Why my enthusiasm for energy stocks is fading

I like spoonbills, and for a while I liked Ørsted. This may seem a curious juxtaposition — a long-legged wading bird with a ridiculous beak and the world’s leading wind farm operator. But there is a connection: the breeding of spoonbills on the Norfolk coast since 2010 is a sign of our warming planet.

Out to sea a little further north, at Hornsea, Ørsted is building its third gigawatt-scale project. Its 12 UK wind farms generate enough electricity to power six million homes. Useful, you might think, if we are to reduce our dependency on the fossil fuels, indirectly responsible for those curious southern European migrants nesting near my doorstep.

For a while Ørsted’s shares soared to silly valuations — they were priced at 56x earnings in 2021 at about the time I sold mine. Since then they have fallen 60 per cent in a rising equity market — to about 18x earnings.

Renewable investments generally have performed dreadfully in the past few years. Mostly, this has been the result of deflating exuberance. There have been management issues, too, but there is also political uncertainty.

You may want to invest in a clean energy future — and the research shows many still do — but how do you go about it? Well, you go carefully, for one thing, since this is one area where politics pulls the strings.

The political tides that had favoured renewable investment now seem to be flowing the other way. The swing to the right in the European elections is likely to lead to a retreat of environmental rules.

Energy is a highly regulated business — there are subsidies, windfall taxes, royalty payments on drilling oil, carbon credits on wind farms . . . I could go on. In the UK, Ofgem sits in the middle of it all. Even in the US, land of the free, people elect their state utility regulator.

In Texas, where for some Republicans, climate-change scepticism is baked into their political identity, funds seen as a divesting from oil companies have had multibillion dollar mandates to manage public money withdrawn. This has an impact on equities. Right wingers point out that those making the loudest warnings on the climate often have stuff to sell — meretricious ESG consulting services or energy transition products that cost a lot with little effect.

In short, most of the long-term consequential decisions are not made by the companies whose shares you are buying, but by politicians. Angela Merkel’s decision to close nuclear power stations in Germany after the accident at Fukushima is a good illustration.

It is not often I say this, but let’s be fair to politicians (or at least to some of them). It’s not surprising that it’s hard to predict their decisions: they have incredibly tough choices to make.

Net zero adds to the complexity. The world had been becoming more energy efficient. Those LED lights you are forced to buy use up to 90 per cent less energy than traditional incandescent bulbs. But artificial intelligence will be power-hungry — a ChatGPT query needs nearly 10 times as much electricity to process as a Google search, according to Goldman Sachs.

Data centres currently account for under 2 per cent of global power consumption. This will double by 2030. In the US, data centres are forecast to use 8 per cent by that time. Producing that extra power without accelerating climate issues is a policy challenge.

Politicians are juggling plans to spend large amounts without knowing which strategy will best benefit the environment. 

For example, as solar panel prices fall and efficiency rises, this is becoming more cost-effective than wind. But solar deployment is “significantly off track” says the UK parliamentary environmental audit committee, which blames barriers in the planning system. And the last offshore wind farm auction failed to attract any bidders because the government set the amount it was prepared to underwrite energy produced too low.  

Renewable energy requires better storage — either battery or hydrogen. Green hydrogen is, in effect, a battery, but it needs to become more efficient — it can take 50 kWh of energy to create hydrogen with an energy value of 33 kWh.

Nuclear power is becoming regarded as a core part of a lower-carbon economy — especially mini-nukes based on the small reactors used, for instance, to power submarines. Again, their return on investment depends on efficient storage of electricity when demand is low.

Even when decisions are made, construction takes time (assuming you can find the workers). Planning makes these timetables longer. 

And one green initiative often depends on another — the switch to electric cars, for instance, depends on a charging infrastructure that falls far short of what is needed.

This raises two questions. How best can politicians support the shift to net zero? And where does this leave investors?

In the two global equity funds I managed between 2000 and last year we invested maybe 12 per cent in renewable companies and stocks that helped with energy efficiency. Private capital has been key in renewable energy investments over the past decade. Around 40 per cent of UK power now comes from renewables, and this has come about with little government direct investment.

Given the risk that private capital returns will be depressed by increased public sector involvement in the UK, I am now wary of investing in renewable energy production

So I am nervous about Labour’s plans for a publicly-owned energy company. Government investment to scale and develop new battery technologies could significantly reduce unit costs and kick-start that industry. But using taxes on domestic fossil fuel companies to “take control of our energy system” risks driving out vital private investment.

Last month, National Grid cut its dividend and announced a sharp increase in capital investment. With pollsters predicting a Labour victory, management arguably chose to do more for the state and less for shareholders. You may approve of this; investors did not. National Grid’s share price fell 10 per cent on the announcement.

Investors need incentives. In the US the electorate is more comfortable with private energy companies making money to provide a public service. Donald Trump may be a climate change sceptic but if he does win, he is unlikely to dismantle President Joe Biden’s Inflation Reduction Act, which gives tax breaks to renewable energy investment. To me this is a better way to encourage private investment. First Solar, the leading US solar stock, has seen its shares rise more than 50 per cent in the past quarter.

Given the complexity of the political situation and the risk that private capital returns will be depressed by increased public sector involvement in the UK, I am now wary of investing in renewable energy production, especially in the UK and Europe.

Where I see most opportunity internationally is in the growth area of energy efficiency. Leading global air-conditioning companies Trane Technologies and Daikin are working hard to improve the energy efficiency of their kit. After that, US freight rail looks attractive — it creates much lower carbon emissions than road freight. As for utilities, I feel for the managements, but I’m out.

Simon Edelsten is a former professional fund manager