Should Solar Stocks Trade on Oil Prices?

Is trading in solar shares as oil prices rise a leap of faith on the part of investors when it comes to predicting the long case for clean energy stocks based on the short-term oil price outlook?

Pavel Molchanov, analyst at Raymond James, who covers both traditional and alternative energy stocks, said that, historically, oil has traded in an inverse relationship to the equities market. In the past few years, that has not been the case, as rising oil prices have coincided with rising equities prices. This correlation explains the rise of the price of a solar stock like First Solar amid a general equities market and oil price upswing.

The Raymond James analyst says that since the financial crisis, oil has been closely correlated to the broader market, and it's not because the equities market causes oil to be up or vice versa, but the fact that both are trading on the same macro drivers: employment, consumer confidence, the Fed policy and China, for example. Solar stocks have a link to the broader markets and are high beta plays, too.

Yet the Raymond James analyst cautions that there is no direct cause and effect between a higher oil price and solar stock performance. In November and December 2010, specifically, solar stock prices swooned, while the price of oil was rising. For the past one-year period, the MAC Global Solar Index (see chart above) was down 26%, while oil was rising, the Raymond James analyst noted.

"Rising oil prices reflect improving oil demand but the average solar stock shouldn't care; it should care about supply and demand in solar," Molchanov said.

Well-established trading psychology related to oil doesn't hurt, but in the end, solar stocks will trade on earnings and demand outlook in the solar sector, and that's not linked to the price of oil -- which raises the biggest fallacy in the trade.

Oil is not what developed markets use as an input for power generation. In some developing markets, like India and Kenya, diesel is used as a source of power generation. Indeed, solar is expected to grow as an alternative for mini-grid community power solutions in India, and as a replacement for diesel fuel, but that's on the margins and not relevant for solar stock trading.

"For some investors generalists, when they think about anything in energy, they look at price of oil, and that's where psychology comes in. They see the price of oil and assume that every energy product becomes more competitive by comparison," Raymond James' Molchanov said.

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Should Solar Stocks Trade With Rising Oil Prices?