More Common Sense in Energy Storage Investing
Since last week's article, Common Sense in Energy Storage Investing, was well-received by readers who've recently discovered this blog and want to better understand the energy storage sector, I've decided to continue with the theme and drill down deeper into some broad issues. Most of today's material is pretty basic stuff, but when the hype machine starts spinning a firm grasp on economic reality and investment fundamentals can be important to investors that want to avoid a boom and bust bubble like we had in corn ethanol.
In the fall of 2008 I confessed to being a shameless early adopter of cutting edge technology. I bought the first portable electronic calculator in 1971; bought word processing, laser printing, videotape, compact disks and satellite TV in the early ‘80s; bought a cell phone and established an Internet domain in the early ‘90s; and established a paperless office and a global law practice by the late ‘90s. If it was new and a major advance, I had to have it first regardless of cost. When I look back at the last 40 years, I'm amazed at how quickly the latest and greatest technologies became obsolete when newer, better and cheaper products emerged. The most recent example of how quickly technologies can rise and fall happened just last week when Sony (SNE) announced that will quit making floppy disks next March. As an investor, I'm horrified by the idea that a technology as important as the floppy disk can rise to global dominance and decline to insignificance in forty years.
In most cases, I've adapted well to changing conditions. My only line in the sand has been an almost religious devotion to the Macintosh operating system, which I switched to in the fall of 1989 based on the personal advice of Dr. Wilson K. Talley of the Lawrence Livermore National Laboratory. While I've never questioned my choice in computers, a graph comparing the long-term stock price performance of Microsoft (MSFT) and Apple (AAPL) serves as a stark reminder of how a sound technical decision played out in the equity market.
Today I can sit back and bask in the glow of being right about Apple's inherent technical superiority, but that doesn't change the fact that I was right too early. If I'd been a truly prescient investor, I would have owned Microsoft for the first dozen years and then switched to Apple for the long term.
Last week I re-printed a table from a July 2008 Sandia National Laboratories report that estimated the current and 10-year projected cost of stationary energy storage systems for solar power installations, including the storage devices and power conditioning equipment necessary for turning DC output into 60-Hz AC power suitable for delivery to the grid. The following chart puts the projected future cost of systems using the ten battery technologies included in the Sandia study in graphic form. While the media is enthralled with lithium-ion batteries because of effective PR and the oh so alluring promise of electric cars, my experience as a Mac user tells me that the vast majority of likely buyers will obey the laws of economic gravity and buy the cheapest system that can do the work.
The bottom-line is that major innovations take decades to evolve and work their way through the markets. The process was first explained in the technology adoption lifecycle, a model that emerged in the '50s and has since been refined by contributions from Geoffrey Moore and others who explain the process with graphs like this one from Crossing the Chasm.
We are living in the first days of the Age of Cleantech, the sixth industrial revolution. The media is chock full of stories about how wind and solar power will change the way we generate electricity, the smart grid will change the way we distribute and use electricity, vehicle electrification will free us from pollution and the tyranny of imported oil, and energy storage will be the keystone – an enabling technology that makes all the other advances possible. What the news stories don't tell us, because frankly nobody knows, is when these technological marvels will hit their stride and make a meaningful difference in the way we live. To help put things into perspective I've used data from a press release teaser for the American Wind Energy Association's annual market report for 2009 to create a graph of the annual and cumulative changes in U.S. wind power capacity over the last 15 years.
The first use of a large windmill to generate electricity was a system built in Cleveland, Ohio, in 1888 by Charles F. Brush. If you only consider the cumulative values since 1995 the growth seems pretty stable. If you think about the hundred and twenty year history of wind and study the annual additions and other data from the teaser, it becomes clear that wind power didn't transition out of the innovators stage until 2004, and then it took another three years to reach the early majority stage.
A similar trend is clear in the 10-year history of the HEV market, as shown by the following graph from hybridcars.com.
Viewed in isolation, HEVs have built an impressive growth history. Viewed as a segment of the larger market, they're just beginning to scratch the surface with 2009 numbers that represented 2.8% of light duty vehicle sales. Returning to the technology adoption lifecycle, HEVs are just now transitioning out of the innovators stage and into the early adopters stage. Plug-in vehicles, in comparison, are at the earliest possible point on the curve. I'm very optimistic about the future of HEVs because they've already demonstrated a decade of consistent growth and built a solid core of satisfied consumers. I'm less sanguine about plug-in vehicles because they have no track record and even their strongest advocates acknowledge insurmountable obstacles to widespread vehicle electrification over the next decade including:
- The high cost of batteries;
- The lack of recharging infrastructure;
- Capacity, regulatory and coordination problems in the electric power sector; and
- Consumer acceptance issues.
If we study the Berger forecast and think back to the technology adoption lifecycle graph, it's pretty clear that HEVs are expected to follow a natural growth path over the next decade as their market share quadruples. It's also clear that something beyond normal market forces is expected to drive the adoption of plug-ins and stop-start systems. In the case of plug-ins the main driver of growth will be subsidies and incentives as governments around the world tax Peter to pay for Paul's new car. In the case of stop-start systems, the main driver will be new CO2 emissions and fuel economy regulations that require automakers to reach increasingly stringent targets. The first approach relies on incentives to create demand that wouldn't otherwise exist. The second approach relies on penalties to force automakers to implement efficiency technologies without regard to consumer preferences. In my experience, government is not very effective when offering a carrot but it's darned good at using a stick. Under the circumstances, I'm inclined to believe the stop-start penetration rates are a sure thing while the plug-in penetration rates include a hefty dose of wishful thinking.
Over the next five years manufacturers of inexpensive energy storage systems for stop-start applications are certain to report major revenue gains from C02 emissions and fuel efficiency regulations that are now fait accompli. The main publicly traded beneficiaries include Johnson Controls (JCI), Exide Technologies (XIDE), Maxwell Technologies (MXWL) and Axion Power International (AXPW.OB). If the planned introductions of plug-in vehicles later this year proceed as planned, the government incentives are successful and innovator class purchasers don't experience too many problems with battery pack failures, range limitations, poor cold weather performance and limited charging infrastructure, battery manufacturers like Ener1 (HEV) and A123 Systems (AONE) may begin realizing revenues that justify their market capitalizations in the second half of the decade.
I've already had my Apple vs. Microsoft experience and don't intend to repeat it. I'll continue to buy green bananas, but my days of trying to carve a new plantation out of the jungle are over.
Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.