The alternative and sustainable energy sector had a tough year in 2024. According to LSEG Lipper data, while the MSCI World Index delivered an impressive 21% return in GBP terms, the MSCI Global Alternative Energy Index, by comparison, suffered a 32% decline. If you have been invested in a thematic focused on alternative and sustainable energy, you will have almost certainly experienced negative performance in 2024.
We are all aware that the global stockmarket has been driven by large-cap tech stocks and that has created considerable concentration risk. Other parts of the market, especially energy, remain out of favour. However, there are reasons for optimism in the sustainable energy market. The sector’s recent struggles are very much underpinned by cyclical events and key structural tailwinds suggest that patient investors could see substantial rewards in the years ahead.
Several factors contributed to the sector’s recent underperformance. The surge in global interest rates put pressure on capital-intensive sectors such as renewable energy. Many companies in the alternative energy space rely on project financing, and elevated borrowing costs dampened growth prospects and squeezed margins. The reluctance of central banks to ease monetary policy kept investor sentiment muted for much of the year.
The rapid expansion of renewable energy over the last decade has led to significant cost declines in key components such as solar panels, wind turbines and battery storage. However, this also created a glut in some areas, driving down prices and profitability. Companies in solar and wind equipment manufacturing saw their earnings decline as excess supply led to lower margins.
While many governments have committed to ambitious decarbonisation targets, uncertainty around policy execution has slowed investment. In the US, aspects of the Inflation Reduction Act remained ambiguous, leading to postponed projects. Additionally, the recent US election added an extra layer of caution for investors waiting to see how policies might shift under Donald Trump.
Also read: Sustainable investing still makes sense in a Trump world
China, a crucial player in renewable energy deployment, faced weaker-than-expected economic growth. This impacted demand for electric vehicles (EVs) and solar power, leading to profit warnings from major players in the supply chain. Nonetheless, sales of EVs in China remain robust, seeing growth of some 40% in 2024 compared to 2023.
While short-term headwinds have weighed heavily on the sector, I believe the long-term case for sustainable energy remains intact.
The world is in the early stages of a decades-long shift away from fossil fuels. The International Energy Agency projects that global investment in clean technologies will reach nearly $2trn by 2035, almost double the amount allocated to fossil fuels. Countries worldwide are setting aggressive targets for renewable energy expansion, with policies in place to phase out coal, increase offshore wind capacity and promote the adoption of EVs.
Another compelling reason to stay invested in alternative energy is driven by simple economics. The costs for wind and solar power generation have continued to decline, with solar now 90% cheaper than in 2010. Onshore wind costs have fallen by 70% over the same period. In many parts of the world, renewables are already cheaper than fossil fuel-based generation, making them the prime choice for future energy projects. While this paints a positive picture for future revenue growth, companies within this sector will need to find ways in which they can increase their margins to avoid being dependent on pure volumes.
With the rise of artificial intelligence, cloud computing and data centres (which are all very energy hungry) the expectation of increased electricity demand is already being realised and will only increase further in the coming years. The sustainable energy sector is well-positioned to capitalise on this shift, as large tech companies commit to running their data centres on increasing levels of renewable power. Similarly, the electrification of transport and heating will create substantial new demand for clean energy sources.
Higher borrowing costs were a significant drag on the sector in 2024 especially as cuts to interest rates didn’t come as quickly as expected. Nonetheless, with inflation easing in key markets, central banks could once again consider cutting rates more aggressively in the near future. This should provide a strong tailwind for renewable energy companies by lowering financing costs for new projects.
Despite the sector’s recent struggles, private equity firms and infrastructure investors have shown increasing interest in acquiring undervalued clean energy assets. Mergers and acquisitions in the sector remain buoyant which signals that industry insiders see significant long-term value in the sector.
For investors, the case for sustainable energy remains compelling, but it requires a longer time horizon. The transition to a low-carbon economy will not happen overnight, and short-term volatility should be expected. However, history has shown that early investors in transformative industries – whether it was the internet, semiconductors or electric vehicles – have been well rewarded.
Funds that focus on sustainable energy are well-positioned to benefit from the accelerating transition. Furthermore, the market dislocations of 2024 may have created an attractive entry point for long-term investors willing to weather short-term turbulence. A good active fund manager should be able to navigate these steadily.
While the past year has been challenging, the underlying structural trends remain intact. Governments, corporations, and consumers are all driving demand for clean energy. Costs are continuing to decline, making renewables more competitive than traditional energy sources. 2024 was certainly a challenging year, but it’s always darkest just before the dawn.
