Tom Konrad CFA

I missed Shimano (SHMDF.PK) in my recent list of bicycle and scooter stocks, but in many ways, Shimano is the best of the lot.

Shimano Inc. manufactures bicycle components and fishing and rowing gear, with the bike segment accounting for about four-fifths of sales, but I had not realized that they were public until I received a note from a reader in response to my recent article on bike and moped stocks.

In that article, I noted that, while bike sales rose in response to rising oil prices in 2008, bicycle repairs surged far more.  As a manufacturer of components, Shimano may be better placed than other bike companies such as Giant Manufacturing (GTMUF.PK) and Dorel Industries, Inc (DIIBF.PK) to take advantage of a surge in bike repairs. 

Shimano has a 70% market share in some key components such as gear wheels, derailleurs, and brakes.  This is possibly due in part to a corporate philosophy that keeps Shimano from competing with its customers by not building complete bikes.  If Shimano did build complete bikes, many bike manufacturing firms might feel compelled to return the favor by making their own high-end components.  As it is, Shimano's place in the bicycle industry is a lot like Intel's place in the computer industry: the maker of many of the highest tech components manufactured with great precision to exacting specifications, and, in fact, Shimano has often been called "The Intel of the bicycle industry." Many bicycle buyers care more that it is made with Shimano parts than which manufacturer does the final assembly.



Two Edged Sword

For investors, the high-end nature of Shimano's products is a two-edged sword.  The benefit is that Shimano's continual research into new technology and strong brand recognition create barriers that help the company maintain market share and margins.  The company's large market share also helps reduce unit cost of production, allowing the company to fend off competition with relatively low prices while maintaining profit margins.  The problem is that the high-end components in which Shimano specializes are less likely to appeal to more casual riders who are interested in using their bikes to run a few local errands than to more hard-core cyclists.  It was this class of casual rider that accounted for most of the new riders in 2008, when high gas prices caused a surge in interest in cycling.

On the other hand, not all of Shimano's products are made for the wanna-be Lance Armstrongs of the world.  For instance, Shimano introduced an automatic gear shifter for bicycles in 2003, designed with the urban commuter in mind.  For someone whose largest concern is dodging traffic and the morning meeting he's preparing for, an automatic shifter is just the thing. 

Valuation

Shimano has an extremely strong balance sheet, a large plus in the current economic climate.  The company has no net debt, an extremely high current ratio of over 5, and strong cash flow from operations even when revenues were depressed by the recession in 2009. 

With so much going for the company, the stock trades at a very high valuation.  At the recent ¥4,350 ($52.50) stock price, the company pays a  1.4% annual dividend, and trades at a P/E ratio of about 32.  As a value investor, I'd like to see the stock drop 30-50% before I'd be ready to buy it.  At the right price, this is certainly a company I'd like to own.

DISCLOSURE: No position.

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 12:45 AM | Permalink | Comments (2)

Tom Konrad CFA

When gas prices rise, more people turn to bicycles for transportation.  Will these bike and scooter stocks ride in the oil price's slipstream?

UPDATE: Here is an article on one more bicycle stock that should have been on this list: Shimano (SHMDF.PK).
A 2008 survey of bicycle retailers found that the vast majority of bike store owners felt that their sales had increased because many people were turning to bicycles for some of their transportation needs because of high gas prices.   95% of store owners reported that they had new customers because of high gas prices.

While few people can completely replace their car with a bicycle, many people can make some trips on two wheels and human power.  And 2008 is not the first time we've seen a surge in bike sales along with a surge in oil prices: the all time record for annual bike sales was in 1973, during the last oil crisis.  If future gas prices return to the levels seen in 2008 and stay there, we should not be surprised to see a sustained increase in the use of bicycles for transport, as well as a rise in the purchase of bikes, bike parts, and accessories. 

One fly in this ointment is that the biggest increases  in sales for bike retailers during 2008 were in service and repair, followed by new bikes and accessories.  Bicycle manufacturers saw increased sales in 2008, but not as large as the increases in ridership, because much new ridership came from cash-strapped individuals dusting off old bikes and getting them in shape to run errands or commute.  I think it will take a longer sustained rise in oil prices than we saw in 2008 to permanently shift the transportation landscape towards bicycles; investors should not expect perfect (or even near-perfect) correlation between oil prices and bike company profitability. 

Bike Stocks

Babies to Bikes- Dorel Industries

Dorel Industries, Inc (DII-B.TO, DIIBF.PK) is primarily a manufacturer of juvenile (baby) and home products, but in 2004 they began acquiring bicycle manufacturing and related businesses with the purchase of Pacific Cycle.  They now own Cannondale, GT, Schwinn, and several athletic apparel and accessory brands such as SUGOI.  This segment accounted for $681M or 32% of 2009 sales, up from 30% in 2008.  So while bicycles are currently less than a third of sales, they are growing in importance.

In terms of valuation, 2009 earnings were $3.21 per share, easily justifying the recent $33 share price with a trailing P/E ratio of slightly over 10. Dorel has relatively little debt at only 36% of equity and good liquidity ratios, but does not pay a dividend.  Overall, the low valuation and strong balance sheet are good compensation for the relatively small fraction of sales that come from bicycles.

from Dorel's 2009 Annual General Meeting presentation

Taiwan's Giant of Bike Manufacturing

Taiwan's Giant Manufacturing (GTMUF.PK, TWSE:9921) is the world's largest bicycle manufacturer, with $1.2B in annual sales, twice Dorel's bicycle sales.  Giant began as a low-cost manufacturer in 1972, getting its start with an early order from then-independent Schwinn.  Today, Giant makes everything for every market, including racing bikes with world-class technology to cheap volume bikes churned out in low-cost factories in China. 

Giant's sales fell slightly in 2009 with the slowing economy and lower gas price, but improved margins meant that earnings per share held constant.  Giant pays a dividend; it was TWD 4.5 dividend in 2010.  The company's stock price is currently trading around TWD 100, having doubled since its March 2009 low.  With no long term debt, this company is well positioned for an oil-induced increase in bike sales, even if the oil price increase also undermines overall economic growth.   Although the trailing P/E ratio is still a reasonable 15, I feel the stock has room to fall because of the recent run up if the current stock market decline continues.

A Scooter Stock: Piaggio
The First Commercially Available Plug-in Hybrid is an Italian Scooter

Piaggio & C.S.p.A. (PIA.MI, PIAGF.PK) is the leading manufacturer of motor scooters under the Piaggio's and Vespa brands.  Where bicycles are more likely to replace the car on short errands than everyday commuting, a scooter will be a practical option for many commuters hoping to reduce their fuel costs.  Piaggio scooters get between 50 and 100 MPG, and the company has even released a high-end plug-in hybrid scooter, the MP3 300ie in Europe.  After the initial version flopped due to too little power for too high a price, Piaggio has given it a larger engine and power to match the 9000 euro price tag.  Even with the larger engine, the hybrid 300ie still gets 141 MPG.

With the stock price at EUR 1.92 Piaggio's Price/Earnings ratio was a reasonable 14, especially if the analyst consensus of a long term growth rate of 30% is correct.  Year over year earnings growth was over 40% in the last year.  The company also boasts a 3.65% dividend yield. 

Electric Bikes and Electric Scooters

Chinese Lithium-Polymer battery and e-bike/electric scooter manufacturer Advanced Battery Technologies (ABAT) was my top pick in my recent  in my article Six More EV and HEV Stocks.  I concluded that about 50% of the company's revenues come from e-bikes and electric scooters, and the company's valuation seems very attractive.  Follow this link for more detail.

Conclusion

For the investor looking for an investment in two-wheeled transport, Giant and Piaggio are attractive pure-play options, and ABAT has an attractive valuation.  These alternative transport companies provide relatively low-cost alternatives to the car that have benefited in the past from rising oil prices.  All three are profitable and don't have excessive debt; Giant and ABAT have no long term debt.  Piaggio pays a decent dividend, but is probably the riskiest of the three given its debt burden.

Because scooters cost considerably more than bikes, Giant would probably be the best investment if rising oil prices exacerbate the weakness of the economy, and people have very little money to spend.  Piaggio would likely perform better if the economy is relatively strong even as oil prices rise.  Advanced Battery Technologies falls somewhere in between the two.

The data in this article comes mostly from third party sites such as Morningstar and Reuters, so I would not make a decision without first investigating each company in more detail. 

DISCLOSURE: No position.

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 10:18 AM | Permalink | Comments (2)

Tom Konrad CFA

My Ten Electric Vehicle (EV) Stocks article drew considerable attention and comments, including suggestions for stocks that did not make the ten.  Here are my takes on the EV stocks suggested by readers.

All of these companies do have something to do with electric vehicles (EVs) or hybrid electric vehicles (HEVs), but many were omitted from the original list because EV and HEV exposure was quite small as a fraction of total revenue.  This matters because, even when a small segment of a company is growing rapidly, it can have very little effect on the company's overall performance.  For instance, if a company gets 5% of its revenues from its EV-related business, and the revenue from this segment doubles, that doubling will only produce a 5% rise in overall revenues.  The company's overall performance is likely to be dominated by other segments if its revenue and earnings are dominated by other segments.

Rogers Corp (ROG) - suggested by Andy Nagle.
Rogers provides products and materials to "a variety of markets, including portable communications, communications infrastructure, consumer electronics, mass transit, automotive, defense and alternative energy" according to the company.  I believe that Andy recommended this one because they compete with CPS Technologies Corp. (CPSH.OB) (mentioned in Ten EV Stocks.)  CPS Technologies also supplies advanced materials for mass transit, wind turbines, and electric and hybrid electric vehicles.  Rogers Corp seems to be more (but not exclusively) focused on high performance foams, while CPS focuses on combinations of metals and ceramics.  Roger's segment breakdown was unhelpful in determining how much of the firm's revenue comes from these alternative energy segments, but most of these seem to fall in their "Custom Electrical Components" segment, which was about 13% of revenues.  If half of this revenue comes from alternative energy, that's still too little to interest me in the company.  Opinion: Not interesting from a peak oil investing perspective.

Capstone Turbine (CPST) - suggested by Robert B Ferguson
Capstone has a patented technology for micro turbines which allow for the relatively efficient combustion of gaseous and liquid fuels at a smaller scale than is possible with conventional turbines.  In the past, I've highlighted Capstone as a potential beneficiary of a move to distributed combined heat and power or cogeneration applications.  Over the last couple years, the company has also been pursuing opportunities as a generator for hybrid electric vehicles, with an emphasis on larger vehicles such as boats, buses, and trucks.  With the exception of buses, Capstone's HEV applications are still in the demonstration stage, but the many other applications for micro turbines in stationary distributed power should be interesting to investors looking for a broader exposure to alternative energy.  Both DesignLine and EcoPower Technology have developed buses using Capstone's 30 kW turbines.  DesignLine has received an initial order of 90 HEV buses incorporating Capstone turbines from the New York MTA.

Unfortunately, Capstone is not profitable and has little prospect of reaching profitability with current cash on hand.  Opinion: Avoid until financial position improves.

Advanced Battery Technologies (ABAT) - suggested by Deepfryer999
I left this Chinese Polymer Lithium-Ion battery company with an interest in electric bicycles and mopeds off my first list not because it does not deserve to be there, but because John Petersen, who also writes for AltEnergyStocks, covers battery companies (including ABAT) for us.  John will probably forgive me for this brief foray into his territory, but check the comments, because he'll also correct me if I get something wrong.

In my opinion, battery companies are among the better ways to play EVs and HEVs, because the market for such vehicles is still very young leading to a lot of uncertainty as to which EV manufacturers will succeed.  In contrast, the market for batteries is established, with many existing profitable companies, and electrified vehicles represent a large new source of demand for the industry's products.  If EVs are a flop and that demand fails to materialize, battery companies will be hurt due to what will turn out to be overbuilding in anticipation of large demand for batteries and government incentives.  On the other hand, a single EV requires so many batteries that if electric vehicles do become popular, the industry will have trouble keeping up with demand: even HEVs alone should be able to accommodate the increased battery manufacturing capacity.

Turning back to ABAT, the company is profitable and has a solid balance sheet.  At the recent price of $3.54, it has a trailing P/E Ratio (9.1) and Price/Book Ratio (1.75) of a value stock.  ABAT acquired Wuxi ZQ, a manufacturer of electric bikes and scooters in May 2009 for an approximate 4.5% ownership stake in ABAT.  Wuxi ZQ is exporting thousands of two wheeled EVs (2WEV) to the US.  According to the most recent quarterly statement, batteries for EVs account for 46% of ABAT's battery sales.  Although the company did not break out the value of 2WEV sales, we can assume that about half of the company's revenues are attributable to EVs.

Opinion: A good prospect for further research.

Toyota (TM) and Nissan (NSANY.PK) - suggested by Big Bear Lake Hostel
In  2009, Toyota sold 195,545 hybrids and no EVs, out of total sales of 1,770,149 vehicles, or 11% of sales.  The 2011 plug-in hybrid Prius will likely have limited runs as Toyota becomes comfortable with plug-in technology.
Nissan has only one hybrid model, the fun-to-drive Altima Hybrid (I speak from experience when I say it's fun to drive: my wife has one.)   With one model available in only 9 states, Nissan sold only 842 hybrids in 2009.  I could not find annual sales numbers for 2009, but the company expects to sell 850,000 units in 2010, which means that 2009 hybrid sales would be only 0.1% of total 2010 sales.  Nissan's hybrids are not the reason people are excited about the company: the excitement surrounds the rapidly selling Nissan Leaf EV.  Nissan now has 17,000 reservations for the Leaf, but only half of those are in the initial launch markets, and most of those are unlikely to be delivered in 2010.  While Nissan claims that Leaf production capacity "will soon approach 500,000 units per year," more likely sales numbers will be shaped by the number of reservations in target markets: perhaps 5,000 Leafs in 2011, or less than 1% of total auto sales.
If either of these car companies can be considered an EV or HEV company, it's Toyota because of its success delivering hybrids, but with the recent quality problems of the Prius, I expect Prius sales to fall as a percentage of total Toyota vehicles sales in 2010.  Opinion: Toyota and Nissan are best analyzed as conventional car companies, not EV or HEV companies.

Charge port for Nissan Leaf EV

Enova Systems (ENA) - suggested by Investingfun
Enova makes drive systems for electric and hybrid electric buses, medium and heavy duty commercial vehicles, stationary power generation systems, train locomotives, transit buses, and industrial vehicles, as well as for light, medium, and heavy duty trucks. It also makes power management and power conversion components for stationary distributed power generation systems, so from the perspective of exposure to electric vehicles, Enova is extremely well placed.  I especially like the exposure to heavy vehicles which I consider well-suited to electrification, and the exposure to alternative transportation in the form of trains and buses.  They have an impressive line-up of deals, including with Smith Electric Vehicles, the development of an electric drive system with Remy, Inc., and a hybrid school bus order all announced in the last few months.

Unfortunately, Enova is still a long way from profitability and most likely will need to raise additional funds within a year.  Unless the financial climate improves, such fund raising will be at the expense of diluting existing shareholders.  Opinion: Avoid until financial situation improves.

Conclusion

The only company in this list I would consider buying is Advanced Battery Technologies, since all of the others are either unprofitable and in need of outside funding, or not firmly in the electric vehicle space.  If you are looking for a Tesla (TSLA) at a better stock valuation, you would do well to research ABAT, as well as the three decent prospects I found among my previous list of ten EV and HEV stocks.

DISCLOSURE: No Positions.

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

Posted by Tom Konrad at 09:08 PM | Permalink | Comments (1)

Tom Konrad CFA

Tesla Motors (TSLA) is not the only electric vehicle (EV) stock.  Here are nine other public companies helping to replace petroleum with electricity in our cars and trucks.

Early in this series on the Best Peak Oil Investments, I put together an in-depth comparison of alternative fuels.  I concluded that the best prospect for displacing oil in the long term is electricity supplemented by biofuels.  Vehicle Electrification is likely to come to dominate the transportation sector because only renewable electricity can supply energy on the scale that we currently use for transportation with limited use of land area.  Biofuels require far more land area to propel a vehicle the same distance.

Many investors see the long term promise of Electric Vehicles (EVs) and think it means that the first EV stock to go public on a North American exchange, Tesla Motors, Inc. (TSLA), will inevitably take off.  Similar thinking lead to the strong investor response to the A123 (AONE) IPO last year.  Such investors should remind themselves that just because an industry has great long term prospects does not mean that the early IPOs are great investments.  Solar energy also has great long term prospects, but investors who bought Sunpower (SPWRA) in the month after its IPO in 2006 for $26 to $32 would now only have half their initial investment after four years.  Earlier solar IPOs were even worse.  Does anyone remember Astropower?  The company declared bankruptcy in 2004.  I can't find the date that it went public, but I remember that it was public in 1999 when I attended an investor presentation by the company President Dr. Barnett.  I bought and sold a small position in the stock shortly after for a nice profit, holding it less than a month.  I believe the people who make the most money on Tesla will also be the traders, not the long term investors, at least in the next few years.

A great technology does not guarantee a great stock, and buying the high-profile leader in a hot sector does not make an investor's prospects any better.  So if you still want to invest in vehicle electrification, here are nine other companies to consider.  Most are dogs, but one or two will almost certainly do better than Tesla, and the fact that these stocks are getting so much less investor attention means that you have a much better chance finding a diamond in the rough.

The Dogs

Li-ion Motors (LMCO.OB) develops and markets lithium-ion powered vehicles, from electric bicycles, scooters, and mopeds, to cars.  It's unclear if they have much proprietary technology.  Financially, the company is on shaky ground, with an annual loss of about $2M and net current assets of only $570,000 in the most recent quarter, the majority of which is "advances to related parties."  The cash flow statement is dominated by advances and payments from related parties, which raises questions in my mind about financial transparency and controls.  However, even without that, Li-ion Motors appears to need to continually raise substantial cash in order to continue operations.  Opinion: Avoid.

Raser Technologies (RZ) Raser Technologies is primarily a geothermal power development firm with a hybrid vehicle arm.  The hybrid vehicle division has developed a drive train technology for larger extended range electric vehicles such as SUVs and light trucks.  Raser is currently experiencing a severe cash flow problem requiring it to sell assets to repay debt.  Opinion: Avoid

ZAP (ZAAP.OB) Zap has been around for quite a while, and has earned a reputation for over-promising and under-delivering its neighborhood electric vehicles.  They recently acquired a large stake in a Chinese automaker and intend to ramp up production.  Given the company's continuing losses and weak balance sheet, they will have to continue to raise new equity and convertible debt, most likely diluting current shareholders.  Opinion: Avoid.

Speculative Bets

ZENN Motor Company (ZNNMF.PK)  ZENN Motor Company develops electric vehicle technologies and solutions that will incorporate EEStor's solid state electrical energy storage units. The Company markets its products primarily to original equipment manufacturers.  ZENN has a large stake in the secretive Austin, TX based EEStor.  If EEStor succeeds in commercializing its novel energy storage devices at reasonable cost, they will be transformational for the electric vehicle industry because of their promised high energy density, quick charge time, and light weight.  Zenn shareholders will stand to profit handsomely.  If not, ZENN is likely to continue to bleed cash rapidly, and will probably need to raise more money before the end of 2010, to the detriment of current shareholders.  Opinion: Avoid.

Balqon Corporation (BLQN.OB) is a developer and manufacturer of zero emission heavy-duty electric trucks and tractors for both off-highway and on-highway applications.  I think that the short-haul electric trucks and heavy equipment that Balqon focuses on have much better short term prospects than electric cars because such trucks are typically fleet vehicles and have predictable driving patterns.  The high up-front costs, low operating costs, and limited range of EVs mean that constant-length routes, heavy usage, and a fixed home base all greatly improve the economics.  The industrial and large commercial owners of such trucks are also likely to already have the heavy-duty electric grid connections needed for rapid charging of such vehicles.  Like most of the other companies listed here, Balqon is also not profitable, and will need to raise money on a fairly regular basis before they reach profitability, and which they have been doing through the sale of convertible debt and warrants.  Because of the continued fund raising, I would avoid the common stock, but expert accredited investors might find it worth their while to investigate the terms of the next convertible offering.  Note that I have not investigated the terms, and am not advising on any such investment.  I just think it might be worth looking into for expert investors.  Opinion: Worth watching.

UQM Technologies (UQM) designs and manufactures electric motors and controllers for EVs and HEVs.  They have experience with electrifying everything from bikes to military vehicles to buses, cars, and trucks.  UQM has a collaboration with first tier auto parts manufacturer BorgWarner (BWA) to develop electric powertrain components, and last year signed an agreement with Coda Automotive (a private Califronia based EV maker) to supply electric proplusion systems for ten years.  They have also received one of the ARRA manufacturing grants.  Although UQM is not profitable and has negative cash flow, they have several years' worth of cash on the balance sheet, and so may be able to reach profitability without further fund raising, although they will most likely continue raising money to fuel expansion to meet their rapid growth in orders.  Opinion: Worth watching.

The Profitable Companies

NEO Material Technologies (NEM.TO) is a producer, processor and developer of neodymium-iron-boron magnetic powders, rare earths and zirconium-based engineering materials and applications, and other high value niche metals and their compounds through its Magnequench and Performance Materials business divisions.  NEO's products are useful in miniaturization, emissions control, and the efficient, lightweight motors needed for electric vehicles.  Although most of the company's revenues come from products other than electric motors, a rapid expansion of the EV industry should increase demand for the company's products.  Unlike most of the other EV stocks listed here, NEO is a global company operating in ten countries with a record of positive cash flow and earnings, and no net debt.  With trailing 12 month earnings of C$0.31, the stock is a reasonable value at the July 13 closing price of C$3.62.  Opinion: Worth watching.

CPS Technologies Corp. (CPSH.OB) develops and manufacturers components using advanced materials, especially combinations of metals and ceramics.  While only a small portion of their business currently comes from hybrid and electric vehicles, they are profitable, have a strong balance sheet and cash flow, and no net debt.  Other alternative energy applications for the company's products include mass transit and wind turbines.  Earnings have been only $0.05 per share for the last year, but the company is experiencing rapid growth, with sales doubling between 2008 and 2009.  If this growth were to continue for the next few years, the company should be worth its recent $1.60 share price, but I don't know the company well enough to come up with my own projection. Opinion: Worth researching further.

BYD Company, Ltd. (BYDDY.PK) is a Hong-Kong Chinese battery manufacturer which launched a electric vehicle division in 2003.  They are already selling electric cars and buses in China, and expect to have models meeting Western safety standards for sale in 2011.  The BYD gasoline-powered F3 sold 24,000 units in China in the first five months of 2010. If any company is going to mass produce an affordable, mass market electric car at high volumes in the next couple of years, I think it's a lot more likely to be BYD than Tesla.  BYD's battery business is profitable, with total company 2009 earnings about $0.26 a share.  Warren Buffett's MidAmerican holdings took a 10% stake in BYD for $232 million in 2009, which would value the company at $2.3 Billion, or about $1 per share.  Buffett's investment helped the company by lending credibility and raising investor interest, but at current prices I would not expect new investors to make money.  Opinion: Worth further research if the stock falls below $3.

Conclusion

I've not looked at any of these companies closely enough to make a buy decision, although it was easy to rule out several.  Of the ones that are left, I think Neo Material Technologies, CPS Technologies Corp, and UQM Technologies are the most likely to be good values at current prices.  I'd buy any of these three before I'd buy Tesla.

This article is part 18 of my Best Peak Oil Investments Series, the index of which is here.

DISCLOSURE: No Positions.

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

Posted by Tom Konrad at 08:11 PM | Permalink | Comments (0)

Tom Konrad CFA

In 2007 and 2008, high gasoline prices gave a large boost to mass transit ridership. Here are the stocks that might benefit if that scenario repeats itself.

Americans are notoriously attached to their cars, but high oil prices in 2007 and 2008 led many to get on a bus or train.  According to a 2009 paper Transit Ridership Models:
Present Status and Future Needs [pdf] by Grace Galluci and John D Allen, Ph.D. from Chicago's Regional Transportation Authority, current published transit ridership models do not yet incorporate changes in gasoline prices.  The authors consider this a serious omission, since, in addition to the obvious intuitive link between gas prices and ridership, they found a strong correlation between gas prices and transit ridership using CRTA ridership data and local gasoline prices.  The following chart comes from this paper, and shows ridership following the local gas price (with a slight lag.)



Gas Price and Transit Profits

Although it may be safe to assume that transit ridership will increase with rising gas prices, a higher gas price may not make mass transit companies more profitable, since diesel to fuel buses and locomotives is a major expense for many mass transit agencies.   Hence, an investor expecting increases in the price of oil should prefer mass transit operators with fleets that use less diesel per passenger mile, and the suppliers to such operators.  Operators and suppliers of electric rail and trolleys are best in this regard, followed by operators and suppliers of fuel efficient hybrid buses and similar vehicles.  Vendors of Smart Transportation systems that allow transit operators to match vehicle capacity to demand in real time should also benefit, since the simplest way to reduce fuel use per passenger mile is to replace fuel guzzling buses with smaller vans at non-peak times, while adding vehicles at peak.

Mass Transit Stocks

Most transit authorities are public entities, but there are still a good number of public companies that provide goods and services to the sector.  What follows is a list of those companies culled from our Alternative Transport Stock List with significant exposure to mass transit.  For each stock, I include a description of its mass transit business, and how exposed the company is to rising oil prices.

Mass Transit Vehicle Suppliers

Alstom (ALO.PA, AOMFF.PK).  About one third of Alstom's business is as a supplier of locomotives for transit and high speed rail applications, in addition to signaling and support services.  Alstom supplies the locomotives for France's high-speed TGV trains.  The balance of Alstom's business is in electrical power generation, with strong presences in Hydropower, Natural Gas, Steam, and Nuclear generation, in that order.  Rising oil prices should benefit Alstom's transportation business, since high speed trains are a much more fuel-efficient alternative to air transport.

Bombardier Inc (BDRBF.PK, BBD-B.TO, BBD-A.TO).  Bombardier is another high speed rail stock, with a slightly greater market share for high speed locomotives than Alstom.  A little over half of Bombardier's revenues and profits come from high speed rail, with the balance coming from aerospace: they also sell regional and corporate jets.  Hence, while Bombardier has a larger percentage exposure to high speed rail than Alstom, the company is more likely to be hurt by rising oil prices than helped, because of the large exposure to aviation. 

New Flyer Industries (NFI-UN.TO, NFYIF.PK).  New Flyer is the largest manufacturer of heavy-duty transit buses in North America, and also one of my Ten Clean Energy Stocks for both 2009 and 2010.  New Flyer builds transit buses for transit operators powered by a wide variety of fuels, from diesel, to diesel-electric hybrids, Compressed and Liquefied Natural Gas, electric trolley buses, and even supplied the fleet of Hydrogen Fuel Cell buses for the Vancouver Olympics.  Rising bus ridership from rising oil prices increases the demand for buses, and also increases the incentive of transit authorities to invest in the more expensive (and profitable to New Flyer) electric hybrid buses.  The beneficial effects of rising oil prices should be felt more quickly by New Flyer than by suppliers of passenger locomotives, since transit authorities can expand bus systems and switch to hybrid buses much more quickly than they can expand rail transit systems.

My most recent in-depth look at New Flyer is here.

Vossloh AG (VOS.DE, VOSSF.PK).  Vossloh supplies rail fastening systems, switching, services, and locomotives, both diesel and electric.  Unlike Alstom and Bombardier, all of Vossloh's business is related to rail transit, making it a good bet in an era of long term rising oil prices.

Mass Transit Operators

Firstgroup, PLC (FGP.L, FGROF.PK).  Firstgroup operates mass transit services in Britain and North America.  In North America (37% of revenues), they operate the Greyhound bus brand, and subcontract the yellow student bus service for school districts.  In the UK (53% of revenues), they operate both bus (19%) and rail (35%) services both competitively and on behalf of transit authorities.  The balance of revenues comes from mass transit contracts in the rest of Europe.

Fristgroup uses financial markets to hedge fuel price risk, and so stands to benefit in the short term from increases in ridership caused by oil prices.

Mass Transit Equipment and Service Suppliers

Cubic Corporation (CUB).  Cubic is primarily a defense contractor (70% of sales) that also provides fare collection systems and services to transportation authorities (30% of sales.)  While I like the Smart Transportation potential of the company's IT and fare collection expertise, Cubic is only likely to benefit over the very long run as increases in mass transit ridership lead to increased demand for the company's services.

L. B. Foster (FSTR). L B Foster supplies a diversified mix of construction materials to the transportation industry, with 47% of sales coming from rail (although not exclusively mass transit) products.  The balance of sales come from sales of steel pilings, fabricated bridges and concrete buildings, and tubular coated products.  The large fraction of sales to the rail industry should help the company over the long term in a rising oil price environment.  The benefit of rising oil prices should increase if L B Foster succeeds in its cash takeover of Portec Rail products, discussed below.  An in-depth discussion of the L.B. Foster bid for Portec Rail Products is available here.

Portec Rail Products (PRPX).  As its name implies, Portec exclusively provides products and services to the rail and rail transit industries.  Products include lubrication and friction management (reducing noise, wear, and fuel use), track components, load securement, rail car repair, and environmental protection products for rail corridors.  If the L B Foster buyout goes though, shareholders will be paid in cash, so Portec is not currently a way to speculate on rising oil prices, but if the takeover fails, Portec's pure-play rail exposure should serve it well in a rising oil price environment.

Wabtec Corporation (WAB). Wabtec, also known as Westinghouse Air Brake Technologies Corporation, primarily serves the freight and passenger rail industries, supplying braking and other safety systems for both rail cars and locomotives.  As a pure-play rail supplier, Wabtec is well-placed to benefit from long term, sustained higher oil prices.

Stock	Percent of Sales from Transit & Rail
Alstom (ALO.PA)	33%
Bombardier Inc (BDRBF.PK)	55%
New Flyer Industries (NFYIF.PK)	100%
Vossloh AG (VOS.DE)	100%
Firstgroup, PLC (FGP.L)	100%
Cubic Corporation (CUB)	30%
L. B. Foster (FSTR)	47%
Portec (PRPX)	100%
Wabtec (WAB)	100%

Thanks to Jim Hansen of Ravenna Capital Management for bringing Vossloh AG to my attention.

DISCLOSURE: LONG PRPX, NFYIF

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 11:03 AM | Permalink | Comments (0)

Tom Konrad, CFA

Great Lakes Dredge and Dock is curiously in the center of a many emerging trends, some of which are not yet being talked about.

I've been watching Great Lakes Dredge and Dock (GLDD) for a few months as a possible alternative transportation stock to talk about for my Best Peak Oil Investments series.  My thinking goes like this: barge and river transport are two of the most fuel efficient ways to move bulk cargo.  Barges are even more energy efficient than rail freight for most uses, according to the Congressional Budget Office.

One barge company I watch is Trinity Industries (TRN) which also manufactures and leases rail cars, as well as building wind towers.  I profiled Trinity in 2008.  While not extremely overvalued at current prices, Trinity is not a bargain at the recent price of $21.60, so I've had my eye out for other companies that might benefit from an increase in barge transport, which is why I started watching Great Lakes Dredge and Dock (GLDD).  The more barge traffic there is, the more need for channel dredging and port expansion projects, both staples of GLDD's business.

The Business

GLDD is the largest provider of dredging, land reclamation, and beach nourishment services in the US.  The company builds and deepens ports, reclaims land, excavates underwater trenches, builds and maintains beaches, and maintains the depth of shipping channels, both in the US and internationally.  They also have a small demolition unit, which accounted for 8% of 2009 revenues.

Geographically, the company has significant operations in high growth emerging markets, supplementing its dominance in the US market.  About 15 to 30% of revenues come from foreign markets, while the US market is effectively protected from foreign competition by two laws passed in the early 1900's: The Foreign Dredge Act of 1906 and the Merchant Marine Act of 1920.  

Growth Drivers

There are many potential growth drivers for the dredging business, some of which GLDD is talking about, and some of which it isn't.  The company lists the following drivers of growth going forward:

• An increase in maintenance dredging due to increased interest in increasing port operating capacity by the US Army Corps of Engineers, the largest domestic user of dredging services.
• Coastal berm construction to protect the Louisiana coast from the oil spill.  A GLDD dredge has recently begun work on these berms.  The size of the spill make me think that berm construction and coastal restoration will continue to create high demand for dredging equipment in the Gulf for years to come.
• Expansion of the Panama Canal and the Port of Los Angeles
• New legislation in congress will create a harbor maintenance trust fund which will add $250-$400 million to the annual US dredging market.
• The 2009 Mississippi coastal improvements program created an additional $400 million demand for barrier island and ecosystem restoration work starting in 2011.

In addition, I see a couple of potential drivers for long term demand growth for dredging services.  Rising sea levels due to global warming will increase the need for artificial barrier islands, wetlands restoration, and beach nourishment.  Global warming is also expected to lead to an increase in severe hurricanes.  That should in turn lead to more contracts such as the recent award as part of the Maryland shoreline protection project.  Meanwhile, increasing fuel prices will increase the demand for fuel-efficient transportation such as barges, and increase the need to maintain and expand port facilities.

Valuation

GLDD pays a $0.07 annual dividend for a modest 1.2% yield at theJuly 2nd $5.84 closing price.  At that price, the 12 month trailing earnings is a somewhat expensive 17.59.  However, the company has fairly low debt when compared to cash flow, and most analysts are expecting fairly rapid (25%+) annual growth over the next five years, so the company does not seem particularly overvalued at current prices, but neither does it seem to be a bargain, as it was when it fell below $4.50 in early March. 

Investor interest arising from the oil spill may keep GLDD from ever returning to the cheap valuations it saw in March.  But I'm not ready to buy just yet... a continued decline in the overall stock market is likely to create another great buying opportunity in either Great Lakes Dredge and Dock or my other barge transport stock, Trinity Industries.


DISCLOSURE: LONG TRN.

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 10:37 AM | Permalink | Comments (0)

Neal Dikeman

For those of you interested in the sector under the sector in electric vehicles, the guts of Li Ion battery technology, the week just got more interesting than an overpriced, over hyped Tesla (TSLA) IPO.

Check out a very quiet unnanouncement in A123's SEC filings noting a multi-year supply deal with ConocoPhillips' Cpreme, the emerging leader in anode materials for Li On batteries.  The technology is a processing technology to make high performance graphite based powders out of plain old petroleum coke materials, that has the potential to be very low cost at scale.  A123 has announced supply deals in the past with Navistar, Fisker, Eaton, Think, the Chevrolet Volt and a number of others.

For those interested in the guts of the Cpreme technology, a good summary is here.  And a quick search of the patents includes: 7,618,678, 7,597,999, 7,323,120.

It wasn't too long ago when the only other contender for Tier 1 battery supplier in the US, Johnson Controls-Saft, was announcing their Cleantech Innovation Award win and DOE award with a Cpreme logo quietly slipped into the presentation, though likewise no announcements were ever made.  Johnson-Controls-Saft had announced lithium ion supply wins with Ford, Mercedes, and BMW.  Maybe the liberal view is right, cleantech can bring manufacturing and green jobs back to the US - courtesy of our oil companies?

Or perhaps we should note that Tesla has announced it's buying its batteries from Panasonic in Japan - with our DOE money (about half of its total capital!) and California tax breaks.  So maybe we'll just ship the new cleantech manufacturing jobs to Japan instead.

Neal Dikeman is a partner at Jane Capital Partners LLC, the Chairman of Carbonflow and Cleantech.org, and a long time cleantech advocate and blogger on Cleantechblog.com.

Posted by Neal Dikeman at 04:48 PM | Permalink

John Petersen

On June 22nd Scientific American rolled-out a Web-only article titled "The Dirty Truth about Plug-in Hybrids, Made Interactive" that summarizes a January 2008 report from Oak Ridge National Laboratory and shows why plug-in vehicles in the U.S. will, on average, be just a little bit dirtier than gasoline HEVs.

You read that right – dirtier, not cleaner!

I first raised the issue in an August 2009 article titled PHEVs and EVs, Plugging Into a Lump of Coal, where I estimated that plug-in vehicles would be about 25% cleaner than HEVs, but the marginal cost of CO2 abatement with plug-in vehicles would be five times higher than the marginal abatement cost with HEVs. The Oak Ridge report went a couple of levels deeper than my simple calculations and evaluated:

• Baseload power requirements and generating facilities in 13 regions in the year 2020;
• The specific types of generating facilities that would be used to charge plug-in vehicles; and
• The regional CO2 increase or decrease from using those generating facilities to charge plug-ins.

The following graph highlights the comparative CO2 increase or decrease in the 13 regions identified in the Oak Ridge study and discussed in the Scientific American article.



After accounting for the projected number of vehicles in each region, the national average was a 0.37% increase in CO2 emissions. Given the modest CO2 reductions from plug-in vehicles in regions like the Pacific Northwest and the significant CO2 increases in the industrial heartland, it would be easier, cheaper and better policy to use domestic natural gas in HEVs and forget about plugs entirely. Where HEVs cut to the heart of the CO2 problem nationwide, plug-ins only nibble around the edges in a few select regions.

Last month the American Chemical Society published a similar white paper from Tsinghua University, Beijing, and the Argonne National Laboratory Center for Transportation Research titled "Environmental Implication of Electric Vehicles in China," which concluded that implementing electric vehicles in China would increase CO2, SO2 and NOX emissions. It also concluded that gasoline HEVs are more environmentally friendly, more commercially mature and less cost-intensive. The following graph comes from page 4 of the white paper.

While the CO2 emissions data from both China and the U.S. is damning, simple calculations prove that electric vehicles like the Leaf from Nissan (NSANY.PK) and the MiEV from Mitsubishi (MMTOF.PK) save an average of 10.4 gallons of gasoline per year for each kWh of incremental battery capacity while PHEVs like the Volt from General Motors save an average of 7.6 gallons of gasoline per year for each kWh of incremental battery capacity.

I'll encourage each of you to run your own discounted cash flow calculations on annual gasoline savings of 10.4 and 7.6 gallons per kWh and then compare your calculated value with current battery costs of ~$1,000 per kWh and projected future costs of ~$500 per kWh. I've run the numbers and am not impressed.

In addition to Tesla Motors, which is scheduled to go public next week at a price of $14 to $16 per share, there are six pure-play battery companies that focus on electrification solutions for transportation. A123 Systems (AONE), Ener1 (HEV) and Valence Technologies (VLNC) are all working on lithium-ion battery solutions for plug-in vehicles. Maxwell Technologies (MXWL) is working on supercapacitor solutions for city bus, stop-start vehicle and HEV applications. Exide Technologies (XIDE) and Axion Power International (AXPW.OB) are working on advanced lead-acid and lead-carbon battery solutions for stop-start vehicle and HEV applications.

The following table assumes the Tesla IPO will go off at $15, the mid-point of the price range, and includes summary balance sheet and market valuation metrics for all seven companies. For both working capital and stockholders equity, the table reflects the dollar amount and the percentage of market capitalization those values represent. The Blue Sky column highlights the spread between market capitalization and stockholders equity.


It doesn't take much training to see that valuation premiums are much higher for plug-in vehicle companies than for lead-acid companies. In March of this year I suggested that stop-start idle elimination and other vehicle efficiency technologies were the investment equivalent of birds in the hand while plug-in vehicles were a flock of wild geese on the wing. In April I reported that the EPA and NHTSA were forecasting a 42% market penetration for stop-start systems by 2016. Over the last month we've seen important articles in prestigious publications expose the zero-emission myth as urban legend. With Oak Ridge and Argonne Laboratories, the American Chemical Society and Scientific American targeting the wild geese with double-barreled shotguns, I'm more convinced than ever that the market will soon shift to a more rational focus on economic reality and business opportunity.

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

Posted by John Petersen at 01:42 AM | Permalink | Comments (2)

Tom Konrad CFA

I'm bullish on Smart Transportation, which is my term for applying information technology to make our transportation system more efficient.  The majority of my list of Smart Transportation Stocks focus on GPS navigation.  I've been a fan of GPS navigation ever since 2001, when I first experienced the relief using one while driving in an unfamiliar city.  But I'm much less enthusiastic about GPS Navigation stocks: I feel the industry is too competitive, which is great for the consumer, but not so great for the shareholder. 

Hence, I'm drawn to the three Smart Transportation stocks that apply IT to transportation infrastructure, enabling congestion-based tolling and the better timing of traffic lights.  The three stocks I've found are AECOM Technology Corporation (ACM), Cubic Corporation (CUB), and Telvent Git S.A. (TLVT).  AECOM provides technical and management services to governments, some of which is on Smart Transportation projects.  Cubic develops and installs transportation fare collection systems and defense electronics, while Telvent provides IT services to a broad range of transportation and energy infrastructure markets.

Each of these companies gets less than a third of their revenues from Smart Transportation.  But in the case of Telvent, the other two-thirds is also interesting: applying IT to electric and natural gas infrastructure.  In other words, the Smart Grid, and smarter pipelines.  The company also has smaller segments applying information technology to agricultural supply chains and environmental services.

Energy

Telvent's Energy segment accounted for 33.5% of revenues in Q1 2010, mostly in North America (this segment is headquartered in Houston), but also from the EU and Latin America.  They provide enterprise-level information management and automation control to companies with large pipeline networks.  They also provide the information management services electric utilities need to manage and use the information flowing from Smart Grid projects.

The value of applying information technology to energy systems lies in the reduction of waste: better information and controls can let a company move more gas through the same pipeline network, and also detect leaks more quickly.  The Smart Grid is about creating a two-way flow of information on top of the electric grid; Telvent's role is to help utilities take this information and use it to better match energy production and load, and also detect system instability sooner, reducing wear on utility assets and potentially preventing blackouts.

Transportation

Telvent's global Transportation segment accounted for 24.8% of revenues in Q1 2010.  This segment struggled in 2009 but is beginning to show signs of recovery.  SmartMobility™ platform is a collection of information services from automated enforcement such as the traffic signals that take pictures of cars running red lights to traffic signal optimization and toll and fare collection.  These are offered a la carte, or as an integrated solution, and help municipalities and other regions manage their road, rail, and maritime transportation systems more effectively.  In short, they help governments make most of the Smart Transportation improvements I mentioned in my recent article.

Agriculture

Telvent's agriculture business is the result of a recent acquisition, and operates solely in North America, and accounted for 12.0% of revenues in Q1 2010.  The segment helps participants in all parts of the grain and livestock complex with weather information, an agricultural products trading platform and real-time pricing information.  Although I'm not bullish about the earnings prospects of biofuels businesses, I think the growing size of the biofuels industry will put increasing strains on other agricultural businesses, and both will require more and more up-to-date pricing and supply chain information.  If I'm right, this trend will be a boon for Telvent's agriculture business.  Tevent is also realizing some synergies from the acquisition my incorporating the real time weather data from the agricultural segment into their SmartMobility™ transportation offering.

Environment

The Environment segment focuses on water system management, monitoring of weather and air quality, and hazardous material containment.  It accounts for 8.6% of revenues and is growing quickly.

Global Efficiency

At 21.1% of revenue, the Global Efficiency segment is a cross-disciplinary IT consultancy offering to help clients use resources more effectively.  Key markets include insurance, health care, finance, government services, and telecommunications.  This segment is struggling against increased competition in Spain, but sees strong potential growth in Brazil.

Valuation

At a recent price of $18, Telvent has a trailing P/E of a little over 13, and pays no dividend.  Although it trades at only 65% over book value, operating cash flow ($33M) is low compared to net debt ($471M) and it has a low current ratio of around 1.  The company recently refinanced its debt, increasing the maturity and stretching out the payment schedule, which means that debt is not an immediate problem, and if the company can achieve decent growth over the next few years, they should be able to handle it easily.  

Although I could not be much more enthusiastic about the business, the high debt to cash flow means that I'll be watching and waiting for much cheaper valuations before I'm ready to buy TLVT stock.

DISCLOSURE: No position.

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 10:41 PM | Permalink | Comments (0)

John Petersen

Later this month, Tesla Motors plans to launch its initial public offering and sell about 12% of the company for $200 million. If the IPO is successful, Tesla's stock will trade on the Nasdaq Stock Market (TSLA) and its initial market capitalization will be roughly $1.5 billion. Since the IPO has spawned a series of analytical articles from better writers, I'll avoid the temptation to analyze the deal terms and focus on product issues instead. Like their cars, Tesla's IPO will undoubtedly attract vanity investors, the philosophically committed and the mathematically challenged. The more cautious element will probably stay on the sidelines.

Calling Tesla an automaker is like calling France's très chic Louis Vuitton, Möet Hennesy Group (LVMHF.PK) a beverage company. Tesla started with a $100,000 roadster in 2008 and has sold 1,063 cars to date. They plan to add a $50,000 family sedan in 2012 and have booked approximately 2,200 reservations over the last year. As a reference point, the star-crossed Delorean Motor Company sold about 9,000 stainless steel gull-wing sports cars for $25,000 (roughly $60,000 current dollars) in 1981 and 1982.

There will always be a market for vanity goods, particularly in the green space where eco-bling is hard to find. Moving down market will be a major challenge, however, because real consumers live in a world of paychecks, stressed budgets and overwhelming economic uncertainty. So while the eco-bling crowd will pay any price for the right status symbol, real consumers tend to think the green in their wallets is more important than the green in their cocktail party conversation. When people seriously consider their transportation needs and put pencil to paper, EVs will always fall short of the mark.

In a conventional car with an internal combustion engine, or ICE, the fixed cost of the fuel tank is insignificant and the variable cost of gasoline is high. In an electric car the dynamic is reversed. The fixed cost of the battery pack is immense and the variable cost of electricity is low.

At current US gasoline prices of $3 a gallon, an ICE that gets 30 mpg has a fuel cost of $0.10 per mile. At EU prices of roughly $6 a gallon, the fuel cost is $0.20 per mile. These numbers will move up and down with fuel prices and are certain to increase over time as oil prices climb, but they won’t change because of an individual owner’s driving habits.

In an EV, the cost calculation is more complicated because there's a capital cost for the battery pack that must be recovered over a period of years and a variable cost for the electricity.

The appropriate cost recovery period is always a thorny issue with EV evangelists claiming that the goal should be breakeven over the life of the car and consumer surveys indicating that three years is the preferred breakeven period. Since no single number will please everyone, I'll default to IRS regulations that require businesses to depreciate cars and light trucks over a maximum of five years, and to new car loans, which commonly run for five years. Five years is probably not a perfect number, but it's more reasonable than either of the extremes.

The Wall Street Journal recently reported that Nissan’s cost of making a 100-mile battery pack for the Leaf is about $18,000. By the time you add Nissan’s normal 25% markup, the retail price should be about $24,000, or $1,000 per kWh. In spite of the facts, many readers believe $500 per kWh battery packs will be a reality within a couple years. Since I'm weary of arguing the reasonableness of those assumptions, I'll use both a $1,000 and a $500 per kWh pack price for this article.

I'll also use a number of other charitable assumptions including stable electric costs of $0.12 per kWh, no loss of battery capacity over time and no cycle-life limitations. While I cringe when reading discussions of second-life value because (a) nobody's demonstrated a 10-year first-life in the real world, and (b) I don't believe a buyer in 2020 will pay more than scrap value for a battery based on 2010 technology that's already logged a decade of service under unknown operating conditions, I'll assume a 15% second-life value to keep the peace.

The following graph presents alternative gas price scenarios of $3, $6 and $9 per gallon, and then overlays depreciation and charging cost curves for an EV with a 25 kWh battery pack priced at $1,000 and $500 per kWh. The solid bold lines show current gas and battery prices. The dashed lines show possible futures that are uncertain as to both timing and magnitude.



The most striking feature of this graph is the shape of the curves. Where prevailing mythology holds that EVs will be wonderful for urbanites with short commutes who don't need much range flexibility, the curves show that the best value will be derived by high-mileage drivers who presumably need far more range flexibility. The reason is simple. Spreading battery pack depreciation over 5,000 or even 10,000 miles a year results in a higher cost per mile than spreading that depreciation over 20,000 or 25,000 miles a year.

The bottom line is that EVs are only economical when you buy no more battery than you need and you use the battery pack heavily. That leads to a life and death struggle between range anxiety and affordability. When you factor in the other uncertainties, I believe plans to electrify passenger cars are doomed until gas prices increase substantially or battery costs fall substantially. While I think both are virtual certainties over the next decade, I don't believe either is likely in time to make Tesla a business success.

Disclosure: None

Posted by John Petersen at 02:33 AM | Permalink | Comments (13)

Tom Konrad, CFA

Satellite (GPS) navigation is a Smart Transport strategy that drivers can implement without waiting for governments to act.  This is a look at five GPS Navigation stocks.   

I recently wrote how Smart Transport stocks may benefit from declining supply and increasing demand for oil.   I call the application of information technology (IT) to transportation "Smart Transportation."  Smart Transportation improves the function of the market for transportation services, just as the Smart Grid improves the market for electricity: by giving market participants better information and making the price of transportation better reflect the costs.  Because reducing congestion also reduces fuel use at very little cost, Smart Transport stocks should benefit from peak oil.

Types of Smart Transport

Smart Transport can be implemented from the top down, or the bottom up.  Top down Smart Transport involves government agencies adding IT such as cameras, card readers, and other sensors to roads or mass transit systems, either to provide drivers or passengers better information about conditions or to charge a usage fee.  Bottom-up involves drivers and riders using IT to acquire better information about road or transit conditions in order to make better decisions about where, how, and when they'll go about getting where they need to be.  That usually means a driver or fleet owner buying a GPS navigation system or systems.

Because GPS Navigation only improves access to information, and does not improve the market structure, it has less potential to reduce congestion than top-down road pricing schemes.  Yet GPS navigation has a major advantage as well: it's quick.  A driver can purchase an learn to use a GPS in an hour or two.  Government agencies seldom implement anything in less than a year, let alone anything that involves charging voters for something they're used to getting for free. In contrast, London's central congestion charge was formally proposed in July of 2001, and was not fully implemented until February 2003.

Will Peak Oil Help GPS Stocks?

If you believe that much of our response to peak oil will be last-minute and on a budget, you may have little trouble imagining growing numbers of people buying increasingly cheap and functional navigation devices or software for their smart phones in order to save gas by avoiding traffic and wrong turns.  As I argued in "The Methadone Economy," my vision of a likely peak oil future, the less prepared we are for peak oil, the more prevalent such bottom-up, quick to implement solutions will become. 

Yet most purchasers of GPS navigation aren't currently motivated by a desire to save gas.  Until drivers begin to make the connection between navigation and gas savings, a higher oil price won't help the share prices of GPS companies.  Some GPS companies know this, and are starting to help customers make this connection.    Features such as Garmin's (GRMN) EcoRoute, which gives drivers feedback on how they can drive more efficiently is an excellent advertisement for the connection between navigation and gas savings, as well as good PR.  Trafficmaster PLC (TFC.L) is even more explicit: Trafficmaster's home page encourages fleet managers to "Cut your fuel bills by up to 30%."  Rising fuel prices will only encourage more GPS companies to jump on the "navigation saves fuel" bandwagon, and encourage more drivers and fleet managers to listen.

Competition

Unfortunately, a company's success requires more than a growing market.  Companies also need to maintain profit margins.  Strong competition in GPS navigation is eroding profit margins.  Smart-phone based navigation programs are challenging the incumbent vehicle based systems and stand alone devices.  Google's (GOOG) entrance into the market with free smart phone navigation software should worry all industry participants.  Before Google entered the market, smart phone based GPS software came with a monthly subscription fee.  A free alternative will make many more drivers wonder if they need a dedicated GPS at all.
  
Stocks

I feel much the same about the GPS navigation industry as I do about the solar PV manufacturing industry.  The industry as a whole has a great future, but there is no guarantee that any industry participant will be able to maintain profitability for long in the face of new competition and constant innovation.  That said, some companies are in better positions than others.  Here are my thoughts on five GPS stocks:

Garmin, Ltd. (GRMN), $32.24

I own a Garmin Nuvï.  It is the best navigation device I've used to date (out of three total,) despite a software bug that sometimes keeps it from booting up properly.  Garmin has an excellent profit margin of 24%, no debt, and great cash flow, with a nice forward dividend yield of 4.4%. I like the fact that Garmin is directly playing the fuel-saving card with ecoRoute software, which might help them in a rising fuel price environment.

Telenav (TNAV), $8.39

Telenav went public on May 13.  The company sells subscription-based navigation software for smart phones.  The direct competition from a free product from Google makes me think this is a good stock to avoid.

TomTom (TOM2.AS), €5.14

TomTom makes stand alone navigation devices as well as software for the iPhone which has received good reviews.  However, the company carries more debt and has a much thinner profit margin than Garmin, leaving it vulnerable to further revenue declines.  TomTom does not pay a dividend.

Trafficmaster PLC (TFC.L), £ 0.47

Much more than other navigation companies, Trafficmaster is focused on helping customers (both fleet and individual) reduce fuel consumption by avoiding congestion.  They use real-time speed from units installed in vehicles to constantly update their congestion data.  They also provide stolen vehicle tracking.  Unlike Garmin and TomTom, the company is still seeing revenue growth, perhaps because of their greater emphasis on value-added services.   The company's trailing P/E is 13, making it one of the best values in the sector.

Trimble Navigation Ltd (TRMB), $30.38

Trimble is a general global positioning company, making GPS chip sets for a large range devices, including navigation systems.  As such, they are in a relatively good position in terms of competition: their chip sets are used in other companies' navigation systems, as well as many other industrial, construction, and agricultural applications.  They're solidly profitable, with no net debt and good cash flow, although with a P/E of 50 (at $30) and no dividend, a lot of expected growth is priced in to the stock.

Conclusion

If I were to buy any stock in this sector, it would be Trafficmaster because of the fuel-saving focus, decent valuation, and value-added services.  Because Trafficmaster uses two-way communication from its units to gather traffic data, the company benefits from network effects.  The more vehicles have Trafficmaster installed, the better the company's data, and the more effective its devices will be at avoiding traffic.  Yet any such advantage may be transitory:  a new competitor might instantly surpass Trafficmaster in network size by using cell phone tracking data from an existing wireless phone operator, or by using some other data source no one else has thought of yet.

The competitive landscape would make me uncomfortable holding any GPS stock for the long term.  As with most highly competitive industries, it's probably better to be a customer than an investor.

DISCLOSURE: No positions.
DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

Posted by Tom Konrad at 02:42 PM | Permalink | Comments (1)

Tom Konrad CFA

What the Smart Grid will do for electricity, "Smart Transportation" will do for road-based travel.  Here are eight companies making Smart Transportation a reality.

Congestion and Peak Oil

In late 2005 Houston was evacuated as hurricane Rita approached.  The memory of Hurricane Katrina was still fresh in everyone's mind, and Houston, also called the Oil Capitol of the World, is extremely car-dependent.   100-mile traffic jams quickly formed on all the major routes out of the city.  Many people were stranded as their cars ran out of gas from driving for hours just to go a few miles.  In the end, the evacuation turned out to be unnecessary as Rita turned and missed the city.

The Rita evacuation is one graphic example of how traffic congestion wastes gasoline to no purpose.  As we look for companies that may benefit from declining oil supplies, one good place to look is companies that help reduce congestion. 

Reducing congestion does a lot more than save oil: it saves everyone time and aggravation, as well as reducing vehicle emissions.  Everyone wants less congestion, but few people want to reduce their own driving, they would prefer that other people get off the road instead.  A 2000 Salt Lake County, Utah referendum on light rail passed in large part because of an advertising campaign that focused on the benefits of light rail to the people who don't use it [pdf, p.7].  The main benefit cited was reduced congestion.  I've heard similar stories about Denver's FasTracks project: the initial polling showed support among commuters not because they wanted to take light rail themselves, but because they wanted other people to take the train and make their driving commute quicker.

Along with buses and road building, light rail projects such as the two referenced above are usually the first options that come to mind when people think about ways to reduce congestion.  Unfortunately, with the exception of bus rapid transit, such projects take a long time to implement.  They are also quite expensive.   FasTracks authorization was passed in 2004, and the project is not scheduled to be completed until 2016.  Although initially cited as a model, it's now billions over budget.

Congestion as Market Failure

The first solutions that come to mind are not often the best solutions. 

Understanding the economic causes of congestion can lead to insights as to the best solutions.

Congestion is an instance of market failure.  In particular, it's a combination of the tragedy of the commons and incomplete information.  The tragedy of the commons occurs when many individuals (drivers in this case) share a common resource (road space) but do not individually pay the incremental cost of using that resource.  Each individual driver benefits by driving, but imposes costs on all other drivers by incrementally slowing traffic and increasing the risk of accidents.  Further, drivers have incomplete information because they typically must chose a route without knowing if the route is congested or blocked by an accident.

The reason that adding lanes and building new roads does not reduce congestion is that these solutions do nothing to address the underlying market failure: they simply increase the size of the common resource, giving drivers a larger incentive to over consume.  Mass transit also increases the common resource (transport services), but, since it is typically not free, mass transit is typically more effective at reducing congestion.  Yet, since mass transit only provides a new option to driving, the congestion benefits of mass transit in the absence of road pricing tend to be small.  Mass transit gives drivers the option of leaving their cars at home, but unless they also have an incentive, only a few drivers will switch to mass transit. 

Enter the Invisible Hand

The most cost effective approaches to reducing congestion address the underlying market failures. 

One way to address the tragedy of the commons is to price the common resource.    The pay per mile pricing programs (also known as Pay as You Drive, or PAYD) for auto insurance and registration I discussed in part X of this series improve the market signal and help reduce congestion.  Electronic ticketing systems can also improve transit ridership by making it easier to pay, effectively lowering the cost of mass transit when compared to driving. In April, a US Department of Transportation (USDOT) report identified several strategies that produce large net savings while reducing CO2 emissions from transportation.  USDOT found urban center cordon pricing, where people are charged to drive into a congested city center, produces $530-640 per tonne in net savings, while congestion based road pricing produces $440-570 per tonne in net savings.  There are relatively few ways to cut CO2 emissions that produce net savings, let alone savings in the hundreds of dollars per ton.  By definition, when a market is efficient, there can be no net gains from changing the market structure.  The large gains found in the USDOT report are the result of massive market failure, and also a sign that congestion based road pricing and urban center cordon pricing both improve the market structure. 

Tackling the problem of incomplete information can also reduce congestion.  New York City has a system of stop lights that respond to traffic conditions and leave fewer people waiting at red lights.  Navigation systems (GPS) with traffic information can help users avoid congestion and accidents, reducing congestion for everyone.  GPS systems without traffic information can also reduce driving by helping drivers find the shortest route to their destinations and make fewer wrong turns.   Routing buses around congestion and signal priority systems can help them arrive on time, encouraging ridership, while satellite tracking systems can keep riders updated about the next arrival time. 

Smart Transportation

I call methods of addressing transportation market failures "Smart Transportation" because they typically apply information technology (IT) to transportation, just as the Smart Grid is the applies IT to the electric grid. Although not obviously IT, pricing structures to address the tragedy of the commons require information about vehicle locations over time in order to charge appropriate prices.

Like most IT, Smart Transportation is scalable: variable costs that come from added vehicles are small compared to the cost of the project.  Smart Transportation requires only relatively cheap tags or navigation systems (from about $30 for tags and $100 to $500 for navigation systems, with prices falling constantly) for each vehicle.  There are even navigation systems for smart phones from Google (GOOG) and TeleNav (TNAV), which had its IPO on May 13th.  Smart phone based navigation is even more scalable than navigation systems, since it requires no new hardware. 

Most Smart Transit project also require sensors, cameras, and/or tag readers placed throughout the covered area.  GPS navigation can benefit from sensors that detect traffic and road conditions, although traffic data can also come from the GPS devices themselves: Trafficmaster (TFC.L) has developed such as system, which becomes more effective the more people use it.  Even when infrastructure is required for Smart Transportation, once it is in place, the infrastructure can service any number of vehicles. 

Stocks

Here are nine stocks that I'd classify as Smart Transportation:

Company (Ticker)	Smart Transportation Businesses	% of Revenues (approx)
AECOM Technology Corporation (ACM)	Transportation planning and design	10-20%?
Cubic Corporation (CUB)	Fare and Toll collection	30%
Garmin, Ltd. (GRMN)	Satellite Navigation (Automotive, Marine, Aviation)	84%
Telvent Git S.A. (TLVT)	Transportation information systems	31%
TomTom (TOM2.AS)	Satellite Navigation and mapping	100%
Trafficmaster PLC (TFC.L)	Vehicle tracking, Satellite Navigation, Traffic monitoring	75%
Telenav (TNAV)	Smartphone based Navigation.	100%
Trimble Navigation (TRMB)	Chipsets for global positioning, vehicle tracking	10-20%?
Google (GOOG)	Mapping and navigation software	<5%

If you know of any I've missed, please add your suggestions in the comments.

Conclusion

Scalability of Smart Transportation can lead to impressive economic outcomes, but road pricing schemes run into political opposition when drivers don't have acceptable transport options other than their car. 
While mass transit projects benefit increased ridership when road pricing is implemented, road pricing is often politically untenable in the absence of reliable mass transit [pdf].  Often these links are made explicit in that the revenues from road pricing are used to improve all transportation options, as is the case with London's successful congestion charging scheme [pdf. p.5]

In future articles of this series on peak oil investments, I plan a more detailed look at some of these Smart Transportation stocks.  I'll also delve deeper into the alternative transport companies such as rail and bus mass transit without which Smart Transportation would be politically untenable.

DISCLOSURE: No positions.
DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

Posted by Tom Konrad at 07:40 PM | Permalink | Comments (2)

John Petersen

Last week the American Chemical Society published a white paper in Environmental Science & Technology from a team of researchers at Tsinghua University, Beijing, and the Argonne National Laboratory Center for Transportation Research titled "Environmental Implication of Electric Vehicles in China." This white paper concludes that:

• Implementing electric vehicles in China will increase national CO2, SO2 and NOX emissions; and
• Gasoline HEVs are more environmentally friendly, more commercially mature, and less cost-intensive.

The following graph comes from page 4 of the white paper and compares the relative fleet wide CO2 emissions for gasoline ICEs, gasoline HEVs and electric vehicles. It's tremendously gratifying to see a high-level analysis that compares all of the available alternatives, instead of simply comparing ICEs with EVs.



While the graph focuses on CO2 emissions and shows that electric vehicles in China will be 50% dirtier than HEVs, the article also explains that EVs in China could double NOx emissions and increase SO2 emissions by 3–10 times. The bottom line is that in the U.S., China and India, PHEVs and EVs will be plugging into a lump of coal for decades to come and popular greenwash extravaganzas like the upcoming Tesla Motors IPO and the $7 to $11 billion Electric Drive Vehicle Deployment Act of 2010 that was introduced in Congress last week will ultimately be condemned for what they are, wholesale plunder of the treasury, the financial markets and the environment.

I have long argued that lithium-ion batteries are too valuable to waste on foolish applications like battery powered electric vehicles. I've even suggested that there won't be a lithium-ion battery glut because the world needs all the advanced batteries it can produce for sensible applications like electric two-wheeled vehicles and HEVs. Insanity is the only word I can use to describe the suggestion that batteries will ever be a cost effective replacement for a fuel tank.

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



In a normal free market, production capacity is allocated first to high value applications and then to successively lower value applications. In cases where supply is constrained by resource availability, manufacturing capacity or a host of other reasons, high value applications that only need a little battery capacity will always be able to outbid lower value applications that need a lot of battery capacity. The end result is that electric vehicles will always end up at the bottom of the food chain and the only batteries available to them will be the dreck and surplus that nobody else needs or wants. The economics of electric vehicles may work for the eco-religious crowd who will pay any price for the right status symbol to express their world view, but it's insanity to believe that electric vehicles have any future in the real world of paychecks and budget-conscious consumers.

I'm frequently critical of lithium-ion battery developers like A123 Systems (AONE), Ener1 (HEV) and Valence Technology (VLNC), but that criticism has nothing to do with the value of their products or the odds that they could develop a sensible business model for the commercialization of those products. The concept of electric vehicles, however, is inherently flawed and when good companies devote immense resources to the pursuit of foolhardy plans the result is invariably catastrophic for investors. Perhaps the latest study out of China will be enough to force some serious soul-searching before it's too late. I have never seen a new business prosper by targeting the most price sensitive, capital intensive and competitive markets first.

Disclosure: Author has no interests in the companies mentioned for obvious reasons.

Posted by John Petersen at 09:11 PM | Permalink | Comments (3)

Tom Konrad, CFA

LB Foster (FSTR) may not succeed in their attempt to buy Portec Rail Products (PRPX) unless they raise the offer price.

As a Portec Rail Products (PRPX) shareholder since 2007, I've been watching the saga of L.B Foster's (FSTR) attempt to buy the company fairly closely, and it's been a lot more interesting than we could expect.  I've put together a detailed time line at the end of this article.

Offer Premium

The tender offer came at only a 4% premium compared to the price the day before it was announced, leading to a spate of class action lawsuits alleging that the Portec board did not do enough to get the best possible price for the company. 

Most analysts agree that the previous close is a poor measure of the value the market places on a company.  The first reason not to use the closing price from on the previous day is often biased upwards when if rumors of the impending merger leak out, and investors buy on this insider information.  Although such insider trading is illegal, my observation of stock price movements convinces me that it happens frequently.  In the case of Portec, the quick price rise right before the merger was announced at the same time that most stocks were falling and there was no significant news also leads me to believe that some investors were buying the company on the basis of rumors or insider knowledge.  The second reason against using the previous day's close is simple volatility: Had other trading prices from the previous day been used instead of the closing price, the offer premium could have been calculated as anywhere between 4% and 10%.

A better way to calculate an offer premium is to use the average price of the stock over the previous month or two.  Using this method, the actual offer premium was between 8.5% and 10.4%, which is still low but not alarmingly low.  A 20% premium is typical.



Class Action Lawsuits

The low offer premium led to a number of class action lawsuits against the Portec board, alleging that they had not fulfilled their fiduciary duty to find the best possible price for shareholders.  I initially opposed these lawsuits and suggested that shareholders unhappy with the price should not tender their shares, rather than joining a lawsuit.  However, the lawsuits ended up doing some good: it came out during the proceedings that Portec had received a slightly higher ($12.00) verbal offer from Ameridan Resources LLC, a merger and acquisition specialist firm.  The judge in the case found that the chairman of the board had breached his fiduciary duty in not bringing this offer to the board's attention, and put a temporary hold on the merger, which Foster and Portec recently filed a motion to have released.

Shares Tendered

According to the terms of the offer, 65% of Portec shares must be tendered in order for the deal to go through.  The companies initially expected to have enough shares tendered by March 25, but shareholder take-up has not been sufficient.  The companies have now extended the tender offer three times.  As of May 28, they still needed 6% of outstanding shares to be tendered in order for the deal to go through.

Will more than 65% of outstanding shares be tendered?  It looks too close to call.  But having enough shares tendered is not enough to ensure the merger goes through.  The judge in the class action suits must also lift her injunction against the merger.  She may not be willing to do so unless Foster raises the offer price to at least the $12 offered by Ameridan.

Conclusion

My best guess is that L.B. Foster will either raise their offer to appease the judge and entice shareholders to tender more shares, or the deal will not go through, opening the door to other potential bidders.  With no net debt and solid operating cash flow, Portec has a strong bargaining position, and the board is likely to be much more careful about their fiduciary duty after this experience.

With Portec stock currently trading around $11.40, new purchasers would make a quick 5% profit in the case of a takeover at $12, or a 3% profit if the deal goes thorough as is.  Since I've liked the company's business for a long time (see here and here), I'm holding my (untendered) shares in the hopes of a better offer or the chance to continue holding Portec for the long term.

DISCLOSURE: LONG PRPX.

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.


L.B. Foster/Portec Rail Products Tender Offer Time Line

• June 2009.  LB.Foster approaches Portec to negotiate a buy-out.
• June-December 2009: negotiations between Foster and one Portec board member.  Most board members are not aware of the negotiations.  Portec shares trade between $8.50 and $10.80.
  
• Dec 18, 2009- February 16, 2009: Portec average closing share price $10.60.
• Jan 17- Feb 16: Portec average closing share price $10.79.
• Feb 17: L.B. Foster announces offer at $11.71/share, a 10.4% premium over $10.60, and a 8.5% premium over $10.79.  News reports call it a 4% premium (over the previous day's close.)
• Feb 17-19: Several class action suits filed alleging board did not work hard enough seeking a higher offer.
• Feb 19: I recommend against joining a lawsuit saying not tendering shares is sufficient.
• March 1-March 21: In anticipation of dividend, tax loss buyers drive Portec to $11.73 to $11.76 a share.  They probably hoped to sell a month later, capturing the $0.06 dividend (subject to a reduced tax rate) and taking a capital loss of $0.06 or less, which can be written off against short term gains.
  
• March 12: Portec announces regular $0.06 quarterly dividend.
• March 22: ex-dividend date.
  
• March 22: L.B. Foster extends tender offer until April 26.  Only 16.55% of outstanding shares have been tendered; 65% are needed.
  
• March 22: Second inquiry from US Dept. of Justice looking into the merger negotiations. 
  
• March 22-April 22: Investors begin to question likelihood of merger.  Tax loss sellers take much bigger losses than they expect as Portec falls from $11.67/share to as low as $11.33/share.
• March 25: Tender offer initially set to expire.  
• April 22: Judge in class action cases puts temporary stop to the merger.  Reveals that Marshall Reynolds, Portec's Board chairman failed to bring tell other board members about a $12 offer from Ameridan Resources LLC.  Says Reynolds breached his fiduciary duties.  Only one member of the board was aware or involved in merger negotiations between June and December 2009.
  
• April 22-26: Portec trades over offer price, and as high as Ameridan $12 offer on speculation that Foster will raise its offer or Ameridan will purchase the company.
• April 26: Offer again extended (to June 1). 54.33% of shares have been tendered; 65% are needed.
• May 13: Dept. of Justice will not block merger on anitcompetitive grounds.  L.B. Foster agrees not to go ahead w/ merger without DOJ approval.  Drop-dead date extended to August 31.
• May 21: Foster, Portec file motion to restart merger in class action case.
• May 28: Third offer extension to July 30.  58.93% of shares have been tendered.
• June 18: Expected ex-dividend date for Portec's quarterly $0.06 dividend.
  
• Aug 31: Drop-dead date: last day the merger can proceed without a new agreement between the companies.

Posted by Tom Konrad at 09:04 PM | Permalink | Comments (1)

John Petersen

I've written several articles over the last year that explain why idle elimination is a crucial first step in the global effort to increase fuel efficiency and curb CO2 emissions. For readers who are new to my blog, or confused by a torrent of news stories and analysts reports that wax poetic on the expected benefits, costs and challenges of gee-whiz vehicles that are "coming soon to a showroom near you," altenergymag.com describes stop-start systems, or micro-hybrids, as follows:

"These are conventional vehicles powered either by gasoline or diesel engines in which the 12-volt starter motor has been eliminated and a specially designed, belt-driven integrated starter/generator, or ISG, has been installed in place of the conventional alternator. While the ISG of a micro hybrid cannot help to propel the vehicle, it can provide two important hybrid features. First of all, a micro hybrid will feature idle stop. Engine control circuitry is included in a micro hybrid which will shut down the internal combustion engine when the vehicle is at rest. This feature alone can improve fuel economy by 10% to 15% in city/urban driving environments. The electronic control system in a micro hybrid can also control the charge cycle of the alternator so that it produces electricity to recharge the vehicle battery primarily during deceleration and braking. This provides a mild amount of regenerative braking and an additional gain in efficiency."

I usually talk about an 8% improvement in fuel economy for an incremental cost of $400 when I write about stop-start systems. Since I know that blog entries from guys like me who have an economic dog in the fight are often viewed as less credible than articles from writers who merely have a philosophical or political axe to grind, I also spend a good deal of time searching for concrete supporting data from reliable collateral sources.

I recently found a fascinating and somewhat disturbing slide in a presentation that General Motors R&D made at the 2010 Annual Meeting of the Minerals, Metals & Materials Society titled, "Challenges and Opportunities Relative to Increased Usage of Aluminum Within the Automotive Industry." The following schematic from page 13 of the presentation tells me that the 8% estimate I've been using is too pessimistic by half and the real fuel economy target for stop-start systems is closer to 17%.

Stop-start is not a complete solution to the fuel efficiency challenge, but it is the lowest and juiciest fruit on the conservation tree. Is it any wonder that industry analysts are predicting that stop-start systems will be built into 20 million cars a year by 2015?

The most common question on articles that discuss stop-start systems is, "if stop-start is so important, where are the automakers' press releases touting the technology?" The answer is simple. Stop-start will not normally be offered as a stand-alone option and will usually be bundled in packages like the EfficientDynamics system from BMW that has begun to attract praise from the mainstream media. More importantly, stop-start may be optional equipment for a couple years, but it is almost certain to become standard equipment because there is no compelling reason to waste fuel while waiting at a stop-light.

Automakers in Europe and North America are under tremendous pressure to meet new fuel efficiency and CO2 emission standards or pay huge penalties for failure. The following table summarizes the CO2 emission standards adopted by the European Union in April 2009.

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

In April of this year, the NHTSA and EPA created comparable standards for the U.S. when they adopted a joint final rule establishing the following fuel economy standards for light duty vehicles including cars, pickups, SUVs and vans.

Model Year	Passenger Cars	Light Trucks	Combined Fleet
2010 (1)	27.5 mpg		23.5 mpg
2011 (1)	30.2 mpg		24.1 mpg
2012 (2)	33.3 mpg	25.4 mpg	29.7 mpg
2013 (2)	34.2 mpg	26.0 mpg	30.5 mpg
2014 (2)	34.9 mpg	26.6 mpg	31.3 mpg
2015 (2)	36.2 mpg	27.5 mpg	32.6 mpg
2016(2)	37.8 mpg	28.8 mpg	34.1 mpg

(1)  Source: Wikipedia Corporate Average Fuel Economy
(2)  Source: NHTSA CAFE-GHG Fact Sheet

The bottom line business dynamic is that every Prius, Volt or Leaf the automakers sell will simplify the task of regulatory compliance, but the lion's share of the progress will come from building simpler efficiency technologies into cars that will be sold to consumers who think the green in their wallets is more important than the green in their conversation.

The second most common question is, "why do you think the widespread adoption of stop-start technology will be a boon to developers of advanced lead-carbon batteries and other systems that combine supercapacitors with conventional starter batteries?" My response has always been that current starter batteries are not robust enough to start an engine several times in a daily commute and systems based on exotic chemistries like NiMH and lithium-ion batteries are too expensive. Until recently, data to prove my point has been limited, which led to some skepticism. Now that hard data is beginning to make its way into the public domain, the task gets easier.

The big problem with stop-start systems is that starting an engine several times in a daily commute is very hard on starter batteries and the constant punishment gives rise to two related problems:

• First, the dynamic charge acceptance rate falls off rapidly, meaning that charge cycles that take 30 seconds with a new battery can take 2 minutes or more after a few months of use;
• Second, charging efficiency falls off rapidly, meaning that more energy is needed to bring the battery back to a full state of charge.

Both of these factors limit the frequency of stop-start events because control electronics won't turn the engine off unless the battery is fully recharged and ready for another start cycle. As the frequency of stop-start events declines, so does the fuel economy.

Last week a reader referred me to a Journal of Power Sources article (Volume 194, Issue 4, Pages 1241-1245) that compared the stop-start cycle-life performance of a conventional starter battery, an advanced lead-acid battery with carbon additives, and a lead-carbon battery-supercapacitor hybrid from Australia's Commonwealth Scientific and Industrial Research Organization called the Ultrabattery. The following graph shows the relative performance of all three devices in simplified cycle life testing that slightly under-charged the batteries to show the differences in dynamic charge acceptance rates.



A graph of their cycle-life testing using a normal charging protocol follows.



Axion Power International (AXPW.OB) reported comparable results in its May 19th presentation at the Advanced Automotive Battery Conference 2010.



The bottom line take-away points for investors are:

• In response to government mandates, stop-start systems will ramp from a few hundred thousand vehicles in 2010 to 20 million vehicles a year by 2015;
• Initial implementation of stop-start systems is planned the 2012 model year, which will require OEMs to reach design specification decisions by the third or fourth quarter of 2010;
• Roughly half of the $400 incremental cost of a stop-start system will be spent on better energy storage devices and the balance will be spent on control electronics and electro-mechanical components;
• While some automakers may choose higher quality conventional lead-acid batteries for stop-start systems, OEMs that want to maximize vehicle efficiency and avoid service problems will prefer technologies that combine the performance characteristics of supercapacitors and batteries; and
• Incremental revenue for manufacturers of storage devices for stop-start systems will run to several billion dollars a year by 2015.

Five public companies are actively developing specialized materials, components and energy storage devices for stop-start systems and will enjoy a substantial first-mover advantage over the next few years, including:

• MeadWestvaco (MWV), a packaging material and container manufacturing company that is developing carbon additives for the lead pastes used in ISS batteries;
• Maxwell Technologies (MXWL), which has teamed-up with Continental AG to develop storage systems for stop-start applications that use supercapacitors in tandem with conventional lead-acid batteries;
• Furukawa Battery Company (Frankfurt - FBB.F), which licensed the Ultrabattery from CSIRO and then sublicensed North American manufacturing rights to privately held East Penn Manufacturing Company, the recipient of a $32.5 million ARRA battery manufacturing grant award in August 2009;
• Axion Power International (AXPW.OB) a manufacturer of lead-acid batteries that has built a formidable patent position in lead-carbon technology and teamed-up with Exide for the commercialization of its PbC® battery-supercapacitor hybrid; and
• Exide Technologies, Inc. (XIDE), a leading global manufacturer of lead-acid batteries that has teamed up with Axion and was awarded a $34.3 million ARRA battery manufacturing grant in August 2009.

While each of these companies is working feverishly to complete OEM testing, build manufacturing facilities and negotiate their first contracts, none of them is truly ready for the anticipated surge in demand. As a result, I believe every company that brings a product to market this year will have more business than it can handle by the middle of next year. When the first design wins are announced later this year, the market response should be impressive, especially in the case of Exide and Axion which are rumored to be trading at depressed prices because of liquidations by troubled funds. Other battery manufacturers will undoubtedly enter the fray, but they'll all be playing catch-up ball for a long, long time.

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

Posted by John Petersen at 10:30 PM | Permalink | Comments (1)

Tom Konrad CFA

CVTech Group (CVT.TO, CVTPF.PK) operates in two of my favorite clean energy sectors: electricity transmission and distribution and efficient vehicles.  Here is a look at the company's fundamentals.

In "The Strongest Strong Grid Stocks" of my 2010: The Year of the Strong Grid? series, I took a quick look at CVTech Group's financial ratios, and decided not to look deeper because they had considerably more debt in comparison to income than the other electricity transmission ("strong grid") stocks I covered in that article.  I came across CVTech again while looking at companies involved in vehicle efficiency for my Peak Oil Investments series.  CVTech came up as a vehicle efficiency stock because it has a division that designs, engineers, and manufactures Continuously Variable Transmissions (CVT).  CVT has the potential to increase vehicle efficiency by 6%, according to independent consultancy Robert Baird & Co, so I decided CVTech deserved a second look. 

Energy Division

CVTech's Energy division accounts for about 88% of revenues, or 84% of the company's EBITDA.  The vast majority of this division is focused on construction and maintenance of electrical utility transmission and distribution (T&D) in Quebec and the Northeastern United States.  According to Judy Chang of the Brattle Group, speaking at the Yale Climate and Energy Institute's Annual Conference in April, the Northeast states will need to invest $10 billion in electricity transmission by 2020 in order to meet their existing renewable energy mandates.  According to a CVTech investor presentation [pdf], Quebec will need to invest more than C$14 billion to upgrade power transmission between 2009 and 2018.  With 2009 Energy division revenues at $140 million, the division could grow rapidly even if it only captures a small fraction of regional T&D spending.

A typical large transmission construction and service contract for the Energy division is a $40M regional "construction, maintenance, of an overhead distribution network" for Hydro-Quebec, with two 1-year renewal options.  A less typical project that caught my eye was installing pole-attached solar panels for PSE&G in New Jersey.  I've been following this project since it was announced because I think it makes a lot more sense for the electric grid to have a large number of small, distributed solar panels than large solar installations.  Distributed solar panels are not subject to large, quick fluctuations in output from cloud transients, yet the mass production and installation of the individual panels for a single owner should allow PSE&G to capture some of the economies of scale that is usually associated with large solar farms.  Because of these advantages, I expect to see more, similar projects in the future, and CVTech's prior experience may give the company an advantage in bidding for them.

Vehicle Division

The vehicle division specializes in the design and manufacture of CVT systems for small vehicles such as snowmobiles, ATVs and Golf Carts.  Because CVTech's CVTs use belts, they do not work well for high-torque applications such as trucks.  They have about 10% of the worldwide market for CVTs in vehicles that use them, but the trend to smaller cars may work to their advantage.  In January, they were selected to supply the automatic transmission option for the Tata Nano, giving them excellent growth prospects.

Valuation

At a $24 trailing P/E ratio and a 1.7% dividend yield, CVTech does not seem like a good value proposition.  However, earnings were depressed by the economic climate in 2009: the P/E ratio would have been below 8 if 2008 earnings were used instead of 2009.   Spending on T&D in the Northeastern US and Quebec needs to not only rebound but grow to keep up with unmet needs, and CVTech should be in a good position to capture some of that growth.  The company also has good potential for a boost from the Vehicle division.  I think the company is well valued at C$1.20, but I plan to delay my own buying because I expect a general market decline has the potential to bring it to a much better valuation sometime this year.

Late Note (5/14/10): CVTech reported first quarter 2010 earnings after this article was written but before publication.  Income was up $0.02 a share, bringing 12 month trailing EPS to $0.07, making the company look slightly more attractive than discussed above.  Top line revenue increased greatly because of a recent acquisition and the severe storms in the Northeast US in Q1 2010. 

Selected data	Date	Value
Stock Price	5/5/2010	C$1.20
Shares Outstanding	12/31/2009	65,288,310
Market Capitalization	5/5/2010	C$78M
Annual Revenues	2009	C$160M
Earnings per Share	2009	C$0.05
Earnings per Share	2008	C$0.17
P/E (trailing 12 month)	5/5/2010 price, 2009 earnings	24.0
Cash per share	12/31/09	C$0.08
Book Value per Share	12/31/09	C$2.24
Net Debt per Share	12/31/09	C$1.19
Current Ratio	12/31/09	1.36
Dividend yield	5/5/2010	1.67%
% Revenues from Electricity(Vehicle) division	2009	88% (12%)
EBITDA from Electricity(Vehicle) division	2009	84% (16%)

DISCLOSURE: No position.

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 02:20 PM | Permalink | Comments (0)

Tom Konrad CFA

The easiest way to reduce fossil fuels is to increase vehicle efficiency.  Government mandates already in place will ensure that such improvements occur.  Some stocks may benefit from the trend, but choose carefully.

Dr. Daniel Sperling knows about as much as anyone about what policymakers can do to reduce the use of oil.  He is the Director of the Institute of Transport studies as the University of California Davis, and a long time member of the California Air Resources Board (CARB), so he understands transportation from both the academic and policy perspectives.  He also recently co-authored a book Two Billion Cars: Driving Towards Sustainability, so he understands the magnitude of the problem as well. 

I had the pleasure of hearing Dr. Sperling speak at the Yale Climate and Energy Institute's first annual conference: Overcoming Barriers to A New Energy System on April 24th.  In his talk (you can download the PowerPoint here[13MB],) he provided an illuminating analogy:  Transforming transportation is like a three-legged stool.  The first leg is improving vehicle efficiency, which is easiest because we have both the technology and the regulatory tools to do it.  The second leg is transitioning to alternative fuels, which is harder because in most cases the technology or the infrastructure are not quite there yet (The first eight parts of this series looked into various alternative fuels, and reached a similar conclusion.) 

The third leg, labeled "VMT" for Vehicle Miles Traveled is the transformation of the transportation system, reducing car usage by providing alternatives and giving people better incentives to use the most effective alternative.  From a policy perspective, VMT is the most difficult leg.  Reducing VMT requires the policy maker to persuade people to change their habits. This is difficult in a democracy, were citizens and businesses typically oppose policies that require change. 

For example, one fairly straightforward way to incentivize VMT reductions would be to mandate that auto insurance, registration, and license fees fees be charged on a per-mile basis, as opposed to an annual basis.  For the average driver, these fees amount to about 9.4¢ per mile, compared to about 6.9¢ per mile for fuel.  A change to per-mile charges would increase fairness because people who drive more cause more accidents, road wear, and congestion, and the poor tend to drive less than the rich, so per-mile charges would also make driving more affordable for them.  Yet, while low-mileage drivers would see significant savings from per-mile charges, rural drivers and suburban drivers with long commutes would see large increases (unless they were able to reduce their driving by combining trips, carpooling, or shifting to public transit.)  Auto insurance companies may lobby against VMT charges because it would require them to change.  They may also fear that the policies will be successful in reducing driving and accidents, undermining their market.  High mileage drivers often unite with auto insurance companies to oppose any proposed change, while low mileage beneficiaries are often unaware of the potential benefits to them.

The Easy Leg: Vehicle Efficiency

According to Dr. Sperling, in the last twenty-five years, auto manufacturers have made great strides in engine efficiency... but they have used the progress to deliver more power at the same MPG, rather than increasing MPG.  Since 1985, average fuel economy has dropped 5%, while vehicle weight has risen 29% and average horsepower has increased 86%.  That's what makes vehicle efficiency easy: even without further advances in engine efficiency, we could greatly increase fuel economy by just returning vehicle weight and horsepower to 1985 levels.

In February, our own John Petersen provided a list of technologies for increasing vehicle fuel economy, compiled from a report by Robert W Baird & Co.   The table shows nine different technologies, many of which can be combined in a single vehicle which increase vehicle efficiency an average of 12.5%. 

	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 table shows it should be possible to increase fuel economy by the 40% from 2009 levels by 2016, as required by current law using only engine and transmission technologies.  Hybrid technology, smaller vehicle size, light weighting, low rolling resistance tires, better aerodynamics, or reducing engine power could each increase efficiency further.   Hence, automakers have a wide variety of potential strategies to meet the 2016 targets with existing technology.  While this plethora of options is good news for automakers, it is not all good news for investors.  With the wide choice of existing options for increasing fuel economy, it's difficult to foresee which technologies will bring the greatest returns to investors.  Further, few of these technologies are proprietary to any single publicly traded company. 

Stocks

Here are three companies from our Clean Transportation stock list that earn a fairly large proportion of their revenues from vehicle efficiency:

• Clean Diesel Technologies (CDTI) is a more focused company that might benefit from a larger market for its diesel emission reduction technologies if higher fuel economy standards lead to shift to diesel engines.  Since they operate in most diesel engine markets, changes in the automotive diesel market will be only one driver of profitability.
  
• CVTech Group (CVTPF.PK, CVT.TO) is a Toronto listed company with a division focused on Continuously Variable Power transmission in small vehicles.  Its other divisions provide construction and maintenance for electrical transmission and distribution in Quebec and the Northeast US.  While transport accounts for only 12% of sales, I include CVT in this list because electrical transmission one of my favorite sectors.  See my Year of the Strong Grid series for more on electricity transmission.
  
• UQM Technologies (UQM) designs and manufactures permanent magnet electric motors and drive systems for electric and hybrid electric vehicles.  They have sold technology to all six major automakers for electric vehicle and hybrid electric vehicle development programs, and are also working with several automotive start ups, most prominently CODA automotive.
  

Two other auto parts suppliers have expertise in some of these efficiency technologies. 
Borgwarner (BWA) produces engine and drive train components, including turbochargers and variable cam timing, while Magna International (MGA) is a diversified automotive supplier with some expertise in hybrid and electric vehicle systems.  However, I don't think that these constitute enough of their business to consider their stocks to be vehicle efficiency investments.

Also not on the list are the large number of manufacturers of batteries, and the auto manufacturers themselves.  Batteries are a critical component for hybrid vehicles, as discussed in part II of this series, but I chose not to include them in order to highlight manufacturers of other components.  For an in-depth discussion of battery company investing I recommend John Petersen's recent articles Common Sense in energy Storage Investing, and More Common Sense in Energy Storage Investing on AltEnergyStocks.com.

Conclusion

Clean Diesel Technologies, CVTech, and UQM may benefit from government mandated increases in vehicle efficiency through increased demand by automakers for their products.  However, higher oil prices and the increased cost of cars may undermine these gains by undermining the market for cars.  A declining car market could occur if people drive less because of high fuel pricesand delay purchases of new cars.  If gains in market share do not outpace market shrinkage, automotive efficiency investors will be disappointed.

Cars are only a slice of the larger transportation pie, so there are companies that can benefit from shrinkage of the automobile market.  Below is a graph from Dr. Sperling's talk, where he projects broad growth in all classes of motor vehicles.


I believe this graph overestimates the growth of the personal car, and that buses, cycles, and scooters will take a relatively larger share of the motor vehicle market.  I also believe that public transit and telecommunications may take an increasing share of the overall transportation services market, which may reduce the overall number of vehicles shown in the projection.

Investors looking for the purest automotive efficiency stock should choose UQM Technologies (UQM), which is more focused on the automotive market than Clean Diesel Technologies (CDTI), although both have significant exposure to other sorts of vehicles.  Investors interested in both electricity transmission and automotive efficiency should take a look at CVTech Group (CVTPF.PK).

Shifting Away From Cars

I personally prefer companies that can grab parts of the transportation pie away from auto and air travel, since I believe that betting on the general shift away from cars is a surer than betting on any one vehicle efficiency technology.  I will cover companies benefiting from this shift later in this series on peak oil investments.

Investments in alternative forms of transport depend on behavior change to be profitable.  Most people will not change their behavior on their own, and most of us have difficultty imagining giving up our car to ride the bus or biking.  Most jobs currently don't encourage telecommuting.  There is an oft-repeated mantra in business circles that deals can only be done face-to-face, and so business air travel will continue despite the rise of increasingly effective teleconferencing services.

The inability to envision a world where we travel less or by alternative modes represents conventional wisdom.  But I believe that rising fuel prices will get people and businesses to do a lot of things that they cannot currently envision when gas is a mere $3 a gallon.  If they won't stand for politicians to tell them to get out of their cars today, when gas is $10 a gallon, they'll be clamoring for those same politicians to provide mass transit and mandate that employers allow telecommuting.

Investors who can foresee a future that most other investors cannot currently imagine stand to make out-sized profits compared to the mass of investors who expect business as usual.

DISCLOSURE: No positions.

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

Posted by Tom Konrad at 11:17 AM | Permalink | Comments (0)

John Petersen

Since last week's article, Common Sense in Energy Storage Investing, was well-received by readers who've recently discovered this blog and want to better understand the energy storage sector, I've decided to continue with the theme and drill down deeper into some broad issues. Most of today's material is pretty basic stuff, but when the hype machine starts spinning a firm grasp on economic reality and investment fundamentals can be important to investors that want to avoid a boom and bust bubble like we had in corn ethanol.

In the fall of 2008 I confessed to being a shameless early adopter of cutting edge technology. I bought the first portable electronic calculator in 1971; bought word processing, laser printing, videotape, compact disks and satellite TV in the early ‘80s; bought a cell phone and established an Internet domain in the early ‘90s; and established a paperless office and a global law practice by the late ‘90s. If it was new and a major advance, I had to have it first regardless of cost. When I look back at the last 40 years, I'm amazed at how quickly the latest and greatest technologies became obsolete when newer, better and cheaper products emerged. The most recent example of how quickly technologies can rise and fall happened just last week when Sony (SNE) announced that will quit making floppy disks next March. As an investor, I'm horrified by the idea that a technology as important as the floppy disk can rise to global dominance and decline to insignificance in forty years.

In most cases, I've adapted well to changing conditions. My only line in the sand has been an almost religious devotion to the Macintosh operating system, which I switched to in the fall of 1989 based on the personal advice of Dr. Wilson K. Talley of the Lawrence Livermore National Laboratory. While I've never questioned my choice in computers, a graph comparing the long-term stock price performance of Microsoft (MSFT) and Apple (AAPL) serves as a stark reminder of how a sound technical decision played out in the equity market.



Today I can sit back and bask in the glow of being right about Apple's inherent technical superiority, but that doesn't change the fact that I was right too early. If I'd been a truly prescient investor, I would have owned Microsoft for the first dozen years and then switched to Apple for the long term.

Last week I re-printed a table from a July 2008 Sandia National Laboratories report that estimated the current and 10-year projected cost of stationary energy storage systems for solar power installations, including the storage devices and power conditioning equipment necessary for turning DC output into 60-Hz AC power suitable for delivery to the grid. The following chart puts the projected future cost of systems using the ten battery technologies included in the Sandia study in graphic form. While the media is enthralled with lithium-ion batteries because of effective PR and the oh so alluring promise of electric cars, my experience as a Mac user tells me that the vast majority of likely buyers will obey the laws of economic gravity and buy the cheapest system that can do the work.



The bottom-line is that major innovations take decades to evolve and work their way through the markets. The process was first explained in the technology adoption lifecycle, a model that emerged in the '50s and has since been refined by contributions from Geoffrey Moore and others who explain the process with graphs like this one from Crossing the Chasm.



We are living in the first days of the Age of Cleantech, the sixth industrial revolution. The media is chock full of stories about how wind and solar power will change the way we generate electricity, the smart grid will change the way we distribute and use electricity, vehicle electrification will free us from pollution and the tyranny of imported oil, and energy storage will be the keystone – an enabling technology that makes all the other advances possible. What the news stories don't tell us, because frankly nobody knows, is when these technological marvels will hit their stride and make a meaningful difference in the way we live. To help put things into perspective I've used data from a press release teaser for the American Wind Energy Association's annual market report for 2009 to create a graph of the annual and cumulative changes in U.S. wind power capacity over the last 15 years.



The first use of a large windmill to generate electricity was a system built in Cleveland, Ohio, in 1888 by Charles F. Brush. If you only consider the cumulative values since 1995 the growth seems pretty stable. If you think about the hundred and twenty year history of wind and study the annual additions and other data from the teaser, it becomes clear that wind power didn't transition out of the innovators stage until 2004, and then it took another three years to reach the early majority stage.

A similar trend is clear in the 10-year history of the HEV market, as shown by the following graph from hybridcars.com.



Viewed in isolation, HEVs have built an impressive growth history. Viewed as a segment of the larger market, they're just beginning to scratch the surface with 2009 numbers that represented 2.8% of light duty vehicle sales. Returning to the technology adoption lifecycle, HEVs are just now transitioning out of the innovators stage and into the early adopters stage. Plug-in vehicles, in comparison, are at the earliest possible point on the curve. I'm very optimistic about the future of HEVs because they've already demonstrated a decade of consistent growth and built a solid core of satisfied consumers. I'm less sanguine about plug-in vehicles because they have no track record and even their strongest advocates acknowledge insurmountable obstacles to widespread vehicle electrification over the next decade including:

1. The high cost of batteries;
2. The lack of recharging infrastructure;
3. Capacity, regulatory and coordination problems in the electric power sector; and
4. Consumer acceptance issues.

While I'm not willing to go out on a limb and predict what future penetration rates will be for powertrain electrification technologies, Roland Berger Strategy Consultants has predicted that full or partial powertrain electrification will be a key automotive efficiency technology by 2020 and forecast high scenario market penetration rates as follows:

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

If we study the Berger forecast and think back to the technology adoption lifecycle graph, it's pretty clear that HEVs are expected to follow a natural growth path over the next decade as their market share quadruples. It's also clear that something beyond normal market forces is expected to drive the adoption of plug-ins and stop-start systems. In the case of plug-ins the main driver of growth will be subsidies and incentives as governments around the world tax Peter to pay for Paul's new car. In the case of stop-start systems, the main driver will be new CO2 emissions and fuel economy regulations that require automakers to reach increasingly stringent targets. The first approach relies on incentives to create demand that wouldn't otherwise exist. The second approach relies on penalties to force automakers to implement efficiency technologies without regard to consumer preferences. In my experience, government is not very effective when offering a carrot but it's darned good at using a stick. Under the circumstances, I'm inclined to believe the stop-start penetration rates are a sure thing while the plug-in penetration rates include a hefty dose of wishful thinking.

Over the next five years manufacturers of inexpensive energy storage systems for stop-start applications are certain to report major revenue gains from C02 emissions and fuel efficiency regulations that are now fait accompli. The main publicly traded beneficiaries include Johnson Controls (JCI), Exide Technologies (XIDE), Maxwell Technologies (MXWL) and Axion Power International (AXPW.OB). If the planned introductions of plug-in vehicles later this year proceed as planned, the government incentives are successful and innovator class purchasers don't experience too many problems with battery pack failures, range limitations, poor cold weather performance and limited charging infrastructure, battery manufacturers like Ener1 (HEV) and A123 Systems (AONE) may begin realizing revenues that justify their market capitalizations in the second half of the decade.

I've already had my Apple vs. Microsoft experience and don't intend to repeat it. I'll continue to buy green bananas, but my days of trying to carve a new plantation out of the jungle are over.

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

Posted by John Petersen at 11:33 AM | Permalink | Comments (7)

John Petersen

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



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

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

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

To their credit the Electrification Coalition has always been upfront about the enormous challenges that electrification of personal transportation entails, including:

1. The current high cost of batteries;
2. The current lack of reliable access to refueling infrastructure for GEVs;
3. Regulatory and coordination problems that will complicate interface with the electric power sector; and
4. Consumer acceptance issues.

To overcome these seemingly insurmountable problems the coalition members propose several policy initiatives that will use your tax money to underwrite their business goals and pay for somebody else's consumption. The principal policy initiatives are summarized below, along with my personal observations.

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

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

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

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

Disclosure: None.

Posted by John Petersen at 01:57 AM | Permalink | Comments (2)

Tom Konrad CFA

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

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

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

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

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

Investment Opportunities

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

Barriers	Biofuels	Electricity	H2	NGV	GTL	CTL
Fueling Infrastructure	A	C	F	F	A	A
Distribution Infrastructure	D	A	D	A	A	A
Density	A	F	C	C	A	A
Overall Barriers	B	C	D	C	A	A
Constraints	Biofuels	Electricity	H2	NGV	GTL	CTL
Current Supply	C	B	F	B	B	B
Long Term Supply	B	A	A	F	F	F
Alternative Uses	C	C	D	C	C	C
Climate/Environment	C	A	A	D	D	F
Overall Constraints	C+	B+	C+	C-	C-	D+

H2= hydrogen; NGV = Natural Gas Vehicles; GTL=Gas to Liquids; CTL= Coal to Liquids.

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

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

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

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

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

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

Vehicle Electrification (C/B+)

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

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

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

Conclusion: The Best Peak Oil Investments

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

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

Here are links to the previous articles in this series:

1. Biofuels
2. Hydrogen and Vehicle Electrification
3. Natural Gas Vehicles
4. GTL and CTL
5. Algae
6. Barriers to Substitution
7. Substitution Constraints
   

DISCLOSURE: None.

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

Posted by Tom Konrad at 06:24 PM | Permalink | Comments (0)

Tom Konrad CFA

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

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

Constraint 1: Conversion Efficiency / Alternatives

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

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

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

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

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

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

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

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

Constraint 2: Total Supply

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

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

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



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

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

Constraint 3: Climate/Environment

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

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

Conclusion

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

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

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

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

Previous articles in this series are available here:

1. Biofuels
2. Hydrogen and Vehicle Electrification
3. Natural Gas Vehicles
4. GTL and CTL
5. Algae
6. Barriers to Substitution
   

DISCLOSURE: None.

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

Posted by Tom Konrad at 06:42 PM | Permalink | Comments (4)

Tom Konrad CFA

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

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

Barrier: Infrastructure

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

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

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

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

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

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

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

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

Barriers: Energy Density

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

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

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

Conclusion

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

Such supply constraints and environmental concerns will be the subject of Part VII.  Previous articles have been:

1. Biofuels
2. Hydrogen and Vehicle Eletrification
3. Natural Gas Vehicles
4. Synthetic fuels: GTL and CTL
5. Algae
   

DISCLOSURE: None.

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

Posted by Tom Konrad at 10:14 AM | Permalink | Comments (7)

John Petersen

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

The Final Rule Release begins with several hundred pages of introductory materials that describe the key efficiency technologies automakers are expected to implement between now and September 2015. It describes start-stop as:

• 12-volt micro-hybrid (MHEV) – also known as idle-stop or start-stop and commonly implemented as a 12-volt belt-driven integrated starter-generator, this is the most basic hybrid system that facilitates idle-stop capability. Along with other enablers, this system replaces a common alternator with a belt-driven enhanced power starter-alternator, and a revised accessory drive system.

After a lengthy discussion of how each of the principal efficiency technologies will contribute to the overall goal and explaining the freedom the individual automakers will have to pick and choose solutions, the Final Rule Release includes the following table, on page 484, that identifies the automakers and estimates the percentages of their 2016 model year fleets that will incorporate each technology.



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

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

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



For eighteen months I've been predicting with increasing confidence that the cleantech revolution would start with baby steps, rather than giant leaps, and that advanced lead-acid and lead-carbon batteries would play a crucial role in the widespread implementation of micro, mild and strong hybrid electric vehicle [HEV] technologies. My confidence ramped up a notch or two last August when President Obama announced $2 billion in ARRA battery manufacturing grants that included:

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

My confidence continued to rise as reports from the Energy Information Administration, Frost & Sullivan, Roland Berger Strategy Consultants and most recently Lux Research concluded that start-stop technology would become a standard option for new vehicles sold in both Europe and the U.S. over the next few years. Now that the NHTSA and EPA have weighed in with their estimate that 42% of the 2016 model year new car fleet will be equipped with start-stop, my confidence level couldn't be higher.

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

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

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

Posted by John Petersen at 02:06 PM | Permalink | Comments (4)

John Petersen

Last week I did a 40-minute interview for Hedge Fund Radio, a weekly investment program hosted by John Thomas, the Mad Hedge Fund Trader. While our conversation focused on the unassailable mathematics supporting my contention that plug-in vehicles are wasteful, I was fascinated by John's description of his recent conversations with Toyota Motors (TM) where Toyota confirmed its commitment to NiMH battery technology for hybrid drive and fuel cell technology for electric drive. Its somehow comforting to know that the world's most successful automaker agrees that the first modern plug-in, GM's EV1, died from congenital birth defects and the same flaws will almost certainly doom the next generation of cars with plugs.

The best part of the interview was that it gave me a chance to clarify and crystallize my thinking on the basic problem of using batteries to replace the fuel tank for an average American who drives 12,000 miles per year and would normally buy a fuel-efficient car with an internal combustion engine. The quick and dirty summary is:

• In a conventional fuel efficient car, a typical user will burn 400 gallons of gas per year;
  
• In a $22,500 Toyota Prius, a 1.3 kWh battery pack will save 160 gallons of gas per year, or 123 gallons per kWh;
• In a $40,000 GM Volt, a 16 kWh battery pack will save 340 gallons of gas per year, or 21 gallons per kWh;
• In a $44,000 Nissan Leaf, a 24 kWh battery pack will save 400 gallons of gas per year, or 17 gallons per kWh; and
• In a $110,000 Tesla Roadster, a 53 kWh battery pack will save 400 gallons of gas per year, or 7.5 gallons per kWh.

Economists would call that a rather shocking example of the law of diminishing returns.

The fundamental problem is that we live on a resource constrained planet and it is the epitome of foolishness to believe that wasting one class of natural resources (battery materials) in the name of conserving another (oil and gas) can ever make sense. It all comes back to the premise that sensible industrial policy will rely on currently available technology to harvest the low-hanging fruit and slash fuel consumption with HEV and stop-start systems while emerging technologies like fuel cells that are better suited to high-hanging fruit evolve and mature. In other words, we need to take baby steps.

I'm often accused of being a Luddite for my cynicism over the electric-drive dream. The truth is I'm an incurable optimist who sees no limits to human ingenuity and creativity. I've lived through one of the most transformative periods in history and know that the rate of technological change is accelerating. Therefore, I don't even question the idea that humanity is likely to see twice as much technological change in the next twenty years as it did in the 20th century. Most of us baby boomers bought 45 RPM vinyl, reel-to-reel tape, 8-track tape, cassette tape, digital audiotape, compact disks and MP3 files. In their respective eras, which were usually short-lived, each of these innovations was the latest and greatest thing until something better changed the game. Given the change I've lived through, I have a hard time putting much faith in anyone who believes 10 to 25 year forecasts are possible, much less reliable. There is simply no way to predict what the disruptive changes will be or when they will occur. After all, if changes were predictable, they wouldn't be disruptive.

Lithium-ion battery developers like A123 Systems (AONE) and Ener1 (HEV) are charging forward with their plans to spend hundreds of millions of dollars on new manufacturing plants that will make batteries for electric cars. While the timing of its IPO isn't clear, Tesla Motors just filed an amendment to its SEC registration statement and will probably make a big splash sometime this spring. When you cut through the fog, however, all of the business models foresee nothing but losses for years to come. The factories won't be built till 2012. Once the factories are built, it will take a couple years to work out the manufacturing glitches and bring and quality control up a level that's competitive with the Japanese and Koreans. Once the quality's in place and the products are dependable, it will take additional time, perhaps a long time, to convince a meaningful number of consumers that electric vehicles, which promise cheap fuel from the grid but cost $3,500 per gallon of gas equivalent in 'fuel tank' capacity, make economic sense. I hope someone packs a lunch.

If battery-powered vehicles offered a decent natural resource balance, the promised "economies of scale" were assured and there were no potentially disruptive technologies on the horizon, I might have a different view about the long-term potential of plug-ins. My experience, however, tells me that something better will almost certainly arrive on the scene before the current A-list of electric-drive supermodels turns the corner to profitability.

Products that become obsolete before their manufacturers become profitable are never kind to investors.

Currently the market is valuing battery companies that won't be profitable for years at nosebleed levels while it values the first clear beneficiaries of the cleantech revolution at embarrassingly low prices. I don't know how long it will take for A123, Ener1 or Tesla to turn the corner and report a profit, but I know that Johnson Controls (JCI) and Exide (XIDE) will be selling millions, if not tens of millions, of stop-start batteries per year within a couple of years and nothing boosts profitability like selling higher value products to existing customers without increasing unit volumes. While I can't be certain until ongoing testing by several first tier automotive OEMs is completed, I'm increasingly confident Axion Power International (AXPW.OB) will play a critical role in the emerging stop-start market.

Every industrial revolution in history has been driven by innovations that have proven their ability to do more valuable work with lower inputs of raw materials, capital and labor. Despite lofty aspirations, consumers are far more motivated by the green in their wallets than the green in their cocktail party conversations. Try as they might, governments are never good at planning economic growth or driving uneconomic technologies into the market. I've long advocated the proposition that a business model that does not make sense without government subsidies does not make sense. I've also been forced by experience to shorten my investment horizons from a couple of decades to a few years. While I haven't yet reached the point in life where I refuse to buy green bananas, I don't have a great deal of interest in carving a new plantation out of raw jungle.

Disclosure: Author is a former officer and director of Axion Power International (AXPW.OB) and holds a substantial long position in its stock. He recently sold his other holdings in the energy storage sector for significant gains.

Posted by John Petersen at 05:30 AM | Permalink | Comments (0)

John Petersen

In a November 2008 thematic report, The Sixth Revolution: The coming of Cleantech, Merrill Lynch strategist Steven Milunovich identified cleantech as the sixth technological revolution. He borrowed his definition from Lux Research which describes cleantech as "the universe of innovative technologies designed to optimize the use of natural resources and reduce environmental impact" and warned that "investors must pay attention because cleantech could revolutionize much of the economy, including the utility, oil and gas and auto industries."

The six technological revolutions Milunovich identified were:

1771	The Industrial Revolution	Britain
1829	Age of Steam and Railways	Britain spreading to Europe and U.S.
1875	Age of Steel, Electricity and Heavy Engineering	U.S. and Germany
1908	Age of Oil, the Automobile and Mass Production	U.S. and Germany spreading to Europe
1971	Age of Information and Telecommunications	U.S. spreading to Europe and Asia
2004	Age of Cleantech and Biotech	U.S. and Europe going global

The new technology classes he identified as critical to the cleantech revolution include:

• Renewable energy led by solar, wind, and biofuels;
• Energy efficiency;
• Energy storage;
• Electric vehicles;
• Nano materials; and
• Synthetic biology.

The fundamental drivers he identified include:

• Increasing global CO2 emissions that may contribute to global warming;
• Rapid industrialization in the developing world that will strain global production capacity for everything; and
  
• Practical peak oil, which I prefer to think of as peak cheap oil.

Quoting Carlota Perez, Milunovich also noted that “Two or three decades of turbulent adaptation and assimilation elapse, from the moment when the set of new technologies make their first impact to the beginning of a ‘golden age’ or ‘era of good feeling’ based on them.” With due respect for the lessons of history, I believe the cleantech revolution will be very different from anything humanity has ever experienced.

Because of my father's diverse business interests I learned about computer leasing and pre-stressed concrete building systems in the mid-60s. I also worked in electronic circuit board and plastic products factories in the late-60s before graduating from high school. When I took computer programming in the mid-70s we used punch cards for data entry and by the late-70s my law school was a beta site for computerized legal research. During my professional career I've lived the transition from magnetic card electric typewriters, four-function desktop calculators and late nights at the financial printer proof reading paper regulatory filings to electronic preparation, filing and distribution of almost everything.

In other words, I've not only lived through the information and telecommunications technology revolution, I've been immersed in the changes as they occurred. As an incorrigible early adopter, I've experienced first hand the transitory nature of the latest and greatest new technology. While it's a simplistic example, I think most in my generation can remember buying some if not all of the following: 45 RPM vinyl, reel-to-reel tape, 8-track tape, cassette tape, digital audio tape, compact disks and MP3. In their respective eras, which were surprisingly short lived in most cases, each of these technologies was the latest and greatest thing until the next greater thing came along. Given all the change I've seen over the last 40 years, I have a hard time putting much faith in anyone who believes long-term forecasts of dominant technologies are possible, much less reliable.

My favorite Seeking Alpha contributor is John Mauldin, a big picture macro-economic analyst who's been remarkably prescient in the 10 years I've been following his weekly letter. One of John's recurring themes is that we're living in an era when the rate of technological change is accelerating rapidly. As a result, John suggests that humanity is likely to see twice as much change in the next twenty-one years as it did in during the entire 20th century. Based on my experience over the last 40 years, I tend to think that John is probably right, and that anyone who tries to predict the future beyond 2015, or perhaps 2020 at the outside, is delusional. There is simply no way to predict what the disruptive changes will be or when they will occur. After all, if changes were predictable, they wouldn't be disruptive.

While I believe there are very few certainties, I know that there are 5.5 billion people on this planet who would like a small piece of the lifestyle that 500 million of us have and frequently take for granted. I also know that thanks to the last industrial revolution, about half of the world's poor know there is something better than mere subsistence. Human nature being what it is, the first response of people who want a better life will be to work for it and the second will be to fight for it. To paraphrase Vinod Khosla, the big challenge of the next century will be finding relevant scale solutions to persistent shortages of water, food, energy and virtually every commodity you can imagine. Any failure to achieve the goal could be catastrophic.

Since I started this blog in the summer of 2008, I've built a bit of a reputation as a contrarian who frequently mocks prevailing wisdom and criticizes innovations that others laud as game changers. The reason I do so is simple. First, I steadfastly adhere to the definition of cleantech as "the universe of innovative technologies designed to optimize the use of natural resources and reduce environmental impact." Second, I steadfastly adhere to the idea that in a world of accelerating change, any forecast that involves a period of more than five or ten years will be wrong. I may not know what the intervening technical change or market force will be, but I know to a certainty that there will be one if not several intervening technical changes or market forces.

I'm an unrepentant critic of plug-in vehicles because they violate both of my core rules. I've published calculations that prove plug-in vehicles are suboptimal users of natural resources and suboptimal at reducing environmental impacts. To add insult to injury, none of the reasonable experts are predicting meaningful market penetration in less than ten years, although they invariably predict wonderful developments over 20 to 30 years. Things may turn out exactly the way the experts predict, but given the disastrous natural resource balance and my experience over the last 40 years of rapid technological change, I have to believe future realities will be far different from the parochial and hindsight intensive forecasts we read today.

All the reasons that lead me to believe plug-in vehicles combine immense risk with insignificant reward and are little more than waste masquerading as conservation lead me to support stop-start, mild hybrid and full hybrid solutions. These are technologies that can be widely implemented today and are likely to become standard options over the next five years. They will almost certainly be displaced by something better within 10 to 15 years, but in the interim the companies that supply the components will thrive while the developers of more exotic technologies are losing money as they learn to out-manufacture Japan and Korea. While I'd be reluctant to suggest that any company is doomed to fail, I'd be equally reluctant to assume success too early in the development cycle.

In April of last year, I posted an Instablog that spoke very highly of the GM PUMA, an ultra light EV concept based on technology originally developed for the Segway. My view was that while using batteries to move one or two passengers and 3,000 pounds of vehicle at highway speeds was irrational, but using batteries to move one or two passengers and a few hundred pounds of vehicle at city transit speeds could be a winner. Just this week I ran across a story that discussed a new joint venture where GM and Shangai Automotive Industry Corp. plan to build a gussied up version of the PUMA called the EN-V for use in congested mega-cities.



I thought it was a good idea a year ago and still do. More importantly it's an outstanding example of the kind of outside the box user oriented thinking that will be required in an increasingly resource constrained world.

Every industrial revolution in history has been driven by innovations that have proven their ability to do more valuable work with lower inputs of raw materials, capital and labor. Despite lofty aspirations, consumers are far more motivated by the green in their wallets than the green in their cocktail party conversations. Try as they might, governments are never successful in their efforts to plan economic growth or drive uneconomic technologies into the market. I've long advocated the proposition that a business model that does not make sense without government subsidies does not make sense. I've also been forced by hard experience to shorten my investment horizons from decades to a few years. While I haven't yet reached the point in life where I refuse to buy green bananas, I don't have a great deal of interest in carving a new plantation out of raw jungle.

Disclosure: No companies mentioned.

Posted by John Petersen at 11:44 AM | Permalink | Comments (0)

Tom Konrad CFA

There are many proposed solutions to the liquid fuels scarcity caused be stagnating (and eventually falling) oil supplies combined with growing demand in emerging economies.  Some will be good investments, others won't.  Here is where I'm putting my money, and why.  This third part looks at the possibility of displacing gasoline with natural gas, by converting vehicles to natural gas.

In Part II of this series, I listed five potential substitutes that have been proposed to replace oil as limited supply and growth in developing markets draw oil away from traditional users.  These were:

• Biofuels and Biochemicals
  
• Vehicle Electrification
  
• Hydrogen
• Natural Gas
• Coal and Natural 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.  Part II looked at vehicle electrification and hydrogen fuel cell vehicles.  This part looks at natural gas vehicles (NGVs), their potential to displace oil, and associated potential investments.

Why Pickens' Plan Won't Work

  To understand why we should not expect too much from NGVs, I find it useful to start with the reasons proponents expect that NGVs should be able to displace oil.  T Boone Pickens is the leading proponent of this strategy, so let's take the main points from his PickensPlan:

1. It's off-the shelf technology
2. Initial costs will fall as manufacturing ramps up
3. Fuel costs are lower than diesel
4. We have abundant domestic natural gas supplies.
5. Electric Vehicles and Hydrogen are not viable for long distance trucking
6. NGVs are a natural fit for fleet vehicles.
7. Natural Gas is the cleanest fossil fuel
8. There is an existing natural gas infrastructure throughout the country.
   

I recently came across a series of well-argued articles by Eamon Keane, a British Energy Systems Engineering Master's student on why NGVs won't decrease oil dependence.  I'm going to let him do most of the arguing here, since he goes into much more detail than I would, and simply point readers to the articles where he takes on each of these points.

Off-the shelf technology That means that we already know how to use natural gas for transport.  This puts it ahead of fuel cells, but not ethanol, biodiesel, or vehicle electrification.  The other side of that coin is, if this is off-the-shelf technology and it's such a wonderful thing, why aren't we already using it?

Initial Costs Will Fall.  It seems like every form of alternative energy that currently has price problems tries to counter them using this shibboleth.  Sure, anything that is widely adopted will be able to be built more cheaply due to economies of scale.  Vehicle electrification proponents say this about batteries, too.  The question is, how far and how fast can the price fall?  Because we've known how to build NGVs for years, NGV technology is unlikely to make giant advances quickly; that's more to be expected from emerging technologies.  Eamon looks at the economics of NGVs here, and finds them wanting.

Fuel costs are lower.  Fuel costs for NGVs are only marginally lower than for diesel vehicles.  This is the argument for electric vehicles as  well, only the fuel costs for electric vehicles are much lower than for NGVs.  See Eamon's economics of NGVs post again.  Most NGV conversions have been spurred by government incentives and mandates, not economics.  Economic demand is practically non-existent.

Abundant Domestic Natural Gas.  Again, we have even more abundant domestic electricity (since natural gas is just one potential source of electricity.)  And natural gas is not as limitless as many of its boosters claim.  We're already using natural gas for industry, residential and commercial uses, and electricity generation.  Only about 3% of natural gas is currently used for transportation.  The demand for natural gas for electricity generation is likely to increase significantly, as electric utilities increasingly cancel plans for new coal powered generation because of lack of funding and climate risk.  At the same time, there is a growing movement to convert many existing coal plants to natural gas for environmental reasons.

Against this backdrop of rising demand for natural gas, proponents place the promise of abundant new supply from shale gas.  I'll let Eamon do the talking here again, but to sum up, shale gas will have serious problems ramping up enough to 1) replace the decline in conventional gas and 2) meet all the new sources of demand.  It will be very difficult for natural gas production to ramp up quickly enough just to replace diesel used in trucking.  Even if they did, refineries don't have much flexibility in the ratio of diesel and gasoline produced, so displacing only trucking diesel would create a diesel supply glut, but not offset the need to import any oil, since we'd still need as much gasoline.

Electric Vehicles and Hydrogen are not Viable for Long Distance Trucking. True.  But natural gas isn't either.  Ask the trucking industry.  They don't like the fact that the fuel tanks weigh more (so fully loaded trucks can carry less) or and even so have much shorter range than diesel trucks.  The fuel tanks on parked trucks can overheat in the sun, causing the tank's pressure release valve to vent fuel, costing money and adding to greenhouse gas emissions.  Even if a national network of natural gas fueling stations were built, the trucking industry would worry about price gouging unless there were multiple competing stations to choose from.  The extra $40 to $70 thousand initial cost of a natural gas truck and lack of competition among truck vendors is also a significant barrier. 

NGVs are a Natural Fit or Fleet Vehicles So are EVs and PHEVs, but EVs and PHEVs have the advantage that they can charge up somewhere other than the home base.  NGVs can't.

Natural Gas is the Cleanest Fossil Fuel.  Fine, if we assume we have to run our fleet on fossil fuels. 

Existing Natural Gas Infrastructure.  There's an existing electric infrastructure, too, and most garages have outlets that can (slowly) charge an EV.  None can refuel an NGV without major upgrades.  EVs can even be charged on the street with a good extension cord.  The fire department probably wouldn't be too happy if you tried that with natural gas.

Investments

The case for natural gas vehicles is only convincing if you don't compare them to the alternatives, or you think you might be able to make money by selling natural gas for fuel.  In most cases, EVs provide a better solution, despite the problems I outlined in Part II.  The only two stocks I'm aware of in this industry are Westport Innovations (WPRT), and Clean Energy Fuels (CLNE).  Westport makes fuel injection systems and engines for gaseous fuels, including natural gas as well as hydrogen and LPG.  Clean Energy Fuels is majority owned by T Boone himself and builds natural gas fueling infrastructure and liquefied natural gas (LNG) shipping terminals.  I'm not sure what the LNG terminals have to do with energy independence... T. Boone does not go into that in his eponymous Plan.

If I had to buy one of these, it would be Westport, because at least they have a diversified business that is not totally reliant on natural gas.  Fortunately, I don't have to buy either... so I won't.  Clean Energy might be worth a short, the next time it spikes, though.  Here's Eamon's take on CLNE.

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 01:55 AM | Permalink | Comments (1)

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 (7)

John Petersen

Today we have a bit of a hodge-podge as I consider sticker shocks, delays and manufacturing capacity forecasts in the vehicle electrification and energy storage sector. Since the sticker shock and delay discussions involve recent news, I'll touch on them first before getting into the fuzzier aspects of manufacturing capacity forecasts.

I'd like to begin with a note of thanks to one of my Seeking Alpha followers, MRTTF, for sending me links to both news stories. For readers who don't delve into the comment streams, MRTTF is a PhD chemist who works in R&D for a leading domestic lithium-ion battery manufacturer. I truly appreciate his willingness to correct me when I make mistakes, provide technical detail that's beyond my competence and remind overly optimistic readers "lithium-ion is best for applications where size and weight are of paramount importance and cost is no object."

Sticker shock from Nissan

It will come as a shock to many EV evangelists who expected the Leaf from Nissan Motors (NSANY) to be a cheap plug-in vehicle, but an article in Wednesday's Mainichi Daily News reported that Nissan has set the price for the Leaf at around 4 million yen, which works out to roughly $44,000 at current exchange rates. Given the earlier known price points of $40,000 for the GM Volt and $51,000 for the i-MiEV from Mitsubishi Motors (MMTOF.PK), I would have been surprised by a lower number. I may be wrong, but I just don't see consumers lining up around the block.

Nissan will no doubt develop a slick promotional campaign to show how the total cost of owning and operating a Leaf will be comparable to the cost of a conventional vehicle after accounting for Federal tax credits, available state and/or local subsidies and the expected spread between gasoline and electricity prices. My sense is the explanation will not be eagerly embraced by budget conscious consumers who expect clear short-term savings instead of a potential long-term breakeven. I have no doubt that Nissan will sell modest Leaf fleets to governments, car rental companies, utilities and corporations that are so desperate to project a green image that they'll buy a wasteful status symbol to do so. However once we get past a small and intensely vocal group of philosophically committed consumers, I think the Leaf will be little more than a curiosity item to lure shoppers into Nissan showrooms where they'll end up buying sensibly priced fuel efficient vehicles without plugs.

Delays from BYD

A more ominous news item out of China that went largely unnoticed was BYD Company Ltd.'s (BYDDY.PK) decision to go back to the drawing board and delay the widely heralded commercial rollout of its Model E6 electric car. A Bloomberg article from Monday reported that after selling a total of forty-eight F3DM plug-in hybrids to government and corporate customers in 2009, BYD has given up on its ambitious plans to mass produce electric cars in China by the middle of this year. Instead, it will build a fleet of 100 taxis for its hometown of Shenzhen, China. Many will be gravely disappointed with the decision. I just think it makes good sense.

One of my longest standing objections to the plug-in vehicle mania has been an almost total absence of long-term testing by normal people in real world conditions. Automobiles are incredibly complex machines and humans are infinitely creative when it comes to finding (or is it creating?) problems that engineers can't even imagine. Under those circumstances, I've always believed the first step had to be a small and closely monitored fleet that operates in a small area, performs a limited function and can be promptly repaired when the inevitable problems arise. Once the first phase testing is completed and the common problems are solved, the next logical step is a larger fleet of several thousand vehicles that will be placed in the hands of a wider variety of users, but still limited to a small area where they can be properly monitored and quickly repaired when new problems arise. Once the second phase testing is completed and the second level of problems are solved, the next logical step is an even larger and more widely dispersed fleet that will identify and solve additional problems, and hopefully result in a product that's ready for commercial sale to customers who expect quality and reliability.

The best analog for the process outlined above is the testing and approval of new drugs, a time-honored process that every pharmaceutical in the world goes through before it can legally be sold to consumers. The process is cumbersome, time consuming and expensive, but even then it's not perfect. Drugs are subjected to rigorous testing and monitoring because dangerous ones can be grave threats to health and safety. It strikes me as preposterous that automakers would expect, or for that matter even want, a free pass to sell potentially dangerous vehicles to customers (or is it lab rats?) without widespread and rigorous testing. I suspect that BYD will be the first of many automakers to delay their commercial rollout plans in favor of the prudent and comprehensive long-term testing that other industries conduct as a matter of course. The one thing I can pretty much guarantee is that trial lawyers everywhere will be lying wait for companies who don't.

Capacity forecasts from Roland Berger Strategy Consultants

I've previously mentioned a recent Forbes article that raises the specter of a lithium-ion battery glut within a few years. I've also said that I don't expect a glut for several reasons including faster than anticipated growth in the HEV market and rapid growth in the electric two-wheeled vehicle market. Other reasons for my confidence include 30 years of experience that new technologies invariably create new demands that were not foreseen by their developers, and the fact that plans are always subject to change, delay and cancellation.

In a recent presentation titled "Powertrain 2020; Li-ion Batteries – The Next Bubble Ahead?" Roland Berger Strategy Consultants presented the following graphic analysis of announced capital spending plans for the 20 largest lithium-ion battery manufacturers in the world. It reflects both cumulative spending through 2015 and the estimated production capacity of the planned factories. For presentation purposes, an EV equivalent is defined as a 25 kWh battery pack.



At current exchange rates, €8.2 billion is roughly $11.2 billion for 2.6 million EV equivalents, or 65 million kWh. The three companies with the most ambitious spending plans are AESC, Nissan's battery manufacturing joint venture, LG Chem, which will make battery cells for the GM Volt, and China's BYD. Curiously, the company with the most modest plans is Panasonic EV Energy, a unit of Toyota Motors (TM), the inventor of HEV technology and the dominant manufacturer in that space. While I have to confess a morbid fascination with the idea that the company with the most vehicle electrification experience is the one with the most modest spending plans, I also suspect there may be a deeper message for the perceptive.

Given the level of disappointment I expect over the price of the Leaf, I wouldn't be surprised to see AESC adjust its capital spending plans. The same goes for BYD, which won't need to build battery plants if it isn't going to be building electric vehicles to use the batteries. If other automakers follow BYD's lead and decide to take a traditional and litigation resistant approach to product development and testing, other capital spending plans are likely to be pared, delayed, shelved or cancelled. In the final analysis, the only battery plants that seem certain to be built are the ones that will be financed by the $1.2 billion in ARRA battery manufacturing grants that President Obama announced last August.

I'm a dyed in the wool plug-in vehicle critic because my calculations prove that the concept is inherently wasteful. While the message is not always clear, I'm a big fan of lithium-ion batteries for applications where size and weight are mission critical constraints and cost is a secondary consideration. When I criticize A123 Systems (AONE) or Ener1 (HEV), my criticism is leveled at applications that I see as foolish waste of good and valuable products. I remain convinced that every company that builds a battery manufacturing plant and brings a good product to market will have all the business it can handle. However I'd feel much better if everybody stopped chasing unicorns, cost effective plug-in vehicles and other mythical beasts.

Disclosure: I have no ownership or other interests in any of the companies mentioned.

Posted by John Petersen at 12:59 AM | Permalink | Comments (2)

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 (12)

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 t