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September 30, 2009

Better, or Beta?

My Quick Clean Energy Tracking Portfolio has produced unexpected out-performance.  Is it because of high beta (β) in a rising market?

I recently asked why two portfolios which I had designed to track green energy mutual funds ended up out-performing them by a wide margin.  

This is the first of a short series of articles looking into possible causes.  Could the portfolios be outperforming because the stocks they contain rise more when the market rises (and fall more when the market falls) than do the mutual funds they were designed to track?  In other words, are they out-performing because of high beta (β) in a rising market?

A Beta Definition

From Wikipedia,

In finance, the beta (β) of a stock or portfolio is a number describing the relation of its returns with that of the financial market as a whole.[1]

An asset with a beta of 0 means that its price is not at all correlated with the market; that asset is independent. A positive beta means that the asset generally follows the market. A negative beta shows that the asset inversely follows the market; the asset generally decreases in value if the market goes up and vice versa.[2]

That's a basic definition.  It's worthwhile to note that β changes for any stock or portfolio over time (usually slowly, but sometimes quickly in times of market turmoil.)  Measured β will also vary depending on the time increment used (are we interested in daily, weekly, monthly, or even hourly changes of a stock with respect to the market,) and it will also vary depending on which market index is used as a proxy for the market as a whole.  In my recent article on hedging using beta, I showed a graph with three measures of beta for my portfolio against various market indexes.

Mathematically, if S is a stock (or portfolio) and M is the market index, then

β = correlation(S,M) x std.dev(S) / std.dev(M)


β = covariance(S,M) / variance(M).

Either formula can be calculated with standard spreadsheet functions.  I gave an example using the first formula in my hedging article, and a spreadsheet using the latter formula is available here.  In both cases, the change in S will be β times the change in M, plus an error term which is uncorrelated to the change in M.

Why High Beta Would Explain Out-Performance

I created my tracking portfolios at the end of February, which was, co-incidentally, right before the stock market began its recent rise.  From this graph,


you can see that both tracking portfolios have out-performed nearly every possible benchmark.  In the first article in this series, I attributed the difference between the two tracking portfolios to "winner-loser" effects (hence the names of the portfolios.)  In theory, without these effects, those portfolios should have produced returns approximately equal to the average of the two.

Since the S&P 500 (my proxy for the market) gained 43% over the period in question, while the mutual funds gained 56% on average, and the tracking portfolios gained 80% on average, if β were the sole reason for the out-performance, we would expect that the average mutual fund β would be about 1.3 (=56%/43%) while the average tracking portfolio β would be about 1.9 (=80%/43%.)  There will be significant errors in these calculations (recall the random error term and other caveats from the definition of β), but we should at least expect that the β of the tracking portfolios is higher than the β of the mutual funds.

In fact, I do not expect that the out-performance of the mutual funds over the S&P500 will all be due to β.  In April, I argued that clean energy in general was outperforming the market due to the greater political support shown by the Obama administration compared to previous administrations, something I dubbed the "Obama Effect."  If this is true, then the β for the mutual fund portfolio will be less than 1.3, but β could still explain the out-performance of the tracking portfolios if their β is approximately 0.6 greater than the β for the mutual fund portfolio.

Calculating β

β for a portfolio is the weighted average of the β's of the portfolio's components.  Furthermore, Yahoo! Finance provides some pre-calculated β's (from Capital IQ, a  division of Standard & Poors), but not for all securities in my portfolios.  Furthermore, I was unable to determine the market index used to calculate the Yahoo! β's.

I used the last 200 trading days of stock market data for the securities in question, and the formula above to calculate β with respect to my market proxy, the S&P 500, using an Excel spreadsheet.  Here are the results:

Stock/Portfolio Beta (β)
CGAEX (Calvert) 0.916
ALTEX (First Hand) 0.912
GAAEX (Guinness Atkinson) 1.117
NALFX (New Alternatives) 0.812
WGGFX (Winslow Green Growth) 1.123
Mutual fund Portfolio 0.974
LSB Industries (LXU) 1.078
Echelon Corporation (ELON) 1.573
First Solar Inc (FSLR) 1.067
South Jersey Industries (SJI) 0.360
American Superconductor (AMSC) 1.675
"Winners" Portfolio 1.151
Citrix Systems (CTXS) 0.979
Echelon Corporation (ELON) 1.573
SunTech Power (STP) 2.186
Cemig (CIG) 0.996
Vestas Wind Systems (VWSYF.PK) 1.318
"Losers" Portfolio 1.410
Average of "Winner" and "Loser" portfolios 1.281

A Partial Explanation

The average β of the tracking portfolios is 0.3 more than the mutual fund portfolio β, but we needed a difference of about twice that to explain all the out-performance.  We also see the Obama effect here, which accounts for the 13% out-performance of the mutual funds over the S&P 500.

My calculated β's, plus the Obama effect on green stocks and funds, can explain an average performance of the tracking portfolios of about 70% over the time period in question, leaving about 10% of the out-performance unexplained. 

As I hypothesized in the previous article, this out-performance could also arise from the way I chose the stocks, which created a bias towards some Cleantech sectors (mostly efficiency stocks  and smart grid stocks) when compared to the mutual funds.  It could also be the mutual fund managers' skill.  In either case, however, an out-performance of 10% during seven months which have been as volatile as these last seven would not be enough for me to reach any firm conclusions.  10% is small enough to be a bias in my β calculations (recall that β depends on the choice of index as well as the frequency of the data used, and it also changes over time.)  10% could also be just luck.  

Since I won't be able to show that any out-performance which remains is not just luck, I see no need to continue this investigation.

An Inadvertent Discovery

It's interesting to note that the β for the "Losers" is higher than that for the "Winners."  In other words, I was wrong to attribute the out-performance of the "Losers" portfolio to winner-loser effects.  "Loser" out-performance is also explained by β.  Why do the "Losers" have higher β than the "Winners"?  Because the "Losers" were the worst-performing of a group of stocks from 2/27/2006 to 2/27/2009, over which period the S&P 500 fell 43%.  Since high-β stocks are likely  to fall more than low-β stocks when the market as a whole is falling, my "Losers" portfolio was biased towards high-β stocks.

None of this explains why the "Winners" portfolio also has higher β than the mutual funds.  While the "Losers" were selected with a high-β bias, the "Winners" were selected with a bias towards low-β stocks.  We would therefore expect that the "Winners" portfolio would have a β lower than the mutual funds from which they were drawn.  

Here are some reasons that the mutual fund β's are lower than the β's of their top holdings.

  1. Mutual funds need to maintain a cash reserve in order to meet redemptions.  Cash has a β of 0, and so an allocation to cash will lower the funds' β overall. For instance, the Calvert fund holds about 4% cash.  Without the cash, the Calvert fund's β would be 0.954 rather than 0.916.  However, the funds would have to be holding about 20% cash for this to be a full explanation.
  2. The greater emphasis of my portfolios on energy efficiency and smart grid technologies does not account for the bias.  The average β for these companies in my portfolios was about the same as the portfolios as a whole.
  3. The funds own a good number of diversified companies with exposure to green energy, but they do not own enough of many of these to put them in the top holdings of the funds.  One example would be Applied Materials (AMAT), a semiconductor firm with growing interests in solar.  Such firms will generally have lower β than pure-play firms, which is why I suggested readers invest in AMAT and nine other large companies with green energy exposure in the spring of 2008: I was concerned about a market decline (not that I had any clue how bad it would be) and low-β stocks are likely to fall less during declines.

Implication: More Bang For Your Buck

The discovery that the top holdings have higher β than the funds has some implications for tracking portfolio creation.  In order to better match the gains and losses of the mutual funds, we will need to invest less money.  By holding some cash, β can be lowered.  Alternatively, by investing the same amount, an investor can get more exposure to the positive trends affecting green energy, such as peak oil and the advent of carbon regulation.  

That's why we're here, isn't it?

DISCLOSURE: Tom Konrad and/or his clients own AMAT, LXU, ELON, and AMSC. The Guinness Atkinson Fund is an advertiser on his website, AltEnergyStocks.com

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.

September 29, 2009

Battery Investing for Beginners, Part II

John Petersen

Last Friday I published "Battery Investing for Beginners" as an introductory piece for investors who don't know much about the energy storage sector but are interested in learning more because of the hugely successful initial public offering by A123 Systems (AONE). Since the article was well received and there seems to be a good deal of reader interest, I've decided to continue the theme with a series of articles where I'll try to build a contextual framework for the industry and show where various types of energy storage devices and their manufacturers fit into that framework. Since I don't want to spend too much time replowing old ground, I'll rely on hyperlinks to my earlier blogs and third party source documents.

I'm a lawyer, not a journalist. My undergraduate degree was in accounting with a solid base of hard science. I've spent the last 30 years working in securities law where most of my work involved small natural resource or technology development companies. I'm not an engineer or scientist, but my chosen field of practice requires me to understand the science well enough to explain it. My foundation in the energy storage sector dates to 2003 when I took on a client named Axion Power International (AXPW.OB) that was organized to develop a novel energy storage device that's half lead-acid battery and half supercapacitor. I spent the next five years working as Axion's general counsel and served as a member of its board for four of those years. I stepped down from my position as Axion's board chairman in January 2007 and brought in successor legal counsel in early 2008. I still own a substantial long position in its stock. In short, I know the energy storage sector well and understand what the principal players are trying to accomplish, but I come from the lead-acid side of the business and because of my long history with high-tech innovation I'm not as excited by gee-whiz technology as many commenters. I like to think of myself as a cautious optimist who sees the opportunities but never overlooks the challenges.

Everybody understands the basic problem. We passed an inflection point for peak cheap oil in the late '90s and fuels that are expensive today can only become more costly in the future. We've also passed the inflection point for peak cheap electricity. When you factor in concerns over CO2 emissions as a possible cause of climate change, we have a real mess on our hands. The good news is that fundamental economics are finally kicking in and forcing us to attack the issue of energy waste while we search for new ways to generate electricity from non-traditional sources. Merrill Lynch strategist Steven Millunovich believes we are at the dawn a new industrial revolution, the age of cleantech. I believe he's right.

When I started writing this blog, I decided to limit its scope to "pure-play" energy storage device manufacturers that file regular reports with the SEC. The decision resulted in three noteworthy exclusions: Johnson Controls (JCI), which is the largest battery manufacturer in the world but only gets 15% of its revenue from battery sales; SAFT Groupe (SGPEF.PK), a profitable French battery manufacturer that does not file reports with the SEC; and BYD (BYDDY.PK), a Chinese manufacturer of cell phones and automobiles that gets 23% of its revenue from battery sales and does not file reports with the SEC. The decision also left me with a small but reasonably comparable short list of companies that only differ in the nature of their products and the development stage of their businesses. For investors who would rather track an index that includes JCI and BYD, I recommend the Energy Storage and Battery Technology Stocks Index (*BTTRY) published by Tickerspy.

There are two basic classes of energy storage devices: cool devices like lithium-ion batteries, supercapacitors and high-speed flywheels that promise extraordinary performance and are relatively expensive in terms of cost per unit of storage capacity; and cheap devices like lead-acid batteries, flow batteries and low-speed flywheels that offer lower levels of performance but are relatively inexpensive. My favorite source of cost data on energy storage technologies is a July 2008 Sandia National Laboratories report on its Solar Energy Grid Integration Systems – Energy Storage (SEGIS-ES) program. The following table separates the raw Sandia data into short duration power technologies, short duration energy technologies and long duration energy technologies; orders the technological contenders based on the average of current and 10-year projected cost data reported by Sandia; and identifies the American companies I follow that are focused on each storage technology.

Current Cost 10-year Projected
Short Duration Power ($/kWh) Cost ($/kWh)
High-speed Flywheels (composite) $1,000 $800
   Beacon Power (BCON)

Lithium-ion Batteries
   Altair Nanotechnologies (ALTI)

   A123 Systems (AONE)

Electrochemical Capacitors $356/kW $250/kW
   Maxwell Technologies (MXWL)

Current Cost 10-year Projected
Short Duration Energy ($/kWh) Cost ($/kWh)
Flooded Lead-acid Batteries $150 $150
   Exide (XIDE)

   Enersys (ENS)

   C&D Technologies (CHP)

Valve Regulated Lead-acid Batteries $200 $200
   Exide (XIDE)

   Enersys (ENS)

   C&D Technologies (CHP)

Low-speed Flywheels (steel) $380 $300
   Active Power (ACPW)

Lead-carbon Asymmetric Capacitors $500
   Axion Power (AXPW.OB)

Lithium-ion Batteries
   A123 Systems (AONE)

   Ener1 (HEV)

   Valence Technologies (VLNC)

   Altair Nanotechnologies (ALTI)

Current Cost 10-year Projected
Long Duration Energy ($/kWh) Cost ($/kWh)
Zn/Br Batteries

   ZBB Energy (ZBB) $500 $250/kWh

There are also two basic classes of pure-play energy storage companies: emerging entrepreneurial companies that are developing new technologies; and established manufacturing companies that have solid customer bases and sustainable business models. A fifth and final class is a rapidly expanding group of Chinese battery manufacturers that have listed their shares in the U.S. but are not expected to be major players in the growth of America's domestic battery industry. To allow for fundamental differences among their technologies and business models, I've segregated my universe of pure play energy storage companies into five classes that I'll briefly describe below and summarize in a series of tables that identify the individual companies and provide summary data on their share prices, market capitalizations and key financial ratios.

Cool Emerging - My cool emerging class consists of thinly-capitalized developers of relatively expensive energy storage technologies. Their annual operating losses are typically large in relation to their total assets and they'll be dependent on additional financing for an indeterminate period of time. Cool emerging companies are typically valued on the basis of the perceived potential of their technology and their expected time to market.

Name Symbol Price Mkt. Cap. P/E P/B P/S
Ener1 Inc HEV $7.07 $826.0
9.8 37.5
Valence Technology VLNC $1.81 $229.7
N/A 11.6
Altair Nanotechnologies ALTI $1.17 $123.5
2.7 33.8
Beacon Power BCON $0.73 $88.1
4.2 213.7

Cool Sustainable - My cool sustainable class consists of well-capitalized developers of relatively expensive energy storage technologies that have a substantial customer base. Their annual operating losses are typically smaller in relation to their total assets and their need for additional financing is generally less pressing. Cool sustainable companies are typically valued on the basis of their earnings potential and business development plans.

Name Symbol Price Mkt. Cap. P/E P/B P/S
A123 Systems AONE $18.73 $1,838.9
3.6 20.5
Maxwell Technologies MXWL $19.27 $500.5
6.2 5.4
Ultralife Corporation ULBI $5.90 $99.8
1.3 0.5

Cheap Emerging - My cheap emerging class consists of thinly-capitalized developers of relatively cheap energy storage technologies. Their annual operating losses are typically large in relation to their total assets and they'll be dependent on additional financing for an indeterminate period of time. Like their cool counterparts, cheap emerging companies are typically valued on the basis of the perceived potential of their technology and their expected time to market.

Name Symbol Price Mkt. Cap. P/E P/B P/S
Axion Power AXPW.OB $2.12 $75.9
18.3 62.8
ZBB Energy ZBB $1.24 $15.4
1.9 8.7

Cheap Sustainable -
My cheap sustainable class consists of well-capitalized manufacturers of relatively cheap energy storage technologies that have a substantial customer base. Like their cool counterparts, cheap sustainable companies are typically valued on the basis of their earnings potential and business development plans.

Name Symbol Price Mkt. Cap. P/E P/B P/S
Enersys ENS $21.71 $1,040.0 15.7 1.4 0.6
Exide Technologies XIDE $8.01 $604.9
2.0 0.2
C&D Technologies CHP $2.14 $56.3
1.3 0.2
Active Power ACPW $0.88 $58.2
3.1 1.3

Chinese Companies -
My last class consists of Chinese companies that have listed their shares in the U.S., but operate solely in Asia. They're generally profitable and may export products to the U.S., but they're not expected to be key players in America's drive to develop a thriving domestic battery manufacturing industry.

Name Symbol Price Mkt. Cap. P/E P/B P/S
Advanced Battery Technologies ABAT $4.09 $253.1 11.8 2.1 5.3
China BAK Battery CBAK $4.19 $241.7
1.5 1.1
China Ritar Power CRTP $5.47 $105.3 20.0 2.8 1.0
Hong Kong Highpower HPJ $3.34 $45.3 23.2 2.5 0.7

My fundamental premise is that current conditions in the energy storage sector are a lot like they were in high-school.

There are four publicly held lithium-ion battery developers vying for supremacy in the high profile contest to become the technology superstar for PHEVs and EVs. They're competing against each other, a number of foreign companies and a host of privately held companies for a market that will be a long time coming. While they all trade at prices that would give value investors a nosebleed, the odds that a particular company will make it to the NFL draft are remote at best.

At the other end of the spectrum there are a small number of emerging and sustainable companies that are manufacturing and developing technologies for the more mundane energy storage needs of the average consumer who would be hard-pressed to buy a $22,000 Prius class hybrid, much less a $40,000 Volt class PHEV.

As the newly born excitement over the energy storage sector wanes and fundamental investment analysis gains supremacy, I expect the relative valuations of the cool technology companies to either remain flat or fall while the relative valuations of the cheap technology companies rise to more reasonable levels. On Thursday I'll put together an analysis of how that investment thesis has held up since last November and establish a new set of foundation metrics for future tracking comparisons. I continue to believe cheap will outperform cool for the foreseeable future. Only time will tell whether I'm right or wrong.

DISCLOSURE: Author has a large long position in Axion Power (AXPW.OB) and small long positions in Enersys (ENS), Exide (XIDE), ZBB Energy (ZBB) and Active Power (ACPW).

September 28, 2009

What Is Peak Oil?

Charles Morand

Peak Oil is a term that has become common currency in energy debates in last three years, due in large part to the spectacular rise in the price of crude between 2005 and the end of 2008. But what does Peak Oil actually mean and, more importantly, what do I mean when I use it in my articles?

In the purest and original sense of the term, Peak Oil refers to the point in time at which the rate of oil production (as measured, for instance, in barrels per day) peaks. This peak, according to the original theory, is then followed by a rapid and irreversible decline as attempts to extract more oil out of the ground run into the absolute geological limits of the resource. Wikipedia, as always, does a great job of explaining the theory of Peak Oil and provides a wealth of resources for those who would like to expand their knowledge further.

I do, on occasion, refer to Peak Oil in my articles, including one I wrote last week where I claimed that Peak Oil would be a powerful driver of gasoline prices in the next few years. Given how contentious this theory is, I wanted to clarify where I stood on it and how readers should interpret what I mean when they see those two words side-by-side in my posts.

Are we about to run into the absolute geological limits of oil in a way that won't allow us to increase production going forward? I don't know and I have nowhere near the appropriate level of knowledge to truly judge the data I see on this weekly. And frankly I don't particularly care; humanity will hit that peak at one point or another and the exact timing is of very little relevance to me.

What is far more relevant is the price point (and time) at which we hit the economic - rather than the geological - peak: let's call that Effective Peak Oil (EPO). EPO occurs where the marginal barrel of oil, which sets the price for all barrels of oil in the market, is so expensive that: (1) it triggers a process whereby governments, people and firms search for and find substitutes in a way that alters the structure of the economy and demand for oil forever and; (2) in the process, it also triggers a substantial economic shock. Does EPO look like a nice, smooth bell-shaped curve? Probably not, or at least not when plotted on a timescale relevant to most human beings (i.e. 60 to 90 years).

In the following interview he gave on CNBC last week (thanks to the Infectious Greed blog), Jeff Rubin, former Chief Economist at CIBC World Markets and author of the new book Why Your World Is About To Get A Whole Lot Smaller, sums up my thinking on this issue better than I ever could. His most memorable quote: "What we are running out of is oil we can afford to burn."


A Better Way to Play Green Stocks?

My Quick Clean Energy Tracking Portfolio continues to outperform all benchmarks and expectations... is it luck, or did I stumble onto a better way to invest in green energy stocks?

I continue to be stunned at how the portfolio which I intended as an easy way to duplicate green energy mutual fund performance at much lower cost continues to blow those green mutual funds out of the water.  I last published an update on this portfolio at the end of May, and was shocked to find that it had beaten the funds it was intended to replicate by over 20% in 3 months.  The trend continues... it's now almost 7 months later, and the portfolio has widened its lead over the mutual funds by 30%.

Winners and Losers

In May, I hypothesized that the out performance might have been due to how I constructed the portfolio: I chose five stocks from the top holdings of the mutual funds which had performed worst over the preceding three years.  I did this because there is a fairly well-documented winner-loser effect [pdf], that shows systematic price reversals in stocks that show long-term gains or losses.  In particular, stocks showing long term losses are more likely to make gains in following years than long term winners.

I tried to test if the out-performance was solely due to winner-loser effects by going back to my original data and seeing how a portfolio constructed with winners rather than losers would fare.  To my surprise, the "winners" portfolio also significantly outperformed the mutual funds (by 10% over 3 months).  I've updated the performance of the "winners" portfolio as well, and it also has increased it's gains compared to the mutual fund portfolio, and is now outperforming by 15% over 7 months.

Winner-loser effects seem to be playing a role, but at most, they explain about a quarter of the out-performance of the "Losers" portfolio so far.  There may be other, as yet unknown, causes of the superior performance of the "Losers" portfolio.  

No matter what the cause, for winner-loser effects to explain all of the difference, the "Winners" portfolio would have to be under-performing the mutual funds by about as much as the "Losers" portfolio is outperforming.  Where did the other three quarters of the out-performance come from?  Is it just luck?

"Losers" Tracking Portfolio

Company Shares Price 2/27/09 Close 9/24/09 % Change
Citrix Systems (CTXS) 48 $20.58 $37.65 82.94%
Echelon Corporation (ELON) 165 $5.99 $12.82 114.02%
SunTech Power (STP) 162 $6.09 $15.96 162.07%
Cemig (CIG) 94* $10.47* $14.66 40.02%
Vestas Wind Systems (VWSYF.PK) 22 $44.85 $69.50 54.96%
Total   $4998.65 $9,415.06 88.35%

*Dividend and split adjusted.

"Winners" Tracking Portfolio:

Company Shares Price 2/27/09 Price Close 9/24/09 % Change
LSB Industries (LXU) 114 $8.66 $15.34 77.14%
Echelon Corporation (ELON) 165 $5.99 $12.82 114.02%
First Solar Inc (FSLR) 9 $105.74 $150.62 42.44%
South Jersey Industries (SJI) 28* $35.11* $34.83 -0.80%
American Superconductor (AMSC) 23 $13.46 $29.73 120.88%
Total   $4975.30 $8,394.90 71.10%

*Dividend adjusted.

Mutual Fund Portfolio

Mutual Fund Shares Price 2/27/09 Close 9/24/09 % Change
CGAEX (Calvert) 122.19 $6.82 $10.29 51%
ALTEX (First Hand) 171.47 $4.86 $7.20 48%
GAAEX (Guinness Atkinson) 205.76 $4.05 $6.49 60%
NALFX (New Alternatives) 29.75 $26.68 $41.51 56%
WGGFX (Winslow Green Growth) 111.71 $7.46 $12.28 65%
Total   $4999.98 $7,794.71 56%

The Other Three Quarters

Since I did the first update, I've come up with three hypotheses to explain the phenomenon:

  1. Higher Beta: The stocks I picked may be more sensitive to market moves than the mutual funds as a whole.  Since the market has been rising, the "Winner" and "Loser" portfolios have been rising more.
  2. Cleantech sectors: My picks put more emphasis on certain Cleantech sectors than do the funds; perhaps the overweight sectors have driven the out-performance.
  3. Mutual Fund Manager skill: The mutual fund managers are likely to hold more of their favorite stocks than they hold of other stocks.  If they each have a few good ideas, then I am taking advantage of those good ideas by selecting my portfolios from the mangers' top five holding.  The high diversification of the mutual funds keeps mutual fund shareholders from fully benefiting from their managers' skill.

Below, I've graphed the performance of the "Winner" and "Loser" portfolios against several possible benchmarks: the blended performance of the mutual funds, the S&P 500 index, and five green energy ETFs (ICLN, QCLN, PBW, PBD, and GEX.)  Since the ETFs each track a difference index for the Cleantech sector, it's reasonable to assume that they represent the performance of the average Cleantech stock.


This promises to be a fairly long investigation, so I plan to break it up into a series that I'll publish over the next few days.  I'll add links to the articles here as I publish them.  The first one, in which I look into my "Higher Beta" hypothesis, will be published here shortly.

It could turn out that none of my hypotheses explain the out-performance we've seen.  In that case, it could be luck, or it could be something I have not thought of.  

Easy Green Money... Too Good to be True?

I'm hoping that I find some evidence for mutual fund manager skill.  To do that, I'll need to eliminate the other possibilities. If I can, we can expect this method to produce out-performance in the future, and under any market condition.  In other words, my attempt at a tracking portfolio might just be a better way to play green stocks.  An easy way to play green energy, without having to pay high fees?  It sounds to good to be true, but in the wild west of green energy investing, in might last for a year or two.

What do you think?  Is there  something else I should investigate?  If so, please leave your suggestion in the comments.

DISCLOSURE: Tom Konrad and/or his clients own LXU, ELON, and AMSC. The Guinness Atkinson Fund is an advertiser on his website, AltEnergyStocks.com

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.


September 27, 2009

Who You Are

Results from our survey of readers.

Thanks to everyone who participated in our reader survey last week.  Our randomly selected winner has been notified by email, and the book has been mailed.  

Most valuable to us were the comments, and we appreciate the overwhelming encouragement from the vast majority of commenters.  But we're realistic enough to know we can always improve the reader experience.

What You Said

Here are a few ideas I plan to act on:

  • Tom, the stocks that you cover range from solid established companies, to pie in the sky speculative ones. I think it's important to make those distinctions clear to your readers, like J P does.
  • Tom could tell us even more often when he sells a stock or changes his opinion of one he has endorsed here in the past. (For this, readers should follow us on Twitter. I don't always have time to post an article, but I'll try to put some more alerts on Twitter.)
  • A request - please do not start to charge for this service. (We don't have any plans to charge.  Rather, we are looking for ideas to attract more readers and advertisers.)
  • More info about stocks to avoid and why. (See Thursday's article on shorting the least green large companies.)

And here are a few things we're discussing as a team:

  • More support for entry level investors (maybe a glossary of terms, or a quick guide to how and where to look for relevant company information, etc)
  • it […] would be useful to have sector by sector analyses or a section on the technology behind each sector
  • Being a beginning level investor, I sometimes am overwhelmed with the wealth of knowledge here. Sometimes a bit more simplification or layman's terms would help. 
  • Maybe a chart showing RE/EE stock performance over long periods.

We will not be able to implement all these quickly, but we hope you like what you see as we make changes over time.

Topics and Authors

We also understand from your comments that some readers would prefer if particular writers covered a wider range of topics, or feel that those writers have little useful left to say on a particular subject.  We hope that the author's name in italics at the beginning of the article, along with the title of the article, will allow readers sufficient information to skip such topics and/or authors altogether.



We asked several questions about you, and we're pleased to know you're a well educated, financially savvy group.  You're also somewhat more mature than the standard internet crowd; I was surprised that we didn't get any responses from readers under 21.  That's perhaps a bit early to start worrying about stock market investments, but I thought we might have a few young readers because they almost universally understand the need to tackle climate change.



AltEnergyStocks.com readers are also very well educated, with a majority having at least a college education.  A good 10% of our readers also have investment management credentials, either a securities license or one of the well-recognized investment professional designations.


I consider it a mark of distinction that both individual investors and professional money managers find the site useful, including the 10% who manage over $1 million, with a few in the tens and hundreds of millions.  

roles.GIF assets.GIF

A few respondents claimed to manage over $500 million, but I threw these in with the "no response" answers because 1) they all claimed to only manage money for themselves and 2) they actually gave us their contact information.  This seemed more characteristic of a reader with a sense of humor than a reader who might make it onto a "rich" list.

The other responses above $50M all came from people who manage money professionally.

Use of Your Information

A few readers were concerned about how we might use the mailing and email addresses we collected.  Our intent was only to use those for the contest, and to follow up with readers on their comments as necessary.  One reader suggested that we only collect emails, and ask the winner of the book for a mailing address after we had determined the winner.  This is a good suggestion, and we intend to follow that procedure in the future.

Once again, thanks for your time.  We're still getting a few responses trickling in even though PollDaddy said they'd only give us 100 responses, so please give it a try if you'd like to give us some feedback or add your numbers to the statistical stew.

Tom Konrad, and the AltEnergyStocks.com Team

September 25, 2009

Battery Investing For Beginners

John Petersen

I've been blogging about the energy storage sector since last July because batteries, single purpose devices that most of us take for granted unless they need to be recharged or replaced, are an essential enabling technology for cleantech, the sixth industrial revolution. With this week's impressive launch of A123 Systems (AONE), the tsunami of investor interest I've been predicting since last fall has finally arrived. Since the A123 Systems IPO has introduced an entirely new class of investors to the energy storage sector, this seems like a particularly good time to go back to square one and explain how energy storage is different from other technology classes. Since I've already written extensively on most of these issues, this article is full of hyperlinks to earlier blogs.

Energy storage is a diverse industrial sector that encompasses a variety of mechanical, electrochemical and electrostatic devices and eighteen pure play public companies that range from well known to unknown. Since some of my earlier blogs came across as fairly harsh, I'd like to make it clear from the outset that I believe there is tremendous long-term potential in every energy storage technology. While I've turned some readers off through my outspoken criticism of wasteful planned uses for extraordinary storage devices and my general disdain for companies that let their stories outrun their business fundamentals, reader comments on my blogs are usually extensive and a well-informed group of regular commenters adds a balance and perspective that I could never achieve on my own. So if you have questions please ask. If I don't know the answer there's a good chance one of my readers will.

Over the last year, I've spent uncounted hours blogging, responding to reader comments and trying to debunk some of the more common misconceptions about energy storage. Those efforts ultimately lead me to a four-sided analytical framework that I believe every energy storage investor needs to understand. The four sides of the framework are:
  1. Batteries rely on chemistry, rather than physics, so the rapid rates of change we've come to expect from information technology and electronics will be rare in the battery industry. Moore's Law simply does not apply. It's perfectly reasonable to assume that battery technologies will continue to improve at single digit annual rates, but expecting disruptive changes that result in huge cost reductions or performance gains is unreasonable.
  2. The battery business is hard-core manufacturing and revenue growth will be tied to the construction of new factories, a process that requires substantial amounts of time and money. Accordingly, the time lag between a new product announcement and the receipt of substantial revenue from product sales will typically be measured in months or years, rather than weeks. Moreover, revenues will tend to stair-step as new factories come on line instead of following a smooth upward trend.
  3. Battery manufacturing requires huge amounts of raw materials that typically account for 70% to  80% of total production costs. So while material constraints have not been major issues in many new industries, they can be important issues for batteries that are based on scarce or expensive raw materials.
  4. The cleantech revolution will be unlike anything that's gone before. For the first time in human history we live in a world where six billion people know about the lifestyle that 600 million of us take for granted. Since they know there is more to life than bare subsistence, each of them is working very hard to earn a small piece of the dream. The only way to accommodate six billion new consumers without catastrophic conflict or horrendous environmental damage is to find relevant scale solutions to chronic shortages of food, water, energy and every commodity you can imagine. The first, and perhaps the most important, step down that path is the minimization of waste in all its pernicious forms.
Investors who learn these framework principles and rigorously adhere to sound discipline can prosper in the energy storage sector. Investors who ignore the framework principles and go off chasing rainbows do so at their peril.

Last fall I wrote an article titled "Alternative Energy Storage: Lithium, Lead or Both?" It remains a personal favorite because it explains a number of important energy storage concepts in simple terms, discusses the history of the battery industry, explains the economic and technical drivers that brought the industry to where it is today, and explains why I believe that:
  • Commercial and industrial energy storage decisions will always be based on detailed studies that carefully weigh the fully loaded cost of storage against the value of the stored energy;
  • Consumer energy storage decisions will be very sensitive to both front-end costs and back-end energy savings;
  • There is no silver bullet technical solution to the energy storage problem and our clean energy future will require the use of several different storage technologies; and
  • The prize will ultimately be shared by dozens of companies instead of being concentrated in one or two.
Like many commenters, I'm not excited about PHEVs and EVs, but the reasons for my cynicism go beyond the commonly cited issues of high-cost, uncertain reliability and unknown consumer demand. I'm an unrepentant critic of cars with plugs because they waste battery capacity; an expensive resource that I believe will become increasingly precious over the next three to five years. The popular Prius from Toyota (TM) uses 1.5 kWh of battery capacity to slash fuel consumption by roughly 40%. The planned GM Volt will use its much larger battery capacity far less efficiently. If the goal is to reduce dependence on imported oil, we're far better off using our available battery production to build large numbers of Prius class HEVs that cost $22,000 each than we would be using the same battery production to build a far smaller number of Volt class PHEVs that cost $40,000 each. If the goal is to reduce C02 emissions, the contrast is even bleaker because most of the electricity that goes into a Volt class PHEVs will come from coal and natural gas fired power plants for the foreseeable future.

According to Frost & Sullivan, the global lithium-ion battery market was roughly $7 billion in 2008, including $5.5 billion for consumer products, $1.5 billion for industrial products and $28 million for transportation. While a number of new lithium-ion battery plants are planned, some of them won't be built and those that are built won't go into production for another couple of years. Since the NiMH batteries that are currently used in most HEVs are severely resource constrained and demand for all classes of HEVs is expected to skyrocket over the next five years in response to aggressive European CO2 emission standards and accelerated U.S. CAFE standards, I have no doubt that every lithium-ion battery manufacturer with an operating factory and a quality product will have more customer demand than it can possibly satisfy. I also expect the emergence of more robust lithium-ion batteries to create entirely new classes of demand that we don't even recognize today.

On balance my sense is that A123 is probably trading at or near a reasonable value given its financial condition and short- to medium-term revenue prospects. I'm not as sanguine about the market valuations of some of the other domestic lithium-ion battery developers because their financial position is far weaker and they've let their stories and stock prices get ahead of business fundamentals. As a result, I don't see a tremendous amount of short-term upside potential in the lithium-ion subgroup.

Notwithstanding my neutral outlook for the lithium-ion subgroup, I continue to believe that the lead-acid subgroup including Enersys (ENS), Exide Technologies (XIDE), C&D Technologies (CHP) and Axion Power International (AXPW.OB) have significant short-term upside potential because lead-acid batteries have been unfairly criticized by lithium-ion battery developers for years and the companies that make them have been largely ignored by a market that's obsessed with searching for the next big thing. Over the next few years, revenue growth in the lead-acid subgroup should outpace revenue growth in the lithium-ion subgroup by a wide margin. Moreover, the companies in the lead-acid subgroup all trade at substantial discounts to their flashier cousins. When I was much younger, a wise old stockbroker taught me that the secret to successful investing was to buy undervalued stocks, hold fairly valued stocks and sell overvalued stocks. Based on everything I know about the battery industry, I believe that cheap will continue to outperform cool over the next year the same way it has since last November.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a large long position in its stock. He also holds small long positions in Enersys (ENS) and Exide Technologies (XIDE).

September 24, 2009

Shorting The Least Green Companies

Newsweek recently released its 2009 Green Rankings for America's 500 largest corporations.  Investors would do well to examine the bottom of the list, as well as the top.

DISCLOSURE: Tom Konrad and/or his clients have short positions in DAL.

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.

Climate Change & Corporate Disclosure: Should Investors Care?

Charles Morand

On Monday morning, I received an e-copy of a new research note by BofA Merrill Lynch arguing that disclosure by publicly-listed companies on the issue of climate change was becoming increasingly "important". The note claimed: "[w]e believe smart investors and companies [...] will recognize the edge they can gain by understanding low carbon trends." I couldn't agree more with that statement.

It was no coincidence that on that same day the Carbon Disclosure Project (CDP), a non-profit UK-based organization that surveys public companies each year on the state of their climate change awareness, was releasing its latest report at event organized by BofA/ML in NYC.

I am fairly familiar with the CDP, having worked on one of the reports in 2006. In a nutshell, the CDP sends companies a questionnaire covering various topics such as greenhouse gas (GHG) emissions, programs to manage the identified risks of climate change, etc. (you can view a copy of the latest questionnaire here). The responses are then aggregated and made into a publicly-available report.

The CDP purportedly sends the questionnaire on behalf of institutional investors who are asked to sign on to the initiative but have no other obligation. The CDP currently claims to represent 475 institutional investors worth a collective $55 trillion. Not bad!

Putting Your Money Where Your Signature Is?

Despite their best efforts, initiatives like the CDP or the US-based CERES are mostly inconsequential when it comes to where investment dollars ultimately flow. Investors are asked to sign on but are not required to take any further action, such as committing a percentage of assets under management to low-carbon technologies or avoiding investments in companies with poor disclosure or that deny the existence of climate change altogether.

Case in point, the latest Global Trends in Sustainable Energy Investment report found that, in 2008, worldwide investments in "sustainable energy" totaled $155 billion. That's about 0.28% of the $55 trillion in assets under management represented by CDP signatories. A mere 1% commitment annually, or $550 billion for 2008, would substantially accelerate the de-carbonization of our energy supply, probably shrinking the time lines;we're currently looking at in several industries to years rather than decades.  

And that's ok. By-and-large, investors are investors and activists are activists. In certain cases, investors can be activists, either from the left side of the political spectrum with socially-responsible funds or from the right side with products like the Congressional Effect Fund. But overall, most sensible people want investors to be investors.

That's because the function that investors serve by being investors rather than activists is a critical one in a capitalist system - they force discipline and performance on firms and their management teams. By having to compete for capital with other firms in other sectors, clean energy companies have an incentive to crank out better technologies at a lower cost, and that process will have positive implications for all of society in the long run.

The problem with the CDP is that it's really an activist organization parading as an investor group. If the Sierra Club were to go around and ask Fortune 500 companies if they wanted to be hailed as environmental leaders in a glossy new report with absolutely no strings attached, I bet you anything they would get 475 signatures in a matter of days. And so it goes for CDP signatories - institutional investors the world over get to claim that climate change keeps them up at night while not having to deploy a single dime or alter their asset allocation strategies.

Approaching Climate Change Like An Investor

Someone approaching climate change like an investor - that is, as a potential source of investment outperformance (long) or underperformance (short or avoided) - isn't likely to care for activist campaigns aimed at forcing large corporates to disclose information on the matter; in fact, they may prefer less public disclosure to more.

That is because one of the greatest asset an investor can have is an informational advantage. In the case of climate change, those of us who believe that it's real and who think they can put money to work on that basis have a pretty good idea where to look and what to look for - we don't need the SEC to mandate disclosure. Those who think it's one giant hoax couldn't care less - they don't need the SEC to get involved, either. Yet this is where such campaigns are going, according to the BofA/ML report.

I like to think of climate change as an investment theme in terms of three main areas: (1) Physical, (2) Business, and (3) Regulatory. All three areas present investment risks and opportunities.

Opportunity Risk
Physical DESCRIPTION: Companies that stand to gain  from strengthening or repairing the physical infrastructure because of an increased incidence of extreme weather events or a changing climate. Examples include electric grid service companies such as CVTech Group (CVTPF.PK), Quanta Services Inc (PWR) and MasTec Inc. (MTZ)

: Medium-term   
DESCRIPTION: Companies that stand to be negatively impacted by more frequent and more powerful extreme weather events, or by a changing climate. Examples include ski resort operators, sea-side resort operators and property & casualty insurers.  

: Long-term
Business DESCRIPTION: Companies that provide technologies and solutions to help reduce the carbon footprint of various industries, be it power generation, transportation or the real estate industry. Renewable energy and energy efficiency are two obvious examples.

: Immediate     
DESCRIPTION: Companies that make products that increase humanity's carbon footprint and that could fall out of favor with consumers on that basis. Examples include car makers with a large strategic and product focus on SUVs and other needlessly large vehicles.

: Medium-term
Regulatory DESCRIPTION: Firms that have direct positive exposure to the regulatory the responses to climate change enacted by governments. Examples include firms that operate exchanges or auction/trading platforms for carbon emission credits such as Climate Exchange PLC (CXCHY.PK)  and World Energy (XWES).

: Near-term
DESCRIPTION: Companies that are in the  regulatory line of fire for carbon emissions. Coal-intensive power utilities are a good example, as are other energy-intensive industries that might have a limited ability to pass costs on to consumers because of high demand elasticity or fierce competition.

: Near-term 

This categorization provides a high-level framework for thinking about what may be in store for investors as far as climate change goes. However, with the exception of Business/Opportunity and Regulatory/Opportunity, the investment case is not necessarily clear-cut and requires some thinking.

For instance, oil would seem like a perfect candidate for the Business/Risk category were it not for another major and more powerful price driver: peak oil. As for Regulatory/Risk, the European experience thus far has shown how open a cap-and-trade system is to political manipulation, and firms there have been able to withstand the regulatory shock more because of achievements on the lobbying side than on the operational side. That is why I have stressed in the past that understanding emissions trading was more about understanding the rules and the politics than about understanding the commodity.

Nevertheless, these trends are worth following for people who: 1) like investing and 2) think that climate change is not the greatest hoax ever perpetrated on the American people. For instance, CVTech Group (CVTPF.PK), a small Canadian electrical network services company, reported that in fiscal 2008 around 58% of its annual revenue increase (C$23.0 MM) was due unscheduled electricity infrastructure repairs as a result of hurricanes in Texas, Louisiana, North Carolina and South Carolina. In the annual report, management noted: "Since 2005, an increase in the occurrence of hurricanes has resulted in growing demand for our services in these states."


I have nothing against the concept of activist organizations going after corporations with various demands, be they influenced by left- or right-wing thinking; after all, we live in a free, open society and it's everyone's right to do so within the confines of the law.

What I don't like quite as much is hypocrisy and greenwashing. As far as I go, if an institutional investor truly believes that climate change can be a worthwhile investment theme, they should put a couple of analysts on it and figure out how to put money to work. If they don't believe that it is, then they should just go on doing what they do best: manage money.

What they shouldn't do is pretend to see an investment risk or opportunity where they really don't just to appease a handful of vocal stakeholders. Lobbying to get the SEC to force disclosure on climate change is nothing more than window dressing; investors who think this is real already know where to look and what to look for and - surprise, surprise - it's not rocket science!


Congratulating A123 Systems On Its Very Successful IPO

John Petersen

This morning Reuters is reporting that A123 Systems, Inc. (AONE) increased the number of shares offered in its IPO from 25 million to 28.1 million and sold those shares at a price of $13.50. If the underwriters exercise their overallotment option, which is usually the case in IPOs of this size, the total IPO proceeds will be $437.5 million before costs, commissions and discounts. This IPO has been a long time coming but it was worth the wait. I want to congratulate the A123 team and the underwriters on a job well done.

Assuming full exercise of the underwriter's overallotment option, A123 will have 104.1 million shares outstanding and carry a market capitalization of $1.4 billion. The offering proceeds, together with its pre-offering cash reserves of $115 million should leave A123 with enough liquidity to finance the continued development of its technology and provide roughly $310 million in matching funds for its ARRA battery grants and its anticipated ATVM loan. Now it's all in the hands of management to implement their strategic plans and bring an important product to market.

I’ve been writing about the energy storage sector for over a year. I believe energy storage will be a fundamental enabling technology for cleantech, the sixth industrial revolution and a major investment theme for the next 20 to 30 years. I’ve written about an emerging consensus that sales in the energy storage sector will grow from $30 billion to well over $100 billion by 2020. I’ve also written about a variety of technologies and companies that will benefit from explosive growth in the sector.

The challenges facing the energy storage sector are enormous, but so are the opportunities. I see an energy storage future where the developers of every technology we know about and many that we don't know about will have far more business than they can possibly handle. It will be great to have a bright line standard like A123 Systems that investors can use to evaluate the relative merits and risks of both established energy storage device manufacturers and emerging developers of new technologies. I look forward to adding A123 Systems to my list of pure play energy storage companies and covering its progress in detail.


September 22, 2009

A123 Increases IPO Price Range

John Petersen

This morning, A123 Systems Inc. (AONE) amended its registration statement to increase the price range for its proposed IPO to $10.00 to $11.50. I take this as an indicator that their IPO road show has been well received and the offering will go to market in a timely manner.

While I've avoided commenting on A123's prospectus, business or financing plans, there is one point that deserves some attention. Their prospectus summary says:

According to A.T. Kearney, the global lithium-ion battery market for automotive application in HEVs, PHEVs, and EVs is estimated to be $31.9 million in 2009. A.T. Kearney projects that this market will grow to approximately $21.8 billion by 2015 and $74.1 billion by 2020, based on a moderate drive for change influenced by increasing governmental regulation, emerging powertrain technology, changing consumer demand and OEM product strategies toward more fuel efficient vehicles.

After spending several weeks thinking about that statement, it finally dawned on me that the only way to reconcile A123's market size forecast with its anticipated product cost was with an assumption that lithium-ion batteries would completely displace lead-acid batteries in the automotive market over the next 10 years. With that assumption as a given, a battery cost of $750 per vehicle and a 100 million vehicle per year market would actually work out to about $75 billion in potential battery sales.

While I wish A123 well and hope its offering is very successful, I feel compelled to point out that the lead-acid battery industry is not likely to take such a challenge lying down. As long-term readers know, I believe the new PbC battery that Axion Power International (AXPW.OB) plans to commercialize in cooperation with Exide Technologies (XIDE), together with other emerging lead-carbon battery solutions, are likely to dominate the stop-start and mild hybrid markets because they will offer comparable performance in stop-start and mild hybrids for one third of the cost of lithium-ion.

In the real world of paychecks and budgets, cost is important and the choice of technology always obeys the laws of economic gravity.

Upgrading from a $150 valve regulated lead-acid battery to a $250 PbC battery is not likely to give rise to substantial resistance from automakers who are actively seeking a more robust and reliable battery technology that will stand up to the demands of stop-start applications.

Upgrading from a $150 valve regulated lead-acid battery to a $750 lithium ion battery is a different story altogether, particularly when none of the automakers has any history using lithium-ion batteries which have a less than stellar track record under the harsh operating conditions that have made lead-acid batteries the technology of choice for automotive starting, lighting and ignition worldwide.

In a way it's comforting to know that like me, A123 believes that stop-start systems and other mild hybrid technologies will become standard equipment over the next decade. I still think it's far too early to claim victory in a technology race that hasn't been called to the starting gates. Under the circumstances, I think A123 investors might want to take a hard look at the emerging lead-carbon battery technologies and consider hedging their bets.

Disclosure: Author has a large long position in Axion Power International (AXPW.OB) and a small long position in Exide Technologies (XIDE).

September 21, 2009

Forestry Stocks and ETFs: The Back Door to Cellulosic Biofuels Investing

ETF % Producers Expense Ratio Daily volume Close 9/17/09
WOOD 60% 0.49% 10K $36.66
CUT 40% 0.65% 70K $17.41

Even given my cursory analysis of each fund's holdings, WOOD stands out as clearly superior to CUT for investors interested in a Forestry ETF as an investment in Biomass, because of the significantly higher exposure to producers than consumers.  CUT does have better liquidity, but that hardly makes up for the lower expense ratio of WOOD, and high exposure to wood consumers.


Even the 60% exposure of WOOD to biomass producers is not enough so that I think these funds are a good way to invest in the sector.  It would be theoretically possible to get exposure just to producers by going long WOOD and shorting CUT, but such theories tend to work a lot better in theory than in practice.

Hence, I feel the best approach to get exposure to wood producers is with individual stocks.  Most of the holdings of these two funds are international, but there are still a few  US-listed ones.  With the caveat that I have not researched any of these companies, here are the US-traded holdings of the two funds that seem to be mostly wood and pulp producers, as opposed to biomass consumers:

Company/Ticker % of WOOD % of CUT Notes
Aracruz Celulose S.A.(ARA) 4.73% 4.97% Brazilian wood pulp producer 
Plum Creek Timber Co. Inc. (PCL) 5.55% 2.24% US Timber REIT; in DJ Sustainability index
Potlatch Corp (PCH) 6.5% 1.35% US Timber REIT; Forests are FSC certified

While a portfolio of only three stocks is not very diversified, few investors are likely to commit more than 10% of their portfolio to forestry, and devoting 3% or less of your portfolio to a single company should bring adequate diversification.  The loss of global exposure (the ETFs contain several Japanese and European companies as well as US and Brazilian ones), but this loss seems worth avoiding significant exposure to an industry (paper and packaging) with a significant input (pulp) that we expect to become more expensive due to competing uses.


Just as farmers are now benefiting from higher corn and soy prices because of the production of ethanol and biodiesel, it seems fairly certain that timber companies will benefit from higher prices for both lumber and previously unused slash.  Nevertheless, there remains a question of when.  Cellulosic ethanol plants are still in the pilot stage, with not nearly enough being produced to make a difference to the forestry industry's revenue.  In contrast, cofiring wood and using it for heat are both established industries.  At the moment, however, these uses for wood tend to be driven by the prices of alternative fuels (coal and heating oil), and not by reduced carbon emissions. 

Although forest waste and sawdust can be practically free at the source, the cost of gathering and transport often means that they are nearly as expensive as the alternatives at the point of use.  In order for the industry to overcome the logistical barriers, a price on carbon emissions is probably necessary.  For US investors considering Plum Creek or Potlatch, it probably makes sense to wait until we see action from the US on climate change before investing.


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.

September 20, 2009

Book Review: Investment Opportunities for a Low Carbon World (Cleantech Indexes, Funds and ETFs)

Charles Morand

This is the third installment of my review of the book book "Investment Opportunities for a Low Carbon World". The second installment covered geothermal power and energy efficiency and the first installment covered wind and solar.

This post reviews three interrelated chapters on the world of cleantech and alt energy indices, funds and ETFs. Two of these three chapters are my favorite in the book so far -  they provide very useful information for the novice investor with an interest in alt energy investing but limited time and knowledge for successful stock picking. 

Cleantech and alt energy are challenging sectors to invest for several reasons: (1) pure-plays tend to be risky investments because substantial technology and business risks often exist; (2) when pure-plays are not so risky (i.e. wind power), stocks tend to trade at outrageous multiples, with several years of strong growth already fully priced in; (3) the stocks of non-pure plays with some exposure to alt energy trade, more often than not, based on what happens in other parts of the company, requiring investors to own businesses they might have little interest in or understanding of (e.g. General Electric (GE) and Siemens (S)).        

The alternative to equities is to invest in one of the alternative energy and cleantech ETFs (either long or short) or purchase one of the alt energy mutual funds. I generally believe the latter option to be less desirable than the former, mostly because of high expense ratios and other fees. ETFs, in my view, provide an excellent way for retail investors to gain exposure to the sector - although overpricing and volatility issues still exist, firm-level risk is eliminated and risk is spread over a large number of securities at a relatively low cost.

Measuring the Performance of Environmental Technology Companies

David Harris, FTSE Group

This chapter provides an introduction to cleantech and alt energy stock indices. Early on in the chapter, the author notes:

"Active managers claim they can identify those companies with above market average growth potential, but at this stage in the sector's evolution it is impossible to know which environmental technology companies will be the winners"

While I don't think this assessment applies equally to all sub-sectors of the environmental technology market, this statement still sums up relatively well the landscape for most retail investors and, as mentioned above, provides a strong argument for index-based investing.  

The chapter then moves on to provide a methodology for breaking down the environmental technology sector into sub-sectors, based on the approach used by FTSE in making its Environmental Technology Index Series. It then lists out the main environmental technology indices available and their key characteristics.

Overall, this is a useful chapter for investors in understanding how index makers approach the process of index creation. Since indices form the backbone of ETFs and are the single most critical determinant of ETFs' relative performance, this is a process worth understanding. However, the author could have provided more technical information to increase the chapter's usefulness to investors with an intermediate level of knowledge.

Investment Approaches and Products for Investors

Clare Brook, WHEB Asset Management

This chapter provides a review of the following investment vehicles: socially responsible (SRI)/ethical funds, cleantech mutual funds, private equity cleantech funds and environmental hedge funds.

We learn that the largest holdings in most ethical/SRI funds are often in industries unrelated to environmental tech such as financial services. That is because such funds, unlike cleantech and alt energy mutual funds, do not invest in anything specific - they merely avoid investing in companies and industries that violate pre-determined ethical standards. For cleantech investors, those funds are generally useless.

As far as real cleantech and alt energy mutual funds go, the author discusses the problem of over-valuation mentioned above - in her view, valuations often reflect more a scarcity of investment options in pure-play cleantech stocks than realistic expectations for future growth.

The criteria provided by the author to evaluate different investment options are the most part of this chapter. The one thing that the author stresses across different actively-managed investment products is the quality of the management team, its experience and its track record. I would tend to agree - if someone decides to invest in mutual funds, these factors should arguably weigh more than the expense ratio, as they help put the expense ratio into perspective.

Exchange Traded Funds as an Investment Approach

Lillian Goldthwaite, Friends Provident  

This chapter provides a detailed overview of ETFs and makes the case well for using them in a portfolio. I particularly liked this chapter.

According to the author, some of the main strengths of ETFs are: they are traded on exchanges and can be bought and sold (and priced) throughout the day; they can be sold short, bought on margin and loaned; the portfolio can be viewed in its entirety at all times and the index construction process is transparent; and the process by which institutional investors can acquire and redeem shares by trading in the stocks of companies in the index ensures that no sizable gap emerges between net asset value and portfolio value.

As with the previous chapter, the author provides a checklist of items to research when doing the due diligence on an ETF. The chapter concludes with a list of ETFs in cleantech and alt energy, but also in nuclear energy, carbon emissions, timber and water.

The author does not delve particularly deep into cleantech  per se, keeping the discussion focused instead on ETFs more generally. 

Overall, I found this chapter interesting and quite useful. As is the case with the preceding two, there is less to say about this chapter than there was about the ones on environmental technologies that I reviewed in the first couple of installments, mostly because these chapters are shorter.

The more seasoned investor is unlikely to learn much from this section of the book. But so it goes for such books in general; they are ideally suited for novice investors who want to get started investing into the sector and want a framework to approach the process.

For those interested in cleantech and alt energy ETFs, the following articles might be of interest:

General alt energy and cleantech 
Carbon emissions   


* We are always interested in reviewing books and reports in the areas of alternative energy, cleantech or other environmental industries, especially where they add value to the investment decision-making process. If your organization would like a new book or report reviewed, please contact us

September 17, 2009

Getting to Know AltEnergyStocks.com Readers

In order to improve AltEnergyStocks.com, we're trying to get to know our readers better. We've put together a short survey, and in order to make it worth your time to tell us about yourself and how we can improve the site, we're offering an incentive.  One respondent will win a copy of Investment Opportunities for a Low Carbon World, of which Charles has reviewed the Wind and Solar and Efficiency and Geothermal chapters so far.

Please take a few minutes to complete our short reader survey.


The AltEnergyStocks.com Team

Note: This contest will end when we reach our 100-response monthly quota on PollDaddy, which we expect to happen sometime on 9/20/09.  If you didn't get a chance to respond, we encourage you to leave your ideas for site improvement in the comments section, or you can return when our monthly quota is reset on 9/26/09.  Thanks to all of you who have responded; the winner will be announced soon.

September 16, 2009

Another Look at the Algonquin Power Income Fund

The Algonquin Power Income Fund (AGQNF.PK) has been one of my star performers in an excellent year.  Is it still a good investment at these prices?

 Since I recommended the Algonquin Power Income Fund (AGQNF.PK/APF-UN.TO) in January as a renewable energy income stock for 2009, the company is up 69%, in addition to the C$0.02 monthly dividend, worth approximately another 8% through August on the US$1.82 purchase price, making it the second-best performing of my ten picks (after Cree, Inc (CREE).)  However, since the major basis for my recommendation at the time was the stock's extremely cheap valuation and high yield, I thought it was worth revisiting, on the occasion of the company's Q2 update [pdf]


Major events in the first half  were Algonquin's planned acquisition of a 50% stake in California Pacific Electric Company (Calpeco), the former California assets of NV Energy (NVE), and the fund's plan to convert into a corporation and acquire some tax loss assets through a deal with Hydrogenics Corporation (HYGS).


The Calpeco deal gives Algonquin some exposure to electricity transmission and distribution (in which their partner Elmira has management expertise) in addition to their current exposure to renewable energy generation.  Since I like the potential opportunities in electricity transmission, I think this was a step in a good direction for Algonquin.  Furthermore, about half of Algonquin's stake in Calpeco will be financed with an equity investment in Algonquin from Elmira at C$3.25 per unit.  Since this is only slightly below the current price, and well above the price at which I recommended the stock, the transaction will be non-dilutive for both me and my readers, and a reasonable exchange for more recent investors.


In July, a reader worried that the deal with Hydrogenics was a bad idea because Hydrogenics is a fuel cell company, an alternative energy sector neither of us is enthusiastic about.  In fact, this is a short term deal, and shareholders need not be concerned with ending up owning a fuel cell company when they thought they owned a renewable energy power producer.  Despite the legal complexity, this deal is not a tie-up with Hydrogenics, but rather a way for Algonquin to acquire corporate status, and Hydrogenics' tax loss assets at the same time.  Because Algonquin is profitable, and Hydrogenics is not, these tax loss assets are valuable to Algonquin, but not Hydrogenics, allowing both companies to benefit. Algonquin will gain the benefit of Hydrogenics previous losses in exchange for a cash payment, which will allow the cash-poor, unprofitable company to continue operations. The transaction has been approved by Algonquin unitholders and Hydrogenics shareholders, and awaits regulatory approvals.


The Trust's first half revenue was down compared to 2008, which management attributes to lower natural gas prices.  Gas prices affect the trust's revenues through lower contract prices for the heat from their thermal generation units.  I find this to be a good sign, since I expect that low current natural gas prices will rebound because they do not provide sufficient incentive for natural gas companies to drill and replace the gas supply from depleting wells. Although I expect that low natural gas prices will depress revenues in the short term, Algonquin's operating cash flow and earnings should continue to be easily sufficient to fund distributions to unit holders with plenty left over to fund Algonquin's growth plans.

At current prices of C$3.32 for APF-UN.TO and US$3.07 for AGQNF.PK, with a yield of 7.2%, I consider Algonquin to be reasonably valued, and continue to hold my positions.  However, because I currently expect a market decline, I would only suggest buying Algonquin today if you also hedge your position against general market moves.

DISCLOSURE: Tom Konrad and/or his clients have long positions in AGQNF.

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.

September 14, 2009

Toyota Tests And Rejects Lithium-ion Batteries For The Prius

John Petersen

Over the last couple of years, the mainstream media has been awash in reports of how automakers are lining up to build fleets of PHEVs and EVs using lithium-ion batteries as a principal power source. I've consistently argued that investing in objectively expensive lithium-ion battery company shares on the basis of testing decisions was dangerous. The reason for my caution is simple, a decision to test a new concept is very different from a decision to commercialize a proven concept and failures in the preliminary testing stages are far more common than successes. In other words, automakers frequently spend a huge amount of money to test a new technology before deciding, "this simply doesn't work for us."

Yesterday and this morning we learned that after secretly testing a fleet of 126 Prius Hatchbacks with lithium-ion battery packs for three years, Toyota Motors (TM) has decided to stick with its tried and true nickel metal hydride, or NiMH, battery technology for the foreseeable future.

The first report appeared yesterday on hybridcars.com, one of the most authoritative sites on the Internet for hybrid car news. The second report appeared today on Bloomberg.com, one of the most authoritative financial sites on the Internet. Commenting on the Toyota tests, Menahem Anderman, president of Advanced Automotive Batteries said. "We now know that a lithium-ion battery can work; that's not really the question," he said. "Cost is critical, and we still don't know enough about long-term durability."

In a February 2009 article titled "DOE Report: Lithium-ion Batteries Are Not Ready For Prime Time" I noted that the DOE's 2008 Annual Progress Report for its Vehicle Technologies Program concluded that the technical barriers lithium-ion batteries would have to overcome before they'd be suitable for use in high-power applications like HEVs were:
  • Cost – The current cost of Li-based batteries is approximately a factor of two too high on a kW basis. The main cost drivers being addressed are the high cost of raw materials and materials processing, the cost of cell and module packaging, and manufacturing costs.
  • Performance – The barriers related to battery performance include a loss in discharge power at low temperatures and power fade over time and/or when cycled.
  • Abuse Tolerance – Many high-power batteries are not intrinsically tolerant to abusive conditions such as short circuits (including internal short circuits), overcharge, over-discharge, crush, or exposure to fire and/or other high-temperature environment.
  • Life – The calendar life target for hybrid systems (with conventional engines) is 15 years. Battery life goals were set to meet those targets. A cycle life goal of 300,000 cycles has been attained in laboratory tests. The 15-year calendar life is yet to be demonstrated. Although several mature electrochemistries have exhibited a 10-15 year life through accelerated aging, more accurate life prediction methods need to be developed.
My reading of Toyota's decision so stick with NiMH batteries for the Prius is that they were happy with the performance of the lithium-ion battery packs, unhappy with the battery pack cost and uncertain about the battery pack's long-term durability (e.g. abuse tolerance and life). I find it more than a bit telling that a 3-year, 126 unit test was not enough to satisfy Toyota that lithium-ion batteries would have a 10-year life.

Toyota's decision to stick with NiMH is not a death knell for lithium-ion batteries. Toyota still plans to build and test fleets of PHEVs and EVs using lithium-ion battery packs and most of the other automotive manufacturers will do exactly the same thing. It's all part of the normal product development cycle and entirely consistent with the process described in 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.

Toyota's decision does tell us, however, that it may be a long time before the major automakers have enough performance data to make a well-reasoned decision to commence large-scale commercialization of PHEVs and EVs. That day may indeed come, but it won't come without adequate testing. After all, automakers understand the meaning of the phrase "warranty repair costs" far better than most and there isn't a snowball's chance in hell that they'll assume warranty risks without adequate long-term testing.

I firmly believe that lithium-ion battery technology holds tremendous potential in the energy storage markets and that like most new technologies, the existence of new technical capabilities will give rise to new markets and new opportunities that we can't yet imagine. That being said, I think it's wasteful arrogance when the highest and best use people can imagine for a great technology like lithium-ion batteries is moving them and 3,000 pounds of steel to and from work.


Book Review: Investment Opportunities for a Low Carbon World (Geothermal + Efficiency)

Charles Morand

Last Thursday, I reviewed two chapters from the recently published book "Investment Opportunities for a Low Carbon World"*. This post reviews two more.

 Geothermal Energy

Alexander Richter, Glitnir Bank (now Íslandsbanki)

Geothermal is one of the most interesting forms of clean power generation there is. As noted by the author, the most convincing argument for geothermal electricity is the fact that it operates at capacity factors in the upper 90s. This makes it the only renewable technology suitable for baseload power with the exception of dam-based (i.e. large-scale) hydro.

However, as the chapter demonstrates, global potential is unevenly distributed, with Asia, North America and Latin America having around three to four times more potential than Europe, Africa and Oceania. Besides a brief review of the global picture, the book focuses largely on the US, which will most likely remain the most active market for a few more years (the US currently accounts for a third of global installed geothermal electric capacity).

The author does a good job of breaking the geothermal development business model into its main phases (exploration, pre-feasibility, feasibility and design & construction) and explaining the various types of capital flows required at each stage, as companies move from a mining exploration business model (exploration, pre-feasibility, feasibility) to a power generation utility model (design & construction). What's missing, however, is a discussion of the probability of project success at each stage, with risk typically culminating in the feasibility phase with important sums of cash being spent on exploration drilling with no guarantee that the resource will materialize.

The chapter's strength is undeniably its assessment of the current state of the US market. The author uses data from a number of different sources to show the future potential of the market. California is expected to lead the way with Nevada coming in second. Based on a database of where the overall pipeline of US projects was at at the end of 2008, the author estimates that several projects will reach the feasibility and design & construction phases in 2011 and 2012, which should lead to greater demand for capital by the industry.

The chapter also touches on direct use geothermal, although the discussion is far less detailed than that on geothermal electricity. This despite the fact that the author writes: "[t]he biggest potential and prospects for the shorter term are in the direct use of geothermal energy, particularly for heating and other applications that use heat directly."

As with the first two chapters I reviewed, I would have liked a few stock picks, and I believe a sub-section on opportunities in the equipment sector might have been interesting. However, this chapter fulfilled its purpose well; it provided a good introduction to the sector and can serve as reference material for later on. The US data was also very useful.

Energy Efficiency as an Investment Theme

Zoë Knight, Cheviot Asset Management

Energy efficiency is the most straightforward way of cleaning up our electricity supply and, given the right incentives, could also be the cheapest one (up to a point, as efficiency investments eventually run into diminishing marginal returns). We learn that in 16 IEA countries with strong efficiency profiles, efficiency measures resulted in aggregate savings worth US$180 billion in 2005 - not bad!

Incentives is thus exactly what a large part of this chapter focuses on. The author provides a thorough review of European policies and US efficiency targets outlined by the Obama administration to date. In both cases, it appears evident now that a trend toward greater energy efficiency incentives and regulations is well underway.

The author also provides a breakdown of global fuel consumption by category and identifies sectoral investment opportunities that could arise in each category. On the manufacturing side, the greatest opportunities are in machine drives (refrigeration, fans, pumps, compressors and materials processing). For households, hot water and central heating are key areas. 

However, as with other chapters I've reviewed so far, there are no specific stock picks. I did learn, however, that Merrill Lynch created an energy efficiency equity index. However, because all substantive info on the index seems to be accessible only to clients, this won't help retail investors much.

I found the review of US and EU policies very useful, but would have appreciated a greater focus on some of the main technologies that are currently commercially available (with the exception of LED lighting which is well covered), as well as some stock picks.

The author makes the following useful point about large companies with exposure to efficiency (most of the opportunities currently available to investors in this area are large conglomerates): "investors need to identify whether the theme is a large enough driver to warrant stock selection or whether there may be other factors that will drive valuation of the stock [...], outweighing the positive structural drivers from increased investment at a government level into energy efficiency. As with any equity investment, positive long-term structural drivers may differ from short-term trading cyclicality."


* We are always interested in reviewing books and reports in the areas of alternative energy, cleantech or other environmental industries, especially where they add value to the investment decision-making process. If your organization would like a new book or report reviewed, please
contact us

September 10, 2009

Book Review: Investment Opportunities for a Low Carbon World (Wind + Solar)

Charles Morand

Tom and I recently received complimentary copies of a new book called "Investment Opportunities for a Low Carbon World", edited FTSE Group's Director of Responsible Investment Will Oulton*. 

Sep 10-09 book review.bmp

The book is a compendium of articles by 31 different authors broken down into three main categories: (1) environmental and low-carbon technologies; (2) investment approaches, products and markets; and (3) regulation, incentives, investor and company case studies.

While Tom will provide a comprehensive review of the book once he's finished reading it in its entirety, I will instead review a few selected chapters over the course of the next couple of weeks.

I decided on this approach as that is how I generally use such a resource; I select the chapters and authors that I am interested in and I read only what I selected. That said, the majority of chapters in this book were of interest to me and I ended up selecting 19 out of 27 that I'm going to read (I won't be reviewing them all!) Truth be told, reviewing the contents section made me feel like a kid in a candy store and I suspect that most alt energy investing aficionados would feel the same. If I like what I read, I will most likely finish the book.    

This first post provides reviews of Chapters 1 and 2 on the wind and solar sectors.

Wind Power

By Mark Thompson, Tiptree Investments ltd

I tend to consider myself pretty well-versed in all things wind power, and so I was especially eager to read this chapter. Overall, I was very pleasantly surprised.

The author provides a good review of the wind turbine and wind turbine component industries. I especially enjoyed the technical discussion on turbine size and optimizing turbine output, which will become a critical competitive element for turbine makers.

For instance, we learn that because of the relationship between diameter and surface area for a circle, the power of one machine can be increased to match that of several smaller machines by simply lengthening the blades, thus lowering requirements for a range of other components and materials (for instance, two turbines with rotor diameters of 40 meters will have a power output of about 1000 kW, whereas one turbine with a rotor diameter of 80 meters can power 2500 kW.) Because of the mathematics of this, power output increases acheived through longer blades should further improve the economics of wind, so this is definitely a trend worth keeping an eye on.  

We also learn that while the turbine market has been chronically under supplied for the past few years, conferring the incumbents an appreciable amount of market power - the author estimates that the top six makers hold a combined 84% market share -, barriers to entry remain high and very difficult to surmount for would-be suppliers. Concerns over quality, durability, track-record and the strength of the balance sheet to support warranties are all factors that make it very difficult to secure funding for projects using a newcomer's technology. It is fair to say that Thompson is bearish on new market entrants.

Finally, we learn that the trend toward turbine makers internalizing sub-component design and manufacturing is restricting investment opportunities in pure-play supply chain opportunities.

However, what I enjoyed the most about this chapter was the detailed overview of how wind projects are built and what factors make them successful. When it comes to wind power, investment commentators tend to focus on turbines and turbine components, even though very interesting opportunities exist in the project development and operation space. In the author's words: "the development process offers some of the best returns in the sector [...]."

One key point made by the author in that regard is that headline figures about the size of various developers' portfolios are rarely - if ever - comparable given the various developments stages involved in bringing a project into operation. The risk-return profile for pure-play wind power developers is far more driven by the quality of the projects than by the size of the portfolio. However, disclosure tends to be weak in that regard, making it difficult for small investors to gauge the real value of a portfolio.

Overall, I thoroughly enjoyed this chapter. In my view, the information would be most useful to a fundamentally-driven investor looking to really understand how wind power and the wind power industry really work. While the chapter does not answer every question an investor might have, it nonetheless provides the right balance of technical and business information to set someone on the right path. It is a reference to which I will go back.  

Those looking primarily for stock picks, however, will be disappointed. The lack of stock picks is probably the chapter's weakest point, especially given that the book is purportedly about investment opportunities. Having said that, investment ideas abound on the Internet these days and books focused too heavily on providing stock picks at the expense of more general information risk having very short shelf-lives.

Solar Power          

By Matthias Fawer, Bank Sarasin

Writing a book or a book chapter on solar power, especially solar PV, is always a risky endeavor as the information could be outdated 12 months after publication. I thus salute the effort of those who undertake to do it, but in my view this sector is best left to specialist consultancies and sell-side analysts because they can easily update their analysis when conditions change, something that happens frequently in the world of solar PV.

Matthias Fawer's chapter does, in a lot of ways, read like a sell-side report. It covers three broad sub-sectors of solar: (1) solar photovoltaic; (b) solar thermal; and (c) solar collectors. Other than for solar thermal, the way in which the chapter is written assumes the reader already has a fair bit of solar knowledge. For instance, unlike your typical generalist piece on solar PV, few if any details are provided on what the main solar PV cell technologies are, how they compare in terms of price and performance and which company makes them.

The advantage of this approach is that it allows the author to jump straight into industry-level dynamics and not waste precious space explaining what many people already know. For instance, we learn fairly early on that Bank Sarasin sees silicon cell production appreciably outpacing module production until about 2012, potentially providing module makers with a margin expansion opportunity. We also learn that the plant engineering firms that had done so well when every cell manufacturer and their grandmother was adding production capacity during 2007 and 2008 could underperform in the next few years.

Of course the drawback from not providing a lot of technical background is that it makes the chapter a lot less useful for the novice solar investor, or even for the investor who knows a little bit but does not follow the industry closely. The author does, however, provide a ranking of the "strategic positioning" of 27 solar PV firms based on a proprietary model, with his top pick being Q-Cells (QCLSF.PK) from Germany.

The section on solar thermal, also known as concentrating solar power (CSP), contains more basic information on the technology, and provides an overall very good introduction to the sector. Unfortunately, there is a dearth of CSP investment options, and this sector is thus effectively off-limit to most retail investors.

The section I liked the most in the chapter was the one on solar collectors for building and water heating, an industry I knew about but had never researched. I learned, much to my amazement, that by the end of 2008 there was 142 GW of solar collector capacity installed worldwide, versus 12 GW of solar PV and 1.3 GW of CSP.

China is by far the largest market for solar collectors and, unlike in other industries, it absorbs, according to the author, 90% of its own production. Fawer expects annual growth to be about 25% until 2011 and to settle at 18% between 2011 and 2020. However, the much larger installed base currently means that the absolute level of new installations could be quite massive. Although the section on solar collector does not provide stock picks, it most definitely poked my interest and convinced me to look further into this.

Overall, while I was a bit underwhelmed by the solar PV section, I found the CSP section useful and the section on solar collectors very interesting. A greater technical focus would have strengthened the chapter given how technologically complex solar is, and more stock picks would have been appreciated. However, I will definitely go back to the chapter when I do research on solar collectors and even CSP.


* We are always interested in reviewing books and reports in the areas of alternative energy, cleantech or other environmental industries, especially where they add value to the investment decision-making process. If your organization would like a new book or report reviewed, please contact us    

September 09, 2009

A123 Systems Files Price Range Amendment

John Petersen

This morning A123 Systems filed another registration statement amendment for its planned IPO. The amendment specifies a preliminary price range of $8.00 to $9.50 and a preliminary offering size of 25 million shares (28.85 million shares with over-allotment option). Amendments like today's filing occur during the late stages of an IPO and it's not unusual to see the price range or offering size increase in later filings.

Both of the preliminary values are about half of what I expected. The price range surprises me because of its rough parity with the $9.20 per share price A123 received in its last private placement. The offering size surprises me because A123 needs to raise significant working capital; needs to raise $250 million in matching funds for the ARRA battery grants it was awarded last month; and needs to raise up to $60 million in matching funds for DOE guaranteed loans it expects to qualify for. If the A123 IPO goes off in the preliminary ranges, it will have an initial market capitalization of $800 to $950 million.

I have to assume that the initial share price and offering size estimates were fixed at conservative levels because of weak conditions in the IPO market over the last year and uncertain current conditions in the broader market. I sincerely hope that the road show surpasses everyone's expectations. I've been waiting for the A123 IPO since the summer of 2008 and believe that a successful offering will draw attention to the energy storage sector in a way that no other event can.

Storage sector investors who want to better understand the impact a significant IPO can have on a sector should read Zachary Scheidt's recent Seeking Alpha article, The Stage is Set for an IPO Rebound. Another worthwhile recent article from Forbes.com that discusses the potential impact of the A123 IPO on the energy storage sector is "Battery IPO Could Recharge New Issue Market."


September 08, 2009

The Black Swan and My Hedging Strategy

Nassim Nicholas Taleb's The Black Swan: The Impact of the Highly Improbable changed the way I trade; I can't give a book higher praise.  This isn't a book review; since the book is over two years old, and I did not get around to reading it until this Spring, I direct readers to this Foolish Book Review, which agrees with my viewpoint quite well, and to the New York Times for a detailed critique.  The latter seemed overly nit-picky to me, but then I'm a fan.

Human Biases

Recently, I've been writing that I expect a good sized market decline, and that I've been hedging my market exposure in response.  The Black Swan, however, is not so much about what we expect, but what we don't.  To massively oversimplify one of Taleb's major points, we (humans) tend to place too much weight on likely and easily imagined events, and not nearly enough weight on unlikely, difficult to imagine events.

In market terms, this should mean that we overvalue insurance against relatively likely, easy to envision events, and undervalue insurance against very unlikely, difficult to envision events.  Readers who have not already read the book can get some ideas of why we make these errors by reading the reviews referenced above, but you'll get a lot more out of it if you read the book itself.

For stocks and market indexes, it's generally more likely that the price will not change much than that it will change a lot.  In general, it's also easier to imagine a stock or market index returning to a value that it has reached recently or is at currently than rise or fall rapidly to something else.

In terms of financial options (which can be considered insurance against a stock's rise (calls) or fall (puts), this implies that options with strike prices near the current price or recent prices are likely to be over-priced, and options with strike prices that are quite far from the current or recent prices are likely to be under-priced.

That means that investors who are aware of this bias (which is unlikely to go away, because it is an artifact of human psychology) should prefer to sell options with strike prices near current or recent prices ("near the money") and buy options with strike prices that are far from recent or current values (far out of the money.)


I generally prefer to use options to hedge my positions because I find the margin requirements are less onerous.  Historically, I've reduced my exposure to the market by selling calls on index ETFs such as SPY, IWM and QQQQ.  For more detail, I wrote a longer post on five ways to hedge, and why I prefer selling calls.

 After reading the Black Swan, I've modified this slightly.  Now I

  • Sell calls that are just slightly in the money (according to the rationale above, these should be priced slightly too high, because they are insurance against likely events)
  • Buy an equal number of far out-of the money calls with the same duration at a considerably higher strike price.

This combination is known as a "call spread."   The calls I sell are much more valuable than the ones I buy, so this spread still loses value when the market rises, and gains value when the market falls.  The moves are not quite as large as they would be for just short calls, so I take slightly larger positions to achieve the same size hedge.

The advantage of hedging with this sort of spread is what happens when things go wrong.  The call spread can only produce finite losses when prices rise, while a short call can produce theoretically infinite losses.  Furthermore, the long out-of the money call position is likely to be underpriced (according to the theory above), which means that it should be an effective use of funds to buy this sort of protection.

The one problem with both short calls and short call spreads as hedging strategies is that they become less effective as the index falls.  If only a small correction is expected, this can actually be an advantage, because as the market falls, the portfolio's beta will naturally increase. 

If the market falls and a hedge is still desired, the downside protection can be enhanced by buying back the short call part of the spread, and selling a new batch of short calls at a strike price closer to the index's new value.

In Short

In other words, the main change in my hedging strategy in response to The Black Swan was the purchase of far out-of-the money calls on the same index I was using to hedge.  This does not have to be done as part of a short call spread; the same advantage arising from the under pricing of far out-of-the-money options can be exploited on its own, or as part of a short-based hedging strategy.

So far, my change in strategy has served me well, since the market has been going up when I expected it to head down.

DISCLOSURE: Tom Konrad and/or his clients have short positions in SPY, IWM, and QQQQ.

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.

September 07, 2009

Five Hedging Strategies for Stock Pickers

Instrument Advantages Disadvantages
Short & Ultrashort ETFs Can use in any brokerage account Sacrifice of upside potential, and loses money over time in volatile markets.
Sell Covered Calls on stocks in portfolio Makes money in flat markets Sacrifice of upside potential; hedge against small declines only.
Buy Puts on index or specific stocks No loss of upside; protects against large losses Works like insurance; has up-front cost.
Short the index Protects against full range of index declines Sacrifice of upside potential; must pay dividends
Sell naked calls on the index Makes money in flat markets Sacrifice of upside potential; limited downside protection.

I list buying Short and Ultrashort ETFs first because this is the option which is most easily available to all investors.  If you can buy stocks, you can buy Short or Ultrashort ETFs based on dozens of market indexes.  If the underlying index rises (falls) by 2% in a day, a corresponding Short ETF will fall (rises) by approximately 2%, and an Ultrashort ETF will fall (rise) by 4%.

Unfortunately, Short and Ultrashort ETFs (along with related leveraged ETFs) have a fatal flaw which makes them unsuitable for long term use.  When the underlying index is volatile, these instruments lose money over time due to the geometric nature of compounding.  To give an example, SH is a short ETF designed to produce the inverse of the S&P500 daily return.  The S&P500 closed on August 4 at 1005.65.  On September 3, it closed at 1003.24, a decline of 0.25%.  Over the same period, SH lost 0.1%, compared to the 0.25% gain you might expect.  Annualized, that's the equivalent of losing about 4.5%.

To show that this is the result of the underlying structure of SH, and not poor execution on the part of the ETF manager, we can see the same effect in a simple example.  Suppose on Tuesday the S&P500 were to go from 1000 to 1100 (a 10% gain), and then fall back to 1000 on Wednesday (a 9.1% decline.)  SH would fall 10% on Tuesday, and gain 9.1% on Wednesday, for a net loss of 0.90 x 1.091-1= -0.018 = -1.8%.  I go into more detail in my article on Ultra ETFs from February, but the result is that these instruments are not suitable for hedging.

Selling Covered Calls on the stocks in your portfolio requires the most basic level of options permission from your broker.  Given the very low risk of this options strategy, however, you do not have to have extensive knowledge or experience with options to get permission to sell (or "write") covered calls.  You can follow the link for a detailed how-to; I'll stick to the advantages and disadvantages of covered calls as a hedging strategy.  

There are two main advantages.  First, covered calls are tools which are reasonably available to most stock market investors with only the hour or so of work which is required to get low level options trading permission from your broker.  Previous options trading experience is unlikely to be necessary, and this is a good way to get options trading experience if your broker requires it in order to start using more sophisticated options strategies.

Second, you only need the market to not go up in order to be better off by selling covered calls.  Ideally, the market will be relatively stable, and you will not lose money on your stocks, but you will make gains on the calls you write.  

The disadvantages of covered calls are that your downside protection is fairly limited, usually to declines of 5-10%, while you give up all the potential of upside gains in the underlying stock.  This is a strategy I use with stocks that I don't think have much potential for outsized gains. Selling covered calls is an incomplete hedging strategy offering no protection against large market declines, and so I use it only in conjunction with at least one of the other strategies listed below.

Buying Puts is very much like buying insurance on your portfolio.  If you want to protect against large declines in specific stocks, you can buy puts allowing you to sell those stocks for a fixed price at a later date.  If you want to protect against a large decline of an index, you can buy puts on that index (or index ETF) which will settle for cash if the index falls below the strike price, or you can buy the ETF at the future reduced price, and sell it at the strike price for a profit, offsetting losses elsewhere in your portfolio.

The main advantages of buying puts are that they offer complete protection against declines past the strike price of your choosing, and there is no loss of upside potential in your portfolio. Puts are one-sided bets.  Like most one-sided bets, they come at a cost.  The insurance puts offer requires paying a premium, and that premium must be renewed when they reach their expiration date.  

Another advantage of buying puts is that it is only slightly harder to get options permission allowing you to buy puts than it is to get permission to sell covered calls.  The strategies which follow both can entail theoretically unlimited losses, and getting permission from your broker to use them is correspondingly more difficult.

Shorting the Index (or index ETF) is the classic way to hedge.  When the index goes up, you lose money on your short position, but your stock portfolio should be rising as well, insulating you from the market move.  When the index declines, the gains in your short position offset the expected losses elsewhere in your portfolio.

The main advantage of shorting the index is simplicity.  Unlike options strategies, you do not need to periodically renew your positions as options expire, or to adjust your exposure as the sensitivity of the options changes with market moves (more about this below).  The main disadvantages are that you will need to pay any dividends declared on the security you are shorting, and you generally do not earn interest on the cash retained in your margin account to cover the short position.  If the short moves against you, you may even have to come up with more cash to cover the short position, or begin paying margin interest.  This is in contrast to selling/writing calls, where you are able to earn interest (or even re-invest the cash received.)

Selling (Writing) Calls on the Index (or index ETF) is a hybrid between selling covered calls and shorting the index.  Unlike shorting, the balance which you need to maintain to cover the position will usually accrue interest, and you will also tend to make money on the premiums for which the calls were written if the index stays relatively flat.

This does have the disadvantage that there is little protection against declines in the index below the strike price of the call you sold.  However, you can sell calls with strike prices considerably below the current level of the index (although this comes at a cost of smaller gains when the index is flat.)  Another strategy is to continue selling more calls dynamically as the index declines, which works so long as the market does not decline so quickly that it is difficult to find call buyers at reasonable prices.

This has long been my primary hedging strategy, but I have recently shifted to a slightly more complex (if related) hedging strategy of selling short call spreads.  I will publish a short article about this strategy later this week, when you can find it at the previous link (which will be broken until then.)

How Much to Hedge

You now should know which market factor you want to hedge against, and which hedging instruments you plan to use.  It's theoretically possible to calculate the precise number of options or shares to use in your hedge in order to achieve a particular exposure.  The calculation depends on the variances and covariances of the various instruments and securities in your portfolio with the index and each other.  These statistics not only require considerable market data and number crunching to calculate, but they are prone to change over time and in different market conditions, making such calculations extremely complex and even unreliable in practice.  

Fortunately, there is a much simpler way to determine and refine the effectiveness of your hedge.  The only data you need is daily price date for the index you have chosen to hedge against, and the daily total value of your account.  The daily historical values of your account are not usually available from most brokers, so this requires logging in each evening and recording the account value.  Fortunately, the method still works if you miss a day here or there.

Set up a spreadsheet with columns as follows:

Date Index Acct Index Change Account Change Beta
A1 B1 C1      
A2 B2 C2 D2=B2/B1-1 E2=C2/C1-1  
... ... ... ... ...  
A3 B20 C20 D20=B20/B19-1 E20=C20/C19-1 =CORREL(D1:D20,E1:E20)*



A4 B21 C21 D21=B21/B20-1 E21=C21/C20-1 =CORREL(D2:D21,E2:E21)*




Once you have the first 20 rows filled in, you can just copy the final 3 columns from a previous row in order to continue the sequence.  Note that corrections will need to be made in the "Account Change" column if you take money out of or put money into your account.

The formula in the "Beta" column uses Microsoft Excel functions to calculate the Beta for your account relative to the index over the last 20 trading days (approximately 1 month).  In other words, for every 1% change in the index over the last 20 trading days, your account changed Beta percent.   A perfectly hedged account will have a Beta of 0. 

Below is a graph of Beta for my largest account for this year against three indexes: The S&P500, the Nasdaq, and the Dow Jones Total Stock Market index.  The magenta line shows the trend for the account itself, while the red line is a composite of those three indexes (click on the chart for a higher resolution view.)


As you can see, I started the year with a Beta of around 0.6. At that time, I was participating in 60% of the gains and losses from general market trends.  I maintained a moderately positive Beta at the start of the year because I was cautiously bullish on the market as a whole.  In April, I began to feel that the market was advancing too far, too fast and I began to increase my hedge by selling calls on market index ETFs.  By early June, I had become increasingly bearish, and published my market call saying "we're near the peak."  Since then, I have continued to hedge, and now the account has a Beta near zero, meaning that changes in the account value will have more to do with my particular stock picks than with general market moves.

By monitoring your own spreadsheet, you can have a good idea how effective your hedge is operating.  If you expect the market to decline, you should keep your own account's Beta at zero, or even negative.  If you're aggressively bullish, you'll want a Beta near 1 or higher.  You can raise your account's Beta by decreasing the size of your hedge or adding to your stock portfolio, and you can decrease your account's hedge by selling stocks or adding to your hedge.  This is what I meant earlier when I referred to "selling more calls dynamically."

A Watchful Eye

The key to hedging is regular monitoring, preferably daily.  The increase in my account's Beta in June was not due to me decreasing my hedge, but to changes in the internal correlations of the market.  You account's Beta will tend to drift over time due to such changes, and effective hedging requires that you make occasional trades to keep it near the desired level.

For most investors, the daily monitoring required to keep a portfolio properly hedged is probably too much work.  If that is the case for you, and you also feel that the market is likely to decline, the best strategy is probably to sell most of your stock portfolio and wait on the sidelines until the market declines to better valuations.  The use of simple hedging strategies such as shorting the index may compensate somewhat for less frequent monitoring, but changing market conditions mean that even this strategy is probably only appropriate for relatively active investors.


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.

September 03, 2009

USPS Study: EV Economics Depend On Smart-Grid Revenue

John Petersen

On August 28th, the Office of the Inspector General of the U.S. Postal Service published the results of a feasibility study titled, "Electrification of Delivery Vehicles." While the feasibility study reaches a foregone conclusion and recommends the purchase of a 3,000 unit demonstration fleet, I was surprised by the high level of Federal subsidies the Inspector General thought necessary to bring EVs within Postal Service capital investment policies. I was even more surprised by the conclusion that the tipping point in the economic analysis was revenue from ancillary vehicle to grid, or V2G, services.

The Postal Service operates a fleet of 219,000 vehicles, including 146,000 delivery vehicles. The feasibility study focused on the long-life vehicles, or LLVs, that have been a part of the American landscape since the late 80's.

LLV Right.jpgLLV Left.jpg

The current version of the LLV is built on a GM truck chassis, costs the Postal Service about $19,000 and gets about 10 miles per gallon; which isn't bad for the kind of low-speed stop-start driving on a typical mail route. The average LLV is driven about 18 miles a day and roughly 96% of the LLV fleet drives less than 40 miles a day. The vast majority of LLVs are parked at Postal Service facilities from 5 p.m. till 8 a.m.

The proposal evaluated in the Postal Service feasibility study would replace the internal combustion engine and drive train with an electric drive and 20 kWh of lithium-ion batteries of unspecified chemistry. The projected cost of a 3,000-unit fleet of electric LLVs, or E-LLVs, is $120 million, or $40,000 per unit. The projected cost of associated charging station infrastructure and training is $16.75 million.

The most striking aspect of the Inspector General's report is the fact that it was written from the perspective of an EV buyer, rather than an EV seller. After years of reading up-beat promotional materials that talk about ten-year battery lives and seven- to ten-year payback periods, it was refreshing to see a more skeptical buyer's analysis that:
  • Assumed the battery pack would have to be replaced after five years;
  • Assumed a fifty percent reduction in repair and maintenance costs;
  • Assumed a stable correlation between gasoline and electricity prices;
  • Required internal returns of thirty percent per year like you see in most businesses;
  • Required payback periods of less than three years like you see in most businesses;
  • Concluded that substantial Federal subsidies were essential; and
  • Concluded that ancillary revenues from V2G services were essential.
The Inspector General's report was not overly kind to E-LLVs, but then I've never expected undue kindness from fleet buyers who are invariably constrained by capital spending policies that require a return on investment, as opposed to a return of investment. The good news for EV developers is that the Inspector General was able to put together a plan that worked for the Postal Service. The bad news is the plan will be difficult for other fleet users to duplicate because the feasibility study assumes that:
  • The Postal Service will get grants for 74% of the cost difference between a standard LLV and an E-LLV;
  • The Postal Service will save roughly $1,300 per vehicle year from reduced fueling costs;
  • The Postal Service will save roughly $1,500 per vehicle year from reduced maintenance; and
  • The Postal Service will earn roughly $2,300 per vehicle year from V2G services.
The Inspector General's report analyzed four possible scenarios. In the basic scenario of no grants and no V2G revenue, the E-LLVs were a poor investment that had a negative return over ten years. In two middle of the road scenarios that included (a) grants without V2G revenues and (b) V2G revenues without grants, the payback periods were in the five-year range and internal rates of return were 15% to 20%. In a best-case scenario that included both grants and V2G revenue, the payback period was under two years and the internal rate of return was over 60%. Since the Postal Services has influential friends in high places, I think it's a safe bet that they'll be able to negotiate the details of a best case project.

The only thing that concerns me about the strategy the Postal Service has adopted for its E-LLV demonstration fleet is the long-term stability of V2G revenue. The E-LLV fleet will be on the road every day from 8 a.m. to 5 p.m., the precise period when demands on the power grid are greatest. So while the proposed fleet of 3,000 E-LLVs will have the theoretical ability to provide 45 MW of frequency regulation services, it will only be able to provide frequency regulation services when demand for those services is relatively low. While I've not been able to find any detailed estimates of the national demand for frequency regulation services during off-peak hours, I have to assume that the aggregate demand for frequency regulation is smaller than demand for other grid-based storage systems. I also have to assume that V2G services will compete directly with alternatives like the flywheel systems that Beacon Power (BCON) is developing which will be available 24/7.

Overall, I believe the Postal Service proposal to deploy a fleet of 3,000 E-LLVs presents an unparalleled opportunity to provide a reliable real-world testing laboratory for ideas that have not yet been reduced to practice. The Postal Service has long promised "neither snow, nor rain, nor heat, nor gloom of night, nor the winds of change, nor a nation challenged, will stay us from the swift completion of our appointed rounds." Since one of the biggest challenges facing America is the efficient use of energy and the prevention of waste, I can't imagine a better organization to lead the way.

In a perfect world, the Postal Service would break its planned E-LLV fleet into as many as a half-dozen subgroups that would each use a different battery chemistry from a different vendor. The willing industry participants I can identify off the top of my head include Altair Nanotechnologies (ALTI), Ener1 (HEV), Johnson Controls (JCI), Valence Technologies (VLNC), and A123 Systems (IPO pending). With proper monitoring, the amount and relative uniformity of the data generated in the first few years of testing for both EV and V2G applications could be priceless.

As a side note, I'm pleased to announce that I've accepted an invitation to appear as a luncheon speaker at the Electrical Energy Storage Applications and Technologies conference in Seattle on October 4th through 7th. While bloggers like me frequently get invited to speak at investment conferences, EESAT is in an entirely different animal. It's a biennial international technical conference co-sponsored by the DOE, Sandia National Laboratories and the Electricity Storage Association. The agenda currently includes technical presentations from the U.S. and eleven foreign countries. EESAT is not appropriate for investors, but it's a must for companies that are active in the energy storage sector and for institutional investors who need to better understand why storage is important and where the growth opportunities lie.


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.

September 02, 2009

Just Sold: Raser Technologies (RZ)

Raser Technologies (NYSE:RZ) did not get the hoped-for DOE loan guarantee.   The company still has good long term prospects, but the short term upside chances are much weaker, prompting me to sell in the hope of buying back in after a general market sell-off.

Raser Technologies (NYSE:RZ) dropped from $2.10 to $1.95 on September 1st, prompting a regular reader to leave a comment asking me if it was time to sell on the original Raser article. (Because he's a regular, he knows my policy of preferring to answer questions posed as comments on the blog to email comments: At the time, I did not see any new news, so I assumed the 7% drop was just part of the general sell-off on Monday.  

The news broke this morning: The DOE had denied a loan guarantee application for Raser's East Thermo project.  This does not mean that the project is dead (as Raser hastened to point out,) but the reason I had bought Raser was the hope that one of Raser's attempts to gain funding would pay off quickly.  I thought the DOE loan guarantee was the best prospect for a quick upside move.  

With the loan guarantee no longer an option, there are still plenty of other possibilities, such as receiving ARRA funding, or working out some sort of customer financing arrangement, like the pre-paid PPAs Raser has been working on.  I think these may take some time to come to fruition, and in the meantime, I'm still worried about a general market decline, which should hurt Raser as well.

I sold the majority of my positions at $1.78 on Sept 2 (a 12-13% loss).  I'm going to wait and see what happens to the stock over the next few months before I buy it back, just like the other 39 stocks on my Clean Energy Shopping List.  I do still own a few option positions on Raser, because options are much less liquid than the stock itself, and they're harder to sell in a hurry.

DISCLOSURE: Tom Konrad and/or his clients have long positions in RZ.
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.


September 01, 2009

A Plug for Plugs

CO2 reduction and fuel savings are not the only reasons to own a Plug-in hybrid electric vehicle (PHEV.)  There is real value in the ability to plug in to the electric grid which is not captured by price projections.

Tom Konrad, Ph.D., CFA

There will be gas lines.

Alternative energy saw its first flowering during the 1970's and 1980's, fueled by the OPEC oil embargo and late oil shocks which followed the peaking of domestic United States oil production.  Demand exceeded supply, and domestic price controls meant that the market could not balance supply and demand; instead gas was rationed by the amount of time your were willing to wait in line.

Elitist Hypocrites

I will not be surprised if those days come again, nor, I think, will John Petersen, who has recently been trashing the case for Electric and Plug-in Hybrid Electric Vehicles (EVs and PHEVs, a.k.a. vehicles with plugs) on these pages.  A friend of mine saw one of John's articles and asked if I felt I had been called an "elitist hypocrite" when he said,

PHEVs and EVs are little more than vanity items for elitists who will happily let up to fifteen other Americans waste up to 2,610 gallons of gas per year so that they can save 462 gallons by driving a 100% green car. The hypocrisy is appalling.

I've said that my next car will be an EV or PHEV, and I admit to being elitist.  The days of happy motoring, if not over already, will be soon.  We're headed for a society where we own fewer cars, and we drive them less.  We may even be heading towards a world in which car ownership will be "elitist."  Since I hope that my investments in clean energy will allow me to remain in the car-owning elite, I'm comfortable with being elitist.

Incidentally, John told me "I'll bet dollars to donuts that by 2015 I'll have both an EV and an ICE [internal combustion engine] in the garage, and the ICE won't get a whole lot of use."  He notes that, by his calculations,  this is not the most economic choice, but he expects most people are far more "sensible" than he is.  

Unlike John,  I don't expect most people to act in an economically rational manner most of the time, but, as you will see below, I think that the purchase of an EV can be an economically rational choice.

The hypocrisy John referred to comes in believing that subsidies for PHEVs and EVs are better than subsidies for more conventional hybrid electric vehicles, such as the Prius.  Again, John and I agree, if the goal is to reduce fuel use and greenhouse emissions, subsidies would be most effective if directed towards high-mileage vehicles of all sorts, with the subsidies proportional to the fuel savings.  If the goal is to jump-start the vehicular battery industry, then the subsidies should be proportional to the size of a vehicle's battery pack, whether or not the car has a plug.

So far, so uncontroversial, at least when we remove John's rather incendiary language.  So why am I bothering to respond?

A Plug for Real Options

A real option, as opposed to the financial sort, such as the cash-covered puts I'm fond of, is the ability to choose something of value in the real world at a later date.  An owner of a PHEV has a real option in terms of fuel.  For short commutes, the battery pack is sufficient to drive using only electricity, but the owner can choose to use this feature or not.  A PHEV will function quite effectively like an ordinary hybrid if it is never plugged in at all.  

This is a real option.   Another version of this same option is owning both an ICE and EV, as John expects to do, and an option I argued for in 2007, followed by a look at the demand curve for the PHEV-EV trade-off (and more here.)

Today, under most gas price scenarios, the amount the owner of the PHEV paid for the option, (i.e. the premium of the PHEV over an ordinary hybrid) is probably more than the value of the option.  John ran through the necessary calculations to show this in his debunking of the PHEV mythology.

But what happens when there are 1970s-style gas lines?  When gasoline carries both a monetary cost and an (unknown) price in time, the real option of plugging in your vehicle and never visiting a gas station rises to the value of the time saved and the increased certainty of being able to get where you need to be.  The fuel cost savings are just icing on the cake.


I can't know for certain that there will be gas lines, or some other form of rationing of petroleum based fuels within the service life of my next vehicle, but I strongly suspect there will be, especially in the world's top oil importer, the United States.  Even if oil production has not yet peaked, net oil exports from oil producing countries probably have.  In a world of declining oil supplies, I have little faith in any government resisting the temptation to use non-market measures to keep what oil it has available to itself.  Many oil producers will simply stop selling oil to importers at any price, preferring to keep it for their own domestic and geopolitical purposes.  So even if the United States government does not yield to the temptation of oil price caps, rationing may have to occur in some form, be it rationing by price, time, or regulation.

There are easily believable scenarios in the not too distant future in which the real option value of a plug could be the difference between a functioning car and an expensive hunk of metal in your garage, be it a conventional hybrid or an ICE.  We don't know if or when we'll see such a scenario.  We also don't know that it won't happen. 

In an uncertain world, it often makes sense to purchase options, even if they won't pay off in the "most likely" scenario.


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.


Live Interview/Call in on Denver PBS Station KBDI 12

A quick note to Denver area readers:  AltEnergyStocks.com Analyst Tom Konrad will be a guest on local PBS show Studio 12 from 8-9PM CDT Wednesday, September 2.  This will be a panel discussion on Alternative Energy, and other guests are likely to be a representative of the natural gas industry, and one of the authors of Energy Sprawl or Energy Efficiency: Climate Policy Impacts on Natural Habitat for the United States of America from the Nature Conservancy.  They're also trying to get local environmental bête noire, Stan Lewandowski.

Viewers will be able to call in and ask questions of their own.

« August 2009 | Main | October 2009 »

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