Crude Oil & Alt Energy: The Non-Relationship That Just Won't Go Away

Charles Morand



The relationship - or lack
thereof - between oil prices and the performance of alt energy stocks
has been a long-time interest of mine. I discussed it last in late
March when I looked at href="http://www.altenergystocks.com/archives/2009/03/do_you_need_to_invest_in_oil_to_benefit_from_expensive_oil.html">correlations
between the daily returns of alt energy and fossil energy ETFs.
At the time, I found that only a weak relationship existed between the
two and that if someone wanted to make a thematic investment play on href="http://www.altenergystocks.com/archives/2009/09/what_is_peak_oil.html">Peak
Oil, alt energy ETFs were not an
ideal way to do so. 



Seeing as the popular press and countless "experts" continue to claim,
whenever they get a chance, that the fortunes of alternative energy
stocks are closely tied to the price of oil, I figured I would revisit
the topic.



Fossil
& Alternative Energy: The Relationship That Isn't There



This
time around, I took a slightly different approach for my analysis: I
correlated the weekly returns for US oil and US natural gas directly
(as opposed to through an ETF) with returns for the S&P 500 and
four alt energy ETFs. For US Oil and Nat Gas, I used price data
provided by the href="http://www.eia.doe.gov/">Energy Information
Administration href="http://tonto.eia.doe.gov/dnav/pet/pet_pri_wco_k_w.htm">here
(Spot Price href="http://tonto.eia.doe.gov/dnav/pet/TblDefs/pet_pri_wco_tbldef2.asp">FOB
Weighted by Estimated Export Volume) and href="http://tonto.eia.doe.gov/dnav/ng/ng_pri_fut_s1_w.htm">here
( href="http://tonto.eia.doe.gov/dnav/ng/TblDefs/ng_pri_fut_tbldef2.asp">Contract
1), respectively. I got ETF and
S&P 500 price and index value data from href="http://www.google.com/finance">Google Finance.




For the ETFs, I picked the href="http://www.altenergystocks.com/comm/content/claymore-mac-global-solar-index-etf/">Claymore/Mac
Global Solar Index ETF (TAN) as
the solar sector representative, because I href="http://www.altenergystocks.com/archives/2009/03/dipping_a_toe_in_the_golden_stuff_1.html">took
a position in it in March (which
I liquidated last week even though I initially claimed I would hang on
to it for 18 to 24 months. I have now grown more worried about downside
risk than I am optimistic about upside prospects over that time
horizon, so I took my money out).     



The other ETFs were: the  href="http://www.altenergystocks.com/comm/content/first-trust-global-wind-energy-index/">First
Trust Global Wind Energy Index (FAN)
for wind, because  href="http://www.altenergystocks.com/archives/2008/08/comparing_the_wind_energy_etfs.html">it
represents a more direct play on the sector than the alternative;
the href="http://www.altenergystocks.com/comm/content/powershares-clean-energy-etf/">PowerShares
Clean Energy (PBW) ETF for alt
energy other than solar and wind, as an href="http://www.altenergystocks.com/archives/2009/05/not_all_alt_energy_etfs_were_created_alike_1.html">analysis
I conducted earlier this year indicated it is the best way to access
other sectors; and the href="http://www.altenergystocks.com/comm/content/transportetf/">Powershares
Global Progressive Transport (PTRP)
ETF, as it provides the only proxy I know of for returns on a basket of
stocks with exposure to href="http://www.altenergystocks.com/archives/clean_transportation/">alternative
modes of transportation.
         



The graph below displays returns for all four ETFs, Oil, Nat Gas and
the S&P 500 between Jan. 1, 2007 and Sep. 25, 2009 (click on
the image for a large view).       
     



href="http://www.altenergystocks.com/assets/Oct%207-09%20Img%201.pdf"> alt="Oct 7-09 Chart 1_2.bmp"
src="http://www.altenergystocks.com/assets/Oct%207-09%20Chart%201_2.bmp"
border="0" height="400" width="550">




The table below shows returns and volatility for all seven assets over
the same time interval but broken down into sub-periods. Seeing as 2009
and the post-Lehman collapse period have been eventful times to say the
least, I thought it would make sense to create a few distinct
sub-periods for analytical purposes.



What jumped out at me from this table is the relatively strong
performance of the  href="http://www.altenergystocks.com/comm/content/transportetf/">Powershares
Global Progressive Transport (PTRP)
ETF, even after adjusting for volatility. As the correlation analysis
below demonstrates, this performance is not due to a rise in
oil prices.



My going theory is that there is a Green Stimulus Effect at
work given how much of global stimulus dollars have gone to
transportation programs. This would be something worth exploring
further but it certainly seems in line, at least on the surface, with a
href="http://www.altenergystocks.com/archives/2008/10/keynes_meets_carson_and_how_you_can_invest_it_part_1.html">prediction
I made nearly one year
ago. 



src="http://www.altenergystocks.com/assets/Oct%207-09%20Fig%201_2.bmp"
height="135" width="550">



The following three tables contain the real meat of my analysis. They
are fairly self-explanatory: they show correlation coefficients between
US Oil, US Nat Gas and the S&P 500 with all other assets. The
correlations are for the periods outlined in the tables or since
inception in the case of href="http://www.altenergystocks.com/comm/content/transportetf/">PTRP
(Sep. 19, 2008), href="http://www.altenergystocks.com/comm/content/claymore-mac-global-solar-index-etf/">TAN
(Apr. 18, 2008) and href="http://www.altenergystocks.com/comm/content/first-trust-global-wind-energy-index/">FAN
(Jun. 20, 2008). The correlation coefficients above 0.5 are
highlighted.





src="http://www.altenergystocks.com/assets/Oct%207-09%20Fig%202.bmp"
height="569" width="544">



These results are, once again, in line with my expectations: there is
little reason to believe that there is a strong relationship between
changes in the price of oil and the performance of alt energy stocks.
Even for natural gas, where one could expect a correlation with wind
and solar given that all three fuels are used in power generation (or
load abatement), there does not seem to be a strong relationship.



href="http://www.altenergystocks.com/comm/content/claymore-mac-global-solar-index-etf/">TAN and
href="http://www.altenergystocks.com/comm/content/first-trust-global-wind-energy-index/">FAN
have not yet been around for long enough to analyze returns going very
far back into the past, but href="http://www.altenergystocks.com/comm/content/powershares-clean-energy-etf/">PBW
has. Although the correlation between href="http://www.altenergystocks.com/comm/content/powershares-clean-energy-etf/">PBW's
returns and oil's returns seems to have strengthened somewhat in the
past year, it certainly does not qualify as strong.



I must admit that I was fairly surprised to find such a low correlation
between the returns on oil and those on the  href="http://www.altenergystocks.com/comm/content/transportetf/">PTRP
ETF. My guess is that this ETF hasn't been around long enough, and that
a relationship might emerge under an extreme href="http://www.altenergystocks.com/archives/2008/04/new_flyer_a_clean_way_to_play_extreme_peak_oil_scenarios.html">Peak
Oil scenario. That said,
spending on public transportation is heavily dependent on the fiscal
health of various levels of government, and href="http://online.wsj.com/article/BT-CO-20091007-713749.html">we've
just been moved from the emergency room to the critical care unit.
   



On the other hand, I was not particularly surprised to see that returns
for all four alt energy ETFs are strongly correlated with returns for the
S&P 500 - that seems intuitive enough given that they all
belong to the same asset class. 



Conclusion



It
doesn't really matter how one slices and dices the data: there just
does not appear to be a strong relationship between returns on oil and
returns on alt energy stocks, including alternative modes of
transportation.



That's not going to matter to a great many commentators who will
continue to claim in newspaper and magazine articles, on blogs and on
TV that the success of alt energy stocks is closely tied to the price
of crude, even though that's mostly untrue.



Those who invest in alt energy should, however, pay close attention.
These results suggest that there are far more important factors than
oil prices, most
notably returns in equity markets in general and href="http://www.altenergystocks.com/archives/2009/07/india_solar_pv.html">regulatory
incentives by governments.



There is a good chance that equity returns and returns on oil will
diverge in the next couple of years as href="http://www.altenergystocks.com/archives/2009/09/what_is_peak_oil.html">oil
prices climb and href="http://seekingalpha.com/article/164452-recession-is-over-depression-has-just-begun?source=article_sb_popular">equities
stagnate or decline. If such a
scenario materializes, those who have the relationship backwards could
be in for unpleasant surprises.   

  

DISCLOSURE: None