The Hidden Benefit Of The Green Energy Transition

The Hidden Benefit Of The Green Energy Transition
Russell Burns

5 months ago5 mins

  • Green technologies will have a deflationary impact, especially for Europe, with significant cost savings for European households and the environment.

  • Solar power looks to be the cheapest renewable and could start to take market share, while the outlook for offshore wind remains uncertain

  • Solaria, a solar power operator with strong profit growth and reasonable valuations, might provide a ray of sunshine in your portfolio

Green technologies will have a deflationary impact, especially for Europe, with significant cost savings for European households and the environment.

Solar power looks to be the cheapest renewable and could start to take market share, while the outlook for offshore wind remains uncertain

Solaria, a solar power operator with strong profit growth and reasonable valuations, might provide a ray of sunshine in your portfolio

The green energy transition has always had benefits that go beyond the environment, and one of the key benefits right now is its deflationary impact. In a new report, Goldman Sachs calculates how big that particular effect might be for both Europe and the US, and spotlights the renewable energy sources that might be set for the biggest boom. And since the green energy landscape is littered with opportunities, I decided to take a look…

So what are the key benefits?

At its leafy core, green electricity addresses three key needs. The first is decarbonization: its alternative sources of energy reduce carbon emissions, and that helps the fight against climate change. The second is energy security: Europe, for one, imports 80% to 90% of its oil and gas, and shrinking its reliance on those imports would lessen the brunt of some of the disruptions it’s seen. The third is re-industrialization: if the green transition is successful, electrification would not only be deflationary for the major economies, but it might also boost long-term investment and lead to some industrial reinvigoration.

For Europe and the US, the deflationary aspect of those benefits is pretty appealing at the moment. Central banks in both places have been jacking up interest rates as they try to rein in some stubbornly hot inflation, and risking economic growth in the process. So things that bring down inflation (i.e. things that are deflationary) are pretty cool right now.

Maybe it’s not a surprise, then, that Goldman created an “electrification cost curve” to really nail down the deflationary impact of the energy transition. It looked at the costs of the key technologies used in the transition – wind and solar, energy storage, heat pumps, EVs, electrolysis, and carbon capture.

The six key green technologies for electrification. Source: Goldman Sachs, Finimize.
The six key green technologies for electrification. Source: Goldman Sachs, Finimize.

It then estimated the levelized cost of energy (LCOE) for each and expressed them in old-school terms, specifically, in barrel-of-oil equivalents to measure their impact on both the European and US economies.

What did it calculate for the European economy?

Assuming an oil price at $80 a barrel (red line), it shows that solar and onshore wind (far left) are highly deflationary for the economy.

Europe’s electrification cost curve in 2023 versus West Texas Intermediate (WTI) crude oil at  $80 a /barrel (red line). Source: Goldman Sachs, Finimize.
Europe’s electrification cost curve in 2023 versus West Texas Intermediate (WTI) crude oil at $80 a /barrel (red line). Source: Goldman Sachs, Finimize.

What’s more, over the next ten years, Goldman estimates that in Europe, around 70% of electrification would be deflationary with oil prices at or above $80. The range of this deflationary impact could be as low as 60% over the next five years, but it expects a steep improvement to around a 90% impact in years six and seven because of the expected growth in EVs.

The investment bank calculates that a “fully electrified European household” – one that uses electric heating and drives EVs – will see its energy bill fall by more than half per year. While the initial costs are estimated at around €8,000 ($8,500) per household, the “payback” – that is, the time taken to see the costs recovered – would be a relatively minimal 3.5 years. And this would reduce annual total carbon emissions in Europe by a pretty impressive 30%.

The deflationary impact of key electrification technologies. Source: Goldman Sachs, Finimize
The deflationary impact of key electrification technologies. Source: Goldman Sachs, Finimize

How about the US economy?

For the US, Goldman’s electrification cost curve looks a lot less dramatic.

The US economy’s electrification cost curve in 2023 versus West Texas Intermediate (WTI) crude oil at $80 a barrel (red line). Source: Goldman Sachs, Finimize.
The US economy’s electrification cost curve in 2023 versus West Texas Intermediate (WTI) crude oil at $80 a barrel (red line). Source: Goldman Sachs, Finimize.

Using the same methodology as before, it showed that only solar and onshore wind are deflationary – and they’re a lot less deflationary than they are for Europe. Goldman estimates that only around 30% of the green capital expenditure (capex) electrification process is deflationary and over the next decade, it sees that growing to only about 40%.

Now, there’s a cheaper energy price in that chart as well – that represents the Henry Hub in $ per barrel, the lower red horizontal line – which is one reason why electrification isn’t quite as deflationary in the US. The country already has lower costs for gas heating and gas-fired power generation, lower taxes on carbon-emitting technologies, and lower gasoline prices. And the US Inflation Reduction Act, with its incentives for electrification, is already helping support consumers by avoiding higher prices from the ongoing transition.

So what’s the opportunity here?

Goldman’s looking at solar and sees it set to boom as falling industry prices have made it increasingly cost-competitive compared to other renewables. The economics of onshore wind also look attractive. However, offshore wind has suffered from huge cost inflation (especially in the US, where there’s an under-developed supply chain) and this could lead to a setback for its future growth potential.

Goldman took a look at the whole global electrification ecosystem – think: EVs, battery makers, heat pumps, and so on. And it put its sharpest focus on the renewable industry – spotlighting RWE, Enel, EDP/EDPR, Solaria, and SSE as the most attractive stocks.

It estimates their share prices are currently factoring in limited growth, if any, over the coming years and says it expects them to trade higher than its historical sector multiples, once they start to realize some of their strong growth prospects.

The estimated 2027 price-to-earnings multiple by company for renewable energy sources developers. Source: Goldman Sachs, Finimize.
The estimated 2027 price-to-earnings multiple by company for renewable energy sources developers. Source: Goldman Sachs, Finimize.

Right now, many of these firms would seem to be trading at a discount to their historic multiples based on their 2027 forecasts, and that’s where opportunities may be.

Goldman says several potential catalysts could cause these stocks to break higher: a peak in interest rates, the possibility of policymakers allowing price revisions or better terms on legacy offshore projects, improved company disclosure around the profitability of projects, or improved capital allocation discipline – a focus on profitability, for example, instead of revenues.

Solaria is the cheapest stock on the chart above and looks especially interesting to me, because it’s a pure play on solar energy. It owns and operates solar plants in Europe and Latin America. A surplus – too much supply – of solar panels has dented the market price of panels, but this should help reduce Solaria’s equipment costs. With forecasted 20% operating growth expected over the next few years and trading under a 10x price-to-earnings ratio based on 2026 estimates, the valuations look pretty attractive.

For those looking for a long-short strategy, you may want to consider shorting Orsted, which is heavily exposed to offshore wind farms. The stock dropped 22% in August after announcing a $2.3 billion writedown on its US operations. Still, the risk of further projects being canceled or delayed remains because of cost increases and the need for further subsidies to keep existing offshore projects viable

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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