Why Clean Energy ETFs Are No Slam Dunk

by on June 28, 2010 | ETFs Mentioned:

It has been more than two months since an oil rig exploded and sank in the Gulf of Mexico, setting off one of the worst environmental disasters in U.S. history. The aftermath of the spill has called into question the very survival of British oil giant BP, and dealt a devastating blow to pension funds and other investors who had come to rely on the company’s dividend payment [see Seven ETFs For Investors Mourning The Death Of BP's Dividend]. But the fallout didn’t end with BP; a proposed moratorium on deep-water drilling threatens to shake up the industry and increased regulatory oversight seems inevitable.

But there have also been a few winners from the spill. President Obama seized an opportunity earlier this month to jumpstart a campaign to reduce dependence on foreign oil and make the U.S. a leader in the global clean energy industry. Not surprisingly, his first Oval Office address sparked interest in clean energy as an investment opportunity as well; some see companies developing alternative power sources as the “next big thing.” But fostering a clean energy revolution is much easier said than done, particularly in the current environment. Clean energy ETFs may seem like a slam dunk, but there is plenty of risk surrounding this sector at present.

Europe’s Woes Weigh On Alternative Energy

Stubbornly high unemployment and massive stimulus measures enacted to pull economies out of the recent recession have left many cash-strapped European countries with few options. With governments across the continent outlining strict austerity measures, perhaps no industry has felt the pinch more than the clean energy. Italy recently relieved the state-run energy management agency of its role as the buyer of last resort for “green certificates” issued to support development of cleaner energy production. The Italian governenment used to offer what were called green certificates, or subsidies and financial aid for companies delving into the renewable energy business. But with these certificates costing the country nearly €500 million a year, Italy has proposed to scrap this program as a whole. “A change in Italy’s public incentives for renewable energy investment has brought financing for the sector to a halt, hitting aspiring players in the green economy,” writes Christopher Emsden.

Italy isn’t alone in scaling back or scrapping altogether subsidies for the still nascent clean energy industry. Germany will also make heavy cuts into their solar energy program to help recover from their debt. Other struggling economies, including Spain, Czech Republic and Slovakia, are the most “at risk” for the withdrawal of renewable energy support mechanisms according to HSBC analysts.

As Italy and other countries around the world have demonstrated, subsidies for the alternative energy industry are among the first things to go when government budget cuts begin. Financial stability is a prerequisite for offering subsidies and tax relief to these renewable energy programs, and much of the developed world finds itself on very unstable fiscal footing.

With a renewed focus on reducing dependence on foreign oil, the clean energy industry has a tremendous opportunity. But there are also significant obstacles in the way, as the industry is falling victim to Europe’s disastrous budget situation. For investors seeking exposure–long or short–to the clean energy sector, we outline several ETF options below:

First Trust ISE Global Wind Energy ETF (FAN)

First Trust’s wind ETF tracks the ISE Global Wind Energy Index, a benchmark made up of companies that are identified as providing goods and services exclusively to the wind energy industry. The majority of the fund is made up of European stocks, with the highest single country allocation being Spain (24%). The predicted slashes in Spain’s wind energy subsidies have weighed heavily on FAN this year; the ETF is down over 30% already.

PowerShares Global Clean Energy Portfolio (PBD)

PBD seeks to replicate the performance of the WilderHill New Energy Global Innovation Index, a benchmark composed of companies that focus on greener and generally renewable sources of energy and technologies facilitating cleaner energy. Similar to FAN, PBD allocates to a significant amount of European equities, creating an uncertain outlook for this ETF. With a beta of 1.43, this particularly volatile fund is down about 25% so far this year.

Claymore/MAC Global Solar Energy Index ETF (TAN)

This ETF measures the MAC Global Solar Energy Index, which is designed to track companies within the various segments of the solar energy industry. TAN has heavy ties with Germany, allocating a quarter of its assets to the country’s solar energy market. TAN holds a majority of its assets in small and medium market capitalization firms, making it one of the most volatile equity ETFs available; the fund’s beta is nearly 2.0. TAN has been hit hard this year, with negative returns eclipsing 30%.

Disclosure: No positions at time of writing.