Renewable energy is off to a roaring start in the 21st century. It may not seem like that, considering electricity generated from wind and solar farms still comprises a minority of total global energy production, but many observers forget that the long-term trajectory of the technologies will be exponential, not linear. You gotta start somewhere, as the saying goes.
The fast rise of wind and solar bodes well for reaching international climate goals, and it has also proven to be great for individual investors who know where to look. That said, there are still quite a few misconceptions about renewable energy -- on both ends of the spectrum -- that could lead investors down the wrong path.
1. Wind and solar are too expensive without subsidies
The funny thing is that I used to make this argument years ago. But it turns out wind and solar energy have sprinted down the cost curve -- and they're headed lower. In fact, according to financial advisory firm Lazard, on a levelized cost basis unsubsidized wind power is the cheapest source of electricity generation in the United States at just $0.03 per kilowatt-hour (kWh). That's followed by the newest natural gas-fired power plants at $0.04 per kWh and, surprisingly, unsubsidized utility-scale solar power at $0.043 per kWh.
That explains why most major electric utilities have ambitious plans to retire coal-fired capacity and replace it with wind, solar, and natural gas. For instance, Xcel Energy (NASDAQ: XEL) could lean on wind and solar to generate 45% of its electricity in 2027, with only 22% coming from coal. In 2005 the company's generation mix was just 3% renewables and 56% coal. You can see similar trends in the generation portfolios of most American utilities, and it's driven almost entirely by economics.
2. Renewable energy can replace nuclear power
There may be no quicker way to sabotage climate goals than arguing that renewable energy can (or even should) replace nuclear power in the short-term. The reason being is power and energy are not the same thing. In the United States, it takes 3.4 gigawatts of solar capacity or over 2 gigawatts of wind capacity to replace the electricity generated from 1 gigawatt of nuclear power. The on-off nature of renewable power assets means that they run at fractions of their nameplate capacity, whereas nuclear power facilities consistently run at 90% capacity or better. That gap will close slightly as technology improves, but if maximizing clean energy is the goal, then nuclear power has an important role to play in the next decade or two.
Unfortunately, undervaluing nuclear power's clean energy production has forced FirstEnergy and Exelon (NYSE: EXC) to announce plans to retire four money-losing nuclear power plants in Pennsylvania and Ohio by 2021. If completed, the four retirements will swipe 40 terawatt-hours per year of carbon-free electricity off the regional grid, called PJM, which produced only 30 terawatt-hours of electricity from all wind and solar installations last year.
Luckily for these utilities, there's a push to get the two states to provide financial assistance with zero-emission credit systems. Similar legislation aided Exelon's operations in Illinois and New York, stemming losses and keeping carbon-free electricity energy on the grid. Investors may want to keep a sliver of hope that the company can persuade policymakers to do the same in additional states, which could further boost the company's profitability.
3. Installed capacity is the most important metric
The difference between power and energy also matters when comparing one renewable energy project to another, especially in different countries. For instance, China and the United States rank first and second, respectively, in installed power capacity from wind and solar. The former had 289 gigawatts of capacity installed at the end of 2017, while the latter had 121 gigawatts installed. That's a difference of 139%, but China's renewable energy growth isn't as good as it seems. The country only generated 38% more electricity from wind and solar than its second-place challenger.
Most of the gap between installed capacity and energy generated can be explained by the quality of technology installed, grid connections, and the large differences in wind and solar potential between the two countries. Nonetheless, the comparison highlights the importance of evaluating the details of international utility projects in the portfolios of renewable electricity yieldcos such as Pattern Energy (NASDAQ: PEGI).
The company is making a big push into Japanese wind power, but the country has relatively poor wind potential compared to the United States. The best wind farms in Japan operate at just 29% efficiency, compared to over 50% in the United States. Heck, the average wind farm in America operates at 37% efficiency. Luckily for individual investors, while the assets produce less electricity compared to similarly sized wind projects in the United States, the company appears to be offsetting that with higher electricity prices in the Japanese market. However, it's a good reminder that power capacity is not the most important metric for investors to focus on for these types of companies.
4. Oil companies have no role in the future of energy
As a group, oil majors generate tens of billions of dollars in free cash flow per year, and they're beginning to invest in renewable energy businesses. That's great news, and should expedite the transition to lower-impact energy production and consumption. Royal Dutch Shell, Total, and BP are spending billions of dollars per year to build profitable renewable energy and clean energy portfolios. The general idea is for these oil and gas giants to slowly transform into electric and gas utilities, which will come in handy as global transportation shuns liquid fuels for electric charging.
That said, few oil companies are going as far as Equinor (NYSE: EQNR), formerly known as Statoil. It changed its name to remove the word "oil", but that's only the start. The Norwegian energy giant is taking its experience operating in the rough waters of the North Sea to become one of the world's leading developers of offshore wind technology, which holds tremendous promise for taking renewable energy to the next level. That's because offshore wind farms can produce amounts of electricity comparable to what you'd get from natural gas-fired power plants, they don't take up land that could be used for other purposes, and they can be located near coastal cities, where most of the world's population lives.
However, the technology is still relatively expensive right now, largely because the industry is just getting started. In 2017 the world had only 19 gigawatts of offshore wind capacity, compared to 495 gigawatts of onshore wind capacity. Equinor is hoping to capture a first-mover advantage, and will soon bring offshore wind power to the United States. The company is building a 1 gigawatt project off the coast of Long Island, New York called Empire Wind, which will electrify 1 million homes. It's early, but the oil company's investments show it's serious about a renewable future.
5. The United States is behind on its climate goals
There seems to be a popular narrative that America is helplessly behind on its climate change goals, but there's a compelling argument to be made that the United States is actually ahead of schedule.
Wind energy is on pace to overtake hydro as the nation's top renewable energy source in 2019 (numbers through the first four months of 2018 hint it could reach that milestone this year). In the first five months of 2018 the amount of electricity generated from solar panels increased 30% compared to the same period of last year. At 55%, solar comprised the majority of all new generation capacity installed on the grid in the first quarter of 2018.
Investors who dare to peek ahead to 2030 will see plenty of reasons to be optimistic for the future of renewable energy. By then it will be feasible for onshore wind power to generate between 15% and 20% of American electricity, while solar power will likely reach a double-digit market share. Throw in offshore wind power (only now getting started in the United States, and excluded from many long-term projections) and next-generation geothermal systems (aiming to leverage hydraulic fracking technology to become economical by 2030), and retiring any remaining coal and nuclear assets might be a slam dunk by 2040. It could even make financial sense to begin early retirement for certain natural gas power plants by then.
How green is your portfolio?
Renewable energy represents a great opportunity for individual investors to build long-term wealth. That's especially true considering two things: First, wind and solar power are among the cheapest sources of electricity, which means they're likely to comprise the majority of new generation capacity for the foreseeable future. Second, exciting new technologies such as offshore wind and enhanced geothermal are coming down the industry's pipeline.
However, it's still important to acknowledge the complexity of energy markets and to make room for nuance in your stock analysis. Doing so might change your mind on power generation companies with existing nuclear power plants, or even the potential for oil supermajors to be considered ultra-long term plays in the future of renewable energy.
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