Education Series: Single-Stock ETPs

Fossil Fuels vs Clean Energy: The Year Ahead

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Russia’s actions in Ukraine – and the resultant sanctions – have obviously thrown energy markets in a tizzy. With the US President signing into an effect a ban on import of Russian energy products yesterday, traders are betting that oil prices could cross $200 a barrel by the end of March. There is also a significant call for diversifying energy away from fossil fuels, given how current energy supply is dominated by nations such as Saudi Arabia, Russia and Venezuela which are frequently in the maelstrom of strife. On top of all this is a long-overdue “ratio cool-off” that has been instrumental in the recent downturn of the US equity market (home to some of the most overvalued stocks in the world) as well as US inflation hitting 40-year highs.

Given these facts, analysing both ends of the energy spectrum would be in order. To do this, two ETFs are examined: the Energy Select Sector SPDR Fund (XLE) with over $38 billion in Assets Under Management (AUM) to represent “fossil fuels” and the iShares Global Clean Energy ETF (ICLN) with around $5 billion in AUM to represent “clean energy”.

The Overvaluation Problem

The ETF’s holdings and their ratios – Price to Earnings (PE), Price to Sales (PS) and Price to Book (PB) – are analysed in 1-year windows starting from May 2019 onwards till 2021. Subsequently, they’re further analysed at the dawn of 2022 (as the ratio cool-off gathered steam) and in the beginning of March (after Russia’s actions in Ukraine and subsequent energy outlook changed).

The ratios are calculated in two formats:

  1. The average; wherein the significant ratios of each of the ETF’s constituents are averaged outright;

  2. The weighted-average; wherein said ratios have each constituent’s weight factored to determine an effective proxy for indicating the ETF’s ratio as a whole.

Note: Most data providers put upper and lower bounds on ratios and fiscals. For example, if earnings are too low or PE is too high, they generally don’t report it as these aren’t considered to hold actionable information. Only reported numbers are considered in these calculations.

Across each window, XLE shows strong consistency in top holdings: 4 out of 6 companies – Chevron, ConocoPhillips, EOG Resources, Schlumberger, Exxon and Phillips 66 – account for a little over 50% by weight in the ETF. On the other hand, ICLN has anywhere from 9 to 11 companies amounting to 50%, with Enphase, Vestas, Plug Power and SolarEdge frequently (but not always) appearing in the Top 5.

In the ratio analysis, there are quite a few items of interest. With respect to PE Ratios, valuations of Clean Energy stocks had been sky high relative to fossil fuel stocks even in 2019. While both sets of stocks were extensively overvalued in 2021, the comparison between weighed and weighted-average indicates some stocks were massively overvalued. This is apparent even in March this year, despite ratios slipping below those observed in H1 2019. In comparison, fossil fuel stocks’ average and weighted-average tend to be close together – suggesting relatively more coordinated valuation.

With respect to both PS and PB Ratios, fossil fuel stocks’ weighted-average tends to be nearly twice the average across the windows, which suggests that the top stocks’ prices are relatively overvalued over the rest in terms of sales and book value. When it comes to clean energy, the converse is true, suggesting that the overvaluation problem is more widespread, with the valuation of smaller stocks (by weight) being more speculative.

There was a reckoning of sorts near H1 2021 where the weighted-average PS Ratios of clean energy stocks fell below that of the average – which suggests that corrective actions had taken place before a bounce back at the end of 2021. However, this has returned in March. Absent overvaluations in PE Ratios, PS Ratios tend to be a strong indicator of stock performance in the recent downturn. Thus, there is a strong chance of overvaluation corrections continuing to drag down the stock price of clean energy stocks.

The Overvaluation Problem

Now, most companies in the clean energy space tend to feed the electricity grid. Electricity rates tend to vary by region but the closest proxy to average consumption in the U.S. would be the “Consumer Price Index: US City Electricity Average” which is tabulated with a slight lag. With the data on hand till the end of 2021, it is observed that ICLN’s performance has a widely-varying correlation with the increasing costs of electricity in the US.

On the other hand, fossil fuel stocks – particularly of companies involved with petroleum – have traditionally strong correlations with company earnings over the years (minus, of course, the cost of exploration and infrastructure). Earnings, in turn, are strongly correlated with crude oil prices. The correlation between Brent and XLE price performance has been strengthening over the recent years with 2022 in the year till date being particularly high.

After a hyperbolic 2020, XLE’s AUM changes have shown an increasingly strong trend with prices since H1 2021 with March starting off on a downward trajectory.

On the other hand, when it comes to XLE, there is very strong lockstep behaviour, with March starting off on an upward trajectory after a panicky drop around the time of Russian actions in Ukraine.

In Conclusion

Given the relative maturity and high operational efficiency of fossil fuel companies as well as crude oil’s bullish outlook, oil-related instruments can only be assumed to go up over the month; these companies are the epitome of value stocks that will likely continue to deliver benefits over the year.

Since clean energy isn’t ubiquitous yet and hasn’t achieved comparable efficiency, these companies are very much in their growth phase. The “ratio cool-off” has been hitting companies with rosy growth narratives particularly hard. However, given the push for energy diversification by recent events, there will likely be several opportunities in either direction for tactical investors. Seasoned strategic investors, on the other hand, will likely be wary as the “floor price” for growth stocks remains uncertain.

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Sandeep Rao


Sandeep joined Leverage Shares in September 2020. He leads research on existing and new product lines, asset classes, and strategies, with special emphasis on analysis of recent events and developments.

Sandeep has longstanding experience with financial markets. Starting with a Chicago-based hedge fund as a financial engineer, his career has spanned a variety of domains and organizations over a course of 8 years – from Barclays Capital’s Prime Services Division to (most recently) Nasdaq’s Index Research Team.

Sandeep holds an M.S. in Finance as well as an MBA from Illinois Institute of Technology Chicago.

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Violeta joined Leverage Shares in September 2022. She is responsible for conducting technical analysis, macro and equity research, providing valuable insights to help shape investment strategies for clients.

Prior to joining LS, Violeta worked at several high-profile investment firms in Australia, such as Tollhurst and Morgans Financial where she spent the past 12 years of her career.

Violeta is a certified market technician from the Australian Technical Analysts Association and holds a Post Graduate Diploma of Applied Finance and Investment from Kaplan Professional (FINSIA), Australia, where she was a lecturer for a number of years.

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Julian joined Leverage Shares in 2018 as part of the company’s premier expansion in Eastern Europe. He is responsible for web content and raising brand awareness.

Julian has been academically involved with economics, psychology, sociology, European politics & linguistics. He has experience in business development and marketing through business ventures of his own.

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Oktay joined Leverage Shares in late 2019. He is responsible for driving business growth by maintaining key relationships and developing sales activity across English-speaking markets.

He joined LS from UniCredit, where he was a corporate relationship manager for multinationals. His previous experience is in corporate finance and fund administration at firms like IBM Bulgaria and DeGiro / FundShare.

Oktay holds a BA in Finance & Accounting and a post-graduate certificate in Entrepreneurship from Babson College. He is also a CFA charterholder.

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