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November 29, 2010

Time To Buy Solar Stocks?

Tom Konrad CFA

Renewable Energy stocks have been suffering for over a year. but the sector's poster-child has also been the whipping boy.  While the S&P 500 has risen 8% percent in 2010, the broader alternative energy sector is down 10% and solar has fared even worse.  Solar is down 27% for the year, with a 17% drop in the last 2 weeks (see chart.)

TAN PBW SPX chart

Ian Tharp - CIBC World Markets

These numbers were brought home to me by a presentation by Ian S. Tharp, CFA, an Executive Director and Cleantech and Renewable Energy Analyst at CIBC World Markets.  He was speaking at The Future of Energy Investing Conference last Thursday.  The sharp down move in recent weeks made me wonder if this might be a sign of capitulation.  I don't follow the solar sector closely, but given its historic volatility, I think there is a lot of potential for astute traders to make money in the sector. 

I asked Mr. Tharp if he thought the sector showed signs of bottoming.  He said "Yes" and gave the following reasons (some of this may be slightly garbled because I'm working from memory)
  • 2010 installed capacity is double what it was in 2009.  This may not be what the industry hoped for, but it's still impressive growth.
  • Silicon prices have stabilized.
  • Solar module prices have also stabilized.
With that background and current low prices for solar stocks, the stage may be set for a strong rally.

The Motley Fool

Travis Holum at the Motley Fool also thinks Solar stocks are ready to rally
, and he quotes management of several solar companies as evidence of continued strong demand:
  • First Solar (NASDAQ: FSLR) said the majority of its production has already been sold for 2011.
  • JA Solar (NASDAQ: JASO) has agreements and received prepayments from customers for 1.2 GW of its 1.35 GW to 1.45 GW of capacity for next year.
  • At Sunpower (NASDAQ: SPWRA) the CEO Tom Werner says "demand is greater than the supply" and the North American commercial business is "70% booked for 2011."
  • This week, Suntech Power (NYSE: STP) said analysis of customer demand saw "it was 30% above our ability to supply for the entire year."
  • Solarfun (NASDAQ: SOLF) sees "healthy market demand" going forward and is adding capacity accordingly.
It seems like there is a good case for a solar rally, so I sent off a couple quick emails to a couple other solar stock experts, asking them the same question. 

J Peter Lynch

J Peter Lynch is an investment banker with a focus on the solar sector at Salem Financial, which he tracks closely.  He says:
I think solar stocks are poised at a critical point.  19 of the 22 stocks I follow have positive momentum (longer term indicator), 20 of 22 stocks have negative weekly momentum (short term indicator) and 21 of 22 stocks are oversold an average of 30.9%.  I think we may see a short term bounce and possibly the continuation of the longer term positive trend indicated by the overwhelming positive monthly momentum.
So the technicals seem good for a rally, although there's some question about how long it might endure.

Jeffrey Cianci

Jeffery Cianci is Chief Investment Officer at Green Science Partners, a hedge fund that invests in both public stocks and private equity.  I wrote about him in my roundup of the cleantech experts at the most recent San Francisco MoneyShow.  Mr. Cianci uses a combination of fundamental and technical analysis, and clearly has a depth of understanding of the stocks he trades.  He is more cautious:
I'm not sure if stocks have bottomed yet.  There needs to be some constraint on the building cycle.  Until then, with European problems possibly limiting the demand side, as well as FIT [Feed-In-Tariff] reductions, there will be 2H11 oversupply worries, and may take time to disprove a negative.  I would feel safer with the solar cap equipment names, not as sensitive to pricing:  GT Solar [SOLR], Amtech Systems [ASYS], and STR Holdings [STRI] the faves, as well as solar inverters, Power-One [PWER] and SatCon [SATC].  The ETF’s are too concentrated on the module guys, so I would avoid them.
I found Mr. Cianci's critique of the Solar ETFs (TAN and KWT) particularly interesting because it parallels my own critique of the general alternative energy ETFs: they tend to be over concentrated in particular sectors.

Conclusion

I tend not to be a short term trader, and the opinions of the experts above are mixed, with even the more bullish hedging their opinions.  Based on the above, I'm not ready to jump into solar stocks, but if I were, I'd be looking at the capital equipment manufacturers Mr. Cianci likes.

DISCLOSURE: No Positions.

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.

November 28, 2010

Can America Regain the Rare Earths Crown?

by Kidela Capital Group

A rare earth element is like air. It only seems to become important when you are running out.

With China suddenly cutting back on exports while controlling 95 percent of the world’s production of rare earth elements, the United States and other countries suddenly finds themselves vulnerable. This vulnerability has to do with the stability of the supply of these strategic commodities. Countries from around the world have suddenly woken up to the realization that the future of their high technology industries could be in the hands of one supplier – China.

In the USA, this realization comes at a time when the Obama administration has committed the United States to replacing more than a million gasoline powered cars with hybrid and electric cars by 2015. These cars – referred to as “green” vehicles – use A LOT of rare earth elements in their power trains. Reducing the US’s reliance on foreign oil is one motivation for moving to green cars. However, given the current situation, and unless alternative supply sources are found – soon – it appears that the US might be replacing a dependence on one commodity (oil) for reliance on a much more difficult to find and more expensive one (Rare Earth Elements – REEs). And these REEs are almost exclusively available from its main trade rival. Somewhat belatedly the USA has discovered the looming crisis in rare earth availability and has only recently begun to look at securing domestic supplies and rebuilding its supply chain.

“If we don’t think this through, we could be trading a troubling dependence on Middle
Eastern oil for a troubling dependence on Chinese neodymium.”

Irving Mintzer, Senior Adviser, Potomac Energy Fund

American rare earth dominance ends only recently

And yet, it didn’t have to be this way. Given China’s near monopoly in rare earths production it might come as a surprise to learn that the United States was the world’s leading producer of rare earths as recently as 1995.

Until 1948, most of the world’s rare earths were mined in India and Brazil. In the 1950s, South Africa assumed the status of world’s leading rare earth source, but a single mine in the United States eventually overtook South Africa’s production output. From the late 1950s, into the mid-1980s the Mountain Pass rare earth mine in California was the world’s leading producer of REEs.

The deposits at Mountain Pass were discovered in 1950 by two prospectors who found a radioactive outcrop and assumed they had located a source of uranium. The prospectors were disappointed to learn that their claim did not contain uranium but rather flouro-carbonate bastnaesite. This mineral was completely worthless to them but was very interesting to the US Geological Survey. The Geological Survey undertook further surveys and discovered non-radioactive deposit of bastnaesite. One of the two original prospectors who found the deposit worked for MolyCorp (MCP) and he persuaded the company to claim the land although it didn’t exactly know what to do with its rare earth ore. MolyCorp spent the next two decades developing a market for the rare earth elements found in its mine: Cerium, lanthanum, samarium, gadolinium, neodymium, praseodymium and europium.

Throughout the 1970s and 1980s, the Mountain Pass mine produced more than 70 percent of the world’s supply of these valuable minerals. At the peak of its operations, the mine produced 20,000 tonnes of rare earth oxides a year.

However, during the mid-90’s commodity prices bottomed out and the mine found it increasingly difficult to compete with cheaper Chinese imported rare earths. In 1998, after hundreds of thousands of gallons of water carrying radioactive waste spilled into and around Ivanpah Dry Lake, the chemical processing at the mine was stopped and the mine shut its doors. After the California mined closed, China assumed the mantle of world leader in rare earth extraction.

Whether focusing on REEs was a deliberate and clever trade strategy or a happy accident, China now had firm control of the world supply of REEs. And while demand remained stable and China exported its REEs at low price points, the US became complacent. Remaining REE stockpiles around the country were sold off and the US as a whole let the REE market completely get away from them.

Scrambling to catch up

Fast forward to 2010, and we find that the demand for rare earths has risen considerably given all of the recent discoveries of additional technological uses for the minerals. Just as REE demand has started to ramp up, China began to restrict exports. The US, like other nations, is scrambling to react and get back in the game. However, ramping up a dormant industry is costly and requires a great deal of time. Obtaining a mining license and the associated environmental permits can be described as a regulatory equivalent of a very long cross country steeple chase.

“When you stop mining in this country, as investment goes down, expertise
on cutting-edge technologies is exported as well.”

Carol Raulston, National Mining Association.

Restarting a mine is no easy task. Environmental regulations in 2010 are considerably more stringent than they were back in the 1970s, costs are multiples of what they were and there is also the challenge to find the expertise needed to mine and process these elements.

While there may be a number of prospective rare earth element sites around the world, the challenge mining companies have is that they have to pay for and put the infrastructure and processes into place necessary to mine and process them.

Until that time, relying solely on Chinese exports does not seem to be an option for the US any longer. The supply chain for a number of commercial and defense related industries has already begun to break down. A Government Accountability Office (GAO) report from April 2010 identified four rare earth element shortages that have already caused some kind of weapon system production delay.

The US government is examining its options. Some of these include: stockpiling REEs supplies, securing other suppliers from around the world and allocating and redirecting REE purchases for defense and national security purposes.

US mining industry lobbies for domestic support

Given its past dominance, it is argued the US has the reserves and capacity to more than meet its domestic needs. Similar efforts have been undertaken in Canada and Australia and both countries are in the early stages of rebuilding the necessary infrastructure.

According to the U.S. Geological Survey, there are 13 million tons of extractable rare earths in the United States, 5.4 million in Australia, and 19 million in Russia and neighboring countries. In 2009, China had 36 million tons.

The US mining industry is acutely aware of the challenges in restarting the US rare earth industry including securing large amounts of investment capital in this rough economic climate. Other challenges include the need to develop and implement advanced mining techniques, and the need to meet stringent environmental impact stipulations. There is also a pressing need for greater domestic research and development efforts related to refining techniques. The process will be a long one and it is has been expected that the return of the US REE industry to former levels will take a decade or more.

“I would say conservatively the earliest that we could open a mine has to be six to seven years.”
Edward Cowle, President and CEO U.S. Rare Earths

Not your grandfather’s rare earth mine

MolyCorp’s rare-earth separation plant at Mountain Pass, resumed operations in 2007. This year, MolyCorp began using stockpiled rock that was mined under a previous permit and employed new separation technologies. The company expects to sell 3,000 tons of rare earths in 2011 and by 2012. MolyCorp expects to eventually produce 20,000 tons a year, and produce rare-earth products at half the cost of the Chinese. However, the company cannot use the processes used in the mine’s heyday: processes that are both economically and environmentally unsustainable. According to the company, their new techniques are both more environmentally sound and save money, techniques such as eliminating the production of waste saltwater. MolyCorp will use a closed-loop system, converting the waste back into the acids and bases required for separation and eliminating the need to buy and transport dangerous chemicals. The company will also install a natural-gas power co-generation facility on site to cut energy costs.

“We want to be environmentally superior, not just compliant.
We want to be sustainable and be here for a long time.”

Mark Smith, CEO MolyCorp

MolyCorp is upbeat, but there are still challenges in getting the mine up and running. Memories of the poor environmental record are long and environmentalists state that they and the regulators will be looking long and hard at their start up plans. There is also the key problem that processing the raw product is a costly time consuming exercise. MolyCorp claims it spends only about 10 percent of its budget on actual mining. The big cost is in the process to chemically separate the rare earths from the minerals that carry them. Rock is milled first into gravel, then sand, and then must be separated by repetitive mixing with solvents sometimes tens of thousands of times. Rare earth oxides are useful in some industries, but items like magnets require pure metals which requires even more processing and which can produce even more environmentally hazardous by-products.

To help fund its quest to reestablish a rare earth mining industry in the US, MolyCorp went public this year and has also appealed to the US government for loan guarantees, and financial assistance for research and development.

MolyCorp expects to reach its peak production capacity by producing 20,000 metric tons of cerium, lanthanum, praseodymium, and neodymium. The mine will also produce small amounts of other critical rare earths – samarium, europium, gadolinium, terbium, dysprosium, and erbium. This production output may be enough to sustain many of the domestic needs of the U.S. MolyCorp is also planning to re-establish domestic supply chains by partnering with domestic magnet producers.

The US mining industry is poised to ramp up its domestic rare earth production but the question remains; can the US wait for the 10 to 15 years it will take to bring the rest of the REE industry fully online in the US? Even with support from US lawmakers, will the broader industry be able to be internationally competitive? The costs might be too high for some in this industry. For example, Molycorp has to pay some $2.4 million a year on environmental monitoring and compliance, costs. Until monitoring and regulations to curb their negative environmental impacts take effect in China, Chinese companies do not have these same cost burdens.

Much is riding on how the US weathers the next couple of years. Get it wrong and it could prove to be very rough going. Get it right, and the vast majority of people will never know they almost ran out of vital commodities that are at the very heart of the technology that keeps the world humming and their homeland safe. As we type this, there are many dedicated and talented people who are taking great strides to rebuild their country’s REE infrastructure and knowledge base in hopes of once again becoming a world leader in REE production.

Disclosure: No Positions.

Kidela Capital Group Inc. is a diversified research, consulting, communications and investor relations firm. We are dedicated to assisting early to mid-stage companies achieve their goals by delivering a range of innovative and effective value added services.

Related articles:

Will Rare Earths Cripple the Green Economy? Part 1 and Part 2 (Eamon Keane, September 2010)
Rarer Rare Earths Are Not Going To Sink The Wind Power Sector (Charles Morand, Aug 2009)

November 24, 2010

Axion Power and BMW Report Impressive Performance Test Results

John Petersen

After seven years of cautious disclosures about the development status, performance and market potential of its serially patented PbC® battery technology, Axion Power International (AXPW.OB), in conjunction with BMW (BAMXY.PK), has finally released impressive performance test results that show why the PbC battery is a superior choice for automotive stop-start applications. Concurrently, Axion released a white paper that discusses stop-start battery requirements in detail and offers some hints about the PbC battery's potential for use in other emerging energy storage markets.

The presentation and the white paper do not show small, incremental gains like you would normally expect from new developments in a 150-year old technology like lead-acid battery chemistry. Instead, they show that compared to a top quality AGM battery the PbC battery provides:
  • 10 times the dynamic charge acceptance;
  • 5 times the cycle life;
  • Stable round trip energy efficiencies in the 85% range; and
  • 30% less weight.
The details of the presentation and white paper are complex, but the results can be quickly summarized with two simple graphs. The graph on the left tracks the dynamic charge acceptance of an AGM battery over two years of simulated use in a vehicle equipped with a stop-start idle elimination system while the graph on the right tracks the dynamic charge acceptance of the PbC battery over four years of simulated use. Where the AGM battery graph shows that the charging rate plummets and the time needed to recharge the battery soars within months after the battery is placed in service, both values remain stable for the entire duration of the PbC battery test.

11.24.10 VRLA.png11.24.10 PbC.png

In a recent report on the battery market for micro-hybrid vehicle applications, Lux Research stated that most automakers believe flooded lead acid batteries are "inadequate" for stop-start applications. It also observed that AGM batteries are "barely suitable" for high performance stop-start systems. In light of early European experience with stop-start systems and the new test data from Axion and BMW, it looks like the PbC will be the best battery choice for automakers that want to optimize the performance of their stop-start systems and minimize exposure to battery-related warranty claims. After all, it's senseless to upgrade mechanical systems in an effort to conserve fuel and slash CO2 emissions, and then handicap the new systems by using batteries that can't handle the load.

For more information on the market forces that will drive rapid global implementation of stop-start idle elimination technologies, my blog archive at Seeking Alpha is a great resource. You may also want to visit  EV Insights for the recorded version of a recent conversation I had with Jack Lifton and Gareth Hatch.

Axion began development work on the PbC battery in late 2003 and in early 2006 it bought the manufacturing equipment of an old-line battery producer in a foreclosure sale. While Axion paid $700,000, replacement cost estimates were an order of magnitude higher. For the last four years, Axion has primarily used the plant as a prototyping facility for PbC batteries. Nevertheless, its permitted capacity is 3,000 batteries per day and the installed equipment includes two flooded battery production lines and one AGM battery production line.

The principal research and development work on the PbC battery is finished, but the device is not yet available as a commercial product. Axion built a first generation fabrication line for the carbon electrode assemblies that are the heart of the PbC battery in 2008 and 2009. Based on lessons learned from the first generation line, Axion has upgraded or replaced several workstations on the first generation line and designed a second generation line that should be operational in the first quarter of 2011. With two electrode fabrication lines, Axion should be able to produce electrode assemblies for about 250 PbC batteries per shift, or 150,000 PbC batteries a year with a three shift operation. Its existing AGM battery line has enough idle capacity to fully absorb electrode production from the first two electrode fabrication lines.

Axion has no debt and enough cash to support its planned demonstration activities in automotive, stationary and rail transportation applications through 2011. It does not, however, have sufficient financing or production capacity to support a full-scale commercial rollout of the PbC battery. Such a rollout would require about $75 million in funding from grants, loans or stock sales to increase electrode fabrication capacity to a million units per year and cover associated working capital requirements.

The first use of future electrode capacity additions will be to bring Axion's AGM line up to full capacity. Excess electrode production will be sold to Axion's manufacturing partners Exide Technologies (XIDE) and East Penn Manufacturing, two of the largest battery companies in North America. Over the long term, Axion intends to focus on electrode manufacturing and sell its electrode assemblies to industry partners that own and operate existing AGM battery plants. The PbC electrode assemblies have been designed to work as plug-and-play replacement components in any AGM battery plant and Axion's business model has been designed to leverage existing global manufacturing capacity while giving its partners an opportunity to sell a premium co-branded product to their existing customers.

From late 2003 through early 2007 I was a director of Axion and I’ve watched the PbC technology progress from the laboratory prototype stage to a pre-commercial product that has drawn a surprising amount of interest from automakers, railroads and developers of wind and solar power installations. While we originally expected to start at the bottom of the food chain and work our way up as the PbC technology matured, it's hard to complain about too much attention from first tier energy storage users. At this point the remaining challenges relate primarily to industrial engineering refinements and completing the rigorous validation and performance testing that first tier users always require before they write a purchase order. In light of the BMW test results, I'm convinced the only open question is "When?"

Over the last year market forces that had nothing to do with Axion’s business fundamentals or the PbC battery's performance have brutalized its stock price. The stock currently trades within spitting distance of the price paid by several highly regarded institutions last December. As an understanding of the new performance data begins to spread, I think the upside potential is significant. For more conservative investors, a solid alternative play on the PbC technology is the stock of Exide Technologies, an Axion partner that I think is fundamentally undervalued.

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

November 23, 2010

In Clean Energy, Active Management Pays

Alternative Energy and Climate Change Mutual Funds, Part V

Tom Konrad, CFA

Actively managed clean energy funds have been producing better returns than index funds, despite much higher expenses.

I've long been critical of the costs of Alternative Energy mutual funds, but I now regret that stance. 

Past Performance of Mutual Funds

When I recently surveyed the performance of Alternative Energy mutual funds, I found the results were pretty good, at least in comparison to the oldest sector index fund, the Powershares Clean Energy Index (PBW).  See the following chart below, which shows the amount you would have had to invest in each of the alternative energy mutual funds at the start of any given year, in order to have $1,000 at the end of October 2010.  Lower values are better, so the lines at the bottom of the chart are the best performing mutual funds.

Performance of Alt E and Climate Change Mutual Funds Vs S&P 500
Note that the orange line, for the Powershares ETF, has performed worse than almost every mutual fund over three or more years.  A couple of the mutual funds performed worse than PBW over the last one or two years, but the shorter the time period in question, the more likely the result is to have been the result of luck than management skill.

Past Performance of ETFs

One possibility is that the apparent superiority of actively managed mutual funds is not the result of the mutual funds being superior, but because I might have chosen an inferior ETF.  In order to check, I performed a similar study on the broad Alternative Energy Sector ETFs:

ETF Performance
As you can see, PBW is the second-worst performing ETF since the start of 2008, although it has performed a little better over the last two years, so some of the mutual funds' apparent out performance is due to my selection of PBW as a benchmark.

But not all.  As you can see from the table below, the average clean energy mutual fund has outperformed the average clean energy ETF by 17% over the last 3 years (which is the entire track record for a majority of the existing funds and ETFs.)  Furthermore, the best mutual fund beat the best ETF by a whopping 52%, and even the worst performing mutual fund beat the worst performing ETF by 3%, so the actively managed mutual funds beat the passively managed ETFs across the board.

Performance Jan '08 to 11/14/10
Worst
Average
Best
Mutual Funds
-63% (GAAEX)
-37%
21% (SRICX)
ETFs
-66% (GEX)
-54%
-31% (PZD)
10 Stocks for 2008, '09, and '10.
-32%

Despite the fact that we only have three years of data, I'm now fairly confident that most investors would be better off choosing one of the clean energy mutual funds than they would be choosing one of the ETFs.  Which mutual fund should you pick?  That's the topic of this series of articles on Alternative Energy and Climate Change Mutual Funds.  So far, I have looked at mutual fund costs (part I), portfolio composition (part II) and past performance (part III).

Stocks Are Still Best

I've also picked out some interesting individual stocks from the mutual fund portfolios (part IV).  That is because, while I've reversed my former position and now think an actively managed mutual fund is better than a passively managed ETF, I've always said that an actively managed clean energy stock portfolio is the best of all worlds. 

An actively managed stock portfolio can be managed at lower cost than the sector ETFs, and much lower cost than the sector mutual funds.  It's also not particularly hard to build such an actively managed stock portfolio.  One approach is cherry-picking stocks from the portfolios of the mutual funds themselves, as I did in part IV of this series.  I tried a similar experiment in 2009 which I called a Quick Clean Energy Tracking Portfolio, and the resulting portfolio strongly outperformed the mutual funds it was built from, although that turned out to mostly due to my selection of high-Beta stocks for the portfolio.

Another easy way to build an actively managed stock portfolio is to use my annual "Ten Clean Energy Stocks" list, which I've been publishing at the start of the year since 2008.  While this is not a truly actively managed portfolio since it only trades once per year, the performance has been better than the vast majority of the mutual funds and ETFs, having lost only 32% since the start of 2008, while the average mutual fund lost 37%, and the average ETF lost 54%.  See the table above.

If you have the time and interest, you can manage a stock portfolio.  That's always been my favorite option, since I do it myself, but it's also practically a full-time job, at least if you want to do it well.

One last option is to use an investment advisor who will manage a portfolio of clean energy stocks for you.  So far, I know of three, although not all of them will take small accounts.  Use the contact link to send me an email if you'd like a referral.  You may also want to read what I have to say about selecting an advisor here.

If you are an advisor who manages green individual stock portfolios for your clients, let me know and I'll add you to my list.

DISCLOSURE: No Positions.  GAAEX is an advertiser on AltEnergyStocks.com.

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.

November 21, 2010

Alternative Energy and Climate Change Mutual Funds, Part IV

Tom Konrad CFA

Cherry picking the holdings of green energy mutual funds.

So far in this series I've concentrated on trying to pick the best of the Alternative Energy and Climate Change Mutual Funds.  This is a difficult task, because while I found in Part III that most of the funds' performance has been better than comparable index ETFs, these mutual funds' costs are quite high, even by the standards of most mutual funds, as I discussed in Part I.  In part II, I tried looking at the sector breakdown of the funds' holdings, to see if I could explain some of their performance that way.  It turns out that funds that buy the most solar stocks have underperformed in the past.

The underperfomance of solar-heavy funds confirms one of the principles of alternative energy sector selection that arise from common misunderstandings about how Alternative will re-shape our economy.  I went into them in more detail in part II, but in short they are:
  1. Underweight Solar
  2. Overweight biomass producers compared to their customers, biofuel producers.
  3. Focus on Energy Efficiency and Conservation.
  4. Invest in the Electric Grid.
  5. Favor Alternative Transport over the personal car.
What follows is my attempt to build a portfolio from the stocks owned by these mutual funds, but conforming to the principles above.

Fund Holdings: Solar Stocks

Many of the funds own large quantities of First Solar Inc (FSLR), SMA Solar Technology (S92.DE), MEMC Electronic Materials (WFR), and JA Solar Holdings (JASO).  First Solar is the largest holding of these mutual funds overall, accounting for 6.6% of the Winslow Green Growth Fund (WGGFX).  Overall, the average fund is about 24% allocated to solar, something I hope to improve on by leaving them out of the portfolio I'm building.

Fund Holdings: Biomass

By far the largest holding biomass holding in these companies is Sino-Forest Corp. (TRE.TO), a commercial forest plantation operator in China.  The second largest holding is Deltic Timber Corp. (DEL), but it's only held by one fund, the DWS Climate Change Fund Class S (WRMSX).  I'm looking for stocks held by at least two funds for this portfolio.

Fund Holdings: Energy Efficiency and Conservation

The top energy efficiency holding is also my personal favorite, Waterfurance Renewable Energy (WFI.TO), a manufacturer of Geothermal Heat Pumps.  Also held in quantity are Rubicon Technology (RBCN), which sells mono-crystalline sapphire and other crystals to the Light Emitting Diode (LED) industry, and LED industry leader Cree Inc (CREE).  In conservation, we have water system repair firm Pure Technologies Ltd. (PUR.V).

Fund Holdings: Electric Grid

The top electric grid holdings were meter-maker Itron (ITRI), and transmission contractor Quanta Services Inc (PWR), both of which I've written about in these pages

Fund Holdings: Alternative Transport

These funds are more focused on Climate Change than peak oil, so alternative transport stocks are few and far between, but one that's owned by three funds is Smart Grid and Smart Transport stock Telvent Git S.A. (TLVT).  In order to get a little more representation in this sector, I'm also going to include rail supply company Wabtec Corporation (WAB), even though it's owned by only one fund, WGGFX.

Green Energy Portfolio

This is my suggestion of a portfolio, which should perform better than most of the green energy mutual funds because of better sector selection and lower costs: TRE.TO, WFI.TO, RBCN, CREE, PUR.V, ITRI, PWR, TLVT, and WAB, equally weighted.  That's 11% Biomass, 45% Efficiency and Conservation, 27% Electric Grid, and 17% Alternative Transportation.  It's not representative of the market, but we're trying to beat the market here, not just match it.

I'll take a look back at this portfolio next year to document how it has performed relative to the mutual funds.

DISCLOSURE: Long PUR.V, WFI.TO, PWR.

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.

November 19, 2010

Introducing EV Insights: In-Depth Analysis of Challenges and Opportunities in Vehicle Electrification

John Petersen

After months of planning, I'm pleased to announce the launch of EV Insights, an Internet site dedicated to in-depth analysis of the challenges and opportunities in vehicle electrification and other cleantech sectors. My partners in this project are Jack Lifton, a highly regarded expert in the fields of rare earth metals, mining and extractive industries, and Dr. Gareth Hatch, a thought leader in the field of permanent magnet materials, components and their end uses in motors and power generation systems.

In coming months we will offer a series of wide-ranging and probing interviews, conversations and debates with experts, industry professionals and executives from a variety of industrial sectors and companies that will play key roles in vehicle electrification and other emerging cleantech sectors. Our goal is to go beyond happy-talk headlines and advocacy and drill down into the more difficult issues of supply chains, technical maturity, sustainability and end-user value. We hope our discussions will give serious investors an edge by increasing their understanding of how these issues will shape and ultimately dominate the sixth industrial revolution, the age of cleantech.

We don't know all the answers, but we have a pretty good feel for the important questions. We hope to learn by listening to people who know more than we do and asking hard questions that never make it into press releases, company presentations and the mainstream media. We're certain that our conversations will have more balanced, informative and probing content than we could ever squeeze into a blog.

Our kickoff conversation is one Jack and I recorded in October that discusses the challenges and opportunities in the battery sector. The recording and transcript are available without charge to visitors who are willing to part with their name and e-mail address.

EV Insights may eventually become a subscription service if initial user feedback is positive, but for now it's just an experiment. We truly hope you'll volunteer as a lab rat by visiting us at www.evinsights.com and taking our first conversation on the battery sector for spin around the block.

November 18, 2010

Alternative Energy and Climate Change Mutual Funds, Part III

Tom Konrad CFA

Past performance of green energy mutual funds.


In part I of this series, I looked at the full costs of alternative energy and climate change mutual funds.  I concluded that they were quite expensive, ranging from over 2% per year, to almost 6%.  In a stock market that has historically produced returns of about 10.5% per year, but has been flat for the last decade, even 2.5% in expenses per year would have resuted in a substantial loss of value.  In order to make up for the drag on returns, these mutual funds will have to show strong evidence of stock picking skill. 

In part II, I looked at the portfolio holdings to determine if they showed evidence of picking sectors likely to outperform, and selected the two funds I thought had the best combination of low costs and likelihood to outperform.  I believe that funds that hold to many solar stocks are likely to under perform because, while solar has a bright future, today's solar companies will probably not be the major participants.

Past Performance

While past performance, especially over just a few years, is no guarantee (or even an indication) of future results, we can still use it to check our intuition.  In the case of my theory that solar stocks tend to be a drag on the performance of mutual funds that hold to many of them, used Morningstar to put together the following chart of past returns for Alternative Energy and Climate Change against the S&P 500 over the last 10 years.

Performance of Alt E and Climate Change Mutual Funds Vs S&P 500
The eight mutual funds shown are the New Alternatives Fund (NALFX), the Guinness Atkinson Alternative Energy Fund (GAAEX), the Winslow Green Growth Fund (WGGFX), the Firsthand Alternative Energy Fund (ALTEX), the Allianz Global Eco Trends Fund (AECOX), the Calvert Global Alternative Energy Fund (CGACX), the DWS Climate Change Fund (WRMSX), and the Gabelli SRI Green Fund (SRICX).  For comparison, I've also included the past ten year performance of the S&P 500 index, and the performance of the oldest Alternative Energy Exchange Traded Fund (ETF), the Powershares Wilderhill Clean Energy Index (PBW). 

The chart is set up to show how much would need to have been invested in any given prior year in order to have $1000 to show for it at the end of October 2010.  I've included mutual fund loads in the calculations, but I have not accounted for any taxes investors might have to pay on capital gains distribution or on the sale of the fund.  With the chart set up this way, the best funds are those at the bottom of the graph, because you would have had to invest less in them to have $1,000 at the end of October 2010.

One thing worth noting is that the Clean Energy ETF, PBW, performed worse than almost all of the mutual funds, despite its lower costs.  As I noted the last time I took an in-depth look at Alternative Energy and Climate Change ETFs, PBW has a high (approximately 35%) allocation to solar stocks.  The average mutual fund has a 24% allocation to solar. 

Second, The two funds that I ended up liking best in part II of this series, the Winslow Green Growth Fund (WGGFX) and the New Alternatives Fund (NALFX) both outperformed the S&P 500 over their lifetimes, with the longer lived New Alternatives performing much better.

Third, the performance of the Gabelli SRI Green Fund (SRICX) beats all the others by a mile. Since January 2008, SRICX is up 21%, while the S&P 500 is down 17% and the next-bet performing of the funds over the same period (NALFX) is down 31%.  But the fund's costs are the highest of the lot. Could it be managerial skill?  It's hard to say after less than three years.  I've asked the lead manager, John Segrich, CFA for an interview about their strategy.  If he agrees, I'll publish the interview as a later entry in this series.

"High Solar" Fund Performance

Since the chart is rather busy, and most of the mutual funds don't have a long enough track record (only three years) to be able to say much about them with any confidence, I cleaned up the chart by eliminating the graphs of the new mutual funds, and replacing them with a composite mutual fund which averages the returns of the three funds that weight solar stocks most heavily.  This is the light blue line labeled "High Solar Funds."

Solar heavy funds vs NALFX WGGFX and PBW

In this cleaned-up chart, it's now clear that the funds with a high allocation to solar did significantly worse than the two low solar funds I picked in the last article, although they did do better than the (also high solar) PBW. 

Conclusion

While past performance does not say much about what will happen over the next few years, the evidence we have seems to support investing in Alternative Energy without putting too much of that investment in solar stocks.  If you want to use a mutual fund, it still looks like the best choices are NALFX (for longer holding periods) and WGGFX (for shorter holding periods), but I think we can do better than that by choosing our allocations according to the five principles I laid out in part II, and using individual stocks to avoid high mutual fund costs

The stocks for this portfolio can be drawn directly from the holdings of the mutual funds we've been discussing.  I'll list the stocks I'd choose in part IV of this series next week.

UPDATE: I've change my mind about my top mutual fund pick.  See: .


DISCLOSURE: No Positions.  GAAEX is an advertiser on AltEnergyStocks.com.

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.

November 17, 2010

Vehicle Electrification And The "Too Good To Be True Rule"

John Petersen

One of the first lessons investment professionals learn is that if an investment proposal sounds too good to be true, the proposal is probably materially false and misleading. On November 15th, the Electrification Coalition released its Fleet Electrification Roadmap and once again proved the wisdom of the "Too Good To Be True Rule." I know that lobbyists are supposed to take a policy position and make the best case they can; but when their case is based on deliberate distortions, somebody has to point out the differences between current realities and bafflegab.

In building the best policy case for the electrification of commercial fleets, the Roadmap used this gee-whiz graph of vehicle emissions by technology and fuel type. The source of the data was a 2007 study by the Electric Power Research Institute.

11.16.10 EC Emissions.png

Unfortunately the 2007 EPRI data that served as a basis for graph is meaningless. The fundamental premise is flawed because the graph assumes well-to-wheel CO2 emissions of 450 grams per mile for a car with an internal combustion engine and 300 grams per mile for an HEV. Unfortunately both estimates overstate current realities by about 50%.

The internal combustion engine values may have been good a few years ago, but they're worthless in light of new CAFE standards that the NHTSB and EPA adopted in April. These standards require the new light duty vehicle fleet to meet or exceed the following increasingly stringent CO2 emissions standards.

Model CO2 Emissions CO2 Emissions
Year
Pump-to-Wheel
Well-to-Wheel
2012
295 grams per mile
369 grams per mile
2013
286 grams per mile 358 grams per mile
2014
276 grams per mile 345 grams per mile
2015
263 grams per mile 329 grams per mile
2016
250 grams per mile 313 grams per mile

Similarly, the HEV values may have been good a few years ago, but they are meaningless in light of the fact that the 2010 Toyota Prius has pump-to-wheel CO2 emissions of 89 grams per kilometer, or 143 grams per mile, and well-to-wheel CO2 emissions of 179 grams per mile.

If you reduce the Roadmap's 450 gram per mile ICE estimate to comply with the regulatory mandate of 313 grams per mile by 2016, PHEVs lose much of their appeal. If you reduce the HEV estimate to the current 179 grams per mile performance of the Prius, the only plug-in that can honestly claim parity, much less superiority, is one that's equipped with a dedicated wind turbine.

I wholeheartedly support the Electrification Coalitions desire to "disseminate informed, detailed policy research and analysis," but think that they should consider adding "accurate, current and balanced" to the desiderata. If any of the CEOs that support the work of the Electrification Coalition published this kind of nonsense in their SEC reports, there'd be hell to pay.

Disclosure: None


November 16, 2010

High Conviction Paired Trade – Short Tesla Motors And Buy Exide Technologies

John Petersen

Short sellers are the bane of every securities lawyer who represents small public companies. In over thirty years of practice I've never advocated a short sale because I hate the idea of profiting from someone else's misery. Based on recent quarterly reports filed by my short-list of pure play energy storage companies, which includes Tesla Motors (TSLA) as an honorary member, I'm compelled to break with tradition and suggest a paired trade that involves a short sale of Tesla coupled with a long purchase of Exide Technologies (XIDE).

The following table summarizes the year-to-date and quarter-to-date performance of the short-list companies. On a year-to-date basis, Tesla has been a runaway success while Exide languished. For the reasons discussed below, that dynamic is sure to change over the coming year.

11.15.10 Performance.png

Most of us know that money managers, analysts and investors tend to follow the herd without asking whether the herd's behavior is rational. Even a simplistic comparison of business fundamentals and market realities shows just how irrational the herd has become over the last year as electric vehicle hype reaches the peak of inflated expectations.

The following table is complex and I apologize for that, but it highlights the huge disconnects between market values and financial statement values that are common in the sector. To keep things comparable I started with data in the most recent quarterly reports filed by the short list companies and adjusted for financing transactions that occurred after the last balance sheet date. The columns with gold headers are business fundamentals derived from financial statements. The columns with green headers are market driven variables.

11.15.10 Fundamentals.png

Why I Would Short Tesla - It doesn't take much market experience to know that companies cannot long sustain market capitalizations of almost twelve times book value, but that's exactly what Tesla is doing. When you drill down into the disclosures in Tesla's most recent quarterly report, you'll find that $88 million of its $202 million in working capital is set aside as restricted cash for capital investments in facilities construction, which leaves a paltry $114 in real working capital to cover anticipated operating losses and the pre-production costs for the 2012 introduction of its Model S sedan.

Any way you cut it, Tesla does not have enough cash to support its business for another year and it's already tapped Panasonic and Toyota. That means Tesla will have to go into the financial markets for additional cash – lots of additional cash. While stock market investors frequently ignore financial statement fundamentals when making investment decisions, I've met very few professionals with a similarly blasé attitude. The probability that hundreds of millions in new capital will be available to Tesla at anywhere close to a 1,200% premium to book value is remote beyond reckoning and it's a virtual certainty that substantial transactions with independent investors will not happen at anything close to the current market price.

Since the market can stay irrational longer than many of us can stay solvent, the safest way to play the likely price collapse will be a long-dated out of the money put option. For purposes of tracking the performance of this long-short pair over time, I'll use the publicly traded January 2012 $25 put, which last traded for $6. The short won't be profitable unless Tesla's price falls below $19, but I still like the risk/reward ratio.

Why I Would Buy Exide - I've discussed Exide at length in other articles including "Valuation Primer For Energy Storage Companies – Lesson #1." The short story is that it's taken Exide five years to emerge from Chapter 11 and restructure its manufacturing operations to a point where consistent long-term profitability is likely. Exide's current price earnings ratio is significantly below normal valuations of 15 to 18 times earnings and its prospects for rapid and sustained growth over the next five years are outstanding due to technological changes like stop-start idle elimination that are sweeping the automotive sector and will improve margins in both its OEM and after-market replacement business. While the financial analysts that follow Exide have an average price target of $10, my sense is that a price toward the high end of the $10 to $15 range is more likely.

Why Valence Terrifies Me - Valence Technologies (VLNC) has been around for years and is making significant progress in its efforts to commercialize a good lithium-ion battery technology. For several years it has depended on the commitment and generosity of a principal stockholder to keep the doors open. Currently Valence has a $7.3 million working capital deficit and a whopping $75.3 million stockholders equity deficit. As long as the principal stockholder is willing to continue providing additional financing on terms that are little more than gifts to the public stockholders, Valence stands a chance. If it is forced to go to unrelated investors that are unwilling to be sugar daddies, the likelihood that it will be able to raise over a hundred million dollars of new capital at prices that bear any relation to the current market price is less than slim. While I have often been forced to rely on the kindness of strangers, hope is not an investment strategy.

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

November 14, 2010

Understanding Stop-Start Idle Elimination And Emerging Energy Storage Solutions

John Petersen

Last week Lux Research published a report titled "Micro-hybrids: On the Road to Hybrid Vehicle Dominance" that forecasts micro-hybrid vehicle sales of three million units this year increasing to 34 million units annually by mid-decade. Lux sent me a courtesy copy of their report and will host a webinar to discuss their findings on November 16th.

While I'm very excited about Lux's conclusions respecting micro-hybrid implementation rates, it's critical for investors to understand that batteries for micro-hybrids will merely be upgrades of batteries that would have been sold in any event. Therefore, the benefit to battery manufacturers will be limited to the difference between the price of stop-start batteries and the price of conventional batteries they'll replace. So while Lux valued the market at $2.7 billion annually, the incremental revenue to the energy storage sector will be a good deal lower.

Micro-hybrids, or more accurately "stop-start idle elimination systems," are baby steps in vehicle electrification. Stop-start systems don't provide any drive power to the wheels and their only goal is to reduce fuel consumption by turning the engine off when the car isn't moving. It's a thoroughly sensible idea, but one that's extremely hard on batteries because instead of starting the engine twice in an average day, an optimal stop-start system will start the engine an average of once per mile while powering all accessories during engine-off intervals.

The following graph is a scale representation of battery loads in a conventional vehicle and in a vehicle equipped with a stop-start system. The conventional vehicle cycle is simply a 1-second starter load of 300 Amps (blue spike) before the alternator kicks in to recharge the battery. The stop-start vehicle cycle, in comparison, has a 60-second accessory load of 50 Amps (pink block) with a one-second starter load of 250 Amps (red spike) at the end. While we naturally tend to think of engine restart as the main issue, the truly serious problem for stop-start systems is the accessory loads that account for a whopping 92% of total energy demand.

11.13.10 Stop-start Load.png

In a typical year, the battery in a conventional vehicle will need to start the engine about 730 times and deliver about 262,800 watt seconds of energy to the starter. In contrast, the battery in a vehicle equipped with a fully optimized stop-start system will need to start the engine 12,500 times and deliver 487.5 million watt seconds of energy. In other words, the batteries for a fully optimized stop-start system will need to provide 17.1 times the cycling and 1,855 times the energy delivery. It's a very tall order.

The harsh reality is that currently available lead-acid batteries are not robust enough to stand up to the demands of stop-start. Therefore, to avoid irreparable battery damage, all stop-start vehicles have control electronics that monitor the battery's state of charge and disable the stop-start system until the battery recovers. On new vehicles with new batteries the stop-start systems work beautifully. As the batteries age and charging intervals get longer, the frequency of stop-start events plummets. In many cases the stop-start system simply doesn't work after a few months. This is a serious problem for the automakers that requires a serious solution.

The first alternatives the automakers tried to improve the performance of stop-start systems included upgrading from flooded batteries to AGM batteries, and/or adding a second battery. While AGM batteries perform better than flooded batteries and two batteries perform better than one, the workarounds don't solve the fundamental problem.

In late September, Continental AG and Maxwell Technologies (MXWL) announced a design win for a dual-device system that will couple a 3,020 watt supercapacitor module with an AGM battery for diesel-powered cars from PSA-Peugeot-Citroën. While Peugeot-Citroën, Continental and Maxwell believe the supercapacitor will make a big difference in the system's ability to handle the heavier starting loads of diesel engines, the 8,784 watt seconds of energy from the supercapacitor won't begin to solve the accessory load issue.

The bottom line is the automobile industry needs better energy storage solutions if stop-start idle elimination is to achieve its full fuel savings and emissions reduction potential.

The Department of Energy believes the most promising short-term alternatives are third-generation devices that combine carbon nanotechnology and lead-acid chemistry in a monoblock battery. The two leading contenders, which both received awards under the DOE's ARRA Battery Manufacturing Grant program, are:
  • The Ultrabattery from CSIRO, Furukawa and East Penn Manufacturing, a flooded device that uses a split-electrode design to replace half of each lead-based negative electrode with a carbon electrode, resulting in a 75% – 25% battery/supercapacitor hybrid; and
  • The PbC battery from Axion Power International (AXPW.OB) and Exide Technologies (XIDE), an AGM device that replaces all of the lead-based negative electrodes with carbon electrode assemblies, resulting in a 50% – 50% battery/supercapacitor hybrid.
The Ultrabattery and the PbC are both in the final development stages. While their developers have been fairly tight-lipped about performance, data is starting to emerge. Last February, a Journal of Power Sources article (Volume 295, Issue 4, Page 1243) included the following graph that compares the performance of a flooded lead-acid battery, an enhanced flooded battery [ISS] and an Ultrabattery in a simulated stop-start environment.

11.13.10 Ultrabattery.png

At this year's European Lead Battery Conference in Istanbul, Axion and BMW published updated versions of the following graphs that compare the PbC battery and a high quality AGM battery over a 40,000-cycle test. The graph on the left is the AGM battery and the downward curving blue line represents the charge acceptance rate, which declines rapidly from an initial value of 70 Amps and eventually stabilizes around 20 Amps. The upward curving black line represents the time required to regain an optimal state of charge which begins at about 30 seconds and eventually stabilizes in the 120 second range. The graph on the right is the PbC battery, which maintains a stable charge acceptance rate of 100 Amps and a stable recovery time of 30 seconds for the entire test period, which approximates a five-year service life.

6.11.10 Axion Graphs.png

The Ultrabattery and the PbC are both properly classified as late-stage development projects. The technologies have performed very well in demonstration and testing, but their developers are working on industrial and production engineering issues and will need to expand production capacity before they can satisfy more than a small fraction of the automotive market. Since both technologies are generational improvements on established lead-acid chemistry, they should enjoy significant speed and cost advantages during the commercial introduction phase because of their ability to leverage supply chains, existing production facilities and global distribution chains that already exist for their flooded and AGM cousins.

Based on interviews with automakers about their current stop-start implementation plans, Lux concluded that enhanced flooded batteries would account for over $1 billion in annual sales by 2015 (39% market share); AGM batteries would account for another $1.6 billion in annual sales (59% market share); and dual-device systems like the Continental-Maxwell battery-supercapacitor product would account for $55 million in annual sales (2% market share). While Lux acknowledged the Ultrabattery and PbC as emerging technologies that could be contenders, it was apparently unwilling to estimate future market penetration rates for devices that aren't available yet.

On the topic of investment opportunities in the stop-start market, the Lux report said, "Unlike the lithium-ion battery space, which sports a number of early-stage start-ups, the micro-hybrid storage market supports few startups outside of Swedish firm Effpower. Outside of the giants like Johnson Controls, Exide Battery, and GS Yuasa, most of the investment/acquisition plays are public companies like Maxwell Technologies [$414 million market capitalization] and Axion Power [$48.5 million market capitalization]. Of the two, Maxwell is the surer bet right now, with revenues over $100 million and a major automotive contract already in place. However, don’t count out Axion completely – although its technology is on the expensive side today, it has a large war chest, a strong partner in Exide, and compelling opportunities in distributed storage and uninterruptible power supply (UPS) systems even if the micro-hybrid market doesn’t pan out." [My additions]

The flooded and AGM batteries automakers are currently using for stop-start systems are woefully inadequate for the job, with and without supercapacitor modules. Since regulations concerning fuel economy and CO2 emissions are the driving force behind the rapid global implementation of stop-start technology, I think it's very unlikely that governments will let automakers circumvent the rules by using conventional flooded and AGM batteries that leave the stop-start systems inoperable within a few months. As reports from stop-start vehicle owners like my friend Graham who says "I can't remember the last time the engine in my Mini turned itself off during a drive," become more common, revised regulations that focus on lifetime performance instead of new vehicle performance are almost certain. At that point the industry will be forced to shift over to more robust batteries for stop-start vehicles even if they are $100 to $150 more expensive.

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

November 12, 2010

Three Top Geothermal E&P Companies

Tom Konrad CFA

Last week, I was on a panel at the Inside Commodities Conference, and spent some time talking with Tyler Mordy, director of research at Hahn Investment.  He's a top-down analyst (and CFA Charter holder) who had recently grown enthusiastic about Alternative Energy in general because the sector is so beaten down. 

We agreed that the most-beaten down sector of alternative is geothermal power stocks, which Tyler finds frustrating because Hahn works with managed ETF portfolios, and there simply is no geothermal ETF.  Nor is there likely to be, since one publicly traded company dominates the industry (Ormat Technologies [ORA]) and the rest of the geothermal Exploration and Production (E&P) companies are small to microcaps. 

My current enthusiasm for geothermal stocks is why I recently began writing about them again.  Last month, I published an overview of the eight geothermal power stocks that trade in North America, as well as an in-depth look at Ormat.  I currently don't like Ormat's valuation, so I've been meaning to delve deeper into the five Geothermal E&P plays to pick the best.  I have not yet had the time to write that article, but Martin Katusa at Casey Energy Opportunities has been following them for years.

Martin just did an interview with The Energy Report, and here is an excerpt of what he has to say:
Because there are so few players and [the geothermal power industry] is so front-CAPEX extensive, consolidation will have to happen... Whether it's Ram Power Corp. (RPG.TO, RAMPF.PK) taking over Nevada Geothermal Power (NGP.V,NGLPF.OB), Nevada Geothermal taking over Ram, Nevada taking over Magma Energy Corp. (MXY.TO,MGMXF.PK), Magma taking over Nevada or a merger between Ram and Magma—there's going to be consolidation. But the question of who will be the consolidator is still up in the air.

You want to be in the company that's going to have the largest upside. We put Nevada Geothermal, Ram and Magma as buys because they're run by excellent people. They're undervalued compared to a year ago. In January, Nevada Geothermal was over $1. We recently wrote about it trading in the $0.50 range. Now the company's refinanced its debt and had a recent equity financing in which very smart money like Rick Rule participated in (as did we). It's producing close to 50 MW now and will be growing production in the very near future; and, better yet, Ormat Technologies Inc. (NYSE:ORA) just bucked up some big money to farm into one of its other projects. A year and a half ago, it wasn't producing; so it's so much cheaper today and is a much better company.
That's the meat of it: his top picks are Ram Power, Nevada Geothermal, and Magma Energy.  Like me, he's not currently a fan of Ormat.  I recommend reading the entire interview; there's a lot more good information about each company, what he likes about them, and the sector in general.

DISCLOSURE: Long NGP,RPG.
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.

November 10, 2010

Valuation Primer For Energy Storage Companies – Lesson #2

John Petersen

On November 6th I published Lesson #1 in this series, which provided a quick side-by-side comparison of Ener1 (HEV) and Exide Technologies (XIDE). Yesterday two more companies that I track, A123 Systems (AONE) and Enersys (ENS), reported results for the September quarter. The quick summary is that Enersys handily beat street estimates while the bleeding at A123 continued unabated.

To follow up with the format I introduced last week, the first graph is a simple market performance comparison of the two companies over the last year.

11.10.10 ENS - AONE Performance.png

The second graph comes from my quarterly tracking data and compares the relative market capitalizations of the two companies since September 2009.

11.10.10 Market Capitalizations.png

The following table compares the balance sheet fundamentals of the two companies, their income statement performance over the last twelve months, and some important per share valuation metrics.

11.10.10 Financial Comparisons.png

The final table presents A123's reported product shipments, sales revenue, cost of products sold and unabsorbed manufacturing costs over the last year, both as gross numbers and on a per kWh basis.

11.10.10 Cost Data.png

I pay special attention to reported revenue and cost data because it's so far out of sync with happy-talk stories in the mainstream media about rapidly falling lithium-ion battery prices. A successful manufacturing enterprise must have a spread of 20% to 30% between unit cost and unit revenue to pay operating overhead and generate a profit. With a $1,010 per kWh average unburdened cost of products sold over the last five quarters, A123 would need to charge its customers between $1,250 and $1,450 per kWh, which is a far cry from the $500 per kWh short-term target for electric car batteries I keep reading about. Barring a visit from the manufacturing cost fairy, I can't see how savings of that magnitude are possible over the next few years. I certainly haven't seen any real progress over the last five quarters.

One could argue that this week's comparison between A123 and Enersys and last week's comparison between Ener1 and Exide are unfair because the lithium-ion battery developers are emerging technology companies while the lead-acid battery manufacturers have global footprints, decades of experience and immense financial muscle. The fallacy in that argument is that lithium-ion battery developers are trying to displace well-established lead-acid battery manufacturers with modest form factor advantages and immense product cost handicaps.

For the last couple of years, the mainstream media has waxed prophetic on the ability of lithium-ion battery developers to slash costs and improve performance, while dismissing the possibility that there could be any significant improvement in lead-acid batteries because they've been around for 150 years. The reality is that lead-acid chemistry has been improving at a rapid pace over the last decade and third generation devices that combine carbon nanotechnology with lead-acid chemistry promise potentially disruptive gains in cycle-life, power and durability.

Since size and weight are irrelevant in most existing applications, electric vehicles can't become mainstream products without huge battery cost reductions, and the two chemistries will be competing for the same customer dollars, I'm convinced valuations in the lithium-ion battery sector are at or near the peak of inflated expectations depicted in the following graph from the Gartner Group.

11.10.10 Hype-Cycle.jpg

Benjamin Graham observed that in the short-run the market acts like a voting machine but in the long run it acts like a weighing machine. As the weighing machine works its magic, valuation multiples in the lithium-ion sector are certain to decline while valuation multiples in the lead-acid sector remain stable or improve. Since the essence of successful investing is buying stocks when they're undervalued and selling them when they're overvalued, the message to serious investors seems clear.

Disclosure: None.

November 09, 2010

Hydrogenics Corp: Splitting Water

by Debra Fiakas, CFA

Most investors, if they have heard of Hydrogenics Corporation (HYGS: Nasdaq) at all, consider them a fuel cell producer. However, about two-thirds of the company’s revenue comes from the design and manufacture of hydrogen generation products based on water electrolysis technology - a somewhat unique, but valuable electrochemical technology that could make important contributions to the world’s future energy base.

Electrolysis or the splitting of water molecules using an electric current produces hydrogen and oxygen - two elements that have market potential in a variety of industrial and power markets. It stands in high contrast to other producers of hydrogen that begin with natural gas and rely on the so-called steam reforming process to produce hydrogen from the natural gas components.

Hydrogenics expanded its production of hydrogen and oxygen gases with the acquisition of Stuart Energy Systems in January 2005. The company now manufactures the HyStat Electrolyser for on-site or on-demand hydrogen and oxygen supplies. Hydrogenics claims they “know hydrogen and know it well,” a talent that puts them in a good competitive position in the renewable energy field.

The company is applying that considerable knowledge to the production of fuel cells which convert hydrogen and oxygen back into water to produce energy. In 2009, power products and services accounted for about a third of the company’s revenue. We expect that portion to shift higher over time as Hydrogenics’ fuel cell products penetrate the market. So far Hydrogenics has focused on the forklift, commercial fleet and urban transit bus markets with its fuel cells.

Why all the fuss about hydrogen? First of all hydrogen is estimated to hold almost three times as much energy as natural gas per pound. Second, its only emission is pure water.

Why all the foot dragging about hydrogen? It is not really a fuel. It is just a way of storing or transporting energy and it has to be concocted in the first place, if not by braking down natural gas then the electrolysis method that Hydrogenics uses. (There are also thermolysis or photoelectrolysis technologies, but we will save those for science lessons another day.) Electrolysis has a theoretical maximum efficiency of about 80% to 94%, but practically speaking actual production can fall short of such efficiency.

Even excluding the production questions, hydrogen is a bit volatile and presents all sorts of technical challenges to transport. That is why Hydrogenics’ hydrogen generation solutions are located on customer sites.

In my view, Hydrogenics management has demonstrated strong execution skills that might be missed by some investors who do not look past the net losses over the past several years. The shift from fossil fuels puts a spotlight on their hydrogen-from-water technology. Furthermore, the use of water, which can be sourced anywhere facilitates on-site hydrogen production, removing transport challenges as an obstacle to customer adoption of hydrogen alternatives.

Debra Fiakas, CFA is the Managing Member of Crystal Equity Research, LLC, an alternative research resource on small-capitalization companies. Ms. Fiakas is a seasoned investment professional with a diversified and successful track record as a research analyst and as an investment banker. Her career includes solid experience in all aspects of the equity capital markets with particular emphasis on emerging growth companies.

DISCLOSURE: Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. HYGS is included in Crystal Equity Research’s The Atomics Index in the Hydrogen Electrolysis group.


November 08, 2010

Alternative Energy and Climate Change Mutual Funds, Part II

Tom Konrad CFA

Choosing the best green energy mutual fund.

In part I of this series, I looked at the costs and expenses of eight Climate Change and Alternative Energy focused Mutual Funds.  I concluded that four out of the eight, the Firsthand Alternative Energy Fund (ALTEX), the Guinness Atkinson Alternative Energy Fund (GAAEX), the Winslow Green Growth Fund (WGGFX), and the New Alternatives Fund (NALFX) each cost roughly 1.5% more in terms of expenses and trading costs per year than the typical Climate Change or Alternative Energy focused Exchange Traded Fund (ETF), with the other four costing 2.5% or more per year than the typical ETF.  I've included my chart of estimated total costs below.  Click on the chart for a link to the previous article containing a full explanation of the costs shown.

Expenses Including Trading Costs

Five Principles for Gaining an Edge in Alternative Energy and Climate Change Stocks

With even the least expensive mutual fund under the most generous cost assumptions costing a full 1% per year more than a typical clean energy ETF, the mutual fund managers will have to demonstrate considerable investment skill to justify the expenses. 

In general, it's very difficult to generate returns that beat the market, let alone returns that beat the market by an average of more than 1.5% per year.  This is the general argument against active management: active managers come with costs, but the average active manager will produce average returns.  If you agree with this argument, the best choice is to stick with a low cost, passively managed fund such as one of the sector ETF.

There are reasons to disagree, however.  The Alternative Energy sector is not yet well understood by most investors.  On one hand, a large portion of the population still denies the reality of Climate Change and is blithely unaware of Peak Oil.  On the other hand, we have a contingent of true believers, who understand both Climate Change and Peak Oil, but who are blinded by the unrealistic hope that Alternative Energy will allow us to replace fossil fuels without fundamentally changing the way we live

Both groups will almost certainly be proven wrong, and the investment manager who today understands how the economy must adapt to accommodate Alternative Energy should be able to outperform the mass of investors who either think nothing is happening, or think that Peak Oil and Climate Change can be "fixed" with cheap solar and electric cars.

I've been writing for years about what the real alternative energy future will look like, as opposed to what we might hope it to be.  Here are some basic differences from the wishful thinking scenario:
  1. To accommodate variable Wind and Solar, we need a more robust electric grid.
  2. All energy will become more expensive, so investing in energy efficiency and conservation is essential.
  3. Biofuel production is a commodity business, and the big winners are more likely to be the owners of the feedstock (biomass and waste) than the biofuel producers.
  4. Expensive fuel (including expensive batteries) will lead to shifts away from the personal car and towards alternative transportation solutions.
  5. Solar will be a large part of our electricity mix in 20-30 years, but that probably won't benefit today's Solar stocks.
Alternative Energy Sector Selection

If I'm right about these principles, then a successful money manager in Alternative energy will have a fairly small investment in Solar stocks, and larger investments in Energy Efficiency stocks, biomass stocks, alternative transportation, and the electric grid.  Unfortunately, there are not standard definitions of what constitutes stocks in each of the various Alternative Energy sectors, but over the last few years Charles Morand and I have built up a fairly comprehensive list of Alternative Energy stocks categorized into thirty subsectors.  I used this list, along with my knowledge of the companies and online company profiles to break down the eight mutual fund's holdings into twelve of the most commonly owned sectors.

The results are shown in the chart below.
Mutual Fund Energy Sector Breakdowns

Returning to my five principles for gaining an edge in Alternative Energy and Climate Change stocks, the easiest to apply is #5: a low allocation to Solar.  Of the four funds with relatively reasonable costs, the Firsthand Alternative Energy Fund (ALTEX), the Guinness Atkinson Alternative Energy Fund (GAAEX), the Winslow Green Growth Fund (WGGFX), and the New Alternatives Fund (NALFX), both ALTEX and GAAEX have high allocations to solar stocks. 

Applying the Principles

That leaves only the Winslow and New Alternatives Funds as worthy of serious consideration.  Checking principle #1, we note that both have about 7% of their portfolios invested in Electric Grid stocks, a slightly higher proportion than most other funds.  While this does not lead to a preference, it does help bolster the case that these fund managers may be adding value. 

Principle #2, which I consider the most important of the five principles, calls for a high allocation to energy efficiency and conservation.  The Winslow fund has a strong emphasis on Green Building which I did not see in any of the other funds, and many Green Building stocks contribute to the Efficiency category (they also contribute to "Other" since much of green building does not have to do with energy.) 

Principle #3 calls for a low allocation to biofuel producers, but a high allocation to Biomass and Waste (which falls under the Environmental/Recycle category in the chart.)  This would seem to lead to an added advantage for the Winslow fund, but a review of Winslow's Environmental/Recycling holdings shows that most of these are metal recyclers.  The New Alternative's much smaller holdings in this category are mostly focused on sewage treatment.

Principle #4 calls of a larger allocation to alternative modes of transportation.  The Winslow fund has a much higher allocation to Transportation and Batteries (7%) than the New Alternatives Fund (2%).  A closer look at the specific holdings show that the Winslow Fund's largest holding is Rail supplier Wabtec Corporation (WAB) at 3.5%, while New Alternatives' transportation allocation is the result of small slices of conglomerates most likely purchased for exposure to other sectors.  For instance, both funds have stakes in Smart Grid and Smart Transportation company Telvent GIT SA (TLVT).

Conclusion

If I had to pick one fund to outperform because of its well chosen energy sector exposures, it would have to be the Winslow Green Growth Fund (WGGFX).  That said, I believe the Winslow Fund only has a slight edge over the New Alternatives Fund (NALFX), and for someone who planned to own the mutual fund for at least a decade, I think NALFX's lower ongoing expenses would give it the edge in long term performance.  For an investor planning to hold one of the mutual funds for less than ten years, I think the Winslow Green Growth Fund is the best choice.

Of course, the least expensive way to get exposure to the right energy subsectors is by using individual stocks.  I will continue this series with a look at individual stocks from these mutual fund portfolios and use them to build an Alternative Energy and Climate Change portfolio at much lower cost than investing in any of these funds.  Such a portfolio should be able to take advantage of the fund managers' stock picking skill, but with greater emphasis on the energy sectors most likely to outperform.

UPDATE: I've change my mind about my top mutual fund pick.  See: .


DISCLOSURE: No Positions.  GAAEX is an advertiser on AltEnergyStocks.com.

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.

November 06, 2010

Valuation Primer For Energy Storage Companies – Lesson #1

John Petersen

I frequently observe that market valuations in the energy storage sector have been wildly distorted by electric vehicle hype that has nothing to do with business fundamentals. Last February I wrote an article that compared Exide Technologies with Ener1, but obviously didn't quite get to the meat of the matter. Since both companies reported earnings on November 4th, this seems like an opportune time to be more direct in the comparison and present a brief primer on valuations in the energy storage sector.

Since a lot of investors never get beyond stock price movements, the first graph presents a simple price performance comparison of the two companies over the last year.

11.6.10 Price Comparison.png

The second graph comes from my quarterly tracking data and compares the relative market capitalizations of the two companies since September 2009. For novices, market capitalization is calculated by multiplying the total number of shares outstanding by the price per share, which serves as a quick estimate of total stockholder value.

11.6.10 Mkt Cap.png

The following table compares the balance sheet fundamentals of the two companies, their income statement performance over the last twelve months, and some important per share valuation metrics. The figures shown for Ener1 give pro-forma effect to an October 1st transaction where the Ener1 Group bought 6.7 million Ener1 shares for $23.7 million in cash and an October 25th transaction where Rockport Capital Partners exchanged 10.2 million shares of Series B Preferred stock in Th!nk Holdings for 4.3 million Ener1 shares.

11.6.10 Numbers.png

I understand that Ener1 (HEV) is developing a way-cool lithium-ion battery technology and Exide (XIDE) is so yesterday with its stodgy lead-acid batteries, but let's get real here. Even if Ener1's plant was fully funded and operational, and it could sell 60,000 EV battery packs per year at $1,000 per kWh, its revenues wouldn't be half of Exide's. If you believe the happy talk about collapsing lithium-ion battery prices, the expectation is more like a quarter of the revenue potential. Since falling prices have a nasty tendency to squeeze operating profits, I don't see any chance that Ener1's bottom line income will be anywhere near Exide's over the next five years.

It's no secret that I see far more downside risk than upside potential in the plug-in vehicle market, which will supposedly be one of Ener1's strong suits. It's also no secret that I see huge upside potential and very little downside risk in batteries for automotive stop-start systems, which will almost certainly be a strong suit for Exide given its relationship with Axion Power International (AXPW.OB). When presented with a choice between betting on a weak business model or a strong business model, I'll take the strong business model every time.

Investing is a cruel dollars and cents business and the market value of a share of stock is supposed to represent the risk adjusted discounted present value of anticipated future returns. Even if you assume that Ener1 will be smashingly successful, it's risk adjusted discounted present value can't hold a candle to Exide's. The dynamic may change in the future, but for now there is simply no comparison if your goal is to grow an investment portfolio.

Next week I'll go through the same drill with A123 Systems (AONE) and Enersys (ENS).

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

November 05, 2010

Energy Storage – Opportunities and Intellectual Short Circuits

John Petersen

After writing about investment opportunities in the energy storage sector for a couple of years, today marks an important transition because I've accepted Nadsaq's invitation to include my blog in the Community section of their website. I'm grateful for the chance to reach a broader audience and hope that my weekly musings can help new readers separate hype from opportunity and avoid the intellectual short-circuits that are all too common in the energy storage sector.

By way of introduction, I'm a working lawyer and accountant who has spent 30 years guiding emerging energy and technology development companies through the corporate finance process. I earned my stripes in the battery industry during a four-year stint as general counsel for Axion Power International that included 20 months as its board chairman. I'm an inveterate early adopter of new technologies, but my investment perspective is tempered by the knowledge that even extraordinary companies can take decades to achieve their potential and the future beyond a five-year time horizon is inherently unknowable.

During the 20th Century rechargeable batteries became a ubiquitous and largely invisible necessity of modern life. Lead-acid batteries started cars, provided back-up power and ran forklifts, golf carts and the occasional electric car, while compact lithium-ion and NiMH batteries powered portable electronics. None of these batteries performed as well as we wanted them to, but the only time we gave them any thought was when they needed to be charged or replaced. Maybe that's why the adjective most commonly used to modify the noun battery is "damned." The bottom line is batteries are and have always been a grudge purchase; devices that satisfied basic needs but fell short of expectations.

Over the last decade a curious dynamic has emerged in the energy storage sector as environmentalists, futurists and other dreamers latched onto the seductive idea that batteries could do everything from eliminating gas tanks to making wind and solar power stable. The eco-evangelical fervor rapidly spread to the media and government, and what started out as wishful thinking quickly morphed into ill-conceived policy. Faced with unreasonable expectations, battery developers found themselves between a rock and a hard place. They could either tell the government and the markets "your goals are unattainable" and reject piles of money, or they could say "we may be able to attain those goals," trusting that the money would flow, asking for forgiveness would be easier than asking for permission and there might even be an unexpected miracle.

The problem with the plan is that today's emerging energy storage demands are orders of magnitude larger than the applications the batteries were designed for. These emerging applications invariably demand extreme levels of battery reliability and performance, and are unbelievably cost sensitive. In other words, the plan itself is a classic example of the triumph of hope over experience.

Notwithstanding the flaws in the plan, the dynamic is now driving a global effort to improve all types of batteries. It's a long, difficult road, however, because battery technology is fundamentally different from information and communications technology, advances typically take seven to ten years to move from the laboratory bench to the factory floor, and the Moore's law gains we saw in IT and communications are not possible in electrochemistry. The innuendo inspired motto of my high school class was "better living through chemistry," but world-changing advances in electrochemistry have been few and far between.

If you spend any significant time reading media stories and analysts’ reports on energy storage, you'll get the feeling that lithium-ion batteries are an amazing new technology that's arrived just in time to save us from the tyranny of imported oil. The reality is lithium-ion batteries have been around for over 20 years, fine companies like Sony, Panasonic, Sanyo and NEC have already optimized their manufacturing processes, the chemistry accounts for over $7 billion in annual sales and the principal economies of scale have already been realized. From this point forward, the gains will be incremental at best until something truly different comes along.

Most investors have heard of disruptive technologies, a term coined by Clayton Christensen to describe simple, low-cost innovations that eventually displace established technologies. According to Dr. Christensen, disruptive technologies usually lack refinement and have performance problems because they're new, appeal to a limited market, and may not even have a proven practical application; but their low cost creates new markets that induce technological and economic network effects and provide an incentive to enhance the disruptive technologies to equal or surpass established technologies. The following graph illustrates the phenomenon.

11.5.10 Disruption.png

If you consider the graph for a minute, the problem with the disruptive technology myth becomes obvious. Lithium-ion batteries were developed for the most demanding applications and are already at the top of the graph. Moving down-market to low quality applications like electric cars and grid-based storage is the industrial equivalent of a salmon swimming upstream to spawn. It's a constant battle with the law of economic gravity, predatory competitors and customers, and natural resource constraints. The lucky ones survive but many perish along the way. The key point to remember is that disruption flows from the bottom up, not from the top down.

If we wanted to create a hierarchy of possible battery applications from the highest value per watt-hour to the lowest value per watt-hour, the list would look something like this:

11.5.10 Battery Hierarchy.png
(1)  Current HEVs use NiMH batteries that are made from the rare earth metal Lanthanum. Since rare earth metal supplies are uncertain, lead-acid and lithium-ion battery developers are working to fill the void.
(2)  In the US and Europe plug-in vehicles will typically use lithium-ion batteries because they're smaller and lighter. In Asia, more thrifty consumers are just as likely to prefer lead-acid. It is unclear whether either chemistry is truly suitable for the application.

I see a bright future for lithium-ion batteries in high value applications that only need a small amount of battery capacity, but think it's foolish to suggest that exotic batteries will become a cost effective technology for electric vehicles or play a critical in stationary applications where size and weight are meaningless but performance and cost are critical.

I consistently write about a short list of 18 pure play energy storage companies. My favorites in the established and profitable manufacturers class include Enersys (ENS), Exide Technologies (XIDE), Advanced Battery Technologies (ABAT) and China Ritar Power (CRTP). In the emerging technology class my favorites are Active Power (ACPW) and Axion Power (AXPW.OB). Unlike many writers, I don't expect leading lithium-ion battery developers like Valence Technology (VLNC), Ener1 (HEV) and A123 Systems (AONE) to thrive over the next couple of years.

In the weeks to come I'll drill down deeper into the myths and realities of the battery industry and the relative competitive positions of the manufacturers and developers I follow. Readers who would like to read my prior articles can find a complete archive at Seeking Alpha. Since I'm bullish on the battery business but bearish on many of today's market darlings, my articles tend to draw a lot of reader comment. I'd encourage investors who want to understand the industry to read my work, follow hyperlinks to source documents and pay attention to the numerous comments from others who disagree with me. If you make the effort, you'll find a depth and breadth of thought and opinion that I could never present if left to my own devices.

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

November 03, 2010

Alternative Energy and Climate Change Mutual Funds, Part I

Tom Konrad CFA

Understanding the costs of green energy mutual funds.

It's been a bit over a year since I last looked at the mutual funds in the Clean Energy sector.  Each year, I comb through their  portfolios for new ideas on where to invest my own funds and those of my green-minded clients, with the added bonus of being able to help readers make better decisions about which fund, if any, is right for them.

This year, I looked at the eight mutual funds from AltEnergyStocks' green mutual fund list.  In order of fund size, they are:
These are not the only "Green" or "Ecological" funds available.  Instead, they are the funds that I feel are the best match to my own focus on clean energy, although each manager has a slightly different slant to how they approach green investing.  There may be a few that should be here but aren't: I added the Gabelli fund to the list when a reader brought it to my attention.

Fund Costs

Far too many investors put their money in a mutual fund without properly considering the costs.  I think this is especially true for green minded investors, who may be more concerned about doing the right thing for the planet tahn doing the right thing for their finances. 

The chart below displays some of the costs of investing in these funds.  The dark blue "Max Load" are for mutual funds that have an up-front charge when you first invest.  Small investments pay this percentage (between 4.75% and 5.75% of the total investment) for the right to invest, after which they pay a somewhat reduced annual expense ratio every year. (The annual expense ratio for load funds ranges from 1.02% for the New Alternatives Fund to 2.01% of the Gabelli SRI Green Fund) shown below in light blue "Load Expense Ratio."   Larger investments in load funds may qualify for a somewhat reduced sales charge or load, as a percentage of the amount invested. 

No-load funds do not have an up-front charge, but typically have a slightly higher annual expense ratio, shown below in orange.  The Calvert, DWS, and Gabelli funds allow both options, which is why they have two ticker symbols.  Typically the no-load shares are called Class C shares, while the load shares are usually called Class A shares.  No-load class C shares charge annual expense ratios ranging from 1.45% for the Winslow Green Growth Fund, to as much as 2.85% for the Calvert Global Alternative Energy Fund.  Other share classes are often available to institutional investors, but I have chosen not to display them here since they are unlikely to be relevant to most of my readers.

Mutual Fund Expenses

Even the least expensive of these fund charges more than 1% each year to manage your money.  Over time, that is a large drag on fund performance, so an investor should be confident that the fund manager is adding considerable value before investing in one of these funds.  If the manager is not adding considerable value, it makes more sense to invest using a typical clean energy Exchange Traded Fund (ETFs).  I've included the expenses for a typical ETF in the chart for comparison.  In the case of an ETF, the "load" is the fixed brokerage commission you pay to buy the ETF; I assumed a $10 commission on a $1000 investment.

Fund Size and Expenses

It's no coincidence that the largest funds (shown at the bottom of the chart) have the lowest expenses.  There are a large number of fixed costs involved in running a mutual fund, and these show up in higher expenses (as a percentage of invested assets) for investors. 

Other Expenses

While a manager cannot do a lot about the size of his fund, one source of expense he can control is trading costs.  Each time a portfolio manager makes a trade, he incurs transaction costs in terms of brokerage fees, liquidity costs, and potential capital gains.  Depending on how liquid the stocks are, and if the fund frequently trades in foreign markets, brokerage commissions and liquidity costs can range from 0.5% to as much as 2% or more of the value of a trade.  If the fund has made profitable investments, any gain on a sale will have to be distributed to fund shareholders at the end of the year in the form of a capital gain distribution, on which tax must be paid.  This is an added burden of trading for taxable investors.

Turnover Ratios

A fund's annual turnover ratio measures how often the manager trades in and out of positions, measured as the percentage of the portfolio that is traded every year.  Funds with annual turnover ratios in excess of 100% trade each position more than once per year.  Each fund's annual turnover ratio is shown in the chart above.

Conclusion

On the (fairly conservative) assumption that trading costs amount to about 1% of trade value, I have combined typical fund expenses with estimated trading costs.  The results are shown below.  The dark blue band represents the cost of the front-end load spread over a ten year holding period, while the dark blue and light blue together represent the cost of the load if it only spread over five years.  The three dark green to pale yellow bands should also be read cumulatively, with the lighter bands added on if we assume the fund's trading costs are higher rather than lower.  The lighter shades of blue and yellow represent a lower likelihood that these costs will occur.

Expenses Including Trading Costs

Solely in terms of cost, the clean energy ETFs remain by far the best option.  After that, the no-load funds the Winslow Green Growth Fund (WGGFX), the Firsthand Alternative Energy Fund (ALTEX), and the Guinness Atkinson Alternative Energy Fund (GAAEX) all have roughly comparable costs depending on your assumption about internal transaction costs, with low estimates of transaction costs favoring the low-turnover Guinness Atkinson fund.  For a ten year holding period, the total costs of the New Alternatives Fund (NALFX) are by far the best deal, but this load fund is only comparable to these no-load funds over a five year holding period, and would be considerably worse over shorter holding periods.

In contrast the Gabelli SRI Green Fund (SRIGX and SRICX), the DWS Climate Change Fund (WRMAX and WRMSX), the Allianz Global Eco Trends Fund (AECOX), and the Calvert Global Alternative Energy Fund (CGACX and CGAEX) are more expensive than the three funds listed above, let alone the sector ETFs.  The Gabelli fund not only has extremely high expenses due to its tiny size, but it then adds to these expenses with frenetic trading expressed in an unmatched turnover ratio of 190%.  The Calvert funds could also do much better as well: although they have done a reasonable job fighting transaction costs by keeping turnover down, the large fund size, at four times that of the considerably less expensive Guinness Atkinson fund, leaves considerable scope for reducing investor costs.

Investors who choose the Firsthand, Guinness Atkinson, Winslow Green Growth, Firsthand, or New Alternatives funds will pay roughly 1 to 1.5 percent per year for the active management available in these funds.  Given that Alternative Energy is a new and evolving sector without extensive analyst coverage, active managers may be able to gain enough of a market edge to pay for those additional costs.  I will look deeper into these four fund managers' strategies and holdings in future articles to try to determine which ones are most likely to be producing value for money.

UPDATE: I've change my mind about my top mutual fund pick.  See: .


DISCLOSURE: No Positions.  GAAEX is an advertiser on AltEnergyStocks.com.

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.

November 01, 2010

Alternative Energy: The Paradigm is the Problem

Tom Konrad CFA

Can We Afford Alternative Energy?

Most serious critiques of alternative energy boils down to, "it costs too much."

True, detractors of wind power sometimes point to the number of birds and bats killed, and some people worry that electric vehicles (EVs) are so quiet that they pose a danger to blind pedestrians. 

While such critiques are legitimate in that they are real problems, they can also be alleviated.  Avian fatalities can be greatly reduced by more sensitive siting of wind turbines, and even painting turbines purple.  Nissan has installed an electric noisemaker in the Leaf to warn pedestrians of its approach.  More to the point, such problems do not come close to outweighing the benefits of the technologies.  Bird and pedestrian deaths from collisions with wind turbines and EVs are likely to be much lower than pollution-related illness and death that both technologies reduce by replacing pollution sources. 

Such arguments are more relevant to the question of how we should be pursuing alternative energy, rather than the much more important question of should we be pursuing alternative energy at all?

"Does Alternative energy Cost too Much?" is a much more relevant question.  If an alternative energy technology really costs "too much," then we should probably be spending our money on other methods of reducing pollution, such as research into more affordable alternatives, or ways to clean up the mess that "cheap" conventional energy leaves behind, such as Carbon Capture and Sequestration.

The problem with the cost question is that not only does the answer depend on a large number of assumptions (interest rates, where and when the power is delivered, and the changing costs of fuel, feedstock, and operating and maintenance costs.)  We also need to decide what "too much" means. 

What Do We Want Energy For?

Before we try to answer the cost question, we need to take a step back, and ask if it's really the right question.  What do we need energy for?  A modern economy runs on energy, but it's the services that energy provides that are important, not the form of energy itself. 

Take a new home as an example.  We can heat it with natural gas, wood pellets, fuel oil, electricity, solar thermal panels, or even passive solar design.  When we decide between this multitude of options, we're not interested in the cost per Btu, but rather how much it will cost us to keep our home comfortable for the year.  We may also be interested in the potential variation from year to year: an average heating cost of $1,500 per year may be desirable, but not if the cost is low most of the time, and it occasionally costs $15,000 in a single year because of volatile fuel prices or unreliable equipment.

Which fuel can keep the home warm at a dependably low cost depends as much on the design and construction of the house as it does on the fuel needed to heat it.  Generally, electric heat is the most expensive way to heat a home, but a well-designed passive solar house needs so little added heat to remain comfortable that a pellet stove may end up being a more expensive option because the heat loss through the flue even when the stove is not in use may cost much more than the little bit of electric heat that will be needed on the coldest of winter nights.

The example of a home shows that the design of a house is at least as important as the choice of heating fuel in determining the overall cost of maintaining comfortable winter temperatures. 

It Costs Too Much for What?

When we assess the true cost of alternative energy, we also need to assess system design. 

Fuel cost per mile
Consider electric vehicles.  As the chart above shows, the fuel cost for an electric vehicle (Battery EV) is much lower than the other alternatives.  Yet any serious look at the life cycle costs of electric cars shows them to be uneconomic under any reasonable assumptions of daily commutes and gasoline prices.  Each mile of range for a battery electric vehicle durable enough to last ten years will cost between $150 in the most optimistic case, and $300 to $400 under more realistic assumptions.  If the car is charged at most once per day (at night), that mile of range will be used for at most 300 miles of driving per year.  If gasoline is $5 per gallon, and electricity is 10¢ per kWh, that will produce 10¢ fuel savings per mile (over a standard hybrid), or at most $30 of annual fuel savings.  If we assume the batteries last for ten years under these very strenuous driving conditions, we can come up with a decent 20% Internal Rate of Return (IRR), but under more realistic assumptions we'll get our money back (0% IRR) over ten years, or even end up losing money.

While we can conclude that electricity is too expensive a way to power a car, electricity can make sense in other transportation systems.  The number of times the battery is charged per day (battery cycles) is crucial.  While multiple charges per day are impractical for most commuters, multiple charges may be practical for fleet vehicles with regular routes.  Electric trains and trolley buses can bypass the expense of batteries all together by drawing their power from lines along their routes.  A Battery-electric bus with this capability would be able to drive on ordinary roads for part of its route, recharging while still on its route when external power from overhead lines was available.

Electric Vehicle Paradigms

In other words, the electric car paradigm is the problem.  Electric transportation, with the right paradigm, can make a great deal of sense despite the high cost of batteries.

Wind and the Grid

The dominant paradigm for electric power holds that electric consumption, or demand cannot be influenced by the utility, so electric utilities should manage their generation assets to meet that demand.  Furthermore, electric transmission is built to bring power from generation (which can be placed nearly anywhere there is water for cooling and the neighbors are unlikely to protest.) 

Wind and Solar power do not fit well into this paradigm, because generation from solar and wind depend on the weather and cannot be controlled by the utility.  These problems are exacerbated by the lack of robust long distance transmission, which would reduce the variability of wind and solar by diversifying away local variations in weather.

Therefore wind and solar are square pegs that do not fit in the paradigm's round holes.  For those who accept the paradigm, solar and wind are "unreliable," and require massive investments in dispatchable generation that can replace their output at any time.  Some opponents even claim that wind power does not lead to any decrease in pollution, because wind forces natural gas and coal plants to cycle more often in order to compensate for the increased variability of wind.  Coal power plants are particularly bad for backing up wind because they operate best a constant power, and a coal-only system will have higher emissions when wind is added.

Such critiques of wind power's variability implicitly assume that nothing can be done to make the electric system more accommodating to wind, when in fact there is much that can be done.  One widely quoted study (paid for by the natural gas industry) showed an increase in pollution per MWh of generated electricity in Colorado.  But Colorado is currently in the process of decommissioning or converting to natural gas most of the coal plants that caused the extra pollution.  With this change to the system, the pollution reducing benefits of wind will be much more strongly felt. 

Even without replacing coal plants, the grid can change to better accommodate wind power.  A May 2010 report from the National Renewable Energy Laboratory, the Western Wind and Solar Integration Study (WWSIS), looked at the system improvements needed to allow 35% wind and solar integration in the Western grid.  Many of these require changing the current paradigm of meeting local demand with local resources. 

While the WWSIS does call for increasing the flexibility of dispatchable reserves, most of the recommendations take the form of changing the paradigm. 
  • The areas over which power supply is aggregated to meet demand, called balancing areas, should be expanded.
  • The expansion of balancing areas should be supported by more robust transmission.
  • The use of more accurate weather forecasting will not reduce the variability of wind or solar, but it can make them seem more reliable, since they will be available when expected.
  • New and existing demand response programs should be used to accommodate demand to the increased variability.  In other words, electricity supply cannot solely change to match demand, demand must also change to accommodate supply.
With these changes to the paradigm, the integration of wind and solar are not costless, but the cost is much lower than it would appear from the perspective of someone operating only within the old paradigm.

Implications for Investors

Why should investors care? 

First, any change in the prevailing paradigms to incorporate alternative energy will reduce the future cost of alternative energy.  If most investors do not yet see beyond the current paradigm, the market is probably underestimating the potential for alternative energy.

Second, stocks involved in the transformations necessary to shift paradigms are likely to be unanticipated winners.  In the case of transport, alternative transportation stocks are likely to greatly outperform efficient vehicle stocks as our transportation paradigm shifts away from the car to other forms of transportation that can better leverage the advantages of electric drive.  In the case of the electric grid, smart grid stocks and electricity transmission stocks may also reap unanticipated windfalls as solar and wind increase their share of electric generation.

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.


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