Top ESG Trade: Long TAN Solar, Short XLE Oil (NYSEARCA:TAN)

The spike in oil and gas prices globally from U.S. sanctions on Russia exports, and fears Europe could be next, may dramatically accelerate the adoption of clean solar energy production, while slashing the desirability and reliance on fossil fuels for energy policy in western nations.

I have been writing more on solar industry manufacturers and builders the last six months, simply because the value proposition has become more interesting. I explained the bullish cases for my favorites in this space, First Solar (FSLR) in an article here during December and ReneSola (SOL) here during February. Near universal short-term pessimism from Wall Street was gripping the sector several weeks ago, largely a function of U.S. government failures to enhance or even keep existing tax-breaks for building out green energy.

Long Solar Energy Logic

Then, the Russia invasion of Ukraine happened, and solar’s competitive arguments have leapt forward. Alternative sources of power generation from the fossil fuel inputs of natural gas, crude oil, and coal have exploded in cost during early 2022. And, they are now mathematically pricing themselves out of the market vs. wind and solar net costs for electricity output.

Today, as I write this article, solar farm electricity production costs are net, net far lower than fossil fuel sources, have distinct advantages over green wind electricity generation (in terms of noise production, land rents, and bird kill), and are nowhere near the same risk level for environmental contamination as nuclear energy in an accident. Honesty, the downside of nuclear plants is in full display in Ukraine as Russian troops fire upon facilities and could easily decide to create a nuclear disaster during the emotional fog of war.

So, if governments around the world, especially in Europe are serious about green energy policy to save the planet from pollution and climate change, solar is the standout answer to meet the challenge. On top of the low pollution excuse to convert power generation to solar, the new catalyst of self-sufficient energy policy down the road for Europe in particular means solar farm buildouts may actually soar into 2023-24.

I am modeling new tax incentives will be passed from government entities worldwide, including in the U.S., encouraging a massive infrastructure construction phase for the solar industry. The whole concept of sustainable, renewable energy produced on your own soil has taken on new urgency. They say, “necessity is the mother of invention.” Well, energy policy not dependent on imported natural gas and crude oil is now a front-burner issue for every nation to tackle quickly.

Short Big Oil Logic

On the flip side of this argument for ownership, I wrote an article this week here on shorting Big Oil names, with a focus on the debt and liability-ridden Occidental Petroleum (OXY) spiking in price from Warren Buffett’s buying spree through Berkshire Hathaway (BRK.A) (BRK.B). To me, this is possibly the last huge spike in oil/gas, as the push to electric vehicles and renewable energy is something like a guarantee to happen now. In the end, “peak profitability” for oil/gas producers could be happening in early 2022 on the geopolitical mess we are facing today.

Why not burn both sides of the candle in brokerage portfolio construction? Investors can prepare for sharp increases in solar industry buildout through a simple long-focused position in the diversified clean-energy Invesco Solar Portfolio ETF (TAN), and sell short the leading dirty-energy U.S. oil names through the Energy Select Sector SPDR (XLE). Believe it or not, absent the countertrend 2021 experience, the past five years have already proved out this trade as sound, if not brilliant for Environmental, Social, Governance [ESG] investor performance.

Below are charts comparing total returns for both ETFs over the past year of sharp oil outperformance vs. solar, the last two years since the pandemic financial market bottom, alongside a long-term 5-year review highlighting solar’s winning proposition over time.

Another chart to ponder is the proposed long/short trade’s past performance over the last five years below. I have drawn the one-for-one spread idea, with a relative strength line for TAN by itself vs. the S&P 500 index. The resulting gain on the hedged trade idea was nearly +200%, assuming $1 in portfolio equity invested in $1 of TAN vs. $1 short XLE in a margin account. That works out to roughly +25% compounded annually, before trading and borrowing expenses, almost double the equivalent-period S&P 500 advance of +13%. Plus, remember this final long/short return is down considerably after the bruising 2021 underperformance span in TAN vs. XLE.

Top 10 Holdings

I am currently long First Solar and ReneSola, while short XLE and other Big Oil names. So, I have largely executed this spread trade idea over the last week. TAN is a great one-decision investment in the solar industry to give you quick and easy exposure. XLE has an annual management expense of 0.10% vs. TAN’s higher cost 0.66%, partly because a number of Chinese panel manufacturers are held with different risks and trading expense than U.S. choices. I believe getting diversified exposure to a variety of solar names outweighs the somewhat high annual expense.

TAN has a total equity value of $2.5 billion currently vs. XLE’s extensive $38 billion in assets. TAN does not pay a dividend. XLE is sitting on a 3.1% trailing dividend yield, and this number should rise markedly toward/above 4% in 2022 with the onset of windfall income on spiking oil/gas quotes.

Below are tables showing the Top 10 holdings for each ETF. Note: XLE is heavily weighted in Exxon Mobil (XOM) and Chevron (CVX), the largest two Standard Oil spin-offs based in America.

Individual Trading Charts

When we review the 12-month technical charts of daily price and volume changes, alongside some of my favorite momentum indicators, little stands out as a screaming buy for TAN. Conversely, XLE has very strong momentum with limited technical-driven evidence to sell. So, in many respects I am anticipating the Russia/Ukraine war marks a major turning point for each ETF. The current jump in oil/gas prices represents a sentiment and price peak in the making, while fear over petroleum and gas supply gives citizens/politicians a huge reason to subsidize/invest in solar farm and project development.

Final Thoughts

What’s the advantage of a long/short trade vs. a regular buy-and-hold TAN position? If you cannot trade shorts in your tax-deferred account, I am quite excited about a long-only solar sector position. However, investors can largely eliminate equity market direction risk with an equally-weighted short position in Big Oil.

I am not wildly optimistic about Wall Street’s general direction over the next few years, with the outside possibility unusual losses of -20% to -40% are coming next for the S&P 500 and other U.S. market averages (beyond the -10% to -15% correction of early 2022). Rising inflation and interest rates from an extreme overvaluation condition are not exactly supportive of rising equity quotes historically. In fact, most stock market peaks have this in common with today.

For example, if the S&P 500 is -30% lower in 24 months, near record-low dividend payouts annually of 1.3% won’t protect your net worth much. Let’s say TAN does “outperform” nicely and is relatively flat the next few years for price, as oil/gas names hit the skids from any recession in energy demand and/or new overproduction problems appearing later in the year to plug today’s fear of a shortage on Russian export sanctions. For a theoretical number, what if XLE declines -40% over the next 24 months. Sure, investors with a flat return from TAN would be relatively happy missing out on substantial equity losses elsewhere. Yet, those both long TAN and short XLE (with equal dollar weightings in their portfolio) could have a net gain of +30% to +35% on the dual position, depending on short-sale borrowing costs at your brokerage house.

The risk of the trade is both positions move against expectations. If solar companies do not see a material expansion in demand for panels and solar farms, while oil/gas prices remain elevated, an investor can lose twice basically. Assuming solar equities decline -20% AND Big Oil advances +20% the rest of 2022, you would be on the hook for a -40% loss of capital (or more depending on trade/borrowing costs).

The upside scenario is geopolitical trouble in Eastern Europe causes decision-makers to commit to new solar projects sooner rather than later, while actual shortages of crude oil and natural gas do not take place in Europe. This win-win potential could create sizable gains for investors in the spread trade idea during the rest of 2022. A rapid +50% gain in solar names this year, in addition to a -20% to -30% total return loss from Big Oil, would mean profits of +70% or better on your invested capital, REGARDLESS of the S&P 500’s direction.

Overall, this may be the best risk-adjusted, long/short investment idea for ESG and regular investors alike in early March 2022. You can take advantage of excessive bearishness in solar and the truly euphoric (borderline hysterical) bullishness in oil/gas names. Considering almost nobody wanted to own the oil & gas industry at $20 crude oil and sub-$2 natural gas after the pandemic shutdowns in the economy during April 2020, the opposite setup for investors exists today. Now is not the time to chase Big Oil names, but may be the time to contemplate and prepare for future winners in the green energy space.

Thanks for reading. Please consider this article a first step in your due diligence process. Consulting with a registered and experienced investment advisor is recommended before making any trade.