In it for the long run: Investing in the German transition to renewables
In 2010, the German government endorsed the Energiewende, a commitment to facilitate the transition towards renewable energy. The policy plan foresees to cut greenhouse gas by 80-95%, expand the share of renewable energy production to 60% and improve energy efficiency by 50% until 2015 respectively. The latest legislation, the renewable energy law (EEG) which was implemented in August 2014, foresees an exit from nuclear energy as of 2022.
At first sight, the policy initiative and the subsequent growth of the sector in Germany appears to be an attractive investment opportunity. According to the OECD, Germany has cut greenhouse gas emissions by 26% and reduced energy consumption by 6%, between 1990 and 2009. Nevertheless it remains the largest emitter of CO2 emissions in the European Union as of 2009.
This mismatch between policy commitment and economic reality should make investing in alternative energy sources in Germany an interesting investment opportunity.
Indeed, interest in the concept of sustainability has increased. According to a recent survey by Professor Henry Schäfer [CORRECT] on behalf of German asset manager Union Investment, 56 percent of institutional investors said to factor sustainability criteria into their investment decisions. The survey, which was conducted among 2015 institutional investors with a combined AUM of €1.5tn, showed an 8 percent increase compared to last year.
Yet precisely because the transition to renewables is such a political issue, investors need to brace themselves for legislative headwinds. In 2012, the German government cut the subsidies for solar energy panels by 20%, with severe repercussions for stock markets.
The Solactive Global Solar Energy Index, which tracks more than 40 suppliers of solar energy, halved between 2011 and 2014 from 100 to approximately 50 points, declines in emerging markets have been even more pronounced.
And investors need to brace themselves for more challenges. The latest EEG law foresees further cuts in subsidies for renewables. “The German government has decided to cut down subsidies with the argument that the market is not ready for renewables, because the stock market price of energy has declined strongly over the last years due to oversupply. This makes it very hard to compete for suppliers of renewables which are relatively new to the market” says Hermann Albers [CORRECT], President of the German Wind Energy Association.
“The problem is that renewables are entering an oligopolistic market. If you would take the production costs for a newly set up wind energy supplier compared to a newly set up nuclear power plant, you would find that wind energy is actually more cost efficient” he stresses.
Dominance of private investments
Yet paradoxically, despite volatility and high risk levels, investments in renewable energy in Germany are until now dominated by the retail sector. According to the German Wind Energy Association, 14% of the market in renewables is financed by private investors, whereas the four leading energy supplies in Germany only have 5% of the market share, banks and investment funds have 13% (figure 1).
Consequently, community projects have been hardest hit by the recent volatility. According to a 2013 study conducted by Werner Daldorf on behalf of the German Wind Energy Association, between 2000 and 2005, private investors in wind parks were promised 20 year returns in excess of 200%.
However, the study concluded that the average return on investments in wind parks currently lies at 2.5% per annum, 50% of wind parks are currently unprofitable to the extent that investors can be glad if they will receive the return of their initial investment after 20 years.
“We have faced a lot of challenges over the last years, especially because the global players are quick to take out their capital once they identify an investment which seems to offer higher returns. Our experience is that investing in renewables works best if the initiators have a stake in the business” concludes Albers.
In it for the long run
Does all this mean that investments in renewables are futile? For investors looking for short term returns, this may well be true. Yet in the long run, Germany’s political commitment to renewables continues to be an important factor to consider.
This is also reflected in the performance of leading energy suppliers, which are largely centred on the production of coal and nuclear energy. As in many other countries, the German energy market is oligopolistic in nature. Since the German government has committed to the transition to renewables, stock market values for market leaders EON and RWE have declined significantly. EON, Germany’s leading energy supplier recorded a 20% fall in profits for the first half of 2014 , underlying net income, used to calculated dividends fell from €1.9bn to €1.5bn YoY. Similarly, for the first half of 2014, RWE, Germany’s second biggest energy supplier reported a 62% decline of its net profits excluding one-time items which are used as a benchmark for dividend payouts. Consequently, both companies have announced plant closures, the German daily Frankfurter Allgemeine Zeitung describes them as “dinosaurs on the abyss.”
Overall, while the German energy market may overall be challenging, investors looking for a long term commitment may still find opportunities in renewables. “It is undeniable that the last years have been difficult. The market in solar energy has been practically destroyed by the recent cuts in subsidies. Nevertheless, there is both economic demand and political will, the challenge is now to attract asmany players as possible to the German market” says Albers.
Source: German Windenergy Association, 2012