A major wind tax subsidy is scheduled, without another renewal, to expire at year's end and natural gas, one of wind's biggest competitors, is dirt cheap. These are some tough conditions for the wind-energy sector and its investors.
But if included as a narrow slice of a diversified portfolio, renewable energy—including wind—is one way to take advantage of emerging markets' growing energy demands and a global "green" mindset that some observers insist will only strengthen in coming years.
Investors can buy the shares of major domestic wind-energy market participants like General Electric (ticker: GE) or overseas firms (also U.S.-listed) Vestas (VWS), Siemens (SI), and Gamesa (GAM). But the more diverse and perhaps lower-cost way to gain exposure is limited to two exchange-traded funds (ETFs). The first is PowerShares Global Wind Energy ETF (PWND), which is based on the NASDAQ OMX Clean Edge Global Wind Energy Index. It has an expense ratio of 0.75 percent. There's also First Trust Global Wind Energy ETF (FAN), with an expense ratio of 0.60 percent. These funds maintain roughly 75 percent overlap of companies. FAN is a little cheaper and includes nearly twice as many holdings as PWND. FAN also commits a 33 percent weighting to companies that are only loosely involved with wind development; there can be advantages and disadvantages to that mix. On the other hand, PWND is more of a pure wind-energy play.
Near-term challenges don't completely diminish the strong underlying reasons for longer-term growth in renewable energy, including wind.
"Although the recent financial crisis has made financing these capital-intensive projects problematic and falling energy prices have further compressed their earnings potential, many utilities are still going forward with their renewable-energy project plans," said Abraham Bailin, Morningstar ETF analyst, in a commentary. "PowerShares Global Wind Energy provides a direct avenue for investors seeking exposure to this growing industry."
Here, we explore five reasons to be bullish longer-term on wind power. But we'll start with five reminders of why investors will have to be patient.
The Bearish Case
Lost support. The sustainability of wind without government incentives is in question, even in higher-production states like Texas. Investment dollars in wind energy will drop by nearly two-thirds if Congress fails to extend past the end of 2012 a key tax credit that's set to expire at year's end, the American Wind Energy Association predicts. Right now, the PTC (Production Tax Credit) program, a five-year depreciation tax credit program, along with state-based RPS (Renewable Portfolio Standards) that mandate a greater percentage of electricity from clean-energy sources, provide powerful incentives for large-scale wind farm development. The PTC provides an income tax credit of 2.2 cents per kilowatt-hour for electricity produced from wind turbines. Congress first enacted the credit in 1992 and has renewed it four times. But lawmakers have also allowed it to expire three times. Another program, a federal Investment Tax Credit (ITC) known as the Treasury 1603 grant, has already expired. A mixed Congress leaves PTC extension uncertain. It has White House support. Sen. Charles Grassley (R-Iowa), one of the sponsors of a bill that would preserve the credit, has said he expects no decision until after the November election.
Overbuilding. Siemens President and CEO Peter Loescher warned in July that oversupply in the market was leading to pricing pressure in its renewables business. The company reported in mid-July that profits from its renewables division fell 48 percent in its fiscal third quarter. Both Gamesa and Vestas management have noted the downward pressure on prices from oversupply, aggravated by reduced project financing because of economic turmoil in the euro zone.
Unreliability. Although wind technology is evolving, Mother Nature isn't always an ally. While there is an abundance of wind in the jet streams, it is much easier to harness ground wind. Is that enough? Tapping into the jet stream remains, for now, an unreachable feat that may prevent wind energy from reaching its potential. Or is it simply a challenge left for evolving technology, and investment in that technology, to solve? There are a limited number of effective wind corridors in the United States that can sustain a desired output of 1MW or larger. Investors might screen wind power companies by focusing on those established in or buying up the most profitable acreage.
Competition. The boom in cheap natural gas can be good news for the environment because it's cleaner than coal. Of course, the extraction practice known as fracking remains an environmental controversy onto its own. But natural gas is a reminder of the uphill climb for renewables such as wind.
Volatility. Investors know it's not the easiest market to stomach. ETF PWND has, over the past three years, posted a standard deviation of roughly 31 percent, according to Morningstar data. To put that in context, the standard deviation of the S&P 500 over the same expanse was about 16 percent.
The Bullish Case
Standing on its own. Generators are trying to position for a subsidy-free existence someday. For example, NextEra Energy (NEE) is an electricity provider whose regulated segment, Florida Power & Light, distributes power to 4.5 million customers in Florida. Consolidated generation capacity totals nearly 41.3 gigawatts and includes natural gas and significant wind and nuclear assets, making it a U.S. leader. The firm's merchant segment generates and sells power throughout the United States and more than 50 percent of this segment's generation capacity is wind. Its executive chairman Lew Hay, who spoke this summer in Washington, desires this future: The U.S. production tax credit for wind should be extended and phased out over five to 10 years.
Heavyweights like GE may be able to withstand the market volatility tied to a lost tax incentive. GE said orders for wind turbines more than doubled in the first quarter of 2012 from a year earlier, although partly because wind-farm developers are scrambling to beat the December tax deadline.
MLPs: Just like gas. The looming deadline has some on Capitol Hill thinking in a different direction. One bipartisan proposal would expand the beneficial tax attributes of master limited partnerships (MLPs) to renewable energy investments. While an MLP resembles a traditional stock in part, the company behind it is handed tax benefits it must pass on to investors, usually through dividends. Current law only allows this special tax treatment for MLPs that invest in oil, natural gas, coal extraction, and pipeline projects.
Private investment as proxy? Private money is still flowing, which could bode well for public follow-through. For instance, Houston-based Clean Line Energy Partners is thinking big, and taking on a big regulatory fight, it details in a press release. The energy infrastructure developer plans to gather permits and rights-of-way for new multi-billion-dollar transmission lines to carry electricity from U.S. wind-power resources in the middle of the Lower 48 to the population centers on the coasts. One way Clean Line's proposal differs from other transmission methods is in its use of direct current transmission, believed to be cost-effective over alternating current. This is a technology embraced in China and expanding its grid.
So far, Clean Line Energy has drawn investor support from the Zilkha family of Houston as well as ZBI Ventures, a unit of Ziff Brothers Investments, which is the principal vehicle of the New York-based Ziff family. Terms of the financing have not been disclosed.
Domestic demand. Because 29 states have renewable portfolio standards, demand for wind has a floor. Plus, states are ramping up renewable energy programs. For instance, California has required that one-third of its energy must come from renewable sources by 2020.
Emerging markets. More than two decades after the first wind farm at sea was installed in Denmark, Europe continues to lead the push toward greater wind development (the U.K. announced a major electricity market overhaul to include more wind in May.) It does face challenges in extending capacity in the current economic climate.
But the bigger story may be elsewhere. According to a report by the International Energy Agency, Brazil alone will add 32 gigawatts of renewable energy to its power grid within the next five years. The move will put the South American economic generator in a fourth-place tie with Germany in renewable energy investment, exceeded only by China (270 gigawatts), the United States (56 gigawatts), and India (39 gigawatts).
According to KuicK Research's "Brazil Wind Power Market Analysis" report, even though the power generation is dominated by hydropower in Brazil, wind power generation has increased by 500 percent from 2006 to 2011.
Bottom line: There are plenty of reasons for longer-term optimism after near-term caution. One advisable strategy when it comes to wind-energy stock investment is to dedicate the majority of your green portfolio mostly to larger corporations that bring stable yields, then fold in smaller companies that are innovating with new technologies or applications.