The sharp decline in the oil price from its high earlier in the year has, for the time being at least, taken some of the urgency out of the debate over energy supplies.
Yet the underlying geopolitical tensions are still there. Many commentators see the recent Russia-Georgia conflict as a result of pipeline politics between major powers, who are jostling to control the energy resources of the Caspian basin and Middle East. With the increase in oil prices over the last decade, and the painful dependence of many countries on hydrocarbons becoming ever clearer, the search for alternative energy sources is still a vital one. As a commentator in the Financial Times put it in a recent article, "The need for a transition to a more diversified, lower-carbon energy economy is as urgent as ever."
Definitions of alternative energy diverge a little - some take the term to include only fuel sources that do not harm the environment or use up natural resources (for example wind, solar, biomass, geothermal, wave and tidal energy), others include all energy sources other than from fossil fuels (so also including nuclear power, for example). In the US ETF market there is now quite a sophisticated choice of funds for investors to choose from in this sector, including diversified clean energy ETFs, with the largest fund of this type, the PowerShares WilderHill Clean Energy Portfolio, now totalling nearly $1.5 billion in assets, but also several specialised ETFs covering solar, wind and nuclear energy producers. How do things look for European ETF investors by comparison?
Although the FTSE ET50 index also includes water technologies and pollution control, and waste and resource management stocks, I've included it in this comparison because of the large weighting it devotes to companies involved in alternative energy and energy efficiency. However there's a clear overlap - as far as this index is concerned - with the universe covered by water ETFs.
As might be expected from a relatively new sector of the ETF market - the oldest fund in the table above has just over a year's track record - there is a proliferation of indices to reckon with. Let's dig deeper into index methodologies for the four non-nuclear ETFs.
The Lyxor New Energy ETF is relatively concentrated, with only twenty constituents. By contrast the PowerShares Global Clean Energy ETF is much more diversified, due to its equal-weighting methodology, with all the holdings set at a 2% weighting when rebalanced. The iShares S&P Global Clean Energy and EasyETF FTSE ET50 ETFs fall somewhere between these two extremes in terms of concentration.
In summary, expect pretty divergent performance from the different alternative energy indices.
How have the ETFs fared during the bear market, and what does the investment case look like for this sector?
This year has been a brutal one so far for holders of the funds - their performance has been much worse than that of the broad market, with a precipitous decline from September onwards. All three of the ETFs that were launched last year have lost more than half of their value from their January highs. The PowerShares Global Clean Energy ETF has declined by 54% from its peak, the iShares S&P Global Clean Energy ETF has fallen nearly 60%, and the Lyxor New Energy ETF is down 57%.
Is this a buying opportunity? The bullish argument is set out in a recent Lyxor presentation, which points out that renewable energy sources currently meet around 13% of global primary energy requirements, while some experts expect this figure to rise to 50% by 2050. Ian Simm, the CEO of Impax, a London-based fund manager specialising in the environmental sector and which provides the specialist design input to the FTSE ET50 index, points out that the alternative energy and waste/water sectors already generate hundreds of billions of revenues worldwide each year, with forecast annual growth rates of 15-20%. In Simm's view, this trend is well-supported by both public and private sector spending.
On the other hand there are plenty of sceptics - Roger Nusbaum of Seeking Alpha has written of a fad in solar stocks, while others have pointed out the distortions introduced to the global energy market and the unforeseen environmental impact of state support for biofuels. The recent stock price collapse of NASDAQ-listed ethanol producer, Biofuel Energy, hasn't helped sentiment, and biofuel stocks in general have had a terrible year.
But at the same time comparisons with the dot-com bubble seem overstated. Taking the current top ten holdings in the iShares fund (and excluding two that have no earnings), the average forecast p/e ratio is currently 12 - hardly in the stratosphere. Others have pointed out that, while a dot-com start-up required little more than an idea, a garage and a computer, alternative energy companies need substantially more in terms of research and development, so barriers to entry in this sector are considerably higher. Whatever way you look at it, investing in the sector via an ETF seems to make sense, as a diversified spread of companies gives you a better chance of picking some winners in what is bound to remain a volatile area of the market.
The assets raised by the European alternative energy ETFs are still tiny - both in the context of the overall market size, and by comparison with similar US ETFs. But active product development continues - Impax and FTSE recently launched an "Environmental Opportunities Index", which might form the basis for another ETF, and the Index Group at Société Générale, parent company of Lyxor, already calculates a number of indices under a "sustainable investment" banner, including BIOX (World Bio Energy) and SOLEX (World Solar Energy), which are not yet available in ETF form, but could no doubt easily be added to Lyxor's range.
Despite this year's decline in oil prices, it seems a fair bet that a return to cheap energy is not on the cards. With the longer term demand/supply outlook still in favour of higher prices, and geopolitical tensions adding to the mix, the alternative energy sector should find some underpinning as one of the true potential growth sectors in the equity market.
