July 28, 2014

The Utility Death Spiral: Beyond The Rhetoric

by Lynne Kiesling

Unless you follow the electricity industry you may not be aware of the past year’s discussion of the impending “utility death spiral”, ably summarized in this Clean Energy Group post:

There have been several reports out recently predicting that solar + storage systems will soon reach cost parity with grid-purchased electricity, thus presenting the first serious challenge to the centralized utility model. Customers, the theory goes, will soon be able to cut the cord that has bound them to traditional utilities, opting instead to self-generate using cheap PV, with batteries to regulate the intermittent output and carry them through cloudy spells. The plummeting cost of solar panels, plus the imminent increased production and decreased cost of electric vehicle batteries that can be used in stationary applications, have combined to create a technological perfect storm. As grid power costs rise and self-generation costs fall, a tipping point will arrive – within a decade, some analysts are predicting – at which time, it will become economically advantageous for millions of Americans to generate their own power. The “death spiral” for utilities occurs because the more people self-generate, the more utilities will be forced to seek rate increases on a shrinking rate base… thus driving even more customers off the grid.

A January 2013 analysis from the Edison Electric Institute, Disruptive Challenges: Financial Implications and Strategic Responses to a Changing Retail Electric Business, precipitated this conversation. Focusing on the financial market implications for regulated utilities of distributed resources (DER) and technology-enabled demand-side management (an archaic term that I dislike intensely), or DSM, the report notes that:

The financial risks created by disruptive challenges include declining utility revenues, increasing costs, and lower profitability potential, particularly over the long term. As DER and DSM programs continue to capture “market share,” for example, utility revenues will be reduced. Adding the higher costs to integrate DER, increasing subsidies for DSM and direct metering of DER will result in the potential for a squeeze on profitability and, thus, credit metrics. While the regulatory process is expected to allow for recovery of lost revenues in future rate cases, tariff structures in most states call for non-DER customers to pay for (or absorb) lost revenues. As DER penetration increases, this is a cost recovery structure that will lead to political pressure to undo these cross subsidies and may result in utility stranded cost exposure.

I think the apocalyptic “death spiral” rhetoric is overblown and exaggerated, but this is a worthwhile, and perhaps overdue, conversation to have. As it has unfolded over the past year, though, I do think that some of the more essential questions on the topic are not being asked. Over the next few weeks I’m going to explore some of those questions, as I dive into a related new research project.

The theoretical argument for the possibility of death spiral is straightforward. The vertically-integrated, regulated distribution utility is a regulatory creation, intended to enable a financially sustainable business model for providing reliable basic electricity service to the largest possible number of customers for the least feasible cost, taking account of the economies of scale and scope resulting from the electro-mechanical generation and wires technologies implemented in the early 20th century. From a theoretical/benevolent social planner perspective, the objective is, given a market demand for a specific good/service, to minimize the total cost of providing that good/service subject to a zero economic profit constraint for the firm; this will lead to highest feasible output and total surplus combination (and lowest deadweight loss) consistent with the financial sustainability of the firm.

The regulatory mechanism for implementing this model to achieve this objective is to erect a legal entry barrier into the market for that specific good/service, and to assure the regulated monopolist cost recovery, including its opportunity cost of capital, otherwise known as rate-of-return regulation. In return, the regulated monopolist commits to serve all customers reliably through its vertically-integrated generation, transmission, distribution, and retail functions. The monopolist’s costs and opportunity cost of capital determine its revenue requirement, out of which we can derive flat, averaged retail prices that forecasts suggest will enable the monopolist to earn that amount of revenue.

That’s the regulatory model + business model that has existed with little substantive evolution since the early 20th century, and it did achieve the social policy objectives of the 20th century — widespread electrification and low, stable prices, which have enabled follow-on economic growth and well-distributed increased living standards. It’s a regulatory+business model, though, that is premised on a few things:

  1. Defining a market by defining the characteristics of the product/service sold in that market, in this case electricity with a particular physical (volts, amps, hertz) definition and a particular reliability level (paraphrasing Fred Kahn …)
  2. The economies of scale (those big central generators and big wires) and economies of scope (lower total cost when producing two or more products compared to producing those products separately) that exist due to large-scale electro-mechanical technologies
  3. The architectural implications of connecting large-scale electro-mechanical technologies together in a network via a set of centralized control nodes — technology -> architecture -> market environment, and in this case large-scale electro-mechanical technologies -> distributed wires network with centralized control points rather than distributed control points throughout the network, including the edge of the network (paraphrasing Larry Lessig …)
  4. The financial implications of having invested so many resources in long-lived physical assets to create that network and its control nodes — if demand is growing at a stable rate, and regulators can assure cost recovery, then the regulated monopolist can arrange financing for investments at attractive interest rates, as long as this arrangement is likely to be stable for the 30-to-40-year life of the assets

As long as those conditions are stable, regulatory cost recovery will sustain this business model. And that’s precisely the effect of smart grid technologies, distributed generation technologies, microgrid technologies — they violate one or more of those four premises, and can make it not just feasible, but actually beneficial for customers to change their behavior in ways that reduce the regulation-supported revenue of the regulated monopolist.

Digital technologies that enable greater consumer control and more choice of products and services break down the regulatory market boundaries that are required to regulate product quality. Generation innovations, from the combined-cycle gas turbine of the 1980s to small-scale Stirling engines, reduce the economies of scale that have driven the regulation of and investment in the industry for over a century. Wires networks with centralized control built to capitalize on those large-scale technologies may have less value in an environment with smaller-scale generation and digital, automated detection, response, and control. But those generation and wires assets are long-lived, and in a cost-recovery-based business model, have to be paid for even if they become the destruction in creative destruction. We saw that happen in the restructuring that occurred in the 1990s, with the liberalization of wholesale power markets and the unbundling of generation from the vertically-integrated monopolists in those states; part of the political bargain in restructuring was to compensate them for the “stranded costs” associated with having made those investments based on a regulatory commitment that they would receive cost recovery on them.

Thus the death spiral rhetoric, and the concern that the existing utility business model will not survive. But if my framing of the situation is accurate, then what we should be examining in more detail is the regulatory model, since the utility business model is itself a regulatory creation. This relationship between digital innovation (encompassing smart grid, distributed resources, and microgrids) and regulation is what I’m exploring. How should the regulatory model and the associated utility business model change in light of digital innovation?

Lynne Kiesling is a Distinguished Senior Lecturer in the Department of Economics at Northwestern University. Her economic specialty is industrial organization, regulatory policy and market design in the electricity industry.  In particular, she examines the interaction of market design and innovation in the development of retail markets, products and services and the economics of “smart grid” technologies. She also teaches undergraduate courses in principles of economics, energy economics, environmental economics, and history of economic thought, and she writes about economics as the editor/owner at the website Knowledge Problem, where this post first appeared.

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July 26, 2014

The Quick Guide To A Green Stock Portfolio

Tom Konrad, CFA

I recently published a quick guide to a green or fossil fuel free stock portfolio aimed at the small investor.  For most people, the best options will be to use mutual funds or an investment advisor.  Some of us like to do things ourselves, and build a portfolio from scratch, using individual stocks.  Doing so could rapidly become a full-time job, but it does not have to be.  Instead, you can use information which mutual funds disclose to piggy-back on their research.  Garvin Jabusch, Co-Founder and CIO of Green Alpha Advisors in Boulder, Colorado, recently told me, "If I were a doctor or a lawyer, I'd probably use this strategy."

The Stock Lists
Technology
Ticker
Beta
Yield
INTC
1.60
3.5%
CSCO
1.26
2.9%
IBM
0.67
2.1%
QCOM
0.85
1.8%
AMAT
1.82
2.0%
ORCL
1.14*
1.1%
GOOGL
0.94
-
FSLR
5.9
-
CSIQ
2.84
-
SCTY
5.7*
-
Healthcare
Ticker
Beta
Yield
MRK
0.50*
3.1%
RHHBY
0.77
2.9%
NVO
1.08
1.4%
GILD
0.98
-
NVZMY
0.50
0.6%
Industrial
VE
1.75
5.3%
PNR
1.24
1.3%
PWR
0.62
-
GNRC
0.89
-
Consumer Defensive
Ticker
Beta
Yield
PG
0.41
3.1%
PEP
0.31
2.6%
UNFI
0.65
-
Consumer Cyclical
JCI
1.77
1.8%
TSLA
1.37
-
Financial
TD
0.56
3.4%
MET
2.20
2.4%
Real Estate
JLL
2.02
0.4%
Utilities
ITC
-0.10
1.5%
Data from Morningstar.com except * from Yahoo! Finance
The Securities and Exchange Commission (SEC) requires that mutual funds disclose their portfolios quarterly, but many often disclose their holdings more frequently on their websites.  Start by selecting a few green mutual funds which you feel reflect your idea of what "green" investing is.  For the purpose of this article, I'm going to use three funds which describe themselves as fossil fuel free.  They are: Green Century Equity (GCEQX), Portfolio 21 (PORTX), and Jabusch's Shelton Green Alpha (NEXTX). The links connect to each funds' list of holdings on Morningstar.

I've used the top 10 holdings of these three funds to compile the list of stocks shown in the box at right.  The sector designations (Technology, Healthcare, etc.) are the categorizations given by Morningstar.  I also used Morningstar (with a supplement from Yahoo! finance to determine each company's dividend yield and Beta, which is a widely used measure of a stock's market risk.

"If I were a doctor or a lawyer, I'd probably use this strategy."
        -- Garvin Jabusch, co-manager of the Shelton Green Alpha mutual fund.

When compiling your own such list, you may use more or less than the top ten holdings, or use different funds, if you think they are a better match for what you consider "green."  A variety of other sources, such as gofossilfree.org's Extracting Fossil Fuels from Your Portfolio [pdf] also include useful stock lists. 

One criticism of green mutual funds is that they tend to be heavy on technology and healthcare stocks, and you can see this is clearly the case with the list I've compiled to the right.  The next step is to correct for this bias.

Balancing The Portfolio

A "Balanced Portfolio" usually refers to a portfolio containing a "balance" of different security types, usually equities (stocks) and fixed income (bonds.)  According to conventional financial theory, the right "balance" for you depends on your financial resources and risk tolerance.  There are any number of online calculators and questionnaires available which will take this sort of personal data and produce a portfolio allocation. 

This article is mostly about the stock or equity portion of the portfolio.  For the fixed income portion of the portfolio, the best choice is to reduce your debt.  Your own debt is probably someone else's fixed income security.  By paying down that debt, you are essentially buying it back from that investor, and also saving yourself the overhead costs that are built into the loan.  If you have no debt, you will be able to bear more risk and invest more in equities.

Other green income options include increasing the energy efficiency of your home, installing solar (and paying for it up front as opposed to using a lease, which is financially similar to purchasing the solar system with debt), the crowd funding site Solar Mosaic (when they have projects available), or a bank CD with a relatively green bank such as Capital Pacific Bancorp (CPBO) or Toronto-Dominion Bank (TD), which also happens to be included in the stock list to the right. 

I personally feel that current interest rates are too low to make traditional fixed income investing attractive, and instead use a portfolio of high-income equities.  While the financial theory that gives us the portfolio allocation referenced above assumes that there is a natural trade-off between return and risk, real world research only finds that trade-off between asset classes (i.e. stocks have higher risk and return than bonds) but not within asset classes (risky stocks do not have higher returns than safer stocks.)  This is called the low-risk anomaly (a.k.a. low-beta anomaly or low-volatility anomaly.)  Historically, low-risk stocks have actually produced higher returns than high-risk stocks. 

A consequence of the low-risk anomaly is that a portfolio of low-risk, high yield stocks is likely to have higher returns and yield than typical portfolios of stocks or bonds, or combinations of the two.  This is why my annual portfolio of ten clean energy stocks contains six high-yield stocks this year.  That list could also be substituted for the holdings of a mutual fund when generating the list of stocks to build your portfolio.

Diversification

The benefit of owning a large number of stocks is diversification: so your investment can't be lost due to bad news for a single company or sector. For the small stock investor, diversification comes with a trade-of  of higher transaction costs.  To keep these costs low, I try to keep brokerage commissions to no less than 0.5% or 1/200th of any transaction, and trade as little as possible.  That means that if you pay $8 per transaction, each position should be at least $1,600 (=$8 x 200.)  For a $20,000 account, that means you can have as many as 12 positions.  If your portfolio is too small to have 10 positions using this rule, you're probably better off opting to the diversification of a mutual fund until you can increase it.  As the account grows, let your transaction size grow, to further reduce investment costs.  20 positions should be plenty for the purpose of diversification if you are careful to select stocks in a wide range of industries so that they behave differently in various economic conditions.

To select a 10 stock portfolio from the list I have compiled to the right, I first select the stock with the best combination of low beta (to take advantage of the low beta anomaly) and high yield (to compensate for not including fixed income.)  That gives me eight stocks: INTC, MRK, VE, PG, JCI, TD, JLL, and ITC. I then choose the next two highest yielding low beta stocks, making sure I don't have more than two in any industry: RHHBY and PEP. 

If you buy equal dollar amounts of each, you have a moderately diversified, low cost, low beta, relatively high yield (2.8%), fossil-free portfolio.

Closing The Circle

I discussed this strategy with Jan Schalkwijk, a green investment advisor at JPS Global Investments.  He pointed out that it is very important not just to buy the stocks and forget about them, but also "close the circle."  To follow this strategy effectively, you need to put in place a plan to update the portfolio periodically.  In 2009, I put together a 5-stock "tracking portfolio" that was designed to mimic the performance of the alternative energy mutual funds using a similar procedure. I checked back on the portfolio six months later, and it was out performing the funds, but then I forgot about it until I started thinking about this article.  I checked the performance, and the portfolio was up only 1.5% over five years, equal to the worst performing of the three mutual funds, and far behind the average return of 61%.  The biggest reason for the relatively poor performance was the inclusion of the now-bankrupt Suntech Power in the tracking portfolio. The mutual funds probably avoided some similar losses by getting out once the dire situation at Suntech became clear.

A good procedure for updating the portfolio would be to repeat the exercise whenever you add or withdraw money, but at least every two years.  If a stock in the portfolio no longer appears in any of your mutual fund holdings (not just the top 10 stocks), you should assume something is wrong and sell it.  You should also sell half of any position which has doubled in value since you bought it.

Re-invest the funds (as well as any new savings) by finding the new stock or stocks which maintain or increase your industry diversification, and also have relatively high yield and low beta.

DISCLOSURE: Long VE.

This article was first published on Renewable Energy World and in Renewable Energy World Magazine.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

July 24, 2014

Charging Your Portfolio With Tesla's Gigafactory

By Jeff Siegel

Last week, Tesla (NASDAQ: TSLA) announced that its next electric offering — a competitively priced electric vehicle — will hit the market in 2017.

Dubbed the Model III, the 200-mile-range electric vehicle will go for $35,000.

Certainly this was big news for electric car enthusiasts — particularly those who can't afford an $85,000 Model S but yearn to drive one. But if you regularly follow trends in the electric vehicle space, at least the way I do, you know Tesla's announcement was just one of many big moves in the space over the past few months.

Truth is, the electric vehicle sector is hotter than ever. And despite continued empty criticisms by internal combustion apologists, electric vehicles are here to stay.

This is great news for those who love driving on homegrown electrons, and it's great news for investors who are looking for more than one way to make a few bucks in the energy space...

$50 Billion Bonanza

Around the same time we learned about Tesla's new Model III, we also got some fresh energy storage market data from the folks over at Lux Research.

According to the research firm's latest analysis, energy storage, driven largely by plug-in electric vehicles, will grow at a compounded annual growth rate of 8% to $50 billion in 2020.

That's less than six years away.

Researchers note that electric vehicles are the largest opportunity in transportation. With modest sales of 440,000 units, electric vehicles still will use $6.3 billion worth of energy storage — more than the micro-hybrids, which will have sales two orders of magnitude higher at 59 million units.

luxrpt[1].jpg

Internal Combustion Blues

One of the more intriguing bits from this recent report is the following statement...
“...incremental evolutions like start-stop technology are leading to significant changes in the energy storage market. With global sales of 59 million, a 53% market share and $6.1 billion in annual revenue, micro-hybrids will, for the first time, overtake the conventional internal combustion engine and emerge the most popular drivetrain by 2020.”
I have to be honest; I never thought I'd see the day when the most popular drivetrain would be something other than that of conventional internal combustion.

Of course, this doesn't mean internal combustion is going gently into that good night. Such a suggestion would not only be naïve, but also a bit dishonest. However, it is interesting to see how rapidly technology is transitioning the personal transportation market.

Heck, I remember when the Toyota Prius was the technologically superior vehicle when it came to fuel economy. In many ways, it still is. But it's so common now that we almost don't even notice those little hybrid superstars anymore. With more than 3 million units sold, such a thing is understandable.

So will the same be said for electric vehicles in another ten years? I think so.

My prediction is that Tesla will continue to be the most innovative and aggressive electric vehicle player in the market. Nissan and GM will continue to push their electric offerings, most likely with worthwhile upgrades by the end of the decade that'll enable increased range and lower pricing.

Asian players like BYD Company (OTCBB: BYDDF), Kandi Technologies (NASDAQ: KNDI), and Tata (NYSE: TTM) will also remain aggressive on non-conventional internal combustion offerings.

Of course, if you're looking for a way to profit from the growth in energy storage applications, look no further than Tesla's new Gigafactory.

GigaProfits!

If you're unfamiliar, the Gigafactory is a $5 billion battery manufacturing facility that Tesla is building right here in the United States.
When completed, the plant will be massive — capable of producing ten times the current production level available today. This equates to the production of 500,000 electric cars every year starting in 2020.

And with this production capability comes economies of scale that will allow Tesla to slash battery costs. Batteries, by the way, represent the most expensive component of electric cars.

My friends, Tesla's current Model S runs about $85,000. But with the new Gigafactory in place, the company will be able to sell you its next model — the Model III — for $35,000.

This is a huge game changer, and those who play it right will make a ton of money.

Now let me clarify: I'm not recommending investing in Tesla here. I'm talking about investing in the batteries — more specifically, the companies that will provide Tesla's Gigafactory with the key ingredients it will need to produce these batteries.

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Jeff Siegel is Editor of Energy and Capital, where this article was first published.

July 23, 2014

Chinese Policy Tailwinds For Ruifeng Renew

by William Gregozeski, CFA

China Ruifeng Renewable Energy Holdings Limited [HK:0527 (“Ruifeng Renew”)] is a holding company with ownership interests in three energy-related businesses.  Its current focus is on wind farm operations, via its majority holdings in Hongsong, a long established wind farm, and Langcheng, a greenfield wind farm (after various purchases and sales of ownership interests it will own 85.36% of the two wind farms on a beneficial level and 68.17% on a direct equity level.  These wind farms have a current installed capacity of 398.4MW, and are expected to increase to 1,190.4MW by the end of 2017.  It also owns a power grid construction business that installs transmission lines and related energy infrastructure for the State Grid and Southern Grid, as well as installs turbines and transmission infrastructure for its wind farms.  The Company also owns a wind turbine blade assembly plant in Chengde, where it builds blades for AVIC Huiteng Windpower, one of the large turbine blade manufacturers in China.
 
Hongsong was established in 2001 as the first wind farm in Hebei Province with its installation of 2.4MW of capacity, which was comprised of four Goldwind [HK:2208, OTC:XJNGF] turbines, making Hongsong one of Goldwind’s earliest customers.  Since then, Hongsong has completed eight phases of capacity expansion, each adding 49.5MW of capacity using 492 Goldwind turbines.  Hongsong’s current installed capacity stands at 398.4MW, with the expectation that 49.5MW will be added annually through 2017, bringing its final installed capacity to 596.4MW.  Hongsong is taxed at the full 25% rate, however all new phases of installed capacity (starting with Phase 8) will enjoy a full tax exemption for three years, followed by a 50% reduction for the following three years, after which it will pay the full tax rate.  
 
Langcheng was established in 2005 to develop a 594MW wind farm in Hexigten Qi in Inner Mongolia.  With the initial infrastructure in place, the Company intends to begin installing wind turbines in 2014, aiming to add three phases of 49.5MW each year through 2017.  Like Hongsong, each new phase of installed capacity will enjoy a full tax exemption for three years, followed by a 50% reduction for the following three years, after which it will pay the full tax rate.  
 
Ruifeng Renew enjoys a number of benefits from its ownership of Hongsong and Langcheng.  The two wind farms are located 30km apart, which allows for shared management and shared substation distribution; Hongsong currently has the infrastructure to support the distribution of up to 596MW of wind power, which will be ramped up to meet the expected increase capacity over the next three years.  The Company’s Power Grid Construction business is expected to install the turbines and distribution systems, which will help reduce the capital expenditure of each phase of increased capacity, while creating additional revenue for that business.  The most recent expansion, Phase 9 at Hongsong, cost approximately RMB270 million and we estimate future phases of increased capacity will cost RMB 270 to RMB 300 million, below the market rate for other producers, which enables management to obtain funding for most of the expansion with near PBOC rate bank debt.
 
Management intends to add capacity in 49.5MW increments, as any wind farm addition of 50MW must apply for a license from the NDRC (National Development and Resource Commission) at the national level, whereas capacity additions below 50MW can receive license approval from the regional arm of the NDRC.  The expectation is that all turbine purchases will be from Goldwind, the third largest wind turbine manufacturer in the world, who grants the Company favorable pricing on turbines due to the longstanding relationship between Hongsong and Goldwind.
 
Ruifeng Renew’s Wind Farm Operations generate revenue primarily from the sale of turbine-generated electricity sold to the State Grid Corporation of China, the seventh largest company in the world according to Forbes.  The State Grid does not enter into formal power purchase agreements (PPAs) with individual producers, but rather commits to buy electricity put on the grid at a fixed price set twice a year, which is currently RMB 0.43/kWh.  Renewable energy producers also receive RMB 0.11/kWh in subsidy revenue from the Finance Ministry, resulting in a total energy tariff of RMB 0.54/kWh.  The average wind farm in China operated for 2,000 hours in 2013, up from 1,900 hours in 2012, but still well below the historic average of roughly 2,250 hours at Hongsong and the expected 2,300 to 2,350 hours at Langcheng.
 
Based on the information above, and put in the context of the growth drivers of the energy and wind power market in China as described in our last article, we believe Ruifeng Renew is ideally positioned to build shareholder value in the coming years.  
 
William Gregozeski, CFA is the Director of Research at Greenridge Global, a provider of institutional-based sell-side services to underfollowed Asian-based companies and special situation stocks.  The author of this article, Greenridge Global and its affiliates do not have a beneficial ownership in the companies mentioned herein or any other disclosable conflicts of interest.
 

July 22, 2014

Fifteen Clean Energy Yield Cos: Where's The Yield?

Tom Konrad CFA

 In the first article of this survey of yield cos, I noted that many of the recent yield co IPOs have risen so far as to "lend the very term "yield co" a hint of irony" because rising stock prices are accompanied by falling annual dividend yields.

Yield Co Worries

Because yield cos invest in clean energy infrastructure such as wind farms and solar facilities, conservative income investors may worry about the durability of the technology.  Will solar panels still be producing power twenty years from now?  Others have brought up the credit quality of utility counter parties, and the untested nature of residential solar leases.

All of these concerns are real.  Some solar panels will fail sooner than expected, and possibly many at a single solar farm.  Utilities in Europe are already struggling financially, in part due to regulatory policies which were designed to promote renewable power.  The residential solar lease model is only a few years old.  Many solar leases contain inflation escalators which cause the price of solar power to rise by a few percent a year.

If electricity prices fall with the cost of power generated from wind and solar, what will homeowners do if they find they are suddenly paying more for electricity from their solar panels than they would for grid electricity?  Might populist politicians pass laws declaring solar leases invalid because the lessees feel like they've gotten a raw deal?

While all of these risks are real, most can be dealt with by diversification.  Falling prices of solar panels will make it cheaper to replace ones that fail prematurely.  Both electricity prices and politics are local, meaning that geographic diversification can do much to manage these risks. Technological risks can be dealt with by diversifying between technologies.  See the second article in this series for details on the types of power generation owned by each yield co.

The Biggest Risk

While all these risks are real, they are fairly standard investment risks, and can be dealt with through portfolio diversification: Don't own just one yield co (especially the smaller ones that own only a few facilities), and don't focus all your holdings on wind or solar. 

The biggest risk, and the one that can't be diversified away is the risk of paying too much.  For yield cos, which are designed to pay healthy dividends, not paying too much means getting a decent yield, now or in the near future.  For me, "decent" means at least 2% more than long term government bonds.  Even 2% is a fairly thin margin to compensate for the risks discussed above.  The ten year US Treasury note currently pays 2.5%, and the 30-year bond pays 3.3%, so anything below a 4-5% dividend yield is too little to be taken seriously, unless we are very confident that dividend growth can continue at a rapid pace for many years to come.

High Expectations For Growth

Most US-listed yield cos have outlined aggressive plans for dividend growth.  NRG Yield (NYLD) is the most ambitious, and expects to grow its dividend by 15% to 18% for five years.  In order of decreasing ambition, Terraform Power (TERP) aims for 15% growth for 3 years, NextEra Energy Partners (NEP) expects 12% to 15% growth for three years, Hannon Armstrong Sustainable Infrastructure (HASI) expects 13% to 15% growth for two years, Pattern Energy Group (PEGI) aims for 10% to 12% for three years, and Abengoa Yield is aiming for relatively modest 6.5% growth over the next 12 months.  Canadian yield cos, like TransAlta Renewables (TRSWF or RNW.TO) and Brookfield Renewable Energy Partners (BEP, BEP-UN.TO) have not laid out specific dividend growth targets, but do have reasonably aggressive growth plans which are likely to boost distributable cash flow and dividends over time.

The three London-listed yield cos, The Renewables Infrastructure Group (TRIG.L), Greencoat Wind (UKW.L), and Bluefield Solar Income Fund (BSIF.L) are less aggressive, and aim simply to increase distributions in line with inflation.

Sources Of Growth

Investing Cash Flow
Since yield cos return most of their investable cash to shareholders, most expected future dividend growth cannot come from re-investing earnings, as we would expect from traditional growth companies.  Hence, dividend growth will have to come either from issuing debt and using that to buy assets, or from buying assets (with debt or new equity) at low prices which make those assets significantly accretive to cash flow per share.

Debt
If debt is used to buy new assets, this will generally increase the dividend, but it will also increase overall risk to shareholders.  There is also a natural limit to debt, because there will come a point where lenders will become unwilling to provide additional funds.  Because of the increased risk inherent in using debt to buy assets and boost the dividend, I do not ascribe much value to dividend increases arising from increasing debt.

Developing Assets In House
In contrast, the ability of a company to obtain clean energy assets such as wind and solar farms at low prices has real value.  With the exception of TransAlta Renewables, the Canadian yield cos including Brookfield Renewable Energy, Primary Energy Recycling (PENGF, PRI.TO), Innergex Renewable Energy (INGXF, INE.TO), and Capstone Infrastructure (MCQPF, CSE.TO) have a tradition of developing projects in house as well as purchasing them from other developers when such projects are available at attractive prices.

In contrast, the US listed yield cos rely on others to develop projects for them.  Hannon Armstrong is fairly unique in this regard, because it is an investment bank which has relationships with a number of blue chip companies that develop energy efficiency and other sustainable infrastructure projects for which it obtains the financing.  Before Hannon Armstrong's IPO, it financed these projects by bundling the debt and selling it to institutional investors like pension funds. Now, while it still creates packages of investments for pension funds, it also keeps some such projects on the books.

I expect that Hannon Armstrong's position as the leading investment bank for such projects as well as its existing relationships should continue to enable the company to invest at attractive prices and continue increasing its dividend.

ROFOs
The other yield cos (NRG Yield, NextEra Energy Partners, Terraform Power, Abengoa Yield, Pattern Energy Group, and TransAlta Renewables) are relying on "Right Of First Offer" or ROFO agreements with their parent companies to obtain projects at attractive prices.  The parent companies are all experienced project developers, and those parents with large portfolios assets and concrete road maps for dropping them down to their yield co offspring have been rewarded with the highest yield co share prices and the lowest current yields

The highest yield among the US-listed ROFO yield co is Pattern Energy Group.  Its parent, Pattern Development is a private company with only a handful of projects that it is currently developing. The other ROFO yield cos all have publicly listed parents which already own significant clean energy assets, and are developing new ones as well.  They have low yields and high stock prices to match. 

The one exception is TransAlta Renewables, which trades at a 6.5% yield, compared to the 2% to 4% yields available on US listed ROFO yield cos.   Its low price and high yield are due in part to the fact that its parent, TransAlta Corp (TAC), has not explained precisely which assets it plans to sell to TransAlta Renewables, and at what prices.  TransAlta Renewables' lack of a US listing is also likely to be part of the reason for its high yield, but even given these factors, I consider TransAlta Renewables to be massively undervalued compared to the other ROFO yield cos.

Finite Growth

The flood of new capital which current and expected future yield cos are bringing to the market is likely to have significant effects on the price clean energy projects sell for.  Most such projects take years to develop, and so the short term supply is limited.  A large source of new capital chasing a finite number of projects is likely to boost the value of those projects on the market. 

As project prices rise and ROFO agreements expire, we can expect that they will be renewed only with prices which are less attractive to the yield cos. Yield cos which develop projects in house will also find that their costs rise as other developers enter the market in order to sell projects into a robust market fueled by cheap yield co money.

Hence, while yield cos many be able to hit their aggressive short term dividend growth targets, this growth must slow over the longer term.  I personally am only willing to believe current projections one to three years into the future.  To reflect that, I have put together the following chart of the 15 yield cos current yield and expected yield growth over the next two years.


Yieldcos by yield.png
The horizontal lines show current yield, the x-axis shows how much yield is expected to increase over the next two years, and the diagonal lines combine these two to show expected yield in two years.

The Best

Paying a high price for a yield co not only reduces its current yield, it also reduces the effect of even very aggressive dividend growth targets.  The chart reflects NRG Yield's extremely aggressive dividend growth target (15% to 18%) with an assumed annual dividend growth of 16.5%.  Because NRG Yield has such a high price, its current yield is only 2.8%, and two years of compounded 16.5% growth bring it up to only 3.8%. Pattern Energy Group may have a less impressive (but still proven) parent in Pattern Development, but it offers a 3.8% yield today. With that sort of head start, it will have no trouble staying ahead of its US-listed ROFO yield co brethren.

Looking at the upper right hand corner of the chart, we see Hannon Armstrong and TransAlta Renewables.  These offer current yields of 6.1% and 6.5% respectively.  NRG Yield would have to grow its dividend at 16.5% per year for five years just to get to where Hannon Armstrong is today.  NextEra Energy Partners, TerraForm Power, and Abengoa Yield would require even longer to get there.

In short, a dividend today is worth more than years of potential dividend growth.  Among the current crop of yield cos, I consider TransAlta Renewables, Hannon Armstrong, Capstone Infrastructure, Brookfield Renewable Energy Partners, Primary Energy Recycling, and Innergex Renewable the most attractive, in that order.  The London listed yield cos are also attractive, especially for geographic diversification, but are extremely difficult to buy for US based investors.  The only one I've been able to purchase is The Renewables Infrastructure Group (TRIG.L).

This ranking of yield cos is almost entirely based on current and future expected yield.  Primary Energy gets a slight boost in the rankings because of the real possibility of a takeover offer in the near future.  In the last article, I looked into how each of the yield cos were structured.  There, I noted that some (especially Abengoa Yield, NextEra Energy Partners, and Terraform Power) have structures which don't completely align management incentives with the interests common shareholders.  That said, the most of the yield cos with the highest yield also have the best alignment of management and shareholder interests.  My analysis of yield co structure only served to re-enforce my preference for those yield cos with the highest current yields.

In the end, is there any fairer way to evaluate yield cos than on the basis of yield?  Without yield, the term "yield co" is just PR.

Disclosure: Long HASI, BEP, PEGI, RNW, CSE, INE, PRI, TRIG.  Short NYLD Calls.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

July 21, 2014

China Poised For Significant Expansion In Wind Power Generation

by William Gregozeski, CFA

China is the world’s largest producer of electricity, surpassing the United States in 2011, with demand increasing alongside its strong, sustained growth in GDP.  Electricity generation in China has increased 9.6% annually, from 2005 to 2013, reaching 5,425.1TWh of electricity.  Coal-fired plants currently make up over two-thirds of power generation, which is partly the result of an abundance of coal in China.  Despite this growth, the country expects demand to continue to increase at a rapid pace, reaching 7.295TWh of demand in 2020 and 11,595TWh in 2040. 
 
However, the growth in electricity production from coal-fired plants has resulted in an increase in air pollution and general lack of efficiency.  China is now moving aggressively to curb pollution and increase the supply of renewable power.  The central government has prohibited new coal-fired plants to be built around Shanghai, Guangzhou and Beijing, which is currently in the midst of having all of its coal plants being converted to natural gas.  Its 12th Five Year Plan, running through 2015, targeted non-fossil fuel energy to account for 15% of total energy consumption.  One of the key industries expected to help meet these goals is wind power. 
 
China Energy Consumption by type.png  
China installed capacity by fuel.png  
China is the world’s largest wind energy producer, with over 90GW of installed capacity as of the end of 2013.  Despite this large figure, the country added 16.1GW of capacity in 2013, up from 13.0GW of new capacity in 2012, and is aiming to add 18.0GW of new capacity in 2014.  By comparison, China added roughly 3.0GW of solar power in 2013, reaching 10.0GW of installed capacity.  In 2013, wind power contributed 137.1TWh of electricity generation, which equates to just 2.5% of total power generation in China.  Based on 90GW of installed capacity at the end of the year and the average wind farm in China operating for 2,000 hours in 2013, up from 1,900 hours in 2012, China’s installed wind capacity was operating at a run rate of 180.0TWh of power generation. 
 
China wind power growth.png  
 While 15% is the near term renewable target, the potential of wind in China is much greater.  In 2009, researchers from Harvard and Tsinghua University found China could generate all of its power profitably from wind alone, making wind power an attractive alternative to coal power, especially as the government moves to reduce pollution.  While the potential for 100% wind power exists, there are a number of practical issues that must be resolved first, including the country’s power grid.  Roughly 15% to 20% of all of the country’s installed wind capacity is not grid connected, due to the lack of transmission infrastructure. 
 
Like other industries in China, the central government plays a key role in the power industry, controlling the power grid and electricity prices.  The power grid in China is tightly controlled by three State Owned Enterprises, led by the State Grid Corporation of China, which provides power to 88% of China and is the seventh largest company in the world, according to Forbes.  The other two grid companies in China are China Southern Power Grid and Inner Mongolia Electric Power Transmission.  Investment in the Chinese power grid has grown 11.4% annually over the last five years.  This growth should accelerate as the State Grid announced in January it plans to increase power grid construction by nearly 20%, with investments that include constructing ultra-high voltage transmission lines and cross-region grids, which should help spur demand for wind energy and enable off-grid wind capacity to be brought online. 
 
The role of the National Development and Reform Commission (NDRC) on the power production industry is also favorable to wind power.  The NDRC not only sets power prices, but also has the role of pushing for increases in renewable power production through measures such as legally requiring the power grid to purchase all renewable power and establishing a subsidy to spur investment in the industry.  Prices set by the NDRC are generally not based on market dynamics, but rather set based on the greater good of the country.  The price of coal has been volatile in recent years.  This, coupled with the constant electricity purchase price has led to large swings between profitability and losses for these producers.  On the other hand, wind is well suited to thrive in this environment due to its lack of a commodity feedstock and small ongoing operating expenses. 
 
William Gregozeski, CFA is the Director of Research at Greenridge Global, a provider of institutional-based sell-side services to underfollowed Asian-based companies and special situation stocks.  The author of this article, Greenridge Global and its affiliates do not have a beneficial ownership in the companies mentioned herein or any other disclosable conflicts of interest.
 

July 20, 2014

Fifteen Clean Energy Yield Cos: Company Structure

Tom Konrad CFA

In the first article of this survey of yield cos, I looked at the possible reasons for the seemingly endless enthusiasm for US-listed clean energy yield cos.  Here, I'll take a look at how these yield cos are constructed, and why investors should prefer one structure over another.

Who's Your Daddy?

Most yield cos have been created by clean energy project developers in order to create a ready, low-cost buyer for those projects.  With the recent string of very successful IPOs, the capital available for such projects may prove to be even lower cost than anyone expected.  Terraform Power's (TERP) on July 18th only makes it more certain that other developers and owners of operating clean energy projects will be rushing new yield cos to market.

A yield co's parent company is often its largest shareholder, and the relationship may work either to the advantage or disadvantage of other shareholders.  On the plus side, many yield cos have a "Right of First Offer" (ROFO) for projects the parent develops.  While the details of ROFOs may vary among yield cos, a ROFO will always be a potential source of value for the yield co because it may provide access to a pipeline of projects at favorable prices, or at least the benefits of dealing with a familiar party such as lower due diligence costs for project acquisitions.  Since a ROFO is a "right," not an obligation to buy projects, having a ROFO with an established developer is an advantage for a yield co, and is likely to be a greater advantage if the parent has a large pipeline of projects.

On the other had, many yield cos' cozy relationships with their parents could easy lead to choices which are not in the best interests of other yield co shareholders.  A ROFO may give the yield co the right to buy a project, but this right is of no value unless the project in question is sold at an attractive price. In some cases, the parent may use its effective control of yield co decisions to obtain above-market prices for unwanted projects, doing harm to other yield co shareholders.

Conflicts of Interest

I expect that it will be virtually impossible for most yield cos to escape the influence of their parent companies.  In order to mitigate the risk that the parent uses its influence to the detriment of other shareholders, it's very important that the parent's interests be completely aligned with those shareholders.  For this purpose, I like the parent company to own a large stake in the yield co composed of the same class of shares as common shareholders. 

Another red flag is "Incentive Distribution Rights" or IDRs.  IDRs allow parent company to receive an increasing percentage of distribution increases.  Advocates of IDRs say that they provide the parent with an incentive to increase the distribution as quickly as possible.  However, if the parent already owns a large stake in the yield co, the distributions themselves should provide adequate incentive for this purpose. 

IDR are also asymmetric  incentives: they pay off for the parent when distributions increase, but do not inflict a penalty for a decrease in distributions.  Because of their asymmetric nature, IDRs may incentivize increased risk taking, such as using higher levels of debt to increase the dividend.  I prefer yield cos without IDRs, or IDRs at low percentages. 

Corporate Structures

Most yield cos are organized as corporations, but a few are partnerships.  The partnership structure facilitates the use of IDRs, but I consider the corporate form of a partnership to be less important than the existence and level of any IDR. 

15 Yield Cos

Six US-Listed Yield Cos

Name (Ticker)
NRG Yield (NYLD)
Hannon Armstrong Sustainable Infrastructure (HASI)
Annual dividend (Management dividend growth target) $1.45 (15-18%, five years)
$0.88 (13% to 15% for 2 years)
Parent (Ticker)
NRG Energy (NRG)
None
Parent's retained interest
65.5% voting with complex share structure.
n/a
Relationship with parent
ROFO. Parent earns management fee based on assets.
Management has significant stake in common shares; insiders mostly buying in public market.
Assets
Solar, Wind, Thermal (facility heating and cooling)
Energy efficiency (performance contracts), Wind, Solar, Geothermal, water, telecommunications and other sustainable infrastructure all of which must contribute to reductions in GHG emissions.

Name (Ticker)
Pattern Energy Group (PEGI)
Terraform Power (TERP)
Annual dividend (Management dividend growth target) $1.29 (10% to 12% for three years)
$0.9028 (15% for 3 years)
Parent (Ticker)
Pattern Development (private)
SunEdison (SUNE)
Parent's retained interest
35%
71%
Relationship with parent
ROFO. Parent will not compete for projects.
ROFO, IDR starting at 0% but increasing to 50%.
Assets
Wind
Solar

Name (Ticker)
NextEra Energy Partners (NEP)
Abengoa Yield (ABY)
Annual dividend (Management target dividend growth) $0.75 (12% to 15% over 3 years)
$1.04 ( 6.5%, 12 months)
Parent (Ticker)
NextEra (NEE)
Abengoa SA (ABGB)
Parent's retained interest
79.9%
66.8%
Relationship with parent
ROFO, IDR starting at 0% but increasing to 50%
ROFO. Parent provides line of credit.  Will have interal management after 1 year.
Assets
Wind, Solar
Solar, Wind, Transmission, Conventional generation (gas)

 Four Canadian Yield Cos and One Dual-Listed Yield Co

Most of the Canadian "yield cos" have existed much longer than the term "yield co," which was coined last year.  With the exception of TransAlta Renewables, these were former Canadian Income Trusts, a structure which lost its tax benefits 2011.  The ones I have chosen to include here are the ones with the highest proportion of clean energy assets.

Name (Canadian Ticker, US OTC Ticker)
TransAlta Renewables (RNW.TO, TRSWF)
Capstone Infrastructure Corp: (CSE.TO, MCQPF)
Annual dividend (My estimate of future growth) C$0.77  (8% to 15%, 2-3 years)
C$0.30 (0%, 2-3 years)
Parent (Ticker)
TransAlta Corp (TAC)
None
Parent's retained interest
70.3%
n/a
Relationship with parent
ROFO, managed by parent for management fee based on EBITDA; Parent also supplying line of credit.
Develops projects in-house.
Assets
Wind, Hydro
Combined Heat and Power, Wind, Hydro, Solar, Water utility, district heating

Name (Canadian Ticker, US OTC Ticker) Innergex Renewable Energy (INE.TO, INGXF) Primary Energy Recycling (PRI.TO, PENGF)
Annual dividend (My estimate of future growth) C$0.60 (2% sustained)
US$0.28 (0%, 2-3 years)
Parent (Ticker)
None
None.
Relationship with parent Develops projects in-house. Develops projects in-house. 
Other notes

The company has stated that it may be for sale.
Assets
Hydro, Wind, Solar Waste Heat Recovery, Combined Heat and Power


Name (US Ticker, Canadian ticker)
Brookfield Renewable Energy Partners (BEP, BEP-UN.TO)
Annual dividend (Historical dividend growth) $1.55 (12%)
Parent (Ticker)
Brookfield Asset Management (BAM)
Parent's retained interest
65%
Relationship with parent
Develops projects in-house.  IDR at 15% of future increases eventually rising to 25%
Assets
Hydro, Wind, Combined Heat and Power

Three UK Listed Yield Cos

These are organized as investment companies, and securities laws make them difficult if not impossible for US based investors to purchase.  Because of this, I'm including the UK based yield cos mostly for comparison purpose.

Name (Ticker)
The Renewables Infrastructure Group (TRIG.L)
Greencoat Wind (UKW.L)
Bluefield Solar Income Fund (BSIF.L)
Annual dividend (Target dividend growth) 6p (with inflation)
6.16p (with inflation)
7p (with inflation)
Parent (Ticker)
The RES Group (private)
none
none
Assets
Wind, Solar
Wind
Solar

Yieldcos by fuel

Up Next

The final article in this series will discuss which I consider the most attractive investments, and why.

Disclosure: Long HASI, BEP, PEGI, RNW, CSE, INE, PRI, TRIG.  Short NYLD Calls.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

July 19, 2014

Bumpy Uphill Road For BYD EVs

Doug Young

Electric vehicle maker BYD (HKEx: 1211; Shenzhen: 002594; OTC:BYDDF) has been zipping in and out of the headlines this past week, including its latest announcement that it will open a manufacturing plant in Brazil to service the BRICS country and the broader Latin American market. The company’s EV business, a major factor that attracted billionaire investor Warren Buffett as a major backer, also got good news from Beijing this week with word of a major government drive to boost new energy vehicle buying.

Despite those positive moves, the company still has yet to received its first major overseas order, though it has certainly set up many pilot programs. Such programs make good headlines, even though they result in very limited actual business. And those programs receive far less attention when they end in failure, which is what recently happened to a high-profile trial in a city near Los Angeles.

Despite the rocky road these last few months, investors seem to be turning bullish on BYD once more after a prolonged slump for its stock due to tumbling profits and poor performance for its older gas-powered car and battery businesses. The company’s shares have more than tripled over the last 2 years, and are up more than 20 percent this year as optimism returns to its EV business.

In its latest piece of upbeat news, BYD announced it will open its first factory in Brazil, with an investment of about $90 million and 450 workers. (company announcement) Operations will begin next year at the plant, which will have an initial capacity to produce 1,000 electric buses each year. BYD made a similar investment announcement for a plant in nearby Argentina in 2011. (previous post)

The bigger news that got investors excited came earlier this week when Beijing announced a major drive to promote EVs through strict quotas for government vehicle buying. Under those quotas, China will require that new energy vehicles account for 30 percent of all government vehicle buying by 2016. (English article) Beijing has also announced a wide range of other new incentives recently, including cheap or free licenses for such vehicles and low tax rates.

China has announced similar incentives in the past, though few have had much effect among the broader consumer market. The mandating of such high quotas for government vehicle buying looks a bit more promising, as it relies on non-negotiable directives rather than financial incentives. But governments can always find ways to get around such quotas, for example by buying cheap electric motorcycles or other cheap low-tech EVs to meet their government targets.

Anyone looking for a better indicator of the longer-term viability for BYD’s EV business would be better to focus on the company’s international programs, which are truly market driven. A company spokesman recently told me BYD is on track to deliver around 4,000 electric buses this year, though it may have to delay some deliveries due to constraints in its manufacturing capacity. The company has 3 pilot programs going in California, and a number of programs in Western Europe and other markets scattered around the world.

But its drive into California also received a major setback earlier this year when the city of Long Beach canceled a high-profile pilot program for the company’s buses. That program had been the subject of previous controversy over accusations of labor law violations, though the spokesman said the cancellation was due to lack of funding rather than labor or technology issues.

Loss of that contract highlights the very real possibility that some or perhaps even many of BYD’s overseas pilot programs could end without any big orders. We’ll have to wait and see if and when any of the pilot programs finally results in one such big order, though I’m sure BYD will make sure that everyone knows when that finally happens.

Bottom line: A string of positive developments could help maintain a rally for BYD stock, but the real sign of long-term viability for its EVs will be a big order from one of its global pilot programs.

Doug Young has lived and worked in China for 15 years, much of that as a journalist for Reuters writing about Chinese companies. He currently lives in Shanghai where he teaches financial journalism at Fudan University. He writes daily on his blog, Young´s China Business Blog, commenting on the latest developments at Chinese companies listed in the US, China and Hong Kong. He is also author of a new book about the media in China, The Party Line: How The Media Dictates Public Opinion in Modern China.

July 18, 2014

Rulings Boost China Wind, Solar In US

Doug Young

In a quirk of timing, 2 completely unrelated rulings are boosting the outlook for Chinese new energy firms from the wind and solar sectors in their complex relationship with the US. The 2 cases are quite different, but each reflects the wariness Washington feels towards these Chinese firms due to their government ties. In the bigger of the 2 cases, a World Trade Organization panel has ruled that US anti-dumping tariffs against Chinese solar panel makers violate WTO rules. In the second case, a US judge’s ruling has given a boost to a Chinese firm that planned to build a wind farm in the state of Oregon, only to get vetoed by Washington over national security concerns.

Neither of these rulings is the end of the story, and it’s still quite possible that Washington could prevail in one or both cases. But the WTO ruling in the solar case could be a tough one for Washington to fight, for reasons that I’ll explain shortly. That could be good news for the entire solar panel sector, as it could force Washington to seek a negotiated settlement in the matter. Such a deal would benefit nearly everyone by maintaining strong global competition, which is a critical element to foster rapid industry development.

All that said, let’s start with a look at the WTO ruling, which was part of a broader series of decisions critical of Washington’s anti-dumping duties. (English article) Washington had argued that Chinese solar panel makers received unfair government subsidies in a number of ways, from subsidized use of government land, to cheap loans from state-run banks, and tax incentives. The US conducted its own investigation 2 years ago, which ended with its decision to impose punitive tariffs against the Chinese firm.

The WTO’s ruling doesn’t dispute Washington’s premise of unfair state subsidies, but rather finds fault with part of the process. Put simply, the WTO’s rules say countries can only impose such anti-dumping penalties if they can prove the guilty companies are wholly or at least partly state owned. That’s a bit problematic in this instance, since many of China’s biggest solar panel makers started out as venture-backed private companies that are now big publicly-traded firms.

In my view the WTO ruling seems based on a technicality, since China clearly subsidizes all domestic solar panel makers due to Beijing’s decision to aggressively promote the industry. But rules are rules, and Washington and everyone else needs to respect the WTO’s guidelines. Washington could still try to prove that private Chinese panel makers like Yingli (NYSE: YGE) and Canadian Solar (Nasdaq: CSIQ) are somehow partly state-owned; but I’m hopeful that maybe the Obama administration will use this moment to re-examine its stance and try to seek a negotiated settlement in the matter.

Meantime on the wind front, a US judge has ruled the Obama administration wasn’t transparent enough when it cited national security concerns as its reason for vetoing a planned wind farm being built by construction equipment maker Sany Heavy (Shanghai: 600031). (English article) This particular case dates back nearly 2 years ago, and reverses a previous ruling by a lower court that had sided with the Obama administration.

In this latest ruling, the judge said the Obama administration was too secretive about its reasons for vetoing the plan, which denied Sany the right to defend itself or seek modifications that might placate the government. Previous reports had speculated that Washington was worried about spying, since the wind farm’s location was near a defense plant making high-tech drone aircraft. I would agree with the judge in this matter, and say that Washington needs to provide at least some of the evidence behind its decision that is likely to cost Sany millions of dollars in lost investment.

Bottom line: A WTO ruling against US anti-dumping tariffs on Chinese solar panels could force Washington to re-think its stance in the matter and seek a negotiated settlement.

Doug Young has lived and worked in China for 15 years, much of that as a journalist for Reuters writing about Chinese companies. He currently lives in Shanghai where he teaches financial journalism at Fudan University. He writes daily on his blog, Young´s China Business Blog, commenting on the latest developments at Chinese companies listed in the US, China and Hong Kong. He is also author of a new book about the media in China, The Party Line: How The Media Dictates Public Opinion in Modern China.

July 16, 2014

Fifteen Clean Energy Yield Cos, Created Unequal

Tom Konrad CFA

Renewable Energy Investing Grows Up.

In January I predicted 2014 would be the year "renewable energy finance comes of age."  Here's how Jennifer Runyon quoted me on Renewable Energy World:

Konrad believes that 2014 will be a great year for renewable energy finance, he said.  He said that we saw the beginning of it in 2013 with the securitization of a bond by Solar City (SCTY) and pointed to Hannon Armstrong’s (HASI) securitization of an energy efficiency bond in late December 2013 as another indicator that renewable energy financing is on track to take off in 2014.

“I think that we will see a few publicly traded ‘yield cos’ (yield companies) in solar listed in 2014,” he said.  A yield co is a publicly traded company that is oriented towards income as opposed to growth.  This type of investment opportunity is a major switch, said Konrad.  “Any stock you have ever written about pretty much has been a growth stock,” he explained.  “Tesla (TSLA) is a growth stock.  People buy Tesla because they think they are going to keep on gaining market share,” he clarified.

“Now there are some new income stocks that came public last year: Hannon Armstrong, Pattern Energy Holdings (PEGI), NRG Yield (NYLD) and Brookfield Renewable Energy (BEP), so there are four, I would say, renewable energy income stocks on U.S. exchanges.”

...Once renewable energy assets are operating efficiently, they generate payback for their investors.  Now that the technology has matured enough to gain the trust of some of the more reticent, risk-averse investors like corporations and banks, expect to see lower cost of capital for projects and greater interest in renewable energy stocks, bonds and mutual funds.

Renewable Energy Investing's Awkward Teens.

It now looks like just "a few" yield cos may be an underestimate. Last month, Abengoa (ABGB) and NextEra (NEE) launched yield co spin-offs Abengoa Yield (ABY) and NextEra Energy Partners (NEP), respectively.  Both IPOs were oversubscribed and priced at the top end of their expected range.  Along with NRG Yield (a spinoff of alternative energy assets from NRG Energy (NRG) from last year) and Pattern Energy Group (PEGI), launched by privately held Pattern Development, these are all up substantially (38% for ABY to 131% for NYLD) from their offering price.  In fact, they are up so substantially that their yields have fallen so far as to lend the very term "yield co" a hint of irony. 

The only real US-listed exceptions are Hannon Armstrong Sustainable Infrastructure (HASI) and Brookfield Renewable Energy Partners (BEP,) which still offer yields of 6.6% and 5.5%, respectively.  I suspect their relatively high yields arise from two factors, a rational one having to do with tax treatment and an irrational one having to do only with investor perception (or lack thereof.) 

With regards to tax, BEP is organized as a partnership and HASI is organized as a REIT, meaning that distributions from HASI are taxed as income, not at the lower rate for qualified dividends, and some investors may not want to bother with the added complication of receiving an annual K-1 from BEP.  Certain institutional investors such as many index funds also avoid there less usual corporate structures. 

While differential tax treatment of dividends can have a significant impact on high income investors, possible investor aversion to the partnership structure has not put investors off NextEra Energy Partners' stock because that company will be taxed as a corporation.  At most, these factors might justify a 20% to 40% discount for HASI, and a 10% to 25% discount for BEP.  Yet even after such discounts, they both trade at about two-thirds of the prices which would put them on par with the typical US-listed yield co.

I think the part of the discounts on BEP and HASI which is not accounted for by their tax structures can be ascribed to the immaturity of yield co investing.  To extend my coming of age metaphor, renewable energy income investors are acting like teenagers: they're a little new to the dating scene, and are more concerned about getting a date for the prom (yield co investment) than they are about the long term viability of the relationship.

Finding An Adult Relationship

I've been managing money professionally as long as many teenagers have been alive, and at this point I'm more interested in a stock's long term potential for total return than dating stock market prom queens. This article is the first in a series which will compare the fifteen publicly traded stocks in the US, UK, and Canada which meet my definition of yield co: a company which owns primarily clean energy assets for the purpose of generating income which is mostly returned to investors in the form of distribution.

For a taste, the following chart shows the types of assets and the portion of the market capitalization not currently owned by the company's sponsor ("market float.")  The numbers for Terraform Power (TERP) are based on the assumption that, like ABY and NEP, the offering will price at the top end of its range ($21) and that the underwriters exercise their full over allotment option.

UPDATE: The next two installments are here and here.

Yieldcos by fuel.png

Disclosure: Long HASI, BEP, PEGI, RNW, CSE, INE, PRI, TRIG.  Short NYLD Calls.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

July 14, 2014

The Story Is Storage

by Joseph McCabe, PE

Walking into the 2014 Intersolar North America San Francisco exhibit it became apparent there was a story embedded in the products and services displayed on the three different floors of the Moscone Center West. The third floor of the exhibits was dominated by PV structure companies which have entered into a competitive blood bath since our last report. Dominating the first floor were Chinese PV manufacturers Jinko Solar (NYSE: JKS), Canadian Solar (NYSE: CSIQ), Trina Solar (NYSE: TSL) and Yingli (NYSE: YGE) all sharing the center exhibit space. Although Chinese solar is a popular topic due to newly imposed import duties, and the PV racking industry is highly competitive, the dominant story of this year’s event was storage which dominated both the conference and the second floor 2014 Intersolar NA exhibits. On-going storage side-sessions were held adjacent to the storage focused exhibits.

Storage Role in the PV Industry

Storage has become such a hot topic because consumer, commercial, industrial and utility PV installations can now benefit from electrical storage. Storage is important for maintaining consistent electrical output from PV due to clouds; enables PV systems to store energy in the morning for dispatching during later hours of the day when the sun has gone down, when the electricity is more valuable; and allows for other high value grid related support functions.

Storage is becoming more prevalent in today’s PV industry for at least two reasons: 1. Because of lower PV installation costs, there are more and more PV installations. Higher amounts of PV, and a higher percentage of PV on the grid requires storage to smooth out drops in PV power output due to clouds, called intermittency (especially important in isolated grids with lots of PV such as in Hawaii).   2. Lower electrical storage costs from batteries, driven by the electric automotive industry, are enabling lower costs and more functionality for PV combined with electrical storage. These factors combined with the now available advanced functionality from PV inverters are opening up new markets for storage. New policies, new electrical tariffs (the way utilities charge customers) and new storage use cases are creating profits for both the PV industry and the utilities. There are many different types of electrical storage which are used for different reasons, some of which are discussed in a previous article. The different kinds of storage will play out in the industry for their particular functionality, cost advantages and reliability.

Eaton booth

Electrical storage requires integration with inverters; in a PV system an inverter with storage produces a more complete, reliable energy solution. Big industrial electronics players like ABB (NYSE: ABB, formerly Power-One inverters), EATON (NYSE: ETN), TMEIC, Bonfiglioli, Advanced Energy (NASDAQ: AEIS) and Solectria Renewables were exhibiting larger and larger inverter solutions including ones integrated with storage.

Solectria booth

ABB booth

There were inverter company exhibits from Outback Power, SolarEdge, Chint Power and Magnum Energy. Kaco, Fronius and SMA (XETRA: S92.DE) have announced US consumer grid tied inverters integrated with electrical storage, similar to those currently offered in Europe. Those companies did not have exhibits but SMA did have a van parked outside displaying their smaller technologies.

sma van

Storage companies like Bosch Energy Storage, JuiceBox Energy, Ideal Power (NASDAQ: IPWR), Princeton Power Systems, Energy Toolbase, Sonnenbatterie GmbH, Hoppecke, Rolls Battery of New England, S&C Electric Company, VARTA Storage, American Vanadium (CVE: AVC.V) and Stem filled up a major portion of the second floor exhibit space.

Aquion storage

Aquion Energy 7 kW, 22 kWh (at 20 hours and 30 degrees C) pallet of storage weighs 3,175 lbs and has a more than 3,000 cycle life. This particular technology doesn’t have chemical fire safety issues inherent with other technologies.

Vanadium redox batteries were discussed in sessions and displayed at this years exhibit. Vanadium redox is an interesting storage technology because in addition to the fast response time for dispatching electricity, it has an end of life value; vanadium is used for strengthening steel for rebar and other stronger, lighter materials when converted to ferrovanadium for use as a steel additive.

Policy leads to profits diagramMany policies are driving storage including California’s AB514, Self Generation Incentive Program, and Electric Program Investment Charge, ConEd’s Demand Management, NYSERDA PV Incentive and Reforming the Energy Vision, Massachusetts Community Resiliency Technical Assistance, New Jersey Storage Incentive, and Rule 21. If storage is positioned correctly with PV it can obtain the federal investment tax credit (ITC). Storage projects are beginning to be implemented with request for offers (RFO) and request for proposals (RFP) for storage at Hawaiian Electric Company (HECO), Southern California Public Power Authority (SCPPA), Southern California Edison (SCE) and Long Island Power Authority (LIPA).

Valuing Storage, Rule 21

What wasn’t being discussed very much at the 2014 Intersolar meeting and relates directly to storage was Rule 21.  Rule 21 is the new utility tariff in California which will be driving the values from/for these electronics and storage solutions. July 18th 2014 is the current deadline for submission of new Rule 21 tariffs by the California Investor Owned Utilities (IOUs) to the California Public Utilities Commission (CPUC). New functions including storage will be implemented, and paid for by these new tariffs.

The proposed first seven functions to be implemented by Rule 21 are Anti-Islanding Protection, Low and High Voltage Ride-Through, Low and High Frequency Ride-Through, Dynamic Volt-Var Operation, Ramp Rates, Fixed Power Factor and Soft Start Reconnection. Some of these functions enable greater PV on the grid, while others provide higher values from PV systems to the grid. Benefits to the utility from, for example, distributed power factor correction (reactive power correction) include but are not limited to increasing available grid capacities, reducing grid losses, and decreasing grid congestion.  These functions help to set the stage for greater amounts of storage + PV on the grid. For example, Anti-Islanding Protection is needed if there are many storage units connected to PV systems. The communications for all these smart grid and advanced functions are being developed by industry players like SunSpec Alliance; communications are the second phase of Rule 21. Storage plays a dominant role in the third phase where scheduling of energy services will become implemented. All these phases will play out in California in the next few years.

Turn-key Storage Solutions

I particularly impressed by a company named Greensmith. They are currently a privately held company with a reported $14M private investment and offices in Maryland and California. The history of this company dates back to 2008 with software development. Finding it easier to do the front and back end hardware themselves they became a turnkey solution for grid support and energy storage. They have a chemistry-neutral battery management system which makes them relevant to the whole storage landscape. The functions being provided by Greensmith are finding utility markets with New Jersey’s PJM frequency response, New York’s energy arbitrage (example: pumped storage resources can arbitrage price by purchasing lower priced off-peak power and selling power during peak hours of the day along with demand management due to Indian Point shut down) and the previous mentioned California Rule 21 tariff. These functions also include ramp rate control, smoothing, peak shaving and capacity shifting. CEO John Jung provided a presentation to the sessions held at the Intercontinental. They have 30 systems installed at 9 utilities with experience in 8 batteries and 6 inverter technologies. The largest of which is a 20 MW turn-key system. Systems include a 500 kW / 1.5 MWh storage system in San Diego and EV Charge + PV in Brooklyn, NY and Honolulu, HI.

greensmith booth

Conclusion

PV combined with storage is becoming more important in the PV industry because of lower costs and greater monetizable values for increased electrical services. Energy, demand, power factor and frequency response are just some of the utility values driving the increased attention for storage when combined with PV.  Turn-key system solutions that address specific use cases for storage will be driving the near-term markets for grid connected storage in the PV industry.

Disclosure: No positions. Photos were taken before exhibits opened.

Joseph McCabe is an international solar industry expert with over 20 years in the business. He is a Solar Energy Society Fellow, a Professional Engineer, and is a recognized expert in developing new business models for the industry including Community Solar Gardens and Utility Owned Inverters. McCabe has a Masters Degree in Nuclear and Energy Engineering and a Masters Degree of Business Administration.

Joe is a Contributing Editor to Alt Energy Stocks and can be reached at energy [no space] ideas at gmail dotcom

This article was first published on AltEnergyStocks.com.  Joe will attempt to answer any comments left on the original article [link].

July 10, 2014

Tesla Faces Costly Trademark Headache

Doug Young

Tesla Logo
Tesla trademark
dispute resurfaces.

After zooming into China with a slick publicity campaign earlier this year, electric car superstar  Tesla (Nasdaq: TSLA) has run into a major new roadblock in one of its most promising markets over a trademark dispute. Tesla thought it had settled a matter that jumped into the headlines last summer as it was preparing to formally move into China. But apparently the trademark squatter who purchased the Tesla names in English and Chinese wasn’t satisfied, and has formally sued the company. Based on past cases, this one could be costly for Tesla, forcing it to pay tens or even hundreds of millions of dollars if it wants to reclaim its name in China.

I’ve previously said that China needs to be more business friendly in this kind of dispute, where opportunistic buyers often hold big corporations hostage. But China seems determined to uphold its laws that often seem to favor those opportunists, not only hurting big foreign names like Tesla but also harming homegrown companies. This kind of opportunism is in the same spirit as many of the less ethical business practices that are common in China landscape, ultimately slowing or stalling the development of new industries.

Tesla thought it had settled its trademark dispute with businessman Zhan Baosheng, who purchased the company’s trademarks in both English and Chinese back in 2006. (previous post) But Zhan didn’t see things that way, and has now sued Tesla for trademark infringement, demanding the company stop using the trademarks in China and pay him 23.9 million yuan ($4 million) in damages. Zhan is also demanding that Tesla cease all marketing activities, shut down its showrooms and also stop development of its national network of charging stations.

The Beijing court has agreed to hear the case on August 5. That means it believes that Zhan may have some legal grounds for his actions, since Chinese courts typically refuse to hear such cases if they believe the plaintiff has no chance of winning. In this instance it’s hard to know what exactly happened, as neither Tesla nor Zhan is publicly commenting about the case. Tesla had said early this year that the matter was settled and delivered its first cars in China in April in a series of high-profile appearances by the company’s charismatic founder Elon Musk. (previous post)

The case looks quite similar to another high-profile dispute in 2012 involving Apple (Nasdaq: AAPL) and its iPad name. In that case, a bankrupt firm named Proview bought the name a decade earlier for a product that never found a market and ceased manufacturing long before the rise of Apple’s popular tablet PCs. Apple even thought it had legally purchased the name from Proview, but a technical glitch meant the transfer was never completed. Rather than honor the spirit of its earlier agreement to sell the name, Proview took the matter to court and Apple was ultimately forced to pay $60 million for the trademark.

The businessman in this latest case probably won’t stop Tesla’s drive into China, but he could easily slow things down with this major distraction. One element in Tesla’s favor is Beijing’s strong desire to promote electric cars as it looks to clean up the nation’s polluted air. There was no such element in the Apple story. To the contrary, Apple may have even gotten harsher treatment than most other companies due to its perception as arrogant by some in Beijing.

While politics could help in this situation, Beijing leaders in the past have shown a surprising lack of willingness to get involved such matters where opportunists attempt to manipulate the law. That’s certainly a desirable attitude in a country where the legal system is mature and independent. But China’s courts don’t really posses either of those qualities, and are likely to end up causing Tesla to lose valuable time and forcing it to pay a hefty settlement in its drive into China.

Bottom line: Tesla’s trademark infringement dispute is likely to delay the company’s drive into China by up to half a year, and cost it tens or even hundreds of millions of dollars to settle.

  Doug Young has lived and worked in China for 15 years, much of that as a journalist for Reuters writing about Chinese companies. He currently lives in Shanghai where he teaches financial journalism at Fudan University. He writes daily on his blog, Young´s China Business Blog, commenting on the latest developments at Chinese companies listed in the US, China and Hong Kong. He is also author of a new book about the media in China, The Party Line: How The Media Dictates Public Opinion in Modern China.

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