Charles Morand

It seems as though the darkest clouds are finally dissipating over alt energy's financing horizon. Over the past few weeks, money has started flowing into the sector again, as evidenced by a number of recent deal announcements:

1. On June 9, I reported on the upcoming IPO for Magma Energy Corp., a geothermal exploration company. The IPO's size will be upped from an initial C$50 MM to C$100 MM, a sign of increased market appetite 
2. SunPower Corp. raised $418 MM in early May through a share and debt offering, and recently announced it had reached a $100 MM deal with Wells Fargo to fund commercial-scale solar PV projects across the US
3. John reported a few days ago that A123 Systems had amended the SEC registration statement for its proposed IPO, positing that it could be much larger than initially anticipated
4.  In late May, Suntech Power raised $277 MM from a follow-on offering of its American Depositary Shares (ADSs), and recently received a $50 MM convertible loan from the IFC
5. On June 23, Yingli Green raised $193 MM through a follow-on offering of its ADSs
6. On June 25, Trina Solar secured credit facilities of about $57 MM
7. New Energy Finance just reported a slight increase in asset financing for Q2 2009, although it cautioned that money flows into renewable energy projects were: (1) down substantially from what they were a year ago (~66% in the US); and (2) far below the level where they need to be if greenhouse gas emissions are to be brought under control by 2020

As noted by both New Energy Finance and John, requirements for matching funds under the ARRA mean that firms that want to access government grants will have to put up some of their own money, potentially leading some of them to go to market even if conditions aren't ideal.

The recent upsurge in public market financing also certainly has to do with  buoyant markets and higher oil prices, a window that could close if the general sentiment turns negative in the coming weeks.

This increased financing activity is good news to be sure. Pure-play alt energy firms, by virtue of the sectors they do business in, typically have much weaker balance sheets than conventional energy firms or firms in more established industries. They are thus generally in a much weaker position to ride out a long capital markets drought.

But the industry is far from out of the woods yet, and I remain convinced that questionable firms are in a much weaker position to conceal their flaws behind generalized cleantech exuberance than they were in 2006 and 2007. The last rally lifted some boats that didn't deserve lifting, and sooner or later those boats will sink again.

DISCLOSURE: None       
            

Posted by Charles Morand at 11:44 PM | Permalink | Comments (0)

Stocks seem expensive now, but that may not last.  Here are two Landfill Gas stocks and three Geothermal stocks I'm hoping to buy if the market falters.

Tom Konrad, Ph.D., CFA

This article continues my Clean Energy Stocks Shopping List series.  So far I've brought you:

• Five clean transport stocks,
• I looked at why it makes sense to wait for better prices,
• Five Energy Efficiency stocks (always my favorite sector), and
• Five Electric Transmission Stocks.

This article takes a look at two of the most economical clean electricity generation technologies, landfill gas and geothermal.

Kilowatts from Trash

As I discussed in my recent article on Advanced Biofuels, I expect that advanced biofuels are likely to have to compete with electricity generation for feedstock, and electricity generation is likely to take a large part of the pie.  More importantly, the most likely companies to gain are the ones that control the feedstock.  I like waste management companies because they already have contracts and experience in dealing with local governments.  As those governments adopt broader recycling measures, waste-to-energy, and even mandatory composting, waste management companies that have the skills to process waste effectively will be able to provide these additional services.  This should increase their revenues and profits from the same amount of trash, and may lead to new opportunities to sell byproducts such as recycled materials and electricity.

#1 Waste Management Inc. (WMI). Waste Management not only collects trash, but also does recycling and waste-to-energy services.  Over the last few years, they have been aggressively expanding their methane gas recovery facilities at existing landfills, and often works under contract with governmental entities.  To me, this portfolio of skills seems ideal for exploiting future opportunities to find value in the stuff that we throw away.

WMI has a rock solid balance sheet, with almost $1 billion in cash, strong cash flow, and low debt-to-equity and current ratios.  A modest forward P/E of 13, and a dividend yield of over 4% makes this company attractive to cautious investors, even at current prices.  This is fortunate, since the low Beta means that the stock is unlikely to decline much in response to a general market decline.

#2 Veolia Environnement (VE) Also provides world-wide waste management services, but is a much broader company with an expertise in government contracting.  In addition to solid waste, they offer a large range of environmental management services, from water and wastewater treatment (there are also opportunities to generate electricity from methane produced at wastewater treatment plants.) They're also involved in several of my other favorite sectors: energy efficiency through their energy management services, and clean transportation through their transit and rail services.

The company is much more highly leveraged than Waste Management, however, and had a very thin profit margin in 2008.  This makes the company much more riskier than Waste Management, with a Beta of 1.8 compared to Waste Management's 0.5.  However, a market downturn may provide the opportunity to buy this company at a dramatically reduced valuation.

Geothermal Stocks

Hot rocks are a hot industry these days, and geothermal electricity has a lot going for it.  First, electric utilities are very comfortable with it, since geothermal plants are baseload and are very reliable, and costing only about 6 to 11 cents per kWh.  Geothermal also has strong support on Capitol Hill, gaining explicit mention and ($350 million) in the Recovery Act.  

#3 Ormat (ORA), a vertically integrated geothermal company works with almost all the players in the industry.  Many of the exploration companies, such as US GeoThermal (HTM), contract with Ormat to build their power plants.  They also do their own exploration, construction, and operation of geothermal plants world wide.

Although I consider the company a core geothermal holding, I recently sold much of my position because the recent rally carried the company to very high valuations, with a forward P/E and dividend yield of 25 and 0.4%.  Given that the stock price has almost doubled since early March, I expect to be able to get back in at much better prices.

#4 Raser Technologies (RZ) is a sharp contrast to Ormat, being the industry upstart with a disruptive business model.  Raser is leveraging cheap, off-the-shelf technology from United Technologies Corp. (UTX) in order to greatly decrease exploration costs and time.  This modularity means that Raser can start building a power plant before they have fully explored a geothermal resource.  If they later find that the resource can support a larger plant, they can simply add units.  Their first plant in Thermo Utah was completed in less than a year, on a known low temperature resource that had been previously been considered too cool to generate power, meaning that exploration was not necessary.

The company recently completed a $25.5 million offering at a 22.5% discount to the stock price at the time.  The stock promptly sold off more than 30%.  With the company rapidly burning through cash, the raise was necessary in order to continue their rapid expansion plans.  I would not have touched the company before the raise (although I listed it as one of Ten Clean Energy Gambles for 2009.  With Raser down almost 30% since then, and some fundraising out of the way for the short term, the odds of the gamble are looking a lot better.  

#5 Nevada Geothermal Power (NGPLF.PK) is a more conventional exploration and development company with a few high quality projects.  This company now expects their first producing project at Blue Mountain to be fully operational in October 2009.  The shift from an exploration company to a power producer should bring a whole new class of investors to the stock, although the recent doubling of the stock price has quite possibly discounted most of these gains.  But with thinly traded stocks such as NGP, any change in investor sentiment could easily drop the price significantly and provide new buying opportunities in the meantime.

DISCLOSURE: Tom Konrad and/or his clients own WMI, VE, ORA, HTM, RZ, UTX, and NGLPF.  

DISCLAIMER: The information and trades provided here and in the comments are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

Posted by Tom Konrad at 09:06 PM | Permalink | Comments (2) | TrackBacks (0)

We may be headed into a renewed market slump.  If so, it will pay to wait before buying, but when the time does come to buy, here are 5 electric transmission stocks I have my eye on.

Tom Konrad, Ph.D., CFA

On June 2, I wrote that I thought the market was near its peak.  That day, the S&P 500 closed at 944.74.  On June 12, it closed up 0.15% at 946.21, and has since trended down, currently trading down 5% as I write.  I expect further declines this year, either with the market heading straight down from here, or bouncing around for a while, possibly for a few months, before declining in earnest.

This article continues my Clean Energy Stocks Shopping List series, which I started with the intent of occupying myself while I wait for the market to fall.  Like most people, I find it difficult not to buy when I find a company I'm interested in, even if I don't like the valuation.  I find planning my future purchases lessens the need to use the cash I've been accumulating now, and possibly will be of some help to readers in the meantime.  So far, I've brought you five clean transport stocks, and five energy efficiency stocks.  I have enough others for about three more lists, which you will be able to find here as they are published.

When I'm done, you should have enough to put together a diversified portfolio of companies involved in what I consider the most promising clean energy sectors.  In other words, don't expect any Algae Biofuel stocks (I like the industry, but not the stocks) or Hydrogen Fuel Cell Stocks (I'm skeptical about the economics of the technology.)

I'm not skeptical about either the electric transmission industry or the technology.  As a century-old industry, it contains many mature, profitable companies, but the need to build out and enhance our existing (and rather decrepit) electric grid in order to integrate renewable energy means that there are also exciting opportunities for growth.  Here are five.

Equipment Providers

#1 General Cable (BGC) produces exactly what you'd expect: cable of all sorts, for electrical transmission, wiring, and communications.  If you believe (as I do) that the long term decline in the use of fossil fuels will mean the increasing electrification of the economy, General Cable is the one company I'd point to as most likely to benefit from the trend.   The company is solidly profitable, with a forward P/E of 10, almost $4 of cash per share, and strong operating cash flow.

#2 ABB Group (ABB) is a global technology  firm based in Switzerland with products focused on electrical transmission and distribution, and one of two global leaders in High Voltage Direct Current (HVDC) transmission (the other is Siemens (SI).)  HVDC is the best currently available technology for transporting large amounts of electricity over long distances, and is essential to the hoped for European Destertec Project, and would likely be necessary if we were to use concentrating solar power in the US Southwest as dispatchable power to balance variable renewable energy in the rest of the US.

On a more prosaic level, ABB also has technology to improve the efficiency of electricity distribution as well as transmission. The company currently trades at a P/E of 12.6, has $3 cash per share on the balance sheet, strong operating cash flow, and pays a dividend over 3%.

Service Providers

The companies which will contract to build out the new electric infrastructure seem most likely to be able to leverage the build-out to achieve high levels of growth, and hence large gains in stock price.  Here are three:

#3 Pike Electric (PIKE) performs service and upgrade of electric transmission and distribution throughout the US.   Although the company has a strong balance sheet and cash flow, analysts expect earnings to drop significantly next year.  If lower earnings materialize, we can expect significant price deterioration (especially in the context of an overall market decline,) and may be able to purchase this stock at an attractive valuation.  The forward P/E is currently over 17 at a stock price of $11.60.  The relatively high valuation makes Pike likely to be hit hard by a general market decline, leading to an excellent buying opportunity.

#4 MasTec (MTZ) not only builds and maintains transmission and distribution infrastructure, they also provide those services for fiber optic communications networks, as well as wind farms.  Mastec is less well capitalized than ABB and General Cable, but still has a strong balance sheet and cash flow, and it currently trades at a more attractive valuation than Pike, with a P/E of only 11.6.  As such, it's an interesting wind and transmission play.

#5 Quanta Services (PWR) No stock list of mine is complete without Quanta Services, which was once described to me by an industry insider as the company to call if you want to put steel in the ground on a transmission project.  Quanta has a strong balance sheet (strong cash flow, $2.65 cash per share, and a current ratio of 3.3,) but its high growth means that it trades at the relatively rich forward P/E ratio of 18.6.  Like Pike, a general stock market drop should hit Quanta disproportionately, providing an excellent buying opportunity.

DISCLOSURE: Tom Konrad and/or his clients own BGC, ABB, SI, PIKE, MTZ, and PWR.

DISCLAIMER: The information and trades provided here and in the comments are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

Posted by Tom Konrad at 11:08 PM | Permalink | Comments (0) | TrackBacks (0)

Charles Morand

Natural gas is the one commodity that has mostly resisted the rally ushered in some three months ago by a growing consensus that the worse may be over for the economy.

A number of reasons have been put forward to explain this, including record storage levels and a growing supply base being unlocked through shale gas production in North America.  

Yet natural gas' future looks bright: (a) it burns a lot cleaner than coal, making it a superior alternative to meet base- and peakload power requirements in a carbon-constrained world; (b) it is receiving growing attention as bridge fuel between gasoline-powered internal combustion engines and electric vehicles; (c) there is ample supply of it in the U.S. and Canada, making it popular with the energy independence crowd.

The near-term picture, however, is bleak...and it could be about to get bleaker. According to analysts at Citigroup Global Markets, trading activity at the US Natural Gas Fund (UNG) may be 'artificially' propping the front-month NYMEX contract. The storage situation is apparently bleak enough to warrant yet lower prices, begging the question: when, if it all, will the chickens come home to roost?

Although the combination of a bright future and depressed prices make natural gas - through UNG - an interesting investment idea for light-green alt energy investors with a time horizon beyond 12 months, there could be further price declines on the way. Right now may yet be a little early to pull the long trigger...

DISCLOSURE: None                

Posted by Charles Morand at 11:00 AM | Permalink | Comments (0)

John Petersen  

After six months of regulatory silence and $100 million in new funding, A123 Systems amended the SEC registration statement for its proposed IPO on June 23rd. While this latest filing may simply be A123's way demonstrating its ability to raise matching funds for a scaled back ATVM loan request of $1 billion and pending applications for $438 million in direct Federal grants, my sense is that the proposed IPO will probably come to market in early September. Since ATVM loans will require 20% cost sharing and direct Federal grants will require 50% cost sharing, the IPO will probably be a good deal larger than the $175 million contemplated by A123's original filing.

I'm very interested in A123's IPO for several reasons. First, it will be underwritten by Morgan Stanley, Goldman Sachs, Merrill Lynch and Lazard, which will give us the first clear picture of how the top-tier investment banks and institutional investors value pure-play energy storage companies. Second, the emergence of A123 as a sub-sector leader will encourage lesser Li-ion battery developers to adopt comparably transparent disclosure metrics that will make it much easier to assess their relative strengths and weaknesses. Third, the existence of a large, adequately capitalized and business driven leader in the Li-ion sub-sector will probably dampen some of the unbridled optimism we've seen in the markets for transition stage Li-ion battery developers. Finally, the A123 IPO is likely to launch a renaissance of interest in a basic industrial sector that's been undervalued and ignored for years.

I spent some time over the weekend studying A123's draft prospectus and was able to glean important current data that tends to highlight the yawning economic chasms that Li-ion technology must bridge before it can compete in applications where the end-user has a choice. During the first quarter of 2009, A123's cost of goods sold was $1.89 per watt hour, which does not compare favorably with an average cost of roughly $0.20 per watt hour for lead acid batteries. Likewise A123's $41 million investment in property, plant and equipment that can manufacture up to 151,000 kWh of batteries per year is at least an order of magnitude greater than the capital cost of lead-acid battery manufacturing facilities.

I fully expect that capital outlays and manufacturing costs for Li-ion batteries will both decline dramatically over the next ten years. For the short- to medium-term, however, I expect gross profit margins in the Li-ion sub-sector to remain narrow and sales revenues to ramp-up slowly as Li-ion battery chemistry and manufacturing methods progress through two or three generations of technological change. It all boils down to baby steps; learning to crawl, then toddle, then walk and then run. The bumps, bruises, skinned knees and tears are all part of the learning process.

As regular readers know, I come from the lead-acid side of the battery business and believe that over next ten years the bulk of the expected revenue growth in the energy storage sector will flow to established manufacturers of inexpensive lead-acid batteries that can do the required work for a reasonable cost even if they are bulkier and heavier. Over the longer term, I expect leading Li-ion battery developers like A123 to overcome a myriad of cost, performance, safety, cycle-life, abuse tolerance and raw material constraints that I've written about in other articles, and ultimately usher in a golden age of cheap energy storage for applications ranging from portable power, to vehicles with plugs, to a smart grid that smoothly integrates a host of emerging power generation technologies. The changes won't come overnight and they will be expensive, but by 2020 the world will be very different from the one we live in today.

While I'm not so old that I avoid buying green bananas, I expect to be cold, dead and buried long before competition from Li-ion batteries results in a year on year decline in global sales of lead-acid batteries. Nevertheless, A123's upcoming IPO is certain to focus the market’s attention on the storage sector in a whole new way. Since I've been around long enough to know that a rising tide of investor sentiment lifts all of the boats in the marina, I think astute investors ought to be doing their boat shopping now.

Posted by John Petersen at 12:46 PM | Permalink | Comments (4)

Last week, an article in Green Car Congress summarized a market forecast that Dr. Menahem Anderman presented at this month's Advanced Automotive Battery Conference in Long Beach, California. In his presentation, Dr. Anderman evaluated the market for HEVs in 2011, projected a $1,230 million market for automotive NiMH batteries, and projected a $320 million market for automotive Li-ion batteries. The following graph comes from Green Car Congress, is based on data from Dr. Anderman's AABC presentation, and shows both unit sales and market value of the Li-ion batteries that will be used in HEVs by 2011 (click on the graph for a larger image).



It's sobering if not downright depressing when you get to the middle of the article and read about Dr. Anderman's analysis of the gasoline prices required for HEVs to make economic sense.

Based on a five-year net present value analysis, Dr. Anderman concluded that:

• Stop-start hybrids make economic sense in the $5 per gallon range;
• Mild and strong hybrids require a gasoline price of roughly $7 per gallon; and
  
• PHEVs and full EVs require a gasoline price of about $10 per gallon.

When he performed an eight-year present value analysis, Dr. Anderman concluded that:

• Stop-start hybrids make sense in the $3 per gallon range;
• Mild and strong hybrids make sense in the $5 per gallon range;
• PHEVs require a gasoline price of roughly $7 per gallon; and
  
• Full EVs still require a gasoline price of about $10 per gallon.

I know very few people that can perform a net present value analysis. I know even fewer who go looking for a new car with the idea that they're going to drive it for five to eight years. Given the dismal economics of mild and strong hybrids and the ghastly economics of cars with plugs, I believe the high-end market for the next several years will be limited to the image conscious affluent who are willing and able to pay big premiums to make a statement. While Dr. Anderman's forecast of 40,000 Li-ion powered HEVs in two years strikes me as a very ambitious target, I'm willing to set aside my reservations for purposes of this article and assume that manufacturers of automotive Li-ion batteries will be guaranteed revenues of $320 million in 2011.

While most would agree that $320 million of total revenue by 2011 sounds impressive, it loses a bit of luster when you consider that advanced lead-acid battery manufacturers can expect $900 million to $1.8 billion of incremental revenue by 2011 from the widespread implementation of stop-start technology as standard equipment.

I've used the following graph from an October 2008 Frost & Sullivan presentation in a couple of recent articles, but it bears repeating because the law of large numbers is the fundamental reason that short term revenue growth in the automotive battery market favors lead-acid by 6 to 1 over Li-ion. The long blue segments represent the stop-start market that will be dominated by advanced lead-acid batteries because they can do the required work, they cost 60% to 75% less than NiMH and Li-ion alternatives, and they are the only batteries that can be manufactured in sufficient numbers to serve the short-term needs of automakers. The red, green and violet segments represent the high priced "centerfold" alternatives favored by EV advocates, reporters, politicians and public relations managers who would rather sell a sweet dream than grapple with economic reality.



In How Short-Term Supply Constraints Will Impact Booming HEV Markets, I explained that Frost & Sullivan based their original forecast on European CO2 emission standards but did not account for President Obama's subsequent acceleration of domestic CAFE standards. That change alone will push growth that would normally have occurred between 2015 and 2020 into earlier years and could easily double the growth rates Frost & Sullivan expected last fall. So with that background in mind, let's run the numbers.

Currently automakers spend between $50 and $100 for the commodity lead-acid batteries they use for starting, lighting, ignition and accessories; call it an average of $60. Since stop-start hybrids put far more stress on the battery, the advanced lead-acid batteries needed for stop-start vehicles will probably cost the automakers $250 to $300 per vehicle; call it an average of $260. That means the battery cost increment for a stop-start vehicle will be in the $200 range.

A quick eyeball of the Frost & Sullivan graph shows forecasted sales of 4.5 million stop-start vehicles by 2011, which works out to about $900 million in incremental revenue for lead-acid battery manufacturers, or roughly three times Dr. Anderman's forecast for Li-ion. If accelerated CAFE standards double global demand for stop-start vehicles, the incremental revenue for lead-acid battery manufacturers will be closer to $1.8 billion, or roughly six times Dr. Anderman's forecast for Li-ion.

Li-ion battery developers Altair Nanotechnologies (ALTI), Ener1 (HEV) and Valence Technologies (VLNC) have a combined market capitalization of $935 million and will be vying with a host of established domestic, European and Asian competitors for a piece of $320 million in total revenue.

In comparison, lead-acid battery manufacturers Exide Technologies (XIDE), C&D Technologies (CHP) and Axion Power International (AXPW.OB) have a combined market capitalization of $340 million and will be vying with their traditional competitors for a share of $1.8 billion of incremental revenue.

Benjamin Graham said, "In the short term, the stock market behaves like a voting machine, but in the long term it acts like a weighing machine." The voting is based on hopes, dreams and expectations. The weighing is based on revenue growth, earnings and other business fundamentals. Any time I can identify one industry sub-sector that trades at one-third of the market value of its more glamorous cousin but is likely to enjoy three to six times the short-term revenue gains, I have to believe the undervalued sector will reward investors handsomely as the weighing machine returns to balance.

DISCLOSURE: Author is a former director and executive officer of Axion Power International (AXPW.OB) and holds a large long position in its stock. He also holds a small long position in Exide (XIDE).

John L. Petersen, Esq. is a U.S. lawyer based in Switzerland who works as a partner in the law firm of Fefer Petersen & Cie and represents North American, European and Asian clients, principally in the energy and alternative energy sectors. His international practice is limited to corporate securities and small company finance, where he focuses on guiding small growth-oriented companies through the corporate finance process, beginning with seed stage private placements, continuing through growth stage private financing and concluding with a reverse merger or public offering. Mr. Petersen is a 1979 graduate of the Notre Dame Law School and a 1976 graduate of Arizona State University. He was admitted to the Texas Bar Association in 1980 and licensed to practice as a CPA in 1981. From January 2004 through January 2007 he was a director of Axion Power International, Inc. a public company involved in advanced lead-carbon battery research and development.

Posted by John Petersen at 02:32 PM | Permalink | Comments (1)

Stocks may be expensive now, but they won't be forever.  Five energy efficiency plays to buy when they're cheap again in efficient HVAC, desalination, thermal imaging, and lighting.

Tom Konrad, Ph.D., CFA

This article continues my Clean Energy Stocks Shopping List series.  In the first, I looked at five clean transport stocks I'll be looking to buy when the market falls.  In the second, I took a step back, and outlined why it makes sense to wait for better prices than to buy these companies now.  Here are five stocks I'll be looking to buy  in my all time favorite sector, Energy Efficiency.  Future articles in this series will be found here.

#1 Energy Recovery, Inc. (ERII)

Much has been written about how energy and water are increasingly becoming interlinked problems, with the production of energy (especially biofuels) and the pumping, sanitization, and desalination of water requiring increasing amounts of energy.  One way to invest in this theme is by investing in wind stocks or solar photovoltaic stocks, since these technologies require little or no water to generate electricity.  

Another way would be to invest in water rights or water suppliers, or a water ETF.  I have long avoided this method, because I consider water to be far too politically sensitive.  People have a deep distaste of companies making money from water, and this often leads to politicians expropriating water company assets or changing the rules so that owners of water rights don't make "unreasonable" profits from them.  With all this political risk surrounding water, the only way I feel comfortable investing is through an equipment supplier which can make a profit by selling equipment to utilities.  Once the sale is made, the profit can be booked, and there is much less ongoing political risk than there would be by investing directly in such a utility.

Energy Recovery, Inc. is such a company.  They sell systems which greatly reduce the energy used in desalination, making this both an energy efficiency play and a water play.  Better, they are currently profitable, and have an extremely strong balance sheet and good cash flow.  However, its valuation ratios are all quite high because of high expected growth. I'm waiting for the price to fall before I buy any more (I'm currently short a few August $5 puts.)

#2 and #3 LSB Industries and Waterfurnace Renewable Energy (WFI.TO / WFFIF.PK)

I wrote about these two geothermal heat pump companies last December, and Waterfurnace is one of my Ten Clean Energy Stocks for 2009.  Since I wrote those articles, Energy Secretary Chu toured a Waterfurnace plant, and announced $50 million in government support for geothermal heat pump use.  Given all the attention, both stocks have risen sharply, and I'd be happy to increase my stakes if a market decline results in a buying opportunity. 

#4 FLIR Systems, Inc. (FLIR)

I also recently covered Flir, which I expect to benefit from the growing number of energy auditors and energy audits which have been spurred by the stimulus package, and this stock, too, has advanced strongly.  The business case remains strong, and if a market decline takes this high-growth, high P/E stock with it, I'll be ready to buy more.

#5 Cree Inc (CREE)

Cree is probably one of my longest standing favorite stocks. It is in both my Ten Clean Energy Stocks for 2008 as well as the 10 for 2009, and I was writing about investing in LED companies long before I started the annual lists.  Because the stock price has gone up so quickly  recently, I've sold most of my position.  I went into some depth as to why I like the company in both articles, and I still like it and the LED industry in general, because it's a rare energy efficiency play that's a simple product, and hence does not encounter many of the barriers to energy efficiency. Reasonably high powered LED light bulbs are becoming more common in stores, as well as LED fixtures.  I recently purchased an LED Lamp for reading, and an LED Grow Light. If a market decline provides the opportunity, I plan to rebuild my position in Cree.

DISCLOSURE: Tom Konrad and/or his clients own ERII, LXU, WFIFF, FLIR, and CREE.  

DISCLAIMER: The information and trades provided here and in the comments are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

Posted by Tom Konrad at 08:01 PM | Permalink | Comments (0) | TrackBacks (0)

There's much excitement about second generation biofuels made from cellulosic feedstocks and algae, be they cellulosic ethanol, biodiesel, biocrude, or electricity from biomass.  There will be winners, but they may not be the technology companies.

Tom Konrad, Ph.D., CFA

At the 2009 Advanced Biofuels Workshop, there were two major themes: developing new feedstocks, especially algae, and the development of new pathways to take biomass into products such as biocrude, which can be used in exiting oil refineries.  

Big Market, Many Competitors

The current federal Renewable Fuel Standard requires the use of 36 million gallons of biofuels, including at least 21 billion gallons of advanced biofuels by 2022.  Advanced biofuels are defined as fuels other than corn-based ethanol and with greenhouse gas (GHG) emissions half that of the fuel they replace.  This creates a gigantic market, so large that some industry observers doubt if it can be met.

Many of these fuels will not be ethanol, a fuel which poses problems with the current fuel transport and distribution infrastructure.  Even for cellulosic ethanol, there are several different processes that different companies are pursuing: Acid hydrolysis, Thermochemical conversion, Biochemical conversion, and Consolidated Bioprocessing, and combinations of these three used in various combinations by various companies.  

Potential products not only include fuels such as ethanol, butanol and higher-carbon alcohols, but biocrude which can be fed into existing refineries.  Other potential products include plastics, and many other products currently produced by the petroleum based energy industry.  

The bewildering array of potential pathways and products make for a very challenging investment landscape.  An investor in any company would need a lot of confidence that the company they are investing in will be able to take their chosen feedstocks to a potential salable product at lower cost than all the competitors out there.  Unsurprisingly, nearly every company feels it has the best process.

Lessons From the First Generation

With so many variables, I find it's often better to take a step back to see what impact the development of the advanced biofuels market will have on the larger economy.  Will there be impacts on the broader economy which will be independent of the eventual mix of products and processes in the advanced biofuels market?

We can learn from the experience of first generation biofuels.  

Below is a chart from William Thurmond, President of Emerging Markets Online and author of Algae 2020: Biofuels Commercialization Outlook, and Biodiesel 2020: A Global Market Survey:

It shows how biodiesel feedstocks (Palm oil, rapeseed oil, and soybean oil) are increasingly following diesel prices.  There is a massive overcapacity for biodiesel production in the EU, as shown in the shown in the following graph, also from Thurmond:

With this excess capacity, if biodiesel feedstock prices were to fall relative to diesel prices, biodiesel producers would purchase feedstock either until they fill their excess capacity, or until feedstock prices rise again to a point where it is no longer profitable to run additional biodiesel capacity.  Put another way, biodiesel producers cannot be more than marginally profitable (and may be unprofitable) so long as there is significant excess capacity.  Excess capacity can only be filled if additional feedstock can be found, or plants permanently shut down.

What does this mean for advanced biofuels?  As advanced biofuel technologies advance, feedstocks prices are likely to rise.

Why Advanced Biofuels are Different

Unlike with biodiesel and starch based ethanol, many second generation feedstocks are not generally internationally traded; many are actually waste streams from other processes, such as yellow and brown grease (the restaurant industry), corn stover, forest trimmings (the lumber industry,) and even municipal waste.  The more that these feedstocks are internationally traded and easy to transport (such as yellow and brown grease), the more likely they are to follow the patterns seen in the feedstocks for first generation biofuels.  According to Thurmond, this has already happened with yellow grease, and the rise in price was a surprise to most biodiesel industry participants.

Many emerging biofuels companies have learned this lesson.  ZeaChem's strategy specifically includes setting up a long term contract to purchase feedstock from dedicated energy plantations because "the availability of sustainable, cost effective raw materials is essential for an economically viable cellulosic biofuel facility," according to Andy Vietor, ZeaChem's CFO, who spoke at the workshop.  BioFuelBox Corporation is tackling the same problem from a different direction: by developing a biorefinery that they expect can produce biodiesel from a zero-cost waste stream (trap grease), but I'm not sure that they have completely absorbed the lesson.  Even trap grease will acquire some value if they can consistently make fuel from it.  I think they could improve their business model by selling their technology as a turnkey solution to the waste stream owner.

Investments and the "Everything vs. Fuel" debate

Investors who expect advanced biofuels to be successful should pay close attention to feedstocks.  Just as supply constraints for batteries will shape the electric and hybrid electric auto market, limited supplies of biomass will shape the advance biofuels industry.  

If an advanced biofuel company expects to make biofuel from an easily shippable commodity, such as wood chips, they'd be advised to stay away, unless that company also plans to contract for their supply of feedstock well ahead of time, and such agreements will probably constrain a company's ability to react to changing conditions.  Lack of flexibility can be fatal to start-up companies.

Companies which produce easily transportable feedstocks being considered by advanced biofuel companies stand to benefit from new markets for their products.  These include forestry companies (wood chips), waste management companies, and most owners of arable or marginal land.  Wood chips are likely to see price escalation even without the advent of advanced biofuels based on them.  Wood chips and pellets can be cofired in many existing coal power plants with only relatively inexpensive modifications, a process which offsets large amounts of carbon emissions at very low cost.  Biomass cofiring was the cheapest renewable energy opportunity identified in California's RETI study last year.  For an apples-to-apples comparison, the greater efficiency of electric motors means that electricity produced from biomass can propel an electric vehicle 81% farther than an otherwise comparable ethanol-fueled vehicle running on cellulosic ethanol produced from the same amount of biomass.

Furthermore, the existing biofuel industry may also find better uses for cellulosic feedstocks than turning them into biofuels.  I attended a session at the 2009 Fuel Ethanol Workshop the following day where gasification of cellulosic waste streams such as corn cobs or stover was presented as an economical way to reduce the carbon footprint of corn ethanol by displacing natural gas used in the production process.

The flip side of the feedstock equation is that industries which compete for feedstock with the biofuels industry are likely to be hurt by rising prices.  Advanced Biofuels may resolve the "Food vs. Fuel" debate, but they will be doing so by, at least in part, replacing it with a new "Everything vs. Fuel" debate.  For instance, the paper industry (especially those companies which do not own forestry assets) will likely be hurt by rising pulp prices, like Mexicans who found they could not buy tortillas.  Recycled paper pulp is an excellent cellulosic feedstock as well.  On the other hand, businesses which produce or collect paper waste may find more robust markets for their products.

This line of reasoning might also give you pause if you're considering warming your home with a wood pellet stove.  The advent of biofuels from wood chips will mean that the price of your wood pellets will start to track the price of petroleum, just like the price of vegetable oils are already doing.   From an economic perspective, heating with wood pellets may become not much different than using heating oil.  We saw the start of this trend last year with wood pellet factories starting to price dairy farmers out of the market for sawdust in the Pacific Northwest.

Algae to the Rescue?

Algae is the only feedstock that has the potential to be productive enough to supply most of our current liquid fuel demand, but it is still unproven.  Most current algae to biofuel production methods cost an order of magnitude more than the fossil fuels they hope to displace.  This is why most algae biofuel companies are currently targeting higher-value synthetic bioproducts, such as animal feed additives.  But Will Thurmond believes that some algae companies may be cost competitive with fossil fuels as early as 2012, but only in his most optimistic scenario; the process of bringing down costs could take much longer.

There are now three publicly traded Algae companies.  I've previously written skeptically about PetroSun (PSUD.PK,) and Thurmond told me, "Petrosun appears to doing well in the news, but if you examine their financial statements, it's a different story."   More recently OriginOil (OOIL.OB) and PetroAlgae, (PALG.OB) have also gone public.  PetroAlgae is the industry high flyer, and is doing some interesting work growing duckweed, at least according to a hallway conversation.  Unfortunately, the stock is so thinly traded that it would be difficult for even a small investor to get in without significant price impact.  OriginOil shows better volumes, but they, too, are early in their technological development.

Algae has great promise, but the only investments currently available to the retail investor are very early stage.  Even if we were to assume that the algae industry will quickly meet its potential, these three companies only amount to a tenth of the current players, and the rigors of being a public company are not the best environment in which to develop an emerging technology.  Algae could well be a monumental success story, but that does not mean that any of these three companies will participate in that success.

DISCLOSURE: None.

DISCLAIMER: The information and trades provided here and in the comments are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

Posted by Tom Konrad at 03:01 PM | Permalink | Comments (2) | TrackBacks (0)

John Petersen

For several weeks I've been writing about robust demand in Europe for a new class of HEVs that are usually referred to as "stop-start" or "micro hybrids." According to the EPA's website:

"Stop/Start hybrids are not true hybrids since electricity from the battery is not used to propel the vehicle. However, the Stop/Start feature is an important, energy-saving building block used in hybrid vehicles.

Stop/Start technology conserves energy by shutting off the gasoline engine when the vehicle is at rest, such as at a traffic light, and automatically re-starting it when the driver pushes the gas pedal to go forward."

The concept is simple and so is the technology. Adding micro hybrid capabilities at the factory typically costs less than $1,000 per vehicle and improves fuel efficiency by an estimated 5% to 8%. It's a baby step, but as my first table in The Obama Fast Track for HEVs shows, it's more cost-effective than any other class of HEV technology. The main reason micro hybrids are so affordable is that they use advanced lead-acid batteries instead of more expensive alternatives.

Since the booming European micro hybrid phenomenon has not reached the U.S., a couple skeptical readers challenged me to show them press releases from major European OEMs announcing plans to produce HEVs that didn't use NiMH or Li-ion batteries. They were not satisfied with my initial response that micro hybrids are being adopted as standard equipment without major fanfare. Yesterday I found an October 2008 "Power Solutions Backgrounder" from Johnson Controls, Inc. (JCI) that proves the point nicely:

"We sold 400,000 advanced batteries for start/stop micro hybrid vehicles in Europe in 2007 and 800,000 in 2008, with the expectation of doubling that number again in 2009 to approximately 1.5 million batteries. These vehicles achieve a 5 percent to 8 percent fuel savings compared to conventional gas vehicles."

I then found www.hybridcars.com, a rich source of data that describes itself as the Internet’s premier website dedicated to hybrid gas-electric vehicles. By combining the micro hybrid battery sales data from JCI with additional data from hybridcars.com, I was able to cobble together the following graph that shows the growth of the global HEV market over the last 10 years. Since I don't have access to comprehensive data on the European micro hybrid market, I assumed that JCI was the only competitor. As a result, the graph understates European micro hybrid sales by a couple of percentage points, but in this case shape is far more important than numerical precision.



With historical data to provide context, the following graph from a 2008 Frost & Sullivan presentation that summarizes their forecast of future growth in global HEV sales makes a good deal more sense than it may have in earlier articles.



As I explained in How Growing HEV Markets Will Impact Battery Manufacturing Revenues, the Frost & Sullivan forecast was based solely on European CO2 tailpipe emission standards that take effect in 2012 and did not account for President Obama's subsequent acceleration of CAFE standards. That recent change will have the effect of pushing growth that would normally have occurred in the 2015 to 2020 timeframe into earlier years and could easily double the growth rates that were expected last fall. While I'm happy to leave the work of updating growth forecasts to experts like Frost & Sullivan, it seems safe to conclude that the next few years will be a challenging time for the battery industry.

Under the growth scenario presented in the Frost & Sullivan graph, the bulk of the unit growth in the HEV markets will go to lead-acid battery manufacturers who will not need to make larger numbers of batteries, but will need to make higher quality batteries that are better suited to the performance requirements of micro hybrids. This changing product mix will reduce production volumes for low-margin valve regulated lead-acid batteries and increase production volumes for high-margin advanced lead-acid batteries, and should lead to rapid and sustained revenue and profit growth for all lead-acid battery producers.

As we move away from the micro hybrid market and focus on the higher value markets for mild, full and plug-in hybrids, the challenges become more daunting. Jack Lifton has written several articles on global production constraints for the rare earth metal lanthanum; the "M" in NiMH batteries. His basic concerns are that substantially all of the world's supply of rare earth metals comes from China; their current production of roughly 33,000 tons of lanthanum per year can only provide raw materials for about a million HEV battery packs; and their domestic demand for rare earth metals is growing at an extraordinary rate that will limit future exports. Since it usually takes several years to increase production from an existing mine and even longer to bring a new mine into production, Jack expects the battery industry to encounter substantial short- to medium-term bottlenecks in the lanthanum supply chain. If he's right, automakers will be forced to make a Hobson's choice for an increasing percentage of their HEV battery needs:

• Use Li-ion batteries despite the performance, cost, abuse tolerance and cycle life concerns; or
• Use advanced lead-acid batteries despite the weight and volume concerns.

On its face this seems to be good news for Li-ion battery developers like Ener1 (HEV), Valence Technology (VLNC) and Altair Nanotechnologies (ALTI) who consistently argue that their proposed products are best choice to fill the gap between surging HEV demand and constrained NiMH battery supply. While many find those arguments persuasive if not compelling, I remain skeptical for several reasons.

First, Li-ion batteries have a checkered history in portable electronics that are used indoors. We know almost nothing about their long-term performance when exposed to the heat, cold, moisture, vibration, driving habits, user neglect and physical stress that automobiles have to endure on a daily basis. The only way to develop that knowledge base will be to get Li-ion batteries out of the laboratory and into test fleets. While many automakers have announced plans to begin limited production of HEVs and PHEVs that use Li-ion traction batteries over the next two years, I can't help but wonder whether the Li-ion battery sector isn't in exactly the same position that the NiMH battery sector was in 10 years ago. My next graph comes from the May 2009 Dashboard at hybridcars.com and shows the 10-year U.S. sales history for HEVs with NiMH batteries. Call me a luddite, but I have a hard time accepting the idea that HEVs with Li-ion batteries will follow a development path that goes from zero vehicles per year to hundreds of thousands of vehicles per year over the course of four or five years. From all of the projections I've seen, the DOE and all major automakers share those reservations.



Second, the world's productive capacity for the large-format Li-ion batteries that are needed for automotive applications is very limited. There have been numerous announcements about plans to build new factories, but the bulk of those planned facilities will not be operational until 2011 or 2012. Since most existing Li-ion battery plants are already running at full capacity to make batteries for the high value portable electronics markets, I don't believe Li-ion batteries will be able to make a meaningful contribution to the auto industry's drive to meet European CO2 emission standards by 2012.

Third, I remain concerned that global rates of lithium production will not be able to keep pace with rapidly increasing demand for batteries. According to USGS publications, approximately 25% of global lithium production is used for Li-ion batteries. While global lithium production has grown at an annual rate of roughly 6% over the last couple of years to a 2008 total of 27,400 tons, the production process for lithium from brines involves an 18-month evaporation cycle before the alkali salts contained in the brine are ready for separation, refining, processing and use. Moreover lithium mining is subject to the same expansion constraints as other extractive industries. I'm no longer worried about the long-term adequacy of global lithium resources and I know that production can be expanded over time, but production capacity cannot be expanded quickly and there are certain to be substantial short- to medium-term production bottlenecks.

Finally, I remain concerned about the current development status of large-format Li-ion batteries for automotive use. In a February article titled DOE Reports That Lithium-on Batteries Are Not Ready for Prime Time, I summarized the conclusions of the DOE's 2008 Annual Progress Report for the Energy Storage Research and Development Vehicle Technologies Program that basically said Li-ion batteries would not be suitable for use in mass market HEV and PHEV applications until technical barriers relating to cost, performance, abuse tolerance and cycle life were overcome. I expanded on that theme in Understanding the Development Path for Li-ion Battery Technologies after a reader sent me sent me an unpublished "pre-decisional draft" of a DOE report titled National Battery Collaborative (NBC) Roadmap, December 9, 2008, a high-level policy analysis that discusses the merits, risks and expected costs of an aggressive eight-year initiative to foster the development and facilitate the commercialization of Li-ion batteries. While the draft roadmap went a long way toward easing my concerns over the long-term future of large format Li-ion batteries, it merely reinforced my conviction that Li-ion batteries are not currently ready for the big show.

Automakers are a conservative lot and they are intensely sensitive to price, performance and supply chain issues. They understand that NiMH and Li-ion battery supplies are constrained by limited global production of lanthanum and lithium, and that large format Li-ion battery supplies will be further constrained for several years by inadequate manufacturing capacity. They also have substantial reservations about the long-term performance of Li-ion batteries under the extreme heat, cold, humidity and vibration conditions that automobiles have to endure on a daily basis. Notwithstanding these known and very real business constraints, the automakers are under strict regulatory edicts to reduce fleet average CO2 emissions to 130 grams per kilometer in Europe by 2012 and improve fuel economy by roughly 35% in the U.S. by 2016. These are very brief timeframes for changes of this magnitude.

The end result is an untenable situation where proven NiMH batteries won't be available in adequate volumes during the regulatory compliance period and even unproven Li-ion batteries will be subject to daunting supply constraints. In a nutshell, supply constraints will leave the booming HEV markets in a critical state of flux for several years. While nothing can be predicted with certainty, I believe the likely responses from automakers will fit in three distinct categories:

1. Automakers will continue to use proven NiMH batteries as their preferred HEV technology until limited lanthanum supplies restrict the ability to manufacture NiMH batteries;
2. Automakers will accelerate their efforts to build demonstration fleets of high value products using unproven Li-ion batteries, but production volumes will remain small until they gather enough hard performance data to justify the widespread commercialization of the technology; and
3. Automakers will significantly increase their use of advanced lead-acid batteries in high volume budget priced product lines, including mild and full hybrids that can tolerate the seventy-five pound weight gain and one cubic foot space loss that will typically arise from using advanced lead-acid batteries instead of NiMH or Li-ion.

This is a sub-optimal environment for all parties because automakers do not have the flexibility to develop new product lines on a multi-year schedule. They have to go to work immediately with the tools at their disposal and bring their product lines into regulatory compliance in a little over five years. The end result will be an accelerated timeline for Li-ion batteries and increased use of advanced lead-acid batteries in product lines that might have been introduced with NiMH batteries under more normal conditions. As automakers develop experience with using both advanced lead-acid and Li-ion batteries in roughly equivalent applications, the unanswered technical and cost-benefit questions about which technology is best for automotive applications will be conclusively answered. In other words, we're going to have a horse race after all.

DISCLOSURE: Author does not own any of the stocks mentioned in this article because all of his personal investments are in pure-play lead-acid battery manufacturers.

John L. Petersen, Esq. is a U.S. lawyer based in Switzerland who works as a partner in the law firm of Fefer Petersen & Cie and represents North American, European and Asian clients, principally in the energy and alternative energy sectors. His international practice is limited to corporate securities and small company finance, where he focuses on guiding small growth-oriented companies through the corporate finance process, beginning with seed stage private placements, continuing through growth stage private financing and concluding with a reverse merger or public offering. Mr. Petersen is a 1979 graduate of the Notre Dame Law School and a 1976 graduate of Arizona State University. He was admitted to the Texas Bar Association in 1980 and licensed to practice as a CPA in 1981. From January 2004 through January 2008, he was securities counsel for and a director of Axion Power International, Inc. (AXPW.OB) a small public company involved in advanced lead-carbon battery research and development.

Posted by Tom Konrad at 07:01 PM | Permalink | Comments (2) | TrackBacks (0)

If the Ethanol industry is going to rehabilitate its image, it needs to understand the issues.

Tom Konrad, Ph.D., CFA

In his opening remarks at the 25th annual, 2009 Fuel Ethanol Workshop, Mike Bryan, the CEO of BBI International called on the attendees to "Take back control of the [fuel ethanol] industry's image."  

It's no secret that the ethanol industry is having problems, mostly, in my mind, due to a classic commodity squeeze: the industry has no pricing power either for its inputs (corn and natural gas,) or its products (ethanol, with a price which closely tracks gasoline.)  This is why, and Mr. Bryan said, the industry could not get plants financed a year before the financial crisis.

Conspiracy or Reality?

For Mr. Bryan, this is about jobs.   He went on to say that he is "not a conspiracy theorist, but a realist,"  but undermined his claim to realism by going on to say, "Tell [the people who say we were building too fast,] "about the people who need those plants for jobs.  Tell that to the community that wants to build an ethanol plant in their community."  Profitable businesses create secure jobs; unprofitable businesses create insecure jobs.  Just as I recently pointed out that investors should not be buying stocks because they need them to go up, the ethanol industry should not be building ethanol plants because they need the jobs.  

Ethanol plants have been a great boon to rural economic development.  As a local value added product to low value commodity corn, they keep more jobs in the community, which in turn create more jobs through economic multiplier effects... but only if the ethanol plants are profitable.  If farmers invest in a local ethanol plant (50% of ethanol plants are locally owned), but that plant cannot be run because they cannot sell the ethanol for the price of the corn, there will be no jobs from the plant, and the investors will lose their investment as well.  Perhaps they should have considered investments in a locally owned wind farm, or making their farming operations more energy efficient.

In short, jobs are not created by, and do not justify unprofitable investments.  There are simply better uses for the money, both in terms of jobs and economic returns.

Is there a conspiracy?  Oil companies don't want to change the way they do business, and be forced to blend in ethanol, nor do they like the competition, even if it is only 7% of their business.  That's real money on the margin, even if land use constraints will not allow ethanol to entirely displace oil.  The food processing industry has even more reason to dislike fuel ethanol.  Although only about 10-15% of price rises in food are due to ethanol-induced corn price rises, ethanol makes a convenient whipping boy for price rises which arise from many factors, most importantly the rising price of energy.  But having people who don't like you does not make for a conspiracy.

Peak Oil

General Wesley Clark, Co-Chairman of Growth Energy, is not a conspiracy theorist.  He, too, is passionate about  the need to take back the industry's image in his keynote address.  For General Clark, ethanol is a national security issue, and I completely agree.   Peak oil means that oil will increasingly be sold at a premium, and as scarcity increases, producing countries will have increasing incentives for producers to keep this high quality liquid fuel for themselves.  

Although the most energy efficient way to power a vehicle is with electric power, batteries are too expensive and have too low an energy density to be practical for long trips.  We will continue to need liquid fuels to power longer trips.  As General Clark said, "Is there any doubt that that the costs of Iraq are related to?  This is about America’s need for imported oil.  It distorts our policy.  It creates friend about people who aren’t our friends; it makes enemies out of people who aren’t our enemies."

Carbon

Compared to the value of ethanol as a liquid fuel, arguments about carbon impact are de minimis.  Bob Dinnen, President of the Renewable Fuels Association an industry lobby group, was the most moderated of the general speakers.  Unlike the other speakers, I'm confident that his assertions can be backed up with studies.  He claims a 61% reduction in greenhouse gas emissions for corn ethanol compared to gasoline.  This is almost certainly the result of a best case analysis, but the worst case analysis are no more than a 30% increase in emissions, and with current technology, there is almost certainly some greenhouse gas savings.  Even if there is a slight increase in carbon emissions from corn ethanol, these extra emissions are likely to be minimal, and less than tar sands..  When it comes to greenhouse gas reduction, ethanol, even corn ethanol, is not the enemy.  The enemy of the human race, as Jim Hansen says, is coal, and while we environmentalists should be concerned about any lack of decrease in greenhouse emissions, we should not lose sight of the true enemy.  The ethanol industry as a whole agrees that they need to increase their efficiency and reduce their carbon emissions.  These should be measured as accurately as possible, but any green washing we see in the ethanol industry pales against that coming out of the coal industry.  Given limited political capital, this is where environmentalists should be focusing our efforts.

Food and Fuel

Ethanol is a domestic fuel, that puts corn to a much better use than high fructose corn syrup that contributes to growing epidemics of obesity and diabetes.  From a historical perspective, we pay hardly any part of our income for food.  Ethanol does reduce the price of gas, and the money we pay for that gas stays closer to home.  Given that, an increase in food prices from corn ethanol may still lead to a net gain for the average consumer, and the economic benefits of a domestic fuel should make us willing to pay for a small net increase in our overall food and fuel budget.  

If we're concerned about Ethanol's carbon footprint, we might pause to consider the carbon impact of our food.  If a rise in food prices results from corn ethanol, the decrease in our collective carbon footprint from what we eat.  Whatever indirect land use impact we attribute to ethanol, we should be attributing a similar indirect land-use impact to the soda we drink that's so full of high fructose corn syrup.

Stop Exaggerating

While environmentalists should not be joining oil companies and food processors by piling on the ethanol industry over its imperfect environmental record, the Ethanol industry could do itself a lot of good by avoiding the exaggerated claims they are prone to.

General Clark said, "There’s plenty of all we need to have all the fuel we want and all the food we want," and Mr. Bryan said something similar.  This is simply false.  The US currently has about 200 million acres devoted to corn and soy.   Corn Ethanol can produce about 200 gallons per acre, while soy biodiesel can produce about 50 gallons per acre of biodiesel.  If all this land were converted to fuel production with corn ethanol (incidentally degrading the land and increasing fertilizer usage), that means we could produce 10 billion gallons of ethanol, the equivalent of about 8 billion gallons of gasoline per year, or about half a million barrels per day.  The US consumed about 20 million barrels of crude per day in 2007, and had to import about 10.5 million barrels of that.  Not all of our imported oil was used for gasoline, but not all of our corn and soy can go to displace oil, either.

The numbers don't add up.  The Ethanol industry undermines its own credibility with these exaggerated claims.

The industry also uses deceptive statistics regarding indirect land use impacts.  Bob Dinnen said that deforestation has to do with grazing and logging, not Ethanol.  They made much of the fact that deforestation has decreased as ethanol production has increased.  Correlation is not causation, nor is anti-correlation lack of causation.  According to a recent article in The Economist, "rate of deforestation tends to move with prices for beef and soya, with a lag of about a year."  This is because the land is cleared for grazing, and then sold on to soy farmers..  As Biodiesel producers discovered to their dismay, rising corn prices leads farmers to shift land from soy to corn, which in turn leads to rising soy prices, and hence to rising deforestation a year later.

As I left the conference on the first day, I walked by Robert Zurbin, author of Energy Victory: Winning the War on Terror by Breaking Free of Oil.  He was sitting in the main lobby with a stack of books to sign.  I had caught the end of his talk an hour before, in which he spun a captivating and convincing yarn about how oil had been key to allied victory in World War II.  I walked up and told him how I only caught part of his talk, but liked what I had heard, and he encouraged me to buy the book.  I was tempted, but then he lost the sale: he told me that, if only 50% of cars were mandated to be Flex-Fuel, it would put a "cap on the price of oil."  While I agree with him that the increased choice would be good for consumers, and even moderate the oil price, there is simply note enough feedstock, either domestically or globally, and too many other valuable uses for that feedstock to cap the price of oil in the face of expanding demand (which is only likely to be restrained by price or economic downturn) and declining oil output. 

There are many good reasons to like Ethanol, even Ethanol from corn.  But it's only part of the solution: Ethanol is not the panacea, and it's not without adverse impacts.  It's also not always good business.  By acknowledging these weaknesses, ethanol advocates would do a lot to raise their credibility with many environmentalists who are natural allies with an industry taking real steps to reduce its environmental impact and enhance our energy security in the face of the much larger challenges of Peak Oil and Global Warming.

My impression is that the major agenda item on the industry's agenda is legislation requiting 50% of vehicles to be flex-fueled.  This would probably be a change for the better, definitely from an economic perspective (the added cost to the vehicle is fairly minimal.  Unfortunately, the use by carmakers of flex fueled vehicles as a loophole in CAFE standards serves to undermine environmental goals.  If the industry wants more environmental allies today, it will need to be clear than environmental goals will not again come second. I think most environmentalists would get behind a 50% or higher requirement for flex fuels vehicles if it were in conjunction with the closure of the flex fuel loophole in CAFE standards.

Posted by Tom Konrad at 07:50 PM | Permalink | Comments (0) | TrackBacks (0)

Charles Morand

There was an interesting post in Barron's tech trader daily on Monday discussing how solar PV stocks are coming under pressure, in part because product prices are falling further than expected. About a month ago, I discussed the potential return effect for households in given states of removing the $2,000 ITC cap. Such measures, it seems, are failing to kickstart demand, and solar recovery might end up being significantly slower than many had been expecting.

Case in point, since hitting a high of $11.49 on June 11, the TAN ETF is down about 12%. KWT, for its part, hit a high of $17.35 on June 10 and is down 11% since. The S&P 500, in comparison, is down about 4% from its June 12 high. While both TAN and KWT are up >30% on the S&P 500 over the past six months, neither is up on the benchmark index over the past 12 months.

I took a long position in TAN in early March at $5.00 when an automatic buy order I had had on it for a while kicked in. At the time, I stated:

This is still very much my belief. I took some profit at $10.00 when an automatic sell order kicked in, and I'll gladly purchase a little more if it goes back down substantially. It must be said, however, that I use sell orders at set return levels to protect profit and not in an attempt to time the market.

Overall, those who are investing in one the two solar ETFs today and hanging on will be happy they did so two years from now and beyond. The road there, however, will be fraught with volatility.

DISCLOSURE: The author is long TAN.

Posted by Charles Morand at 11:21 PM | Permalink | Comments (2)

Charles Morand

A little while ago, we received the following request from a reader:


While we don't plan on launching a licensable index or a mutual fund because of all the regulatory thicket we'd have to cut through, this request nonetheless led to a few internal exchanges about the merits of this idea and what could go into such an index/fund.  

Tom had the following to say:

Neither the electric grid (let alone the transmission subsector) nor energy storage, taken alone, features a sufficiently large universe of stocks to allow for the construction of a solid index and, in turn, the creation of a dedicated ETF or mutual fund.

The small number of firms for which either sector is material means that effectively all of the available stocks would have to be included in the index to achieved a level of diversification worth paying for, if such a level was even achievable. A small number of stocks also means that an investor might be able to reproduce the portfolio directly on his/her own at a lower cost than the ETF management fee.

Efficiency is somewhat different, seeing as so many activities and products - including some that fall under the grid umbrella - can be counted as 'efficiency'. Besides your garden variety electricity efficiency solutions such solid-state lighting, everything from insulation technology manufacturers to demand-side management service providers could be included. Of the three, efficiency stands the greatest chance of seeing its own ETF pop up in the near to medium term - in fact, I wouldn't be surprised if someone was already working on this.  

Nevertheless, this request and the subsequent discussion piqued my interest, and got me wondering what an Electric Grid Index might look like - I decided I would give it a shot.

The electric grid has received a significant amount of focus in the bailout package and has recently been on the political radar to a greater extent than at any other time in the past few decades.

Last week, the results of a survey of wind power firms revealed that "transmission or interconnection issues [are viewed] as the single greatest barrier to wind development in the United States. " Transmission is also a significant barrier to geothermal power development and, as utility-scale facilities gain in popularity, will definitely become so for solar PV as well.

In my view, the grid will be one of the strongest performing sub-sectors in alt energy over the next four years, because so much of America's renewable power potential depends on a significant expansion of domestic transmission and distribution capacity. At the same time, the growing popularity of smart grid technologies, as evidenced by the Obama administration's efforts to jump-start this sector, will most likely expand in the years ahead as utilties and large consumers become increasingly comfortable with the concept.

The Electric Grid Index

Last February, I wrote a post where I differentiated between what I called the Old World and the New World grids. In a nutshell, I ascribed the New World label to companies working on making the grid into an information-rich environment that can be managed dynamically by using two-way communication, aka the smart grid. Old World companies are firms working on more conventional areas such as cables, towers and maintenance.

I also added a new category: A Bit of Both. This idea came after a reader pointed out the importance of power electronics in enabling a smarter grid, and the need to not be so clear-cut when discussing the Old and the New Worlds. This category also contains firms that actually do do a bit of both.

In order to create a basic list of stocks for a smart grid index, I went back over past articles we wrote on the matter and pulled out a list of firms that had been identified as plays on the grid. I then read through their 2008 10-Ks, 20-Fs and/or annual reports and included only firms that derived 20% or greater of their revenue from the grid or power management activities.

I left out MW-scale storage although the case could certainly be made for adding it...or not. I also left out system operators such as ITC Holdings (ITC) and focused instead on product and service providers.

The following is the final list of grid companies I came up with.      
    

Name (Ticker)	Market Cap ($US MM)	Dividend Yield (%)	% '08 Sales Related to the Grid	Core Business	PE
New World
RuggedCom (RUGGF.PK)	275	0.00	100%	Communication Equipment & Services	22.15
Comverge (COMV)	242	0.00	100%	Communication Equipment & Services	N/A
EnerNOC (ENOC)	458	0.00	100%	Communication Equipment & Services	N/A
Itron (ITRI)	2,146	0.00	N/A*	Communication Equipment & Services	405.33
Echelon Corp. (ELON)	310	0.00	100%	Communication Equipment & Services	N/A
Telvent (TLVT)	702	0.00	~27%	Communication Equipment & Services	14.77
Old World
Composite Technologies (CPTC.OB)	99	0.00	~44%	Cables	N/A
General Cable (BGC)	2,000	0.00	N/A*	Cables	10.87
MasTec Inc. (MTZ)	930	0.00	N/A*	Services	12.08
Quanta Services (PWR)	4,638	0.00	~57%	Services	28.73
Resin Systems (RSSYF.PK)	59	0.00	>90%	Poles	N/A
CVTech (CVTPF.PK)	74	0.00	>80%	Services	9.25
Valmont Industries (VMI)	1,876	0.80	~23%	Poles	14.17
Stella-Jones (STLJF.PK)	255	1.54	~36%	Poles	9.31
Pike Electric Corp. (PIKE)	386	0.00	100%	Services	11.42
A Bit of Both
ABB Group (ABB)	37,984	2.80	~30%	Multiple	14.72
Siemens AG (SI)	65,944	1.90	N/A*	Multiple	21.19
Schneider Electric (SBGSF.PK)	19,195	6.17	>50%	Multiple	7.96
* Exact % not disclosed in filing but assumed significant based on other disclosures

Coming up with a simple list is easy enough. However, in order for this list to be considered an index in the true sense of the term, individual stocks have to be weighed according to certain criteria - the weight different stocks and sectors receive is critical to performance for this type of index.

Depending on who creates and index and for what purpose, methodologies for ascribing weights to different stocks can vary. In this case, since this is a purely fictional exercise, I originally opted for a simple capitalization-weighted methodology.

The problem I ran into with using straight capitalization-based weights is the huge discrepancy between the size of the A Bit of Both stocks and the rest: together, they account for nearly 90% of the list's capitalization. This means that even large movements in several other index components would have a marginal effect at best on index performance if those three did not move or moved in the opposite direction.

I thus decided to give each of the three categories (New World, Old World and A Bit of Both) and equal weight of 1/3, to measure each capitalization's weight within its own category only, and to do a weighted-average of those weights using 1/3. For example, Siemens accounts for 54% of its category's aggregate market cap, so its weight in the index is 0.54 * (1/3) = 17.85%.

The 1/3 weight is arbitrary. If I were to create an index like this for purposes of an ETF, my preference would be to rely heavily on business and fundamental information in deciding how to weigh individual stocks. However, given the time and cost involved in conducting solid fundamental analysis on 18 companies, this isn't something I would do for a simplified demonstration such as this one.

The category weights could be changed to reflect sectoral expectations. For instance, a less risk-averse investor could weigh the New World category more heavily as it is likely to generate stronger capital gains, although those will almost certainly come at the expense of lower volatility.

Name (Ticker)	Market Cap ($US MM)	% Total	% Own Category	Weight	Weighted Average (%)
New World
RuggedCom (RUGGF.PK)	275	0.20	7	1/3	2.22
Comverge (COMV)	242	0.18	6	1/3	1.95
EnerNOC (ENOC)	458	0.33	11	1/3	3.69
Itron (ITRI)	2,146	1.56	52	1/3	17.31
Echelon Corp. (ELON)	310	0.23	8	1/3	2.50
Telvent (TLVT)	702	0.51	17	1/3	5.66
Old World
Composite Technologies (CPTC.OB)	99	0.07	1	1/3	0.32
General Cable (BGC)	2,000	1.45	19	1/3	6.46
MasTec Inc. (MTZ)	930	0.68	9	1/3	3.00
Quanta Services (PWR)	4,638	3.37	45	1/3	14.98
Resin Systems (RSSYF.PK)	59	0.04	1	1/3	0.19
CVTech (CVTPF.PK)	74	0.05	1	1/3	0.24
Valmont Industries (VMI)	1,876	1.36	18	1/3	6.06
Stella-Jones (STLJF.PK)	255	0.19	2	1/3	0.82
Pike Electric Corp. (PIKE)	386	0.28	4	1/3	1.25
A Bit of Both
ABB Group (ABB)	37,984	27.61	31	1/3	10.28
Siemens AG (SI)	65,944	47.93	54	1/3	17.85
Schneider Electric	19,195	13.95	16	1/3	5.20
TOTAL	137,573	100	N/A	N/A	100

The index is set at 100 for now. I will measure performance periodically to see how I fare.

While it may not be practical for many investors to reproduce this index because of the number of stocks, I hope it provides a good base to start from. Tom is often a proponent of the portfolio approach to investing (i.e. taking small positions in several stocks to spread risk), and such lists can often provide a good starting point for those interested in following this approach.          

DISCLOSURE: Author is long ABB    

Posted by Charles Morand at 02:26 AM | Permalink | Comments (0)