Solar ETFs: Bright Future Or Headed For A Burnout?

by on February 4, 2010 | ETFs Mentioned:

The ETF industry has been credited with bringing exotic asset classes and investment strategies within the reach of all levels of investors. But it has also provided a potentially better way to invest in asset classes and industries that have historically exhibited significant volatility. Because the ETF structure provides immediate diversification of holdings at a reasonable rate, it has been embraced as an efficient way to invest in junk bonds, micro cap stocks, and tech companies. ETFs have become a popular way to establish both long and short positions in the alternative energy industry, and multiple funds now offer targeted exposure to solar energy. 

The concept of harnessing the sun’s energy to power homes and businesses has been around for decades, but the solar energy industry is still at a relatively early stage of development, and the extent to which solar energy will be widely adopted is extremely uncertain. In addition to competing with traditional sources of energy, solar power must compete with other alternative forms, including wind and water power. To the extent that other alternative energy sources are proven to be sustainable and cost-efficient, the prospects for the solar energy industry could be dimmed considerably.

Performance Drivers

Solar ETFs have historically been quite volatile, in part because valuation of early stage companies without stable cash flows is difficult, but also because the industry is impacted by a wide variety of factors. During the most recent recession, prices were hammered as investors ran from risky investments. But shares surged leading up the the global climate change conference in Copenhagen in December 2009, before falling back as the summit produced no definitive timelines. Price drivers of solar ETFs include:

  • Oil Prices: There has historically been a strong positive correlation between prices of traditional energy commodities (such as crude oil) and public support for clean energy initiatives. When gas priced jumped above $4, anti-oil industry rhetoric picked up noticeably and plans for reducing dependence on crude gained serious traction. But when oil prices dip, so does the urgency for clean energy intiatives.
  • Government Subsidies/Economic Incentives: The development of sustainable sources of clean energy is a regular campaign focus, but has a history of being pushed to the back burner when more pressing issues arise. Much of the momentum gained by proponents of alternative energy in recent years was lost during the most recent economic downturn, when stemming job losses and stimulating economic spending became much higher priorities.
  • Technological Developments: The future of the solar energy industry depends heavily on technological advancements made in coming years. Although the industry has come a long way, it still relies heavily on subsidies to compete with traditional sources of energy, an arrangement that is not sustainable over the long term.

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China Makes Push As Germany Bails

Over the last two decades, Germany has become one of the capitals of the solar energy industry, providing attractive economic incentives to companies engaged in the manufacture of solar panels and other products. But a prolonged downturn in the European economy has forced Germany to make some difficult budget decisions, and its generous support of the solar industry will seemingly be cut back. Responding to a plan to wean the industry off of government subsidies, some German lawmakers have begun to push for deeper cuts than initially proposed. Environment Minister Norbert Roettgen recently announced that the government would propose a cut of 15% in addition to reductions already outlined in Germany’s Renewable Energy Act.

While Germany is scaling back its support of the solar power industry, China is making a push to become a market leader. Beijing has set a goal of 10 to 20 gigawatts of solar capacity–compared to about 50 megawatts  in 2008–by 2020. “The Chinese national government has put in place two significant subsidies for solar photovoltaic installations,” writes Jonathan Shieber. ” Through the ‘Golden Sun’ program, the Ministries of Finance, Science and Technology and the National Energy Administration are offering to subsidize half of the construction and connection costs of on-grid solar-power plants and 70% of the cost of off-grid installations from now until 2011.”

China’s status as one of the world’s fastest-growing economies puts the government in a position to pursue opportunities that debt-laden developed markets are unable to pursue. Dozens of solar power companies have expressed interest in either establishing or expanding operations in China, a sign that the lucrative incentive programs are having the desired effect.

Solar ETF Options

Investors looking to gain exposure (either long or short) to alternative energy have a number of options. Funds offering diversified exposure to this sector include:

  • PowerShares WilderHill Clean Energy Portfolio (PBW): This equal-weighted ETF invests is composed of companies that focus on greener and generally renewable sources of energy and technologies facilitating cleaner energy. 
  • Market Vectors Global Alternative Energy ETF (GEX): This ETF tracks the Ardour Global Index, a benchmark measuring the performance of companies engaged in the alternative energy industry. Major holdings of GEX include Vestas Wind Systems, First Solar Inc., and Kurita Water Industries.
  • PowerShares Global Clean Energy Portfolio (PBD): This ETF is similar to PBW, but maintains a global focus, giving significant allocations to China, Germany, and Spain as well as the U.S.
  • PowerShares WilderHill Progressive Energy Index (PUW): The index underlying this ETF is based on an index that consists of U.S.-listed companies that are significantly involved in transitional energy bridge technologies, with an emphasis on improving the use of fossil fuels.
  • First Trust NASDAQ Clean Edge Green Energy Index Fund (QCLN): This ETF consists of U.S. clean energy companies that are engaged in manufacturing, development, distribution and installation of emerging clean-energy technologies including, but not limited to, solar photovoltaics, biofuels and advanced batteries.

The ETFs profiled above offer diversified exposure to the clean energy industry, including wind, solar, and water power. For those looking to specifically target the solar energy industry, there are two primary options:

  • Claymore/MAC Global Solar Energy Index ETF (TAN): This ETF is based on an index designed to track companies that produce solar power equipment, companies that produce fabrication products (such as the equipment used by solar cell and module producers to manufacture solar power equipment) or services (such as companies specializing in the solar cell manufacturing or the provision of consulting services to solar cell and module producers) for solar power equipment producers, and companies that supply raw materials or components to solar power equipment producers or integrators. TAN charges an expense ratio of 0.65% and has 30 individual holdings.

TAN

  • Market Vectors Solar Energy ETF (KWT): This ETF tracks a benchmark that provides exposure to publicly traded companies from around the world that derive at least 66% of their revenues from solar power and related products and services. On a weighted basis, the companies in the underlying index derive in excess of 90% of their revenues from the solar industry. Similar to TAN, KWT charges 0.65% and has 30 individual holdings.

KWT

Disclosure: No positions at time of writing.