Bubble or no bubble?

Comparing the Nasdaq with an index of clean energy stocks might reassure investors fearing a renewable energy bubble. But irrational exuberance might still undo the unwary, says Michael Liebreich

Financial transactions in the clean energy industry last year topped $100 billion for the first time, according to figures from New Energy Finance, with $70.9 billion of new money invested. The latter figure is up 43% from 2005 and more than double the $27.5 billion total for 2004. The biggest growth was in public market and venture capital/private equity inflows, up 141% and 167% respectively, while asset-based finance grew at a more sedate 22.9% after a dramatic surge in 2005.At the time of writing in mid-February, the NEX global index of clean energy stocks was trading at 330 – up 60% from the start of 2006, and up more than 200% in the last four years.

Given these sorts of figures, it is small wonder that the world’s commentators are starting to ask whether we are in the midst of an industry bubble.

Looking at a chart of the NEX against the Nasdaq (see Figure 1), it is easy to see why the question arises.The NEX has soared ahead of the Nasdaq, and indeed of all market measures other than the Amex Oil and other energyrelated indexes.

However, rebasing the NEX and mapping it against historic figures for the Nasdaq shows that there is little about the NEX’s recent moves that matches the Nasdaq’s behaviour during the overheated period of 1999–2000. Although the NEX is growing strongly, its rate of growth is not accelerating – which should have been the surest sign during the technology boom that values were becoming inflated.

The nearest match is with the Nasdaq’s behaviour in the period between 1994 and 1998 (see Figure 2).These were the years just before the tech bubble took off.

So the message is that no,we are not experiencing a clean energy investment bubble. But the next two years will be critical in establishing the robustness of the clean energy industry as an investment sector.

To see continuing, non-volatile growth in the clean energy industry, we need to see three things. First, we need policy-makers not to go crazy. Existing policies, combined with high energy prices, are spurring healthy growth rates in most clean energy sectors and countries.This is not to say that there are not areas that still need attention, or policy instruments that can be improved, but in general the challenges facing the clean energy industry lie more on the supply side than on the demand side. The second thing we need is continuing high energy prices. Heightened public concerns about climate change and energy security have given policy-makers the mandate to support the development of clean energy. However, this consensus has not been tested in a cheap-energy environment. What happens to public support for costly biofuels if oil drops below $40 a barrel? What if gas prices plummet, leaving wind energy once again two to three times the cost per kilowatt hour of gas-fired power?

And finally, investors must not relax their investment discipline.We know of no fewer than 1,246 venture capital and private equity investors either investing in the clean energy sector, or intending to do so. There are no doubt hundreds more of which we are unaware.

So how can you avoid getting caught on the wrong side of an irrationally exuberant surge in clean energy asset prices? Here are three rules.

First, think about what the energy industry will look like in 15 years.We are moving from an era in which clean energy (other than traditional biomass and large-scale hydro) was of vanishingly little importance, to an era in which it will make up 15–20% of all energy supply in all countries around the world. Whether this takes 15 years or 25 is not the issue.There is no doubt about the direction and eventual scale of the change. So figure out country by country and sector by sector what the clean energy future will ultimately look like. And only invest if you are convinced that the opportunity you are looking at will form part of the eventual solution.

Second, avoid investment that is predicated on just one piece of legislation. As long as clean energy is more expensive than dirty, its uptake will, to a large extent, be dependent on legislation.This is unavoidable – but investors should avoid situations where just one piece of legislation can decide success or failure. Where individual investments are exposed, balance your risk by investing across different technologies, geographies or business models.

Third, stick to the type of investment you know. If you are a technology venture capitalist, don’t build biofuel refineries, which are asset-intensive ways of playing commodity arbitrage – with additional construction and policy risks thrown in for good measure. Leave it to agribusinesses, which do this stuff for a living. If you are a public asset manager, don’t consider illiquid private equity investments. If you are a hedge fund manager, don’t confuse yourself with someone who can support early-stage technology entrepreneurs – you don’t speak their language. If you are a consultant, don’t launch a carbon brokerage business – you don’t have the skills.

Of course there will be plenty of investors who ignore these rules and just invest on gut feel and momentum.They are essentially gambling and, like all gamblers, some will make money but most will not.

Michael Liebreich is CEO and founder of New Energy Finance, a London-based information provider. E-mail: michael.liebreich@newenergyfinance.com