The dirty truth behind renewables

Billed as the "last big chance to slow rising global temperatures", COP26 gathered in Scotland this week to thrash out a climate change deal.

The global talk shop has been going since 1992, when the UN held its first convention on climate change. But in almost 30 years, no real agreement to curb carbon emissions has ever been struck.

In the meantime, weather disasters have become five times more common today than they were in the 1970s. And there are few who haven’t seen the harrowing footage of polar bears stranded as the ice caps melt, or the billions of plastic bottles choking seas and waterways.

Yet, increasingly, there are big changes afoot to limit the rise in global temperatures to 1.5°C by 2050. They’re happening because, finally, the economics for green power are looking better than those of dirty coal.

Solar and wind energy have become the cheapest sources of electricity production, says Prof Anton Eberhard, an energy specialist at the University of Cape Town. In a nutshell, he says, "technologies and investments associated with clean energy and storage will grow in value; those linked with fossil fuels will decline."

Andrew Canter, chief investment officer of Futuregrowth Asset Management — SA’s biggest debt lender — tends to agree.

"The collapse in the price of alternatives [to fossil fuels] only happened over the past few years, coming down by as much as 80% per kilowatt hour," he says.

"The answer is now in front of us, but the world is catching up to the reality of what’s happened to the price."

Stupid money

The big issue for retail investors and pension fund managers is whether the stampede for cleaner energy translates into a rash of new investment opportunities.

The answer is yes — and no.

Aeon Investment Management’s chief investment officer Asief Mohamed cautions that "when it comes to a new trend, you’ve got to be in early".

He’s worried that the returns for investment in SA have "dissipated", and compares the return on renewable projects to that of the 10-year government bond.

"If you look at the returns on that basis, you’ll get an annualised return of less than 9%, and the 10-year risk-free bond rate is close to 10%, so why would you invest in these projects now?" he asks.

It’s a crucial question for equity investors: you want to back the companies at the forefront of the green revolution, but will you get money out of doing that?

Consider that the signatories of a global "net-zero asset managers alliance initiative" together account for more than $40-trillion in funds. That’s a "substantial" portion of global assets under management, says Allan Gray analyst and ESG specialist Raine Naudé.

The problem is that "whenever there’s a lot of capital rushing into a sector, we get concerned", says Naudé. "A lot of times, the market has built a lot of expectations into these clean-energy companies."

Take the share price performance of Tesla — the poster child for future-fit electric vehicles and battery storage technology — against the relics of the motor vehicle world: General Motors, VW, BMW, Ford and Toyota.

There’s no comparison.

Protea Capital Management, too, urges caution around the popular narratives. "Whenever something is popular and capital is almost looking for an excuse to invest, you get valuations that are higher than they should be," says CEO Jean Pierre Verster.

Protea has, instead, found opportunities to short in the renewables sector, where it decided the hype was too much. But that’s also difficult, because you have a wall of money coming at you.

"If you are a company in the business of setting up solar farms or wind farms and you say you are both an infrastructure company and an ESG renewable energy company, my goodness, everyone wants to give you money," says Verster.

Still, that doesn’t mean you need to lose your head — or ignore the companies that are undervalued now, but which may score down the line.

Take the old dogs: combustion engine automakers.

"BMW has actually outperformed recently," says Naudé, pointing out that people recognise that the company has the research & development capabilities and cash flow to support a green transition. There’s not going to be just one winner, she says, but "there’s a lot of ‘green premium’ on the stocks that are perceived to be these green winners."

Allan Gray likes "ESG improvers" — companies trading at extremely depressed p:e multiples "that are less obvious".

Naudé cites a recent research report from US investment bank Morgan Stanley, which identified decarbonisation opportunities in the US market. It whittled the list down to just 68 stocks. With no small irony, 19 of them were in the oil and gas value chain, 10 were (mostly fossil fuel-based) utilities and five were traditional industrial shares. There were only 17 "pure play green revolution stocks" — including 9 electric vehicle manufacturing/EV charging stocks.

While the oil majors have been slammed for "greenwashing" their carbon footprint, these companies are spending huge amounts of money to stay in the game.

"About three years ago, less than 1% of capital was going towards alternative energy, now it’s 18-20%," Naudé points out.

Verster says much the same. "It is the ‘dirty’ generators of electricity that are spending significantly to migrate or transition their own businesses because they have the most to lose — think of Sasol, for instance."

Still, the other argument — of which green agitator Greta Thunberg is the principal proponent — is that investors have to ditch these companies entirely, and immediately, for the world to make any headway in achieving its carbon-reduction promises.

Some are listening. Last week, the Netherlands’ ABP, one of the world’s largest pension funds, said it would sell all its holdings in fossil fuel companies, worth more than €15bn, by 2023. It means ABP, probably for the first time, will hold no shares in the national flagship, Royal Dutch Shell.

The upside for clean-energy producers is that their cost of capital is low and falling, and listed companies’ shares are running.

"Because companies get highly rated, they can issue more shares and use that money to build projects — so at least something good happens," says Aeon’s Mohamed.

But there’s another route in, he says: through companies such as PPC or WBHO, which will supply the cement or build the roads for wind farms in SA.

There are, for now, very few listed options on local stock markets, aside from two small-cap companies that began life as special purpose acquisition companies to trade on the green energy push a few years back: Hulisani and Gaia (renamed Mahube Infrastructure).

The coal conundrum: a hot mess

Despite the falling cost of renewables, not every country is willing, or able, to ditch its coal-fired power stations. SA, for example, will struggle to do that.

That resistance — and the fact that alternative energy supplies such as solar and wind aren’t always reliable — means coal is far from dead. And, ironically, it may be one of the more lucrative investments over the next decade, as the "just transition" to renewables takes shape.

For Futuregrowth, like many others, coal is entirely unfundable. Clean coal, says Paul Semple, Futuregrowth’s head of unlisted credit, is a fallacy. But not everyone shares that view, especially those in the industry.

July Ndlovu, chair of the World Coal Association and CEO of SA’s Thungela Resources, says the obituary for coal is premature. The facts "don’t support" it, he says, noting that even the International Energy Agency recognises that coal power will still be a significant contributor to the global energy mix in 2040.

In Asia, for example, there are 200 coal-fired power stations under construction now, including 95 in China, 28 in India and 23 in Indonesia, according to US nonprofit Global Energy Monitor. And, globally, coal plants supplying 43GW of power were built in the past decade. Those plants are capable of operating for 50 years and longer, so demand remains.

But because funders such as banks and asset managers are under pressure to shun coal, little traditional funding for new coal production is forthcoming. And so, with supply under pressure, coal prices have surged.

Verster, who casts around the world for investment opportunities, says: "I think what we are seeing in the case of the huge spike in the cost of traditional energy, principally big coal and gas in Europe and the US, indicates that ... now that the first few effects [of the just transition] are becoming visible, what people thought would be good steps are perhaps having the opposite effect."

But Clyde Mallinson, director of Virtual Energy & Power, a company that develops storage-backed renewable energy projects, says it’s simply a bump on the energy journey. "We’re at the very beginning of ... this disruptive change in the system.

"And hiccups like that are because we haven’t really started the replacement in full yet." Still, it means that for now there’s money in both old and new power supply. PwC Africa, for example, reckons coal will be a money-spinner for the next 10 years or so.

Ndlovu similarly believes the lack of investment will support coal prices, and provide good returns to the pragmatic investor who recognises the transition will take time.

As it is, some banks in SA have warned that they will have to keep funding at least some coal projects, given political and economic pressures in the country.

It is, says Verster, with devastating restraint, "a tricky problem".

"It’s political, it’s economic and it’s environmental. And I think if the solution were easy, it would be implemented; it’s not."

While China is arguably no longer a poor country, Indonesia, India and SA are. And their energy is still derived largely from coal.

Says Verster: "It is not ‘just’ to expect that poor countries must carry the burden of unaffordable coal, while rich countries have more exposure to wind, solar and battery capacity to store energy."

Hannes van den Berg, joint head of SA equity at asset manager Ninety One, is equally worried that the pendulum "has swung far and very fast".

"The current focus is on the ‘E’," he says of ESG initiatives. "But we’re worried that there is a social impact here as well. If you stop producing from coal, that has a very big social and job-creation impact."

Protea, like a few other savvy investors, has made good money from ructions in the coal market. One of its best trades this year was buying shares in Thungela — Anglo American’s unwanted coal assets, which were jettisoned by the group and listed separately in June.

Hedge fund Boatman Capital vowed that Thungela was a terrible investment, on the wrong side of the energy revolution, and with huge environmental liabilities to boot. That report — released a day before Thungela’s listing — spooked investors, and the stock crashed 16% on its first day.

But, as Verster points out, "when something is popular, the opposite is an investment opportunity.

"Look at the area that is being shunned — and that, in the last year or so, has been the coal industry."

Protea thought Thungela was cheap, which is why it initially snapped up shares. Then the coal price began to run.

"We were tracking that and we thought: ‘Wow.’ Every day the coal prices were higher and the Thungela share price was still at low levels. And every day the coal prices went up and we updated our models, we saw that the profits would increase substantially, and the business was just getting cheaper and cheaper, so we kept on buying, and then the coal price went ballistic."

That was lucky, he says. But "if you focus on shares where very low expectations have been discounted, you don’t need to accurately forecast the future. If you buy things that are cheap, and things don’t turn out great — it’s probably in the price. If things do turn out great, you have a real winner."

Not everyone agrees, but actually supporting coal companies so they can be more environmentally responsible might be the more ESG-friendly thing to do, says Verster.

And if technologies such as carbon-capture utilisation and storage are successfully taken up, it would further extend the life of the coal industry — and make it greener. For now, the technology is uneconomic and, because it is associated with coal, unpopular.

But, says Louis van Pletsen, director of inAfrica Holdings, a private firm invested in energy and other sectors in Africa, "we need to apply our mind on how to clean the exhaust gas that comes from that power plant. And then what to do with that CO² that we’ve captured."

There’s another problem: with the rapid drop in costs of renewable energy, the rate of return has plummeted.

"For an investor today, the returns on wind and solar are actually very low — a single-digit IRR [internal rate of return] — and that’s because the risk profile of the project is very low," says Van Pletsen.

But the growth prospects are still huge. Jan Fourie, the Sub-Saharan Africa GM of Norwegian solar firm Scatec, says roughly 18GW needs to be brought into the SA market between now and 2030. "So, with the commercial and industrial market, you’re talking about a multiple-gigawatt market, which is billions and billions of rands of investment in bricks and mortar."

Just who will lose isn’t clear

As for the obvious losers, nothing is obvious.

As Mohamed points out, "20 years ago people were saying that document storage companies like Metrofile were going to go bust. If you look at it today, it’s making bucket loads of money. And with Exxaro and Thungela, it’s the last-man-standing story."

Aeon owns Exxaro shares. "I think the coal producers will still make reasonable amounts of money in the short term," he says. "If you talk about BHP Billiton, it’s going into phosphates, playing on the theme of food security because of climate change ... and it’s benefiting from the high oil price. Sasol might have enough money to invest in carbon emission reduction and chemicals might still be in demand, it really depends on technology."

Like Verster and Naudé, Van den Berg says many of the old fossils of the market have just become too cheap. "These stocks have derated," he says, "but they might have derated too much."

Ninety One owns Sasol and recently snapped up some European energy producers, though Van den Berg says these companies are unlikely to see the market rating they enjoyed a decade ago.

"The concern for a company like Sasol is that it’s now meant to decarbonise, and it’s got great strategies, but where’s the cash flow going to come from to do that?" he asks. "It means it’s going to have to use a high percentage of free cashflow every year to execute its [plan]."

Ninety One believes it’s important to back savvy management, as companies with good management teams "tend to be the ones that deal with innovations the best".

Overseas, it particularly likes Iberian company Iberdrola, which sets up renewable energy structures and plants, and then farms out the electricity.

Says Van den Berg: "Once [Iberdrola’s] solar farms reach steady state and generate a return, it sells these off to the government or companies around it. It’s a beautiful business — it has a steady earnings growth profile, a good dividend yield and it’s got a decent balance sheet."

He reckons the pipeline of opportunities for such a company is huge.

You could also consider buying shares in companies such as Siemens and GE, say Naudé and Verster: both companies have huge divisions that do business in the renewable sphere.

But if you feel that the profiteering from this transition is cynical, you’re not alone.

"It’s hard to reconcile as an environmentalist," says Naudé. "We need a 50% emissions reduction by 2050, but it’s hard to see how it plays out."

Allan Gray’s left-field pick in the sector is Glencore — not only does it have a US justice department investigation into shady deals hanging over its head, but it’s also the world’s largest producer of seaborne coal. Yet, as Naudé says, "coal isn’t going anywhere in the medium term — it’s going to be very cash-generative".

"Then, [Glencore] has this commodity basket of future-forward metals — copper, zinc, cobalt, nickel — that it’s investing in with the cash generated by coal. So it seems like a win-win."

She also prefers Glencore’s approach of winding down its thermal coal assets to that of Anglo, which simply dumped its coal business. As she points out: "Thungela, as soon as [it was] unbundled, was planning on increasing its production, so it doesn’t change anything from a climate perspective."

The old system will die …

Investors will also have noted the fifth round of the government’s renewable energy programme, announced last week.

Twenty-five projects will deliver wind and solar energy to SA — more than 2,500MW worth — at record low prices of 42c-49c per kilowatt hour.

Consider that Eskom’s coal alone costs 42c per kilowatt hour — before you factor in the cost of maintaining and refurbishing the utility’s power stations.

"When you get a disruptive change, the old system dies off because it goes into a sort of negative feedback loop," says Mallinson. "It’s losing attraction, it’s costing more and it’s in a vicious declining cycle. Whereas the new system is in a virtuous growth cycle. And it feeds upon itself in a positive way. And so generally the new system supplants the old system, and is normally much larger."

Eventually, he says, it will become a non-issue to shut down a coal plant.

Last week Norwegian solar energy group Scatec won preferred bidder status on three solar projects totalling 273MW.

As Fourie tells the FM, renewable energy "just makes economic sense nowadays".

But while the shift away from coal isn’t going to happen overnight, Fourie says there’s no reason it shouldn’t pick up speed. He reckons SA can start weaning itself off carbon in five to 10 years, especially with global institutions gagging to give the country money to help it decarbonise. While the availability of solar and wind resources — and land — may be a challenge in some countries, that’s certainly not the case in SA.

But the country does face a crippling power shortage now, and renewables are the fastest, cheapest and lowest-regret option to plug the gap.

"If you put up a solar plant today or wind plant, it’s got a 20-year horizon," says Canter. "Maybe it runs a bit more, say 30 years, but you’re not married to it. So you’re not going to make a big mistake with solar [or renewables] in SA."

Still, the inability to store renewable energy economically has yet to be solved. Battery storage is available — but at a cost that typically doubles the price of a solar installation.

There are technologies that are considered cleaner and cheaper than coal, but they demand a larger, long-term commitment. Gas, for example, provides the flexibility to ramp up and down as needed. But you have to build the infrastructure — and you need the gas itself.

Nuclear is pricey, but it can provide consistent, carbon-free energy for decades. While many have written off nuclear power, Canter says it remains an option in the longer term, provided there is a proper bidding process, with competitive bidding from international suppliers.

Mineral resources & energy minister Gwede Mantashe remains a nuclear fan, but Eberhard says the industry is moribund. It peaked at 17.5% of global electricity production in 1996, and has since fallen to just 10%, due in large part to the Fukushima disaster of 2011, when an earthquake hit Japan’s eastern coast, killing 18,000 people and forcing 150,000 others to evacuate the area.

"Nuclear energy’s dismal track record will need a radical turnaround for it to be an attractive investment," argues Eberhard.

Meanwhile, the standing joke about hydrogen is that it is the fuel of the future — and always will be. Certainly, it’s not expected to be commercially viable for five to 10 years. Still, industrial users, such as Sasol, are looking to drive the development of green hydrogen, hoping it will offer a way to decarbonise their operations.

There’s clearly plenty of choice in the energy sector. But that means governments that want to decarbonise are often caught in the headlights, says Futuregrowth’s Semple. "Everyone is afraid to make the wrong move, in case something else comes up that proves to be a better option," he says.

Good work if you can get it

There is one fund manager in SA that has come up with a way to get retail investors into an actual renewable energy plant — Kruger International.

Mia Kruger, one of the family firm’s portfolio managers, tells the FM: "We’d been looking at how we could make some of the renewable infrastructure/energy projects viable for retail investors."

Most of the major financial institutions in SA, in some way or another, are involved in funding projects, and there are private equity companies invested too. But if you want a slice of the action you’d have to stump up tens of millions of rands, which makes it impossible for most retail investors to get directly involved.

Instead, Kruger got an opportunity to buy a holding in the Tsitsikamma Community Wind Farm (TCWF).

The company spent months working with lawyers and regulators on bringing the investment — which was done in conjunction with Gaia Infrastructure — into its unit trust fund.

"The main objective was to see how we can add alpha," says Kruger — the holy grail of higher than average returns. In other words, "bringing something to retail investors that they couldn’t get hold of before, in a responsible way, where you don’t overcharge and benefit at their cost, and where you make a proper contribution to the country. All of that we think we accomplished by going into the TCWF."

Her view is that renewable energy infrastructure "is very uncorrelated to other asset classes, so you’ve got a much more stable earnings profile that’s linked to inflation".

As for the returns, the TCWF has so far yielded the equivalent to the consumer price index plus 9%.

All the fund managers the FM has canvassed cite green bonds as an investment option, while Ninety One singles out PSG Group for its unlisted Energy Partners investment. And almost all say Sibanye-Stillwater is a canny option.

"Yes, it’s a commodity company — but all the investments it’s making are focused towards battery technology," says Kruger.

Scatec, meanwhile, is listed on the Oslo Stock Exchange, though its big break was with the first two rounds of SA’s independent power producer programme. From about 2016, its shares slowly trundled higher; then, in January 2020, the stock peaked at €38.78. This year it collapsed, more than halving to about €14 by the beginning of October (though it has since started moving higher again).

Ultimately, says Ndlovu, the future of fossil fuels is in consumers’ hands. "If the customer wants us to decarbonise by 2050, the world has to account to make sure that we’re beginning to take the necessary steps to get there," he says.

"I’m just saying there are significant constraints to getting there — that if we don’t act with wisdom and clarity of thought, all we’ll do is replicate the same progress we made between Paris [COP21, held in 2015] and now. And how much progress have we made?"

The upside for clean- energy producers is that their cost of capital is falling, and listed companies’ shares are running

—  What it means:

ALL ABOUT COP26

What is COP26?

The UN Climate Change Conference – the 26th Conference of Parties – is taking place in Glasgow, Scotland, from October 31 to November 12. The annual gathering, first held in 1995, is part of the framework established by the 1992 UN convention on climate change.

Who will be there?

There’s an expected turnout of about 25,000 participants, including heads of state, international financiers and NGOs, climate change experts, activists such as Greta Thunberg and business leaders. Even the British royal family make an appearance (though Queen Elizabeth is giving it a miss this year, for health concerns).

Who are the no-shows?

The leaders of China, India, Russia and Iran – all countries on the top 10 polluter list, according to emissions offsetting company ClimateTrade – will reportedly be skipping the event (some will send envoys in their stead, or address the conference virtually). Brazil’s Jair Bolsonaro will also be a no-show, Japanese Prime Minister Fumio Kishida’s attendance remains uncertain and Pope Francis is set to address the gathering remotely. Given the November 1 elections in SA, environment minister Barbara Creecy is reportedly standing in for President Cyril Ramaphosa.

What’s the aim?

Participants are expected to take stock of mitigation efforts since the signing of the historic Paris climate agreement at COP21. It aims to limit global warming to below 2°C (but preferably 1.5°C) against pre-industrial levels. Given a shortfall in meeting the target, it’s expected that there will be a call at COP26 for more drastic measures – and more specific pledges – to limit emissions.