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April 29, 2010

Stock Market Advice for Solar Energy Investors


J. Peter Lynch

I have been reading your articles for years and always thought your stock market related insight was interesting and helpful for me as an investor. At the current time I am worried about the market and am wondering where you think the market is currently, given the major run up we have had in the past year. I would also be curious about your view on solar stocks and what you see for them.

-- Claude M., France.

Claude, great questions.  You are really going to make me think about this one. Sorry for the long answer but the question really got me going.

Every step of the way since April of 2009 we have heard the popular financial press and the frenetic cable pundits tell us a litany of things to worry about - foreclosures, unemployment, the growing deficit etc. and it still continues today.

However, all along this troubled path the market has steadily moved up, climbing a classic “wall of worry” with all the major averages advancing significantly from the March 2009 lows - S&P 500 +77%, Dow Jones +68% and Nasdaq + 94%.

These are very strong numbers, by any historical measure and the logical conclusion to draw is that the market must be close to a top. I certainly understand that and in fact, personally “feel” (read that as “emotion”) that this is the case. But what is important to understand is not your or my emotions or what we think “should” be, but what is. Sounds simple and obvious, but believe me, it is not.

As I stated on 3-17-2009, a few days after the market bottomed and this bull market started:

I have been a student of the market since 1975 and I can assure you that there is plenty of FEAR out there now. Nothing is 100% for sure, as we all know. But I think we are either at a significant bottom or very close to it. Everything is so “oversold” at this time, that I think the worst case is that we get a significant rally in what could still be a bear market.

Once again, sounds obvious with all the historical data available. But how many people recognized this and had the courage and discipline to jump in at that time?

Currently the market is performing in a very orderly manner and the underlying technical measurements are sound and are still pointing to a higher market with the major longer term uptrend still intact, despite all of the worries and other concerns.  It is also true that the market is currently at a HIGHER relative level of risk (overbought short term) and things could change quickly.  But the market has done this before – back in late 2003 and early 2004 the market stayed at a comparable high level of risk for extended periods of time climbing another classic “wall of worry.”

At this time, some additional relevant historical data is worth considering. Since the beginning of this new bull market (March 2009) the stock market has had two meaningful corrections of greater than 5% and less than 10% (June – July 2009 and January-February 2010) and no corrections more than 10%.  This situation is historically a sign of a healthy unfolding stock market.   A market that goes “straight” up with no corrections is a dangerous situation not a healthy situation. 

As I said, the market has not had a correction of 10% or greater since March of 2009.  Why is that significant?  It is significant because there has never been a bull market in the last 80 years that has not had at least one 10% correction before it topped out (Credit: Invest Tech Research). As a result, it is likely (from an historical statistical point of view) that we will have at least one 10% correction and then another move upward before the end of this bull market.  Historically a lot of money has been left on the table after the first 10% correction, if you sold out too soon and did not give the market a chance to run its course.

Where we are now?  Somewhere toward the end of Stage 2!

I always think that a picture can tell a better story than hundreds (or thousands) of words, so take a look at the diagram below.  This is a snap shot of the classic stock market pattern, how it “usually” unfolds and where I think we are now on the curve.

These stages are the four classic stages of a typical market cycle that generally moves from fear to greed and back.

Stage 1 - Capitulation:  This was late 2008 and early 2009. The world as we know it is ending and all was lost. If you go back and look at the “headline hysteria” back then this would not seem far from the truth and the general consensus at the time.

Stage 2 – Doubt and Skepticism:  This is the period we are in currently, climbing a wall of worry. The market has been moving up for over a year and still most people do not believe that this can be real. This psychological fact is reflected in the various measures of investor sentiment according to the American Association of Individual Investors, which are currently approaching levels that are historically seen at correction or market tops. It is a scary time, but the main trend is still intact and can remain intact for quite some time, even at these levels. But a watchful eye is necessary at this time. Risk is higher, but opportunity may still be around until we see indications of entering stage 3.

Stage 3 – Euphoria:  Here is where the greed factor and fear of being left behind starts to come into play and usually after one last correction the market takes off on its last glorious run up, taking the general public with it. This always ends the same way. After this last run up there are no more buyers, the professionals are sellers and the public is left holding the bag with only hope to cling to. During this stage you will start to see very positive headlines and the pundits pointing to a bright future.

Stage 4 – Hope followed by Fear:  As the market begins to roll over and start down the slopes of hope investors keeping hoping that it will come back. Despite the clearly deteriorating underlying technical factors, people just do not want to believe (i.e. emotional decision) that it is happening.  They seem to think “this time it will be different.”  But alas, that is very seldom, if ever, true and the hope gives way to fear and finally to capitulation when investors dump all the rest of their stock (Feb-March 2009).

My advice to you is do not lose heart. I have been an investor for over 35 years and I know all of the above perfectly. But that does not mean that I do what I say and what I know from experience.  It is a constant battle and the best you can do is be aware of it, learn from it and try to develop an unemotional method to deal with it. It is an amazing 4-stage phenomenon (cycle) and the good news is that it has consistently repeated over the years and I would expect will continue to do so. If you are NOT invested now, I would not start now and I would at least wait for a pullback from current over-bought conditions.

Solar Stocks

Solar stocks did great for the first 12 months of the current bull market (3/09 – 3/10) — up an average of 124%. But as I mentioned in an earlier article the vast majority of that gain was centered in a 8 Chinese stocks — CSIG, CSUN, JASO, LDK, SOLF, STP, TSL and YGE — which were up an amazing 267.96% on average, certainly the major reason that the group as a whole was up 124%. Without the Chinese companies the solar group would have actually underperformed the major averages for that 12-month period.

 Looking a bit deeper, more than 50% of the 267.96% gain was from 2 stocks — CSIG and TSL.  This is an extreme case of narrowing (2 of 21) leadership in a sector and is usually a bad sign for the sector. Also the fact that all of these leaders were Chinese companies indicates to me that the trend is clearly to lowest cost.  Good for the Chinese companies, maybe not so good for U.S. and European companies.

Looking at the first quarter of 2010 the numbers reflect this narrowing with solar sector underperforming the general market significantly.

Solar Stock Performance  First Quarter 2010

 

 

 

 

 

All Solar Stocks Average

-9.89%

 

 

 

 

 

Dow Jones

 

+4.11%

 

S&P 500

 

+4.87%

 

NASDAQ

 

+5.68%

 

 

 

 

 

So what does this mean for the investor interested in the solar market sector?

 It means that the industry is starting another transition phase in its long-term growth.  This is a period of “lowest cost wins” and of industry wide profit margin compression. It means that because of these factors and probably a host of other factors (lower natural gas prices, uncertainly of government policy etc.) that the solar segment has been a lagging market sector and probably not one that is optimal at this time for new investment. Especially given the higher risk level that the general market is at now.

It also means, in my opinion, that the U.S. has to wake up and start to move forward now (instead of our usual approach of thinking about having a meeting to discuss planning to do something maybe sometime in the future when all the stars are perfectly aligned i.e. all talk and very little action of any significance) with a strategy to compete with our lower cost Chinese friends. I do not think we can beat them at their own game – lowest cost via cheap labor.

What the U.S has to do now is to do what we do best — innovate.  This is the time for investment and focus on new technologies and “out of the box” thinking. This is a time to increase focus, investment and activity rather than slow down and wait for someone else to do something that we have historically always been the best at doing. The ball is in our court.

Mr. Lynch has worked, for 33 years as a Wall Street security analyst, an independent security analyst an investment banker and private investor in small emerging technology companies. He has been actively involved in following developments in the renewable energy sector since 1977 and is regarded as an expert in this field. He was the contributing editor for 17 years to the Photovoltaic Insider Report, the leading publication in PV that was directed at industrial subscribers, such as major energy companies, utilities and governments around the world. He is currently a private investor and advisor to a number of companies. He can be reached via e-mail at: SOLARJPL@aol.com. Please visit his website for the promotion of solar energy – www.sunseries.net.



April 28, 2010

Ten Green Energy Gambles for 2010: Update 2

Tom Konrad, CFA

The stock market is up, and my bets against it are down, except in energy.  It's time to double down.

Earlier this week, a client asked me if I'd found any buying opportunities while doing research for my "Best Peak Oil Investments" series.  The answer is, "no," although I've found a few companies I'm hoping to buy at lower prices, later. 

As regular readers know, I've been bearish since June 2009, after I cashed in on the quick rally in March, April, and May of that year.  My last ten months of sitting on the sidelines as the general market has risen 30% has been far from fun, but it has not made me question my decision to get out.  At the time, I judged that the potential gains did not justify the downside risks, and I believe the rise since then has only reduced any potential gains and increased the risks of staying in.

When I published my 10 Green Energy Gambles for 2010 in January, I had just these risks in mind, and suggested that readers use them to hedge any long stock positions, or use them to speculate on a decline. 

Readers who took this advice have lost about a third (34%) of their money, which is about what we've seen from my benchmark, composed of puts on the broader market and a clean energy ETF (down 38%).  If they had used this portfolio of puts as a hedge against the S&P 500 by investing $1 in this portfolio for every ten in the S&P 500, they would have acheived a net 2.5% gain, compared to a 4% unhedged gain on the S&P.

The following table shows how the individual picks have performed so far this year:


Security Weight
Underlying sector
1/9/10* 4/27/10*
Gain
EWW Jan 2011 $30 Put 20% iShares Mexico (EWW)
Misc
$0.825 $0.40
-52%
CHK Jan 2011 $17.5 Put 7% Chesapeake Energy (CHK)
Energy
$0.865 $0.955
+10%
DAL Jan 2011 $7.5 Put 7% Delta Airlines (DAL)
Travel
$0.975 $0.60
-39%
AMR Jan 2011 $5 Put 7% AMR Corp (AMR)
Travel
$0.85 $0.655
-23%
LUV Jan 2011 $7.5 Put 7% Southwest (LUV)
Travel
$0.50 $0.10
-80%
CNX Jan 2011 $35 Put 7% Consol Energy (CNX)
Energy
$2.325 $3.30
+42%
BTU Jan 2011 $30 Put 6% Peabody Energy (BTU)
Energy
$1.45 $1.13
-22%
HOT Jan 2011 $25 Put 10% Starwood Hotels (HOT)
Travel
$1.725 $0.30
-83%
JBHT Jan 2011 $20 Put
10% JB Hunt (JBHT)
Travel
$0.65 $0.20
-69%
Power Efficiency Corp 20%
Misc
$0.275 $0.26
-7%
Portfolio
100%




-34%
Benchmark
DIA Jan 2011 75.000 put
80%
DIAMONDs (DIA)

$1.49
0.84
-44%
Powershares Wilderhill Clean Energy (PBW)
20%


$11.74
$10.08
-14%
Benchmark
100%




-38%
* Prices given are the midpoint between the bid and ask at the close on the given date.

I've also categorized these picks as "Travel" (including airline, trucking, and hotel stocks), "Energy" (including coal and shale gas stocks), and "Misc" including my bet against Mexico's peak oil economy and the energy efficiency company Power Efficiency Corp. (PEFF.OB).  The following chart shows how the portfolio as a whole and these sectors have performed against the benchmark.

Chart
As you can see, the portfolio (blue) as a whole is tracking the benchmark (orange) closely, but the energy companies have fallen (and the puts have risen) despite the market trend, while the travel companies have outperformed the market (and the puts on travel companies have fallen.) 

The star performer was the put on Consol Energy (CNX) a firm with interests in both shale gas and Appalachian coal.  The main reason for its share price decline has been a large dilutive issue of common stock, priced at $42.50 a share that has depressed the share price.  The stock was trading at $56 when I first priced the option.

Outlook

The occaisional stock on the list may fall due to specific news, but if these gambles are going to pay off, it will require either a spike in oil prices that causes a steep decline in the price of the travel stocks, or a significant broad market decline, or both.  I think either or both is likely this year, and the recent market rise makes a decline from these levels more likely. 

If you've been hedging your portfolio with some or all of these puts, you should realize that as stock prices rise, the value of  these puts as a hedge against relatively small declines in stock prices falls.  Hence, if you want to maintain your hedge, it makes sense to add to it now with some more puts on some of the higher-flying travel and transport stocks, such as Starwood Hotels (HOT), Southwest Airlines (LUV) and JB Hunt (JBHT) at strike prices closer to the current stock price. 

DISCLOSURE: Short EWW,DAL,AMR,LUV,CNX,BTU,HOT,JBHT,DIA.  Long PEFF.

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.

April 27, 2010

The Best Peak Oil Investments, Part IX: The Methadone Economy

Tom Konrad CFA

No alternative fuel or combination of alternative fuels will allow our transportation system to operate the way it does today on oil.  As oil becomes increasingly scarce and expensive, the way we get our transportation needs met will have to change.  Understanding what the future of transportation may look like is key to making good investments in transportation.

If the measure of success for alternative fuels is the ability to continue to live in suburbs and commute in multi-ton boxes of metal on congested freeways for hours each day, then alternative fuels will fail.  No alternative fuel has the existing infrastructure, supply potential, energy density, and low environmental impact that we would need to replace oil without changing our unsustainable lifestyle.

Peak oil may mean the end of bigger and bigger cars driven farther and farther on more and more congested roads.  Peak oil may mean the end of suburban life as we know it.  Yet life as we don't know it does need not be a vision out of Mad Max.  Peak oil will mean changes, some for the better, some for the worse. 

The surest change peak oil will bring is less driving, in fewer vehicles that are filled closer to capacity.  Those vehicles will use less oil (or alternative fuels) per person-mile.  We'll also find ways to satisfy the desires and needs that we currently satisfy with travel without traveling.

Alternative Fuels

The first eight parts of this series looked into alternative fuels.  I concluded that no alternative fuel listed could replace oil as we use it today fast enough to replace dwindling oil suppliesConventional biofuels cannot be produced in enough quantity, and making hydrogen is an inefficient use of electricity or natural gas.  Electric vehicles are too expensive or have too little range.  There is not enough natural gas and there is too little fueling infrastructure to make natural gas vehicles practical on a large scale.  Gas-to-liquids makes sense for stranded natural gas, but there are too many other high value uses for natural gas to make a large dent in declining oil supplies.  Coal to liquids does too much environmental harm, and algae needs too much more technological development to achieve its promise in time.

The biggest problem with alternative fueled vehicles, however, is not the alternative fuels, the problem is the vehicles and how we use them. 

Oil was a one-time bonanza of a readily available, easily transportable, durable, energy-dense liquid.  With oil, humanity won a natural resources lottery ticket.  Like a lottery winner who blows cash that could have lasted a lifetime in a few months, we now need to realize that we've spent most of our winnings.  It's unreasonable to expect that we're going to win another such jackpot before we have to start watching our fuel budget again.  The main question is how soon and how deliberately we will make the necessary adjustment.  Will we act like the lottery winner who uses his last hundred thousand to tide him over while he looks for a job?  Will we keep partying to the bitter end, until one day we wake up, hung over in the gutter?  Will it be something in between?

The Methadone Economy

Switching to a drug analogy, most alternative fuels are the methadone to treat our petroleum/heroin addiction.  Methadone is given to heroin addicts in treatment because it mitigates withdrawal symptoms and can block the euphoric effects of heroin, morphine, and similar drugs, reducing the urge to use.

Alternative fuels can be sufficient to allow our society to function, but we're not going to feel the highs we felt when the oil was flowing freely.  Alternative fuels cannot take us back to a "normal" pre-peak oil state because our use of petroleum over the last few decades as been far from "normal:" it has been one long, fossil-fueled high.  We will eventually kick the petroleum habit with the help of alternative fuels not because alternative fuels are better than petroleum and can bring us something that petroleum cannot, but because our supplier will be getting smaller shipments over time, while the number of fellow junkies knocking on his door will keep going up with big increases in petroleum demand from emerging economies.

There are several competing visions of a future powered by alternative fuels, ranging from wildly optimistic to gloom-and-doom, with variations depending on how effectively the prognosticator thinks we can replace fossil fuels with alternatives. 

A high-technology optimistic vision includes smoothly running efficient pods in mass transit systems powered by renewable energy.  High speed bullet trains network the land, making overland air travel unnecessary.  The low-technology optimistic vision involves a peaceful return to local economies where food is grown locally, and increasing local interdependence fosters strong local community ties, and people grow happier as they become more connected to the land and each other.  The low-technology pessimistic vision is a free-for-all scramble for dwindling resources like the vision out of Mad Max referenced above.

I'm long on optimism about technology, but short on optimism about our will to make the necessary sacrifices to implement that technology quickly or efficiently.  I'm betting on a pessimistic, high-technology future.  In this future, we manage to cobble together a hodge-podge of last-minute, jerry-rigged solutions to keep the economy functioning at a basic level, but not at all smoothly or evenly. In it, we lurch from a crisis caused by financial melt-down, to a crisis caused by peak-oil to one caused by climate change.  We'll tackle each crisis with incredible ingenuity, staving off total chaos, but at the cost of mis-allocated resources and a deteriorating standard of living.  We hold out in the belief that after just this one more fix, the world will be back to normal and we can stop worrying.  But that day will never come. 

Forward thinking planners in some municipalities and communities will work on implementing true, long-term solutions.  But they will not have enough money or resources to do more than ameliorate the next crisis.  The large-scale, system wide solutions of better mass transit, algae biofuels, and continent-wide electricity transmission of the high-technology optimistic vision will be implemented too slowly, on too small a scale to achieve the economic stability the techno-optimists hope for.  But these half-built systems will still bring considerable benefit, and keep the succession of crises from being the complete disaster that would come with a complete lack of planning.

This is the Methadone Economy.  Alternative-fuel oil replacement therapy is necessary because oil supply will not keep pace with demand; we must replace oil or do without.  But alternative fuels are not oil, and will require more effort devoted to energy production to produce the same effect.  The Methadone economy will function, but it won't give us the highs we got from the cheap, concentrated, easily accessible energy of oil.

A future characterized by thoughtful, long-range planning seems unlikely to arise from the same political class and voting public that has not meaningfully prepared for anything but good times in decades.  The first IPCC report was released in 1990, and it made clear that human activities were substantially increasing levels of greenhouse gasses which would warm the planet.  Two decades later, greenhouse gas emissions are still rising.  We had the first warnings about peak oil in the 1970s oil crises, but only now are we starting to put serious political and economic capital into searching for solutions.  When the pre-2008 global debt bubble was on, NINJA (No Income No Job no Assets) loans were welcomed by politicians praising financial innovation and its ability to bring home ownership to people who could not previously afford it.

The Methadone Economy may sound gloomy, but I see it as the most optimistic vision possible given the political reality we see around us.  More pessimistic visions abound, but if you expect them, you're probably better off investing in guns and physical gold than you are investing in the stock market.

Conclusion

I see three major investment themes in the Methadone Economy.

First, there is the knowledge that long-term solutions will be implemented, although not completely and at insufficient scale.  Investors in contractors who specialize in mass transit and high-speed rail should do well, as should the longer-term alternative fuel solutions discussed in earlier articles of this series.  Vehicle efficiency improvements will find rapidly growing markets as fuel becomes more expensive.

Second, band-aid solutions will thrive.  Bike lanes, electric scooters, buses, and any other transportation solution which can be implemented with only small changes to existing infrastructure.  Road pricing schemes and the software technology to help people coordinate ride sharing.  The clever use of a few resources will always win over grand schemes when there are few resources to spare.

Finally, the Methadone Economy is an economy where we cannot expect long term growth.  More likely, we will see periods of anemic (and occasionally robust) growth punctuated by periodic crisis-driven declines.  This will be mirrored in the stock market, and so investors in the above two solutions should do well to hedge their overall exposure to the market.  My Green Energy Investing for Experts series and Ten Green Energy Gambles for 2010 provide several hedging ideas.

The next few articles in this series will look at more specific investments in the long-term and band-aid solutions to peak oil mentioned above.

DISCLOSURE: None.

DISCLAIMER: The information and trades provided here 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.

April 25, 2010

Common Sense in Energy Storage Investing

John Petersen

In the wake of last fall's initial public offering by A123 Systems (AONE) I wrote a four part series on battery investing for beginners. Over the last six months, changes in the storage sector have been coming at a fast and furious pace and many of my recent blogs have focused on technical minutiae rather than the stock market. They've led to heated debate with die hard EV advocates who don't understand the difference between technical and economic reality and religious belief, but I'm not sure how useful they've been for investors who see the potential in energy storage and want to understand how to position their portfolios to capitalize on the opportunities. Since my new followers outnumber old friends and critics by a wide margin, and that points to a surge of interest among mainstream investors, I've decided to back up and try to refocus my attention on the fundamental forces that are shaping the energy storage sector.

Economic fundamentals
 
Everybody hates the inexorable upward spiral in oil prices and we all have a favorite scapegoat to blame. For some it's evil oil companies and ruthless speculators, for others it's grasping and corrupt foreign governments and for others still it's the eco-religious who've consecrated promising oil and gas exploration frontiers as shrines to their green goddess. My favorite explanation comes from a classic December 20, 1973 column by the late Art Buchwald who laid the blame squarely at the feet of the Harvard Business School:

"Almost every sheik now in charge of oil policy for his country was trained at Harvard. Everything they learned there they have put into practice to the detriment of the Free World. The Harvard Business School taught the sons of Arab potentates how to sell oil, raise prices and demand outrageous profits for the black gold they have in the ground. Had these same sons been sent to the University of Alabama, Oklahoma or Texas, they would now be involved in developing football teams instead of putting the screws to everyone."

In the end, there's only one fact that matters. The world's appetite for oil has grown faster than the ability to produce it and immutable laws of supply and demand have had their way with prices. Everything else is a sideshow. The scary news is that oil prices have nowhere to go but up and the only way to avoid the financial pain at the pump is to accept individual responsibility and become more efficient. Ultimately, higher oil prices will be the cure for high oil prices.

Oil prices are foremost in our collective consciousness because we all buy petroleum in minimally processed form on a weekly basis. While the changes are less obvious, prices for every major commodity have been following a relentless upward trend for decades with no signs of moderation. In other words, the world's appetite for everything is growing faster than the ability to produce anything. We're careening toward a commodity cliff at 180 miles an hour and nobody seems to notice because we can't take our eyes off the gas gauge. The problem isn't just peak oil; it's peak everything.

I'd love to tell you that things are going to get better, but they're not. We live on a planet where six billion poor live in squalor and deprivation while 500 million of us enjoy relatively comfortable lives. As long as the poor didn't know that there was more to life than mere subsistence, they neither contributed to nor demanded from the global economy. For better or worse, the information and communications technology revolution gave half of them cell phones so the cat's out of the bag and the existence of a better life is no longer a secret. For the first time in history, we live in a world where more than half of the population knows that a better life exists and they all want a small slice of the economic pie. Human nature being what it is, their first natural response will be to work harder and compete for a place at the global economic table. If that doesn't work, their second natural response is likely to be a far less pleasant.

The challenge of our age is not changing our carbon footprint because every ton of coal we don't burn in developed countries will be burned somewhere else. The same holds true for oil and natural gas. The inconvenient truth is that global consumption of these energy resources will continue apace no matter what we do and if antrhopogenic global warming is more than the latest in a long-string of frightening but profitable alarmist theories, it's already too late to change the future and humanity will have to do what it's done since the dawn of time – adapt.

In the final analysis, our only challenge is finding relevant scale solutions to critical shortages of water, food, energy and every imaginable commodity. Whether we like it or not, the days of plenty have already passed and we must turn our attention to eliminating waste now, because if we don't make room at the table for six billion new mouths the only possible outcomes are catastrophic conflict and horrific environmental devastation.

Last week I described cleantech as "an ethical system based on the responsible application of technology to optimize the use of natural resources and increase the well-being of the six billion people that live on this planet." It all boils down to using every available resource for its highest and best purpose; and that's where storage becomes a critical enabling technology. It can reduce waste in transportation by capturing braking energy for immediate reuse. It can reduce waste in wind and solar power by smoothing out inherent variability. It can reduce waste in the power grid by smoothing out load fluctuations and potentially shifting power from when it's produced to when it's needed. In short, storage is the beating heart of cleantech and an investment mega-trend that will probably outlive us all. Storage is not, however, a silver bullet that can solve all of humanity's problems.

Technical fundamentals

The last forty years have been a time of mind-boggling progress in information and communications technology. As a result, everybody knows next years' products will be more powerful and cheaper than last years' products. We've all gotten used to the idea that Apple can launch iPad in April and sell millions by the end of the year. We've also come to expect that new products will be immediately successful and highly profitable. Unfortunately, none of the factors that drove the information and communications revolution have any bearing on energy storage, or for that matter cleantech in general.

The fundamental technical difference is that the laws of physics ruled our last industrial revolution. Those laws gave innovators the ability to improve performance through miniaturization and double capacity every 18 to 24 months. With minor exceptions, the laws of chemistry rule energy storage. Those laws are less flexible to begin with and they're subject to absolute natural limits. In a Moore's Law world, the performance progression is 1, 2, 4, 8, 16, and each new generation of products needs fewer high-cost material inputs than its predecessor. In the world of chemistry, the progression is 50%, 75%, 87.5%, 93.75%, and each generation of products requires more high-cost material inputs than its predecessor. In a Moore's Law world, the time between generations is falling, but in the world of chemistry a generational change takes seven to ten years and the time lags are increasing.

The bottom line for investors is that energy storage is subject to a different set of rules and while progress is inevitable, it will be very time consuming and very expensive. Over 90% of the advances announced by research scientists will be too expensive or complex to successfully bridge the gulf between science and a manufactured product. The 10% that can bridge the gap will typically require a decade of product development and industrial engineering. As a result, most advances will be modest incremental improvements and while disruptive changes are always possible, they'll usually arise from the combination of new materials with established chemistries. Where our last industrial revolution soared on the wings of eagles, the cleantech revolution will be a long hard slog through an alligator infested swamp.

Emergence of Storage as a Discrete Sector

There is little in life more boring than a battery. In fact, the only time most of us even think about our batteries is when they need to be charged or replaced. It's a classic love hate relationship. We want them, we need them and we know in our hearts that they're going to fail just when we need them the most. Is it any wonder that the modifier most frequently used with with the word battery is 'damned?'

Until a few years ago there were two principal types of batteries that were used for widely divergent applications and didn't face much in the way of crossover competition. Lead-acid batteries started cars, provided uninterruptible power for critical infrastructure and provided traction power for golf carts, forklifts, wheelchairs and the oddball electric car. Advanced batteries like NiCd, NiMH and lithium-ion powered portable electronics and power tools.

Energy storage entered a new epoch in 1999 when Toyota introduced a radical product named the Prius, a hybrid electric vehicle, or HEV, that captures some of the energy normally lost in braking, stores it in a battery, and then uses the stored energy to boost the next acceleration cycle. Over the last decade the Prius has earned a sterling reputation as the most fuel-efficient car in the fleet. In the process Toyota became the undisputed King of Hybrid Hill and built an intellectual property fortress that made life almost impossible for automakers that wanted to compete, but couldn't bear the humiliation of licensing Toyota's technology. So instead of innovating, the laggards went back to the scrapheap of automotive history, resurrected the inherently flawed concept of a battery powered electric vehicle and then excused their lack of imagination with the tired promise that "this time it's different." Experience tells me that this time is never that different.

While Toyota was making impressive progress in transportation, a second and equally important change was occurring in wind and solar power. After 25 years on the fringe, these clean power technologies finally reached an inflection point where they promised nameplate cost parity with conventional power sources within a few years. The only fly in the ointment was that the sun doesn't always shine and the wind doesn't always blow, which limits the usefulness of these variable power sources in countries that expect 99.9999% reliability in the electric grid. Despite the nameplate cost parity claims, the reality is that wind and solar are intermittent and a generator that provides variable power for part of the day isn't equivalent to a conventional plant that provides stable power 24/7. In the end, the best way to maximize the value and reliability of wind and solar is to couple them with cost-effective storage to smooth out the variability and shift power from when it's generated to when it's needed.

A third evolutionary driver that has emerged over the last few years is the recognition that our current power grid isn't up to the challenges of the future and it will need to be upgraded to a smarter, more stable and more efficient system over the next couple decades. While there are only a few grid-scale applications that make economic sense in today's environment, big changes are afoot and the prize to companies that can deliver cheap utility scale energy storage systems is immense.

The rapidly escalating demand for energy storage in cleantech applications created a huge problem for battery manufacturers because none of the technologies we relied on in the last century were good enough or cheap enough. Lead-acid batteries had always been the dominant technology for large-scale storage systems, but they didn't have the durability and cycle-life needed for the new applications. Similarly, advanced batteries were great when it came to durability and cycle-life in portable electronics, but they were designed to store a few watt-hours of energy for devices that would be replaced every couple of years, not mega-watt hours for an industry that thinks in terms of decades. For several years, battery manufacturers worldwide have been working feverishly to upgrade their products to meet the new demands. While they're all making progress, energy storage is not a horse race and there will never be a single winner. Instead there will be a broad range of technologies serving a broad range of needs and every company that brings a cost-effective product to market will have more business than it can handle.

Cheap vs. Cool

There are two basic kinds of energy storage products: cool devices like NiMH batteries, lithium-ion batteries, high-speed flywheels and supercapacitors that promise extraordinary performance and are objectively expensive; and simpler devices like lead-acid batteries, flow batteries, sodium nickel chloride batteries and low-speed flywheels that make less dramatic claims and are far cheaper. My favorite source of cost data on energy storage technologies is a July 2008 report from the Solar Energy Grid Integration Systems – Energy Storage (SEGIS-ES) program at Sandia National Laboratories. While critics often suggest that the Sandia numbers should be ignored because they're not as optimistic as forward looking statements and stories in the mainstream media, I believe the Sandia estimates are less prone to puffery and unbridled optimism.

Sandia Costs.png

There are three basic types of pure-play energy storage investments: established manufacturers with sustainable business models, entrepreneurial companies that are developing new technologies, and Chinese companies that have listed their shares in the U.S. but won't be players in America's domestic battery industry. To allow for fundamental differences among their technologies and business models, I've segregated the universe of publicly held pure play energy storage companies into five classes as follows:

Cool
Cool
Cheap
Cheap
Chinese
Emerging
Sustainable
Emerging
Sustainable
Companies
Ener1 (HEV)
A123 Systems (AONE)
Axion Power (AXPW.OB)
Enersys (ENS)
Advanced Battery Technologies (ABAT)
Valence Technologies (VLNC)
Maxwell Technologies (MXWL)
ZBB Energy (ZBB)
Exide Technologies (XIDE)
China BAK Battery (CBAK)
Altair Nanotechnologies (ALTI)


C&D Technologies (CHP)
China Ritar Power (CRTP)
Beacon Power (BCON)


Active Power (ACPW)
Hong Kong Highpower (HPJ)

Since I started writing this blog my basic premise has been that market expectations for companies with objectively cool technologies are too optimistic while market expectations for companies with objectively cheap technologies are too pessimistic. That premise led me to believe that over time the cheap technology companies would outperform the cool technology companies. The following graph tracks the composite market performance of my tracking categories from November 14, 2008 through March 31, 2010.

3.31.10 Composite.png

The past is never a guarantee of the future, but my basic premise seems to be holding up pretty well.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

April 22, 2010

Two Hundred And Twenty Billion New Reasons To Be A Plug-in Vehicle Skeptic

John Petersen

On April 8th the Electrification Coalition, a recently formed industrial lobby comprised of top-level executives from Cisco Systems (CSCO), Aerovironment (AVAV), NRG Energy (NRG), Rockwood Holdings (ROC), Nissan Motors (NSANY.PK), FedEx (FDX), A123 Systems (AONE) and a gaggle of private companies released a slick but wholly unenlightening white paper titled, "Economic Impact of the Electrification Roadmap." I haven't seen so many finely sculpted curves and unspoken assumptions since the tax shelter forecasts of the early-80s. The only clear message is that electric drive will be little more than a footnote in automotive history unless the powers that be agree to provide $121.1 billion in direct subsidies and incur another $100 billion in unspecified budget deficits over the next decade. Then, if everything goes according to plan and nobody develops a better personal transportation alternative, we can start thinking in terms of cost recovery and potential benefit to society.

4.21.10 EC Budget.png

I'd love to be able to provide an in-depth analysis of the assumptions, but they're conspicuously absent. For me, that fact alone makes the analysis about as worthwhile as a call to the psychic hotline. While I hate to be a stick in the mud about history, I think it's always worthwhile to remember other transportation technology schemes conceived in the halls of government and sold to investment markets as the next big thing, including:

25 years ago Methanol
15 years ago Electric Vehicles
10 years ago HEVs and Electric Vehicles
5 years ago Hydrogen Fuel Cells
3 years ago Ethanol and Biofuels
Today Grid Enabled Vehicles
2012 ???

Given the sweeping technological change I've witnessed over the last thirty years, I have to chuckle when anybody is naïve enough to suggest that any technology can ascend to dominance and hold that position for the next thirty years. On balance, I see the forecast decade of sunk-costs as realistically achievable but view the forecast cost recovery and long-term benefit decades as highly suspect.

To their credit the Electrification Coalition has always been upfront about the enormous challenges that electrification of personal transportation entails, including:
  1. The current high cost of batteries;
  2. The current lack of reliable access to refueling infrastructure for GEVs;
  3. Regulatory and coordination problems that will complicate interface with the electric power sector; and
  4. Consumer acceptance issues.
To overcome these seemingly insurmountable problems the coalition members propose several policy initiatives that will use your tax money to underwrite their business goals and pay for somebody else's consumption. The principal policy initiatives are summarized below, along with my personal observations.

Policy One - $13.75 billion
Establish tax credits for installing automotive grade batteries in stationary applications to help drive scale Giving utilities credits for using uneconomic automotive batteries in uneconomic grid applications is like buying eggs for a dime, selling them for a nickel and trying to make up the difference on volume.
Policy Two - $10.00 billion Establish loan guarantees for retooling automotive assembly lines and manufacturers of GEV components.
Last time I checked, $10 billion in loan guarantee costs can add up to $50 to $100 billion in government liabilities if the borrowers default.
Policy Three - $9.70 billion Establish a guaranteed residual value for used large-format automotive batteries.
Doesn't anybody believe the happy talk about the future resale value of used EV batteries?
Policy Four - $74.10 billion Modify electric vehicle tax credits to make them variable such that the upfront cost of a new PHEV or EV is equal to a comparably sized conventional vehicle.
I thought consumers were lining up around the block to pay a premium price for less utility, performance and flexibility.
Policy Five - $12.60 billion Establish business tax credits equal to 75 percent of the cost to construct public charging infrastructure.
Risk money is hard to find in a chicken or egg situation.
Policy Six - $0.80 billion Extend consumer tax credits for home charging equipment.
Home charging stations are part of the car cost.
Policy Seven - $0.18 billion Establish utility tax credits for up to 50 percent of the costs of the necessary IT upgrades to sell power to electric vehicle consumers.
Why is pocket change IT spending even an issue?
Black Hole Policy Costs
The unexplained $100 billion gap between the $121.1 billion in line item costs and the $220 billion cumulative increase in the Federal deficit by 2019.
What's a $100 billion between friends?

When I consider the electrification coalition policy initiatives, it's easy to see why the members are eager supporters of a proposal to convert huge piles of taxpayer money into operating revenue. I have a harder time, however, with the tacit admission that electric drive has no real future without government intervention to force the issue. The wheels really come off the bus when I consider the duplicity of suggesting that we can expect quantum leaps in battery powered electric drive technology, but must ignore the likelihood that some other nascent technology will gain enough ground over the next decade to give battery powered personal transportation a run for the money.

At its core, cleantech is an ethical system based on the responsible application of technology to optimize the use of natural resources, moderate global warming, secure energy independence, offset rising energy costs and increase the well-being of the six billion people that live on this planet. There has never been an industrial revolution led by a technology that promised to deliver less economic benefit at a higher economic cost. Shifting the burden from consumers to taxpayers is like re-arranging the deck chairs on the Titanic, a hollow subterfuge that does nothing to eliminate the burden of unconscionable waste masquerading as conservation.

Were I made of sterner stuff I'd short them all. Fortunately, experience has taught me that the market can remain irrational longer than I can remain solvent. So I'll just watch the predictable train wreck from the sidelines.

Disclosure: None.

April 19, 2010

The Best Peak Oil Investments, Part VIII: Alternative Fuel Report Card

Tom Konrad CFA

There are two types of solution to the liquid fuels scarcity caused by stagnating (and eventually falling) oil supplies combined with growing demand in emerging economies.  The most obvious is to find a substitute to replace oil.  Each potential substitute has barriers to its use which stand in the way of it from becoming a complete substitute for petroleum based fuel.  Understanding those barriers also leads us to the investment opportunities that arise from these substitutes. 

In the last two articles of this series, I looked at barriers to adoption for alternative fuels, and the limits and constraints that will likely prevent most of them from reaching sufficient scale to replace our current oil use. 

The first barrier was the last of existing infrastructure for many fuels: the lack of a fueling infrastructure that would allow drivers to fuel their vehicles when and where they need to at competitive prices, while the lack of a distribution infrastructure can keep the fuel from getting to the regions of the country where it is needed.  The second barrier is energy density: in order to deliver the range that people expect from their vehicles, an alternative fuel and the tank or battery that holds it works best if it is both light and compact.

The constraints were the total available supply (current and long term), alternative uses which might divert that supply to more economic purposes than fuel, and the damage producing and using the fuel does to the climate and environment.

To be a success, an alternative fuel must be able to overcome both barriers, and not have such severe constraints that there is little fuel available.  The barriers put limits on the short term profitability of the technology.  The constraints limit the short-term or long-term size of the market for the fuel, and the economics of the fuel.

Investment Opportunities

The table below summarizes the discussion in parts VI and VII.  I've rated the barriers and constraints for each fuel from A to F, with F being the least favorable to the adoption of the alternative fuel, and A being the most favorable.

Barriers
Biofuels
Electricity
H2
NGV
GTL
CTL
Fueling Infrastructure
A C
F
F
A
A
Distribution Infrastructure
D
A
D
A
A
A
Density
A
F
C
C
A
A
Overall Barriers
B
C
D
C
A
A
Constraints
Biofuels
Electricity
H2
NGV
GTL
CTL
Current Supply
C B
F
B
B B
Long Term Supply
B
A
A
F
F
F
Alternative Uses
C
C
D
C
C
C
Climate/Environment
C
A
A D
D
F
Overall Constraints
C+
B+
C+
C-
C-
D+
H2= hydrogen; NGV = Natural Gas Vehicles; GTL=Gas to Liquids; CTL= Coal to Liquids.

Hydrogen (Barriers D / Constraints C+)
If you agree with my assessments in the previous articles and as laid out in the above chart, it seems clear that hydrogen is a non-starter as an alternative fuel: the barriers are much worse for hydrogen than any of the other alternatives, and while hydrogen does have the long term advantages of potentially unlimited supply with minimal environmental impact, electricity has these same advantages, but has fewer barriers to overcome.

Natural Gas Vehicles (Barriers C / Constraints C-)
Natural Gas Vehicles are questionable as a peak oil mitigation strategy as well.  Natural gas is usually touted as a transitional fuel as we move away from oil and towards renewables.  But with the barriers to vehicle electrification no worse than the barriers to NGVs, a direct transition to electric vehicles seems a better choice. 

Biofuels (B/C+) and Gas to Liquids (A/C-)
  Biofuels and Gas to Liquids will likely have roles to play, but these roles will be limited by supply constraints.  Companies that can solve some of the problems for these two alternatives (such as land and water use for biofuels) may be profitable investments.  Algae is one possible way to overcome the supply constraints and environmental degradation caused by biofuels, but as I discussed in Part V, the publicly traded algae companies and technology is still too early stage to make attractive investments.  Biofuel feedstocks grown in salt water also have good long term potential.

The big questions lie with Vehicle Electrification and Coal to Liquids (CTL). 

Coal to Liquids (A/D+)
CTL would have a lot of potential as a short-term peak oil mitigation strategy if either 1) we choose to ignore the associated climate impact, or 2) we find and develop an economical way to sequester the associated carbon emissions.  I personally don't think that carbon sequestration is likely to be economical except in special (and small scale) situations such as enhanced oil recovery, but if a company manages to crack this nut, it is likely to be an excellent investment opportunity.

Likewise, so long as the true costs of greenhouse gas emissions are not paid by the polluters, high oil prices may make coal to liquids plants quite profitable in the short term given the ease with which synthetic diesel can be used in the current distribution and retail infrastructure.  However, such plants would be subject to potentially bankrupting regulatory risks because of the real chance that regulators may decide to price these externalities at a later date.  These risks mean that many lenders will be unlikely to finance Coal to Liquids plants.  We have seen a similar trend with many banks deciding not to finance new coal-fired electricity generation because of regulatory risk.  This trend is not all one-way, however, as some lenders (like the World Bank) are less subject to market forces, and may continue to fund environmentally harmful projects if they feel such projects are in line with other goals, such as development.

Vehicle Electrification (C/B+)

Where the prospects for Coal to Liquids are all short-term, the prospects for vehicle electrification are all long-term.  Energy density and the cost of batteries present serious near-term barriers to vehicle electrification.  In contrast, the long term prospects for vehicle electrification are much brighter than for any other alternative fuel.  The potential to deliver clean renewable electricity from wind and solar is sufficient to power all the worlds current electricity and transportation needs hundreds of times over.  Electric vehicles have the added advantage that they can smooth the natural variability of these most abundant renewable electricity sources by charging when the wind blows and the sun shines.

But the prospects for vehicle electrification come with a huge caveat: Plug-in Hybrid Electric Vehicles (PHEVs) and pure Electric Vehicles (EVs) are far from cost-effective ways to displace oil because of the huge cost, weight, and volume requirements of batteries.  Batteries are getting better, and many governments are pouring in the funding dollars, but for now only the mild vehicle electrification available with conventional hybrids uses batteries cost-effectively enough to make economic sense, even with a doubling or tripling of gas prices.  PHEVs and EVs can make sense as niche vehicles where performance (sports cars), silence (golf carts), or environmental sensitivity is at a premium.  They may also make sense for some fleet vehicles that follow predictable routes and can benefit from multiple battery swaps or charging sessions per day (mass transit, postal vehicles) but the cost-benefit analysis of such applications will be very sensitive to the application.  Smaller vehicles such as electric bikes and scooters also have great potential because their lower power and range requirements are easier to meet with current commercial battery technology.

Even these more limited applications for vehicle electrification are large compared to the current battery market.  As I wrote in part II, battery companies, especially those making progress with chemistries not currently the subject of intense investor interest, are compelling investment prospects.

Conclusion: The Best Peak Oil Investments

There is no perfect substitute for fossil fuels.  In the end, we are going to have to find ways to address the reality of peak oil that go farther than simply replacing one fuel with another: we are going to have to reduce our usage.  Fortunately, a number of strategies for reducing fuel use exist.  Not only is there considerable potential to increase vehicle efficiency, but there are also many ways to encourage conservation which can have net economic benefits for society.  For investors, these strategies also hold promise, although it is not always obvious how companies can turn a profit from helping consumers consume less.  

The "Best Peak Oil Investments" are not be the substitutes I have been talking about so far.  The best peak oil investments are the technologies that allow us to use less oil and still get our transportation needs met.  Future articles in this series on peak oil investment strategies will attempt to tease out the investment opportunities that arise from reducing our use of oil, not just finding substitutes for it.

Here are links to the previous articles in this series:
  1. Biofuels
  2. Hydrogen and Vehicle Electrification
  3. Natural Gas Vehicles
  4. GTL and CTL
  5. Algae
  6. Barriers to Substitution
  7. Substitution Constraints

DISCLOSURE: None.

DISCLAIMER: The information and trades provided here 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.

April 15, 2010

The Best Peak Oil Investments, Part VII: Peak Substitutes?

Tom Konrad CFA

There are two types of solutions to the liquid fuels scarcity caused by stagnating (and eventually falling) oil supplies combined with growing demand in emerging economies.  The most obvious is to find a substitute to replace oil.  Supply constraints limit the full replacement of oil by most potential substitutes.  Understanding those constraints leads us to the investment opportunities that arise from these substitutes. 

Increasing demand and constrained supply of oil is fueling the search for oil substitutes to use in its place.  Unfortunately, almost all of these potential substitutes also have limited supply.  This article looks at the factors that limit the supply of (or demand for) potential substitutes.  The next article, Part VIII will combine the insights about the barriers to adoption discussed in part VI and the constraints discussed here to highlight the investment opportunities which arise from these barriers and constraints.

Constraint 1: Conversion Efficiency / Alternatives

All alternative fuels require significant resources.  Conventional biofuels require agricultural land, fertilizer, pesticides, water, enzymes, and heat in fermentation.  Gas to liquids uses natural gas. 

To understand if a particular alternative fuel will ever be economic, it helps to consider what else might be done with these inputs.  If the alternative uses for these inputs have more economic value, then making fuel from them will never be an economic proposition.

With conventional biofuels, there is a trade off between one group of people driving, and another group eating (the food-vs.-fuel debate) and also the effects of land use change because of biofuels' tendency to increase the area used for crop land.  These trade offs are typically complex, and often difficult to calculate precisely, but in a few cases, the results are quite clear and enlightening.

Stranded Natural Gas is gas co-produced with oil far from transportation infrastructure.  Such gas is essentially a waste stream which would be burned to prevent it from venting into the atmosphere, so if the gas could be economically transported to market, either as liquefied natural gas or a Gas to liquids (GTL) product that can be shipped out with the oil, there will be a net gain, no matter how much of the gas is lost in the conversion process.  In contrast, pipeline natural gas has many alternative uses, and so its value as a transportation fuel must compete with power generation, domestic, and industrial uses.  Further, the direct use of natural gas as a transportation fuel in vehicles is in direct competition with GTL technologies.  Because much of the energy content is lost in the GTL process, it is unlikely that GTL will be viable for pipeline gas, even though it may make sense for stranded natural gas. 

A useful tool for making these sorts of comparisons is Energy Return on Energy Invested (ERoEI), which is the ratio of the energy put into a process to the energy embodied in the products.  ERoEI is useful in large part because there is a fairly extensive body of ERoEI analysis for various fuels.  In general, if two processes use the same feedstock, the one with the higher ERoEI is likely to be the most economic.  This comes with many caveats, however, since it does not take into account the different qualities of the fuels (can you really compare high-grade energy such as electricity to low grade energy such as heat?)  Further, ERoEI does not take into account the timing of the energy flows.  A process with an ERoEI of 1.1 may be better than a process with an ERoEI of 2, if the first process takes only a day and can be repeated every day, and the latter process takes a year.  I looked at a way to account for the timing of energy flows with a measure I call EIRR here and here.

Many companies are considering ways to use Municipal Solids Waste (MSW) and industrial waste streams to make various alternative fuels.  Purer waste streams with higher energy content have the most alternative uses, and the use with the highest economic value is likely to render most of the other uses uneconomic.  For instance, waste paper can be recycled, burned to produce electricity, or converted into liquid fuels by a variety of enzymatic, chemical, and thermochemical processes.  There is also economic value in reducing the amount of recycled paper at the source, by printing double-sided or moving to paperless processes.  In the case of waste paper, I do not expect it to ever be converted into fuels on a large scale, because of the potential for recycling.  If a ton of waste paper were turned into fuel, that would be a ton of paper which could not be recycled, leading to an additional ton of paper which would need to be made from virgin wood.  This is economically similar to growing the wood for biofuel, and skipping the intermediary paper step.

Another use for MSW with high energy content is to convert it into electricity via incineration.  It can also be used to make ethanol or other liquid fuels with a biomass to liquids process.  Much can also be recycled or composted.  Which one of these processes will be used for any particular waste stream will depend on the nature of the waste itself, as well as the local market for each fuel.  It also depends on the value of carbon credits, since while producing electricity tends to be the most effective way to reduce carbon emissions, electricity is difficult to store or use as a transportation fuel. 

One relatively easy comparison arises from Hydrogen.  Hydrogen currently is made by either reforming natural gas or using electricity to electrolyze water.  In both processes, some energy is lost, and the original natural gas or electricity are better fuels on several measures than the hydrogen itself.  I don't expect the hydrogen economy to progress beyond the demonstration stage unless we first find much more efficient ways of creating hydrogen and cheaper ways of storing it and using it in vehicles.

Constraint 2: Total Supply

The reason we're concerned with peak oil investments is because the total supply of oil is finite.  When total supply over time is finite, the amount pumped in any given year is also limited, and so must have a maximum, or peak.  The timing of the peak is less important than the elasticity of supply.  Elasticity of supply is a measure of how much the price of a commodity has to change in order to increase or decrease the amount supplied in response to changes in demand.  If a small change in demand requires a large change in price in order to bring supply into balance, then the supply of the commodity is inelastic.  If a large change in demand requires only a small change in price to bring supply into balance, then the supply of the commodity is elastic.  The elasticity of demand is the same, with regards to changes in price in response to changes in supply.

Sometime near the peak, oil supplies will become inelastic.  Increasing demand will produce higher prices, but the higher prices will not be able to stimulate supply to match the increased demand.  Instead, oil prices will stay high enough for reduced demand (demand destruction) to bring supply and demand back into balance.

Although we may not have reached "Peak Oil" in the sense of maximum annual production, I believe that the wild swings in the price of oil since 2007 demonstrate that we've reached peak oil in the sense of inelastic supply, as described in the preceding paragraph.  Although worldwide oil production was slightly higher in 2008 than 2005, overall production was basically flat for the whole period since 2005, despite rapidly rising prices.  The increased price volatility combined with tiny changes in market volume are strong signs of decreased elasticity or supply or demand.  I see no reason for demand to have become significantly less elastic in recent years, so I assume the observed decreased elasticity is elasticity of supply.

WTI Oil Price

Biofuels can be produced in relatively small quantities without much impact to the food supply and agricultural system.  Yet as we scale them up to replace a significant fraction of our oil use, they impact farmland and require the conversion of natural ecosystems to farmland.  Intensive biofuel production can also degrade existing farmland.

Only electricity has no real constraints on total supply, with wind and solar resources sufficient to supply all our energy needs hundreds of times over, so long as we build the wind and solar farms. 

Constraint 3: Climate/Environment

How we account for environmental externalities will also have a large influence on which alternative fuels thrive and which ones become historical footnotes.  Because of the fairly large supplies of relatively inaccessible coal, Coal-to-Liquids (CTL) technology compares favorably to all the other alternatives I've discussed until you consider the carbon emissions, disposal of the waste, and the impacts of coal mining that it entails.  All fossil fuels, even coal, are finite, and so using alternative fossil fuels at best delays the impact of peak oil.  Renewable options, in contrast, are steps towards a long-term solution.

Nevertheless, CTL stocks may turn out to be good investments despite the environmental harm.  After all, environmental harm is an externality, and so long as the local government chooses not to make the CTL producer pay the real costs of production, high oil prices could make CTL plants very profitable.  On the other hand, large unpriced externalities represent a significant risk to the companies creating them: new regulation may put a price on Greenhouse Gas emissions or take other regulatory steps which make the process unprofitable at the stroke of a pen.

Conclusion

Failing to take into account all constraints on a technology is a simple and common mistake.  Unfortunately, this common mistake leads investors to overly optimistic conclusions, often followed by overly optimistic investments.  Since overly optimistic investments are one of the surest ways to lose money, investors will be wise to keep these constraints on potential oil substitutes in mind when considering investments.

One reader of part VI made just this mistake.  He made the case that the supply of conventional gas (Constraint 2: Total Supply) might not limit the use of natural gas vehicles because of the potential for biomethane from cattle.  What he failed to consider is that while biomethane can be used as a fuel for natural gas vehicles, it can also be used for anything else that natural gas is currently used for (Constraint 1:Alternatives.)  Because Biomethane and natural gas are essentially interchangeable, it is more informative to consider the potential contribution of Biomethane to total natural gas supply than to calculate how many vehicles could potentially be fueled by biomethane.  I was not able to find a national resource assessment for biomethane, but I did find an assessment for California.  In California, the technically feasible biomethane resource (including biomethane from livestock) was less than 1% of California's natural gas usage.  Hence, fluctuations in natural gas supply are likely to swamp any increases in biomethane production.

If we want to understand the amount of natural gas available for natural gas vehicles, we need only consider the supply of fossil natural gas.  Biomethane is only a rounding error in the overall calculation.  Hence, while biomethane may make some investors rich by growing rapidly from a small base, it will have a negligible difference to the success of natural gas vehicles.  If you believe biomethane will take off, the best way to invest based on that belief would be to invest in dairy farms, not in natural gas vehicles.

In part VIII, I'll bring together these ideas about constraints with my thoughts about barriers from part VI, and highlight the investments that should benefit from both.

Previous articles in this series are available here:
  1. Biofuels
  2. Hydrogen and Vehicle Electrification
  3. Natural Gas Vehicles
  4. GTL and CTL
  5. Algae
  6. Barriers to Substitution
DISCLOSURE: None.

DISCLAIMER: The information and trades provided here 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

April 13, 2010

The Best Peak Oil Investments, Part VI: Barriers to Substitution

Tom Konrad CFA

There are two types of solution to the liquid fuels scarcity caused by stagnating (and eventually falling) oil supplies combined with growing demand in emerging economies.  The most obvious is to find a substitute to replace oil.  These substitute have barriers to their use as a replacment petroleum based fuel.  Understanding those barriers also leads us to the investment opportunities that arise from these substitutes. 

As I wrote the first five parts of this series, looking into potential substitutes for gasoline and diesel, it was clear that many potential substitutes would need to overcome barriers to its adoption.  This article and the next will look at these barriers, and what they say about the potential for investments in substitutes for liquid fuels from petroleum.  Part VII will look at factors which constrain the supply of these substitutes.  Part VIII will combine the resulting understanding of these barriers and constraints to highlight the investment opportunities arising from them.

Barrier: Infrastructure

One great advantage gasoline and diesel have over most of the proposed alternatives is an extensive infrastructure.  In addition to an extensive pipeline network, we also have a large number of competing fueling stations.  If a new fuel requires new fueling stations, like natural gas and hydrogen, or charging points and (potentially) battery swapping stations (electricity) it may not be enough to make sure that enough filling stations exist for would-be drivers to make long trips.  If there is only one national network of filling stations, drivers will likely become concerned that the lack of competition will mean that they overpay for fuel.

Among the possible substitutes, the synthetic fuels discussed in part IV, as well as biogasoline are the best placed in that they can use existing infrastructure. 

In terms of having a nationwide transportation network, the best placed substitutes are natural gas and electricity.  In terms of point of sale delivery, electricity has an advantage in that it's safe and relatively cheap to place charging infrastructure in parking lots, and most homes already have the capability of charging an electric vehicle, although it takes a long time from the 120V outlets in most garages.  Most homes do not have natural gas in the garage, and even when they do, a compressor is necessary. 

Conventional biodiesel and ethanol can be dispensed from the same pumps used for fossil fuels, but both present some difficulties in transport and storage.  Biodiesel cannot be allowed to get too cold, because it begins to congeal, so in colder climates, storage tanks as well as transport tankers must be insulated and even heated.  Ethanol cannot be shipped through pipelines that are also used for gasoline, because it absorbs too much water.  Hence ethanol and biodiesel are mostly shipped in tanker trucks and rail cars.  But both can be blended with conventional fuels, meaning that little new dispensing infrastructure is needed.  The importance of a competitive fueling infrastructure can be seen in in this November 2009 statement from the Trucking industry to the US Senate [pdf] about the conversion of trucking from diesel to natural gas.  They say,

It is not sufficient to have a single LNG vendor with stations built at strategic locations along key freight corridors. Absent a competitive refueling infrastructure, trucking companies could face unreasonably high prices at individual retail LNG stations that have no competition in a particular geographic area. While competition exists in the natural gas industry, the high barriers to entry for retail LNG refueling stations may slow the development of a competitive refueling infrastructure. A competitive LNG refueling model would require the presence of multiple entities selling LNG in the same geographic area.

This objection applies to any potential alternative vehicle which locks the user into one fuel, and includes Electric Vehicles (EVs) such as the Nissan Leaf and Hydrogen Fuel Cell Vehicles, but not to flex fuel vehicles (E85 ethanol) or biodiesel (which can be used in any diesel engine.)  It also does not apply to Plug-in Hybrid Electric vehicles, such as the Chevy Volt, because while charging points and battery swapping stations may be limited, the existing fueling infrastructure provides supply competition.

The fuel with the weakest infrastructure is hydrogen.  Like natural gas, it needs specialized filling stations, but hydrogen lacks a national pipeline network.

Incomplete infrastructure can be either a barrier or an opportunity.  If a potential fuel is compelling for other reasons, firms well placed to provide the necessary infrastructure should be able to profit handsomely.  If, on the other hand, a fuel lacks an existing infrastructure and also faces significant other barriers, it will be unlikely to become a significant transportation fuel, and infrastructure investors are likely to lose their shirts along with everyone else interested in the fuel.

Barriers: Energy Density

When talking about energy density, it's important to consider not only the fuel, but the tank.  Both volume and weight are important.  Few fuels are as energy-dense as gasoline and diesel, both of which can be stored in simple, unpressurized fuel tanks.  In contrast, the fuel tank for electric vehicles is the battery, and batteries are not only large and heavy for the amount of energy they store, they are also extremely expensive and degrade over time.  Although the cost of driving an electric vehicle are very low compared to gas or diesel, the large up-front investment in batteries makes the total cost of owning an eelctric vehicle higher except for drivers who use the vehicle for frequent, short trips with time to recharge in between. 

The big winners for energy density are synthetic fuels, as well as conventional biofuels such as ethanol and biodiesel.  Although ethanol has been criticized because it only contains about 2/3 of the energy of the same volume of gasoline, it's close enough that people using ethanol don't have to completely change their behavior in order to use it in a conventional vehicle.  In contrast, electric vehicle manufacturers find that the range of their vehicles is constrained not only by the cost of batteries, but also by their size and weight.  Weight is particularly important, because as a vehicle gets heavier, more of the energy is used to move the vehicle rather than the occupants, which in turn requires even more batteries.

In between energy-dense biofuels and bulky batteries lie gaseous fuels: natural gas and hydrogen, which have good energy per gram, but require heavy pressurized tanks to pack them into a space small enough to fit in a vehicle.  Hydrogen requires a pressurized tank that takes up a lot of space, even if it is not very heavy.  Natural gas can either be used as Compressed natural gas (CNG) or Liquid Natural Gas (LNG.)  CNG is similar to hydrogen, although it is a little more energy dense.  LNG has the same energy density as diesel, but requires considerable energy to compress into that form, and is not available from a home fueling station.  Hence, natural gas vehicles present a tradeoff between energy density and fueling infrastructure.

Conclusion

Considering just the barriers of energy density and infrastructure, it is clear why the conventional biofuels ethanol and biodiesel gained an early lead over alternatives such as electricity and hydrogen.  The big questions about biofuels arise from constraints in their total supply, and the harm that many forms of biofuel agriculture do to the environment.  Synthetic fuels made from natural gas and coal (GTL and CTL) can also have excellent energy density and can take advantage of existing infrastructure and vehicle fleets, but so far have not been adopted in a large way becasue they have had to compete with cheap oil.  As oil prices rise, we will probably also see the rise of synthetic fuels, but, like biofuels, their long term prospects will be limited by total supply and possibly by concern about the environmental harm they do. 

Such supply constraints and environmental concerns will be the subject of Part VII.  Previous articles have been:
  1. Biofuels
  2. Hydrogen and Vehicle Eletrification
  3. Natural Gas Vehicles
  4. Synthetic fuels: GTL and CTL
  5. Algae

DISCLOSURE: None.

DISCLAIMER: The information and trades provided here 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.

April 11, 2010

EPA and NHTSA Predict 42% Market Penetration for Start-Stop Systems by 2016

John Petersen

On April 1st the National Highway Traffic Safety Administration [NHTSA] and the Environmental Protection Agency [EPA] announced a joint final rule establishing fuel economy standards for all light duty vehicles sold in the United States. In my last article, I focused on the overall fuel efficiency improvements the new CAFE regulations will require. After spending a couple days reading and digesting the Final Rule Release, which runs to 1,469 pages, I've concluded that my initial optimism over the future of start-stop technology was understated.

The Final Rule Release begins with several hundred pages of introductory materials that describe the key efficiency technologies automakers are expected to implement between now and September 2015. It describes start-stop as:
  • 12-volt micro-hybrid (MHEV) – also known as idle-stop or start-stop and commonly implemented as a 12-volt belt-driven integrated starter-generator, this is the most basic hybrid system that facilitates idle-stop capability. Along with other enablers, this system replaces a common alternator with a belt-driven enhanced power starter-alternator, and a revised accessory drive system.
After a lengthy discussion of how each of the principal efficiency technologies will contribute to the overall goal and explaining the freedom the individual automakers will have to pick and choose solutions, the Final Rule Release includes the following table, on page 484, that identifies the automakers and estimates the percentages of their 2016 model year fleets that will incorporate each technology.

CAFE Technologies.png

In the supplemental tables to its "Annual Energy Outlook 2010," the Energy Information Administration forecast new light duty vehicle sales of 16.5 million units in 2016, which implies nationwide sales of 7 million vehicles with start-stop systems if the NHTSA and EPA estimate is accurate.

I've previously explained why start-stop technology is hard on starter batteries. It basically boils down to the fact that the battery will need to start the engine several times during a typical commute instead of starting it once. While the automakers can get better start-stop performance by using ultra-premium lead-acid batteries, even premium batteries have problems with a chemical process known as sulfation which is the primary reason lead-acid batteries fail.

I've also explained how a new generation of lead-carbon battery technologies including the Ultrabattery from Australia's Commonwealth Scientific and Industrial Research Organisation [CSIRO] and the PbC® battery from Axion Power International (AXPW.OB) are a game changer for energy storage because they reduce or eliminate sulfation while significantly increasing both acceptable charging rates and available power. The end result is a battery that's price competitive with premium lead-acid batteries and performance competitive with lithium-ion batteries, as shown in the following graph from Sandia National Laboratories.

Sandia PSOC.png

For eighteen months I've been predicting with increasing confidence that the cleantech revolution would start with baby steps, rather than giant leaps, and that advanced lead-acid and lead-carbon batteries would play a crucial role in the widespread implementation of micro, mild and strong hybrid electric vehicle [HEV] technologies. My confidence ramped up a notch or two last August when President Obama announced $2 billion in ARRA battery manufacturing grants that included:
  • $34.3 million to Exide Technologies (XIDE) with Axion Power International for the "production of advanced lead-acid batteries, using lead-carbon electrodes for micro and mild hybrid applications;" and
  • $32.5 million to East Penn Manufacturing for the "production of the UltraBattery (lead-acid battery with a carbon supercapacitor combination) for micro and mild hybrid applications."
My confidence continued to rise as reports from the Energy Information Administration, Frost & Sullivan, Roland Berger Strategy Consultants and most recently Lux Research concluded that start-stop technology would become a standard option for new vehicles sold in both Europe and the U.S. over the next few years. Now that the NHTSA and EPA have weighed in with their estimate that 42% of the 2016 model year new car fleet will be equipped with start-stop, my confidence level couldn't be higher.

Since I started blogging I've argued that media and political hype about plug-in vehicles has created an odd dynamic where market expectations for the potential long-term beneficiaries of the cleantech revolution are highly inflated while market expectations for the likely near-term beneficiaries are unreasonably low. There is simply no other way to explain the fact that Exide trades at 17% of historical sales while A123 Systems (AONE) trades at 3x forecasted 2012 sales, or that Axion trades at less than 4x its tangible book value of $26 million while Ener1 (HEV) trades at closer to 10x its tangible book value of $57 million.

For the reasons I've discussed at length in a series of articles about the fundamentally flawed idea that we can use batteries to replace fuel tanks, I believe there are significant risks that the lithium centerfolds will fail to meet the market's high expectations and their stock prices will suffer. Conversely, I see a very high probability that Exide, Axion and others will outperform the market's modest expectations and their stock prices will respond accordingly.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and has a substantial long position in its stock.

April 09, 2010

The Best Peak Oil Investments, Part V: Algae


Tom Konrad CFA


There are many proposed solutions to the liquid fuels scarcity caused be stagnating (and eventually falling) oil supplies combined with growing demand in emerging economies.  Some will be good investments, others won't.  Here is where I'm putting my money, and why.  This fifth part takes a look at the growing consensus that our biofuels should come from non-food crops grown on land that is not otherwise productive, and the one crop that shows promise of delivering the high yields needed to satisfy our enormous thirst for fuel is algae.

In part I of this series on Peak Oil investments, I looked at Biofuels and Biochemicals as a substitute for petroleum based transportation fuels and chemicals.  I concluded that the best such investments were investments in biofuel feedstocks, but one such feedstock I didn't mention was algae.  

The Promise of Algae

If you need to own your own feedstock to be a profitable biofuel company, you can either grow it, or make use of the waste from some other economic activity.   The potential of biofuel from waste is inherently limited by the waste currently produced, and the amount of available waste is likely to fall over time as the economy becomes more resource-efficient because of rising commodity prices.  While I think compaines that control waste streams care good investment opportunities, waste is inherently limited when it comes to replacing oil.  It's the very limitation of waste as a resource that makes it a good investment.

If you grow your feedstock on good agricultural land, you will be giving up the opportunity to produce valuable food.  If you grow hardy non-food crops on marginal land, you will probably have very low yields.  For instance, Jatropha has long been heralded as a non-food crop that can produce oil for biodiesel on marginal land, but the best Jatropha yeilds are produced on well-drained soil with ample fertilizer and rainfall or irrigation.  Since most arable land and available water are already in use, the potential for additional biofuel production from conventional crops is limited.

Many observers herald biofuel from algae as a way to thread this needle.  Algae grown in open ponds is likely to produce 5,000-10,000 gallons of oil per acre per year, while companies using bioreactors have made claims approaching 10 million gallons per acre.   The higher-end claims for algae in bioreactors are either pure fantasy, or would require vertical farms with artificial light, but a 100,000 gallons per acre per year (1/100th of the high-end claims) is generally considered achievable.  For comparison, Zeachem is aiming for 2,000 gallons of ethanol per acre of sugarcane per year, one of the most productive conventional biofuel crops.  Corn produces less than 500 gallons of ethanol per acre per year.

The potential of a hundred times improvement in fuel yields over conventional crops keeps people excited about algae.  On paper, such yeilds would allow algae to replace oil in our economy.  Actually achieving these yields is tricky.  Open ponds have problems with contamination by wild algae, and evaporate enormous amounts of water into the atmosphere.  They also need to be fed with carbon dioxide and nutrients to achieve good yields, without so much stirring that the algae (which prefer still water) are disturbed.  Bioreactors help solve the contamination and water evaporation problems, and can allow more surface area for light absorption and algal growth.  But bioreactors cost much more than open ponds, and require more maintainance and attention to keep them at the proper temperatures and light levels.  Like open ponds, they need to be fed CO2 and micronutrients to achieve optimal growth without creating too much turbulence for the algae to grow.
Yes, But

One of the greatest dangers for Alternative Energy investors is confusing great technological potential with great investment potential.  I recently argued that solar stocks are not a good long term investment because of extreme competition and a rapidly evolving technology.  The same arguments apply to algae companies, most importantly the the point about rapidly evolving technology.  While solar technology got its start in the 60s and 70s, algae research began only in the 1990s.  We still don't know what sort of bioreactors will end up being economic, which types of algae will work best, and what the best ways to extract the oil from the algae will be.  This is an extremely immature technology, and as such, it is unlikely to be a profitable sector for investors in public companies.  With over 200 startups working on algae, only four of which are public (see below), the most likely winners are private companies.   Many of the winners have not even been incoprorated yet. 

That said, I think that bioreactor companies will probably dominate the industry over the long term.  In the short term, open ponds probably have an advantage, because they require less technological development and lower capital cost, but their long term potential is limited compared to bioreactors.  Open ponds are only practical in areas with abundant water, and these locations will likely be suitable for other forms of farming.   High-productivity algae farms will need to be located near a source of carbon dioxide, such as a power plant, and be in sunny locations.  These conditions will probably favor the bioreactors, which can be located in dry, sunny locations. 

Stocks

Here's a quick list of the publicly traded companies I know of that are working on algae, and what they do:

Green Star Products, Inc. (GSPI.PK).  Green Star's primary business seems to be selling continuous flow biodiesel reactor technology.  This is not a great business because it's currently hard to sell biodiesel for more than the cost of the inputs needed to make it.  They have also developed a formulation of micronutrients that they think are excellent for increasing the productivity of certain algae strains.

OriginOil, Inc. (OOIL.OB). Origin has developed a process using electromagnetic fields to extract oil from living algae without killing the cell.  If they can make it work at reasonable cost, this technology should be a real boon to the industry.  Unfortunately, the company is losing money hand over fist, and does not have revenues or cash to speak of.  Since the company will have to keep raising new money from investors for the foreseeable future, the stock will almost certainly continue to fall until it can begin to fund its operations internally.

PetroAlgae, (PALG.OB). PetroAlgae is attempting to commercialize an open pond "microcrop" technology (they are working with other small aquatic plants such as duckweed as well as algae.)  Yields will likely be relatively low for algae because they do not add carbon dioxide to the process, and they will have to cope with large water losses from evaporation.  Like OriginOil, PetroAlgae has no revenues and will need to raise money soon to continue operations.  On March 5, the company privately sold stock at $8 per share, despite the fact that its shares are currently trading for around $22 on the open market.  I can't imagine why the stock has climbed since it went public in 2008 at around $3.  If you can find shares to borrow, this looks like a stock to short.

PetroSun Inc. (PSUD.PK).  Back in September 2007, PetroSun made a splash as the first public company to try to commercialize algae for biofuel.    I was skeptical at the time, and said so in March 2008.  My skepticism now seems justified, since now their website has a couple mentions of algae, but the catfish farms they converted into algae farms in 2009 are not mentioned, and their only projects and prospects are traditional oil and gas projects.  The stock is down to $0.045 from $0.16 since I panned it in 2008.

Conclusion

Algae has great promise for producing liquid fuels in sufficient quantity to replace petroleum, and it can do so without using excessive water or farmland.  That potential, however, is fairly far off.  The technology is capital intensive and far from commercialization, a combination almost certain to make investors in the public stocks poorer rather than richer.  If and when fuel made from algae is available in significant quantity to make a dent in our thirst for fossil fuels, it will probably have been developed by companies that public investors cannot currently buy.  Stock market investors should wait until this industry matures from its current infancy to something closer to adolescence.  Buyers of the current batch of infant companies are likely to suffer the fate of other new parents: many sleepless nights.

Other articles in this series on Peak Oil investments:
  1. Biofuels
  2. Vehicle electrification and hydrogen
  3. Natural Gas Vehicles
  4. Biomass-to-Liquids, Gas-to-Liquids, and Coal-to-Liquids.

DISCLOSURE: None.

DISCLAIMER: The information and trades provided here 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.


April 07, 2010

Will New CAFE Standards Make Stop-Start Engine Technology Standard Equipment?

John Petersen

On April 1st the National Highway Traffic Safety Administration (NHTSA) and the Environmental Protection Agency (EPA) announced a joint final rule establishing fuel economy standards for all light duty vehicles sold in the United States. Since the existing standards don't apply to light trucks, I used vehicle sales forecasts from the Energy Information Administration's "Annual Energy Outlook 2010" to estimate a current baseline fuel economy of 19.6 mpg. The new rules will be phased in over a five-year period beginning with the 2012 Model Year and are certain to drive rapid evolution in the auto industry. The following table summarizes the new fuel economy standards:

Model Year Passenger Cars
(mpg)
Light Trucks
(mpg)
Combined Fleet
(mpg)
2010(1) 27.5
23.5
2011(1) 30.2
24.1
2012(2) 33.3 25.4 29.7
2013(2) 34.2 26.0 30.5
2014(2) 34.9 26.6 31.3
2015(2) 36.2 27.5 32.6
2016(2) 37.8 28.8 34.1
(1)  Source: Wikipedia Corporate Average Fuel Economy
(2)  Source: NHTSA CAFE-GHG Fact Sheet


In plain English, the new rules mandate a 26% improvement in passenger car efficiency and a 30% improvement in light truck efficiency by September of 2011, with long-term goals of 45% and 47% by September of 2015. Overall, the EPA expects to bring CO2 emissions for the new car fleet down to 250 grams per mile by the 2016 Model Year.

The US is not alone in its implementation of stringent fuel efficiency standards. In April 2009, the EU adopted new CO2 emission standards that establish a fleet wide target of 130 grams of CO2 per km that will be implemented on the following timetable:

Calendar Year Percent of Fleet CO2 Emission Standard MPG Gasoline MPG Diesel
2012 65.00% 130 g/km ~42 ~48.2
2013 75.00% 130 g/km ~42 ~48.2
2014 80.00% 130 g/km ~42 ~48.2
2015 100.00% 130 g/km ~42 ~48.2

While the EU CO2 standard appears to be more stringent than the US CAFE standards, the two are fairly comparable because the EU standard is subject to adjustment at 45.7% of the base rate for new passenger cars that weigh more than 1,372 kg, or about 3,000 pounds. In the case of a European car like a BMW 5-Series that weighs closer to 4,000 pounds, a fairly typical American value, the allowable CO2 emissions will be 150 grams per km, which works out to 240 grams per mile, a figure that's almost identical to the US target.

While it may be fun to debate the long-term viability of plug-in vehicles, which I characterize as unconscionable waste masquerading as conservation and even the first great fraud of the new millennium, it's clear that plug-ins will offer no help by 2012 and their contribution to meeting 2016 fuel efficiency standards will be insignificant. Therefore the heavy work will have to be done by conventional fuel efficiency technologies that are available and cost effective today.

In mid-February, I wrote an article titled Energy Efficiency in the Automotive Sector that included the following summary of HEV and automotive efficiency technologies I assembled from the www.fueleconomy.gov website.


Efficiency
Hybrid Electric Technologies Gain
Prius-class strong hybrids with idle elimination, electric-only launch, recuperative braking and acceleration boost. 40%
Insight-class mild hybrids with idle elimination, recuperative braking and acceleration boost. 20%
Engine Technologies
Direct Fuel Injection (with turbocharging or supercharging) delivers higher performance with lower fuel consumption. 11-13%
Integrated Starter/Generator Systems (e.g. stop-start systems) automatically turn the engine on/off when the vehicle is stopped to reduce fuel consumed during idling. 8%
Cylinder Deactivation saves fuel by deactivating cylinders when they are not needed. 7.5%
Turbochargers & Superchargers increase engine power, allowing manufacturers to downsize engines without sacrificing performance or to increase performance without lowering fuel economy. 7.5%
Variable Valve Timing & Lift improve engine efficiency by optimizing the flow of fuel & air into the engine for various engine speeds. 5%
Transmission Technologies
Automated Manual Transmissions combine the efficiency of manual transmissions with the convenience of automatics (gears shift automatically). 7%
Continuously Variable Transmissions have an infinite number of "gears", providing seamless acceleration and improved fuel economy. 6%

In a presentation at last fall's Frankfurt Motor Show, Dr. Wolfgang Bernhart of Roland Berger Strategy Consultants predicted that full or partial powertrain electrification would become a critical automotive efficiency technology by 2020 and forecast high scenario market penetration rates as follows:


ICE Stop-start HEV Plug-in
Western Europe 6% 67% 7% 20%
United States 23% 51% 13% 13%
Japan 17% 60% 15% 8%
China 48% 30% 6% 16%

If the Roland Berger forecast is accurate, stop-start engine systems will likely become a standard feature within 10 years; a conclusion mirrored in an October 2009 report from HSBC Global Research. The forecasts were a good deal easier to ignore a couple months ago than they are today.

Last month Lux Research published a new industry report titled "Emerging Technologies Power a $44 Billion Opportunity for Transportation and Grid" that forecast energy storage system sales growth of $890 million for stop-start vehicles by 2015. Of that total, Lux reported that roughly 10% would be spent on supercapacitor-based systems and the remaining 90% would be spent on advanced lead-acid batteries.

After the NHTSA announcement, I called the author who confirmed that his estimate of $890 million in stop-start battery purchases was based primarily on EU regulations, and the subsequent adoption of the new CAFE regulations would require a significant upward revision in his forecast. My guess is that by the time the dust settles, the forecast revenue gains for advanced lead-acid battery producers will be on the order of $2 billion by 2015, a number that handily eclipses Lux's forecast of $1.2 billion in lithium ion battery sales growth during the same period.

The four publicly traded U.S. companies that stand to benefit most from the widespread implementation of stop-start technology as standard equipment in the U.S. and Europe are Johnson Controls (JCI) Exide Technologies (XIDE) Maxwell Technologies (MXWL) and Axion Power International (AXPW.OB). For more detailed information on the strengths and weaknesses of these companies in the stop-start space, my author's archive at Seeking Alpha is a good starting point that provides a variety of detailed discussions, along with copious links to third-party source documents.

While there are times when I feel like a broken record for revisiting the same topics over and over again, the last twenty months have been a time of tremendous change in the energy storage sector and every relevant development has supported my premise that cool technologies will progress more slowly than the market expects and companies that manufacture objectively cheap products have a far greater economic potential over the next five years.

I continue to believe the baby steps of the cleantech revolution will be taken with cheap and reliable solutions like advanced lead-acid batteries. Something better, stronger and cheaper will undoubtedly emerge in the future. But until it does we need to go to work with the tools we have, solve our problems through old fashioned hard work and be ready to embrace new technologies when they prove to be something more than airbrushed centerfolds.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and has a substantial long position in its stock.

April 03, 2010

The Best Peak Oil Investments, Part IV: Gas-, Biomass-, and Coal-to-Liquids

Tom Konrad CFA

There are many proposed solutions to the liquid fuels scarcity caused be stagnating (and eventually falling) oil supplies combined with growing demand in emerging economies.  Some will be good investments, others won't.  Here is where I'm putting my money, and why.  This fourth part takes a look at the possibility of converting coal,  natural gas or Biomass into gasoline or diesel we can use in unmodified vehicles.

In the first three parts of this series, I looked at various substitutes for oil based transportation fuels:
This part looks at the potential of technologies to convert coal, natural gas, and other biomass into liquid fuels that can be used directly in place of gasoline and diesel. 

The Other Fossil Fuels

Like oil, coal and natural gas are fossil fuels and so their use will eventually be constrained by limited supply. However, both are more abundant and have not been as heavily exploited as oil, and so many people hope that we will be able to use them in place of oil when oil supply can no longer keep up with demand.  If this hope for a cornucopia of synthetic liquid fuels is to be realized, several question will first have to be answered:
  1. Are the technologies economically viable?
  2. Will the process be environmentally benign enough to be politically acceptable?
  3. Can we produce coal and natural gas fast enough to meet both current existing needs and supply an increasing amount of synthetic liquid fuels?
Economics

The underlying factors for the economics of synthetic liquid fuels are 1) the cost of the feedstock, 2) the efficiency of the process, 3) the capital cost of the plant, and 4) the price of oil.  I found an in depth survey of gas-to-liquids technology from BP Statistical Review of World Energy, but it is eight years old.  At the time, the authors were predicting that gas to liquids (GTL) technology would be economic at oil prices of around $20-$25/bbl.  Coal to Liquids (CTL) technology also seems to cost between $25/bbl and $60/bbl.  It's not surprising that the economics are better with natural gas, because gas is more uniform than coal and is easier to handle.  At current prices of around $80/bbl for oil, these technologies seem to be comfortably economic, at least as long as the price of the feedstock stays low.

Most of the commercial applications of these technologies to date focus on stranded feedstocks, especially stranded natural gas which cannot easily be shipped to markets.  The largest gas to liquid plants are being built in Qatar, a country with enormous gas reserves that dwarf its export infrastructure.  Biomass resources by their nature are almost always "stranded" because they have very high transport costs.  Colorado based Rentech (RTK) is developing a number of biomass based projects in addition to projects that use a mix of stranded fossil and biomass resources.  The problem with stranded resources is often limited quantities.  Synthetic fuel technologies are most economic at very large scales, but free and nearly free feedstock are usually only available in much smaller volumes... otherwise it might make sense to build the infrastructure to transport the feedstock directly to markets.  A couple companies attempting to tackle the scale problem for natural gas are Compact GTL and Velocys, which are competing to produce small gas to liquids plants to be used in Brazil's Tupi oil field.

In terms of efficiency, the dominant Fischer-Tropsch (FT) based process converts about 60% of the energy in the feedstock into useful outputs.  The low efficiency of the process means that these technologies are most likely to be used only for feedstocks that cannot be easily transported or used locally.  Stranded natural gas is a good candidate.  Such natural gas is a byproduct of oil extraction, and is typically flared (burned without doing useful work) when there is no gas pipeline available to bring it to a market.  GTL can allow such stranded gas to be transported out with the oil.  Coal from mines without rail links or with heavy moisture content are also a good match for CTL technology, but only if the environmental harm of the extremely high carbon emissions are ignored. 

Environmental Impact

The biggest worry about these technologies, especially coal to liquids, are the enormous carbon emissions arising from the low efficiency of the process.  This is not a concern for stranded natural gas that might otherwise be flared. The carbon from burning stranded gas will be released into the atmosphere in any case, and if some of that gas can be used, we have a net economic gain without any net emissions.  Remote and low-grade coal resources would likely be left in the ground if not used for CTL.  Diesel made from coal will have about 2 times the associated carbon emissions of diesel made from oil, because of the higher carbon content of coal and the low conversion efficiency.  If CTL enables more coal resources to be exploited, it will result in more carbon emissions, while GTL used on stranded antural gas will not.

Where will the Gas and Coal Come From?

It would be difficult to ramp up natural gas production to a point where a significant portion of the trucking fleet could be converted to run on natural gas.  Since converting natural gas first to diesel and then using it to fuel trucks would require even more natural gas because of low GTL efficiencies, I think GTL will be mostly used on stranded gas resources. 

The same is true for coal, but with different implications.  Many coal resources are remote, and coal's bulk means that it is difficult to access such resources without a huge investment in rail lines.  The United States has large coal resources in Montana and Alaska that are remote from rail transport.  Although the "200 years of coal" doctrine is questionable, the main questions lie around declining quality and accessibility of coal reserves, not the amount of coal actually in the ground.  Peak oil is likely to continue to raise investor interest in Coal to Liquids. But prospective investors in such projects should be cautious.  Greenhouse gas regulations such as California's Low Carbon Fuel Standard could destroy the economics of CTL investments at the stroke of a pen.

Investments

In addition to most of the oil majors, the main companies developing these technologies are South Africa's Sasol (SSL), Oklahoma based Syntroleum (SYNM), and Colorado based Rentech (RTK) mentioned above.  Sasol is a diversified oil and chemicals firm with long experience running Coal-to-liquids plants.  Syntroleum and Rentech are development stage companies with efforts focused on biomass to liquids and stranded natural gas.  Rentech puts considerable effort into managing the carbon footprint of its fuels by finding ways to sequester the carbon it produces.  In terms of investment attractiveness, I would not consider Sasol as an investment because of its CTL focus.  I like Rentech's environmental efforts, but the company is several years at least from profitability, so it is worth watching but I would not consider buying the stock yet.  Syntroleum has a stronger balance sheet and cash flow, is near profitability, so this is the stock I would pick if I had to choose one of the three.

Conclusion

I think the best investment opportunities in this sector will probably go to those investors who choose to wait.  I think the greatest potential is in Gas to Liquids technology that can be scaled down small enough to be portable, like that being developed by the private companies Compact GTL and Velocys mentioned above.

The potential for Coal to Liquids technology is large, but companies focused on this technology are at great risk from any sort of carbon regulation.  Gas to Liquids technology will have a robust niche based on stranded natural gas, and the companies developing technologies which can operate at high efficiency on a small scale seem the most promising.  Biomass to Liquids technology also show promise, in particular because of its feedstock flexibility.  Where the feedstock is uniform and controllable, biofuels and biomass to electricity technologies will probably have the upper hand, but Biomass to Liquids technology seems to have good potential where the feedstock is available in quantity, but irregular in quality.  Municipal solid waste seems like one such potential source feedstock.

Of the publicly traded companies in the sector, Rentech seems like the most interesting one to watch because of their focus on biomass and waste feedstocks.  Nevertheless, the company is too far from profitability to make a compelling investment.

DISCLOSURE: None.

DISCLAIMER: The information and trades provided here 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.

Cap and Trade: Right Debate, Wrong Solution

David Gold

         As we have seen in just the past few years, fossil fuel prices can vary dramatically over very short periods of time.  Creating greater certainty regarding steady increases in fossil fuel prices over the coming decade would have an enormous impact on private sector investments in both alternative energy and energy efficiency.  Cap and trade is the right debate to be having because it focuses the discussion on how to change the fundamental economics of fossil-based energy.  But ultimately cap and trade is the wrong solution; superior means exist to achieve the results we need not only for the environment but also for national security and our economy.  A better solution is a strategically targeted “ceiling” tax on carbon combined with a tax dividend.          Cap and trade sounds good on the surface. Seemingly it would allow the market the freedom to choose among implementing technologies that reduce greenhouse gas emissions, paying to use existing technologies that emit greenhouse gases, or paying for offsets from another entity.  But cap and trade is inherently flawed in its complexity and the slow rate at which it can propel change.  The potential for loopholes  and corruption, both through the specifics of how the law is implemented and the trading markets that will be created, are enormous.  If you have read my blog previously, you may be surprised to hear me come out against a seemingly market-based solution like cap and trade.  Many assume that because cap and trade worked for acid rain, it will work for greenhouse gases.  But for markets to work well there needs to be transparency around both price and what actually is being purchased.  As the graphics shown help illustrate, the complexity of greenhouse gases are enormous compared to the simplicity of sulfur emissions from coal plants. The challenges around accurate and transparent accounting of how much carbon is emitted or “re-sequestered” through an offset is fairly daunting.  There have already been significant challenges around carbon offsets with the European cap and trade efforts.  So far in Europe, the impact on greenhouse gas emissions has been much less than desired (for additional reading see the upcoming book by Roger Pielke).   Because of these factors, not only does cap and trade create risk of corruption because of the challenges around defining exactly what has been emitted or how much an offset has recaptured, but its ability to actually achieve the desired reduction in greenhouse gases also falls into question.

         Efforts to implement a cap and trade system that would be truly comprehensive would treat all long-lived greenhouse gases as equal. To make any meaningful difference, the price of carbon must be set high enough to move the meter significantly on the cost of fossil fuels.  Many experts estimate that price to be as much as ten times the current price in Europe.  As a result, if a cap and trade system is actually going to result in a meaningful reduction in greenhouse gas it will have an enormous impact on the economy given the scope of activities that generate greenhouse gases.  In addition, the sheer process of requiring businesses to account for their emissions would lead to significant wasteful administrative costs beyond the cost of the carbon emissions themselves.  Such a requirement would, however, create a great jobs program for accountants, attorneys and even investment bankers who would get paid to navigate the complicated mess that would result.  This reality is why many cap and trade proposals end up being limited to areas of highly concentrated emissions that are easy to track.  This effectively means focusing on power plants, which represent about 39% of the impact-weighted greenhouse gas emissions (of which 85% is from coal-fired plants).  And most proposals generally leave transportation -- which produces about 33% of the impact-weighted U.S. greenhouse gases – largely unaffected.

         “So what?” you say.  Let’s focus on reducing the 39% that is largely from coal-fired plants, right?  From an environmental perspective it does not matter where we reduce emissions – just that they are reduced.  But from an economic and national security standpoint it matters significantly.  The U.S. is home to roughly 25% of the world’s coal and supplies virtually all the coal Americans consume.  Meanwhile, the U.S. imports the majority of petroleum that we consume.  Reducing consumption of coal will not strengthen our national security, and the most immediate effect on our economy will be negative.  Even if one doesn’t believe those are important factors (hard for me to fathom but I know some feel that way), I suspect that everyone would agree that the political ability to implement something that moves the meter is critical.  A policy that appeals to the left and right of the political spectrum holds the best promise.

       Tax and dividend, whereby a tax is placed on carbon and some, if not all, of the proceeds are distributed back to those who paid the tax, is a concept that has begun to receive discussion as a potential alternate solution.  Such a system taxes based on consumption but the dividends are paid out without respect to specific consumption.  So, the motivation to move to alternative fuels or implement energy efficiency remains because the dividend will still be received even if tax payment is reduced.  Yet, the sting of the tax is reduced by receipt of the dividend.  Tax and dividend eliminates many of the problems associated with the complexity and lack of transparency with cap and trade and it largely leverages systems already in place to tax things like gasoline, coal, etc.  However, it still is flawed in that it treats all carbon as being equal.  Again, while all emitted CO2 is equal from an environmental standpoint, it is not from an economic or national security standpoint.  In addition, the greater the scope of the tax, the more interest groups it will upset and the less likely it is that it can ever pass Congress to become law. 

         The better solution, both from an efficacy and political standpoint, than cap and trade or tax and divided is a strategically placed “ceiling” tax on carbon combined with a tax dividend.  Our greatest opportunity lies at the nexus where greenhouse gases are reduced, national security is strengthened and our economy is at least not harmed.  As a result, the first element of the solution should focus on petroleum consumption, which is predominantly consumed in vehicles and the first strategic place for a “ceiling” tax is on CO2 emissions from fossil-based transportation fuels used in automobiles and trucks.  This is effectively a gas tax, except it would apply to gasoline, diesel and any future form of fossil-based fuel sold for ground transportation and would be based on the amount of non-renewable CO2 emitted upon combustion.  In addition, the tax rate would be determined by the difference between the price the retailer/vendor pays for the fuel and a pre-determined fixed maximum charge to the consumer (individuals and businesses alike).  If the ambient price of the fuel commodity increases, the tax that is charged would decrease.  Thus, it creates a “ceiling” on the tax where there is an ambient price at which the tax would no longer be charged.  Implementing the tax in this manner accomplishes several objectives:
  • It creates clarity, certainty and stability around the price that alternatives will need to compete with.
  • It sends a clear political message that this tax is not forever; it has a built-in mechanism to end when the ambient market price catches up with the artificial price created by the tax.
  • It puts a limit on the pain inflicted at the pump.  If fuel prices spike, the tax will diminish and even go to zero if the maximum charge to consumers is exceeded.
Now, what to do with the revenue?  We must ensure that the negative impact on our economy is minimized as much possible.  In addition, we have to be realistic and create something that can fly politically.  As a result, the tax revenue should be sent right back to the consumers who paid it.  For individuals, the amount received could be based on the size of the family to reflect the likely increased transportation needs.  Economically speaking, the dollars received by each family will be much more meaningful to a low-income family.  Yet, the payment is not based on income – something for Democrats and Republicans to celebrate.  For businesses, we must endeavor to avoid making specific businesses non-competitive. If a business has a transportation intensive business, the cost increase could be substantial.  So, distribution to companies could be based on their fuel consumption for transportation over a multi-year period prior to enactment of the tax.  That way, transportation-intensive companies will receive a much larger share than those that use little transportation directly in their business. What about the impact on the oil industry?  No doubt that such a tax would have an impact on oil consumption and therefore production.  It may even be politically required to dividend some of the tax proceeds back to the oil industry.   After all, democracy is the art of the possible.  This would likely mean a smaller oil industry to the extent that the industry doesn’t redirect its efforts to other profitable business efforts (e.g., geothermal, solar, etc.).  However, with a tax on transportation fuels, there would be a clear economic upside to the change.  The clarity provided with respect to future prices of gasoline and diesel would provide significant impetus and support for private sector investments in renewables as well as vehicle energy efficiency.  In addition, such clarity would spur significant economic growth in the automotive industry as consumers become eager to find energy efficient or alternative energy vehicles. One need only look at what happened with the sales of hybrid vehicles when gas prices spiked a few years ago. The auto industry would see a boom as consumers looked to switch to vehicles that consume less fossil fuels. President Obama’s desired goal is a 17% reduction by 2020 from 2005 emission levels.  If the tax is set at a high enough level, studies indicate it would drive significant change in buying decisions and driving behavior of consumers.  A key to the success of the tax is that it creates long-term certainty with consumers regarding the likely price of gasoline and diesel.  A Congressional Budget Office Study found that a 10% long-term increase in fuel prices would result in roughly a 4% reduction in fuel consumption (through a combination of reduced driving as well as purchase of different vehicles).
If the ceiling tax were set based on a target price of $5 per gallon retail price for gasoline, this would create long term visibility into a price increase and would imply we could see a reduction in fuel consumption (and corresponding emissions) of 40%-50% representing a 13%-17% reduction in overall greenhouse gas emissions.  The U.S. consumes more than 6x the gasoline per capital than Europe and one reason is that gasoline costs 2-3x as much at the pump than the U.S.  What the CBO study did not take into account (given the challenge of doing so) is what happens to petroleum consumption when alternative fuel vehicles then become cost-competitive.  I would suggest that the accelerated innovation that would occur in such vehicles once businesses knew they would be competing with a $5/gallon price would drive even greater reductions in greenhouse gas emissions and petroleum consumption well beyond 17% in 10 years. Clearly, such reductions are much less meaningful from an environmental perspective if carbon emissions elsewhere were to increase.  Given that electric vehicles are a probable future for some vehicles, we must address the emissions created by electricity production.  Otherwise, we will simply push CO2 creation from the tailpipe to the smokestack.  But rather than a complex loophole- and scandal-fraught cap and trade system, a strategically placed ceiling tax on CO2 emissions and corresponding dividend should also be used in the utility industry.  The challenge here is that just like cap and trade, in order to have a meaningful impact regarding the business decisions made on utility plants, the price of carbon must be set fairly high.  Because electricity costs impact every person and business in the nation, a carbon tax applied to power plants significant enough to be meaningful would have a broad-based negative impact on the economy.  Everything would become more expensive. Instead of a blanket tax, the ceiling tax on CO2 from electricity production should be much more strategic.  First, the tax placed on existing plants should be fairly modest and intended primarily to generate tax revenue that would be utilized specifically to provide funding to the coal industry for clean coal and sequestration technologies.  That is not only the politically correct move; it is economically smart given our vast coal resources.  A tax of just $2 per million metric tons of carbon would generate roughly $5 billion a year in tax revenue (U.S. utilities generate roughly 2,400 million metric tons per year).  Yet, it would add an average of about one tenth of a cent to the cost of every kilowatt-hour (U.S. total electricity production is roughly 4,100 billion kilowatt hours per year) or roughly a .01% increase in retail price.   Second, the tax on new plants built after a couple-year grace period for those already being constructed, should be set at a much higher level that ramps up over time to a capped amount. An initial tax rate of roughly $30 per metric ton would equate into a cost increase of about 3 cents per kilowatt-hour for the worst offending coal-powered electricity generation.  However, the specific amount of the tax should also vary based on the price of the underlying commodity (e.g., coal or natural gas).  That way, if there were a spike in a commodity price (like with natural gas a few years ago), the tax is automatically reduced or eliminated, thereby eliminating excessive spikes in electricity prices.
To make a carbon tax on utilities achieve the desired goal of driving a change in decisions regarding which type of plants to build, it is critical that utilities are not allowed to work the tax into their rate base - they must eat the tax cost or implement new plants that emit less or no CO2.  In addition, when plants reach a set timeframe after the end of their depreciation period, they would begin to be subject to the higher tax on new plants.  The incentive must be squarely placed on utilities to implement low carbon or no carbon means – all of which they can work into their rate base.  That means implementing renewable, nuclear, sequestration and likely some additional natural gas.  Given that the incremental plants will, by and large, create more expensive electricity than the base coal plants, utilities will have increased incentives to promote energy efficiency and implement the smart grid.   Until technology innovation allows otherwise, most incremental electricity load above the current base will likely cost more to deliver.  Such a tax, if set high enough on new plants, would likely create something akin to a cap on any increases in carbon emissions by utilities. As aging plants are replaced or retrofitted, reductions in emissions would begin.   In 10 years, if the vast majority of new electricity production beyond what was currently being built has been low- or no carbon and if just 15% of aging coal plants are replaced with low or no-carbon emitting alternatives, we would see a reduction from 2005 utility emissions of 3%-6% on top of the at least 13%-17% reductions from action on transportation fuels but without a severe negative impact on the economy.  And the clean coal and sequestration technologies developed from the R&D generated through the taxes would hopefully enable an acceleration in reductions as they are able to be implemented in the following years.


 In making decisions about how to reduce green house gas emissions, as a nation we cannot and should not focus solely on the issue of global warming while ignoring the equally important goals of maintaining our national security and economic strength.  We must implement a system that changes the economics of energy in a way that supports all of these goals.  Not only will cap and trade be unable to achieve these three goals, but without an extremely high price on carbon that likely cripples our economy it won’t even have a significant impact on the single goal of reducing green house gas emissions.  A system that does not focus first on our consumption of petroleum has little chance of strengthening our economy or national security.  In addition, to be successful, we must create greater clarity over long-term fuel price that the alternatives must compete with in order to provide the impetus for private sector investment in energy efficiency and alternative energy.  Cap and trade cannot give this clarity and the government cannot simply buy our way out of this problem.  We must have the innovation, creativity and financial power of the private sector motivated to making the scale of change that is required.  A strategically targeted ceiling tax on carbon with focused use of the dividends could create the log term clarity needed in the market and will motivate the private sector to dramatically increase investment in the type of innovation and change that is the source of ours (and the world’s) prosperity.

David Gold is an entrepreneur and engineer with national public policy experience who heads up cleantech investments for Access Venture Partners (www.accessvp.com).  This article was first published on his blog, www.greengoldblog.com.

April 02, 2010

Energy Storage Performed Poorly in the First Quarter of 2010

John Petersen

The first quarter was unkind to publicly traded companies in the energy storage sector, which saw their stock prices fall by an average of 16.22% over the last three months. While the shares of Enersys (ENS) and C&D Technologies (CHP) posted gains of 12.8% and 3.2% respectively, all of the others in my universe of 17 pure play energy storage companies traded down. The following table summarizes first quarter performance and provides some important valuation metrics.

Q-1.10 Summary.png

The following table summarizes the portfolio performance a hypothetical investor would have realized over the last three months if he invested $1,000 in each company and the three broad market indexes on December 31, 2009.

Broad Market Indices +4.89%
Cool Emerging Companies -14.85%
Cool Sustainable Companies -25.50%
Cheap Emerging Companies -29.24%
Cheap Sustainable Companies -6.65%
Chinese Battery Companies -13.70%

After publishing performance updates for a year and a half, I've decided that quarterly snapshots don't provide enough information to show how my tracking categories and companies have performed over time. In an effort to make these summaries more useful to investors, I'm going to introduce a new format that breaks the data down into more digestible chunks. I hope it helps.

Cool Emerging Companies

My Cool Emerging Companies category includes four companies that are developing cool but objectively expensive energy storage technologies that are not fully commercialized. The companies in this category are Ener1 (HEV), Valence Technology (VLNC), Altair Nanotechnologies (ALTI) and Beacon Power (BCON). These four companies were down an average 14.85% in the first quarter and have fallen an average of 36.80% since November 14, 2008.

The following table provides quarterly price information for each company's stock and is accompanied by a graph that illustrates their relative price performance compared with their closest peers and the Dow.

Q-1.10 Cool E.png

Cool Sustainable Companies

My Cool Sustainable Companies category includes three companies that manufacture cool but objectively expensive energy storage devices and generate substantial recurring revenue from product sales. The companies in this category are A123 Systems (AONE), Maxwell Technologies (MXWL) and Ultralife (ULBI). These three companies were down an average 25.50% in the first quarter, but have gained an average of 12.19% since November 14, 2008.

The following table provides quarterly price information for each company's stock and is accompanied by a graph that illustrates their relative price performance compared with their closest peers and the Dow.

Q-1.10 Cool S.png

Cheap Emerging Companies

My Cheap Emerging Companies category includes two companies that are developing effective but objectively cheap energy storage technologies that are not fully commercialized. The companies in this category are Axion Power International (AXPW.OB) and ZBB Energy (ZBB). These two companies were down an average 29.40% in the first quarter and have fallen an average of 12.76% since November 14, 2008.

The following table provides quarterly price information for each company's stock and is accompanied by a graph that illustrates their relative price performance compared with their closest peers and the Dow.

Q-1.10 Cheap E.png

Cheap Sustainable Companies

My Cheap Sustainable Companies category includes four companies that manufacture effective but objectively cheap energy storage devices and generate substantial recurring revenue from product sales. The companies in this category are Enersys (ENS), Exide Technologies (XIDE) C&D Technologies (CHP) and Active Power (ACPW). These four companies were down an average 6.65% in the first quarter, but have gained an average of 103.72% since November 14, 2008.

The following table provides quarterly price information for each company's stock and is accompanied by a graph that illustrates their relative price performance compared with their closest peers and the Dow.

Q-1.10 Cheap S.png

Chinese Companies

My Chinese Companies category includes four companies that manufacture a variety of energy storage devices including lead-acid, NiMH and lithium-ion batteries, and generate substantial recurring revenue from product sales. The companies in this category are Advanced Battery Technology (ABAT), China BAK Batteries (CBAK), China Ritar Power (CRTP) and Hong Kong Highpower (HPJ). These four companies were down an average 13.70% in the first quarter, but have gained an average of 80.28% since November 14, 2008.

The following table provides quarterly price information for each company's stock and is accompanied by a graph that illustrates their relative price performance compared with their closest peers and the Dow.

Q-1.10 Chinese.png

Murky Crystal Ball

Since July of 2008 I've consistently told readers that energy storage is an essential enabling technology for the cleantech revolution and has immense potential in transportation, wind and solar power and the smart grid. I've also consistently cautioned that the prevailing valuation metrics in the cool technology groups were far less attractive than the prevailing valuation metrics in the cheap technology groups. Since I believe Benjamin Graham was right when he said, "In the short run, the market acts like a voting machine, but in the long run it works like a weighing machine," I've consistently predicted that the cool technology groups were likely to stagnate or underperform on a go-forward basis while the cheap technology groups were likely to outperform. I think the comparative price performance charts say it all, particularly when you realize that China Ritar Power (CRTP) makes lead-acid batteries, instead of the lithium-ion and NiMH batteries made by the other Chinese companies.

The biggest challenge for energy storage investors is separating business reality from press release hype and establishing a realistic mental timeline for expected changes in the energy storage sector. Late last month, Lux Research published a new industry report titled "Emerging Technologies Power a $44 Billion Opportunity for Transportation and Grid." Some of the more intriguing conclusions I gleaned from my copy of the report are:

  • Heavy electric vehicles like hybrid buses, electric delivery vehicles, and hybrid trains will represent a $0.4 billion opportunity over the next five years for supercapacitors, and lithium-ion and molten salt batteries;
  • Annual revenue from battery sales for vehicle electrification will grow by about $6.8 billion over the next five years, including:
    • $4.5 billion in battery sales for e-bikes and e-scooters (predominantly lead-acid);
    • $1.2 billion in battery sales for plug in vehicles (predominantly lithium-ion)
    • $0.9 billion in battery sales for stop-start micro hybrids (exclusively lead-acid);
    • $0.5 billion in battery sales for HEVs (predominantly NiMH);
  • Annual revenue from grid-based storage will grow by about $1 billion per year, led by applications like wind and solar power integration ($810 million) and frequency regulation ($140 million); and
  • While lithium-ion battery sales will increase faster than lead-acid battery sales, lead-acid will remain the king of energy storage for the foreseeable future.

  • The futurist in me likes to look ten; twenty or even thirty years down the road and imagine what the world might be like. The realist in me knows long-term forecasts are always wrong because technological change is inherently unpredictable and the rate of change has been accelerating for decades. Therefore the investor in me tries very hard to concentrate on where the growth will occur over the next five years, and where market perceptions are out of synch with reality.

    The combined market capitalization of the lithium-ion and NiMH battery companies I track is about $2.75 billion. In comparison, the combined market capitalization of the lead-acid battery companies I track is about $1.8 billion. When a highly regarded firm like Lux reports that over 75% of the expected revenue growth during the next five years will go to companies that make lead-acid batteries, I have to believe the market's weighing machine mechanisms will significantly increase the valuation of the cheap technology companies while the cool technology companies tread water or decline. So far the theory seems to be holding up pretty well.

    The following table identifies six pure play energy storage companies that I'd classify as speculative. For each company I've taken the raw financial data from their December 31, 2009 SEC reports, eliminated derivative accounting impacts that make no sense in micro-cap companies and adjusted for stock conversion and financing transactions reported since year end.

    Q-1.10 Speculations.png

    If you focus on the intangible premium column, you’ll see a huge variation among the six companies. At the low end of the spectrum ZBB Energy’s (ZBB) market capitalization is only $6.8 million more than its tangible net worth. In my experience that’s a low premium for a speculative stock. At the other end of the scale, Valence Technologies (VLNC) and Ener1 (HEV) have intangible premiums of $185.7 million and $536.5 million, respectively. In my experience, both premiums are unsustainably high. The other three companies are clustered in the $40 to $70 million range, which is low compared to historical norms, but probably not unreasonable under current economic conditions.

    Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its stock.

    SPECIAL SUPPLEMENT:

    Tom Konrad suggested that it might be worthwhile for me to prepare a composite graph that showed the average performance of my five tracking categories to either support or refute my cheap vs cool methodology. I ran the graph for him and decided to add it to this article.

    Q-1.10 Composite.png

    Cheap may not always beat cool, but it's done a heck of a job over the last 18 months.

    April 01, 2010

    Exclusive Report: How to Profit from Global Warming!

    Dr. K.

    Global warming worriers like Al Gore are missing the many wonderful things that global warming will bring to the world, not to mention the many opportunities to profit from this so-called "climate catastrophe."  Global warming isn't about hot weather, it's about hot stocks in your portfolio.  A new report tells you the stocks to buy now!

    Global Warming is the greatest opportunity for investors in a generation.  Some stocks may fall, but others will be headed upward like a the famous hockey-stick chart from the 2001 IPCC report.  For just $499.95, you can buy my exclusive 20 page report on the best Global Warming plays that are certain to set fire to your portfolio like Australian brush during a heat wave after a decade long drought.

    Your portfolio

    This report details twenty hot stock picks all with the potential to skyrocket between 562% and 10,873%!  Here's a sample:

    Online University Stock Set to Soar!

    The people running this little known online university stock are no dummies, and they are ready to cash in on a new opportunity.  The reality of climate change has already created a shortage of respectable scientists willing to question it.  But rising oil prices and the threat of greenhouse gas legislation continues to increase the demand from hydrocarbon companies anxious to continue destroying the planet to protect their investors.  In order to cash in on this trend, this University will be launching a new multi-disciplinary Denial Education (DE) department.

    DE students will be able to take valuable correspondence courses such as Philosophy 621: "Missing the Forest for the Trees" and Photography 202: "Taking Pictures of Snow that Isn't Yet Melting."   Such courses come without such onerous nonsense like exams or learning, and, along with the new degrees the university confers to any student willing to pay the fee, will help the would-be denier into the lucrative industry of accepting the fat payments for lazy research supporting pre-determined conclusions.  In the response to the success of computer hackers at the University of East Anglia, they've quickly added offerings in computer security as well.

    In a sure sign of the strong demand for DE graduates, a large oil company has endowed a faculty chair, while a leading coal miner is helpfully providing student loans which may be repaid in services rather than cash when the budding deniers graduate. 

    But don't wait too long!  Soon thousands of freshly-minted DE graduates will be publishing papers about how it still snows in winter, and how big Al Gore's house is to pay off their student loans!

    More Sure-Fire Global Warming Winners:

    • A Real-estate investment trust that's ready for rising sea levels.  They're currently buying up tomorrow's beach-front property at today's fire-sale prices!
    • A biotech firm with treatments for many tropical diseases. Today, the company barely breaks even selling expensive medicine to poor countries, but as Global Warming brings tropical diseases into rich Europe and North America, they'll be in for a gigantic payday!
    • A company rolling up zoos sold off by cash-strapped municipal governments.  With species going extinct at a record pace, soon zoos will be the only place to see wildlife.  Attendance will soar, and this company will soar with it.
    ...and many, many, more!

    As an added bonus, I'll tell you about three stocks to short!  Like the global seller of saunas which is sure to go into terminal decline because of aggressive, low-cost competition from a competitor that does not need to make a profit: Mother Nature.

    Don't Miss Out!

    Don't let these hot-planet winners get away from you!  Everything you need to know to become a Global Warming billionaire is yours for just $499.95!  Order now!
     
    You don't want to be a global warming loser.  There are plenty of ways to make money, and if everyone else is worse off, it will be all that much easier to lord it over them with your new-found profits. 

    You will look back and thank me when you are sipping a Mai-Tai in the cool ocean breeze of your tropical North Dakota beachfront estate.

    Disclaimer: This post is not intended as investment advice.  If you're considering basing any investment decision making on anything in this article, you should 1) check yourself into a mental ward, and 2) check the publication date.


    « March 2010 | Main | May 2010 »

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