We have to wait a few weeks to see just how green President Joe Biden’s stimulus plan turns out to be. But we’re already in the middle of an unplanned green investment boom. It will end both badly and usefully.
Energy of all varieties is a capital-intensive business, so the cost of that capital often makes or breaks a new project. This is especially so for renewable-energy projects where all the investment is up front and, unlike an oilfield for example, there is no option embedded in terms of volatile commodity prices. Similarly, the more cutting-edge technologies, such as vehicle electrification, are often at start-up stage or otherwise unprofitable, so access to capital is an existential issue.
Hence, when people talk about the “energy transition,” on some level what they’re describing is a transition of capital, or money being deployed into one type of energy infrastructure over another. Which makes this chart very important:
The forward price/earnings multiple for the WilderHill Clean Energy Index was an already-lively 41x a year ago. Today, it’s a positively thirsty 123x. Express that as an earnings yield, all 0.8% of it, and you get a sense of how freely capital is flowing into the sector.
Within that, consider one of the index’s more famous members, Tesla Inc. Having surged almost eight-fold in the past year, the electric-car maker has announced no less than three equity-raisings totaling $12.3 billion, far more than in its prior decade combined. The stock has kept on going up. Meanwhile, well over a dozen cleantech or climate-related businesses have gone public via special purpose acquisition vehicles, and more green-tinged SPACs are out there hunting for cash or targets.
Like the stock market in general, this has all the hallmarks of a bubble: high multiples, rapid price increases, a big (and vocal) retail element and a cool story to justify it all. It feels like we’ve been here before.
As we all know, bubbles aren’t good. On the other hand, that doesn’t mean their only legacy is flyblown Florida subdivisions, pointless dotcoms and shredded egos. Economist Ruchir Sharma coined the phrase “good binge” to describe a frenzy of investment that, even though it might ultimately end with a crash, leaves behind some productive asset or advantage. That doesn’t apply to flyblown Florida subdivisions. But it does to useful things like railroads, the Internet, shale, fiber-optic networks and gas-fired power plants.
This will also most likely apply to cleantech. It already has. The stunning decline in the cost of solar power owes a great deal to subsidized Chinese capital building factories targeting panels at a subsidized German power market. Optimal? No. Bankruptcies? Yes; anyone who bought Q-Cells SE stock at EUR81 in 2007 has only bitter experience to show for it. Transformation of zero-carbon energy economics? Absolutely.
Similarly, regular readers will know I think Tesla’s valuation is nuts raised to the power of three. But if Tesla disappeared tomorrow — or its stock just fell by a lot — would the electrification strategies of the world’s major automakers (along with multiple countries and cities) or the progress made on battery costs vanish with it? No.
Even SPACs may have their uses. Rob Day, partner at Spring Lane Capital, a sustainable investment fund, argues in a recent Forbes piece that one thing spurring the cleantech SPAC craze is that, unlike in the technology sector, incumbent energy companies have been slow to finance or acquire promising new ventures. This has created a “target-rich environment” for the blank-check crowd, he writes. At least some of those targets could have staying power.
We went through this cycle with the shale boom, which upended the U.S. (and global) energy market and, by crushing coal demand with cheap gas, reduced carbon emissions (methane’s a different story). Yet somehow energy posted the worst performance of any S&P 500 sector in the 2010s. The classic good-binge twofer of transformation and mortification.
In shale’s case, however, it’s important to emphasize one especially non-good element of the binge: the outsize role of debt. The need to work off this burden long after the good times have passed intensifies the hangover, as we are seeing now with many E&P firms, as well as formerly exuberant pipeline operators. In contrast, the cleantech bubble is centered more on equity (public, private and venture), more akin to the late 1990s tech bubble.
To say that mania will end up funding some good things isn’t to advocate for complacency. As Chris Watling, founder of London-based analytics firm Longview Economics, told me the other day, we don’t know when bubbles will pop, but we do know they always pop for the same reason: withdrawal of cheap money.
The likeliest trigger is the Federal Reserve (and bond market) finally losing its nerve on inflation. This is the trade du jour in certain corners of the market already (including commodities like oil) and has much to recommend it.
Watling’s firm calculates a combination of higher income, including relief payments, and suppressed spending may add up to $3.8 trillion, or 17% of pre-pandemic GDP, of “spare” cash waiting to be deployed into a U.S. economy with heavily disrupted supply chains. Against this, Covid-19 still stalks us, unemployment is almost 7% and there is spare capacity elsewhere, not least in that usual inflation villain, the oil market. So timing the pop is, as ever, a fraught exercise.
If anything, the evident bubble in cleantech is yet another reminder of the need for holistic energy and climate policy in whatever Biden unveils next month. Relying on bubbles and busts for industrial progress is quintessentially American. But in this instance, it’s also disruptive and prone to inefficiencies in tackling a problem that is both colossal in scope and urgent: climate change. Before you reach for your Gadsden flag, bear in mind the entire electricity grid is a regulated construct and that gasoline demand owes more than a little to the federally funded building of interstate highways.
This doesn’t mean we need X million of federal dollars earmarked to every pet technology (some of which are likely to be overinvested due to the bubble anyway). But aligning policies to capture the existing exuberance could make more of it turn out to be rational. Pricing mechanisms for emissions, such as Biden’s proposed revival of social-cost calculations for greenhouse gases, and clean-energy or efficiency standards are all ways of setting the table without dictating on what investors choose to gorge.
Financiers are already taking advantage of negative rates to build castles in the air. Government policy should harness some of the same mojo to put (or encourage) some steel in the ground — and cement the energy transition we need.