The Outlook for Investing in Green Energy

Solar companies like SunPower and Suntech Power Holdings have nosedived more than 40 percent this year on concerns about subsidy cuts and the high cost of polysilicon used to make traditional solar cells. (First Solar's rise happened in part because it doesn't use the stuff to make its cells.) "Advanced biofuels are starting to recover," says Ted Sullivan, senior research analyst at Lux Research. "Solar is on its way down. The companies are still trading at 100 to 200 times [earnings per share]." Sullivan says the next miniboom will be in batteries and other storage technologies as demand grows for ways to hold all the energy produced using greener means.

In short, green is set to see some peaks and valleys. Still, the industry's big gains since 2004 mean near-term noise isn't worrying analysts who are still smitten with the sector's long-term prospects, even with this year's dip. "I don't think people appreciate how solar will be over the next few years and the role products will have worldwide in the energy infrastructure," says Michael Carboy, an analyst with Signal Hill. "The pullback in prices is more a reflection of a failure to understand the opportunity that the solar industry presents to the investment community over the next two years. Step two or three years out, and people will regret not owning solar stocks."

Wind power, the most established corner of the green sector, looks less volatile with most of the market in the hands of big players like General Electric, Siemens, and Spain's Gamesa. Emerging Energy Research, a consultancy, sees the wind industry growing at a 15 percent annual rate between 2007 and 2020. The Cleantech Index, a broad group of green stocks, swooned early this year but, unlike the rest of the market, managed to rebound. It's up a bit compared with a year ago.

So what could derail all this green optimism? First is the uncertain price of crude. This year's recent run to nearly $150 a barrel has been only a mild tail wind for green companies' shares. While the industry will endure even if oil prices fall back, the same can't be said for green stocks. And remember that investing in the oil industry this year would have netted you far better gains than most green investments. The iShares oil and gas exploration exchange-traded fund is up about 5 percent this year. Most green ETF's are in the red for 2008.

A bigger worry is shifting commitments by governments, which ultimately pay for renewables today. Despite recent progress, new carbon-friendly technologies simply can't compete on price with burning coal or fossil fuels. Until they can, government subsidies—including national plans in Spain and Germany and the U.S. investment tax credit—remain another unpredictable determinant of the industry's fate. And eventually, of course, all the hype and investor enthusiasm will bid shares to crazy levels, and there will be a nasty shakeout. But we're not there yet. Not even close.