook are investing heavily in renewable energy companies. Many companies, like Apple, are running “carbon-neutral” offices, which means that all of their electricity is generated from renewable energy sources. Africa is benefitting from these initiatives as well, as Google has partnered with the Kenyan government to construct the largest planned wind farm. Goldman Sachs and other investment firms, in an initiative announced by the White House, will invest more money in clean energy to curb greenhouse gas emissions.
In the face of the financial crisis, many alternative energy companies have come up with new strategies to stay in business. Many parent companies have started setting up yieldcos in other countries, like China and European countries, which are actively promoting clean energy companies. Expanding globally reduces the impact of an unprecedented event in one country, since the returns from other countries will remain stable. However, energy companies are expanding yieldcos very slowly abroad, due to relatively low yields and economic instability in Asian countries.
On the other hand, energy companies like Trina Solar have decided to abandon the idea of yieldcos altogether. According to Bloomberg Business, the idea of a growthco is being floated by Trina Solar. Unlike a yieldco, a growthco is focused on growth and expansion instead of returning steady profits to investors. This model is beneficial in countries where yields are currently low, like China, and it is more practical to focus on starting new projects rather than increasing profits. It may be easier to garner financing for these kinds of projects, which will align with the outlook of alternative energy investors.
While there are encouraging signs for the growth of the alternative energy sector, there are still peripheral concerns that need to be addressed. One major one is the effect of alternative energy company growth on oil and gas dependent areas. States like West Virginia, whose largest industry is coal, will be faced with increased unemployment if governments move to limit their coal consumption. States like Texas and Pennsylvania and countries like Russia, Venezuela, and the Gulf countries will be the hardest hit unless steps are taken to either diversify these areas’ economies or retrain millions of workers.
The future of alternative energy sources is mixed, and unless scientific and industrial research produces a breakthrough in terms of cutting costs and increasing efficiency, oil and gas will continue to remain the dominant sources of electricity.
Abhiram Karuppur is a freshman writer from New Jersey. He joined The Financier this fall. Please reach out to firstname.lastname@example.org for any questions, comments, or concerns!