The Climate Economy’s Rough Patch, Explained

Shares in climate-related companies — green hydrogen, residential solar, renewables developers — have been flagging in the past few months, and it seems like the damage may have spread to the private markets as well, where fledgling companies seek funding from individual venture capital firms.

The S&P Clean Energy Index — a group of 100 “global clean energy-related businesses from both developed and emerging markets” — has declined around 30% so far this year, compared to the broader stock market going up 12%.

While there are many different types of clean energy companies, the widespread malaise across the sector’s shares can mostly be attributed to high interest rates and changing public policy.

Many in the environmental business, advocacy, and public policy worlds are optimistic that clean energy can eventually become — or even already is — cost competitive with fossil fuels (not to mention better for the planet), but much of the sector is still both largely future oriented and heavily tied to government-provided incentives and policy preferences.

This means in sectors like hydrogen or offshore wind, big fights over tax credits and contract adjustments can meaningfully impact the future profitability of, or at least investor excitement around, clean energy companies if those battles go the “wrong” way.

The hydrogen company Plug Power is down around 45% this year, as is the residential solar company Sunrun. The energy company NextEra, which has massive wind and solar investments and is looking to be a big player in hydrogen, is down by more than a third. The Northeast energy company Avangrid, which paid $48 million to get out of an offshore wind deal in Massachusetts, is down by about a quarter this year. Orsted, the Danish wind company with projects up and down the East Coast, many now in some form of limbo due to rapidly accelerating costs, is down almost 50% this year.

And there’s evidence that capital may be becoming scarcer in the private markets as well. According to the audit and consulting firm PwC, overall funding from venture and private equity investors for climate technology companies fell by about 40%, taking it down to a level last seen five years ago.

Much of the fall can be chalked up to an overall decline in start-up funding — which fell 50% — the PWC analysis said. Indeed, the portion of all start-up investment that’s devoted to climate investments has actually gone up in the last year. This might be welcome news for the long-term prospects of the sector, but it’s still cold comfort for climate tech companies hunting for cash to stay afloat or expand.

While stock prices and business outlooks are not always the same — a stock price can decline because investors decided they were overly optimistic about a company’s prospects even if it’s still growing — there are some unifying causes to the troubles the clean tech industry is facing.

The one that pops up everywhere is interest rates, which are at the highest level in decades in the United States.

When the Federal Reserve raises interest rates and keeps them high, money becomes more expensive to borrow (just ask anyone who’s trying to buy a house right now). This matters a lot for a bevy of clean energy companies, because they often need to spend now — to, say, build a utility-scale solar array — in order to secure flows of payments in the future. When interest rates are high, funding is not only costlier, but future payments are less attractive compared to, say, buying low risk government bonds, which can offer a sizable return with less risk.

“Recently investors have been concerned that higher interest rates mean shrinking NPV, or value creation, for new renewable projects … lack of access to capital, prohibitively high renewables costs, lower renewables demand, and significantly lower value of future growth pipelines,” Morgan Stanley analysts wrote in a note earlier this week. (They ultimately described the sell-off as “overdone”).

Much of the sell-off, the Morgan Stanley analysts said, was attributable to an announcement made last month by NextEra, which is both a leading renewables company and the owner of a Florida utility. NextEra said that the growth rate of dividends paid out by an affiliated company that buys its renewable projects would be cut in half in order “to reduce financing needs and better position the partnership to continue to deliver long-term value for unitholders.”

That’s a mouthful, but it essentially means that a source of capital for a leading renewables developer is less optimistic about the business and decided to cut what it paid to its investors instead of acquiring another solar, wind, or battery project.

This announcement led to a quick, sudden decline in the company’s stock price, knocking around $30 billion off its market value and dragging the broader sector’s valuations down by about 12% soon after the announcement.

For specific companies and sectors, they’ve had their own challenges that have brought down stock prices.

Publicly traded residential solar companies have seen their valuations fall dramatically in the last year, which can be chalked up to, Morgan Stanley analysts argue, “the combination of higher interest rates and policy changes in California,” referring to a new state policy which dramatically cuts back payments to homeowners selling solar power to the electric grid. “Overall, we expect another rough quarter for residential solar companies,” Citi analysts said, in a note downgrading two solar companies, SunPower (stock down two thirds this year) and Sunnova (down 47%).

“Interest rates are highly relevant for the renewables space as installers are effectively financing companies and as renewable project expected returns are sensitive to interest rate changes,” analysts at Citi said in a note this week.

In August, Sunrun, a leader in residential solar, told investors that “recent interest rate increases, inflationary pressures, and working capital needs have prevented us from generating meaningful cash generation.”

And in offshore wind, there have been declines across the board. “The U.S. offshore wind market has run into challenges as project returns have declined due to cost inflation and higher cost of capital,” Morgan Stanley analysts said in a note. “While some offshore wind projects have proven to be NPV-negative and companies have cancelled contracts, we do not see risk of onshore wind, solar, and storage contracts facing these same issues.”

For companies looking to invest in green hydrogen, there is a lot of money being poured into the sector by the federal government, but also a lot of uncertainty around which projects will qualify for tax benefits. Morningstar analyst Brett Castelli described Plug Power as “a high-risk high-reward investment in the green hydrogen economy” with “operating losses and heavy capital investment associated with its green hydrogen network.” The company, Castelli said, would do better, “the more flexible the [federal] rules.”

There is still, of course, a tidal wave of money from the Inflation Reduction Act and Infrastructure Investment and Jobs Act set to flood into the energy sector, but there’s no guarantee it will go to specific companies or startups. Meanwhile, the rollout of the bills has been, well, let’s say methodical, as rules get written and spending programs get built out.

And that leaves investors asking “show me the money.”