Tom Konrad CFA

There are many proposed solutions to the liquid fuels scarcity caused by stagnating (and eventually falling) oil supplies combined with growing demand in emerging economies.  Some will be good investments, others won't.  Here is where I'm putting my money, and why.  This second part looks at hydrogen and electrification strategies for replacing oil.

In Part I of this series, I listed four potential substitutes that have been proposed to replace oil as limited supply and growth in developing markets draw oil away from traditional users.  I've since added a fifth to my list of potential substitutes:

1. Biofuels and Biochemicals
   
2. Vehicle Electrification
   
3. Hydrogen
4. Natural Gas
5. Coal and Gas to Liquids

Part I looked deeper into the potential for biofuels to displace oil, and made some recommendations as to which stock might benefit most from this trend.  In this article I'll look at vehicle electrification (including traditional hybrid electric vehicles (HEVs) such as the Prius, plug-in hybrid electric vehicles (PHEVs) and pure electric vehicles (EVs)), and hydrogen vehicles, since they have many similarities. 

John Petersen on PHEVs and EVs in One Paragraph

Readers of AltEnergyStocks.com will be familiar with John Petersen's cost-related arguments that PHEVs and EVs are over-hyped bad policy and are unlikely to form a substantial part of the vehicle fleet anytime in the next decade.  From an economics perspective, the core of his argument is that batteries are a limited and valuable resource, and they can be used most effectively to reduce dependence on fossil fuels in HEVs, rather than PHEVs or EVs.  While PHEVs or EVs can use no gas, they require as many batteries as ten or more HEVs.  Ten hybrids will each save 20-50% of a normal car's gas consumption, for a total gas savings equivalent to taking two to five normal vehicles off the road.  For a single PHEV or EV to save more gas than two to five normal vehicles, it will have to be driven two to five times as much as a normal vehicle when powered by electricity.  This means the large battery packs of PHEVs and EVs will only make sense for vehicles that are driven much more than normal vehicles, and which can be recharged multiple times per day. 

You can find another take on the economics of PHEVs and EVs direct from a Lawrence Berkley National Laboratory battery researcher here and here.  He reaches the same conclusions as John, but includes interesting technical discussions of the technological barriers to making batteries small and cheap enough for widespread adoption of PHEVs and EVs.

Charge port for Nissan Leaf EV

What Vehicle Electrification Means for Stock Market Investors

From an investment perspective, the above discussion is most useful in that it highlights batteries as the critical, high-value component that makes vehicle electrification possible.  Some industry observers worry that scarcity of rare earth metals may make the electric motor in an HEV too expensive to be practical.  If electric motors become more expensive, the economic solution will be to make each electric motor do more, and and build more PHEVs and fewer EVs.  In either case, batteries will remain a critical component that limits the supply of electrified vehicles for the foreseeable future.  Hence, the best investment in vehicle electrification will be investments in batteries.

Another lesson from the above discussion is that, if PHEVs and EVs are currently over-hyped, then the batteries used in PHEVs and EVs (almost exclusively Lithium-ion) are probably over-hyped as well, at least relative to the batteries used in HEVs (Nickel-metal hydride as well as Lithium-ion.)  Some classes of mild HEV also use advanced Lead-Acid batteries.  In other words, I end up agreeing with John that while Lithium-ion batteries have an extremely bright future, investors would do well not to dismiss the cheaper and more mature battery technologies.  Here is John's list of battery companies, organized by battery type.

Hydrogen

I don't see current hydrogen technology as a viable alternative to oil, but I thought I should mention it since it does have its proponents.  The main barriers to the hydrogen economy are

1. The price of hydrogen fuel cells
2. Lack of hydrogen infrastructure
3. Inefficiency of hydrogen electrolysis

A hydrogen fuel cell converts hydrogen stored in the Fuel Cell Vehicle's (FCV) tank into electricity, which is then used to power an electric motor.  Because fuel cells are extremely expensive, it makes sense to use as small a fuel cell as possible.  This can be accomplished by configuring the FCV as a PHEV, and using the fuel cell constantly while the vehicle is in operation keeping the batteries charged for when extra power for acceleration is needed.  Hence, even if I am wrong about FCVs being the wave of the future, battery investors are likely to benefit as well as investors in other vehicle components.

The lack of hydrogen infrastructure and inefficiency of electrolysis (making hydrogen) both point to the conclusion that PHEVs are superior solutions for displacing oil than Fuel Cell Vehicles.  There is already an electric grid everywhere in the developed world, so a charging infrastructure only requires the installation of charging points, not a new set of hydrogen pipelines as well.  And if you have electricity and want to use it to propel a car with an electric motor, your car is going to be able to go much farther if you simply charge the car's batteries than if you first convert the electricity to hydrogen using electrolysis, then convert it back to electricity with a fuel cell, losing energy in each conversion step.

Conclusion

Vehicle electrification does have potential to displace a significant amount of oil demand, but it will come mostly in the form of more HEVs, at least in the short term.  PHEVs, EVs, and especially FCVs are likely to only be viable in niche markets, at least for the next decade.  Hydrogen does not have much potential to displace oil, but if it does, the high cost of fuel cells means that FCVs will also need batteries.  The best investments in vehicle electrification are batteries. The hype about PHEVs and EVs means that companies with less sexy battery technologies are probably better bets than Lithium-Ion companies, simply because you should be able to buy such stocks at a more reasonable price.

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.

Posted by Tom Konrad at 04:48 PM | Permalink | Comments (0)

John Petersen

Albert Einstein once said, "If you can't explain it simply, you don't understand it well enough." So when the editor of Batteries International asked if I could present my analysis of plug-in vehicles in two pages and prove my numbers in a way that any open-minded adult could follow, understand and verify with an Internet search engine, I jumped at the challenge. The article was published yesterday in their Winter Edition. Since the numbers have profound implications for the energy storage sector and an expected flurry of ill-conceived electric vehicle projects like the planned Tesla Motors IPO, I've decided to reprint the article here and then offer some thoughts and observations on what the numbers mean for prudent investors.

The first great fraud of the new millennium
(Reprinted from Batteries International, Winter 2010)

PT Barnum would have been proud.

While hype-masters loudly proclaim that plug in cars will save the planet by slashing oil consumption and CO2 emissions, the numbers tell a different story; that plug-ins are all sizzle and no steak. The result is the industrial equivalent of a snipe hunt, a wild goose chase based on flawed assumptions.

Let me explain how I reached this conclusion. On December 31, 2009 Forbes published an opinion piece titled System Overload that questioned whether the battery industry was overbuilding global manufacturing capacity. The third paragraph noted:


While the article went on to question whether there would be buyers for all those batteries, the capacity estimate got me thinking: “In a world that wants to save fuel and reduce CO2 emissions, but can only make 36 million kWh of batteries per year, what is the highest and best use for the batteries?”

I hate unanswered questions. So I fired up my computer and went to work. Within a few minutes, I found myself wondering whether anybody in Brussels or Washington DC owns a calculator and understands grade school math.

The calculations were simple but the answers were amazing — at least to me. The sweet and simple summary is that the venerable Prius-class hybrid is five to six times more effective at reducing global gasoline consumption than its plug-in cousins and, in the US, it's seven to 10 times more effective at reducing CO2 emissions.

In other words, plug-in vehicles are not the effective albeit expensive saviours of the planet that have been sold to credulous reporters and intellectually lazy regulators. They're unconscionable waste masquerading as conservation.




I'm agnostic when it comes to the relationship between CO2 emissions and global warming. I simply don't know enough to have a firm conviction.

I'm not the least bit agnostic when it comes to the fact that six billion people on this planet want a small piece of the lifestyle that 500 million of us have and take for granted.

For all of recorded history, the poor toiled in ignorance and didn't know that there was more to life than subsistence.

Thanks to information and communications technology, the cat's out of the bag and fully half of the world's poor know that there is something better. The biggest challenge of this century will be making room at the table for six billion new consumers.

Accomplishing that without horrific environmental consequences and catastrophic conflict requires relevant scale solutions to persistent shortages of water, food, energy and every commodity known to man.

Using 100% of the forecast global battery production capacity to make plug-in vehicles will save less than five hours of oil production and CO2 emissions per year. I can’t see how any thinking man would consider that scale sufficiently relevant to justify the plunder of far scarcer mineral resources.

In my opinion, the plug-in vehicle industry is perpetrating the first great fraud of the new millennium by using one-on-one vehicle comparisons instead of fleet comparisons.

Yes, indeed PT Barnum would have been proud.



Implications for prudent investors

The most fascinating aspect of this analysis is that battery chemistries and costs are irrelevant. The numbers don't work any better if you use NiMH or even lead acid batteries instead of lithium-ion. They also don't work any better if you slash battery costs and make really cheap plug-in vehicles. Those factors might change the cost-benefit analysis for an individual driver or a particular vehicle, but they wouldn't change the cost-benefit analysis for the only planet we have. It is arrogant insanity to believe we can conserve a relatively plentiful natural resource like petroleum by plundering scarcer mineral resources like aluminum, copper, lead, rare earth metals and even lithium to make batteries for plug-ins.

The gaping flaw in the logic of EV evangelists is their insistence that all analysis stop at the fifth step; a point where plug-ins can look reasonable to a casual observer. In the real world, rational energy, economic, and industrial policies compel the sixth step comparison of fleet-wide performance, which is where the house of cards comes tumbling down. Over the next few years, global investments in advanced battery, plug-in vehicle and charging infrastructure schemes will be north of $20 billion. The best possible outcome will be a one or two percent reduction in global oil consumption by 2020.

That dog won't hunt. We can and must do better.

My core philosophy comes from Benjamin Graham, the patron saint of value investors, who observed, "In the short run, the market acts like a voting machine, but in the long run it acts like a weighing machine." While the numbers have convinced me that business models based on the plug-in dream are doomed because the concept is fundamentally flawed; I understand the hype cycle, recognize that markets can be irrational for extended periods of time and know that irrational markets can be alluring to opportunistic traders who are smart enough to enjoy popping corks and go home before the music stops.

For those who can't resist the hype and glitz, my favorite for "Best in Show" honors is France's SAFT Groupe (SGPEF.PK). While I don't write about SAFT regularly because it isn't registered with the SEC, it's a fine company that was the second largest beneficiary of the ARRA battery manufacturing grants President Obama announced last August. Unlike the other ARRA grant recipients, SAFT walked away with a double dip from a $299.2 million award to its U.S. joint venture with Johnson Controls (JCI) and a separate $95.5 million award to Saft America.

SAFT has a diversified revenue base from battery sales to military and industrial customers. As a result, SAFT earned €28.9 million on 2009 sales of €559.3 million and had €306.8 million in stockholders equity at year-end. Despite its solid track record, SAFT carries a relatively modest market capitalization of €730.5 million, which works out to 1.3 times trailing sales, 25.3 times trailing earnings and 1.3 times equity plus anticipated DOE grant funding.

For "Domestic Best in Breed," my favorite is A123 Systems (AONE), which edged out SAFT for the top spot on the ARRA battery grant list at $249.1 million. A123 also plans to borrow up to $233 million under the DOE's Advanced Technology Vehicle Manufacturing (ATVM) loan program.

In the wake of a successful IPO last September, A123 finished 2009 with $528.2 million in stockholders equity and a clean balance sheet, but it lost $85.8 million on sales of $91 million. A123's market capitalization of $1.7 billion works out to 18.2 times trailing sales and 2.3 times equity plus anticipated DOE grant funding. While A123 doesn't offer SAFT class value, it stands head and shoulders above other domestic lithium-ion battery developers, particularly in light of its ongoing efforts to hedge its plug-in vehicle bets with forays into the utility and industrial markets.

Ener1 (HEV) has always struck me as a company that could go either way, but was likely to disappoint investors who bought at inflated prices. Ener1 took fifth place on the ARRA battery grant list with a $118.5 million award. It also applied for loans under the ATVM program, but hasn't completed due diligence. Since the ARRA battery grant requires matching funds equal to 100% of the grant amount and any ATVM loans will require matching funds equal to 25% of the loan amount, management recently cautioned that the company will need $150 million in additional equity before the dust settles.

Ener1 finished 2009 with a $3.7 million working capital deficit and $116.2 million in stockholders equity, but its balance sheet includes $13.2 million of intangible assets and a whopping $51 million of goodwill. Since both values strike me as incredibly speculative in the context of a company that lost $51 million on 2009 sales of $34.8 million, I believe potential investors will probably focus on Ener1's net tangible book value of $51.9 million for analytical purposes.  Based on 30 years of experience with investors who were willing to invest in my clients but wore brass knuckles to pricing negotiations, my big concern is that Ener1 will have a tough time justifying a huge multiple of net tangible book value to large investors who know that its grants and loans can't close without matching funds.

If it successfully completes it's planned IPO, I'd put Tesla Motors a couple tiers below A123 because there isn't a whole lot of  diversification potential for an electric vehicle manufacturer. There may be a couple years of splash and spectacle before the inevitable becomes obvious, but Tesla is not a stock that I'd buy and put in a drawer for my grandkids.

I believe plug in vehicles combine immense risk with insignificant reward, a potentially catastrophic dynamic. SAFT strikes me as a decent investment because its fundamentals are sound without considering any speculative upside from plug-in vehicles. If A123 can diversify into commercial and industrial markets, it may also be a long-term survivor. Until Ener1 solves it's chicken or egg dilemma of not having the cash it needs to absorb future losses and close on its ARRA grant and ATVM loan, I'd be extremely cautious.

Disclosure: I plan to sit this one out.

Posted by John Petersen at 12:05 AM | Permalink | Comments (6)

Tom Konrad, CFA

Portec Rail Products (PRPX) agreed to be acquired by L. B. Foster Company (FSTR) on February 17. At least four law firms have started class action suits against the Portec board.  Here is why not to join any of them.

Portec Rail Products has been a longtime favorite of mine.  It's profitable, and delivers valuable services to the rail and rail transit industries.  This article goes into a lot more detail as to why I like Portec.  In large part because of the acquisition, Portec is the best performing of my Ten Clean Energy Stocks for 2010.  I will be sad if the merger goes through, because I will need to find a replacement in my portfolio, although the cash will soothe the hurt nicely.  L. B. Forster might be that replacement, but when I have a choice, I prefer microcap companies like Portec.

The lawsuits allege that Forster is not paying enough of a premium (4% over the closing price the day the deal was announced), and that the directors breached their fiduciary duty in not looking for other buyers: i.e. not shopping the company around more to get a higher price.  One analyst of my acquaintance thinks a more reasonable premium would have added another buck per share.

But when was the deal negotiated?  Almost certainly over the last month or more. 


For most of January, Portec was trading around $10.50, and it started December at $9.  The purchase price of $11.71 per share is an 11.5% premium over $10.50: not great, but not horrible.  It's a 17% premium over $10 per share.

But no matter what you think of the price, there's no reason to join the lawsuit.  Every dollar going to a lawyer is money that comes, eventually, out of some investor's pocket.  You probably see an ad asking you to join one of the class action lawsuits next to this article: they're plastering them all over the internet.

If you don't like the price, you already have a perfectly viable option.  It's called democracy.  Don't tender your shares.  65% of shareholders must tender their shares for the merger to go through.  If clean energy supporters had 65% of the votes in the US Senate, we'd have climate change legislation by now.

Why has the stock risen so quickly in the last few weeks?  Perhaps rumors got out about the negotiations, and people with this inside information were (illegally) buying shares to make a quick buck.  Despite being illegal, that sort of thing happens all the time.  The trading pattern was particularly suspicious the day before the merger was announced . 

Those insiders are the people to send the lawyers after!

DISCLOSURE: Long PRPX.

DISCLAIMER: The information and trades provided here and in the comments are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

Posted by Tom Konrad at 10:17 PM | Permalink | Comments (0)

John Petersen

As a result of sweeping regulatory changes, the second decade of the new millennium is shaping up as a time of unprecedented progress in automotive fuel efficiency. In the EU, where small cars have been prevalent for decades, gasoline prices of $5 to $8 per gallon are the norm and consumers prize diesel engines, new regulations will require automakers to reduce tailpipe CO2 emissions to an average of 130 grams per kilometer (g/km) as follows:

• For 65% of the fleet, by 2012;
• For 75% of the fleet, by 2013;
• For 85% of the fleet, by 2014; and
• For 100% of the fleet, by 2015.

The penalties for non-compliance start at €5 per vehicle for the first g/km, and ramp up to €15 per vehicle for the second g/km, €25 per vehicle for the third g/km, and €95 per vehicle for each subsequent g/km. The EU's long-term target is 95 g/km by 2020. The following data comes from the European Federation for Transport and Environment and shows how automakers stacked up against the standards in 2008.

	2008 Sales	CO2 g/km
Fiat	1,131,005	138
PSA Peugeot-Citroen	1,794,593	139
Renault	1,253,371	143
Toyota	784,054	147
Hyundai	467,673	149
Ford	1,388,335	152
GM	1,366,069	153
Honda	245,395	154
BMW	784,736	154
Suzuki	229,074	156
Mazda	229,596	158
Volkswagen	2,870,570	159
Nissan	323,340	161
Daimler	760,925	175
Total	13,628,736	151

The bottom line is automakers must improve the efficiency of their European fleets by an average of 14% over the next few years or pay dearly for their failure to do so. This is a today issue, not a someday issue.

While the EU standards are aggressive, the challenges facing US automakers are even more daunting because they're starting from a less efficient baseline. The following chart comes from the EPA and shows the adjusted fuel economy for cars and light trucks sold in the US from 1975 through 2009.

Last September the EPA and the NHTSA published their proposed rules for Light Duty Vehicle Greenhouse Gas Emission Standards and Corporate Average Fuel Economy Standards. While the rules have not been finalized, they leave no doubt that the pressure on US automakers to radically and immediately improve fuel economy will be immense. The following table summarizes the proposed fuel economy standards, in miles per gallon, for the next few years.

	2011	2012	2013	2014	2015	2016
Passenger Cars	30.2	33.6	34.4	35.2	36.4	38.0
Light Trucks	24.1	25.0	25.6	26.2	27.1	28.3
Combined Cars & Trucks	27.3	29.8	30.6	31.4	32.6	34.1

Unlike the European rules, the proposed EPA and NHTSA rules will not let vehicle manufacturers pay fines in lieu of meeting emission standards. So once again, this is a today issue, not a someday issue. The following data comes from the Executive Summary Tables that accompany a recent EPA report on Light-Duty Automotive Technology, Carbon Dioxide Emissions, and Fuel Economy Trends: 1975 Through 2009 and shows how the principal US automotive marketing groups stacked up against the proposed standard in 2009.

	MPG
Honda	23.6
Hyundai-Kia	23.4
Toyota	23.2
Volkswagen	22.8
Nissan	21.6
BMW	21.6
General Motors	19.9
Ford	20.5
Chrysler	18.7
All	21.1

The bottom line is automakers may well be required to improve the efficiency of their US fleets by an average of 29% by 2012 and by a whopping 38% by 2016. Absent a tea party style revolt among new car buyers, I expect pickups, vans and SUVs to all but disappear from the marketplace. Even with smaller European type vehicles, the bulk of the work will have to be done with a combination of proven technologies that are fully developed and ready for widespread commercialization today, including:

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

The foregoing list of energy efficiency technologies was assembled from data on the EPA's www.fueleconomy.gov website and is not exhaustive. With the exception of the VTEC variable cam and valve timing technology that Honda first introduced in the Acura NSX (far and away the finest car I've ever owned) I don't know who the leaders are. My sense is that almost everybody is working on their own variants for most of these technologies because the pressures are so great and the timing is so tight.

I regularly mock plug-in vehicles because even the EPA acknowledges that "electric cars and trucks are unlikely to be available in large volumes anytime soon," which is a polite way of saying they won't be more than vanity products for years and those that are produced will be horrendously inefficient at reducing national gasoline consumption and CO2 emissions. The more important issue is that manufacturing plug-ins will directly and adversely impact the auto industry's ability to meet rigorous short-term CO2 emission and CAFE standards that are either in place or will be shortly. It's all well and good to daydream about rescuing the princess, but if a dragon guards her you have to deal with first things first.

Batteries are critical enabling devices for three of the four most important fuel efficiency technologies. For the next several years, every vanity car with a plug that rolls off an assembly line will preclude the production of 10 to 20 affordable fuel efficient vehicles. The dynamic may change toward the end of the decade when current battery research may result in the a new generation of inexpensive, safe and abuse tolerant electric drive batteries, but over the next five years fleetwide efficiency will be the only thing that matters.

Ultimately efficiency will be the touchstone for all successful alternative energy investments. Those that deliver more work with lower natural resource inputs will be very successful. Those that deliver less work with higher natural resource inputs will fail. The laws of economic gravity will not tolerate another outcome. While the bulk of the market's attention will invariably focus on the gee whiz, the bulk of the money will be made in mundane applications and sectors that focus primarily on saving money and only secondarily on saving the planet.

Disclosure: No companies mentioned.

Posted by John Petersen at 10:41 AM | Permalink | Comments (0)

John Petersen

On January 28th the DOE announced the closing of a $1.4 billion ATVM loan to Nissan North America, a unit of Nissan Motors (NSANY), for the purpose of retooling a factory in Smyrna, Tennessee to produce the Leaf, a zero emission electric car that will be released later this year. Nissan will use the loan proceeds to create "up to 1,300 American jobs" at a cost of about $1.3 million each and the 200,000 Leafs it hopes to produce and sell each year will "conserve up to 65.4 million gallons" of gas, a whopping 327 gallons per car per year. Secretary Chu said, "This is an investment in our clean energy future. It will bring the United States closer to reducing our dependence on foreign oil and help lower carbon pollution." I don't know whether to laugh or cry.

With due respect to Nissan and its PR team, no electric car can honestly claim zero emissions because unless they're sold in a bundle with a wind turbine or solar panel, the best any electric car can do is take distributed CO2 emissions from the roads and centralize them in a coal or gas fired power plant. Even under the most optimistic of renewable energy scenarios, American EVs will be plugging into a lump of coal for decades. I'm the first to point out that the Leaf will be responsible for a little less than half the CO2 a comparably sized car with an internal combustion engine would produce, but calling the Leaf 'zero emission' has all the intellectual integrity of a no-peeing section in the public swimming pool.

Nissan's alliance with France's Renault (RNSDF.PK) makes it a major player in the global automotive industry with combined sales of roughly 6 million vehicles in 2009. While Nissan and Renault both make marketable products, neither company has a sterling reputation as an automotive trendsetter, particularly when it comes to electric drive technologies. Nissan was fighting for survival while Toyota (TM) was developing its highly successful Hybrid Synergy Drive. As a result, the best Nissan could do was license the synergy drive from Toyota for use in the Altima. As recently as 2006, Renault was snubbing HEV technology in favor of fuel-efficient diesel engines. Now it seems that they've both found religion and want to leap-frog a decade of real-world electric drive experience by introducing an audacious, expensive and unproven electric car that will be underwritten by taxpayers and sold to customers (a/k/a lab-rats) as part of the grandest science fair project in history.

The best part is, Nissan wins no matter what happens. If the Leaf is a successful product, Nissan will have a taken a clear lead in the field with taxpayer money. If the Leaf is a failure, Nissan will be able to look regulators and EV advocates in the eye and say, "we spent billions to throw your stupid EV party and nobody came." No wonder Nissan CEO Carlos Ghosn is happy. Heck, even P.T. Barnum and W.C. Fields would have been proud.

To date Nissan's pricing plans for the Leaf have been cloaked in mystery, resulting in a plethora of conflicting press reports. Most seem to agree that Nissan will copy the 'batteries not included' section from Mattel's (MAT) business plan and lease the batteries to consumers under a separate contract. This strategy has the dual benefit of concealing the true cost of the Leaf while deflecting customer backlash from battery pack failures or service life issues.

I hate going back to unpleasant realities, but the Smyrna plant will need roughly 4.8 million kWh of lithium-ion batteries per year to build 200,000 Leafs. If Nissan-Renault had taken the time and spent the money to develop a competitive HEV technology of their own, those same batteries would be enough to upgrade more than half of their global auto production to HEVs and save 500 million gallons of gasoline per year in the process.

Last October a White House advisor called it 'calculator abuse' when ABC News had the temerity to suggest that stimulus jobs cost taxpayers an average of $160,000 each. I would love to hear a cogent explanation of how it makes sense to:

• Put taxpayers on the hook to the tune of $1 million for each new job created in Smyrna;
• Save 64.5 million gallons of gas with a small fleet of Leafs instead of saving 500 million gallons of gas by upgrading half of Nissan-Renault's global production to HEVs; and
  
• Reduce total CO2 emissions by 335,000 tons with a small fleet of Leafs instead of reducing CO2 emissions by 5 million tons with a larger and more affordable fleet of HEVs.

As things presently stand, I have to wonder whether the inmates aren't running the asylum.

Disclosure: None

Posted by John Petersen at 06:49 PM | Permalink | Comments (2)

John Petersen

I'm going to apologize up front for revisiting a topic that inevitably draws furious comment from readers who just don't get it, or who refuse to get it. I understand that it's painful to learn that politicians, environmental advocates and the mainstream media have been lying about critical issues, but that doesn't make exposing the lies less important. So I'm going to endure the slings and arrows of the eco-religious one more time and use a new example to show that plug-in vehicles are a luxury no nation can afford.

Ener1 (HEV) is a pure-play manufacturer of lithium-ion batteries. While I am frequently critical of Ener1's penchant for vague disclosures and EV happy-talk, today I'm going to take a different tack and accept their disclosures as gospel. In the Company section of its website, Ener1 describes its domestic production capacity as follows:

"Current production capacity is 10,000 electric vehicle (EV) packs per year, equivalent to 100,000 hybrid electric vehicle (HEV) packs. Capacity will peak at 30,000 EV packs per year in the current Indiana-based facilities at full utilization.

On receipt of the conditional $118.5 million in federal grants from the U.S. Department of Energy (DOE), EnerDel will double this number by 2012, to give a production capacity of 60,000 EV (600,000 HEV) packs per year, creating an estimated 1,700 new jobs in the State of Indiana. ..."

In a press release dated January 21, 2009, Ener1 disclosed that it planned to spend $237.5 million to expand its domestic battery production capacity to approximately 600,000 HEV or 60,000 EV packs per year. Roughly half of the planned expansion funding will come from a $118.5 million ARRA battery manufacturing grant that Ener1 was awarded in August 2009. Ener1 will have to raise the balance from open market equity sales and other non-government sources to fulfill the requirements of its grant.

HEVs and EVs both use advanced batteries and sophisticated electric drive technologies to capture energy that would have been lost in braking, use the captured energy in subsequent acceleration cycles and minimize the waste of gasoline. While HEVs draw the line at maximizing vehicle efficiency, EVs go a step further and use additional battery capacity to replace the fuel tank, which means an outlet in your garage becomes your fuel source instead of your neighborhood filling station.

The typical American drives about 12,000 miles per year and if he buys a new fuel-efficient car he can expect to pay roughly $18,000 for the vehicle and buy about 400 gallons of gasoline per year. In comparison, a consumer who buys a new HEV for roughly $22,000 can expect to buy 240 gallons of gasoline per year and a consumer who buys a new EV for roughly $40,000 won't buy any gasoline at all.

According to www.fueleconomy.gov burning one gallon of gasoline produces 20 pounds of CO2. While EVs don't burn any gasoline and are widely touted as super-green, the power plants that generate electricity in the U.S. release an average of 9.7 pounds of CO2 for each gallon of gasoline equivalent.

With those numbers firmly in hand, let's do some simple comparisons of what happens when the batteries from the Ener1 expansion leave the plant and are used to manufacture 300,000 additional HEVs or 30,000 additional EVs.

Incremental manufacturing revenue	HEV	EV
Per vehicle	$4,000	$22,000
Plant total	$1.20 billion	$0.66 billion
Annual gasoline savings
Per vehicle (gallons)	160	400
Plant total (gallons)	48 million	12 million
Annual CO2 emission reduction
Per vehicle (tons)	1.60	2.06
Plant total (tons)	480,000	61,800

It's important to note that the table presents the two extremes on the range of possibilities and the likely impact on manufacturing revenue, gasoline consumption and CO2 emissions is somewhere in the middle. Nevertheless, I think it's important for everyone to understand that using the additional battery production from the Ener1 plant to produce 300,000 HEVs instead of 30,000 EVs would be twice as effective at creating jobs, four times as effective at reducing national gasoline consumption and eight times as effective at reducing national CO2 emissions, especially when I consider that the taxpayers are going to pick up half the tab for the plant expansion.

How about you?

This really isn't a rhetorical question. I want to know what my readers think. Please take a few seconds and respond to the following single question poll.



Disclosure: None.

Posted by John Petersen at 04:30 AM | Permalink | Comments (14)

John Petersen

Writing an investment blog on hype-riddled sectors like vehicle electrification and energy storage is tough because the topic is emotionally charged and expectations are often based on political promises, issue advocacy, press releases and mainstream media stories that never tell the complete truth. As a result I spend a huge amount of time debunking popular mythology that's 180 degrees out of sync with business realities and responding to commenters who refuse to believe cars with plugs will be:

• Five to six times less efficient than HEVs when it comes to reducing national gasoline consumption;
• Nine to twelve times less efficient than HEVs when it comes to reducing national CO2 emissions;
• Subject to short-term supply constraints because of their reliance on scarce raw materials;
• Experimental concepts that require years of testing before they're ready for prime time;
• Beyond the price range of all but the most affluent consumers; and
• Wholly unacceptable to consumers that expect a three to five year payback on the cost premium.

The risk and the opportunity for investors is that distorted perceptions of commercialization timelines have led to unreasonably high expectations for lithium-ion battery developers that may experience huge revenue growth in the second half of the decade and unreasonably low expectations for lead-acid battery manufacturers that are certain to experience huge revenue growth over the next five years. As the revenue impact of current automotive production decisions becomes more clear and the wide gulf between expectations and reality narrows, I believe that the equities of objectively cheap lead-acid battery manufacturers will surge while the equities of objectively expensive lithium-ion battery developers underperform.

Press Releases

For better or worse the markets are emotional creatures that can't help but react to press releases and news stories designed to fire the imagination and inspire "wouldn't it be great if ...?" thinking. Some of the more inspirational examples of the unrelenting electric vehicle hype we've seen over the last few months include:

• Tesla Motors' production of its thousandth electric Roadster in time for the 2010 Detroit Auto Show;
• Fisker Automotive's planned production of the Karma plug-in hybrid on the strength of a 1,300 unit order book;
• Th!nk Global's rescue from bankruptcy on the strength of a 2,300 unit order book;
• Toyota Motors' (TM) planned demonstration fleet of 500 plug-in hybrids based on their Prius HEV platform;
• General Motors' planned production of the Volt plug-in hybrid at a rate of 8,000 to 10,000 vehicles annually;
  
• Mitsubishi Motors' (MMTOF.PK) planned production of the MiEV electric car at a rate of 8,500 vehicles annually;
  
• Nissan Motors (NSANY) planned production of the Leaf electric car at a rate of up to 20,000 vehicles annually; and
• President Obama's audacious goal of a million plug-ins on the road by 2015.
  

If one just reads the press releases and news stories, it seems like the whole world is going electric and the days of sunshine, lollipops and roses along Electric Avenue are just around the corner. Perhaps it's my skeptical nature, but plans alone don't impress me because I've seen so many ill-conceived plans fail. I also remember that:

• DeLorean Motor Company produced and sold 9,000 cars in 1981 and 1982 before its CEO decided that he needed to boost revenue by importing agricultural products from South America;
• Ferrari sells approximately 7,000 vehicles per year;
• The Bentley division of Volkswagen sells 8,000 to 10,000 vehicles per year; and
• Toyota Motors (TM) sold its millionth Prius in 2008 and is gearing up to produce 1,000,000 HEVs annually by 2011.

In isolation, the press releases and news stories seem impressive. In the context of an industry that sold 10.5 million vehicles in 2009 during the worst recession since the 1930s, the planned introduction of cars with plugs is inconsequential. These are PR stunts, not credible products. While cars with plugs may become credible by 2020 if they can earn consumer confidence at rates that are comparable to HEVs, I believe their growth potential over the next five years is modest at best.

The following graph comes from www.hybridcars.com and shows annual domestic HEV sales over the last decade. In light of high cost, limited flexibility and unresolved consumer acceptance, performance and safety issues, I have to believe the ramp rate for cars with plugs will be far slower than the ramp rate for HEVs, which took nine years to hit the million vehicle mark.


The eco-religious will strenuously disagree with my admittedly conservative view that a goal of "one million plug-ins by 2015" is sheer presidential fantasy, but differences of opinion are what make horse races and investments interesting.

Production Decisions

Once you back away from the wishful thinking and start looking at automakers' real-time production decisions, a different picture emerges. Instead of trying to leap tall buildings with a single bound, the automakers know that a journey of a thousand miles begins with a single step and they've started on the journey because their customers demand it. The technologies that are going into production, however, are rational incremental steps to improve efficiency without reinventing the industry. The step that is most important for energy storage investors is the rapid implementation of idle elimination technologies, which are typically referred to as either micro-hybrids or stop-start systems.

There are few ideas that are more sensible than idle elimination. Instead of burning gasoline and spewing emissions while you're stuck at a stoplight, turn the engine off until the light turns green. Stop-start systems have little value for a drive in the country, but they can reduce fuel consumption in congested city driving by 6% to 10% for an outlay of a few hundred dollars. After several years of testing, automated stop-start systems have proven themselves to the point where the entire industry is adopting them as standard equipment. A few examples of major stop-start production decisions include:

• Mercedes Benz, which will introduce stop-start systems throughout its entire passenger car line;
• BMW, which has already implemented stop-start systems on all Series 1 and 3 vehicles with manual transmissions;
• Volkswagen, a stop-start pioneer that is implementing the technology throughout its passenger car line;
• Toyota, which has already impemented stop-start systems in its Auris and Yaris lines; and
• Ford, which plans to introduce stop-start systems throughout its entire passenger car line.

In short, the widespread implementation of stop-start technology is not something that might happen on some fine day in the vaguely defined future. It is happening today in factories around the world and while the future of cars with plugs is unclear, it is virtually certain that stop-start technology will be standard equipment within a few years because it's a cheap and proven way to improve fuel economy and reduce emissions. The following graph comes from a 2008 Frost & Sullivan presentation and summarizes their forecast of global hybrid vehicle sales over the next five years, broken down by technology type. The blue sections of each column represent stop-start systems.



Micro hybrids with stop-start technology are already saving about a hundred million gallons of gasoline per year. By 2015 they'll be saving well over a billion gallons of gasoline per year, which compares favorably to the 400 million gallons that could be saved if the presidential goal of a million plug-ins by 2015 was remotely possible. Once again, sensible action by private enterprise has trumped central planning by delivering vastly superior results for far less money.

The major challenge with stop-start technology is that it's very hard on starter batteries because instead of starting the car once per trip, a stop-start system will stop and restart the engine at every stoplight. The current approach is to use premium lead-acid batteries instead of the lower quality batteries the auto-industry historically used as original equipment. The long-term solutions that are currently in final stages of development include:

• Using a combination of batteries and supercapacitors to satisfy the intense demands of stop-start systems, an approach that's being developed by Maxwell Technologies (MXWL) and Continental AG (CON.DE).
• Using lead-carbon batteries that combine battery and supercapacitor characteristics in a single device, an approach that's being developed by Exide Technologies (XIDE), Axion Power International (AXPW.OB) and East Penn Manufacturing.
  

While the numbers were eclipsed by the headline awards to lithium-ion battery developers and largely ignored by investors, President Obama's August 2009 announcement of the recipients of $1.2 billion in ARRA battery manufacturing grants included:

• $34.3 million to Exide Technologies with Axion Power for the production of advanced lead-acid batteries using lead-carbon electrodes for micro and mild hybrid applications; and
• $32.5 million to East Penn Manufacturing for production of the Ultrabattery (lead-acid battery with a carbon supercapacitor combination) for micro and mild hybrid applications.

In other words, these are real technologies that are being built into real production model vehicles and being sold to real customers today. There's no wishful thinking involved. The wave of change has hit the shore and will wash through the entire industry over the next few years.

The Hype Cycle

Professional investors understand that all emerging technologies are subject to a phenomenon the Gartner Group calls "the hype-cycle" and they time their investments accordingly. Venture capital types typically buy before the technology trigger point and sell at the peak of inflated expectations. Value investors frequently wait for the trough of disillusionment before they buy for the long term. The only professional investors that are active during the peak of inflated expectations are traders. TIAX LLC offered the following overview of emerging vehicle technologies and the hype cycle at the Plug-in 2008 Conference.



The big problem with graphs like this one is that they don't provide specific guidance to investors on where individual companies stand. Since I've never been one to avoid controversy and experience has proven that my opinions don't impact the markets I've decided to bite the bullet and offer one man's views of where the pure-play energy storage companies are located on the hype cycle curve.

A123 Systems (AONE) had a tremendously successful IPO in September and is currently trading at 132% of the offering price. It finished 2009 in solid financial condition and has done a great job of managing short-term expectations. All things considered, I'd peg A123 somewhere along the upward slope between the technology trigger and the peak of inflated expectations. While I expect A123's focus on cars with plugs to eventually result in significant disillusionment, the day of reckoning is probably 18 to 24 months off.

Ener1 (HEV) has been a centerfold darling of the cars with plugs set for several years and may well be past its peak of inflated expectations. Ener1 finished 2009 in dreadful financial condition and will require massive capital infusions to stay afloat and provide matching funds for the ARRA battery manufacturing grant it received last August. Ener1 recently filed a Form 8-K to disclose the presentation materials it's currently using in discussions with private investors. Given current market conditions and the huge hits that other companies have taken in recent down-round financings, my sense is that Ener1 is headed into the trough of disillusionment unless management can pull off a major miracle.

Maxwell Technologies (MXWL) has done a very effective job of publicizing its work on stop-start solutions and explaining the potential to investors. As a result, its stock has gone from a low of $4.50 to a closing price of $17.23 on Friday. I've toured Maxwell's supercapacitor plant in Rossens, Switzerland and believe their Boostcap technology has an important role to play as the micro-hybrid market develops. My sense is that Maxwell has already passed through its trough of disillusionment and is now working its way up the slope of enlightenment.

Exide Technologies (XIDE) has done a terrible job of publicizing its work on stop-start solutions because it already sells a couple billion dollars of batteries into the automotive market every year. So unlike the new kids on the block, Exide doesn't need to attract new customers. It just needs to visit existing customers and show how the new lead-carbon product will better serve the customer's needs. The same dynamic exists at East Penn Manufacturing, which couldn't care less about PR because it's privately held and already has a massive customer base. I believe that Exide is out on the plateau of productivity and rapidly approaching a new technology trigger point with the lead-carbon solutions for the micro-hybrid market. With a stock price that only equates to 24% of trailing sales, I think Exide has tremendous potential as customer testing of its new products matures into substantial purchase orders over the next year.

Axion Power International (AXPW.OB) is my old home team and I'm far from unbiased because I've watched the PbC technology mature from laboratory experiment through commercial prototype and am proud of the time I served as board chairman. Axion has always been a public relations oddity because it partnered with East Penn in 2004 and Exide in 2008, which means it's always had to behave like a mature manufacturer instead of taking some of the liberties one would normally expect from a technology start-up. As a result of its existing partnerships with two of the three largest automotive battery manufacturers in the world Axion doesn't need to attract its own customers because its partners already have them. Axion's stock price took a bit of a beating in December when it completed a $26 million down-round financing with some very high quality institutional investors, but when its partners start signing high-volume supply contracts with their existing customers, I expect a technology trigger response that bodes well for Axion's future stock price.

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

Posted by John Petersen at 09:57 AM | Permalink | Comments (1)

Tom Konrad, CFA

I included the Powershares Global Progressive Transport Portfolio (PTRP) as an investment option instead of three stocks in my Ten Clean Energy Stocks for 2010, as part of a simplified portfolio for small investors wanting to minimize costs by making fewer trades.  The other Exchange Traded Fund I used in this way was the First Trust Nasdaq Clean Edge Smart Grid Infrastructure Index Fund (GRID).  I took a look at the holdings of the Smart Grid ETF here, and they are not exactly what you would expect from the name.  Since it makes sense to know what you're buying, I decided to do the same for PTRP.

The left side of the chart below shows my classification of the companies held by PTRP (as of the end of 2009).  Some companies fell into multiple categories, so I divided their industry allocation accordingly.  The right side shows a similar treatment for the three stocks I suggested substituting PTRP for in my "10 for '10" portfolio (New Flyer (NFYIF.PK-bus), Portec Rail Products (PTRP-rail), and First Group PLC (FGP.L - Bus & Rail))

Notes on Categories

• Smart Transit: routing traffic/freight/etc. more intelligently
• Efficient Vehicles: Improvements to internal combustion engines, and materials to lighten vehicles.
• Alt Fuel: mostly natural gas, but some propane and hydrogen as well.
• Electric/Battery: Battery manufacturers, material suppliers, and suppliers of electric motors and transmissions.
• Other: the non-transportation parts of the businesses of included companies.

Comparison with the 10 for '10 Portfolio

As you can see, PTRP is far from a perfect substitution for the 3 stocks from my 10 for '10 portfolio.  This is for several reasons:

1. While I included a battery company (C&D Technologies (CHP)) in the 10 for '10 portfolio, I counted it as a "grid" investment as opposed to an electrified transport investment (since batteries serve both functions.)  If both substitutions for grid and transport investments are made, the allocation to batteries actually works out fairly well.
2. My favorite transport investments are alternative modes that directly reduce fuel use, such as rail transit, bus transit, and bicycles.
3. I did not include a bicycle investment in the 10 for '10 portfolio because none trade in the US or Canada.  One of the things I like most about PTRP is the 8% allocation to bicycle companies.

I don't expect that PTRP will track the three companies from the 10 for '10 portfolio very well, but the greater diversity of the holdings makes it a little less risky.  The downside, however, is that I chose the large allocation to busses for a reason: I think this is the quickest and cheapest option (other than bicycles) we have when we finally get serious about reducing our dependence on petroleum.  Such a decision probably won't be voluntary.  Rather, it will be the consequence of our near total unpreparedness for the reality of peak oil.  That very unprepardness is what gives busses and bus rapid transit an advantage over rail based transit: it takes a lot less time and money to order buses and designate a bus lane than it does to build a rail transit system.

DISCLOSURE: Long NFYIF,  PRPX, CHP.

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.

Posted by Tom Konrad at 10:20 AM | Permalink | Comments (0)

John Petersen

Generation specific cultural references can be treacherous ground for bloggers because the flashback effect is usually limited to readers with long and vivid memories. In this case, however, the lessons of history are so relevant that I'll accept the risk and offer some context for younger readers.

In my youth a war wrapped in the liberal ideology of the Kennedy and Johnson administrations and fueled by an underlying concern over who would control oil and gas resources in the Gulf of Tonkin was fought in the jungles of Vietnam, Laos and Cambodia. By current standards, the toll of 47,424 battle deaths was staggering. By the late '60s opposition to the War was widespread and a galvanizing force behind the antiwar movement was music, including an iconic folksong from Pete Seeger, Waist Deep in the Big Muddy.



While my use of an antiwar anthem to make a point about plug-in vehicles is certain to draw howls of outrage from advocates and true believers, I think the analogy is apt because the ideologically inspired road to disaster we trod during the late '60s is frighteningly similar to the path we're on today with plug-in vehicles where the prevailing attitude seems to be "damn the facts, push on."

Our fundamental energy problems are easy to identify – increasing oil prices and increasing reliance on imports. Both numbers have been climbing steadily for decades and consumers have been stubbornly reluctant to change their behavior in response to prices. The burden on the economy becomes heavier with each passing year and if you're willing to extend the current price channel out for another decade, oil price expectations in the $150 to $180 per barrel range don't seem all that far fetched.



For as long as automakers have been proposing plug-in electric vehicles, skeptics like me have been noting that fuel savings are unlikely to give consumers a cash-on-cash payback of their incremental cost over the life of the vehicle, much less the three to five year window that consumers typically expect. There are countless vague promises about  economies of scale driving down costs as the industry matures, but at least in the battery sector where raw materials and plant automation are the primary cost drivers and labor is almost a rounding error, I have a hard time banking on a fairy godmother to restrain commodity prices and equipment costs. While the following graph of long-term industrial and precious metal prices from Credit Suisse is a little dated, it certainly has the same general shape and slope as the most recent decade on the oil price chart.



"We were knee deep in the Big Muddy, the big fool said to push on."

For several years realists like Vinod Khosla and others have noted that since the U.S. gets roughly 50% of its electricity from coal and will likely do so for decades to come, the environmental benefits of plugging an electric vehicle into a lump of coal will be few and far between. Last week, I offered a simple comparison of plug-in vehicles with conventional HEV technology (without plugs) that proves plug-ins are about one-quarter as effective at reducing oil imports as cheaper HEVs that can point to a decade of performance under real world conditions.

"We were waist deep in the Big Muddy, the big fool said to push on."

The real flies in the ointment are that plug-in vehicles don't significantly change the energy balance, they're far too resource constrained to make a dent in oil imports, and the fundamental economic premise only works if you are willing to assume that historically moderate trends in retail electricity prices will continue forever.

From an overall energy balance perspective, plug-ins don't change the amount of energy needed to move a vehicle down the road. Instead, they merely move the conversion of fuel to energy from under the hood to a local power station while increasing vehicle cost by 50% to 100%.

Likewise, the batteries that will be used in plug-ins are made from raw materials that are orders of magnitude less abundant than oil. The resource constraint issues go far beyond lithium availability and extend to every component in batteries and battery packs. Those materials all have alternative uses in high value products and from a resource availability standpoint, using batteries to conserve oil is a lot like using gold to conserve copper.

Finally, it's almost impossible to find a newspaper or magazine that doesn't have several articles on the evolution of the electric grid. We're seeing massive investments in wind and solar power installations and the estimated cost of the coming smart grid runs to trillions of dollars. Since the one certainty is that private capital will not finance alternative energy or the smart grid without expecting both a return of capital and a return on capital, it's patently absurd to believe that electricity price increases will remain as benign in the future as they have been in the past.

"We were neck deep in the Big Muddy, the big fool said to push on."

When I was but a lad one of my mother's favorite quips was "use your head for something besides a hat rack." It was her way of teaching me to look beyond my immediate circumstances, consider the factors that led me to a decision-point and reflect carefully on the likely consequences of my actions. When it comes to plug-in vehicles, investors and the general public have been little more than hat racks for too long. Instead of thinking things through and questioning assumptions, they've been placated by "wouldn't it be great if ...?" sound bites. Instead of asking whether crossing the big muddy is possible or the effort worthwhile, they've allowed themselves to be led down the garden path by politicians and activists who vainly promise gain without pain and reward without risk.

If it weren't so damned expensive, I'd describe vehicle electrification beyond the HEV stage as a zero sum game. Given the immense costs that are becoming increasingly clear with each passing day, I'd characterize it as a game where we can't reasonably hope to break even.

Disclosure: No stocks mentioned because we all know who they are.

Posted by John Petersen at 10:20 AM | Permalink | Comments (6)

John Petersen

For eighteen months I've been blogging about the energy storage sector and discussing the current and potential markets for batteries and other manufactured energy storage devices. A recurring theme that I've discussed many times is the unrecognized but undeniable truth that while plug-in vehicles masquerade as conservation measures at an individual level, they're incredibly wasteful at a societal level. The conclusion is counter-intuitive and my articles on the subject invariably draw heated criticism from self-anointed defenders of the faith. Their arguments, however, do not change the inescapable truth that plug-in vehicles are one of the most wasteful concepts ever foisted on gullible government officials and an unsuspecting public.

Today I'm going to do my level best to simplify the numbers and expose the plug-in fraud for what it is. If you want to delve into more detail, you should visit my article archive at Seeking Alpha.

On December 31, 2009 Forbes published an opinion piece titled System Overload that questioned whether the lithium-ion battery industry was overbuilding global manufacturing capacity. The third paragraph said:

"By 2015 the new factories will have the global capacity to produce 36 million kilowatt-hours of battery capacity, enough to supply 15 million hybrid vehicles, or 1.5 million fully electric cars, says Deutsche Bank."

The article then went on to question whether there would be buyers for all those vehicles. I firmly believe that every battery manufacturer that brings an automotive battery to market within the next few years will have more demand than it can satisfy. That being said there is no denying the fact that fully electric cars and plug-in hybrids are unconscionably wasteful.

In America, the average car owner drives about 12,000 miles per year. To power a car for that distance, he'll need about 400 gallons of gasoline for a conventional internal combustion engine; 240 gallons of gasoline for a Prius class HEV; and no gasoline for a fully electric vehicle. The eco-religious among us are beside themselves with glee over the appealing but patently absurd idea that fully electric vehicles are the best way to slash dependence on oil imports and protect mother earth. The numbers tell an entirely different story.

If we stick with the Deutsche Bank numbers quoted in the Forbes article, 1.5 million fully electric cars would save 600 million gallons of gasoline per year. That's a very impressive number until you realize that 15 million Prius class HEVs without plugs would save approximately 2.4 billion gallons of gasoline per year. In my book, the difference of 1.8 billion gallons of gasoline per year is subsidized waste on a massive scale.

While the gasoline consumption comparisons are miserable, the CO2 emission comparisons are nothing short of tragic.

Each gallon of gasoline used in an internal combustion engine releases 20.35 pounds of CO2. While fully electric vehicles are cleaner, they're not CO2 free because the power plants that generate the electricity release a national average of 9.68 pounds of CO2 per gallon of gasoline equivalent. Returning to the Deutsche Bank numbers, 1.5 million fully electric cars would cut annual CO2 emissions by 2.9 million tons, another very impressive number. In comparison, 15 million Prius class HEVs without plugs would slash annual CO2 emissions by a whopping 24.4 million tons. In my book, the difference of 21.5 million tons of CO2 emissions per year is subsidized pollution on a monumental scale.

The final nail in the coffin comes from purchase price comparisons. Toyota's (TM) base sticker price for a 2010 Prius is $22,400. In comparison the base sticker price for the planned GM Volt will be about $40,000. While Federal tax credits of $7,500 are expected to reduce the end-user cost of the Volt to $32,500, it will still cost the consumer $10,000 more than a Prius. The last time I checked, a $10,000 purchase price difference is important to the average consumer, particularly when study after study reports that the Volt is not expected to pay for the price difference in fuel savings.

On a micro-scale, fully electric vehicles and plug-in hybrids are feel good eco-bling for the emotionally committed and the mathematically challenged. On a macro-scale they use more gasoline, emit more CO2 and are more expensive than established HEV technology. At this point I have to wonder, does anybody in Washington DC have a calculator?

I'm a lawyer, a battery guy and a policy geek. I know that six billion people on our planet would like to have a piece of the lifestyle that 600 million of us have and take for granted. I also know that as a result of the information technology revolution, about half of the 6 billion have access to electronic data and understand for the first time in history that there is more to life than subsistence. Even if we assume that they will only become consumers at 5% to 10% of purchasing power parity, the increased pressure on water, food, energy and every commodity you can imagine will be immense beyond imagining. The big challenge will be creating enough room at the table so that we can avoid the unthinkable consequences of inaction.

I love HEV technology because it minimizes waste of both gasoline and other natural resources. I'd love it even more if it were tied to a compressed natural gas fuel system that would eliminate dependence on imported oil, but that's a different discussion. I'm also a big fan of micro- and mild-hybrid technologies that use less robust electric motors and simpler batteries from companies like Johnson Controls (JCI), Exide Technologies (XIDE) and Axion Power International (AXPW.OB) to reduce waste for drivers who can't afford to upgrade to a Prius class HEV. I am offended by the P.T. Barnum class hucksters at Ener1 (HEV), A123 Systems (AONE), BYD Company (BYDDF.PK) and others that use the false promise of fully-electric vehicles to maintain bloated market capitalizations and lead investors down a garden path that will almost certainly end in massive losses once the market understands the true costs and illusory benefits.

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

Posted by John Petersen at 06:51 AM | Permalink | Comments (25)

John Petersen

Before moving to Switzerland in 1998 I lived and worked in Houston, Texas, a place that teaches you the importance of keeping an eye on long-term weather forecasts, particularly during hurricane season. Most of the time it turns out to be wasted effort because Mother Nature is fickle and highly unpredictable, but when it's important it's really important. The same logic holds for investments in energy storage and electric vehicle technologies. You have to keep a close eye on the industrial and regulatory climate and be ready to change your plans when conditions change.

For eighteen months I've cautioned that lithium-ion batteries are not suitable or cost-effective for use in cars with plugs, which are collectively classified as grid enabled vehicles, or GEVs, by the Electrification Coalition, a newly organized industrial lobby for the lithium-ion battery and electric vehicle industries. I raised the storm watch flag based on a DOE report that discusses the technical and economic challenges of using lithium-ion batteries in GEVs; a White House report that the GM Volt is not likely to be competitive; an unpublished DOE roadmap for lithium-ion battery development that highlights the need for several generations of improvement in battery chemistry and manufacturing technology; a National Research Council report that battery costs are likely to remain high for decades; and an Energy Information Administration forecast that GEVs won't account for more than 3% of the market before 2035. Politicians, reporters and eco-clerics are all enamored with GEVs, but they generally live in a "wouldn't if be great if ...?" world where economics, paychecks and monthly bills don't matter. In contrast, the people who bear the front line responsibility for implementing unsound policies see nothing but problems.

Now I think it's probably time to upgrade the storm watch to a storm warning.

Storm Warning I: Lithium-Ion Batteries

On December 7, 2009, the DOE's Advanced Research Projects Agency – Energy, which goes by the acronym ARPA-E, released a $100 million funding opportunity announcement for battery research and development projects that have a reasonable chance of achieving the long-term price and performance goals for electric vehicle batteries that lithium-ion technology can't even approach. While DOE funding opportunity announcements are a little arcane for most investors, I found the discussion in the Background section of the Program Overview revealing, which is why I'm upgrading my storm watch to a storm warning.

The background discussion starts out by repeating the widely publicized facts that the U.S. imports roughly 60% of its petroleum and uses almost 70% of available supplies for transportation. After describing the desirable economic and environmental impacts of shifting transportation to the electric grid, ARPA-E lays the blame for the anticipated shortcomings of GEVs squarely at the feet of the battery industry:

"However, the widespread deployment of electric vehicles has been prevented to date by their limited range and high upfront capital costs due to the limitations of currently available battery technologies. Currently available high performance Lithium-ion battery technologies are limited to system level energy densities of ~100-120 Wh/kg, costs of $800-$1200/kWh, and short cycle life, resulting in unacceptably short driving range for the vast majority of consumers and un-economically high lifetime costs for electric vehicles."

After praising recent strides that have been made toward developing high-power batteries for HEVs (without plugs), the tone becomes decidedly ominous on the topic of high-energy batteries for GEVs where oft-stated performance goals "are pushing up against the fundamental energy density limits of traditional Lithium-ion based batteries." After referencing "strong doubts in the battery community as to whether the energy density of Lithium-ion batteries will be able to be pushed to the 200+ Wh/kg system level energy densities required for widespread deployment of all-electric vehicles" and grave reservations "as to whether traditional Lithium-ion based battery production for electrified vehicles offers an opportunity for the U.S. to assert domestic technology and manufacturing leadership within the context of the existing Lithium-ion based battery technology platform," the funding opportunity announcement confirms ARPA-E's "strong interest in supporting the development of new high energy, low cost battery technology approaches beyond traditional Lithium-ion batteries" and offers up to $100 million in grants for battery researchers that are willing to rise to the challenge.

Overall the discussion struck me as a politically guarded admission of the inescapable reality that lithium-ion batteries are not good enough, durable enough or cheap enough for GEVs; and they're not expected to improve much in the foreseeable future. In other words, it's time to kick lithium-ion batteries to the sidelines, launch Plan B and develop new battery technologies that may actually be capable of doing the required work at an acceptable cost.

Storm Warning II: Raw Materials Constraints In Electric Drive Motors

A second storm warning that came to my attention this weekend is an issue that my friend Jack Lifton has been writing about for years -- Chinese domination of the global market for rare earth metals. On December 22, 2009 the DOE released a "Notice of Intent - FY2010 Vehicle Technologies Program Wide Broad Agency Announcement" that includes the following area of interest:

"Subtopic 3 (d)-Motors Using No Rare Earth Permanent Magnets for Advanced EDV Electric Traction Drives

This subtopic is for motor technologies that eliminate the use of rare earth permanent magnets. Analysis of recent price trends and resource availability indicate cost and availability concerns of these material types. Approaches may include the use of non-rare earth magnet materials or motor technologies that do not use permanent magnets to meet the desired size, weight, and cost targets."

I can't wait to see the formal funding opportunity announcement on this one. We may even see a carefully worded admission that the Chinese need their rare earth production to satisfy domestic demand and mining is so unpopular with the eco-clerics that it's easier to do without GEVs unless we can invent a whole new class electric drive motors that are not material constrained. I wonder how long the anti-mining attitudes will last when the general public comes to the realization that the generators in wind turbines are subject to the same raw material constraints.

The Perfect Storm

In combination I view these two DOE funding opportunities as a one-two punch for GEVs. The lithium-ion batteries that the investment world is valuing at nosebleed levels are not going to be up to the job and even if the batteries improve beyond the DOE's wildest expectations there won't be any permanent magnet motors to drive the wheels. From where I sit, it's beginning to look like another abortive government attempt to create a market for technologies that consumers don't want and global supply chains can't support. Other fine examples of the syndrome include:

Timeframe		Revolutionary Technology
25 years ago		Methanol
15 years ago		Electric vehicles
10 years ago		HEVs and Electric vehicles
6 years ago		Hydrogen Fuel Cells
3 years ago		Ethanol
Today		Grid Enabled Vehicles
2011		What’s next?

Every industrial revolution in history has been driven by innovation that gave people the ability to do more with less. While I believe the coming cleantech revolution will be driven in large part by constraint and increasing competition for water, food, energy and virtually every commodity you can imagine, efficiency is inherently cheaper than waste and the winning solutions will be technologies that allow us to do more with less. Technologies that require more and deliver less will, of necessity, end up on the dung heap of history.

Disclosure: Author is a former director Axion Power International (AXPW.OB) and holds a large long position in its stock. He also holds small long positions in Exide Technologies (XIDE), C&D Technologies (CHP) Active Power (ACPW), ZBB Energy (ZBB) and Great Western Minerals Group (GWG.V).

Posted by John Petersen at 08:20 PM | Permalink | Comments (12)

Green Energy Investing For Experts, Part IV

Tom Konrad, CFA

Mass air travel is incompatible with a sustainable economy.  Air travel is energy and capital intensive, creates a gigantic carbon footprint, and is likely to  remain dependant on the high energy density of fossil fuels much longer than surface transport.  As such, it is a prime candidate for the short side of a clean energy portfolio.

I'm writing this post on a United Airlines (UAUA) flight from Baltimore to Denver in a seat that cost me $99, plus $15 to check a bag.  One sign of the economic unsustainability of flying me and my luggage at 8 cents a mile is airlines increasingly undignified scramble for marginal revenue, like that charge for checked baggage.

My flight left a half hour late because of airlines' desperate attempt to raise more revenue without raising prices by charging for checked baggage.  This has the unintended but unsurprising consequence of encouraging people to bring larger and more carry-on baggage, and spend more time wrestling it into the overstuffed overhead bins.  

Because most airlines are now charging for checked bags, it will be difficult for an airline to switch to a more rational policy that does not encourage passengers to bring excess carry-on baggage causing needless delays without making their prices seem relatively more expensive than their competitors.  (It's interesting, if not statistically rigorous, to note that JetBlue (JBLU) does not charge for the first checked bag, and Southwest (LUV) does not charge for the first two. Both usually seem to be among the best airlines for on-time departure rates.)

Airlines blamed an increase in flight delays on weather in October. I blame it on the increase in passenger awareness of the increased cost of checking bags.  In the short term, dropping ticket prices and charging for baggage will probably create a boost for airlines bottom lines.  In the long term, delays and strained backs from packing fewer, heavier bags can only decrease demand for air travel, just as the indignities of airport security have already made many potential passengers think twice when considering air travel.

The Icarus Industry

The above rant about checked baggage is just an example.  Airlines' economic woes are longstanding.  Airlines' current pursuit of short term revenues at the expense of the industry's long-term viability is more a symptom than a cause of industry woes.  Rather, the problem is chronic over-investment (by both private investors and governments) in the airline sector.  Flight has a visceral emotional appeal to humans, and industries with emotional appeal attract both government support and investment dollars, even from investors and governments who should know better.

With nearly unparalleled emotional appeal, the airline industry has been in a state of chronic oversupply practically since its inception.  This deprives airlines of pricing power, and makes it impossible for the industry  to recoup its  true costs over the long term.  Over its entire 120 year existence, the airline industry has racked up a net loss.  I think the Financial Times aptly summarized the consequence of these horrible economics in the line: "Grown up investors avoid the airline industry."

Peak Oil

As bad as the history of the airline industry has been, I expect the situation to get worse over the next few years. As we've seen since 2008, air passenger demand is highly sensitive to the health of the economy.  Hopes of economic recovery are seen by industry insiders as key to a "return" to industry profitability.  But in the current era of tight oil supplies, economic recovery will boost demand for oil, and raise the price of jet fuel, airlines' single largest cost category.   The following slide is taken from a 2004 presentation by Dr. Chris Smith of SH&E, an airline consultancy [pdf.]  With oil prices now around $70 a barrel, we will have seen another increase in the fuel cost category almost as large again as the rise shown.

 

My $114 flight on a Boeing 757 from Baltimore to Denver alone used about 18 gallons jet fuel (using numbers from here).  Unlike motorists, airlines pay little or no tax on jet fuel, meaning that any increase in oil prices will cause a much larger percentage increase in airline operating costs than it does for ground transportation.  

In short, airlines are a major source of marginal demand for oil.  Since the realities of peak oil constrain the expansion of supply, increases in demand for oil fueled by economic growth or decreases in supply caused by depletion must be matched to decreases in demand somewhere in the economy.  Air travel's profligate use of oil and relative price sensitivity mean that the industry will continue to reduce consumption faster than other transport sectors.  Given slow turnover in the airline fleet and stagnant efficiency improvements, most of the decrease in oil use will have to come from a decrease in passenger miles traveled.

Substituting alternative fuels for oil is also unlikely to help the economics of aviation.  A recent Rand study states, "Early in our study, we recognized that certain fuels may be more appropriate for automotive applications than for aviation.  Moreover, supplies are limited for nearly all the alternative fuels we examined."  (Thanks to Jim at The Master Resource Report.)  In other words, alternative fuels don't solve the underlying problem of not enough liquid transportation fuel to go around.

There's also the real chance that airlines will not only have to deal with peak oil, but climate change legislation as well.  Even if a global tax on air travel does not come out of the Copenhagen summit, airlines are an easily identifiable target for lawmakers and other groups interested in reducing global warming emissions.

None of this will not be good for airline stocks, making the industry a prime candidate for the short side of a green portfolio, the focus of this series.  (So far, I've also looked at the Mexican economy, and Shale Gas.)

How to Short Airlines

There is an airline sector Exchange Traded Fund (ETF), the Claymore/NYSE Arca Airline ETF (FAA), but, as I found with the iShares MSCI Mexico Index Fund (EWW), it is not widely held, and shares are not available for shorting.  Like Mexico, but unlike shale gas, I expect peak oil to erode the economics of aviation over time, and I think this erosion is fairly likely.  Hence, my preferred instrument is to short a stock in combination with a long call on the same stock, and my second choice would be a short call spread.  (See the Mexico entry in this series for my reasoning.)

In the case of EWW, I chose to use a short call spread, because most of the EWW's holdings are not traded on US based exchanges, and so I would also have had trouble obtaining individual Mexican shares to short.  In contrast, many airline shares are widely traded and held, so, rather than selling a short call spread that might require me to cover in haste if an early exercise left me in a short position without available shares to borrow, and so I chose to short individual airline stocks.

Since I'm not an airline industry expert, I wanted to short a representative sample of the airline industry similar to what I would have found if I were to short FAA, so selecting airline stocks to short was as simple as picking the largest holdings of FAA.  

The top three holdings are Delta Air Lines (DAL) at 16.6%, AMR Corp (AMR) the parent of American Airlines at 16.3%, and Southwest Airlines (LUV) at 14.7%.  Beyond these three, the next largest holding is United Air Lines (UAUA) at only 4.4%. Since the top 3 holdings compose 47.6% of the ETF, shorting these three should provide most of the diversification benefits of shorting FAA, but with much better liquidity.  While FAA trades an average of 21 thousand shares a day, Delta, AMR, and LUV trade about 12, 18, and 9 million shares a day, respectively.   They are also all widely held, making it simple to borrow shares to short, and exchange traded options expiring in January 2012 are available.  In contrast, the longest-dated options available on FAA are for June 2010.

Since airlines are one of the least green and most energy intensive forms of transport, a green investor should seriously consider shorting DAL, AMR, and LUV (combined with appropriate out-of-the-money long calls) as an investment in efficient transport.

DISCLOSURE: Short EWW, UAUA, AMR, DAL, and LUV.

DISCLAIMER: The information and trades provided here and in the comments are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

Posted by Tom Konrad at 01:15 PM | Permalink | Comments (10) | TrackBacks (0)

John Petersen

On December 14th the National Research Council of the National Academy of Sciences issued a new report sponsored by the U.S. Department of Energy titled "Transitions to Alternative Transportation Technologies – Plug-in Hybrid Electric Vehicles." The press release headline announcing the report proclaims, "PLUG-IN HYBRID VEHICLE COSTS LIKELY TO REMAIN HIGH, BENEFITS MODEST FOR DECADES." In other words, grid-enabled vehicles, or GEVs, are nowhere near ready for prime time and investors that buy into the GEV hype can look forward to decades of pain and suffering. Serious investors who want to understand the electric vehicle space and the energy storage sector must make the time to read the entire 140 page report or be prepared to suffer the consequences. You can read a free online version here or download a PDF copy for $30.

The report considered plug-in hybrid electric vehicles with both a 10-mile electric only range (PHEV-10) and a 40-mile electric only range (PHEV-40). The summary results and conclusions from pages 7 through 9 of the report are:

1. Lithium-ion battery technology has been developing rapidly, especially at the cell level, but costs are still high, and the potential for dramatic reductions appears limited. ... Assembled battery packs currently cost about $1,700/kWh of usable energy.  ... Costs are expected to decline by about 35 percent by 2020 but more slowly thereafter. ...
2. Costs to a vehicle manufacturer for a PHEV-40 built in 2010 are likely to be about $18,000 more than an equivalent conventional vehicle, including a $14,000 battery pack. The incremental cost of a PHEV-10 would be about $6,300, including a $3,300 battery pack. In addition, some homes will require electrical system upgrades, which might cost more than $1,000. In comparison, the incremental cost of an HEV might be $3,000.
3. PHEV-40s are unlikely to achieve cost-effectiveness before 2040 at gasoline prices below $4.00 per gallon, but PHEV-10s may get there before 2030. PHEVs will recoup some of their incremental cost, because a mile driven on electricity will be cheaper than a mile on gasoline, but it is likely to be several decades before lifetime fuel savings start to balance the higher first cost of the vehicles.  Subsidies of tens to hundreds of billions of dollars will be needed for the transition to cost effectiveness.  Higher oil prices or rapid reductions in battery costs could reduce the time and subsidies required to attain cost-effectiveness.
4. At the maximum practical rate, as many as 40 million PHEVs could be on the road by 2030, but various factors (e.g., high costs of batteries, modest gasoline savings, limited availability of places to plug in, competition from other vehicles, and consumer resistance to plugging in virtually every day) are likely to keep the number lower. ...
5. PHEVs will have little impact on oil consumption before 2030 because there will not be enough of them in the fleet. More substantial reductions could be achieved by 2050. PHEV-10s will reduce oil consumption only slightly more than can be achieved by HEVs. ...
6. PHEV-10s will emit less carbon dioxide than nonhybrid vehicles, but more than HEVs after accounting for emissions at the generating stations that supply the electric power. PHEV-40s are more effective than PHEV-10s, but the GHG  [greenhouse gas] benefits are small unless the grid is decarbonized with renewable energy, nuclear plants, or fossil fuel fired plants equipped with carbon capture and storage systems.
7. No major problems are likely to be encountered for several decades in supplying the power to charge PHEVs, as long as most vehicles are charged at night. ...
8. A portfolio approach to research, development, demonstration, and, perhaps, market transition support is essential. ...

The only other point I would have included in the summary is:

"It is the committee’s opinion that [the DOE's battery price goals] beyond 2012 are extremely aggressive and are unlikely to be reached by the target date or even for a significant time beyond." (Page 22 of the report)

Overall, I applaud the report's frank and unbiased discussion of the challenges inherent in the commercialization of GEVs and the decades it will take before GEV technologies can make a meaningful difference in either oil imports or CO2 emissions. Its two big shortcomings were (1) the failure to consider natural gas vehicles, or NGVs as an alternative, and (2) the failure to consider critical raw material supply issues; most notably the availability of heavy rare earth metals for the permanent magnet motors that will drive a wholly or partly electrified transportation system.

The introduction starts by noting, "transportation is responsible for more than two-thirds of U.S. oil consumption, and about 60 percent of the oil we use must be imported." The rough parity between these two figures leads to the inescapable conclusion that we could pretty much eliminate oil imports if we could eliminate the use of gasoline and diesel fuel for transportation. While the eco-religious among us insist that GEVs are the only way to achieve this laudable goal, the fact is a simple combination of HEV and NGV technologies can get us to the same point faster, cheaper and cleaner because:

• HEVs slash fuel consumption and CO2 emissions by up to 40% for less than half the expected cost of a PHEV-10;
• America is blessed with enormous natural gas reserves that could be used in transportation;
• Natural gas is much cheaper than oil when you run a basic thermal equivalency comparison;
• A natural gas powered engine produces 30% less CO2 per mile than a comparable gasoline powered engine;
• Each gallon of gasoline or diesel replaced by natural gas will reduce oil imports by a like amount;
• Money spent on natural gas helps the domestic economy while money spent on oil imports benefits foreign powers;
• The current cost of an NGV is roughly equivalent to the expected cost of a basic PHEV-10;
• NGV technologies offer significant opportunities for real economies of scale where GEVs don't; and
• Using a combination of NGV and HEV technologies will be cleaner than plugging a GEV into an average utility.

There are several good reasons why 20% of all new light vehicle purchases in Italy are NGVs. The technology is available today, readily scalable, relatively inexpensive and very cost-effective. It's exactly what the consumer is looking for, particularly in recessionary times when splashing out a 50% to 100% premium for eco-bling seems fiscally imprudent.

For a detailed discussion of the rare earth metals supply constraints that will almost certainly make a cruel joke of the current GEV hype, readers should review the work of Seeking Alpha contributor Jack Lifton who has forgotten more about that topic than I'll ever learn. The quick and dirty summary is that 95% of the global market for rare earth metals is controlled by China which expects to use substantially all of its rare earth metal production to satisfy domestic demand within a few years.

I'm an oddball among alternative energy bloggers because I believe that green in my wallet is more important than green in my philosophy. My biggest worry is that six billion people want a small piece of the lifestyle that 500 million of us have and usually take for granted. While the teeming masses once toiled in poverty and ignorance and accepted the inevitability of their misery, the information and communications technology revolution changed all that. For the first time in human history the mass of the world's poor know that there is something better than mere subsistence and they're working very hard to earn a place at the table. The trick will be finding a way to raise the standard of living in developing economies without crushing the standard of living in developed economies. For that to happen without catastrophic conflict and horrific environmental consequences, the world must find relevant scale solutions for persistent shortages of water, food, energy and virtually every commodity you can imagine. In other words, the cardinal sins of extravagance and gluttony can no longer be tolerated in any of their pernicious forms.

I’m also an incurable optimist who believes that “In America we get up in the morning, we go to work and we solve our problems." (From The Lost Constitution by William Martin) We can’t solve persistent global shortages of water, food, energy and commodities without first minimizing waste. We also can’t wait for miraculous GEV technologies to eventually solve basic transportation problems that become more pressing with each passing day. We have to go to work today with the toolbox we own and be ready to replace our tools with better ones when they become available.

When we back away from the GEV hype and rationally analyze the myriad technical, economic and environmental issues that must be solved before GEVs can be cost-effective, it becomes clear that the baby steps including stop-start engine  systems, HEVs and NGVs are where the business growth will lie for the next decade. The principal beneficiaries of the short-term trends will be established automotive battery manufacturers like Exide Technologies (XIDE) and Johnson Controls (JCI), advanced lead-acid battery developers like Axion Power International (AXPW.OB), HEV technology leaders like Toyota (TM) and NGV technology leaders like Fuel Systems Solutions (FSYS). In a decade or two when long promised advances in battery technology are historical fact rather than forecast and GEVs have moved away from technology's bleeding edge, the best investment choices may be different. But I plan to be retired by then and living off my fixed income investments.

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

Posted by John Petersen at 02:56 AM | Permalink | Comments (2)

John Petersen

Last Tuesday a reader sent me a copy of "Ending the ICE Age," a new industry overview from Bank of America Merrill Lynch analyst Steven Milunovich on the future of plug-in vehicles, which the newly organized Electrification Coalition has christened grid enabled vehicles, or GEVs. After spending several hours studying the report I concluded that Mr. Milunovich has found the true religion of the new millennium while I'm still an unwashed pagan, or worse yet a heretic.

The grim reality is that when you look at American energy policy as a faith-based initiative, a new religion with its own rigid doctrine, dogma and ritual, it begins to make sense. It explains why our Secretary of Energy feels comfortable with a public comment that he's agnostic about natural gas. It also explains why the coastal waters of California and Florida together with huge swaths of Alaska have been forever consecrated as holy ground. It even explains why climatologists, eco-clerics and fanatic faithful feel justified suppressing facts and ostracizing skeptics that call their world-view into question.

It's a 21st century version of the Spanish Inquisition and I have a front row seat. What fun!

The Milunovich report is the third bullish analysis of GEVs that I've reviewed since the beginning of October. The other two came from Credit Suisse and HSBC. All three reports wax poetic on the fuel savings and CO2 reduction potential of GEVs, all three assume that battery pack costs will fall from current levels of roughly $1,200 per kWh to something on the order of $500 per kWh over the next five to ten years, and all three warn that the GEV industry will not bear fruit unless lithium-ion battery developers can deliver on their promises to make cheap, powerful, durable and safe products. The fundamental problem with all three reports is they don't ask whether the premise of GEVs is reality, or blue smoke and mirrors. The only way to answer that question is with a spreadsheet that presents a side-by-side comparison of the alternatives. I'll try to keep it simple.

Reality vs. Blue Smoke and Mirrors

The best information I've been able to lay my hands on indicates that the capital cost of a new lithium ion battery plant is on the order of $1,000 per kWh of annual capacity. The following table provides a simplified analysis of the economic impact of a hypothetical $500 million plant. It provides a baseline column for conventional internal combustion vehicles, together with additional columns that allocate 100% of plant capacity to battery packs for Leaf class BEVs, Volt class PHEVs and Prius class HEVs. To minimize controversy, I've assumed that the batteries will cost $500 per kWh; every vehicle will travel 12,000 miles per year; every GEV will get 4 miles of electric-only range for each kWh of charge; and all GEVs will use electricity from utilities that emit the national average of 585 grams of C02 per kWh.

Economic Impact of $500 Million Lithium Ion Battery Plant
Production Capacity 500,000 kWh Per Year
	ICE		BEV		PHEV		HEV
Battery Pack Requirement			24 kWh		16 kWh		1.3 kWh
Vehicles enabled per year			20,833		31,250		384,615
Vehicle cost without batteries	$20,000		$19,500		$21,600		$21,800
Battery Cost at $500 per kWh			$12,000		$8,000		$650
Total vehicle sales price	$20,000		$31,500		$29,600		$22,450
Annual Gasoline Use (gallons)	400		0		0		240
Annual Electricity Use (kWh)			3,000		3,000
Annual CO2 Emissions (metric tons)	3.7		1.8		1.8		2.2
Annual economic impact
Battery sales (000s)			$250,000		$250,000		$250,000
Non-battery vehicle sales (000s)			$406,250		$675,000		$8,384,615
Tax credits to purchasers			-$156,250		-$234,375
Net economic impact			$500,000		$690,625		$8,634,615
Annual Gasoline Savings (000s)			8,333		12,500		61,538
Annual CO2 Reduction (metric tons)			40,425		60,638		568,062

While the HEV values in the table are very attractive in the context of a gasoline fueled car, they get downright gorgeous if you take the analysis a step further and factor in the potential use of CNG as a substitute fuel in conventional HEVs. Think about it – a CNG fueled HEV uses no imported oil and its carbon footprint is lower than a BEV that uses electricity from an average utility. The only significant drawback is an underdeveloped retail CNG distribution system but that impediment is relatively easy to solve since America's natural gas distribution backbone is pervasive, robust and far more modern than the electric grid.

When you calculate gasoline savings and C02 emission reductions per dollar of capital investment, no technology fares better than advanced lead-carbon batteries for start-stop micro-hybrids. To put things in perspective, a $500 million investment in plant and equipment for micro-hybrid battteries would permit the production of 7.5 million vehicles per year, generate roughly $1.9 billion in battery sales, slash gasoline consumption by 180 million gallons and reduce C02 emission by 1.7 million metric tons. In other words it is very likely that the $68 million in ARRA battery manufacturing grants that went to lead-carbon battery manufacturers will generate greater gasoline savings and C02 emission reductions than the $1.2 billion in ARRA grants that went to lithium-ion battery companies. This is not a question of faith. The numbers cannot lie and the magnitude of the differences is too big to ignore. If you really want to make a difference, you take the baby steps and harvest the low-hanging fruit first.

Nobody with a spreadsheet and a rudimentary understanding of mathematics can honestly argue that subsidizing batteries for GEVs will hold a votive candle to using the same funds to subsidize batteries for Prius class HEVs. Adding the cost of GEV charging stations to the abysmal economics results in a picture that nobody but the blindly faithful could love. I have no doubt that a variety of GEVs will be introduced over the next couple of years because that's what the new religion demands. For obvious reasons, I expect the phenomenon to be a flash in the pan.

The Hype Cycle

While I was doing my background research for this article, I came across a wonderfully informative graph titled "Hype Cycle of Emerging Technology" that TIAX LLC adapted from a Gartner Group concept and presented at the Plug-in 2008 conference. The graph is particularly useful for investors because in addition to showing how public perceptions of technologies develop over time, it shows how early stage markets for equity securities develop.



While TIAX suggested that PHEVs were approaching their peak visibility level in May 2008, I don't think we'll reach the peak until 2012 at the earliest. By 2015, when significant numbers of GEVs have been sold to consumers who discover to their chagrin that their oh so sexy GEV is little more than a 20 foot power cord connected to an expensive, temperamental and inflexible automotive supermodel that doesn't like heat, cold or hills, and has a nasty habit of taking several hours to recharge and refresh just when you need it most, we should be well into the trough of disillusionment.

I can almost hear the phone conversations now, "I understand that Johnny Jr. needs to see a doctor for that projectile vomiting thing but I just plugged my GEV into the charging station and I won't be able to get to the school for another four hours. Could you do your best to keep him comfortable, give him a book or maybe an aspirin and tell him that daddy will be there soon?"

I'm a big fan of hard-core economics. I have no fundamental problem with Government subsidies to manufacturers that support critical infrastructure and have a reasonable chance of accomplishing their stated goals. It's an entirely different matter when taxpayer money is used to subsidize luxury consumption. New factories make the economy richer if the fundamental business premise is sound. Eco-bling subsidies to the new faithful have no justification in sound public policy. We deserve better.

The supermodels of the energy storage sector including A123 Systems (AONE), Ener1 (HEV) and Valence Technologies (VLNC) are well up the hype cycle curve and approaching the Peak of Inflated Expectations. In contrast the stalwarts of the battery business including Exide Technologies (XIDE) and Johnson Controls (JCI), together with new technology entrants like Maxwell Technologies (MXWL) and Axion Power International (AXPW.OB) that are developing disruptive enhancements to established battery technologies, are just approaching their technology trigger point. As stop-start and mild hybrid technologies become standard equipment on internal combustion engines over the next few years, I believe these overlooked low-priced companies with sustainable business models that work in the real world of pagans and heretics will sparkle.

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

Posted by John Petersen at 10:49 AM | Permalink | Comments (25) | TrackBacks (0)

John Petersen

On Monday of this week the Electrification Coalition, a newly organized industrial lobby that styles itself as a "nonpartisan, not-for-profit group of business leaders committed to promoting policies and actions that facilitate the deployment of electric vehicles on a mass scale in order to combat the economic, environmental, and national security dangers caused by our nation’s dependence on petroleum" released a 170 page policy paper titled, "Electrification Roadmap, Revolutionizing Transportation and Achieving Energy Security." Like most industrial lobbies jostling for position at the Federal trough, the coalition's core membership includes a baker's dozen of top executives from AeroVironment (AVAV), NRG Energy (NRG), Nissan (NSANY), Johnson Controls (JCI), FedEx (FDX) and A123 Systems (AONE), along with several lesser known private companies. Their basic pitch is that the economic, technical and practical challenges associated with a transition to PHEVs and EVs, which the cognoscenti will hereafter refer to as "grid enabled vehicles," or "GEVs," are insurmountable in a free market economy. Quoting from the preface:

"Ideally, the technology and deployment of electric vehicles would emerge through regular market mechanisms. Events conclusively demonstrate that this path to electrification is unlikely, however. Therefore, if the desired transformation is to occur anytime in the foreseeable future, focused and sustained public policy will be required."

In less florid terms, GEVs won't be an affordable transportation alternative in the foreseeable future and the only way to overcome the abysmal economics of electric transportation is to hide part of the costs in the utility rate base, provide lavish subsidies for GEV manufacturers, increase tax credits for GEV purchasers and concentrate command and control on the banks of the Potomac where all wisdom resides and all power truly belongs. I'm still having a bit of trouble with the idea that American consumers can't afford a GEV future while American taxpayers and utility customers can, but I guess some sophisticated economic concepts are just above my pay grade. The good news is that implementing the Electrification Roadmap should be less costly than Obamacare. The rest is less encouraging; particularly for ordinary folks who think that investments should turn a profit from sales of competitive products.

The core problem we all want to solve is oil prices, which hit an inflection point in the late '90s and show no signs of deviating from their new trend. To help readers visualize the problem I've created a simple graph from historical statistics published by the Energy Information Administration and then added a price channel overlay in blue. While there are any number of opinions about the future of oil prices, history clearly shows that severe price spikes lead to recessions that lead in turn to equally severe price troughs.  Over the long term the only prediction I feel comfortable making is that oil prices will probably bounce around in the price channel until we hit another inflection point. The only certainty is that each of us will be forced to choose between suffering the pain of increasing oil prices or taking individual responsibility for our choices and changing our behavior as consumers.



I believe America should do everything in its power to escape the fiscal tyranny of imported oil and minimize the obscene indirect costs of protecting tenuous supply chains in a dangerous world. I do not believe, however, that a rapid transition to GEVs is either possible or desirable. There is only one commercially available GEV on the market today. While several manufacturers plan to introduce GEVs beginning in 2010, their forecasts and performance claims are based on computer models, estimates and laboratory testing instead of real-world experience. Can you imagine the outrage if somebody tried to pull that kind of crap with a new drug? It took ten years for the venerable Toyota Prius to build a reputation for reliability and earn consumer trust and loyalty. The idea that a radically new product class that costs twice as much and offers far less flexibility can or should be forced into the market ignores human needs and is, by definition, irrational.

The roadmap begins with a lengthy discussion about the cost effectiveness and relative cleanliness of electricity as an energy source for transportation. It also mentions in passing that batteries are not sources of energy, but devices that store energy. In a conventional car the energy storage system costs about $5 per gallon of fuel tank capacity and the energy costs about $0.10 per mile. In a GEV the energy only costs $0.02 per mile but the energy storage system will cost over $4,500 per equivalent gallon of capacity even if widely promised and incredibly vague economies of scale materialize. Ultimately the trade-off is operating costs vs. capital costs. By the coalition's reckoning, the unsubsidized cash-on-cash breakeven point for a new GEV will be 10 to 12 years. If you include Federal tax credits in the calculations, the breakeven point is pushed forward into the 5 to 8 year range. Those payback periods may appeal to the philosophically committed or the mathematically challenged, but they will be non-starters for budget conscious consumers.

Like people, lithium-ion batteries work best in climate-controlled spaces. The bulk of our experience as battery users comes from consumer electronics we use in our homes, offices and cars. The limited experience most of us have with using batteries in extreme heat or cold is generally bad. I'm the first to acknowledge that GEVs may perform well in the friendly climates of San Diego and Honolulu, but their performance on frigid winter days in Chicago and torrid summer days in Phoenix will leave much to be desired. While the roadmap doesn't delve into the impact of terrain,  I've spent enough time pedaling my bicycle uphill to know that the eco-optimists in San Francisco will be less than enchanted with GEV performance in their fair city. The inescapable truth is that by the time you eliminate places that are too cold, too hot, too hilly or simply too sprawling, GEVs will be little more than niche products in the U.S., even with unlimited governmental support. GEVs may make some sense in Europe and Asia where daily drives are shorter, public transport is better, gasoline taxes are three to ten times higher and socialism is politically correct, but even then I have grave reservations.

One of the more startling aspects of the roadmap is its frank discussion of charging infrastructure requirements and costs, a subject that I've completely overlooked in earlier articles. Initially, the coalition believes two public charging stations will be required for every new GEV. For Level II (220 volt) charging stations, the costs will typically be in the $6,000 to $10,000 per vehicle range. When the capital cost for public charging stations is viewed as part and parcel of the aggregate GEV investment, the dismal economics only get worse. While I've suspected as much for a long time, the roadmap also makes it clear that  persistent happy talk about Level III quick charge stations (30 kW to 250 kW) is meaningless because first generation GEVs will be designed to accept a 220 volt charge at less than 30 Amps and it doesn't take an engineer to know that something expensive will turn to slag the minute you plug a 6.6 kW battery pack into a 30 kW charging circuit.

Batteries are commodities, as are all of the raw materials that are used to make the batteries, motors and other components required for a GEV. The roadmap assumes away critical issues of raw materials availability by proving that the elements exist in nature and then ignoring fundamental natural resource development issues like location, economics, environmental impacts and the difference between known mineral resources and developed mineral reserves. It also assumes that recycling issues will resolve themselves despite the fact that the only class of ARRA battery manufacturing grants that went begging was battery recycling.

In How PHEVs and EVs Will Sabotage America's Drive For Energy Independence I showed that until batteries are dirt cheap and available in unlimited quantities, basic Prius class HEVs are more efficient users of available battery capacity than GEVs. In PHEVs and EVs; Plugging Into a Lump of Coal, I showed that the same dynamic applies to CO2 emissions. In both cases, the unpalatable but undeniable truth arises from the law of diminishing returns. A Prius class HEV uses about 1.3 kWh of battery capacity to reduce both fuel consumption and C02 emissions by 40%.  GEVs will use 10x to 20x the battery capacity to reduce fuel consumption and C02 emissions by about 65%. When you consider that every GEV that rolls off an assembly line will preclude the production of 10 to 20 Prius class HEVs, there is simply no contest in terms of either fuel consumption or C02 emissions.

The first 40% is low hanging fruit that can be harvested with 1.3 kWh of battery capacity per vehicle. That last 25% is a technical nightmare that cannot be solved without an unconscionable waste of natural resources. In a world where six billion people want a small piece of the lifestyle that 500 million of us have and take for granted, I'm appalled by the arrogance. What ever happened to the concepts of personal responsibility and shame?

Real albeit modest vehicle electrification solutions are already being implemented by a variety of companies in the energy storage and automotive sectors. These simple and cost effective baby steps are nowhere near as exciting as the quantum leaps envisioned by the Electrification Coalition, but at least they don't expect Peter to pay for Paul's eco-bling.

In a market economy companies thrive by selling reliable products that satisfy human needs at competitive prices. Businesses that feel compelled to hire lobbyists to argue that their business models can't work in the absence of massive governmental intervention are doomed from the start (think grain ethanol). I may be an optimist, but even I understand that sometimes a 170-page pile of manure is not hiding a pony.

DISCLOSURE: None.

Posted by John Petersen at 11:16 AM | Permalink | Comments (8) | TrackBacks (0)

John Petersen

Mother always taught me that if you can't say something nice, it's usually better to say nothing. While regular readers might question my ability to follow Mom's advice, this is an article I had really hoped somebody else would write. The quick summary is that while the shares of A123 Systems (AONE) may be a reasonable investment at current prices, the shares of BYD Co. Ltd. (BYDDF.PK) are an irrational value proposition, the shares of Ener1 (HEV) are even worse, and the shares of Valence Technologies (VLNC) are beyond understanding. Since many readers find detailed tables more confusing than enlightening, I'll use words instead of numbers to explain my reasoning. I'll also assume that every company I mention has a great technology. Accordingly, this article will focus exclusively on the hard-core financial data and be far shorter than most.

To create a baseline for comparisons, I'll start with Exide Technologies (XIDE) and Enersys (ENS), the two largest pure-play battery manufacturers in the world. During the twelve calendar months ended June 30, 2009, Exide was restructuring its operations and lost $113.1 million on sales of $2.9 billion. During the same period Enersys earned $67.5 million on sales of $1.7 billion. Exide's current market capitalization of $552 million represents roughly 176% of book value and 19% of annual sales. Enersys' current market capitalization of $1.14 billion represents roughly 157% of book value and 66% of annual sales. For the sake of simplicity, I believe a baseline market price standard of 2x book value and 1x sales is probably reasonable for established manufacturers of traditional battery products.

Until recently, it was almost impossible to establish a baseline for emerging manufacturers of advanced battery products. That all changed when A123 Systems (AONE) completed its IPO last month. After adjusting A123's June 30, 2009 financial statements for roughly $400 million in IPO proceeds and $250 million in ARRA battery manufacturing grants, A123 had a pro forma stockholders equity of $823 million and potential annual revenue from existing facilities of roughly $233 million. Its actual revenue for the twelve months ended June 30, 2009 was roughly $72.1 million. Based on yesterday's closing price, A123's market capitalization of $2.35 billion represents roughly 3x book value, 10x potential sales and 33x trailing sales. As A123 uses its available resources to build new manufacturing capacity, its market capitalization to potential sales ratio should fall to roughly 2x potential sales. While I'm convinced that PHEVs and EVs are suboptimal uses for advanced batteries, I have no doubt that A123 will have more demand than it will be able to satisfy. Accordingly, I believe a baseline of 3x book value and 2x potential sales is probably reasonable for emerging manufacturers of advanced battery products.

BYD Co. Ltd. (BYDDF.PK) is a classic example of why it is never a good idea to make investment decisions based on simple questions like "What did Warren do?" Everybody knows that MidAmerican Energy, a subsidiary of Berkshire Hathaway (BRK.A), agreed to buy a 10% stake in BYD for $230 million in September 2008. At the time, BYD was generating roughly $4 billion in annual sales that included $1.6 billion in cell phone components (43%), $1.3 billion in automobiles (31%) and $1.1 billion in batteries (26%). For the first six months of 2009, auto sales more than doubled to $1.3 billion (55%), cell phone components remained flat at $780 million (33%), and batteries fell by a third to $281 million (12%). While it started out as a battery manufacturer, BYD is currently an automaker first, a cell phone manufacturer second and a battery manufacturer by default because it needs the batteries for its core product lines. With first half sales of roughly $2.4 billion, it would be hard to classify BYD as anything other than an established manufacturer of traditional products. BYD's financial statements are available here. According to Yahoo! currency. the conversion factor between the U.S. Dollar and the Chinese Yuan is 6.8336.

So far, the one critical fact that seems to evade most commenters and investors is that MidAmerican's purchase price worked out to $1.02 per share, or 1.2x book value and 0.5x sales. Overall, the MidAmerican purchase is exactly what one would expect from Messrs. Buffett and Munger, a solid value with good growth potential. Since the Berkshire announcement (the purchase didn't actually close till July of this year), the share price of BYD has rocketed to $10.82 per share, which works out to 10x book value and 5x sales. At present, BYD has 2.275 billion outstanding shares and a market capitalization of $24.6 billion. These valuation metrics are out of line with the auto industry, out of line with the cell phone industry and out of line with the battery industry; proving once again that the value of an investment depends on your entry price. BYD was a great deal at $1.02, but it's terrible for investors at $10.82.

Following Ener1 (HEV) over the last year has been a lot like watching a slow-motion train-wreck. Its final private financing round brought in $42 million of offering proceeds in 2007 and $31 million of warrant exercise proceeds in 2008. In the second quarter of 2009, Ener1 entered into a $40 million open market sale agreement that generated $5.8 million in proceeds during the second quarter and has presumably generated another $33 million since the end of June. When these fundraising activities are offset against operating losses, Ener1 has been treading water for a long time.

At June 30, 2009, Ener1 had a $1 million working capital deficit and $26.3 million in long-term debt, including $9.7 million in related party debt. After giving effect to $33 million in new financing, an $18 million investment to rescue a potential customer from bankruptcy and estimated third quarter losses of roughly $10 million, I expect Ener1 to report approximately $129 million in stockholders equity and about $4 million of working capital at September 30, 2009. Its current market capitalization of $758 million is roughly 6x estimated book value and 34x trailing sales. If you adjust Ener1's book value to eliminate $14 million of intangible assets and another $48 million of goodwill, the ratio of market capitalization to estimated net tangible book value soars to 11x. On balance, I think Ener1's report for the quarter ended September 30th will paint a very bleak picture.

While Ener1 was awarded a $150 million ARRA battery manufacturing grant in August, that award is wholly contingent on its ability to provide a like amount of matching funds. With no meaningful working capital, a major investment in a fledgling EV manufacturer that's just emerging from bankruptcy and a large related party debt balance, I can't see where the matching funds will come from. It's certainly not a business picture I would encourage a client to take to market for a secondary offering.

Valence Technology (VLNC) carries a market valuation that never ceases to amaze me. For the last several years, Valence has relied on loans from its principal stockholder to support average losses of roughly $20 million per year. At June 30, 2009, Valence had $27 million in assets and $95 million in debt, resulting in a negative stockholders equity of $69 million. While Valence has recently inked a deal that will throw off up to $2 million per month in proceeds from dribble-out sales of its common stock, the expected proceeds will do little more than keep the company afloat until the next bi-weekly closing. Since Valence's market capitalization of $190 million represents 9.5x trailing sales and the common stockholders are under water to the tune of $0.55 per share, all I can do is scratch my head.

DISCLOSURE: Author has small long positions in Enersys (ENS) and Exide Technologies (XIDE).

Posted by John Petersen at 10:07 AM | Permalink | Comments (6)

Portfolio theory can lend insights into which carbon abatement strategies policymakers should pursue.  If policymakers listen, what will it mean for green investors?

Tom Konrad, Ph.D., CFA

Good Info, Not Enough Analysis

I've now read most of my review copy of Investment Opportunities for a Low Carbon World.  The quality of the information is generally excellent, as Charles has described in his reviews of the Wind and Solar and Efficiency and Geothermal chapters.  As a resource on the state of Cleantech industries, it's generally excellent.  As an investing resource, however, it leaves something to be desired.  Each chapter is written by a different expert in a particular field, which means that the information is up to date, and comprehensive, but this approach means that there is little attempt to compare the potential of the different investment opportunities presented.  What is the point of in-depth research into carbon abatement technologies if we do not then take the next logical step and emphasize the technologies with the greatest potential for carbon abatement and investment returns?

A Portfolio Approach

The most useful attempt at investment decision-making is buried in the otherwise uninspiring last part of the book. A summary of a 2007 report from the London Accord, A Portfolio Approach to Climate Change Investment and Policy is buried among self-promoting chapters from companies such as Nissan (NSANY)and BP (BP) promoting their (real) investments in clean technology,   The report uses a Monte Carlo implementation of Modern Portfolio Theory to determine low-risk mixes (portfolios) of carbon-mitigation strategies, and was written by Professor Michael Mainelli of Z/Yen Group, and James Palmer.

While intended primarily for policy decision-makers, A Portfolio Approach attempts to determine which portfolio of carbon reduction technologies is likely to produce a desired level of climate change at the lowest cost (or highest investment returns) at the lowest risk of failing to achieve the reduction goal.  Phrased this way, it is easy to see why portfolio theory is an appropriate tool, since it is designed to minimize systematic (overall) risk even when all individual strategies in the portfolio have significant risks of achieving the expected returns and carbon reductions.

Data

The data on various carbon reduction strategies came mainly from the 2007 IPCC Working Group report, "Mitigation of Climate Change."  This report is not complete, omitting some technologies with significant CO₂ reduction potential, in particular solar thermal collectors such as solar hot water heaters and larger installations for process heat in industrial processes.  "Solar," as referred to in the report, refers solely to solar Photovoltaic and Concentrating Solar Power (CSP.)

One decision I found questionable was to ignore the carbon reduction potential of investments with "negative abatement costs on the basis that these investments should be undertaken under any business-as-usual scenario, and are not strictly investment measures as a response to climate change." (p5/22)  This is circular logic.  For an investment with negative cot to exist, there must be a market failure.  Almost by definition, in a well functioning market, all investments with negative cost will have already been made.  Simply saying that these investments "should" be made assumes that these market failures will correct themselves without any effort on the part of policymakers.  Why should energy market failures correct themselves in the future if they have not already?  

In the authors' defense, they run one scenario (#3) in which investments with negative abatement costs are allowed, and they state "Further examination of negative abatement proposals seems in order, as it should be important to understand why these investments fail to be made under current financial conditions.  Neglected negative abatement may justify regulatory intervention by policymakers, e.g. imposing minimum building or transportation efficiency requirements." (pp.17/22 and 18/22)  

From the hedging in this statement, and the fact that they spend less time discussing scenario 3 than either of their other two, I conclude that something prevents the authors from giving market failures the attention they are due.  I find this an extremely common failing among financial practitioners, and believe it is an unfortunate and common consequence of in-depth training in financial modeling.  Most financial models contain an assumption of market efficiency, and do not produce meaningful results in cases of large and persistent market inefficiencies.  Without tools to model market inefficiencies, practitioners are prone to ignore them, convincing themselves that the inefficiencies are unimportant or will cure themselves.  Most of the critiques of "Green Jobs" programs are based on this fallacy.

Put another way, if you have a hammer (a modeling technique which assumes market efficiency, such as modern portfolio theory), you tend to see all problems as if they are nails (efficient markets.)

Results

Since the authors only look at scenarios 1 and 2 (those which ignore negative cost investments) in depth, these are the scenarios I will focus on.  I believe the results of these scenarios are still relevant answers to the question, "After negative cost investments in energy efficiency have been made, which positive cost investments should we pursue?"  Even if all the necessary carbon reductions could be achieved with negative cost investments, it would most likely be unwise to pursue such an approach to mitigate climate change: like all investments, there is no assurance that the expected reductions/returns will be achieved.  Pursuing a wide variety of carbon-reduction strategies provides the greatest chance that some such strategies will achieve the expected reductions, and others will exceed expectations, thus making up for any investments in the mitigation portfolio which do not achieve the expected reductions.

The chart below shows a series of "frontier portfolios": That is, portfolios of carbon abatement investments which achieve specified levels of carbon abatement at minimal cost.  The vertical axis is gigatons (Gt) of equivalent CO₂ emissions (CO₂e) reduced annually, and the horizontal axis is the annual investment needed to achieve this level of reduction.

 

There are diminishing returns for carbon abatement, with the cost of incremental abatement increasing significantly above 15 Gt CO₂e per year, and no practical increase in abatement beyond 20 15 Gt CO₂e and $400B expenditure per year.  

For comparison, to stabilize the atmospheric concentration of CO₂ at 350 ppm, a goal which, according to Joe Romm, will require 8 Gt CO₂e (approximately portfolio 2) of reduction by 2030, and another 10 Gt CO₂e (for a total of 18 Gt CO₂e, or portfolio 4) by 2060.  Since the model does not include negative cost investments in energy efficiency or solar thermal collectors, it is likely that these levels of abatement could be achieved at considerably lower cost by incorporating these opportunities.

The pie charts in the first column show the fraction of carbon abatement expected from each investment in the selected frontier portfolios, while the second column shows the cost of each investment.  The two columns differ because different investments produce different levels of abatement per dollar of investment.  For instance, the cost wedge for Biofuels in portfolios 3 and 4 are much larger than the corresponding abatement wedges.  This indicates that abatement with biofuels is more expensive on a per-ton basis than for the other investments in those portfolios.

I will focus on portfolios 2, 3, and 4, since those are the portfolios which deliver the necessary levels of abatement, which we will need to ramp up to over the coming years and decades.

Forestry

The most striking thing about these portfolios is that Forestry dominates CO₂ abatement, as well as cost in portfolios 2 and 3.  The more aggressive portfolio 4 has three relatively large cost wedges: Building Efficiency, Forestry, and Biofuels.

Unfortunately, according to the report's authors, the carbon abatement from Forestry is very uncertain.  To make matters worse, the methodology used in the report is extremely sensitive to the expected returns (or abatement, in this case) of particular investment classes.  Small errors in the expected returns can lead to frontier portfolios which are dominated by a single investment class, in this case Forestry.  The report notes that "forestry abatement potential is highly uncertain." (p.8/22)  While we can conclude that forestry is likely to be a significant part of our carbon abatement strategy, there is a good chance that forestry will not dominate the mix as it does in the model.

For stock market investors who want to allocate part of their portfolio to forestry, I recently wrote about investing in forestry stocks and forestry exchange traded funds (ETFs). While I was focusing on the potential for forestry to benefit from biofuels and bio-electricity in the article, any marginal demand for forestry services (including carbon sequestration) should benefit this sector.

Hydropower

Hydropower is also a significant investment in these portfolios.  Much of this investment will probably take place in the developing world, but there are also significant opportunities for upgrades to facilities at existing dams in the developed world.  I looked at the potential for hydropower stock market investments last year.

Biofuels

Biofuels also contribute significantly to all the portfolios, especially in the higher abatement scenarios, although the costs are high relative to other investments.  I don't believe that this is very realistic if we are also going to have large contributions to carbon abatement from forestry.  My guess here is that the authors did not take into account the negative interactions between forestry and biofuels, where an increase in one will drive up the costs of the other because of competing land and water use.  Land used for forestry cannot also be used for biofuels, and vice versa.

Wind

We see significant contributions from wind in portfolios 3 and 4, and the costs and potential for wind are much better understood than for many of the other scenarios.  Better yet for stock market investors, investments in wind are simple, with two wind energy ETFs allowing a simple investment in the sector.  Of the two, I have a slight preference for FAN (you can see my reasoning here.)

Efficiency, in all its Forms

Finally, port folio 4 shows considerable investment in Building Efficiency and Industrial Efficiency (which we usually refer to as just Energy Efficiency), while portfolio 2 has a good slice of Transport efficiency (what we usually call Clean Transportation.)  Keep in mind that these slices are only investments that do not have "negative cost," that is they do not cost less than new investments in conventional generation.  Since efficiency dominates investments with negative cost, the total investments in all forms of efficiency are likely to be many times what we see in these graphs.  While there is not yet an energy efficiency ETF available, there is one focused on clean transportation, the Global Progressive Transport ETF (PTRP).  I also have a few stock picks in clean transport.

For industrial and building efficiency, there is no ETF, but here are five of my favorite efficiency stocks, and you can find a much larger list of energy efficiency stocks here.  It's also important to note that smart grid stocks will fall into this category as well, at least for the purposes of the report.   Here are five of my favorite smart grid stocks.

Geothermal

Geothermal also has a small slice of portfolios 2 and 4.  This is significant given the small current size of the industry: even these small slices imply rapid growth for an underappreciated sector.  I mentioned three geothermal stocks to consider here, but I have since sold my stake in Raser Technologies (RZ), and will probably not repurchase it.  Our Twitter followers saw that first.  Charles did a good run-down of the public geothermal stocks in June.   

Other Thoughts

It's also worth looking at what is not in the efficient portfolios, but since this entry is already quite a thesis, I'll save that for later.

DISCLOSURE: None.

DISCLAIMER: The information and trades provided here and in the comments are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

Posted by Tom Konrad at 12:52 PM | Permalink | Comments (6) | TrackBacks (0)

John Lounsbury

With the furor over the potential for hybrid, plug-in hybrid and all-electric cars recently, one might think the hydrogen car was dead. Nothing could be further from the truth. Feasibility at an affordable price appears to be established and market availability of hydrogen powered cars may come sooner than you think.

Many issues remain to be addressed and this article will try to cover them. The problems to be overcome are not insurmountable, but are also not trivial. These problems include the economics of hydrogen production, transportation, distribution and storage systems, as well as safety issues for cars involved in collisions.

Alan Ohnsman, writing for Bloomberg, reports that GM (MTLQQ), Toyota (TM), Daimler AG (DAI) and other car makers want to start supplying car fueled by hydrogen as soon as six years from now. Quoting from the article:

"The advances that have been made by the automobile manufacturers are remarkable,” said Scott Samuelsen, director of the National Fuel Cell Research Center at the University of California, Irvine. “Infrastructure is the Achilles’ heel.”

The fuel cell center opened in 1998 and is funded mainly by the U.S. government and California Energy Commission. It has also received grants from Toyota and Royal Dutch Shell Plc’s hydrogen unit, said Kathy Haq, a spokeswoman for the center.”

Here is a picture of a Royal Dutch Shell (RDS-B) hydrogen fueling station in New York City, discussed in a Seeking Alpha Instablog in August



According to the Ohnsman article, the economic factors are starting to line up for hydrogen. He quotes a Toyota objective of a $3,600 price premium for a hydrogen fuel cell powered car. This compares to the current price premium for the Synergy Hybrid Drive system from Toyota, currently averaging around $4,000 for the Camry. This is quite a change from the $1,000,000 price tag estimated to build one of these vehicles just a few years ago.

Advantages of Hydrogen Fuel Cells over Batteries

To understand the significance of this topic, one must first recognize how the hydrogen fuel cell powers a vehicle. Hydrogen fuel cell powered vehicles are electric vehicles. Hydrogen is not burned like a hydrocarbon fuel. Hydrocarbons are storage media for thermal energy which is released for power in an internal combustion engine. The hydrogen fuel cell is a storage medium for electrical energy, which is released when hydrogen and oxygen are combined electrochemically to release electricity. The hydrogen fuel cell is conceptually a battery, providing electricity to power an electric car. Unlike other battery powered cars, the fuel cell uses an onboard source of energy (hydrogen “fuel”) to generate electricity and does not have to stop to be recharged. The advantage of hydrogen powered cars is basically a long driving range, requiring only a fuel refill like internal combustion cars do today.

The hydrogen powered car has advantages for long trips. For daily commutes under 100 miles round trip, the operational convenience of battery and fuel cell energy storage is similar. In fact, it could be argued that the convenience of plugging in within your own garage to recharge batteries is more convenient than finding a refueling station every few hundred miles. The ultimate decision for most commuters will be which power source is cheaper.

Fuel Cost

The most convenient metric to compare fuel costs across the ICE (internal combustion engine) – electric drive interface is the fuel cost per mile. Miles per gallon (mpg) becomes an awkward measurement. Consumers will be required to start thinking in cost per mile terms, because that will become the comparative price on the new car sticker. According to http://www.costpermile.org/, the electricity “fuel” cost per mile (CPM) for electric cars will be between $0.01 and $0.05. Currently electric utility charges per kWh (kilowatt hour) run between $0.10 an $0.15 in most of the U.S., so most of this large range in costs must be associated with the difference in engineering technology and size of the vehicle.

Since I like a larger car, my example will compare to a mid-size Toyota Camry Hybrid. The assumed cpm for an equivalent electric car will be $0.05. (Disclosure: I own a Camry hybrid.) At $2.50 per gallon (near the national average price as this is written), the Camry has a cpm of $0.07 at $3.50 per gallon, the cpm is $0.10. I have used 35 mpg for the Camry hybrid. This is 3% higher than the sticker and 10% lower than my actual experience.

For the standard Camry the cpm would be $0.08 and $0.11 (highway and city, respectively) at $2.50 per gallon and $0.11 and $0.16 at $3.50 per gallon. The sticker mileage numbers have been used for the ICE Camry. These fuel costs are summarized in the following table.

Estimated Cost per Mile (CPM)
Car	Gas at $2.50 per gallon		Gas at $3.50 per gallon
Design	City	Highway	City	Highway
Camry ICE	$0.11	$0.08	$0.16	$0.11
Camry Hybrid	$0.07	$0.07	$0.10	$0.10
"Camry"* Electric	$0.05	$0.05	$0.05	$0.05
*An electric car equivalent to the Toyota Camry.
Electricity cost assumption for Camry equivalent is $0.05 cpm

If the range available with an all electric car is sufficient, then customer acceptance will require that purchase costs (and maintenance costs, which will be ignored here) to be such that the purchase price difference is more than recovered in, say, 100,000 miles. The cost savings for city driving at $2.50 per gallon for gasoline is $6,000 per 100,000 miles of driving, compared to an ICE car. At $3.50 per gallon the cost savings would be $11,000. If two cars are available for our commuter and the electric car purchase cost difference is less than $5,000 more, there will be a big market. If the purchase price is $12,000 more, the market will be limited until the cost of gasoline exceeds $3.50-$4.00 per gallon.

In an August 6 press release, Toyota reported the results of a one-time driving test comparing a Toyota Hybrid Highlander with a new 4^th generation fuel cell equipped Highlander Hybrid. In that test, the cpm for the production hybrid was more than double the cost for the fuel cell equipped model. I am taking this test result with a grain of salt because it was a one time test.

The remaining comparison to be made is hydrogen fuel cells to plug-in electric vehicles. Hydrogen requires power for production by electrolysis of water. If the same power is used that is available at the residential power plug, all the added costs of handling, storing, transporting and distributing hydrogen are added to the costs that one has at his own power plug. Hydrogen is very uncompetitive on a cost basis with other sources of power in this scenario. If the cost of gasoline goes much higher than the $3.50 we have in our examples, then hydrogen might compete there. But hydrogen can never compete with electricity for local driving (right now under 100 miles per day) if the same electricity source is used for both battery recharging and fuel cell operation.

Never forget that a hydrogen fuel cell is nothing more than another form of battery, wherein a chemical reaction produces electrical current. A hydrogen fuel cell car is an electric car.

Can Hydrogen be Produced with Cheap Power?

Do sources of electrical power exist that are cheaper than what we produce (or can produce in the future) for domestic consumption? The short answer is: Yes. (Well, maybe.)

One possible source of cheap electrical energy is from ocean currents that have a large temperature differential between the surface currents and those at depths of 1000 feet or so. This process is called OTEC, Ocean Thermal Energy Conversion.



The above graphic, from The World Energy Council 2007 Survey of World Energy Resources, shows that most of the areas with the largest thermal differentials occur in areas that are too far from populated shorelines to make feasible electricity generation for transmission into a power grid. Temperature differentials of 20^o C or more are necessary for efficient power generation.

The cost estimates for power from OTEC are somewhat problematic. The World Energy Council estimates that a single 10MW demonstration plant would produce electricity at a cost somewhere between $0.14 and $0.21 per kWh, depending on factors such as recovery of potable water and marketable chemicals such as ammonia and various salts. The existence of carbon tax credits could lower the costs further by as much as $0.03.

It is only with the building of multiple plants of the same design that costs may come down below $0.12, the reference cost for existing electricity generation. For example, eight 10 MW plants could produce electricity at a cost between $0.098 and $0.119.

There is potential here, but the costs have to come down more to bring electricity from OTEC to a price to make hydrogen production economically attractive. Remember, we need to transport this hydrogen from the point of generation by ocean going tanker and distribute it by truck or rail tanker (or pipeline) to retail points.

Another potential source of electricity for hydrogen production is wave and tidal motion. To supply electricity for a power grid, the waves and tides must be close to populated shore lines. Wave motion can be used anywhere for hydrogen production, not just where is occurs close to populated shore lines. The same is true for tidal action in remote regions of the planet. The picture below, from New Scientist, shows a SeaGen tidal electricity generator, made by Sea Generation Ltd, in the tidal currents at Strangford Lough in Northern Ireland. Sea Generation is a division of privately held Marine Current Turbine Ltd.



Generation costs for electricity from capital costs alone will be about $0.07 per kWh for a 25 year depreciation. There will be additional unspecified maintenance and operation costs.

Wave action can also be used to generate electricity. The picture below (from New Scientist) shows a wave operated electrical power generator in a generation farm off the north coast of Portugal.



These generators are made by privately held Pelamis Wave Power Ltd. Each generator is a 150-meter-long steel jointed structure, which flexes to drive hydraulic generators and produce 750 kilowatts of power. The company claims electricity generation a competitive costs, but provides no specifics.

The reasons I selected these examples as potential hydrogen generation power sources are:

1. Potential for a lower electricity price point;

2. Electricity generated with plentiful raw material (water) present to produce hydrogen; and

3. With OTEC, the potential for additional revenue from side products.

Battery Costs vs. Fuel Cell Costs

The implications from currently available information are that the costs and durability will be similar. The current objective for Toyota is to have a price premium for hybrids less than the current price premium for a hybrid. The latest generation fuel cell engine is about the same size as a typical 4-cylinder ICE engine and contains about 30 grams of platinum. This is down from the previous generation fuel cell stack which was more than twice the size and contained 80 grams of platinum. The costs just for the platinum alone have been reduced from more than $4,000 in the previous generation to less than $1,500 in the current one. The final fuel cell structure is expected to use only 10 grams of platinum, the same amount as a typical catalytic converter today.

The dramatic change from the previous generation hydrogen fuel cell stack power system to the current generation is seen in the following picture from AutoBlogGreen.com, showing the latest fuel cell drive system on the left next to the drive system used in the past few years in the Chevy Equinox test vehicles that have been driven by volunteers in California, Washington, DC and New York. The power, range and performance of the two systems are the same. The horsepower rating is the equivalent of a current four-cylinder ICE.



Transportation of Fuel and Wholesale Distribution

The technology for distribution by tanker truck and railway car exists today. You can not spend a few hours on any interstate highway near a population center without seeing several pressurized gas tank transports sharing the roadway with you. Pipeline distribution for pressurized hydrogen gas may require different features than currently use for natural gas, but there is no reason to believe that the engineering and construction would present any more challenges or costs. Currently, there is no data reflecting transportation and wholesale distribution impediments to scaling up the use of hydrogen to higher volumes.

Retail Distribution

The cost to build a new gasoline station has been estimated to be in the $250,000 to $450,000, with the largest variable being land cost, using estimates obtained from national average costs at RS Means Cost Works. Obviously, where land costs are extremely dear, near the center of major cities, for example, the cost to build a gasoline station could be much higher, up to $1,000,000 or more.

The cost of building the first 32 hydrogen refueling stations in Southern California has been quoted as $32 million. As high as this cost projection is, it is less than the current cost for a hydrogen refueling pump in Los Angeles, according to Phil Baxley, President of Shell Hydrogen, quoted in the Ohnsman article. He said currently the cost is from $1 million to $5 million per pump, depending on capacity. Even the lower quoted cost, averaging $1 million each for 32 stations, seems to be more costly than all but the most expensive gasoline stations. However, there are three factors related to hydrogen refueling stations that mean this apparent current cost difference may decrease or even be reversed. These are:

1. externality cost exposures for gas stations;

2. lower costs for hydrogen stations in the future through economies of scale; and

3. lower costs to add hydrogen to existing gas stations than to build new.

There are major externality exposures for petroleum based fueling stations. The biggest exposure pertains to future liabilities for soil and ground water contamination by petroleum products and fuel additives. When these externalities are realized, they can be more than the original construction cost (even adjusted for inflation) and occasionally are many millions of dollars. Hydrogen refueling stations do not have these environmental cost exposures.

When the initial costs and the externalities are considered, the refueling stations for hydrogen have an original construction cost of the same order as petroleum fuel stations. Hydrogen refueling stations may decrease in construction costs from the estimates for the first 32 stations in Southern California when many hundreds are constructed per year. If hydrogen were to become ubiquitous, there might be a few thousand new stations per year for a couple of years. A more likely progression would be the modification of existing gas stations to also offer hydrogen refueling facilities at a fraction of the cost of building new stations.

Other countries have more advanced plans for infrastructure development.Both Japan and Germany are working to build large scale distribution networks, with over 1,000 stations on line for each county in five years.

Safety

To start with, we must recognize that hydrogen would not be replacing something that did not have an extremely high fire and explosion hazard. We have managed to live with the risks of gasoline for more than a century, with the material being stored in thin walled tanks that can easily rupture.

Hydrogen, a pressurized gas, would be stored in thick walled, virtually indestructible tanks. Pressurized gases are handled in such containers in a variety of industrial environments today and have been for most of the past 100 years. There are few examples of these tanks being breached. The risks have been associated with the pressure reduction valves (regulating the controlled release of the gas) being broken by impact damage. The major risk associated with using hydrogen will be the exposure to the fuel lines being damaged and allowing the tanks to lose pressure rapidly, turning them into jet propelled missiles.

The pressurized gas tank as a missile is the major safety hazard. It is not insignificant, but should not be an insurmountable problem.

Conclusion

There are still a lot of questions to be answered. But one thing is clear: hydrogen powered cars are not dead. In congested metropolitan areas where electrical costs are high, hydrogen may become widely utilized. The further advantage of much longer travel ranges may also give hydrogen an additional edge over plug in alternatives.

It is too early to make investment decisions trying to select eventual winners. It is not wise to assume there will not be a viable hydrogen car and hydrogen distribution systems during the next decade.

John Lounsbury, CFP, PhD is a financial planner in Clayton, NC. He has extensive experience in computer technology research and development both as an engineer/scientist and in corporate management with academic degrees in physical science. He is a regular contributor to Real Money at TheStreet.com and to Seeking Alpha. Dr. Lounsbury also has his own professional blog, PiedmontHudson. His articles are widely circulated on the internet.

Posted by Guest Contributor at 11:25 AM | Permalink | Comments (8)

Charles Morand

Last week, I conducted an analysis showing the lack of evidence supporting claims that oil and alt energy returns are strongly correlated (claims that sometimes come from outfits as reputable as Bank of America Merrill Lynch).    

I don't want to belabor this topic but I thought I would post the results of another, similar analysis I conducted following comments I received on how to improve the first one. In a nutshell, the comments suggested I do the following:

1) Look at daily correlations or even smaller periods, as "common knowledge" market movements can often dominate over the real relationship in the short and very short run

2) Look at absolute (price) correlations as well as relative (return) correlations (my first analysis looked only at relative movements)

3) Look at directionality (i.e. what % of the time do assets X and Y move in the same direction regardless of the size of the move)

4) Extent your analysis to five years or greater

New Analysis, Same Difference

The three sets of tables below show daily return correlation coefficients, daily price correlation coefficients and daily directionality statistics (% of days that the assets close Up, Down or No Movement together) for oil, nat gas, the S&P 500 and alt energy stocks.

The time periods have been extended from three to five years or since inception. The oldest alt energy ETF available is PBW that was listed on March 03, 2005 - not quite 5 years but a decent chunk of time nonetheless. The other 3 ETFs (sector specific) were all listed in the 2^nd half of 2008.









The first set of tables show that returns on oil are not particularly useful at explaining returns on alt energy stocks on a daily basis (let's say that we enter useful territory at 0.5 and above), although the results for PBW show the relationship strengthening somewhat in the last year (which has been anything but a normal year for the markets). These results are in line with those from my previous analysis which looked at weekly returns.

As far as absolute prices go (the second set of tables), correlation coefficients for oil and alt energy are high, but they are just as high if not higher for alt energy and the S&P 500. PBW shows the relationship strengthening over time, but it strengthened even more between oil and the S&P 500, something Tom opined might be the case a few months ago.

I don't find absolute price correlations all that useful. In the medium and long terms, returns matter far more than absolute prices. If a $1 movement in oil consistently results in a $1 movement in an alt energy ETF over the long run, the high coefficient could obscure a divergence trend between the returns on both assets as their prices rise.

Finally, the directionality tables (note that assets appear in a different order) show a fair bit of co-directionality between oil and alt energy (with the exception of PTRP [alternative transportation], something Tom and I discussed last week). But here again, the S&P 500 emerges as the stronger predictor.

Conclusion

I did not go any more granular than daily data: anything beyond that becomes relevant only to traders.

Once again, the general conclusion that emerges from this analysis is that oil - whether in terms of returns, prices or directionality - is not a particularly useful indicator to go by when investing in alt energy stocks, especially when compared to equity markets in general (i.e. the S&P 500).

The implication for investors is that they should not invest in alt energy as a hedge against or a play on rising oil prices. If anything, what little relationship does exist will probably tend to disappear overtime as alt energy and cleantech stocks respond more to core business fundamentals than to seemingly logical yet unproven narratives about external drivers.  

DISCLOSURE: None

Posted by Charles Morand at 02:21 PM | Permalink | Comments (6)

Charles Morand

The relationship - or lack thereof - between oil prices and the performance of alt energy stocks has been a long-time interest of mine. I discussed it last in late March when I looked at correlations between the daily returns of alt energy and fossil energy ETFs. At the time, I found that only a weak relationship existed between the two and that if someone wanted to make a thematic investment play on Peak Oil, alt energy ETFs were not an ideal way to do so. 

Seeing as the popular press and countless "experts" continue to claim, whenever they get a chance, that the fortunes of alternative energy stocks are closely tied to the price of oil, I figured I would revisit the topic.

Fossil & Alternative Energy: The Relationship That Isn't There

This time around, I took a slightly different approach for my analysis: I correlated the weekly returns for US oil and US natural gas directly (as opposed to through an ETF) with returns for the S&P 500 and four alt energy ETFs. For US Oil and Nat Gas, I used price data provided by the Energy Information Administration here (Spot Price FOB Weighted by Estimated Export Volume) and here (Contract 1), respectively. I got ETF and S&P 500 price and index value data from Google Finance.

For the ETFs, I picked the Claymore/Mac Global Solar Index ETF (TAN) as the solar sector representative, because I took a position in it in March (which I liquidated last week even though I initially claimed I would hang on to it for 18 to 24 months. I have now grown more worried about downside risk than I am optimistic about upside prospects over that time horizon, so I took my money out).     

The other ETFs were: the First Trust Global Wind Energy Index (FAN) for wind, because it represents a more direct play on the sector than the alternative; the PowerShares Clean Energy (PBW) ETF for alt energy other than solar and wind, as an analysis I conducted earlier this year indicated it is the best way to access other sectors; and the Powershares Global Progressive Transport (PTRP) ETF, as it provides the only proxy I know of for returns on a basket of stocks with exposure to alternative modes of transportation.          

The graph below displays returns for all four ETFs, Oil, Nat Gas and the S&P 500 between Jan. 1, 2007 and Sep. 25, 2009 (click on the image for a large view).             



The table below shows returns and volatility for all seven assets over the same time interval but broken down into sub-periods. Seeing as 2009 and the post-Lehman collapse period have been eventful times to say the least, I thought it would make sense to create a few distinct sub-periods for analytical purposes.

What jumped out at me from this table is the relatively strong performance of the Powershares Global Progressive Transport (PTRP) ETF, even after adjusting for volatility. As the correlation analysis below demonstrates, this performance is not due to a rise in oil prices.

My going theory is that there is a Green Stimulus Effect at work given how much of global stimulus dollars have gone to transportation programs. This would be something worth exploring further but it certainly seems in line, at least on the surface, with a prediction I made nearly one year ago. 



The following three tables contain the real meat of my analysis. They are fairly self-explanatory: they show correlation coefficients between US Oil, US Nat Gas and the S&P 500 with all other assets. The correlations are for the periods outlined in the tables or since inception in the case of PTRP (Sep. 19, 2008), TAN (Apr. 18, 2008) and FAN (Jun. 20, 2008). The correlation coefficients above 0.5 are highlighted.




These results are, once again, in line with my expectations: there is little reason to believe that there is a strong relationship between changes in the price of oil and the performance of alt energy stocks. Even for natural gas, where one could expect a correlation with wind and solar given that all three fuels are used in power generation (or load abatement), there does not seem to be a strong relationship.

TAN and FAN have not yet been around for long enough to analyze returns going very far back into the past, but PBW has. Although the correlation between PBW's returns and oil's returns seems to have strengthened somewhat in the past year, it certainly does not qualify as strong.

I must admit that I was fairly surprised to find such a low correlation between the returns on oil and those on the PTRP ETF. My guess is that this ETF hasn't been around long enough, and that a relationship might emerge under an extreme Peak Oil scenario. That said, spending on public transportation is heavily dependent on the fiscal health of various levels of government, and we've just been moved from the emergency room to the critical care unit.    

On the other hand, I was not particularly surprised to see that returns for all four alt energy ETFs are strongly correlated with returns for the S&P 500 - that seems intuitive enough given that they all belong to the same asset class. 

Conclusion

It doesn't really matter how one slices and dices the data: there just does not appear to be a strong relationship between returns on oil and returns on alt energy stocks, including alternative modes of transportation.

That's not going to matter to a great many commentators who will continue to claim in newspaper and magazine articles, on blogs and on TV that the success of alt energy stocks is closely tied to the price of crude, even though that's mostly untrue.

Those who invest in alt energy should, however, pay close attention. These results suggest that there are far more important factors than oil prices, most notably returns in equity markets in general and regulatory incentives by governments.

There is a good chance that equity returns and returns on oil will diverge in the next couple of years as oil prices climb and equities stagnate or decline. If such a scenario materializes, those who have the relationship backwards could be in for unpleasant surprises.   
  
DISCLOSURE: None

Posted by Charles Morand at 09:18 PM | Permalink | Comments (6)

John Petersen wrote a series of popular articles last week to introduce new investors to the battery sector, following the A123 IPO.  We've had a couple requests from readers who missed one part or another, so here is a quick index to the articles.

1. Part I - Battery industry overview.
2. Parrt II - Comparison of energy storage technologies and companies.
3. Part III - Benchmarking Performance of battery stocks
4. Part IV - Debunking misconceptions about electric vehicles and battery technology.

Posted by Tom Konrad at 11:56 AM | Permalink | Comments (0)

Tom Konrad, Ph.D. CFA

Should reduced liquidity at New Flyer Industries concern investors?

New Flyer Industries (NFI-UN.TO, NFYIF.PK) is one of my largest single clean energy investments. The company describes itself as the "leader in the heavy-duty bus market for the US and Canada."  This is why I first brought it to the attention of readers in April 2008, as a company likely to benefit from peak oil. Increasing the fuel efficiency of our vehicle fleet can reduce our consumption of oil in North America, but not at a pace sufficient to both accommodate declining oil supplies and increasing oil demand from the developing world.  

United States net imports are likely to decline much more quickly than world oil supply.  Furthermore, while converting some of our transportation fuel to natural gas or electricity may offset some of these lost imports, both require turnover in the vehicle fleet, and battery electric vehicles and plug-in hybrid vehicles are likely to be too expensive and too limited by available battery manufacturing to make a large enough difference in oil consumption to offset the lost imports.  Biofuels (both advanced and conventional) are similarly limited by available able feedstock.

If improvements in the automotive fleet and fuels will come too slowly to offset import declines, we'll have to look beyond the automobile for fuel savings.  If we drive less, we'll either have to travel less, or shift to other modes of transport.  The best solution would be to travel less, and live closer to where we work.  Such changes are likely to happen only slowly.  Having recently massively "invested" in the suburban project, America is unlikely to retreat quickly from those investments.  Ever hopeful, exurban homeowners will cling on, despite rising and volatile gas prices, waiting for the market to "come back" to a place it never should have been in the first place.  Even those exurbanites who chose to shift to a more urban, fuel-efficient, lifestyle will sell their houses to others who believe they are getting a great deal, if only because the price has be reduced by 20%.  Gas prices are likely to cause suburban home prices to fall faster than urban ones, but it will be longer before most of those suburban homes are unoccupied.

Transit Busses

Both a trend towards urbanization, and unaffordable suburban commutes should favor bus transit.  While rail transit is more efficient and more pleasant, it takes years to build out rail transit.  Bus transit only requires the purchase of busses, and perhaps some repainting of roads and other minor changes to improve bus speed by giving them preferential right-of way.  And because, as Winston Churchill said, "Americans can be counted on to do the right thing... after they have exhausted all other possibilities," we're not doing nearly enough to prepare for rapidly decreasing oil imports today.  Instead, we're going to be engaging in an after-the-fact, jerry-rigged effort to keep our society functioning when the gasoline lifeblood it depends on suddenly costs several times what we can afford.

In other words, rather than smooth rail transit, most Americans will make due with jerky busses from suburban park-and-rides.  If we're lucky, the busses will be hybrid electric, because if you've ever ridden on one, you'll know that both acceleration and deceleration is much smoother.

Most bus manufacturers are part of larger truck or automotive manufacturers (Scania, Freightliner, DaimlerChrysler) or are privately held (Gillig, Blue Bird, North American Bus Industries, Nova Bus.)  New Flyer is an exception, being both publicly traded, and focused on just busses.  They have a wide range of products, including compressed and liquid natural gas busses, as well as hybrid and electric trolley busses.

Then and Now

I purchased about half of my current holdings of New Flyer in Spring of 2008, mostly around US$11, and doubled my position in December in the low US$5 range, for an average cost basis of US$8.34, right around current prices.  Since the company pays a large combined dividend/interest payment, I've been happy with my overall results (The 2008 annual payment was C$1.17, 1/3 of which was qualified dividends and 2/3 of which was interest.) Investors who bought the company when I recommended it as one of my Ten Clean Energy Stocks for 2009 at anywhere near the US$6.60 it was trading at when I wrote the article should be quite pleased as well.

New Flyer's structure is unusual, with cash flows and payments to holders of "Income Deposit Securities" or IDSs.  Each IDSs is composed of a common share of New Flyer Industries, Inc., an Ontario Corporation, and C$5.53 principal amount of subordinated notes of "NFI ULC" an Alberta unlimited liability corporation.  

A reader left a comment on my original article expressing concern about the unlimited liability of the ULC.  It's important to note that the IDS holders are not shareholders of the ULC, but rather holders of subordinated notes of the ULC, i.e. debt, not stock.  Investors in the IDS (i.e. NFI-UN.TO or NFYIF.PK) should not be subject to any claims beyond their C$5.53 per IDS share NFI ULC subordinated note.  IDS investors have an ownership stake in NFI ULC only indirectly through New Flyer Industries, and hence are not exposed to unlimited liability from NFI ULC because New Flyer Industries is a limited liability corporation.

Working Capital

What investors might be concerned about is the deterioration of the cash position of the companies.  In the 2008 annual report, the company reported a "customer specific engineering design issue during 2008 Q4 which resulted in delayed bus completions and deliveries creating a temporary swelling of year-end inventory levels."  The Management Discussion and Analysis went on to say "these engineering deficiencies have been resolved and management expects the contract to be substantially delivered during the first half of 2009.  

The second quarter 2009 report updates the situation: "As of July 5... 73 of the total 225 equivalent units related to this customer's contracts had been delivered."  73 of 225 does not sound like "substantially delivered" to me, but the problem does seem to have been mostly resolved to the customer's satisfaction since the customer has "initiated further option conversions" (i.e. ordered more busses.)  Update: This customer is the Chicago Transit Authority (CTA).

However, the delay of deliveries to the CTA, and a smaller delay involving a 30 bus contract with another customer have swollen New Flyer's inventory and caused NFI ULC to draw down its cash reserves and tap its revolving credit line.  In the 2008 annual report management attributed an inventory buildup of 70 units to this problem, which corresponds to an estimated $28 million of deferred revenue.  At the end of 2007, the company had $25M in cash, while at the end of Q2 2009, it had no cash and a revolving bank debit of $16M, meaning that the company's cash position deteriorated by $41M.  Because of this negative cash balance and covenants on the subordinated debt, NFI ULC has been unable to make dividend payments to New Flyer, and has instead advanced loans to allow New Flyer to continue dividend payments to shareholders.  For IDS holders, this amounts to taking money out of one pocket and loaning it to another, a practice which would become worrying if it were to continue for long.  Management has determined that this arrangement will need to continue at least though Q3 2009.

One other major hiccup was an order deferral, announced in June from another major US municipal customer.  Because the company's busses are engineered to order, the company cannot simply shift planned production to other customers.  The deferral was due to delays in state funding to the customer.  The company has laid off 320 workers and will close plants for 2 weeks at the end of the year in response.

Conclusions

Although these problems seem to be the type which the company will be able to work through, is now working with less than its usual buffer of working capital.  Because of the current state of state and municipal budgets, it would not be too surprising to see another order deferral like the recent one.  If that were to happen, the company most likely could not continue the current sleight of hand which allows it to continue paying dividends to shareholders, and payments on IDSs would probably be reduced by 1/3 to just the interest on the subordinated notes.

If that were to happen, IDS holders could expect a sharp decline in IDS share prices, as income investors fled the company.  Depending on the particular circumstances, that would most likely be an excellent buying opportunity. 

With the increase in funding from the ARRA stimulus available over the next year and a half just starting to be distributed, I don't expect any such hiccups to threaten New Flyer's long term survival.  Still, such hiccups could impact short term profitability due to the company's inability to substitute new orders for orders which are unexpectedly deferred.  Note that the company does not expect any such deferrals, nor do they expect a drop in EBITDA, or to have to reduce IDS payments.  

In other words, any such hiccup would be unexpected (by management, at least.)  Investors should realize that it is a possibility, and only hold the securities if they consider the potential for appreciation and a hefty income stream to be worth the risk.  On the other hand, if business proceeds as management expects, we can expect price appreciation relative to the market as production continues to increase and inventory falls strengthening both revenues and the company's cash buffer.  The liquidity issues should be watched, but should not yet be a cause of deep concern.

I consider New Flyer a stable company in an extremely attractive industry.  We can already see some benefits to the company from greater awareness of oil price risks: the company's product mix has been shifting to include a greater proportion of hybrid busses.  The better product mix has allowed them to expand revenues despite the setbacks.  Furthermore, the current combined interest and dividend yield of over 13% continues to compensate well for the risk of any price fluctuations.  If the payments were reduced to just the payment on the subordinated note, it would still be well over 8%.   Meanwhile, the potential for appreciation goes hand in hand with potential increases in the price of oil.

DISCLOSURE: Tom Konrad and/or his clients own NFYIF.

DISCLAIMER: The information and trades provided here and in the comments are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

Posted by Tom Konrad at 08:00 AM | Permalink | Comments (2) | TrackBacks (0)

John Petersen

In "The Sixth Revolution: The Coming of Cleantech," Merill Lynch strategist Steven Milunovich heralded cleantech as a new investment theme and forecast a period of gut wrenching change followed by an age of plenty. A few days later venture capital icon Vinod Khosla warned his audience “500 million people on earth enjoy a lifestyle that 9 billion people will want in 2050.” The differences between these two informed viewpoints are more than a little stark, but they highlight a frightening truth about cleantech: for the first time in human history the fundamental drivers of a technological revolution are constraints rather than opportunities. In this final installment of my series on battery investing for beginners, I want to explain why cost considerations and the transitory nature of government policies should temper the optimism of energy storage investors.

Warren Buffett advocates investing in companies you understand, companies that that sell products and services you know, trust and use. Unfortunately, that advice is almost impossible to follow in cleantech because most of the players are new, few can point to a long and successful operating history and the principal disclosures investors rely on are forward-looking statements from people that are trying to build a company in an emerging industry; people who are by nature optimists. Any time you put an optimist's forward-looking perspective into the hands of an optimistic reader, the only possible outcome is optimism squared and that's a dangerous equation.

In 1999, Toyota (TM) introduced a radical concept called the Prius, a hybrid electric vehicle, or HEV, that used recuperative braking, stop-start idle elimination, electric only launch and electric boost to reduce energy waste and slash fuel consumption by roughly 40%. Over the last 10 years, the Prius has progressed from an eco-bling status symbol to a mass-market product. In the process it won the loyalty of consumers and forced other automakers to develop competitive vehicles. The following 10-year graph of domestic HEV sales comes from hybridcars.com and shows how unit sales and product offerings ramped up over time.

US hybrid market historical sales (1999 – 2009)

This chart shows a normal market for an innovative product that evolved organically in response to consumer demand. If not for the current recession, it's easy to see how HEV sales could easily have been in the 500,000 to 700,000 vehicles per year range by now. The HEV is a winning concept that can only get more popular as the base of satisfied customers broadens and gasoline prices rise.

The unspoken truth about PHEVs and EVs is that the fundamental driver for change is government compulsion, not customer demand. The automakers know that they can't possibly meet new U.S. CAFE standards and European CO2 emission standards without including a high percentage of HEVs or a more modest percentage of PHEVs and EVs in their sales forecasts. The government's theory seems to be "if you build it they will come." While there is a high degree of automaker skepticism over whether the average consumer can or will pay an 80% to 100% premium for a PHEV or EV, the automakers all know that if they spend the money to build and introduce PHEVs and EVs and consumers refuse to buy, they'll have the perfect cover when the regulators come calling. Greenwash is expensive, but it's not as costly as being excluded from major markets or finding another line of business.

The hard question I think investors need to ask themselves is, "do you plan to spend at least $40,000 to buy yourself a PHEV or EV?" Unless your answer is an enthusiastic yes, you need to question whether investing in a battery company that has tied its future to the success of PHEVs and EVs makes sense.

My favorite part of the blogging experience is the lengthy debates I get into with informed and opinionated readers. They add a depth and balance I could never achieve on my own. They also provide wonderful insights into what people believe the future holds. The following is a compendium of a few cherished mythologies and incontrovertible realities that I’ve seen time after time in reader comments.

Cherished Mythology lithium-ion batteries are expensive today but they'll get cheaper with economies of scale.

Incontrovertible Reality The lithium-ion battery industry already sells $7 billion of products annually and big companies like Sony, Sanyo, Panasonic, LG Chem, Toshiba and Johnson Controls have done a great job of optimizing their production economies. According to a presentation by RolandBerger Strategy Consultants at last month's Frankfurt Auto Show, between 65% and 75% of the manufacturing cost for lithium-ion batteries represents the purchase price of raw materials and another 20% to 30% represents the cost of increasingly sophisticated and expensive equipment and factories. The balance goes for energy, labor and overhead. The only factors that can reasonably be expected to significantly reduce costs are generational improvements in battery chemistry and manufacturing technology.

Cherished Mythology PHEVs and EVs have limited range for now, but they'll have more flexibility in the future.

Incontrovertible Reality A typical PHEV or EV will get about four miles of travel range for each kWh of useful battery capacity. A comparable car with an internal combusion engine would get at least 28 mpg. In a normal car the fuel tank is cheap and the fuel is expensive. In a PHEV or EV the dynamic is reversed and the battery pack is the functional equivalent of a fuel tank that costs $7,000 per gallon of capacity (28 mpg/4 miles per kWh @ $1,000 per kWh). Once you buy the tank, filling it is dirt-cheap. Under current economic conditions long-range PHEVs and EVs can never be cost effective and the only way to make the economics come close to working is to buy no more battery capacity than you plan to use every day.

Cherished Mythology PHEVs and EVs will help reduce America's dependence on imported oil.

Incontrovertible Reality A PHEV or EV will use 10 times the battery capacity of an HEV. If the batteries are used in one PHEV or EV, national gasoline consumption will fall by 400 gallons per year. If the batteries are used in 10 HEVs, national gasoline consumption will fall by 1,600 gallons per year. In truth, PHEVs and EVs will sabotage America's drive for energy independence instead of supporting it.

Cherished Mythology PHEVs and EVs will help reduce America's CO2 footprint.

Incontrovertible Reality A PHEV or EV will use 10 times the battery capacity of an HEV. If the batteries are used in one PHEV or EV, national CO2 emissions will decline by 190 grams per mile, or roughly 2.375 metric tons per year. If the batteries are used in 10 HEVs, national CO2 emissions will fall by 135 grams per mile, or roughly 16.875 metric tons per year. Until we stop generating electricity with coal, PHEVs and EVs will not significantly reduce CO2 emissions.

Cherished Mythology PHEVs and EVs will become a dominant automotive technology in the next decade.

Incontrovertible Reality In its 2009 Annual Energy Outlook, the DOE estimated that PHEVs and EVs would account for 1.26% of the new light duty vehicle sales in 2020 and grow to 2.28% by 2030. At the Frankfort Auto Show, Roland Berger Strategy Consultants forecast the following market penetration rates for the principal automotive powertrain technologies in 2020:

	USA	Europe	Japan	China
Internal combustion	23%	6%	17%	48%
Micro hybrid	51%	67%	60%	30%
Mild hybrid	5%	6%	9%	4%
Full hybrid	8%	1%	6%	2%
PHEV	9%	15%	4%	10%
EV	4%	5%	4%	6%

 
Cherished Mythology Lithium-ion batteries will be needed for mild, micro and full hybrids.

Incontrovertible Reality Advanced lead-carbon batteries and systems that combine lead-acid batteries with supercapacitors are up to 75% cheaper than lithium-ion batteries and offer acceptable performance in the micro and mild hybrid vehicles that Roland Berger says will account for 56% of U.S. auto sales, 69% of Japanese auto sales and 73% of European auto sales in 2020. While lithium-ion batteries will undoubtedly be used in some luxury hybrid vehicles, they're not expected to be a major factor in the mass markets for affordable light duty vehicles.

Cherished Mythology Revenues will ramp up rapidly for lithium-ion battery manufacturers over the next decade.

Incontrovertible Reality There is no substantial unused lithium-ion battery manufacturing capacity anywhere in the world and future revenue growth will be directly tied to the construction of new factories that typically take three years to plan and build. The only energy storage device manufacturers that already have excess manufacturing capacity are in the lead-acid group. As a rule of thumb, lithium-ion battery manufacturers plan on $1 in capital spending for every $1 of incremental sales revenue. In comparison, lead-acid battery manufacturers generally plan on $1 in capital spending for every $3 to $5 of incremental sales revenue.

Cherished Mythology New battery technologies will take revenue away from established manufacturers and hurt their bottom lines.

Incontrovertible Reality History teaches that increased energy efficiency leads to increased energy consumption and new technology inevitably increases aggregate demand by facilitating the development of new applications that were impossible using old technology. For the foreseeable future, demand for all classes of energy storage devices will increase at rapid rates and the only losers will be companies that can't bring a competitive product to market.

Lithium-ion batteries are a very valuable technology and their future importance to the cleantech revolution cannot be overstated. Nevertheless we've all seen the disastrous consequences investors suffered from ill advised governmental policies to encourage the use of ethanol, the wonder fuel of the new millennium. In a slideshow presentation at a recent clean air conference one auto industry executive described government's "technology du jour syndrome" and offered the following table to prove his point.

25 years ago	Methanol
15 years ago	Electric vehicles
10 years ago	HEVs and Electric vehicles
5 years ago	Hydrogen Fuel Cells
2 years ago	Ethanol
Today	PHEVs and Electric vehicles
2011	What’s next?

It's enough to make you go Hmmm.

As a young lawyer in Houston, my first mentor taught me that you can describe every oil and gas deal with a venn diagram that consists of three concentric circles. The outer circle represents the seller's expectations, the middle circle represents the buyer's expectations, and the innermost circle represents the actual outcome. In the market for energy storage stocks I worry that the venn diagram is distorted because investor optimism exceeds industry expectations by a wide margin. These are conditions that can give birth to bubbles.

My favorite story of unbridled optimism begins with a straight-laced father who thinks his son is overly optimistic and decides to teach the boy a lesson by telling him that a load of manure is his birthday gift. The manure is delivered and dumped in the driveway and the father puts a big red bow on top of the pile. When the son gets home from school, he promptly dives headfirst into the manure pile and starts digging. When the surprised father asks "What's going on?" the boy promptly replies, "There has to be a pony in here somewhere!"

The good news is there are several workhorses in the pile. The bad news is that none of them are the pretty ponies that the government, the mainstream media and the environmental activists are praising with quasi-religious fervor. Unless investors are willing to spend a huge amount of time studying deathless tomes on energy storage, the only rational way to invest in the sector is through a diversified portfolio of cheap and cool stocks.

This will be my last blog for a week or so because I'm scheduled to give a luncheon speech at Sandia National Laboratories’ EESAT 2009 Conference in Seattle on Tuesday. In connection with the speech I'll have an opportunity to attend three days of high-level presentations on electrical energy storage applications and technologies. Hopefully I'll return with some new insights that can help make readers better investors.

DISCLOSURE: None

Posted by John Petersen at 10:47 PM | Permalink | Comments (7)

John Petersen

I've been blogging about pure-play energy storage device manufacturers since July 2008. By mid-November I'd assembled a short list of thirteen pure-play public companies that accounted for almost 25% of the $30 billion global battery market. Frankly I was shocked to learn that major battery manufacturers like Exide (XIDE) and Enersys (ENS) that report billions in annual sales carried tiny market capitalizations when compared with far riskier technology development companies like Ener1 (HEV) and Valence Technology (VLNC) that would be little more than rounding errors on the big boys' financial statements. As I focused on the obvious valuation disparities, it became clear that the market was paying huge premiums for companies that are developing cool energy storage devices and heavily discounting companies that manufacture objectively cheap energy storage devices. My belief at the time was that the cool companies were likely lose ground while the cheap companies were likely to gain ground. My original peer group comparison table follows (click on the image for a larger view).



While the last ten months have been anything but normal, I revisited my valuation analysis in May of this year and showed that from November 14, 2008 through April 30, 2009, the cheap group appreciated an average of 56.5% while the cool group appreciated an average of 6.7%. I revisited the analysis again in August of this year and showed that from November 14, 2008 through July 31, 2009, the cheap group appreciated an average of 59.2% while the cool group appreciated an average of 21.42%. We all know that past performance is never a guarantee of future performance, but the theory seems to be holding up pretty well.

With it's successful IPO last week, A123 Systems (AONE) dropped a $2.2 billion market capitalization rock into what was previously a $4.4 billion market capitalization pond. The ripple effect will be felt for months as analysts and investors perform detailed comparisons of the publicly traded energy storage companies in an effort to ferret out the bargains and identify the diamonds in the rough. Now that the initial volatility of A123's IPO has passed, the market seems to be returning to more normal conditions, and we've reached the end of a calendar quarter, this seems like a convenient time to do a final comparison of market performance since November 14, 2008. It also provides an opportunity to conform the cheap and cool classifications to the tables I used in Battery Investing For Beginners, Part II and reset the baseline for future comparisons using yesterday's closing prices.

The following table provides comparative price data for the pure play energy storage companies I track. It shows closing prices on November 14, 2008 and September 30, 2009; calculates the percentage of change since November 14, 2008; and shows current market capitalization of each company. It also provides comparable tracking data for the Dow, the S&P 500 and the Nasdaq Index. While I've included A123 in the cool sustainable group effective September 30th, I have not adjusted the historical performance of the group for the first week of trading in its stock (click on the image for a larger view).



The following table summarizes the portfolio appreciation that a hypothetical investor would have realized over the last ten months if he had invested $1,000 in each company on November 14, 2008. It also presents comparable data for the broad market indexes.

Tracking Category	Percentage Gain
Broad Market Indexes	25.09%
Cool Emerging Companies	4.30%
Cool Sustainable Companies	75.14%
Cheap Emerging Companies	54.73%
Cheap Sustainable Companies	121.02%
Chinese Battery Companies	126.24%

Equity markets are driven by a combination of greed and fear, emotional reactions that are frequently at odds with economic realities. Over the past few years, the cool companies have been driven by headlines that highlight opportunities while the cheap companies have been driven by headlines that highlight problems. Since headlines inevitably feed the greed and fear cycle, the cool companies were driven to objectively high valuation levels while the cheap companies were driven to objectively low valuation levels. If the last ten and a half months are any indication, the pendulum is moving back toward a more balanced position where the cheap group valuations will eventually reach a more reasonable parity with the cool group valuations. They still have a long way to go.

I have consistently argued that every energy storage decision in transportation, alternative power and the smart grid will boil down to a cost-benefit analysis. As long as the cost of storage exceeds the value of the stored electricity, waste will prevail. When the value of the stored electricity is higher than the costs of storage, the market will respond appropriately. While there is no doubt that the cool companies will have more business than they can handle, there is also no doubt that the bulk of the incremental sales revenue will flow to companies that serve the mundane needs of the average user, rather than the extreme needs of "power users." It's ultimately a choice between meat and potatoes or rainbow stew.

While I believe the cleantech revolution will result in rapid and sustained growth across the entire spectrum of energy storage companies, I remain convinced the best stock market performers will be manufacturers of objectively cheap energy storage products. Vinod Khosla is fond of reminding investors that "The most important thing to remember is economic gravity — the cheapest thing ends up winning." Mark Twain once quipped, “History doesn’t repeat itself, but it does rhyme.” Henry Ford didn’t make the best cars; he made the cheapest cars. Microsoft didn’t make the best operating system; it made the cheapest operating system. Xerox invented and then failed to commercialize more cool technologies than I can even begin to count. Examples of the fundamental economic reality that cost trumps coolness are too numerous to mention. When you cut through the energy storage hype and drill down to business fundamentals, I have to believe that investors who want market beating returns in the energy storage sector should be focusing on companies that make cheap products.

DISCLOSURE: Author is a former director Axion Power International (AXPW.OB) and holds a large long position in its stock. He also holds small long positions in Exide (XIDE), Enersys (ENS) Active Power (ACPW) and ZBB Energy (ZBB).

Posted by John Petersen at 10:52 AM | Permalink | Comments (0)

John Petersen

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

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

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

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

DISCLOSURE: None

Posted by John Petersen at 09:35 AM | Permalink | Comments (0)

John Petersen

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

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



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

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

The most striking aspect of the Inspector General's report is the fact that it was written from the perspective of an EV buyer, rather than an EV seller. After years of reading up-beat promotional materials that talk about ten-year battery lives and seven- to ten-year payback periods, it was refreshing to see a more skeptical buyer's analysis that:

• Assumed the battery pack would have to be replaced after five years;
• Assumed a fifty percent reduction in repair and maintenance costs;
• Assumed a stable correlation between gasoline and electricity prices;
  
• Required internal returns of thirty percent per year like you see in most businesses;
• Required payback periods of less than three years like you see in most businesses;
  
• Concluded that substantial Federal subsidies were essential; and
• Concluded that ancillary revenues from V2G services were essential.
  

The Inspector General's report was not overly kind to E-LLVs, but then I've never expected undue kindness from fleet buyers who are invariably constrained by capital spending policies that require a return on investment, as opposed to a return of investment. The good news for EV developers is that the Inspector General was able to put together a plan that worked for the Postal Service. The bad news is the plan will be difficult for other fleet users to duplicate because the feasibility study assumes that:

• The Postal Service will get grants for 74% of the cost difference between a standard LLV and an E-LLV;
• The Postal Service will save roughly $1,300 per vehicle year from reduced fueling costs;
• The Postal Service will save roughly $1,500 per vehicle year from reduced maintenance; and
• The Postal Service will earn roughly $2,300 per vehicle year from V2G services.

The Inspector General's report analyzed four possible scenarios. In the basic scenario of no grants and no V2G revenue, the E-LLVs were a poor investment that had a negative return over ten years. In two middle of the road scenarios that included (a) grants without V2G revenues and (b) V2G revenues without grants, the payback periods were in the five-year range and internal rates of return were 15% to 20%. In a best-case scenario that included both grants and V2G revenue, the payback period was under two years and the internal rate of return was over 60%. Since the Postal Services has influential friends in high places, I think it's a safe bet that they'll be able to negotiate the details of a best case project.

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

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

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

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

DISCLOSURE: None

John L. Petersen, Esq. is a U.S. lawyer based in Switzerland who works as a partner in the law firm of Fefer Petersen & Cie and represents North American, European and Asian clients, principally in the energy and alternative energy sectors. His international practice is limited to corporate securities and small company finance, where he focuses on guiding small growth-oriented companies through the corporate finance process, beginning with seed stage private placements, continuing through growth stage private financing and concluding with a reverse merger or public offering. Mr. Petersen is a 1979 graduate of the Notre Dame Law School and a 1976 graduate of Arizona State University. He was admitted to the Texas Bar Association in 1980 and licensed to practice as a CPA in 1981.

Posted by John Petersen at 10:53 AM | Permalink | Comments (19)

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

Tom Konrad, Ph.D., CFA

There will be gas lines.

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

Elitist Hypocrites

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

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

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

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

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

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

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

A Plug for Real Options

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

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

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

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

Uncertainty

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

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

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

DISCLOSURE: None.

DISCLAIMER: The information and trades provided here and in the comments are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

 

Posted by Tom Konrad at 09:40 PM | Permalink | Comments (5) | TrackBacks (0)

John Petersen

Since I've stirred up a hornet's nest over the last two weeks first by debunking the mythology that PHEVs and EVs will save their owners money and then by showing how PHEVs and EVs will sabotage America's drive for energy independence, I figured I might as well go for the triple-crown of harsh realities by showing readers that in the U.S., where 70% of electricity comes from burning hydrocarbons, PHEVs and EVs won't make a dent in CO2 emissions. They'll just take distributed CO2 emissions off the roads and centralize them in coal and gas fired power plants.

I started to seriously question the policy arguments in favor of PHEVs and EVs when McKinsey Quarterly published an article titled "Profiting from the low-carbon economy" in early August. The article included a "Global carbon abatement cost curve" that shocked me because it showed that HEVs offered a substantial cash benefit from carbon abatement while PHEVs imposed a significant carbon abatement cost. A few days ago I got permission to reprint the original graph from a recent McKinsey & Company report titled "Pathways to a Low-Carbon Economy. Version 2 of the Global Greenhouse Gas Abatement Cost Curve," 2009."



While the graph is fairly complex because it shows both the benefits and costs of various carbon abatement options and the potential amount of CO2 that each option could eliminate, the key issue is the relative positions that HEVs and PHEVs occupy on the curve. HEVs are shown on the left hand side of the graph between residential insulation retrofit and electricity from landfill gas; which means that HEVs save €30 ($43) per metric ton of carbon abatement. PHEVs are shown on the right hand side of the graph between nuclear power plants and low penetration wind farms; which means that PHEVs cost €12 ($17) per metric ton of carbon abatement. Since the McKinsey graph analyzed abatement costs at a 'global' level, I felt compelled to dig a little deeper and analyse their impact in the U.S.

In its latest report on greenhouse gas emissions in the U.S., the Energy Information Administration said that CO2 emissions from electricity generation were 2,433.4 million metric tons in 2007. In its 2007 annual summary of electric power in the U.S., the EIA reported that net generation of electric power during 2007 was 4,157 billion kilowatt-hours from the sources identified in the following graph.



When you divide the total CO2 emissions from electricity generation by the total amount of electricity generated, it works out to 585.4 grams of CO2 per kWh. While the figures vary among manufacturers, the average electric-only range of the PHEVs and EVs planned by General Motors, Nissan (NSANY), Mitsubishi (MMTOF.PK), BYD (BYDDF.PK), Tesla Motors, Fisker Automotive, Th!nk Global and a legion of others is roughly 4 miles per kWh of useful battery capacity. So in the U.S., a PHEV or EV will ultimately be responsible for about 146 grams of CO2 emissions per mile unless the owner has the foresight and dedication to buy solar panels or wind turbines to generate the electricity his PHEV or EV will use.

To review the math, a gallon of gasoline releases 20.35 pounds of CO2 (9,231 grams) when it is burned in an internal combustion engine. So a normal car that meets current CAFE standards of 27.5 mpg is responsible for roughly 336 grams of CO2 emissions per mile. In contrast, an HEV like the Prius, which slashes fuel consumption by roughly 40% through a combination of recuperative braking, idle elimination and electric launch will be responsible for roughly 201 grams of CO2 emissions per mile.

The following table compares typical vehicle costs (without tax subsidies) and CO2 emissions per mile for each class of vehicle. It then goes two steps further and (a) calculates an average carbon abatement cost for HEVs, PHEVs and EVs, and (b) calculates an incremental carbon abatement cost for PHEVs and EVs. Both carbon abatement costs are expressed in dollars of capital spending per gram/mile of CO2 emissions.

	Vehicle Cost	CO2 Emissions	Average Abatement Cost	Incremental Abatement Cost
Internal combustion	$20,000	336 g/m
Prius HEV	$26,500	201 g/m	$48.15 g/m
GM Volt class PHEV	$40,000	146 g/m	$105.26 g/m	$245.45 g/m
Nissan Leaf class EV	$40,000	146 g/m	$105.26 g/m	$245.45 g/m

Is it any wonder that Vinod Khosla keeps telling interviewers that in the U.S., China and India, PHEVs and EVs will be plugging into a lump of coal for years to come?

News stories, speeches and press releases can only maintain the electric drive illusion for so long. Sooner or later the public is going to realize that it's all hype, blue smoke and mirrors, and that PHEVs and EVs have little of substance to offer customers in the U.S. market. When the public comes to the realization that electric drive vehicles:

• Won't save their owners significant amounts of money;
• Won't be as fuel efficient as HEVs when battery capacity is factored into the equation;
• Won't be as CO2 efficient as HEVs when utility emissions are factored into the equation; and
• Are nothing more than feel-good, taxpayer subsidized eco-bling,

the backlash against lithium-ion battery developers like Ener1 (HEV) and Valence Technologies (VLNC) that have attained nosebleed level market capitalizations based on electric drive hype may be vicious. The big winners should be developers of cheap and efficient high-performance lead-carbon batteries like Exide Technologies (XIDE) in cooperation with Axion Power International (AXPW.OB); C&D Technologies (CHP) in cooperation with Firefly Energy; and East Penn Manufacturing in cooperation with Japan's Furukawa Battery Co. (FBB.DE).

It would be wrong for readers to assume that I dislike lithium-ion battery technology, because I believe it will be an increasingly important part of the coming cleantech revolution. I also believe that companies like Advanced Battery Technologies (ABAT), Altair Nanotechnologies (ALTI), Johnson Controls (JCI) and A123 Systems (IPO pending) that are taking a diversified approach by focusing on products for a wide variety of consumer, industrial, utility and military applications will grow and prosper. But the companies, reporters, financial analysts and politicians that have built a mountain of unreasonable expectations from an electric drive molehill may be in for a tough time.

DISCLOSURE: Author is a former director and executive officer of Axion Power International (AXPW.OB) and holds a large long position in its stock. He also holds a small long position in Exide (XIDE).

John L. Petersen, Esq. is a U.S. lawyer based in Switzerland who works as a partner in the law firm of Fefer Petersen & Cie and represents North American, European and Asian clients, principally in the energy and alternative energy sectors. His international practice is limited to corporate securities and small company finance, where he focuses on guiding small growth-oriented companies through the corporate finance process, beginning with seed stage private placements, continuing through growth stage private financing and concluding with a reverse merger or public offering. Mr. Petersen is a 1979 graduate of the Notre Dame Law School and a 1976 graduate of Arizona State University. He was admitted to the Texas Bar Association in 1980 and licensed to practice as a CPA in 1981.

Posted by John Petersen at 02:49 PM | Permalink | Comments (22)

John Petersen

Yesterday I asked a frequent commenter and staunch electric vehicle advocate whether he ever questioned the ethics of building an EV that can save one owner 400 gallons of gas per year while using enough batteries to build ten Prius-class hybrids that could save their owners a combined total of 1,600 gallons of gas per year. I then spent an hour in stunned silence as the critical importance of that question crystallized in my mind. I didn't get a responsive answer from the commenter, but I did get one of those rare moments of clarity when everything suddenly falls into place.

For years the mainstream media, scientists, elected officials and promoters have written and spoken ad nauseum about how a new generation of plug-in hybrid electric vehicles, or PHEVs, will liberate America from the tyranny of imported oil. The problem is the promises are based on flawed assumptions and utterly false. At their best, PHEVs and EVs are all sizzle and no steak when it comes to national energy independence. At their worst, they are deep cover saboteurs that will undermine America's drive for energy independence while stridently claiming to be part of the solution.

The simple facts

The average American drives about 12,000 miles per year. If his engine meets current CAFE standards and averages 27.5 mpg, the average American will burn about 436 gallons of gasoline and generate about 4.4 tons of CO2 per year.

The Prius is a hybrid electric vehicle, or HEV, manufactured by Toyota Motor Corporation (TM) that carries a base sticker price of $22,750. The Prius has an enviable 10-year track record of slashing gas consumption by roughly 40% through a combination of idle elimination, electric only launch and recuperative braking. It's a marvel of efficiency engineering that eliminates waste wherever possible. Each new Prius uses about 1.6 kWh of NiMH batteries to save the average owner roughly 174 gallons of gas per year while eliminating 1.7 tons of CO2 emissions.

General Motors is getting ready to launch its eagerly anticipated, irresponsibly hyped and largely untested Volt, a PHEV that will use a combination of electric drive and gasoline engine technology to offer 40 miles of electric only range before the gasoline engine kicks in. The Volt is expected to have a base sticker price of roughly $40,000 before tax subsidies of $7,500 per vehicle. Each GM Volt will use 16 kWh of lithium-ion batteries and save the average owner up to 436 gallons of gasoline per year.

In 2010, Nissan Motors (NSANY) plans to launch its highly touted Leaf, a pure EV that will do the Volt one better by eliminating the gasoline engine altogether. The Leaf is rumored to have a base sticker price that will be competitive with the Volt and enjoy comparable tax subsidies. Each Nissan Leaf will use 24 kWh of lithium-ion batteries and save the average owner 436 gallons of gasoline per year.

The following table summarizes the maximum impact that Toyota, General Motors and Nissan can have on gasoline imports for every 48 kWh of battery capacity used in their products:

	Vehicle	Battery	Gas Savings	Number	Total Annual
	Cost	Capacity	Per Vehicle	of Vehicles	Gas Savings
Toyota Prius	$22,750 (a)	1.5 kWh	174 gallons	32 vehicles	5,568 gallons
GM Volt	$40,000 (e)	16 kWh	436 gallons	3 vehicles	1,308 gallons
Nissan Leaf	$40,000 (e)	24 kWh	436 gallons	2 vehicles	872 gallons

I used 48 kWh for this example because it's the lowest common denominator.

Automotive drive-train batteries are scarce resources, which is why President Obama recently announced $1.2 billion in Federal grants to help finance the construction of new battery manufacturing facilities. Despite the scarcity, developers of outrageously expensive PHEVs, EVs and the lithium-ion battery packs that will be used in their manufacture have convinced a gullible Congress that their products, which will only save a little gasoline, deserve huge Federal subsidies while more modest HEVs, which could save a lot of gasoline, deserve no Federal support.

Does anybody in Washington DC have a calculator and the capacity for independent thought?

The battery wars

Much of the blame for the current state of affairs belongs at the feet of lithium-ion battery developers like Ener1 (HEV), Valence Technology (VLNC), Johnson Controls (JCI) and others that have mounted a highly effective PR campaign to convince everyone that lithium-ion is the only battery technology that's small enough and light enough to power a fleet of PHEVs and EVs. Their illusory promise of energy independence coupled with frequent assurances that the cost, performance, abuse tolerance and cycle-life issues that plague lithium-ion batteries will be solved in the immediate future have led to an absurd situation where the Federal government is heavily subsidizing a wasteful alternative that will ultimately sabotage America's drive for energy independence..

I have written at length about the development path lithium-ion battery developers must follow if they want their products to become cheap enough and durable enough for the automotive market. I have compared the performance of lithium-ion batteries with far cheaper lead-carbon batteries being developed by Exide Technologies (XIDE) in cooperation with Axion Power International (AXPW.OB); by C&D Technologies (CHP) in cooperation with Firefly Energy; and by East Penn Manufacturing in cooperation with Japan's Furukawa Battery Co. (FBB.DE). I have demonstrated that lithium-ion batteries are not necessary in micro, mild and full hybrids where a 77 pound weight advantage and 0.7 cubic feet of saved space can't justify $1,250 in incremental battery cost. I have also explained how billions of dollars in existing lead-acid battery manufacturing facilities can be leveraged to facilitate the inexpensive implementation of micro, mild and full hybrid technologies in the U.S. and Europe in years instead of decades without the short-term supply chain constraints that will impede the commercialization of other battery technologies.

In December of last year I wrote that the energy storage sector needs to take baby steps before it can run and I regularly quote a favorite a line from "The Lost Constitution" by William Martin that says, "In America we wake up in the morning, we go to work and we solve our problems." America has the technical ability and the manufacturing infrastructure to implement HEV technology in all new light vehicles within a decade. If we wait for cheap lithium-ion batteries and cost effective PHEVs and EVs, the process will take far longer, cost much more and offer less flexibility to consumers. I strongly advocate the continued development of lithium-ion and other battery technologies because HEVs are not the journey's end and we can do better. We cannot, however, take a giant leap into the future without first taking the reasonable steps that are available and affordable today.

Notwithstanding the deafening drumbeat of hype from mainstream media, academics, elected officials and lithium-ion battery developers, the undisputed facts are that lithium-ion batteries are not ready for prime time and PHEVs and EVs are little more than vanity items for elitists who will happily let up to fifteen other Americans waste up tp 2,610 gallons of gas per year so that they can save 462 gallons by driving a 100% green car. The hypocrisy is appalling.

DISCLOSURE: Author is a former director and executive officer of Axion Power International (AXPW.OB) and holds a large long position in its stock. He also holds a small long position in Exide (XIDE).

John L. Petersen, Esq. is a U.S. lawyer based in Switzerland who works as a partner in the law firm of Fefer Petersen & Cie and represents North American, European and Asian clients, principally in the energy and alternative energy sectors. His international practice is limited to corporate securities and small company finance, where he focuses on guiding small growth-oriented companies through the corporate finance process, beginning with seed stage private placements, continuing through growth stage private financing and concluding with a reverse merger or public offering. Mr. Petersen is a 1979 graduate of the Notre Dame Law School and a 1976 graduate of Arizona State University. He was admitted to the Texas Bar Association in 1980 and licensed to practice as a CPA in 1981.

Posted by John Petersen at 08:02 AM | Permalink | Comments (19)

Charles Morand

In an upcoming article in the journal Resources Policy, David Humphreys, former Chief Economist at Rio Tinto and Norilsk Nickel, argues that skeptics are right to question the notion that mineral prices in the 2003 to 2008 period were rapidly uptrending as part of an emerging multi-decade supercycle.

He argues that the rise in demand underpinning steep mineral price increases had two distinct causes: (1) an "extended economic upswing" driven by an ample supply of cheap credit (we know now where that got us); and (2) a "deeper-rooted structural shift in the economy" resulting from the growing industrialization and urbanization of emerging markets, driven in large part by a labor cost advantage.

While Humphreys agrees that mineral resource prices may not continue to increase sharply - once the world emerges from recession - for the next 20 or 30 years as would be the case if we were engaged in a supercycle, he nonetheless disagrees that once supply catches up to demand things will go back to "normal".

Supply catching up to demand means prices reflecting the industry's marginal production costs, or the costs of extracting each incremental unit of resource. Although the increase in  mineral prices may not go on for decades, the author argues, there is nonetheless a high probability that the new "normal", when marginal production costs stabilize, will mean substantially higher prices than the old "normal", and that this will become the new reality.

The insight provided by Humphreys applies equally well to oil and gas. Unconventional  resources such as oil sands, shale gas and deep offshore drilling, while they will certainly help alleviate the supply-side impact on prices of declining production in conventional fields, will appreciably raise the industry's marginal production costs, thus contributing to higher long-term prices even if stabilization occurs in a matter of years rather than decades.

Either way - whether we are engaged in a supercycle or not - we can now be fairly certain that we are entering a world where some of the natural resources that were essential to our becoming industrialized and wealthy will no longer be cheap, save for the odd recessionary period.   

The impact on the prices of final goods will vary based on how labor-intensive they are; for many manufactured goods, cheap labor in emerging markets will continue to limit the price impact of more expensive commodities, whereas for goods where commodity costs account for the bulk of final price the impact will be much more direct.

One of the industries that will be most heavily impacted by this is the car industry because of high gasoline prices. Given all of the hurdles that currently stand in the way of electrification, there is a good chance that we reach, within the next few years, a point where drivers are hit really hard in the wallet by high gas prices but not quite hard enough to justify the much higher expense - both in terms of money and foregone conveniences like trunk space and unlimited range - of an EV or PHEV.

The most likely winner from this, in my view, will be mass transit. As I argued in an earlier article on Obama's high-speed rail plan, mass transit is to transportation what efficiency is to energy; although a renewable kWh is good, an avoided one is even better, and so it goes for EVs/PHEVs.

There are three stocks that I see as potentially major beneficiaries from a growth in mass transit - two rail stocks and one bus stock. The two rail stocks are Bombardier (BDRBF.PK) and Alstom (AOMFF.PK), which I profiled earlier this year. The bus stock is New Flyers Industries (NFYIF.PK), which Tom profiled last year. All three stocks will see material positive earnings impacts from growing expenditures on mass transit, unlike Siemens (SI) that, despite a strong position in rail, is highly diversified outside of transit and unlikely to see success in rail move the needle substantially on the earnings front.

As Tom pointed out in his article on New Flyers, it will take a lot for Americans to change their lifestyles and driving habits. However, all signs point to the fact that "a lot" is what we have coming our way - in fact, it will become the new reality and will have crippling economic impacts if we don't find a way to adjust. Moreover, Americans are no longer the only consumers that matter - North American cities are growing more slowly than Asian ones, our population will most likely begin to decline sometime in the next few years and wealth creation is increasingly shifting to Asia. Many emerging markets are already embracing mass transit and will have a much bigger stake than we do in trying to limit the impact of secularly high oil prices on their economic development.

DISCLOSURE: None                      

               

Posted by Charles Morand at 10:40 AM | Permalink | Comments (2)

John Petersen

A123 Systems filed another amendment to the registration statement for its proposed IPO on August 19th. With this amendment, A123 is much clearer on its anticipated Federal funding than it was in earlier filings. In addition to discussing the recent DOE announcement that they'll receive $249.1 million in ARRA battery manufacturing grants, they've reduced their estimate of the ATVM guaranteed loans that they'll be eligible for from $1 billion in their July filing to $235 million in the current filing. This most recent number is specific enough to indicate that it reflects ongoing negotiations rather than hopes and aspirations. I hope they get it.

When A123 originally filed their registration statement last summer, the planned offering amount was $175 million. Under the ARRA battery grant program they'll need to come up with $250 million in matching funds. Similarly, under the ATVM loan program they'll need to come up with roughly $60 million in matching funds. If one assumes that all of the matching funds requirements will need to be satisfied by the IPO, they'll need to raise $500 to $700 million in the IPO to meet their cash requirements.

If the IPO goes off for $500 million or more, it will be a watershed event on Wall Street and likely result in a frenzy of activity for other stocks in the energy storage sector. I'm excited because there are still a number of storage sector stocks that trade at objectively low valuations.

In early August I wrote an article titled "Alternative Energy Storage: Cheap Continues to Outperform Cool" which suggested that the companies in the Cheap Emerging and Cheap Sustainable classes still had significant upside potential. I continue to believe that these companies will be solid performers after a major storage sector IPO. I'm less sanguine about the ability of Ener1 (HEV) and Valence (VLNC) to maintain their current market capitalizations in the wake of a major IPO for a company that makes a competitive product and has far stronger business fundamentals.

September should be a very interesting month.

DISCLOSURE: None

John L. Petersen, Esq. is a U.S. lawyer based in Switzerland who works as a partner in the law firm of Fefer Petersen & Cie and represents North American, European and Asian clients, principally in the energy and alternative energy sectors. His international practice is limited to corporate securities and small company finance, where he focuses on guiding small growth-oriented companies through the corporate finance process, beginning with seed stage private placements, continuing through growth stage private financing and concluding with a reverse merger or public offering. Mr. Petersen is a 1979 graduate of the Notre Dame Law School and a 1976 graduate of Arizona State University. He was admitted to the Texas Bar Association in 1980 and licensed to practice as a CPA in 1981.

Posted by John Petersen at 04:47 AM | Permalink | Comments (0)

John Petersen

This week has been fascinating because of three articles that found their way to my computer. The first was a thematic piece in McKinsey Quarterly titled "Profiting from the low-carbon economy" that included a carbon abatement cost graph which showed full hybrid automobiles (HEVs) offered CO2 abatement savings of roughly $50 per ton while plug-in hybrid automobiles (PHEVs) imposed CO2 abatement costs of roughly $20 per ton, or slightly more than a nuclear power plant. The second was GM's widely publicized announcement that the Volt would get 230 miles per gallon. The third was a special report from CNNMoney.com titled "Volt vs. Prius: What's the better deal?"

After reading and thinking about these articles for a few days, I went to work on an Excel spreadsheet to analyze the differences between HEV and PHEV options and reduce them to a simple customer oriented financial analysis. The summary results I share in this article demonstrate once again that the glittering promise of PHEVs is nothing more than post-modern mythology that does not stand up to even basic economic analysis. For readers that take issue with my assumptions and want to test their own theories, a copy of my Excel spreadsheet is available here. The server copy is write protected but you can save it to your system using a different name and check my work at your leisure.

Gas Price Assumptions

Since 1999, the average annual increase in the price of crude oil has been roughly 17.5%. Based on the following graph that I've used in other articles, I believe oil prices will stabilize around $80 per barrel later this year and continue to move upward within the price channel until we hit the next inflection point.



The following table shows potential future gasoline prices over the next 10 years based on three scenarios: a 17.5% annual rate of increase like we've had for the last decade; a 25% annual rate of increase and a 32.5% annual rate of increase. Any way you look at it, the numbers are incredibly ugly. We cry and complain that gas prices peaked at $4.50 last year. Can you imagine the pain and economic dislocation arising from $12.50 gas prices 10 years out?

Calendar	17.5% Annual	25.0% Annual	32.5% Annual
Year	Gas Price Increase	Gas Price Increase	Gas Price Increase
2010	$2.94	$3.13	$3.31
2011	$3.45	$3.91	$4.39
2012	$4.06	$4.88	$5.82
2013	$4.77	$6.10	$7.71
2014	$5.60	$7.63	$10.21
2015	$6.58	$9.54	$13.53
2016	$7.73	$11.92	$17.92
2017	$9.08	$14.90	$23.75
2018	$10.67	$18.63	$31.47
2019	$12.54	$23.28	$41.70

Since the goal of this article is to debunk prevailing PHEV mythology, I'll assume that oil price increases over the next decade will mirror the 17.5% rate we experienced in the last decade.

Other Key Assumptions

In a recent Instablog titled "Lies, Damned Lies and MPG Claims for the Volt" I criticized GM for claiming 230 mpg for the Volt because any attempt to combine electric vehicle "EV" range with internal combustion engine "ICE" range is meaningless. I also speculated that the easiest way to get to a 230 mpg figure for the Volt was to assume a 46 mile daily commute, a 40 mile EV range, and 30 mpg fuel economy for ICE powered driving. While I found the numbers arbitrary for a public fuel efficiency announcement, they didn't strike me as inherently unreasonable. So I've decided to follow GM's lead and use the same basic assumptions for this article:

Daily driving distance	46 miles
Annual driving days	250 days
Annual vacation trips	1,000 miles
Total annual mileage	12,500 miles
Basic ICE fuel economy	30 mpg
Baseline electricity cost	$0.115 kWh
Inflation rate for electricity	4.0%
Discount Rate for      present value calculations	7.5%
Minimum car ownership period	5 years
Maximum car ownership period	10 years

My Baseline Scenario

As a baseline scenario I started with a $20,000 new car equipped with a standard ICE that would get 30 mpg and use 417 gallons of gasoline per year. A consumer who bought the car for cash, used 417 gallons of gas per year, and sold the car after five years for 35% of his initial purchase price would have an undiscounted total cost of ownership of $21,671 for the five year period. Stretching the ownership period out to 10 years and reducing the resale value to 10% of the purchase price results in an undiscounted total cost of ownership of $46,090. To keep things as simple as possible, I ignored maintenance and assumed all batteries would last for the entire service life.

The HEV Alternatives

I then used the same basic assumptions to calculate the total cost of ownership over five and ten year periods for:

• A $21,000 micro hybrid that would improve fuel economy by 8%;
• A $23,000 mild hybrid that would improve fuel economy by 20%;
• A $26,000 full hybrid that would improve fuel economy by 40%; and
• A $32,500 PHEV (after tax credits) that would offer 40 miles of EV range and 30 mpg fuel economy from its ICE.

The five and ten year total cost of ownership values are summarized in the following table.

	Purchase	5 Year	Resale	Undiscounted
	Price	Fuel Cost	Value	Cost of Ownership
Pure ICE	$20,000	$8,671	($7,000)	$21,671
Micro Hybrid	$21,000	$7,977	($7,350)	$21,627
Mild Hybrid	$23,000	$6,936	($8,050)	$21,886
Full Hybrid	$26,000	$5,202	($9,100)	$22,102
PHEV 40	$32,500	$2,598	($11,375)	$23,723
	Purchase	10 Year	Resale	Undiscounted
	Price	Fuel Cost	Value	Cost of Ownership
Pure ICE	$20,000	$28,090	($2,000)	$46,090
Micro Hybrid	$21,000	$25,843	($2,100)	$44,743
Mild Hybrid	$23,000	$22,472	($2,300)	$43,172
Full Hybrid	$26,000	$16,854	($2,600)	$40,254
PHEV 40	$32,500	$6,823	($3,250)	$36,073

This table is a very simplistic presentation that assumes a buyer will pay cash for his vehicle and doesn't worry about details like the time value of money. Nevertheless, it shows that a PHEV will represent a 9.5% up-charge for customers who buy with a 5 year ownership horizon and a maximum savings of 21.7% if they buy with a 10 year ownership horizon.

To take the level of sophistication up a notch, the following table calculates the discounted present values of the five and ten year total cost of ownership using an imputed interest rate of 7.5% per year. While it's easy to argue that a 7.5% discount rate is far too low for an individual's financial transactions, the table makes it clear that a PHEV will represent a 21.3% up-charge for customers who buy with a 5 year ownership horizon and a 3.4% savings for customers who buy with a 10 year ownership horizon.

	Purchase	5 Year	Resale	Net Present Value
	Price	Fuel Cost	Value	Cost of Ownership
Pure ICE	$20,000	$6,855	($4,876)	$21,979
Micro Hybrid	$21,000	$6,307	($5,120)	$22,187
Mild Hybrid	$23,000	$5,484	($5,607)	$22,877
Full Hybrid	$26,000	$4,113	($6,339)	$23,774
PHEV 40	$32,500	$2,076	($7,923)	$26,652
	Purchase	10 Year	Resale	Net Present Value
	Price	Fuel Cost	Value	Cost of Ownership
Pure ICE	$20,000	$17,550	($970)	$36,579
Micro Hybrid	$21,000	$16,146	($1,019)	$36,127
Mild Hybrid	$23,000	$14,040	($1,116)	$35,924
Full Hybrid	$26,000	$10,530	($1,262)	$35,268
PHEV 40	$32,500	$4,421	($1,577)	$35,344

Sensitivity Factors

The most critical sensitivity factor for the total cost of ownership calculations is expected future gasoline prices. In general, ultra-rapid escalation of gas prices makes PHEVs increasingly attractive on a net present value basis, but only at the cost of imposing a crushing burden on the global economy.

The second major sensitivity factor is the imputed interest rate used for the present value calculations. As the discount rate approaches credit card rates of 15%, PHEVs become less attractive.

The third major sensitivity factor is battery cost. The current Federal tax credit for electric drive vehicles is the rough equivalent of a $500 per kWh discount on the purchase price of the batteries. For PHEVs to become truly cost-competitve with micro, mild and full hybrid vehicles, the industry will need to shave another 50% off current heavily subsidized price levels. Unless the government decides that it wants to subsidize PHEV battery costs in perpetuity, battery prices will eventually have to fall from $1,000 per kWh to roughly $250 per kWh, which may indeed be possible given another decade of battery chemistry research and manufacturing technology development. Unless and until we see massive reductions in battery costs, however, PHEVs will be little more than vanity purchases for the green elite who can pay big premiums for status symbols.

We've all heard the mythology that PHEVs will save users buckets of money by using cheap electricity instead of expensive gasoline. The hard reality is that none of the HEV or PHEV options is a money saver for the consumer. To make matters worse, all of the planned PHEVs will be considerably less convenient and reliable than their less glamorous cousins. While I grew up with the family car and have a difficult time imagining life without one, it may be time for the industrialized world to consider a paradigm shift of the type proposed by Seeking Alpha contributor Bill James in his recent article "Personal Rapid Transit: Preempting the Need for Oil in Urban Transport."

The days of using any kind of energy to move 3,000 pounds of steel and 200 or 300 pounds of passengers at highway speed are over! We've just been avoiding that particular reality because it's unpleasant.

In a world where 6 billion people are working overtime to earn a small piece of the lifestyle 500 million of us take for granted, the idea that we can continue to waste any natural resources, including water, food, oil and battery materials, must be crushed. Personal rapid transit may not have all the comfort and convenience we've come to expect from a car, but it beats the heck out of forcing huge segments of America's working population to rely on electric bicycles and scooters.

John L. Petersen, Esq. is a U.S. lawyer based in Switzerland who works as a partner in the law firm of Fefer Petersen & Cie and represents North American, European and Asian clients, principally in the energy and alternative energy sectors. His international practice is limited to corporate securities and small company finance, where he focuses on guiding small growth-oriented companies through the corporate finance process, beginning with seed stage private placements, continuing through growth stage private financing and concluding with a reverse merger or public offering. Mr. Petersen is a 1979 graduate of the Notre Dame Law School and a 1976 graduate of Arizona State University. He was admitted to the Texas Bar Association in 1980 and licensed to practice as a CPA in 1981.

Posted by John Petersen at 02:27 PM | Permalink | Comments (9)

Jason Hamlin

The lithium market is buzzing as GM, Nissan and other car manufacturers get set to roll out a new series of electric cars that will greatly increase demand for the obscure silver-white alkai metal. GM has announced plans to construct a $43 million plant in Michigan to build lithium-ion batteries for its Chevrolet Volt electric-powered car, which captured headlines with its claim of 230 miles per gallon.

Adding to the lithium mania is Washington’s support in the form of $2 Billion in stimulus funding:

“New plug-in hybrids roll off our assembly lines, but they will run on batteries made in Korea. Well I do not accept a future where the jobs and industries of tomorrow take root beyond our borders –and I know you don’t either. It is time for America to lead again.”

- President Obama

For those with concerns that fuel efficiency alone is not enough to entice America’s automobile consumer, consider the company Tesla Motors. While their roadster is the first production automobile to use lithium-ion battery cells and travel more than 200 miles per charge, it is also capable of doing 0-60 in under 4 seconds. Not only will the Tesla Roadster leave most sports cars in its dust, the car recently set a distance record in April 2009 when it completed the 241-mile Rallye Monte Carlo d’Energies Alternatives with 36 miles left on the charge. While the Roadster’s price tag may be out of reach for the average consumer at just over $100,000, Tesla has taken more than 1,000 reservations for the car and expects to begin production of an all-electric and more affordable sedan starting in late 2011. While Tesla remains a private company whose stock you are unlikely to get your hands on, their success bodes well for the future of lithium battery-powered cars.

Lithium prices have nearly tripled over the past decade with 22% compound annual growth since 2000 for use in laptops, cell phones and other electronics. While this demand is expected to continue rising, the recent lithium mania has been ignited by the fact that electric cars require about 3,000 times the lithium needed for an average cell phone or 100 times the lithium used in a computer battery. This huge spike in demand should propel lithium prices much higher over the next few years. Investors are eager to get ahead of the curve and are scrambling to find the companies that stand to benefit most from this new demand.

While most investors turn to the world’s largest lithium producer, Sociedad Quimica y Minera de Chile (ADR) (NYSE:SQM), only a small percentage of their revenue is derived from lithium sales. SQM generates the bulk of their sales from iodine and specialty fertilizers for the agriculture sector.

My preferred way to profit from the coming lithium boom is through the company Western Lithium (CVE: WLC or PINK: WLCDF), which owns the largest known lithium deposit in North America. The near surface lithium clay deposit is located in Nevada, USA and was initially discovered by the US Geological Survey and Chevron USA in the 1970’s. Engineering work completed by Chevron, and later by the US Bureau of Mines in the 1980’s, is now being advanced by Western Lithium.

The company’s flagship Kings Valley property has a National Instrument 43-101 resource estimate for the initial stage of development and in total hosts a historically estimated 11 million tonnes of lithium carbonate equivalent (LCE). The project has a well developed local infrastructure and Nevada has a long history in the metals and industrial mineral mining industry. The company plans a scoping study during Q3 of 2009, a pre-feasibility study with results from additional drilling during 2010 and projected production by 2013. A chart with the world’s largest lithium deposits is below (click on the chart for an enlarged image).

Western Lithium is well-funded and debt free with CDN$7.3 million (US$6.7 million)) cash on the books. They recently completed a CDN$5.5 million (US$5.0 million) private placement in May of this year and have a market cap of CDN$70 million (US$63.8 milllion). As you can see below, the stock has broken out recently on heavy volume. While some might view the stock as overbought, I believe lithium mania is only getting started and that Western Lithium will outperform its peers both in the short and long term. Despite the recent spike in price, shares are selling at a premium of just 20% to their highs which were put in well before the recent flurry of bullish news. The last time the stock made a move like the current one, it continued to produce a gain in excess of 800%!

We might not know for sure “Who Killed the Electric Car?,” but it appears to be making an impressive resurrection.

DISCLOSURE: The author is long Western Lithium

Jason Hamlin owns the Gold Stock Bull. The Gold Stock Bull Portfolio is up 115% year-to-date in 2009 with a record of 29 profitable trades and 14 losing trades. Click here for more information or click here to get started right away.

Want to write a guest article for AltEnergyStocks.com? Write us! We're always looking for a fresh perspective on investing, alternative energy or both.    

Posted by Guest Contributor at 01:00 AM | Permalink | Comments (1)

Last week, an article in Green Car Congress summarized a market forecast that Dr. Menahem Anderman presented at this month's Advanced Automotive Battery Conference in Long Beach, California. In his presentation, Dr. Anderman evaluated the market for HEVs in 2011, projected a $1,230 million market for automotive NiMH batteries, and projected a $320 million market for automotive Li-ion batteries. The following graph comes from Green Car Congress, is based on data from Dr. Anderman's AABC presentation, and shows both unit sales and market value of the Li-ion batteries that will be used in HEVs by 2011 (click on the graph for a larger image).



It's sobering if not downright depressing when you get to the middle of the article and read about Dr. Anderman's analysis of the gasoline prices required for HEVs to make economic sense.

Based on a five-year net present value analysis, Dr. Anderman concluded that:

• Stop-start hybrids make economic sense in the $5 per gallon range;
• Mild and strong hybrids require a gasoline price of roughly $7 per gallon; and
  
• PHEVs and full EVs require a gasoline price of about $10 per gallon.

When he performed an eight-year present value analysis, Dr. Anderman concluded that:

• Stop-start hybrids make sense in the $3 per gallon range;
• Mild and strong hybrids make sense in the $5 per gallon range;
• PHEVs require a gasoline price of roughly $7 per gallon; and
  
• Full EVs still require a gasoline price of about $10 per gallon.

I know very few people that can perform a net present value analysis. I know even fewer who go looking for a new car with the idea that they're going to drive it for five to eight years. Given the dismal economics of mild and strong hybrids and the ghastly economics of cars with plugs, I believe the high-end market for the next several years will be limited to the image conscious affluent who are willing and able to pay big premiums to make a statement. While Dr. Anderman's forecast of 40,000 Li-ion powered HEVs in two years strikes me as a very ambitious target, I'm willing to set aside my reservations for purposes of this article and assume that manufacturers of automotive Li-ion batteries will be guaranteed revenues of $320 million in 2011.

While most would agree that $320 million of total revenue by 2011 sounds impressive, it loses a bit of luster when you consider that advanced lead-acid battery manufacturers can expect $900 million to $1.8 billion of incremental revenue by 2011 from the widespread implementation of stop-start technology as standard equipment.

I've used the following graph from an October 2008 Frost & Sullivan presentation in a couple of recent articles, but it bears repeating because the law of large numbers is the fundamental reason that short term revenue growth in the automotive battery market favors lead-acid by 6 to 1 over Li-ion. The long blue segments represent the stop-start market that will be dominated by advanced lead-acid batteries because they can do the required work, they cost 60% to 75% less than NiMH and Li-ion alternatives, and they are the only batteries that can be manufactured in sufficient numbers to serve the short-term needs of automakers. The red, green and violet segments represent the high priced "centerfold" alternatives favored by EV advocates, reporters, politicians and public relations managers who would rather sell a sweet dream than grapple with economic reality.



In How Short-Term Supply Constraints Will Impact Booming HEV Markets, I explained that Frost & Sullivan based their original forecast on European CO2 emission standards but did not account for President Obama's subsequent acceleration of domestic CAFE standards. That change alone will push growth that would normally have occurred between 2015 and 2020 into earlier years and could easily double the growth rates Frost & Sullivan expected last fall. So with that background in mind, let's run the numbers.

Currently automakers spend between $50 and $100 for the commodity lead-acid batteries they use for starting, lighting, ignition and accessories; call it an average of $60. Since stop-start hybrids put far more stress on the battery, the advanced lead-acid batteries needed for stop-start vehicles will probably cost the automakers $250 to $300 per vehicle; call it an average of $260. That means the battery cost increment for a stop-start vehicle will be in the $200 range.

A quick eyeball of the Frost & Sullivan graph shows forecasted sales of 4.5 million stop-start vehicles by 2011, which works out to about $900 million in incremental revenue for lead-acid battery manufacturers, or roughly three times Dr. Anderman's forecast for Li-ion. If accelerated CAFE standards double global demand for stop-start vehicles, the incremental revenue for lead-acid battery manufacturers will be closer to $1.8 billion, or roughly six times Dr. Anderman's forecast for Li-ion.

Li-ion battery developers Altair Nanotechnologies (ALTI), Ener1 (HEV) and Valence Technologies (VLNC) have a combined market capitalization of $935 million and will be vying with a host of established domestic, European and Asian competitors for a piece of $320 million in total revenue.

In comparison, lead-acid battery manufacturers Exide Technologies (XIDE), C&D Technologies (CHP) and Axion Power International (AXPW.OB) have a combined market capitalization of $340 million and will be vying with their traditional competitors for a share of $1.8 billion of incremental revenue.

Benjamin Graham said, "In the short term, the stock market behaves like a voting machine, but in the long term it acts like a weighing machine." The voting is based on hopes, dreams and expectations. The weighing is based on revenue growth, earnings and other business fundamentals. Any time I can identify one industry sub-sector that trades at one-third of the market value of its more glamorous cousin but is likely to enjoy three to six times the short-term revenue gains, I have to believe the undervalued sector will reward investors handsomely as the weighing machine returns to balance.

DISCLOSURE: Author is a former director and executive officer of Axion Power International (AXPW.OB) and holds a large long position in its stock. He also holds a small long position in Exide (XIDE).

John L. Petersen, Esq. is a U.S. lawyer based in Switzerland who works as a partner in the law firm of Fefer Petersen & Cie and represents North American, European and Asian clients, principally in the energy and alternative energy sectors. His international practice is limited to corporate securities and small company finance, where he focuses on guiding small growth-oriented companies through the corporate finance process, beginning with seed stage private placements, continuing through growth stage private financing and concluding with a reverse merger or public offering. Mr. Petersen is a 1979 graduate of the Notre Dame Law School and a 1976 graduate of Arizona State University. He was admitted to the Texas Bar Association in 1980 and licensed to practice as a CPA in 1981. From January 2004 through January 2007 he was a director of Axion Power International, Inc. a public company involved in advanced lead-carbon battery research and development.

Posted by John Petersen at 02:32 PM | Permalink | Comments (1)

John Petersen

For several weeks I've been writing about robust demand in Europe for a new class of HEVs that are usually referred to as "stop-start" or "micro hybrids." According to the EPA's website:

"Stop/Start hybrids are not true hybrids since electricity from the battery is not used to propel the vehicle. However, the Stop/Start feature is an important, energy-saving building block used in hybrid vehicles.

Stop/Start technology conserves energy by shutting off the gasoline engine when the vehicle is at rest, such as at a traffic light, and automatically re-starting it when the driver pushes the gas pedal to go forward."

The concept is simple and so is the technology. Adding micro hybrid capabilities at the factory typically costs less than $1,000 per vehicle and improves fuel efficiency by an estimated 5% to 8%. It's a baby step, but as my first table in The Obama Fast Track for HEVs shows, it's more cost-effective than any other class of HEV technology. The main reason micro hybrids are so affordable is that they use advanced lead-acid batteries instead of more expensive alternatives.

Since the booming European micro hybrid phenomenon has not reached the U.S., a couple skeptical readers challenged me to show them press releases from major European OEMs announcing plans to produce HEVs that didn't use NiMH or Li-ion batteries. They were not satisfied with my initial response that micro hybrids are being adopted as standard equipment without major fanfare. Yesterday I found an October 2008 "Power Solutions Backgrounder" from Johnson Controls, Inc. (JCI) that proves the point nicely:

"We sold 400,000 advanced batteries for start/stop micro hybrid vehicles in Europe in 2007 and 800,000 in 2008, with the expectation of doubling that number again in 2009 to approximately 1.5 million batteries. These vehicles achieve a 5 percent to 8 percent fuel savings compared to conventional gas vehicles."

I then found www.hybridcars.com, a rich source of data that describes itself as the Internet’s premier website dedicated to hybrid gas-electric vehicles. By combining the micro hybrid battery sales data from JCI with additional data from hybridcars.com, I was able to cobble together the following graph that shows the growth of the global HEV market over the last 10 years. Since I don't have access to comprehensive data on the European micro hybrid market, I assumed that JCI was the only competitor. As a result, the graph understates European micro hybrid sales by a couple of percentage points, but in this case shape is far more important than numerical precision.



With historical data to provide context, the following graph from a 2008 Frost & Sullivan presentation that summarizes their forecast of future growth in global HEV sales makes a good deal more sense than it may have in earlier articles.



As I explained in How Growing HEV Markets Will Impact Battery Manufacturing Revenues, the Frost & Sullivan forecast was based solely on European CO2 tailpipe emission standards that take effect in 2012 and did not account for President Obama's subsequent acceleration of CAFE standards. That recent change will have the effect of pushing growth that would normally have occurred in the 2015 to 2020 timeframe into earlier years and could easily double the growth rates that were expected last fall. While I'm happy to leave the work of updating growth forecasts to experts like Frost & Sullivan, it seems safe to conclude that the next few years will be a challenging time for the battery industry.

Under the growth scenario presented in the Frost & Sullivan graph, the bulk of the unit growth in the HEV markets will go to lead-acid battery manufacturers who will not need to make larger numbers of batteries, but will need to make higher quality batteries that are better suited to the performance requirements of micro hybrids. This changing product mix will reduce production volumes for low-margin valve regulated lead-acid batteries and increase production volumes for high-margin advanced lead-acid batteries, and should lead to rapid and sustained revenue and profit growth for all lead-acid battery producers.

As we move away from the micro hybrid market and focus on the higher value markets for mild, full and plug-in hybrids, the challenges become more daunting. Jack Lifton has written several articles on global production constraints for the rare earth metal lanthanum; the "M" in NiMH batteries. His basic concerns are that substantially all of the world's supply of rare earth metals comes from China; their current production of roughly 33,000 tons of lanthanum per year can only provide raw materials for about a million HEV battery packs; and their domestic demand for rare earth metals is growing at an extraordinary rate that will limit future exports. Since it usually takes several years to increase production from an existing mine and even longer to bring a new mine into production, Jack expects the battery industry to encounter substantial short- to medium-term bottlenecks in the lanthanum supply chain. If he's right, automakers will be forced to make a Hobson's choice for an increasing percentage of their HEV battery needs:

• Use Li-ion batteries despite the performance, cost, abuse tolerance and cycle life concerns; or
• Use advanced lead-acid batteries despite the weight and volume concerns.

On its face this seems to be good news for Li-ion battery developers like Ener1 (HEV), Valence Technology (VLNC) and Altair Nanotechnologies (ALTI) who consistently argue that their proposed products are best choice to fill the gap between surging HEV demand and constrained NiMH battery supply. While many find those arguments persuasive if not compelling, I remain skeptical for several reasons.

First, Li-ion batteries have a checkered history in portable electronics that are used indoors. We know almost nothing about their long-term performance when exposed to the heat, cold, moisture, vibration, driving habits, user neglect and physical stress that automobiles have to endure on a daily basis. The only way to develop that knowledge base will be to get Li-ion batteries out of the laboratory and into test fleets. While many automakers have announced plans to begin limited production of HEVs and PHEVs that use Li-ion traction batteries over the next two years, I can't help but wonder whether the Li-ion battery sector isn't in exactly the same position that the NiMH battery sector was in 10 years ago. My next graph comes from the May 2009 Dashboard at hybridcars.com and shows the 10-year U.S. sales history for HEVs with NiMH batteries. Call me a luddite, but I have a hard time accepting the idea that HEVs with Li-ion batteries will follow a development path that goes from zero vehicles per year to hundreds of thousands of vehicles per year over the course of four or five years. From all of the projections I've seen, the DOE and all major automakers share those reservations.



Second, the world's productive capacity for the large-format Li-ion batteries that are needed for automotive applications is very limited. There have been numerous announcements about plans to build new factories, but the bulk of those planned facilities will not be operational until 2011 or 2012. Since most existing Li-ion battery plants are already running at full capacity to make batteries for the high value portable electronics markets, I don't believe Li-ion batteries will be able to make a meaningful contribution to the auto industry's drive to meet European CO2 emission standards by 2012.

Third, I remain concerned that global rates of lithium production will not be able to keep pace with rapidly increasing demand for batteries. According to USGS publications, approximately 25% of global lithium production is used for Li-ion batteries. While global lithium production has grown at an annual rate of roughly 6% over the last couple of years to a 2008 total of 27,400 tons, the production process for lithium from brines involves an 18-month evaporation cycle before the alkali salts contained in the brine are ready for separation, refining, processing and use. Moreover lithium mining is subject to the same expansion constraints as other extractive industries. I'm no longer worried about the long-term adequacy of global lithium resources and I know that production can be expanded over time, but production capacity cannot be expanded quickly and there are certain to be substantial short- to medium-term production bottlenecks.

Finally, I remain concerned about the current development status of large-format Li-ion batteries for automotive use. In a February article titled DOE Reports That Lithium-on Batteries Are Not Ready for Prime Time, I summarized the conclusions of the DOE's 2008 Annual Progress Report for the Energy Storage Research and Development Vehicle Technologies Program that basically said Li-ion batteries would not be suitable for use in mass market HEV and PHEV applications until technical barriers relating to cost, performance, abuse tolerance and cycle life were overcome. I expanded on that theme in Understanding the Development Path for Li-ion Battery Technologies after a reader sent me sent me an unpublished "pre-decisional draft" of a DOE report titled National Battery Collaborative (NBC) Roadmap, December 9, 2008, a high-level policy analysis that discusses the merits, risks and expected costs of an aggressive eight-year initiative to foster the development and facilitate the commercialization of Li-ion batteries. While the draft roadmap went a long way toward easing my concerns over the long-term future of large format Li-ion batteries, it merely reinforced my conviction that Li-ion batteries are not currently ready for the big show.

Automakers are a conservative lot and they are intensely sensitive to price, performance and supply chain issues. They understand that NiMH and Li-ion battery supplies are constrained by limited global production of lanthanum and lithium, and that large format Li-ion battery supplies will be further constrained for several years by inadequate manufacturing capacity. They also have substantial reservations about the long-term performance of Li-ion batteries under the extreme heat, cold, humidity and vibration conditions that automobiles have to endure on a daily basis. Notwithstanding these known and very real business constraints, the automakers are under strict regulatory edicts to reduce fleet average CO2 emissions to 130 grams per kilometer in Europe by 2012 and improve fuel economy by roughly 35% in the U.S. by 2016. These are very brief timeframes for changes of this magnitude.

The end result is an untenable situation where proven NiMH batteries won't be available in adequate volumes during the regulatory compliance period and even unproven Li-ion batteries will be subject to daunting supply constraints. In a nutshell, supply constraints will leave the booming HEV markets in a critical state of flux for several years. While nothing can be predicted with certainty, I believe the likely responses from automakers will fit in three distinct categories:

1. Automakers will continue to use proven NiMH batteries as their preferred HEV technology until limited lanthanum supplies restrict the ability to manufacture NiMH batteries;
2. Automakers will accelerate their efforts to build demonstration fleets of high value products using unproven Li-ion batteries, but production volumes will remain small until they gather enough hard performance data to justify the widespread commercialization of the technology; and
3. Automakers will significantly increase their use of advanced lead-acid batteries in high volume budget priced product lines, including mild and full hybrids that can tolerate the seventy-five pound weight gain and one cubic foot space loss that will typically arise from using advanced lead-acid batteries instead of NiMH or Li-ion.

This is a sub-optimal environment for all parties because automakers do not have the flexibility to develop new product lines on a multi-year schedule. They have to go to work immediately with the tools at their disposal and bring their product lines into regulatory compliance in a little over five years. The end result will be an accelerated timeline for Li-ion batteries and increased use of advanced lead-acid batteries in product lines that might have been introduced with NiMH batteries under more normal conditions. As automakers develop experience with using both advanced lead-acid and Li-ion batteries in roughly equivalent applications, the unanswered technical and cost-benefit questions about which technology is best for automotive applications will be conclusively answered. In other words, we're going to have a horse race after all.

DISCLOSURE: Author does not own any of the stocks mentioned in this article because all of his personal investments are in pure-play lead-acid battery manufacturers.

John L. Petersen, Esq. is a U.S. lawyer based in Switzerland who works as a partner in the law firm of Fefer Petersen & Cie and represents North American, European and Asian clients, principally in the energy and alternative energy sectors. His international practice is limited to corporate securities and small company finance, where he focuses on guiding small growth-oriented companies through the corporate finance process, beginning with seed stage private placements, continuing through growth stage private financing and concluding with a reverse merger or public offering. Mr. Petersen is a 1979 graduate of the Notre Dame Law School and a 1976 graduate of Arizona State University. He was admitted to the Texas Bar Association in 1980 and licensed to practice as a CPA in 1981. From January 2004 through January 2008, he was securities counsel for and a director of Axion Power International, Inc. (AXPW.OB) a small public company involved in advanced lead-carbon battery research and development.

Posted by Tom Konrad at 07:01 PM | Permalink | Comments (2) | TrackBacks (0)

John Petersen

For the last three weeks I've been writing about why rising oil prices, tightened CO2 emission standards in Europe and accelerated CAFE standards in the U.S. will combine to foster rapid implementation of hybrid electric vehicle (HEV) technology in the automotive industry and result in huge revenue increases for all automotive battery manufacturers. These articles have generated record numbers of comments and questions from readers that want a clearer understanding of what the rapidly changing demand picture means for battery investors. While I generally try to avoid revenue forecasts because they require pricing assumptions that can be fertile ground for nit picking, I'll ask readers to bear with me because the conclusion does not depend on the initial assumptions. The bulk of the hard market data I've used in this article was graciously provided by Frost & Sullivan, a leading global consultancy and market research firm that provides best in class coverage of the energy and power systems markets.

So far, the one bright spot in the global recession has been savings at the gas pump. For every $1 decline in prevailing gas prices, nationwide spending on gasoline falls by $12 billion per month and those savings go directly to consumers. Unfortunately, the relief was short-lived and gas prices are once again rising. The following graph is based on historical oil price data downloaded from the DOE's Energy Information Administration. To give readers an idea of why I'm convinced that oil prices will stabilize around $80 over the next few months and be a primary market driver for the shift to HEVs, I've added a simple price channel overlay on the ten-year trend.




In The Obama Fast Track for HEVs, I explained that there are four basic types of HEVs:

• Micro-Hybrids stop the internal combustion engine ("ICE") when the car comes to a stop and restart the ICE on demand, but do not provide any acceleration boost to the powertrain;
• Mild Hybrids stop the ICE when the car comes to a stop, restart the ICE on demand and provide limited boost to the powertrain during acceleration;
• Full Hybrids stop the ICE when the car comes to a stop, launch the car from a stop in electric-only mode, restart the ICE when needed and provide a higher level of boost to the powertrain during acceleration; and
• Plug-in Hybrids will allow the car to operate in electric-only mode for up to 40 miles before starting an ICE to recharge the batteries.

I then explained how President Obama's decision to accelerate the effective date of Federal CAFE standards will require manufacturers to increase fuel efficiency by roughly 35% over the next seven years and eliminate fleet-wide averaging, thereby forcing each class of vehicles to carry its own weight. My conclusion was that while the accelerated CAFE rules were not an HEV mandate, they put HEVs on a regulatory fast track in the U.S.

In a follow-up article, Why Advanced Lead-Acid Batteries Will Dominate the HEV Markets, I drilled deeper into the economics of using various types of batteries in HEVs and explained how recent changes in European tailpipe CO2 emission standards would accelerate efforts to make micro-hybrid technology standard equipment. That article included the following graph from an October 2008 Frost & Sullivan presentation that explained their estimates of near-term growth in global HEV demand and showed how that growth would be divided up among micro, mild, full and plug-in hybrids.



Since the October 2008 Frost & Sullivan presentation focused on the impact of European CO2 emission standards and assumed that revised CAFE standards would not take effect until 2020, I believe global HEV demand during the forecast period will ramp up far faster than the growth rate reflected in the baseline estimates. For analytical purposes, Table 1 starts from an estimated base of 2 million units in 2009 and then increases production to 5 million units in 2010, 11 million units in 2012 and 20 million units in 2015. In order to put NiMH and Li-ion batteries in the best possible light, Table 1 uses the 2015 Frost & Sullivan market penetration percentages for all years.

Table 1	Market	2010 Increment	2012 Increment	2015 Increment
	Penetration	3 Million Units	9 Million Units	18 Million Units
Micro Hybrid	78%	2,340,000	7,020,000	14,040,000
Mild Hybrid	6%	180,000	540,000	1,080,000
Full Hybrid	15%	450,000	1,350,000	2,700,000
Plug-in Hybrid	1%	30,000	90,000	180,000
Total HEV Demand	100%	3,000,000	9,000,000	18,000,000

All currently available HEVs use beefed-up lead-acid batteries for their start-stop functions and NiMH batteries for their powertrain functions. Table 2 summarizes the incremental battery cost for each HEV type assuming a $150 premium for a more robust start-stop battery system and $800 per kWh for powertrain batteries, a value taken from the most recent DOE cost estimate for heavy-duty NiMH batteries.

Table 2	Start-Stop	Powertrain	Powertrain	Total
	Batteries	Battery Capacity	Battery Cost	Batteries
Micro Hybrid	$150		-0-	$150
Mild Hybrid	$150	0.75 kWh	$600	$750
Full Hybrid	$150	1.50 kWh	$1,200	$1,350
Plug-in Hybrid	-0-	1.00 kWh	$8,000	$8,000

Table 3 summarizes the additional expected demand for lead-acid batteries for new HEVs assuming they will only be used for start-stop applications.

Table 3	2010 Revenue	2012 Revenue	2015 Revenue
	Increment	Increment	Increment
	(millions)	(millions)	(millions)
Micro Hybrid	$351	$1,053	$2,106
Mild Hybrid	27	81	162
Full Hybrid	_68	203	405
Totals	$446	$1,337	$2,673

Table 4 summarizes the additional expected demand for NiMH and Li-ion batteries for new HEVs assuming they will be used for all powertrain applications.

Table 4	2010 Revenue	2012 Revenue	2015 Revenue
	Increment	Increment	Increment
	(millions)	(millions)	(millions)
Mild Hybrid	$108	$   324	$   648
Full Hybrid	540	1,620	3,240
Plug-in Hybrid	240	720	1,440
Totals	$888	$2,664	$5,328

While Tables 3 and 4 paint an optimistic demand scenario for all battery manufacturers, the unvarnished truth is that the incremental near-term demand for NiMH and Li-ion powertrain batteries cannot possibly be satisfied.

Battery manufacturing is capital intensive and it takes 3 to 4 years to build and equip a new NiMH or Li-ion battery plant. According to Frost & Sullivan, global sales of NiMH batteries for automotive powertrain applications were roughly $833 million in 2008. Of that total, $580 million (70%) represented batteries that Panasonic EV Energy, a Toyota subsidiary, made for its parent. Frost & Sullivan has also reported that total global sales of Li-ion batteries were roughly $7 billion in 2008 and substantially all of those batteries were used in non-automotive products. Notwithstanding the flurry of recent press releases about planned battery plant construction in Asia, Europe and North America, those projects cannot be completed before 2011 or 2012 and meeting the incremental automotive powertrain battery production schedule in Table 4 would require manufacturers to build new factories that are equivalent to the world's entire NiMH battery manufacturing capacity every year for the next six years.

Battery manufacturing is also raw material intensive and according to metal mining and natural resource development expert Jack Lifton there are critical production constraints on both the lanthanum that is essential for NiMH batteries and the lithium that is essential for Li-ion batteries. While supplies of both of these metals can be increased over time if enough development capital is available to mine owners, the average lead-time to expand an existing mine or bring a new mine into production is on the order of 5 to 7 years. So even if the battery manufacturing plants could be built fast enough to satisfy the anticipated near-term incremental demand for HEV batteries, the miners can't increase lanthanum and lithium production fast enough.

Automobile manufacturing is a tough business and many product development decisions are driven by legal requirements, supply chain needs and cost considerations that often transcend engineering preferences. The undeniable facts that the auto industry is being forced to come to grips with today are:

• Strict C02 tailpipe emission standards have already been adopted in Europe and must be met by 2012;
• Accelerated CAFE standards have already been adopted in the US and must be met by 2016;
• NiMH battery production cannot increase fast enough to satisfy near-term increases in HEV demand;
• While validation tests are planned, Li-ion batteries cannot currently meet market standards for HEVs;
  
• Li-ion battery production cannot increase fast enough to satisfy near-term increases in HEV demand;
• Lanthanum production cannot increase fast enough to satisfy near-term increases in HEV demand;
• Lithium production cannot increase fast enough to satisfy near-term increases in HEV demand; and
  
• Since it will be impossible to manufacture enough NiMH or Li-ion batteries to meet the regulatory deadlines, the only alternative is less expensive and more readily available lead-based batteries.

Given the crushing manufacturing capacity and material supply constraints that face both NiMH and Li-ion batteries, I believe it is virtually certain that lead-acid and lead-carbon batteries will be used as substitutes for the NiMH and Li-ion batteries that cannot be manufactured at any price. Under the circumstances, I cannot imagine a near-term future where the incremental revenue to lead-acid and lead-carbon battery manufacturers will be less than the incremental revenue to NiMH and Li-ion battery manufacturers.

I don't foresee a time in the near-term future when lead-acid batteries will supplant NiMH and Li-ion batteries in the hearts of scientists and engineers. I also believe that NiMH and Li-ion batteries are likely to retain their current status as the preferred solution for plug-in hybrids. Nevertheless, in a supply constrained environment like the one we will have to deal with for the next 5 to 7 years, automakers will make the difficult choices, use expensive NiMH and Li-ion batteries for their high value products and use cheaper lead-acid and lead-carbon batteries for their budget priced products.

As I discussed in Why Lead-Acid Batteries Will Dominate the HEV Market, the weight advantage of NiMH and Li-ion batteries in micro, mild and full hybrids is less than 75 pounds and the space savings is less than a cubic foot. While automakers pay a lot of attention to weight and space, these savings are insignificant in the context of a 3,000-pound car.

Overcoming an entrenched competitor like NiMH batteries is difficult and without looming supply constraints it would be difficult if not impossible for lead-based batteries to make inroads into the mild and full HEV markets. For the next few years, however, automakers will be forced to use lead-based batteries because there are no alternatives. My fondest hope is that after the industry has accumulated several years of experience with using lead-based batteries in budget priced HEVs, they'll conclude that the added cost of NiMH or Li-ion batteries is not justified. But even if they conclude otherwise, the benefit of using lead-based batteries as a bridge while Li-ion batteries complete the development process I described in Understanding the Development Path for Li-ion Battery Technologies is substantial.

In his book The Lost Constitution William Martin wrote, "In America we wake up in the morning, we go to work and we solve our problems." We use the tools that are readily available to us and we remain willing to adopt newer and better tools when they become readily available at reasonable prices. Sometimes, however, we give the new tools a try and then decide that the old tools are better for the job at hand. That's the way free markets work.

For most Americans and Europeans the word "shortage" has little personal meaning because we've always been able to buy the goods and services we wanted as long as we were willing to pay the price. For the first time, American and European car buyers will have to accept the fact that some HEV battery options are not going to be available at any price. It will come as a shock to many, but it will also be an increasingly common reality in a resource constrained world where 6 billion people want to earn their share of the lifestyle that 500 million of us have and take for granted.

Welcome to the age of cleantech, the sixth industrial revolution.

Fund managers are beginning to recognize the telltale signs of bubble pricing in the Li-ion battery stocks that I've been writing about for almost a year. Moreover, skeptical reports on the near-term potential of Li-ion battery developers are beginning to find their way into the mainstream financial press. The market has not yet come to grips with the inescapable conclusion that the lion's share of the revenue gains from the HEV revolution will flow to companies like Johnson Controls (JCI), Enersys (ENS), Exide (XIDE) and C&D Technologies (CHP) that have substantial existing manufacturing capacity in both Europe and the U.S., and from technology driven newcomers like Axion Power International (AXPW.OB) that can rapidly and inexpensively expand their production capacity to satisfy soaring demand from the HEV market. The window of opportunity is closing rapidly.

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

John L. Petersen, Esq. is a U.S. lawyer based in Switzerland who works as a partner in the law firm of Fefer Petersen & Cie and represents North American, European and Asian clients, principally in the energy and alternative energy sectors. His international practice is limited to corporate securities and small company finance, where he focuses on guiding small growth-oriented companies through the corporate finance process, beginning with seed stage private placements, continuing through growth stage private financing and concluding with a reverse merger or public offering. Mr. Petersen is a 1979 graduate of the Notre Dame Law School and a 1976 graduate of Arizona State University. He was admitted to the Texas Bar Association in 1980 and licensed to practice as a CPA in 1981. From January 2004 through January 2008, he was securities counsel for and a director of Axion Power International, Inc. a small public company involved in advanced lead-carbon battery research and development.

Posted by John Petersen at 02:29 PM | Permalink | Comments (0) | TrackBacks (0)

Stocks may be expensive now, but they won't be forever.  Five Peak Oil plays to buy when they're cheap again: Two busses, two rails, and an ETF.

Tom Konrad, Ph.D., CFA

Two weeks ago, I told you why I feel that the market is more likely to head down than up from here (it's been flat since then.)  I've been selling covered calls on my holdings, several of which have been called away.  I plan to sit on the cash until the market has fallen at least 10%, after which I may start selling cash covered puts, but I won't start buying in earnest until the level of fear in the markets is much higher than it is today.

To occupy myself during the wait, I'm putting together my shopping list of stocks I plan to buy when next they are cheap.  This first installment is a set of clean transport stocks, which are combination plays on Peak Oil and Climate Change.  You will be able to find future articles in this series here.

#1 New Flyer Industries (NFYIF.PK, NFI-UN.TO)

New Flyer is a long-time favorite, and I probably won't be buying more even if it falls: I doubled my holdings in this company in the beak days of December 2008, at US$5.09-$5.29.  This is one stock I have not been selling in the recent run-up, despite the fact that it has doubled since then.  So I probably won't be buying more even if it falls just to keep my portfolio relatively diverse.

#2 Portec Rail Products (PRPX)

I brought Protec to your attention on February 26, when the price was trading around $5, for what I felt was no good reason.  Although I already owned some, I put in an order that day to buy more at $4.85, but the stock has never been back there since, and now trades around $10.  If it falls back to $6, I may not be so greedy this time.  Until then, I'm still holding my initial position.

#3 FirstGroup, PLC. (FGP.L)

I first ran across FirstGroup in late 2007 when looking for bus stocks for my investing in mode-shifting theme.  As I mentioned in early 2008, the stock seemed overvalued to me at the time, and I focused my attention instead on New Flyer.  Like Portec, I now wish I'd snapped up a bunch of it near the March lows, but it had dropped off my radar until The Economist brought it back to my attention with a fascinating profile of the CEO, Sir Moir Lockheed, in early April.  By that point, the stock had rebounded sharply, and I'm left waiting for the next buying opportunity.

#4 Wabtec Corporation (WAB)

Also known as Westinghouse Air Brake Technologies Corp, Wabtec was also profiled in my article on rail transit stocks in 2007 (as was Portec.)  Like FirstGroup, it fell off my radar because I didn't like the valuation at the time.  Today, the price is about the same as it was back then, but income has increased, especially in the first quarter of 2009, and we now have much more political support for rail transit spending.  As a profitable company with a strong balance sheet, this is one to scoop up when opportunity presents.

#5 Powershares Global Progressive Transport ETF (PTRP)

Okay, this one's not really on my shopping list, but I many readers might consider it.  I like picking stocks, and generally believe that the diversification benefits of specialty ETFs don't usually justify the expense ratios (PTRP's is 0.75%).  The exception is when the ETF gives access to foreign stocks which the investor might find hard to buy individually.  PTRP does have significant investments in several foreign companies, so it might be worth considering.  Some names in the portfolio the North American investor might find hard to buy are China's BYD group, bike makers Giant and Shimano, and Charles' high speed rail picks, Bombardier (BDRBF.PK), Alstom (AOMFF.PK), not to mention FirstGroup, above.

DISCLOSURE: Tom Konrad and/or his clients own NFYIF and PRPX.

DISCLAIMER: The information and trades provided here and in the comments are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

Posted by Tom Konrad at 12:07 PM | Permalink | Comments (0) | TrackBacks (0)

John Petersen

Today I'm going to begin with an apology because I've done a terrible job of describing the basics of hybrid electric vehicle (HEV) technology for energy storage investors. Many of my earlier articles dove straight into the mind-numbing details of battery technology without first providing an overview of what those batteries will be used for. In other words I'm guilty of putting the cart before the horse. It's time for me to make amends.

While the differences between HEV technologies have always been important to automobile manufacturers, the public's understanding of those differences is limited. That dynamic is about to change because of President Obama's decision to accelerate the effective date of Federal fuel economy standards that were first adopted during the Bush administration. These accelerated standards will require manufacturers to increase fuel efficiency by approximately 40% over the next seven years. They will also eliminate fleet-wide averaging and force each class of vehicles to carry a fair share of the fuel economy burden. I don't want to oversimplify a very complex topic, but I believe the most cost-effective way to meet the new goals will be the widespread adoption of HEV technology across all classes of cars and light trucks. The new rules are not an HEV mandate, but they have put HEV technologies on a regulatory fast track that will rapidly drive revenue growth across the entire spectrum of battery manufacturers.

There are four primary classes of HEVs including the micro, mild and full hybrids that are available today and the plug-in hybrids (PHEVs) that are scheduled for next year. The following sections provide a simple overview of what the various classes of HEV technology do and what they're expected to cost. More detailed information is available from the Green Car Congress, the National Alternative Fuels Training Consortium and the Electric Drive Transport Association.

Micro Hybrids do not use an electric motor to propel the vehicle. Instead, they rely on hybrid technology to:

• Use a small portion of the energy that is normally lost in braking to recharge their batteries;
• Stop and start the internal combustion engine (ICE) when the vehicle stops and starts; and
• Power accessories like heat and air conditioning while the ICE is off.

The current cost of micro hybrid technology is roughly $500, plus batteries. The main benefit of micro hybrid technology is fuel savings of up to 10% that arise from turning the ICE off when the vehicle isn't moving.

Mild Hybrids use an electric motor that is integrated into the ICE to boost power during acceleration. They also rely on hybrid technology to:

• Use a larger portion of the energy that is normally lost in braking to recharge their batteries;
  
• Stop and start the ICE when the vehicle stops and starts; and
• Power accessories like heat and air conditioning while the ICE is off.

The current cost of mild hybrid technology is roughly $1,500, plus batteries. The main benefit of mild hybrid technology is fuel savings of up to 20% that arise from using a smaller ICE and turning it off when the vehicle isn't moving.

Full Hybrids use an electric motor that's separate from the ICE and powerful enough to move the vehicle on its own. Full hybrids typically launch from a stop in electric mode, start the ICE when needed and then use both the electric and ICE systems for acceleration. They also rely on hybrid technology to:

• Use most of the energy that is normally lost in braking to recharge their batteries;
  
• Stop and start the ICE when the car stops and starts; and
• Power accessories like heat and air conditioning while the ICE is off.

The current cost of full hybrid technology is roughly $2,000, plus batteries. The main benefit of full hybrid technology is fuel savings of up to 40% that arise from using battery power in stop and go traffic, using a smaller ICE and turning it off when the vehicle isn't moving.

Plug-in Hybrids fall into one of two sub-classes. A parallel hybrid is essentially a full hybrid with a larger battery pack that increases the EV range and decreases reliance on the ICE. A series hybrid is essentially an electric vehicle that runs on battery power for the first 10 to 40 miles and then uses a small ICE to generate electricity for the powertrain. Both sub-classes rely on hybrid technology to use most of the energy that is normally lost in braking to recharge their batteries.

The estimated cost of plug-in hybrid technology is roughly $2,500, plus batteries. While fuel economy estimates vary widely depending on assumed driving patterns, most commonly quoted estimates fall in the 60% range.

Cost-Benefit Table The following table summarizes the relative costs and benefits of micro, mild, full and plug-in hybrid technologies using lead-acid batteries for lighting, accessory and related systems, and using NiMH or Li-ion batteries for the electric powertrain. The price of $1,000 per kWh for electric powertrain batteries represents a rough average of the current cost of NiMH and Li-ion batteries published in a July 2008 Sandia National Laboratories report on its Solar Energy Grid Integration Systems – Energy Storage program.

	Lead-acid	Advanced	Mechanical	Incremental	Fuel
	Batteries	Batteries	Components	Cost	Savings
Micro Hybrid	$200		$500	$700	10%
Mild Hybrid (1 kWh powertrain battery)	$100	$1,000	$1,500	$2,600	20%
Full Hybrid (2 kWh powertrain battery)	$100	$2,000	$2,000	$4,100	40%
Plug-in Hybrid (10 kWh powertrain battery)		$10,000	$2,500	$12,500	60%

Cost-Benefit Graph To help remind readers what matters to buyers, I've put together a simple graph that superimposes the purchase price data from the Cost-Benefit Table over a normal bell shaped curve. In this particular graph there is no direct correlation between the background curve and the price points in the foreground. The curve does, however, help put the cost differences and fuel savings into the context of normal forces in a free market.




In combination, the table and the graph clearly show why I believe the vast majority of buyers will choose micro, mild and full hybrid alternatives over their more expensive plug-in cousins. It's a simple matter of economics. Cars with plugs simply do not work for anyone other than the emotionally committed or the mathematically challenged.

The following graph comes from the DOE’s 2009 Annual Energy Outlook and forecasts that sales of full and mild hybrids will grow from 346,000 units in 2007 to 4.8 million units in 2030. Over the same time frame, sales of micro hybrids will grow from 13,000 units to 3.2 million units. Collectively HEVs will account for roughly 63% of unconventional vehicle sales and approximately 40% of all light car and truck sales by 2030.



The companion graph forecasts that less than 7% of the HEVs sold in 2030 will be plug-ins. The other 93% of sales come from full, mild and micro hybrids. Overall, the forecast corresponds well with the distribution I would ordinarily expect under a normal bell shaped curve.



While the sex, glitz, glamour and hype are clearly skewed toward the PHEV tail of the normal bell shaped curve, the bulk of future sales will almost certainly come from the more affordable micro, mild and full hybrid alternatives. Accordingly, I believe the question that investors need to ask themselves is, "which battery technology is best suited to the requirements of these lesser HEV technologies?" The following summary paragraphs may help in that analysis.

Energy and Power The distinction between energy and power is frequently blurred in discussions of HEV technology. In simple terms, energy measured in kilowatt-hours (kWh) limits the distance of travel while power measured in kilowatts (kW) limits acceleration and speed. In PHEV applications that rely on the batteries for an extended travel range, energy is the most important performance metric. For micro, mild and full hybrid applications that use the batteries for short bursts, power is far more important and there are many battery technologies including lead-carbon, NiCd, NaNiCl, NiMH and Li-ion that can easily do the required work. In other words, no technology has a clear performance advantage.

Size and Weight NiMH and Li-ion battery developers emphasize that they enjoy a substantial weight advantage over lead-acid batteries. I'll be the first to concede that weight differences can be critical in the context of a PHEV that needs to carry a 10 to 25 kWh battery pack to provide the desired range. But the weight advantage is almost irrelevant in the context of a micro, mild or full hybrid that only needs to carry a couple kWh of battery capacity.

Cycle Life NiMH and Li-ion battery developers emphasize that they enjoy substantial cycle-life advantages over the lead-acid batteries normally used for starting, lighting and ignition. Those comparisons are inherently unreasonable because they use the best examples of their technology and the worst examples of lead-acid technology. When the best NiMH and Li-ion technologies are compared with the best lead-acid technologies, the cycle-life advantages disappear.

Battery Cost The one metric NiMH and Li-ion battery developers never emphasize is cost, unless it's in the context of a happy-talk prediction that future economies of scale will slash the cost of their products. The simple fact is that the best NiMH and Li-ion batteries cost an average of three times as much as the best lead-acid carbon batteries and there is no reason to believe that the developers will ever be able to close the cost gap.

Revised Cost-Benefit Graph If one assumes that advanced lead-carbon batteries will be the technology of choice for micro, mild and full hybrid applications, and that NiMH and Li-ion batteries will be the technology of choice for PHEVs, the revised cost-benefit graph looks like this:



Over the last couple years the media has fixated on the romantic notion of PHEVs, which has drawn substantial investor attention to small public companies like Ener1 (HEV) and Valence Technology (VLNC) that are generally perceived as leaders in the PHEV battery market. As a result, the stock prices of both companies have risen to levels that include huge premiums for intangible future potential. While the market for PHEV batteries will undoubtedly be large, my sense is that the market has not fully considered the business, technical, operational, competitive, financial and ethical risks these companies are certain to face. That leads me to conclude that both companies have far more downside risk than upside potential under current conditions.

While the media attention has been focused on the right hand tail of the bell shaped curve, established lead-acid battery companies like Exide (XIDE), Enersys (ENS) and C&D Technologies (CHP), along with technology driven newcomers like Axion Power International (AXPW.OB), have been quietly developing next generation technologies that will be affordable for consumers in the middle of the bell shaped curve who need HEV fuel savings but can't afford Li-ion or NiMH batteries. These middle market solutions won't have the high per vehicle value of Li-ion and NiMH solutions, but with far higher market penetration rates, they should easily make up the difference in volume. As I've discussed in earlier articles, the lead-acid sector has been treated like an orphan stepchild of alternative energy for years. That leads me to conclude that these companies have far more upside potential than downside risk under current conditions.

I believe the revised Federal fuel efficiency standards will drive the implementation of micro hybrid, mild hybrid and full hybrid technologies more rapidly than anyone could have predicted and increase overall penetration rates. While the changes are bullish for the energy storage sector in general, the biggest beneficiaries are likely to be the undervalued lead-acid battery manufacturers that will ultimately be the primary source of middle market HEV battery solutions.

In closing I would like each reader to take another look at the last graph and consider a broader ethical issue that we all need deal with. The resources required for micro, mild and full hybrid technologies ramp up gradually as fuel savings climb from 10% to 40%. The incremental resources required for that last 20% in fuel savings one gets by upgrading from a full hybrid to a PHEV are immense. In effect, to save 100 gallons of gas per year by upgrading a single full hybrid to a PHEV, we will have to forego using those batteries to build four additional full hybrids that could have collectively saved 800 gallons of gas per year. This is one of the most appalling examples of selfish and wasteful arrogance I can imagine. It has no place in a resource constrained world where 6 billion people have come to understand how the other 500 million live and the primary challenge for our species is finding relevant scale solutions to persistent shortages of water, food, energy and virtually every commodity you can imagine.

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

John L. Petersen, Esq. is a U.S. lawyer based in Switzerland who works as a partner in the law firm of Fefer Petersen & Cie and represents North American, European and Asian clients, principally in the energy and alternative energy sectors. His international practice is limited to corporate securities and small company finance, where he focuses on guiding small growth-oriented companies through the corporate finance process, beginning with seed stage private placements, continuing through growth stage private financing and concluding with a reverse merger or public offering. Mr. Petersen is a 1979 graduate of the Notre Dame Law School and a 1976 graduate of Arizona State University. He was admitted to the Texas Bar Association in 1980 and licensed to practice as a CPA in 1981. From January 2004 through January 2008, he was securities counsel for and a director of Axion Power International, Inc. a small public company involved in advanced lead-carbon battery research and development.

Posted by John Petersen at 12:40 PM | Permalink | Comments (8)

David Hannum was right! There's a sucker born every minute and they're all waiting with bated breath for the low-cost plug-in electric vehicles that are coming soon to a dealership near you; if they're not quietly cancelled first.

It's the most insidiously appealing idea of our age: replace those nasty gasoline burning engines with cheap batteries that recharge in minutes and save a fortune on fuel while you "See the USA in Your [electric] Chevrolet." It's so appealing in fact that it ranks right up there with free lunch.

P.T. Barnum would have been proud.

Listen up America – It's a scam! The emperor has no clothes! There is no such thing as a cost-effective electric vehicle that will carry a family of four at highway speeds. But the cautionary if not downright conservative analysis from sources as diverse and credible as the Department of Energy, the White House and Carnegie Mellon University somehow manages to get lost in a media sideshow that focuses on scientific breakthroughs that promise a 5-minute recharge time for batteries nobody can afford to buy.

I hate to be a buzz-kill and point out the brown object floating in the punch bowl but this graph comes from the DOE's brand new Annual Energy Outlook 2009 and shows their best estimate of the market penetration rates for various classes of hybrid electric vehicles over the next 20 years. In this chart, the PHEV-10 and PHEV-40 categories are the only cars with plugs. Everything else is either a full hybrid (HEV) or a mild hybrid (MHEV).



So while your future car is very likely to have modest hybrid capabilities, there is almost no chance it will have a plug or need a charging station. For people like me who think numbers tell a more compelling story, the following table presents some detailed forecast data that I've gleaned from the Supplemental Tables to the Annual Energy Outlook 2009.

New Car Sales (Thousands)	2010	2015	2020	2025	2030
Gasoline ICE Vehicles	5,554	7,567	7,999	7,878	7,678
TDI Diesel ICE	53	152	359	596	802
Electric-Diesel Hybrid	0	3	8	7	5
Electric-Gasoline Hybrid	195	546	985	1,471	2,034
Plug-in 10 Gasoline Hybrid	0	101	138	198	250
Plug-in 40 Gasoline Hybrid	0	49	57	81	113
Other alternative power systems	312	823	1,176	1,150	1,155
Total New Car Sales	6,114	9,241	10,722	11,381	12,035
Percentage of New Cars With Plugs	0.0%	1.6%	1.8%	2.5%	3.0%
New Light Truck Sales (Thousands)	2010	2015	2020	2025	2030
Gasoline ICE Vehicles	5,152	4,701	3,664	3,332	3,033
TDI Diesel ICE	195	381	637	921	1,174
Electric-Diesel Hybrid	0	1	1	1	1
Electric-Gasoline Hybrid	92	336	620	951	1,223
Plug-in 10 Gasoline Hybrid	0	32	22	43	65
Plug-in 40 Gasoline Hybrid	0	0	0	0	0
Other alternative power systems	950	1,884	1,613	1,394	1,269
Total New Light Truck Sales	6,389	7,334	6,557	6,641	6,765
Percentage of New Trucks With Plugs	0.0%	0.4%	0.3%	0.6%	1.0%

With due respect for emotionally committed carbon activists who sincerely believe plug-ins are the only way to save our beloved planet, the DOE estimates that cars with plugs will be 0.0% of the new car fleet in 2010, 1.1% of the new car fleet in 2015, 1.3% of the new car fleet in 2020, 1.8% of the new car fleet in 2025 and 2.3% of the new car fleet in 2030. In simpler terms, plug-in vehicles are not the Greatest Show on Earth and the three ring circus we fondly refer to as the auto industry would close the sideshow if it wasn't such a big draw for children of all ages (including government) that bring fat wallets.

We've all been buried in press releases and reports about carmaker plans to introduce plug-in hybrids over the next few years. These are PR stunts, not business decisions. They remind me of a controversy that erupted in the mid-1800s when an entrepreneur named George Hull had the Cardiff Giant carved from a block of gypsum, aged and buried in a field. He then found the treasure while digging a well and promptly sold a two-thirds interest to a credulous investor syndicate managed by a banker named David Hannum. After the sale, Hannum's syndicate moved the Cardiff Giant to Syracuse and increased the entry fee to $1, which was serious money in the 1860s. Things really got rolling when P.T. Barnum tried to lease or buy the Cardiff Giant and was unable to do so. At that point Barnum had a plaster of paris copy made and promptly began denouncing the original as a fake. In newspaper stories about the dispute, Hannum was quoted as saying, "There's a sucker born every minute" in reference to the people who were paying to see Barnum's fake giant instead of the original giant that his syndicate had bought from Hull, which was also a fake. While it's not entirely clear whether Hannum was a sucker or a huckster, they all ended up in court where Hull confessed that the Cardiff Giant was a hoax and the judge ruled that truth was an absolute defe