Analysts say oil is on its way to $80—why that’s great news for climate change
2014 was a phenomenal year for renewable energy. According to a report from consultancy giant McKinsey & Company, global clean energy investments rose 17 percent that year, reversing two years of declines. But then, 2015 happened. The global energy market was shaken by one of the worst downturns in the oil and gas industry in decades, even worse than what transpired during the 2008 recession. In all, oil prices fell from over $100 per barrel in 2014 to $27 per barrel by Feb. 2016. The drop in commodity prices took renewable energy with it—global investment in renewable energy stalled last year, as consumers and enterprises were incentivized to burn more fossil fuels, to take advantage of low prices.
The good news is, now that oil and gas prices have nearly doubled off their Feb. low, the renewable energy industry can use relative pricing to its advantage. As costs have come down across wind and solar energy, the economics have once again shifted in favor of renewable energy. Analysts are increasingly of the belief that the current rally in oil prices is sustainable; if they’re right, the climate change movement and the renewable energy industry will be among the major beneficiaries.
Analysts: Get ready for higher oil prices
As oil crashed to $27 per barrel in February, there was a great deal of uncertainty as to how low oil could go. With oil back near $50, the question on investors’ minds now is how high oil will go? Analysts widely missed the decline to $27, and through a desire not to miss the next major move, some analysts are trying to get ahead of the rally.
On June 20, Raymond James sent a note to clients predicting that oil would continue to rally to $80 per barrel. A team of analysts led by J. Marshall Adkins wrote, “Over the past few months, we've gained even more confidence that tightening global oil supply/demand dynamics will support a much higher level of oil prices in 2017," the team says. "We continue to believe that 2017 WTI oil prices will average about $30/barrel higher than current futures strip prices would indicate."
According to the analysts, global supply cuts are underpinning the recent rally, and are expected to continue pushing prices higher. Raymond James analysts note that production cuts outside the U.S. in China and Mexico have reduced global oil supply by 400,000 barrels per day. Furthermore, global supply cuts due to political unrest are expected to continue. The recent supply disruptions in Libya, Nigeria, and elsewhere that have taken 800,000 barrels of supply off-line are expected to linger into 2017, based on Raymond James’ forecast.
And, this says nothing of production cuts in the U.S., which have accelerated this year. The recent Baker Hughes (NYSE: BHI) rig count data states that, while the drop in rigs has slowed down, total rigs in operation in the U.S. remain 50 percent below the number in operation at the same point last year. When combined with a slight uptick in global demand, the rational for a sustained rally to $80 per barrel becomes clear.
But while higher oil prices mean higher prices at the pump, it is also a meaningful incentive for growth of the renewable energy industry.
Why a higher oil price is great news for renewables
Renewable energy could be one of America’s next major growth industries. Costs are coming down in wind and solar, and demand is going up. The economics are becoming more favorable, and over time, consumers will see vast benefits in producing electricity from clean, unlimited sources. However, renewable hasn’t yet taken off in the U.S., primarily because of low oil and gas prices.
With crude oil at approximately $50 per barrel in the U.S., consumers are more incentivized to purchase gas guzzlers. Natural gas prices have dropped as well, and while natural gas is a valuable bridge fuel to a future based on renewables, the steep drop in oil and gas prices has created a major speed bump for the renewable energy movement. But a sustained rise in the price of commodities including oil, natural gas, and coal, would actually be a tailwind for renewable energy.
In a recent analysis by FTI Consulting, the cost of wind energy has come down so much in the past few years that it is now very competitive with fossil fuels. For example, FTI states that at $65-120 per megawatt hour, gas is more expensive than wind energy. If commodity prices increase from current levels, it will only widen the spread.
According to the U.S. Energy Information Administration (EIA), wind energy capacity is set to rise by 11 percent this year. Furthermore, between now and 2022, the EIA estimates that renewable energy sources will account for the majority of new power.
Companies to watch
For investors looking ahead, 2017 could represent a major turnaround year for downtrodden renewable energy industries. If oil prices continue to rally to $80 per barrel, which would represent 60 percent further upside, investors may want to reallocate their investments toward renewable energy. Three exchange-traded funds that could benefit from accelerating growth in renewable energy next year are PowerShares Clean Energy ETF (NYSE: PBW), FirstTrust Global Wind Energy ETF (NYSE: FAN), and iShares S&P Global Clean Energy (Nasdaq: ICLN).
All three of these funds have lost value over the past two years, with the ICLN and PBW funds losing 21 percent and 40 percent of their value in that time, respectively. These funds have lagged far behind the S&P 500, which has gained 8 percent in the past two years. Renewable energy investments have fallen out of favor with investors under an environment of declining oil and gas prices, but a sustained rally in commodities could be the catalyst needed for a return to growth. Investors may find that renewable energy is one of the best turnaround stories of 2017.
Bob Ciura is an independent equity analyst. Since 2012, his work has focused on fundamental investment analysis of publicly-traded companies in the energy, technology, and consumer goods industries. Bob has a Bachelor's degree in Finance and an MBA in Finance.