Renewable energy is a hot topic right now, and the sector is popular with investors hoping the new Biden administration will invest in it. That popularity could be a near-term thing, depending on which way the political winds are blowing. However, I decided to look beyond the near term and focus on the long-term case for investing in the leaders in wind power: General Electric (GE 0.26%), Vestas (VWDRY -1.51%), and Siemens Gamesa Renewable Energy (GCTAF).
The key argument for investing in renewable energy stocks involves a reason based on these truths:
- Based on projections from the U.S. Energy Information Administration (EIA), renewable energy will become more economically viable than traditional energy sources over time, even without tax credits.
- However, investing in renewable energy requires a long-term mindset, as the medium-term outlook is mixed.
Image source: Getty Images.
Renewable energy will become more economically viable
The EIA measures energy plants' viability through the average value cost ratio. The ratio is the average revenue available to the generator within a given period divided by the cash resources required to build and operate a generator over a given period. A ratio of more than 1 means a project generates more revenue than the cost needed to develop and operate it. In other words, it makes sense to build it.
The average revenue is defined as the levelized avoided cost of electricity (LACE), and the average cost is defined as the levelized cost of electricity (LCOE). Simply put, the LACE should be higher than the LCOE for a project to make sense.
Energy Information Administration data needs to factor in tax credits
Now, let's look at the EIA projections across various options. For reference, the most attractive of the traditional plants is the combined-cycle plant. These plants are made up of a gas turbine that generates electricity and a steam turbine that runs on exhaust heat captured from the gas turbine. GE Power and Siemens Energy (SMEG.F 2.61%) are the leaders in combined-cycle plants.
First, let's look at the data with the projections for 2023 and 2040, factoring in tax credits. The average value/cost column -- remember that a figure above 1 is favorable -- for 2023 explains why operators have been rushing to invest in renewable energy like wind and solar in recent years. It's also part of why gas turbine orders have halved since 2015, to the detriment of GE Power and Siemens Energy.
| Power Source (With Tax Credits) |
LACE |
LCOE |
Average Value/ |
LACE |
LCOE |
Average Value/ |
|---|---|---|---|---|---|---|
|
Combined cycle |
$31.8 |
$33.2 |
0.96 |
$36.3 |
$36.3 |
1.00 |
|
Onshore wind |
$27.1 |
$22.5 |
1.21 |
$32.7 |
$30.8 |
1.06 |
|
Solar, stand-alone |
$27.2 |
$23.9 |
1.14 |
$30.1 |
$27.7 |
1.09 |
Data source: EIA report. Uses capacity-weighted figures for LCOE. LACE and LCOE figures are presented as 2020 dollars per megawatt-hour.
Observant readers will note that the value/cost ratio gets worse from 2023 to 2040 for onshore wind and solar. That's because the EIA projections assume there will be no tax credits for onshore wind in 2040, and tax credits for solar will fall from $6.71 per megawatt-hour in 2023 to $2.06 per megawatt-hour in 2040.
A better way to consider matters would be to look at the figures without factoring in tax credits, not least because this gives a better approximation for the global situation. Here you can see that ratios are forecast to get better for renewable energy and surpass combined-cycle plants over the long term, even without tax credits.
| Power Source (Without Tax Credits) |
LACE |
LCOE |
Average Value/Cost 2023 |
LACE |
LCOE |
Average Value/Cost 2040 |
|---|---|---|---|---|---|---|
|
Combined cycle |
$31.8 |
$33.2 |
0.96 |
$36.3 |
$36.3 |
1.00 |
|
Onshore wind |
$27.1 |
$30.4 |
0.89 |
$32.7 |
$30.8 |
1.06 |
|
Solar, stand-alone |
$27.2 |
$30.6 |
0.89 |
$30.1 |
$29.7 |
1.01 |
Data source: EIA report. Uses capacity-weighted figures for LCOE. LACE and LCOE figures are in 2020 dollars per megawatt-hour.
The medium-term outlook for renewable energy is mixed
Based on the EIA base case projections, renewable energy will be more economically viable in the future even without tax credits -- all of which point to a good demand environment for wind power. That's a view backed by long-term demand projections at Vestas and GE Renewable Energy.
That said, investors need to be mindful that investing in renewable energy is a long-term play, not least because the medium-term outlook is mixed. For example, Vestas, GE, and Siemens Gamesa cite research from the Wood Mackenzie consultancy.
The consultancy's forecast calls for a slow decline in new onshore wind installations from 2020-2025. The overall market only starts to expand again from 2021 to 2025 due to offshore wind installation growth.
Data source: Wood Mackenzie.
Investing in renewable energy
All told, investing in renewable energy is a long-term endeavor. The economic viability of renewable energy, even without tax credits, is likely to improve, leading to demand growth. Unless natural gas prices drop significantly over the long term (making combined-cycle plants cheaper to run), renewable energy will likely be at least as economically viable as a combined-cycle plant, even without tax credits and subsidies.
However, investors should prepare for the possibility of a slowdown in new installations over the medium term. Renewable energy has a bright future, but investors will need to be patient.
