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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.



was posted on AltEnergyStocks.com.


       

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Comments

Why did you choose to segregate Chinese companies, rather than grouping them by technology and profitability, as you do all the others?

I've spent enough time in Asia to know that the human, business, banking and regulatory cultures are very different, and that I don't understand the differences as well as I'd like to. Given the vast cultural differences and my belief that peer group comparisons are one of the best ways to identify companies that are likely to outperform or underperform, I tend to think the Chinese companies have more in common with each other than they have in common with American companies developing comparable chemistries.

"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."

If you go back to my last quarterly review, you'll see that CRTP and ABAT were the top performers while HPJ and CBAK lagged behind. I'm very impressed with CRTP's growth trends and it's focus on lead-acid. ABAT is intriguing because it has recently integrated up the value chain into electric two-wheeled vehicles. Both appear to be good values for investors who want the international diversification.

John, Surely any discussion of exchange listed battery manufacturers is incomplete without BYD & Co (HK:1211) ?
The fact that it's share is listed on the Hong Kong stock exchange should not be a reason for it's omission.

I find myself in a delicate position as a working lawyer who practices before the SEC. They would obviously prefer that all companies who have substantial US stockholder bases register with them. Knowing that, I'd really rather not get off into companies that aren't registered. It is a shame because SAFT (Paris) is one of the finest advanced battery companies in the world and I'd love to talk about it more. But my licenses and regulatory relationships matter to me so I don't push too far afield.

My focus is pure play battery companies, which is something that BYD has never been. Historically it was a manufacturer of cell phone components that derived about 25% of its revenue from batteries. Now it's transitioning into an automaker and batteries will be an increasingly minor part of its revenue stream. So basically I don't talk much about BYD for the same reason that I don't talk much about JCI, it's not a pure play battery company.

Since you've raised the subject, I'll offer an opinion that BYD was probably a great deal when Mid-America bought stock at $1.12 a little over a year ago. Now that the price is 8x higher than the Mid-America price, I see a limited upside combined with a substantial short-term downside. BYD may in fact be a runaway success that never looks back, but that's not a risk I'm willing to take.

We are definitely bullish on alternative battery technologies. We feel the carbon non tube battery is the future. Although stocks are fluctuating and what you mentioned about the cultures of different countries, overall, any company divesting into alternative energy sources for power will do fine.

I have relationships going back to the early 1990s with carbon nanotechnology researchers from Rice university. In my view, structured nano-carbons like CNTs and graphene have incredible potential in batteries. The big issue right now seems to be cost and learning how to work with them, but I remain very optimistic.

I follow battery technologies, but work in a different technology sector. The numbers and analysis here focus on storage, though you do discuss auto batteries.

For autos (whether hybrid, PHEV, or EV), there's a basic deficiency in battery storage density currently (at any price). Vehicles demand batteries that are an order of magnitude better than today's in two ways--better storage AND cheaper.

My impression is that these large improvements will come out of efforts at fundamental innovation rather than incremental improvements to existing technologies. I base this on the assumption that existing technologies are closer to maturity and are more likely to be close to their maximum potential. In some innovator companies and in academic labs (esp. in the U.S. and Japan), work is being carried out to reinvent batteries. Most attempts will certainly fail, but some may pan out.

If you buy this line of thinking, success would seem to favor "cool" companies presently, rather than "cheap" companies. "Cool" companies would be more likely to develop the right technology in house, and would also be much better able to carry development forward on a prototype out of a university or a company acquisition/license.

I'm not sure that you want to move this discussion into the EV realm, but I'd be curious to get your take on these comments.

I'm a pretty harsh critic when it comes to cars with plugs because I believe the batteries we can currently manufacture are good enough for use as efficiency technologies in an HEV, but not good enough for fuel tank replacement in a plug-in. I don't see that dynamic changing until somebody does something completely different.

I basically agree with your view that most advances by public companies will be the incremental or sustaining type. The really big changes, when they arrive, are likely to originate in some innovators garage. One of my biggest concerns about the cool companies is that they're developing highly sophisticated devices but have no meaningful experience in manufacturing highly sophisticated devices, yet assume that they'll be better at manufacturing than the Sony's of the world.

The big problem with battery innovation is that it takes years, costs a fortune and fails more often than it succeeds. So until something better comes along and proves its worth in a free market, the best investments will be the companies that can manufacture and deliver cheap and reliable products today.

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