Renewable energy: green bubble trouble

Forget Wall Street mania over chatroom stocks. The big money is flooding into ESG plays such as clean energy. Are these a bubble too? Patrick Pouyanné chief executive of French oil producer Total, thinks so. Valuations for renewable energy assets are “crazy”, he told the Financial Times.

Pouyanné may have a point. His rivals are not simply other latecomers, such as BP and Royal Dutch Shell, which are trying to elbow their way into solar and wind-power projects. Many portfolio investors in publicly listed equities are proffering capital to businesses that have been quicker and smarter than most oil majors in following a green agenda.

Wind farm developer Orsted Energy, itself once an oil producer, and biofuels refiner Neste Oil have seen their market worth and earnings multiples climb ever higher, reducing their cost of equity. Their respective forecast price to earnings ratios have doubled over the past two years. Both could easily raise equity capital to fund more investments.

That demand would come from ESG investors. Inflows into funds bearing the “environmental, social and governance” tag have more than doubled annually since 2018 to $326bn in 2020, according to Morningstar. In contrast, inflows to broad market funds have grown in paltry percentages.

This has had a marked effect in the past year. The average price-to-earnings ratio for the green stocks in the Morgan Stanley universe has jumped by 24 points, equivalent to years of profits. PERs for other shares have moved by a small fraction of that. Vestas, the Danish wind turbine maker, has an implied annual earnings growth rate of 4.5 per cent out to 2050 — probably double what analysts would have assumed a couple of years ago.

Lex believes that wind-farm projects have a very good future. But Vestas does have serious competition and only so much capacity. Valuation distortions have occurred in a limited group of headline stocks, such as electric-car maker Tesla, partly as a result of momentum trading.

The good news is that a swath of corporates pursuing a greener, more sustainable approach should be rewarded by the equity market. Stakeholders pressing companies to take action on environmental concerns are also putting up the capital needed for transition. Crazy valuations for scarce, trophy assets are the catalyst that increases supply and reduces prices. Better for bosses to participate in that democratisation than complain about its initial stages.

The Lex team is interested in hearing more from readers. Please tell us whether you think there is a bubble in renewables in the comments section below.