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Are Oil Prices Irrationally Correlated To Solar?
Dec. 2, 2014 11:16 AM ET | 17 comments | About: Guggenheim Solar ETF (TAN), Includes: FSENX, FSLR, SCTY, TSLA, VSLR
Disclosure: The author is long SCTY. (More...)
Summary
Oil and solar are not in direct competition with each other.
The market correlation between oil and solar has been largely due to investor ignorance and market inefficiency.
The currently depressed solar markets represent a great buying opportunity for investors.
For the last few months, oil prices have plummeted from above the $100 mark all the way down to the $65 range. Panic predictably set in as this precipitous price drop was occurring, and a massive sell-off in the energy sector occurred. In this same period, solar stocks also experienced a massive drop. While this may not seem strange at first, given that solar and oil are both part of the broader energy market, the solar sell-off during this period looks irrational upon closer inspection.
The Guggenheim Solar ETF (NYSEARCA:TAN) has seen its shares decrease by more than 20 percent since oil prices started crashing. Despite the seeming real-world correlation between solar and oil, the rationale behind this correlation is faulty, at best. While oil is the main source of energy for transportation, only about 1% of oil is used for electricity generation (the market which solar is involved in). On top of this, it is usually only in the areas of the world with little to no refinery capacity that oil is used for electricity generation. In the vast majority of places in the world, though, oil prices would have to become absurdly low in order for it to become a direct substitute good for solar.
(Here is a graph depicting the plummeting shares of the Guggenheim Solar ETF during the oil price crash.)
(click to enlarge)
(Source: YCharts)
Even though the oil and solar markets have very little overlap, the solar market continues to act drastically based on the price movements of oil. While it is not entirely clear why such a correlation exists between these two differing markets, there are several theories that could explain this phenomenon.
Uninformed Investors
One of the most obvious reasons for why solar stocks are plunging in concert with oil prices is simply investor ignorance. Most investors have no idea that the solar and oil markets for the most part do not cross, and some energy analysts even push the idea that they are somehow directly related. While this fallacy can be quickly dispelled with a little research, many investors are still surprisingly uninformed about the almost nonexistent connection between solar and oil.
Of course, the part of the solar sell-off caused by investor ignorance has caused frustration among many in the solar industry. Some analysts have even noted that despite the fact that recent solar sector fundamentals in the past few months have been stronger than ever, most solar stocks in that time frame have either stayed flat or most likely plummeted by 20%-30% of their original values. Since oil had begun dropping, for instance, the largest U.S. solar panel manufacturer First Solar (NASDAQ:FSLR) had dropped from around $72 per share to around $48 per share, marking approximately a 30% decrease.
All Inclusive Energy-Based Mutual Funds and ETFs
While solar and oil are not direct substitute goods, there are many energy-based mutual funds and ETFs that hold both solar and oil stocks. As a result, whenever there is a sector-wide sell-off of oil-related mutual funds and ETFs, solar stocks are oftentimes included in the casualties, so to speak. The Fidelity Select Energy Portfolio (MUTF:FSENX), for instance, holds a variety of oil and solar stocks, and anyone selling this ETF for oil-related reasons will also be inadvertently selling their solar holdings associated with this ETF.
While the efficient market hypothesis assumes that the market would immediately notice this unwarranted drop in solar sector prices and thus correct for this, the market has clearly not done so, and solar stocks continue to stay at depressed levels. As a result, these artificially low solar stock prices offer investors a great potential for upside.
Possible Real-World Connections Between Oil and Solar
Although oil and solar operate in separate markets for the most part, there are still some fringe scenarios where oil prices could impact solar stocks, albeit in an extremely limited manner. For instance, while most solar companies should have remained unaffected by the falling oil prices, some solar companies, namely distributed residential solar companies such as SolarCity (NASDAQ:SCTY) or Vivint Solar (NYSE:VSLR), could actually benefit from lower oil prices. Because the installers of residential solar companies spend a comparatively large amount of money driving their vans, cheaper oil would certainly help with their profit margins. While these benefits certainly do not extend as well into solar manufacturers, solar installers could clearly benefit from the lower oil costs.
Additionally, falling oil prices could potentially decrease electric car sales. With cheaper gas prices, electric cars could lose their appeal to many. Companies like Tesla Motors (NASDAQ:TSLA) may lose market share to traditional gas cars, consequently reducing the size of the electric generation market (which solar operates in). While this would have little to no impact at present to solar companies, as the electric car market is still tiny in comparison to traditional fuel cars, it may have a larger long-term effect if the lower gas prices manage to stunt electric car growth.
Of course, these real-world connections between the oil and solar markets are so minimal and relatively inconsequential as to be almost nonexistent. These possible connections certainly do not warrant the huge solar sell-off that has been occurring in the past few months.
Conclusion
At the end of the day, solar is not in competition with oil in any meaningful way. A great buying opportunity has been presented, largely due to investor irrationality and market inefficiency. There has largely been no good reason for the solar sector's sudden drop-off, and investors looking to profit should look into the current solar markets. At the current discounted solar market levels, many solar stocks offer great value propositions.
