By any measure, renewable energy is an increasingly important investment theme. Recently, the U.S. recommitment to the climate goals of the Paris Agreement, alongside China and India’s pledges to target net zero carbon emissions, have underscored the power of the clean energy trend. It’s a multi-decade investment opportunity, in our view. While valuations for renewable stocks have risen significantly over the last year, we believe attractive investment ideas can still be found. In this note, we examine the economic, environmental and policy backdrops, and identify renewable energy investment opportunities and risks.

Clean energy: Replacing coal and gas in the global electricity mix

Renewable energy currently accounts for 7% of global electricity demand, up from 2% in 2010. But it’s still early days. Renewable’s share is expected to more than triple, to 25%, by 2030 and then double again, to 56%, by 2050 (Exhibit 1). The world’s vast energy requirement of 180 gigawatts (GW) per annum would mean building the equivalent of two Californias of generation capacity every year—potentially for 30 years or more—to replace coal and nuclear power. And that’s in just the 13 largest power markets in the world (plus meeting a 1.5% annual growth in demand).

By 2050, wind and solar will dominate the global electricity mix, replacing coal and gas

EXHIBIT 1: GLOBAL POWER GENERATION MIX, 1970-2050 EST

Source: Bloomberg NEF, October 2020.

Political buy-in, improved economics

Two key factors give us confidence in the strong long-term growth potential of renewable energy:

• Political agreement: Nearly all of the world’s largest countries have acknowledged the need to move to a zero-carbon economy. The majority have committed to reach that target at some point in the next 30–40 years. Most significantly, in the last 12 months the leading carbon emitters, China, India and the U.S., have all made such commitments. In addition, U.S. President Joe Biden has proposed a USD 2 trillion climate plan and the European Union has set aside about 30% of a €750 million pandemic recovery fund for green investment.
  
  
• Improved pricing: The economics of renewables have improved significantly over the past decade. That is largely due to a dramatic increase in the size of wind turbines (from 0.5MW turbines in 1995 to 15MW today) and the greater efficiency of solar panels (from 1% initially to more than 25%). The power price required for a new solar project to break even has fallen by over 80% since 2010, and it has declined by 40% for a new wind generator. This breakeven price has now reached the point that—almost anywhere in the world—wind or solar is the cheapest option for new power generation capacity (Exhibit 2). It’s a game changer, in part because renewables no longer need government subsidies to be profitable.
  
  

Renewables are now cheaper than coal and gas

EXHIBIT 2: COST OF WIND, SOLAR, NATURAL GAS AND COAL
Mean LCOE,* 2020, dollar per megawatt hour

Source: BP Statistical, Bloomberg, Eurostat, Lazard, METI, J.P. Morgan Asset Management Guide to Alternatives; data as of December 31, 2020.
*LCOE is levelized cost of energy, the total cost of building and operating a generating asset over its whole lifetime, divided by the total units of electricity produced over its whole lifetime. It is often taken as a proxy for the average price that the generating asset must receive to break even over its lifetime.

As the world’s electricity systems are increasingly powered by renewables, an obvious way to decarbonize other large carbon-emitting sectors (transport and heating, for example) is to electrify them. Case in point: the burgeoning development of electric vehicles. Electrification feeds back into the need for more clean energy, as the decarbonization of additional industrial sectors creates surging growth in global electricity demand, requiring even more new renewable capacity.

Stock selection: A sustainable competitive advantage

Renewable stocks delivered very strong returns in 2020 and in some cases now look fully valued (if not overvalued). For the 30 largest renewable stocks globally, the median return for the 12 months ended March 23 was almost 120%, despite a 10% decline in the last month. These stocks trade on a one-year forward P/E of more than 25x.

However, we still find opportunities. In an increasingly competitive landscape, we look to invest in companies that enjoy sustainable competitive advantages. Among them:

• Ørsted is the global leader in offshore wind, a form of renewable energy that we expect to grow almost 20% annually (2019–30) in terms of installed capacity. Ørsted enjoys competitive advantages from both its scale (giving it a cost advantage on construction and operation) and its position as global leader, giving it an advantage in auctions for new offshore wind projects, especially in countries building their first offshore wind farms. Countries new to wind energy often prefer an established partner. Compared with other renewables, offshore wind projects offer a very high degree of visibility on cash flows, as power prices are typically fixed for 15 years or more and usually backed by governments in developed markets (including Germany, the UK and the U.S.).
  
  
• NextEra is one of the largest renewable developers in the U.S. (as it has been for 15 years), giving it an unparalleled ability to add capacity while maintaining returns. The company operates a regulated utility in Florida and an unregulated renewable development business with a material competitive advantage stemming from its size, scale and scope of operations. The duration of the renewable build-out in the U.S. positions NextEra well for an extended period of growth.
  
  
• Iberdrola is the world’s largest operator of renewable power generation, with a significant presence in Spain, the UK, the U.S. and Latin America. The company will invest more than €30 billion in new renewable capacity over 2020–25, almost doubling its current capacity, from 32GW to 60GW. Like NextEra, Iberdrola was an early leader in renewable technology, and it has more than 20 years’ experience in building and operating these assets. Its long track record, scale and excellent operational management give the company a competitive advantage in markets with very strong growth prospects for renewables.
  
  

These companies represent just a sample of the attractive investments we have identified even after renewable energy stocks have surged over the past year. To be sure, the clean energy trend presents some risks. These include rising competition from new entrants (among them oil majors) and the challenges of maintaining security of supply as renewables form an increasing share of electricity production. But these risks should be manageable, we believe. Looking ahead, rapidly unfolding decarbonization offers an important multi-decade investment opportunity set.

The companies mentioned in this article are for illustrative purposes only. Their inclusion should not be interpreted as a recommendation to buy or sell. The use of the companies mentioned herein is in no way an endorsement for J.P.Morgan Asset Management investment management services.