Key Points:
Overview of 2023 Green Economy Stocks: The year 2023 saw initial optimism in green economy stocks due to the US Inflation Reduction Act and high gas prices but later faced challenges from rising real interest rates, elevated input costs, and policy shifts.
ESSi Performance Analysis: The new Eight-Seven-Sixty Indices (ESSi) reveal varied sector performances: ESSi Mobility surged with over 60% YTD return, while ESSi Generation, Manufacturing, and Others saw declines ranging from 7% to 35% YTD, impacted by market and policy dynamics.
Sector-Specific Trends and Challenges: ESSi Mobility's outperformance was driven by electric vehicle sales, despite challenges in the EV charging sub-sector. ESSi Generation struggled with high-interest rates and policy changes. Manufacturing faced pricing pressure, particularly in the solar sub-sector, while ESSi Other grappled with financing issues and market volatility.
2024 Outlook: Mixed expectations for 2024 with potential interest rate cuts balancing against declining fossil fuel prices.
2023 has been a tumultuous year for stocks in the green economy sector. Initially, there was optimism, spurred by the passage of the US Inflation Reduction Act and then-high gas prices, which seemed to promise a brighter demand outlook for the industry. However, this optimism later waned due to a combination of rapidly rising real interest rates, elevated input costs, project cancellations, all of which negatively impacted the industry.
Amidst these challenges, certain companies have managed to thrive, while others face a challenging path ahead. This week’s edition of 8760 utilizes the new Eight-Seven-Sixty Indices (ESSi) for green economy stocks to review the year’s performance. I’ll spotlight both the winners and the underperformers in this sector, and shed light on key trends and expectations for the upcoming year.
Introducing the Eight-Seven-Sixty Indices (ESSi)
ESSi is a set of indices created to monitor the performance of various sectors within the green economy. The beta version currently encompasses 173 international stocks, boasting a total market capitalization of $2.0 trillion as of December 12. The primary index, ESSi Composite, evaluates the overall performance of the green economy industry. Subdivided from ESSi Composite are four ESSi Sectoral indices, each focusing on a specific area:
Mobility: Comprising 17 electric vehicle and charging network companies, this sector has a market capitalization of $961 billion. Tesla stands as the largest company by market capitalization. Additionally, two sub-sector indices are calculated, specifically for Electric Vehicles and Charging Networks.
Generation: Featuring 59 companies deriving significant revenue from renewable energy generation, this sector's market capitalization totals $674 billion. It includes three sub-sector indices: Generation Ex. China, Generation – China, and Networks Plus.
Manufacturing: Encompassing 56 companies involved in producing capital goods essential for the green economy, this sector has a market capitalization of $308 billion. It is further divided into three sub-sector indices: Wind, Solar, and Ancillaries.
Other: This sector includes 41 companies participating in smaller or emerging activities within the green economy, with a combined market capitalization of $41 billion. It is broken down into four sub-sector indices: Biochemicals, Hydrogen, Energy Services, and Future Technologies.
ESSi indices are valued in US dollars and use market capitalization for weighting. The indices started at 1,000 on December 29, 2022. The accompanying figure illustrates the progression of ESSi Composite and the four ESSi Sectoral indices. All data in this article are updated as of December 12, 2023, with all year-to-date (YTD) figures based on the December 29, 2022 benchmark.
The ESSi Composite’s 9% YTD return lags notably behind the 21% return of the S&P 500. The index peaked at 1,330 in July, following the broader market trend, before experiencing a significant decline in Q3 into early Q4, impacted by negative industry news and a substantial negative valuation effect from the steep increase in long-term real interest rates.
Performance varied greatly between sectors. ESSi Mobility outperformed, being the only sector with a positive return, soaring over 60% YTD. Despite a recent upturn, ESSi Generation saw a 7% YTD decrease, with most underperformance occurring in Q3. ESSi Manufacturing and ESSi Others paralleled each other's performance, both underperforming significantly: ESSi Manufacturing dropped 29% YTD, while ESSi Other fell 35%.
ESSi Mobility – Scale is the Name of the Game
ESSi Mobility gained more than 60% YTD. The index peaked at 2,000 in July before declining to 1,609 in the latest update. The figure below shows the evolution of the two sub-sector indices under ESSi Mobility:
ESSi Electric Vehicles: This index consists of nine electric vehicle manufacturers, collectively valued at $958 billion in market capitalization.
ESSi Chargers: Comprising eight companies that manufacture EV chargers and manage EV charging networks, this sector has a market capitalization of $3.2 billion as of December 12.
The outperformance of ESSi Mobility can be primarily attributed to the electric vehicle sub-sector. Despite the pessimistic news surrounding the electric vehicle sector, sales of battery electric vehicles and plug-in hybrids have surged, climbing over 20% in November compared to the previous year, and setting a new record high.
In contrast, the charging sector is not reaping the benefits of the rise in electric vehicle sales, with ESSi Chargers plunging 50% YTD, the steepest decline among all ESSi Sub-Sector indices. Tesla's move to open its supercharging network to non-Tesla electric vehicles has significantly undercut the growth prospects of independent charging companies. In this industry, scale is crucial. Independent charging companies lack the financial resources for the rapid expansion that Tesla possesses.
Similarly, scale is vital in electric vehicle production, where a larger scale typically means reduced costs per unit, enhancing competitive pricing. The top performers in the ESSi Electric Vehicles index are those with larger production scales. For instance, Tesla aims to produce 1.8 million vehicles this year, while Li Auto has set a goal of over 300,000 vehicles. On the other hand, smaller-scale manufacturers like Fisker, which recently reduced its production goal to about 10,000 vehicles, and Polestar, targeting 60,000 vehicles, are among the lower performers. For these smaller producers, raising new capital for expansion is challenging due to their current low valuations. This situation may further solidify the dominance of the leading companies unless there's a shift back to a lower interest rate environment.
ESSi Generation – Interest Rate Play
ESSi Generation experienced a 7% YTD decline. The index reached a high of 1,046 in January before falling to 822 in October. Below is an illustration of the progress of the three sub-sector indices within ESSi Generation:
ESSi Generation China: This index includes 11 Chinese renewable electricity producers, with a total market capitalization of $159 billion.
ESSi Generation ex China: Comprising 37 renewable electricity producers outside China, this sector has a combined market capitalization of $146 billion.
ESSi Networks Plus: This index covers 11 companies involved in both regulated electricity network businesses and renewable electricity generation with a combined market capitalization of $369 billion.
ESSi Generation China has seen a 5% YTD increase. Leading performers in this category are state-owned hydroelectric companies like Sichuan Chuantou and Huaneng Lancang River Hydropower, benefiting from factors such as policy support for hydropower expansion, higher spot electricity prices, and increased power generation for some. The laggards are private generators lacking access to government preferential lending rates. High real interest rates in China are also squeezing margins, and new pricing policies that lower daytime prices due to surplus solar generation are impacting solar profits.
ESSi Generation Ex. China declined by 20% YTD, with many companies experiencing negative stock returns. Major renewable energy developers, like Orsted, faced significant impairments and write-downs due to project cancellations, while reduced power prices affected profits for merchant renewable developers. The sharp rise in real interest rates in early Q4, due to their bond-like revenue structure, further impacted the sector. This index hit a low of 699 in early November but recovered to 801, anticipating large interest rate cuts in 2024. In contrast, Indian generators such as NHPC, SJVN, and ReNew are benefiting from the government's accelerated pace of renewable auctions from 15 GW to 50 GW per annum, with SJVN surging 164% YTD.
ESSi Networks Plus is down 6% YTD. The performance of this group is influenced by unique factors. Cia Paranaense De Energia's success is largely due to optimism in Argentina following the presidential election. Enel Chile's improvement is partly attributed to increased hydroelectric generation and the effects of policy interest rate cuts on valuations. The underperformers, both U.S.-based utilities, faced specific challenges: Avangrid struggled due to issues in the U.S. offshore wind sector impacting growth prospects, while Nextera Energy's downturn resulted from difficulties in selling down renewable projects to Nextera Energy Partners.
ESSi Manufacturing – All About Pricing Power
ESSi Manufacturing declined 29% YTD. The index reached its highest at 1,132 in February and its lowest at 665 in October. The following figure depicts the progress of the three sub-sector indices within ESSi Manufacturing:
ESSi Solar: This sub-sector, comprised of 33 companies focused on producing solar panels and components, has a combined market capitalization of $159 billion.
ESSi Wind: Including 9 companies specializing in manufacturing onshore and offshore wind systems and components, this sub-sector is valued at $48 billion in market capitalization.
ESSi Ancillaries: This group contains 14 companies involved in producing various energy products other than solar, wind, and batteries. Companies engage in producing energy efficiency products, building insulation, power control systems, and grid technologies, with a total market capitalization of $111 billion.
The Solar sub-sector is the most negatively impacted, plummeting 47% YTD. Excessive production capacity has led to a drop in pricing, with solar cell prices reaching record lows consecutively, suggesting some manufacturers are pricing below cost. Nextracker Inc. stands out as a positive performer in this challenging environment, as it manufactures solar tracking systems and software and benefits from a robust backlog and pricing power.
The Wind sub-sector has also struggled, declining 12% YTD. The sector faces challenges due to legacy contract losses and increasing expenses related to quality claims and repairs. TPI Composites experienced the most significant drop, 80%, primarily due to ongoing warranty charges. Ming Yang's performance was hampered by reduced demand for new wind turbines in China after the termination of offshore wind subsidies. However, India's Suzlon Energy saw a significant increase of more than 277%, buoyed by the Indian Government's acceleration of renewable auctions.
The Ancillaries sub-sector, in contrast, grew 9% YTD, largely driven by the robust performance of power semiconductor manufacturers like American Superconductor and Navitas Semiconductor. The growth in this sub-sector is tempered by the significant presence of Siemens Energy, which now primarily profits from grid technologies rather than wind turbines. The demand for power semiconductors has been bolstered by the rapid adoption of renewables and storage, industrial electrification, and initiatives for energy efficiency. These semiconductors play crucial roles in power management through converters, controllers, and regulators.
ESSi Other – High Risks Low Returns
ESSi Other declined 35% YTD. The index saw its highest point at 1,236 in February and its lowest at 579 in November. The subsequent figure illustrates the trends of the four sub-sector indices under ESSi Other:
ESSi Biochemicals: This sub-sector, comprising 7 companies involved in producing chemicals from biomaterials like biogas and biofuels, has a total market capitalization of $7 billion.
ESSi Hydrogen: Encompassing 14 companies providing various hydrogen-related products and services, including fuel cells, electrolyzers, and hydrogen project development, this sub-sector is valued at $11 billion.
ESSi Services: Including 10 companies offering energy transition services like solar installation and energy-as-a-service, the combined market capitalization here is $12 billion.
ESSi Moonshot: This innovative sub-sector contains 10 companies developing next-generation technologies such as solid-state batteries and electric planes, with a total market capitalization of $10 billion.
The relatively small market capitalization of the Other sector and its components doesn't reflect the sector's full investible potential. Many companies in this area have been acquired by major oil and gas corporations or are held by private equity firms. For instance, the Biochemicals sub-sector has experienced significant acquisition activity from gas utilities and oil & gas majors expanding their renewable natural gas portfolios. Notably, Enbridge acquired U.S.-based Morrow Renewables for $1.2 billion, and Shell purchased Europe's largest RNG producer, Nature Energy, for $2 billion. Despite these developments, the sub-sector fell 28% YTD, with companies like Verbio and GEVO Inc. struggling due to falling biodiesel prices and challenges in securing funding for expansion.
The Hydrogen sub-sector is the most negatively impacted in ESSi Other, dropping 46% YTD. Despite much discussion about hydrogen, only a small fraction of announced projects have reached the Final Investment Decision stage. The U.S. industry is particularly awaiting the final rules on hydrogen production tax credits under the Inflation Reduction Act, and it's still uncertain which part of the hydrogen value chain will benefit most from future growth. Based on the performance of ESSi Manufacturing Index, the answer would be anyone but the manufacturers of the machines needed to produce hydrogen.
ESSi Moonshot, while being the most volatile, has performed relatively better, declining only 7.5% YTD after a high of 60% increase in July. Most stocks in this subsector have seen significant declines, as high interest rates challenge companies in the proof-of-concept phase with limited revenue and cash resources. A notable exception is electric air taxi manufacturer Joby Aviation, whose shares have risen 89% YTD, buoyed by their first aircraft delivery and over $1 billion in available cash.
Conclusion for 2023
Throughout 2023, high real interest rates significantly influenced all ESSi sectors. In Mobility, smaller-scale companies faced difficulties in maintaining competitiveness due to financing constraints imposed by these high rates. This situation hindered their ability to scale production and reduce per-unit costs. In contrast, established companies maintained their dominance thanks to their already lower unit production costs.
In Generation, the most affected were those relying on the sale of shares in developed renewable projects for growth funding. Elevated interest rates devalued projects initiated in the era of cheap capital, reducing the proceeds from share sales. Consequently, these companies had to cut dividends or scale back growth plans, further depressing their stock prices.
In Other, similar financing challenges affected research and capacity expansion. Given their generally smaller balance sheets, the cost of capital exerted a substantial impact on their performance.
Policy has also played a significant role in the sector's performance with India being the lone bright spot this year as players across the value chain benefit from the greatly expanded renewable energy capacity auctions from 15 GW/year to 50 GW/year. Conversely, the termination of offshore wind subsidies in China severely impacted turbine manufacturers, leading to a price collapse. Additionally, changes in China's on-grid power purchasing prices threaten new solar projects, exacerbating the overcapacity in solar manufacturing.
Outlook for 2024
Looking ahead to 2024, I anticipate a balance of positive and negative factors. Potential interest rate cuts are a positive prospect while declining fossil fuel prices present a challenge.
Federal Reserve officials hinted at possible 75 basis point cuts in nominal interest rates, following reduced inflation rates. A continued decline in inflation, outpacing the decrease in nominal rates, would lower real interest rates, benefitting ESSi Generation first, followed by Others and Mobility. Manufacturing could see increased orders, but persistent overcapacity might continue to suppress profitability.
The realization of these rate cuts depends on economic trends and ongoing inflation reduction. The housing sector is key; a rebound in house prices, driven by lower mortgage rates, could lead to increased shelter inflation and consequently limit the scope for interest rate cuts. Indicators like the high performance of house builders ETFs and a sharp rebound in real estate broker shares post the Federal Reserve’s December meeting suggest this possibility.
Globally, fossil fuel prices are decreasing. US Henry Hub prices are trading back below $3/MMBtu while European TTF gas prices are back below EUR35/MWh. Lower natural gas prices, without counteracting policy measures, could hinder renewable growth, especially in the industrial PPA sector. The viability of existing high-priced PPAs, signed during the peak of the European gas crisis, might also be jeopardized if they render industrial off-takers less competitive.
Development Notes
Currently in beta, ESSi plans several enhancements in the coming months, including the introduction of a battery subsector within ESSi Manufacturing, a nuclear technology subsector across both ESSi Manufacturing and ESSi Other, and a mining subsector in ESSi Other. These additions will affect the ESSi Composite. Any methodology changes during the beta phase will necessitate recalculating all ESSi indices back to December 29, 2022.