How to invest in renewable energy?

This week's Big Question is from subscriber Ian Oliver of Armidale, New South Wales. He asks: With increasing political and public interest in climate change, the time seems right to invest (directly or indirectly) in a diversified portfolio of renewable energy companies (preferably Australian). How would you invest say $20,000 to gain a diversified exposure to this sector?

David Ferris, investment manager at ASX-listed Australian Ethical Investments says: There are essentially three types of “pure” renewable energy plays within the listed equity sector: manufacturing companies; utility-type yield plays; and smaller, speculative technology companies. The appropriate mix will reflect the risk profile of the investor.

Sadly, however patriotic you might like to be, most of the more attractive investments in manufacturing and utilities are listed on overseas exchanges.

The main reasons are scale and regulatory support. Cost reduction is essential for renewable energy to compete and there are economies of scale in manufacturing (turbines and solar cells); big balance sheets support the necessary capital investment; first-mover, size and branding advantage; etc. In short, with many companies and few likely to be winners, the bigger plays look better bets.

In the race to achieve scale, Australian firms are hampered by domestic market size, and have had nowhere near the level of regulatory support as, for example, in Germany (no accident that German firms have taken market leadership in solar cell manufacture).

Having said that, where do we look? Possible renewable energy investments could be made across the following sectors:

Wind power

Of all renewable energy forms, wind power is the lowest risk and most widely utilised. It is the fastest-growing form of energy in many countries.

Choices include manufacturers as Vestas (Denmark) and Gamesa (Spain) – both high growth/high P/E stocks – and “safer”, more utility-like listed wind farm owners include Babcock & Brown Wind Partners (Australia) and EDF Energies Nouvelles (France).

Solar power

The potential for solar power is large, but it has further to go in terms of efficiencies before it is cost-competitive. So it is a higher risk technology to back than wind.

The largest pure solar companies are typically listed in Germany (such as Conergy, Solarworld and the US (SunPower, First Solar, Suntech). Suntech does have an Australian connection with much its R&D being undertaken at UNSW.

As yet, there are no listed “solar farm” portfolio managers, but it would not surprise to see these develop (probably in Western Europe) over the next few years.

Geothermal power

This form of power is widely used in Pacific Rim countries, particularly New Zealand. The main pure geothermal power company is Ormat (US) which both owns geothermal assets and sells power plants. New Zealand utility Trustpower has a mix of geothermal and windpower assets and is worth considering (although tightly held).

Other

Focusing more now on Australian companies, Energy Developments and Viridis both own assets exploiting the waste gases from landfill sites around the world. Viridis is a purer yield play, with Energy Developments having both more growth upside and more project development risk.

For those who can cope with a bit more risk, there are some interesting technologies and small companies which can be invested in. Geodynamics, Petratherm and Green Rock Energy are at the cutting edge of looking to exploit the potential of hot fractured rocks at much greater depths than conventional geothermal.

There are also small solar-related companies such as Solco (mainly hot water heaters), Dyesol (providing interesting alternative inputs to solar cell producers), and Enviromission (an ambitious solar power generation project). And there are a range of technology companies trying to make breakthroughs in fuel cells, power electronics and other market niches. Ceramic Fuel Cells is an example of a company involved in renewable technology which has niche market prospects.

More broadly

I’ve focused here on pure renewable plays and direct listed investments. Some major “traditional” power companies are active in renewables; internationally GE and Siemens, and domestically Origin has a range of impressive initiatives.

For those looking to avoid the research involved in picking winners in a complicated environment, there is the option of going in through a managed fund. Most genuinely “green” SRI funds (such as Australian Ethical Investment or Portfolio 21 in the US) have large holdings in renewable stocks within an overall screened portfolio. There are also increasingly specialist “cleantech” funds focusing only on renewables such as Powershares in the US.

Finally, I’d make the point that although renewable energy is the obvious area that will get a “kick” from increasing governmental focus on climate change, there are other places to invest, which both help fight climate change and may get some indirect investment benefits. As an example, at Australian Ethical we have gone to great lengths to find bicycle companies (Dutch company Accell) and public transport companies (MTR Hong).