John Petersen

A couple days ago Lux Research published a new report titled “Every Last Drop: Micro‐ And Mild Hybrids Drive a Huge Market for Fuel‐Efficient Vehicles” that focuses on rapidly growing markets for micro-hybrid vehicles and their battery systems.

During 2011, automakers sold an estimated 5,000,000 micro-hybrids worldwide, mainly in Europe. By 2017, Lux forecasts global micro-hybrid sales of 39,000,000 cars a year and a $6.3 billion annual market for their battery systems, which represents an across the board average of $161 per vehicle compared to an auto industry average of less than $60 per vehicle in 2009. While most US investors aren't even aware that micro-hybrid technology exists, it's already crossed the chasm and become a mainstream automotive technology.

To put the micro-hybrid phenomenon into perspective, most auto industry observers believe combined global sales of HEVs, PHEVs and EVs will be lucky to reach the 2,000,000-vehicle a year mark by 2017. Electric drive technologies may become mainstream architectures for 2025 and beyond, but for the next six years there's no doubt that cheap and easily implemented micro-hybrid technologies for mass-market vehicles will be at the epicenter of battery industry growth and profitability.

The term micro-hybrid is used to describe idle elimination systems that reduce fuel consumption by turning the engine off when it's not being used to power the wheels. They typically replace both the starter motor and the alternator with a belt-driven starter-generator, or BSG, upgrade to a better battery and add required control electronics. No other changes are necessary. While a BSG will offer a couple horsepower of cranking and generate a couple kilowatts of electricity, BSG's are not robust enough to drive a vehicle's wheels. Nevertheless, they're simple to combine with existing engine architecture and very cheap to implement. Because of their mechanical simplicity, micro-hybrids only cost $400 to $1,000 more than a conventional vehicle, but promise fuel savings of 5 to 15 percent. Micro-hybrids are a baby step, but 39,000,000 baby steps a year can cover a lot of ground and save about 15 millions of barrels of oil per year.

In their latest report, Lux divides micro-hybrids into three distinct classes that require different types of batteries.

Light Micro-Hybrids are typically sub-compact and compact cars that offer limited stop-start functionality and don't have regenerative braking. The current batteries of choice for light micro-hybrids are enhanced flooded lead acid batteries. The global market for light micro-hybrids is expected to grow to 8.5 million vehicles per year by 2017.

Medium Micro-Hybrids range from sub-compact through full-size cars that offer greater stop-start functionality and may offer limited regenerative braking. The current batteries of choice for medium micro-hybrids are enhanced flooded lead acid batteries and advanced AGM batteries. The global market for medium micro-hybrids is expected to grow to 22.2 million vehicles per year by 2017.

Heavy Micro-Hybrids are typically mid-size and full-size cars that offer the highest level of stop-start functionality, take full advantage of regenerative braking and implement other fuel economy innovations. Because of their extreme power demands, heavy micro-hybrids need better performance than the best AGM batteries can offer. The global market for heavy micro-hybrids is expected to grow to 8 million vehicles per year by 2017.

The following graph from the latest Lux report shows how the market is expected to evolve over the next six years.



On a regional basis, Lux is forecasting that:

• The European micro-hybrid market will grow from over 4 million units in 2011 to 12.6 million units by 2017.
• The North American micro-hybrid market will grow from a standstill in 2011 to over 8 million units by 2017.
• The Japanese micro-hybrid market will grow from about 400,000 units in 2011 to over 6 million units by 2017.
• The Chinese micro-hybrid market will grow from under 300,000 units in 2011 to 8.9 million units by 2017.

Last November I used the following table to highlight the differences between the daily battery load in a normal car and the daily battery load in a micro-hybrid for a typical city driving commute with 15 engine-off opportunities per leg.

Power Event	Conventional	Stop-Start
Initial engine start	500 Amp Seconds	500 Amp Seconds
Engine-off accessory loads		45,000 Amp Seconds
Engine restart loads		4,500 Amp Seconds
One-way battery load	500 Amp Seconds	50,000 Amp Seconds
Round-trip battery load	1,000 Amp Seconds	100,000 Amp Seconds

We're all familiar with the flooded lead-acid batteries that have been standard automotive equipment for decades and I don't think anybody would suggest that they can do 100 times the work without quickly failing. The automakers know that better batteries are needed, but they all want to get by with the cheapest better battery they can find because every dollar of cost matters in mass-market products.

Some automakers are using enhanced flooded batteries for their light and medium micro-hybrids solely because of cost considerations. They reason that enhanced flooded batteries offer twice the lifetime energy throughput of their simpler siblings and twice the throughput is always a good thing. The problem, of course, is that the numbers don't balance if you double the throughput of the battery and expect it to do 100 times the work.

A similar, albeit less dramatic, dynamic exists for the automakers who are upgrading medium micro-hybrids to AGM batteries that cost twice as much as their more primitive cousins but offer ten times the lifetime energy throughput. After all, improving performance by an order of magnitude is huge – until you understand that they're increasing the required work by two orders of magnitude. The bottom line is that AGM batteries will be the best available technology for micro-hybrids until a significantly better solution emerges, proves its merit and becomes available at relevant scale. Once a better solution is widely available, the market must gravitate to better performance unless the incremental cost exceeds the value of the incremental fuel savings.

I follow two companies that will be the first big beneficiaries of the rapid global adoption of micro-hybrid technologies. Johnson Controls (JCI) and Exide Technologies (XIDE) both manufacture enhanced flooded batteries for micro-hybrids and are rapidly expanding their AGM battery manufacturing capacity in North America and Europe. They will clearly be preferred suppliers for light and medium micro-hybrids from American and European automakers for the foreseeable future. While enhanced flooded batteries won't have a huge impact on either revenues or profits, their rapidly expanding AGM battery sales will double their per vehicle revenue and triple their per vehicle margins. It truly is a manufacturer's dream scenario. As micro-hybrid production numbers ramp rapidly over the next few years I expect both companies to outperform the market's expectations by a wide margin.

From my perspective the most interesting segment is heavy micro-hybrids that demand more performance than AGM batteries can hope to deliver. These next generation systems will push the frontiers of micro-hybrid technology by maximizing regenerative braking and adding other nuanced features like passive boost, which disables the BSG during acceleration, opportunity charging, which increases power to the BSG when the vehicle is decelerating, and engine-off sailing, which turns the engine off while the vehicle is rolling to a stop. The heavy micro-hybrid market is the prime target for two advanced technology systems that are working their way through the development and commercialization process, and stand a good chance of becoming industry leaders over the next few years.

In the fall of 2010, Maxwell Technologies (MXWL) and Continental AG introduced a dual device system that matches a supercapacitor module from Maxwell with an AGM battery and control electronics from Continental. The first design win for the Maxwell-Continental system is diesel powered micro-hybrids from Peugeot-Citroën. A comparable system will be used by Mazda in it's iELOOP heavy micro-hybrid. Other automakers will almost certainly follow their lead in adopting dual device systems for heavy micro-hybrids.

A second advanced energy storage system for heavy micro-hybrids is the PbC battery from Axion Power International (AXPW.OB). The PbC is an integrated battery-supercapacitor hybrid that combines lead-based positive electrodes from a battery with carbon based negative electrodes from a supercapacitor in a single cell. While the PbC is not yet available as a commercial product for heavy micro-hybrids, it is two and a half years into evaluation by BMW and other leading automakers, and offers a performance profile that simply can't be matched by anything short of a lithium-ion battery pack. If Axion can clear the last testing and manufacturing hurdles, the PbC has the potential to be a game changer in the heavy micro-hybrid space because it offers 5X the capacitance of dual device systems and 5X to 20X times the dynamic charge acceptance after a few months in service.

Last week I spent some time with a former Enersys engineer who noted that there are only two components in a car that automakers refuse to put their brand on. The first is the tires and the second is the battery. If a consumer has problems with either of those components, the automakers say, "Take it up with the manufacturer" who frequently says, "You abused our product by pushing it beyond design limits."

While the traditional blame game has a long and storied history, it can't continue indefinitely because micro-hybrids are being sold by the automakers as fuel efficiency and emissions control systems. Over the short term, the automakers will continue to play the game of using cheap batteries that can't stand up to the duty cycle. Over the longer term, applicable regulations will change to require that the OEM battery installed in a micro-hybrid be designed to satisfy the requirements of the vehicle's electric load profile.

For investors who want to benefit from the micro-hybrid vehicle trend but don’t have the time or inclination to study the various energy storage technologies in depth, a balanced portfolio weighted in favor of the large established battery manufacturers makes the most sense. While I have a personal favorite, I expect all four companies to outperform over the next three to five years.

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 04:58 PM | Permalink | Comments (0)

John Petersen

I have a new favorite word — AGGREGATION!

At the risk of sounding like a reporter, I’m going to summarize a pre-holiday news story you might have missed but need to know about.

In late November the PJM Interconnect, the largest of nine regional grid system operators in the US, announced that it had begun buying frequency regulation services from small-scale, behind the meter, demand response assets in Pennsylvania.

The first resources brought on-line by PJM were variable speed pumps at a water treatment plant and a 500 kW industrial battery array at a factory. Each of these resources has been configured to respond to PJM’s signals within four seconds and provide 100 kW of frequency regulation capacity.

In the water treatment plant, the operator will change pump speeds as necessary while keeping average throughput at 80% of nameplate capacity. For the industrial battery array, the operator will shift loads to the battery when the grid needs power and charge the battery when the grid has excess power.

The contract operators for both installations envision portfolios of flexible industrial loads that can be aggregated and operated as a distributed virtual utility that responds instantaneously to supply and demand conditions on the grid side of the meter. They’re literally turning grid loads into grid assets.

How cool is that?

I learned about the development because my old team at Axion Power International (AXPW.OB) built the battery array and is using its New Castle plant in Pennsylvania as the test-facility. But this was more than just an Axion event because it opens a world of opportunity for all manufacturers of industrial power quality and reliability systems.

Traditionally, the battery industry’s pitch on industrial energy storage systems focused on ensuring the highest possible level of power quality and reliability for industrial customers. More recently manufacturers have refined their pitch to include other behind the meter benefits like time of use and demand charge management.

This latest twist creates a whole new set of opportunities to reduce the net cost of a customer’s power quality assets by aggregating incremental revenue from grid-side ancillary services. The battery industry is at a tipping point because energy prices have finally reached a level where waste isn’t always cheaper than storage.

It’s still a tough cost-benefit equation because customers hate anything that eats into margins, but as energy storage system (ESS) developers find new ways to aggregate benefits and use their facilities more efficiently, the potential market grows exponentially.

Now it’s time to shuck the reporter’s fedora and give my horns a little room to breathe. Let’s drill deeper into the inherently confusing metrics ESS developers use to describe grid-scale storage systems.

In a recent report on grid-scale ESS costs, the DOE’s Sandia National Laboratories took a bifurcated approach to pricing that separated the costs of the power control subsystem from the costs of the energy storage subsystem. Their summary table of generic ESS costs using the principal battery chemistries breaks down like this.



The problem arises when battery manufacturers focus on a power metric in their public statements, instead of an energy metric, and fail to give readers any clues about who contributes what share of system value.

To highlight the problem I’ll use Sandia’s numbers to estimate the prices of Axion’s PowerCube and A123 Systems’ (AONE) Laurel Mountain wind farm project.



ESS buyers aren’t stupid. They won’t let battery manufacturers earn the same margin on the power control subsystem that they earn on the energy storage subsystem.

That leads to the inescapable conclusion that a $2 million ESS sale that’s 70% power control systems and 30% batteries is not the same as a $2 million battery sale. At some point the failure to clearly distinguish between purchased components and proprietary components will give rise to stakeholder confusion that could have been avoided. If market participants can’t find a way to effectively communicate the difference between power control subsystem sales and energy storage subsystem sales, they run an enormous risk that investors, analysts, bankers and other stakeholders will over-estimate the relative impact of ESS sales on the bottom line and then be disappointed when their inflated expectations aren’t met. Losing credibility with stakeholders is a luxury that no company can afford.

Life was simpler when UPS systems integrators built their products and bought batteries as necessary components. It gets far more difficult when battery manufacturers sell ESS products where the bulk of the added value comes from upstream component suppliers.

While my cup usually overflows with sage advice for anybody who’ll listen, I don’t see any easy answers to this conundrum. I suppose the industry could take the easy way out and claim that the batteries just keep the turbines turning when the wind dies down, but that’s really not an acceptable answer either.



NOTE: This article was first published in the Winter 2012 issue of Batteries International Magazine and I want to thank editor Michael Halls and cartoonist Jan Darasz for their contributions.

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 09:42 AM | Permalink | Comments (0)

John Petersen

On Friday A123 Systems (AONE) announced a direct registered offering that's an elegant example of a well-structured financing transaction in a difficult market. A123 had a solid financial base before the offering and the stock was starting to turn a critical corner into an upward trend. The new financing should add momentum to that trend.

The first stage deal terms are pretty straightforward. The investors will buy units consisting of one share of common stock and one common stock purchase warrant for $2.034 per unit, a 10% discount from the closing price of A123's common stock on Thursday. The warrants will be exercisable at $2.71 per share, a 20% premium to Thursday's close, during the 24-month period beginning six months after the closing date. The net proceeds will be approximately $23.5 million after costs and expenses.

An elegant second stage gives A123 the right to require the investors to buy up to 12.5 million additional shares next summer at a 10% discount to the 10-day average market price if A123 calls on the standby commitment and exercises what's effectively a put option. The only substantive limitation on A123's right to require the investors to buy additional shares is that they can't be required to invest more than $100 million, or $8 per share, in the second stage.

The thing I find most fascinating about the transaction is the tension between A123's current sacrifice and the investors' longer-term commitment. 

Last April I wrote that the market over-reacted to an attractive financing transaction and A123's stock was undervalued in the $6 range. The market disagreed with my conclusion and over the next eight months A123's stock price crumbled to an all time low of $1.51 in mid-December before turning to the upside. At Thursday's close, A123 was trading at a 19% discount to its September 30th book value of $2.80 per share. That makes a sale of additional shares at a 10% discount to market painful because the new investors will enjoy a modest accretion to book value while the existing stockholders will suffer a slight dilution, as summarized in the following table.

Book value per share at September 30th	$2.80
Estimated fourth quarter loss	($0.46)
Estimated book value per share before offering	$2.34
Estimated book value per share after offering	$2.30
Accretion to new investors	$0.27
Dilution to existing stockholders	($0.04)

When you factor in 100% warrant coverage at a 20% premium to Thursday's close, the first stage terms are attractive for the new investors. The second stage terms, however, are very attractive for A123 because they give the company six months to execute on its business plan and require the investors to standby with up to $100 million of additional financing if A123 decides it wants the money. The standby commitment may not be needed, in which case A123 will have no duty to sell the additional shares, but it sure is nice to have a second stage transaction locked, loaded and ready to go if more money is needed.

Earlier this month I picked A123 as a break out stock for 2012. As the following graph shows, A123's 10- and 20-day moving averages have turned up nicely and a simple reversion to the 200-day moving average would suggest a value in the $4.25 range as the stock reverts to a mean.



Since stocks that are significantly undervalued tend to over-correct as they revert to the mean, I would not view a six- to twelve-month target in the $6 range as unreasonable.

Like all battery technology developers, A123 faces a myriad of execution, market acceptance and business risks that each investor will have to assess assess in light of his own expectations and risk tolerance. It is, however, the clear sector leader in the lithium-ion battery space and likely to significantly outperform the market this year.

Disclosure: None.

Posted by John Petersen at 03:53 AM | Permalink | Comments (0)

An Elephant Hunter's Theory About Axion Power's Price Surge

John Petersen

Over the last few days I've been inundated with questions from readers who want to know why Axion Power International (AXPW.OB) has smoothly surged from a low of $0.25 on December 30th to a closing price of $0.58 yesterday. The short answer is the stock is finally emerging from the mother of all supply and demand imbalances and the persistent sellers that punished the price over the last 20 months are almost out of the picture. Since I believe we're witnessing the beginning of an entirely new market dynamic, a detailed explanation seems appropriate.

In December 2009, Axion closed a private placement transaction where four large buyers and 47 small investors bought 45.8 million shares of common stock at a price of $0.57 per share. I was thrilled. At the time I wrote:

"To my way of thinking, the most impressive aspect of Axion's financing is sheer size. Axion had roughly 37 million common share equivalents outstanding before the placement and sold 46 million additional shares. Selling 55% of a company without surrendering control is extremely rare. The more telling fact is that the cumulative reported trading volume in Axion's stock for 2009 has only been 6.6 million shares. In other words, these private placement investors bought roughly seven times the annual trading volume in a single transaction. Nobody in his right mind buys that kind of weight with the expectation that he'll be able to resell at a profit in an illiquid market. That tells me this group of investors is taking a long-term view and swinging for the fences with Axion's other large holders. I'm delighted to have the company, even if they did get a better price."

Based on 30 years in the trenches as a small company corporate finance lawyer I believed the 2009 private placement would put a solid floor of $1.20 under the stock price. The market behaved about the way I expected it would for three and a half months and then all hell broke loose when:

• A busted hedge fund that owned 2.7 million shares began liquidating;
• A bankruptcy estate that owned 544,000 shares began liquidating; and
• Resale registration statements for 2008 and 2009 private placement shares went effective.

All of the sudden there were far more shares in the hands of willing sellers than the market could absorb. As the sellers started pushing their offer prices down in an effort to clear their books or turn a quick profit, the price fell from a 10-day moving average of $1.18 on March 30th to $0.80 on May 30th. By the end of July the 10-day average had fallen to $0.55. There were no problems with Axion's business, but there were a number of large shareholders who forgot the fable of the goose that laid the golden eggs.

A few days ago one of my followers on Seeking Alpha drew my attention to the daily short reports OTCBB market makers file with FINRA. The FINRA data is unusual because the market makers report all sales of shares that aren't under their control as short sales. Therefore, two types of transactions show up in the FINRA reports:

• True short sales; and
• Transactions where a selling stockholder has a physical stock certificate that must be converted into electronic form prior to delivery.

Other transaction types are reported from time to time, but they're rare. Since true short selling has never been an issue for Axion, it occurred to me that the FINRA daily short sale reports might provide an accurate and reliable way to track resales by private placement purchasers. On Tuesday my data-mining friend H. T. Love sent me FINRA short data going back to April 1, 2010, just before the resale registration statements for the private placement shares went effective. The accuracy of the FINRA data as a tracking tool for resales of private placement shares is astounding.

Since April 1, 2010, the total of short sales reflected in daily FINRA reports from market makers is 35,888,306 shares. During that period, my best estimate of the shares that have moved from physical certificates to electronic form follows:

Busted hedge fund	2,746,869
Bankruptcy estate	543,600
Deceased stockholder	8,245,614
The Quercus Trust	5,724,978
Special Situations Funds	7,433,411
Weak 2009 small investors	10,800,000
Total	35,708,594

My best estimate of the shares remaining in the hands of 2008 and 2009 private placement purchasers follows:

Blackrock	7,150,000
Manatuck Hill Partners	7,200,000
The Quercus Trust	2,846,451
Strong 2009 small investors	3,600,000
Total	20,796,451

The only numbers in the tables that are an outright guess are the shares held by weak vs. strong 2009 small investors, and that guess simply assumes that 3/4 the small 2009 investors were spooked by the market decline and decided to take their cash out of the game at a break-even price. While the data for Blackrock and Manatuck Hill is based on old SEC filings, both should file updated reports by mid-February.

If you look at the Axion chart for the last 20 months there is nothing that would attract a short-term trader, except for a brief run-up in January through March of 2010. In fact, the chart would terrify every trader I know. That means the only people who might have been attracted the stock were investors who attended an Axion presentation and decided to buy, or who've followed my blog for a long time, climbed a personal wall of worry and decided to swing for the fences in hopes of an elephant hunter's return.

I believe my long-term readers have bought the substantial bulk of Axion’s float. Unless Manatuck Hill, Blackrock or the remaining 2009 small investors start selling in meaningful volume, it looks like the only reliable source of supply is the Quercus Trust which will probably sell the rest of its shares over the next few months. From this point forward, I believe the market price is in the collective hands of the investors who bought over the last 20 months.

The last 20 months have been a very trying time for Axion's stockholders because of a highly unusual supply and demand dynamic. In a  normal market I would have expected the floor of $1.20 to hold till the summer of 2010 when Axion announced an important development contract with Norfolk Southern that would normally have boosted the price into the $1.80 range. Last fall I would have expected Axion's disclosure of superior testing results with BMW to boost the price into the $2.70 to $3.60 range. At this point I don't know what an objective fair value for Axion's stock is, but I expect to find out over the next few weeks.

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 06:30 AM | Permalink | Comments (5)

John Petersen

In 1883 Thomas Edison said, "The storage battery is one of those peculiar things which appeals to the imagination, and no more perfect thing could be desired by stock swindlers than that very selfsame thing. ... Just as soon as a man gets working on the secondary battery it brings out his latent capacity for lying."

The problem isn't so much the batteries, which haven't improved all that much over the last century. Instead, the problem lies in the fertile imaginations of scientists, engineers, politicians, ideologues, analysts and investors who focus on new energy storage applications, overestimate the potential, underestimate the challenges and make a quantum leap from the reasonable to the absurd. There is no issue in the energy storage sector that's more wildly over-estimated than the short- to medium-term potential for using manufactured energy storage devices in the electric grid.

This week, the Smart Grid Intelligence Team at Lux Research, aka the hype busters, presented a 46 minute webinar on the current state of the grid-based energy storage market and its likely development over the next few years. After listening to the live webinar I asked Lux if they're be willing to share their work with my readers and they graciously agreed. Readers who want to listen to the entire webinar can do so by clicking on this link to "Grid Storage: Connecting dots in a fragmented market." For readers who don't have the time for the webinar, I'll try to summarize some of the highlights.

While respected institutions like Sandia National Laboratories have estimated that grid based energy storage represents a $200 billion opportunity, the global installed base of manufactured energy storage devices cost about $1.1 billion, roughly half of that capacity was built in 2011, and a similar amount of new capacity will be added next year. The following table offers a more granular analysis that allocates the installed base and planned additions, expressed in millions of dollars, among the five storage technologies Lux evaluated.



By 2015, Lux forecasts an annual market for grid-based storage in the $1.5 billion range. Other firms like Pike research expect faster growth rates. While the prospect of rapid and sustained growth is enough to awaken the animal spirits in all of us, Lux took pains to emphasize several key points:

• There is no silver bullet solution for the grid and several technology classes will be important;
• There is no unified mass market for grid-based energy storage technologies;
• The market for grid-based energy storage is highly fragmented and extremely price sensitive;
• The two largest market segments for grid-based storage are behind the meter installations for commercial and industrial facilities and in front of the meter facilities for renewable power generators;
  
• Most buyers of grid-based energy storage will require several years of reliability data before making a major capital commitment to any energy storage technology; and
• End-users of energy storage systems will try to aggregate as many value streams as possible to maximize the total economic benefit of their energy storage investments.
  

For energy storage investors, the most important question is always "Cui Bono?," who will benefit. While there are a lot more questions than answers at this point and Lux did not focus on the principal players in the emerging grid-based storage sector during the webinar, there is a fairly short list of public companies that are actively involved in developing large scale energy storage systems for the grid connected market including:

• Japan's NGK Insulators (NGKIF.PK), which has built and installed the overwhelming bulk of the high-temperature sodium-sulfur battery systems in the world and is currently trading at about 40% discount from recent highs because it has suspended battery sales pending investigation of a recent fire.
• General Electric (GE), which has built a new manufacturing facility for a high-temperature molten salt device known as the Zebra battery and is preparing to launch a series of products for large commercial and industrial users.
• A123 Systems (AONE), which has a strong working relationship with AES Corporation (AES) and is making rapid progress in the renewable power generation market with its high-power lithium-ion battery systems that are used for output smoothing and renewable to grid integration.
• Altair Nanotechnologies (ALTI), which has demonstrated a high-power lithium-ion battery system for frequency regulation and negotiated a significant sale in El Salvador that's bogged down in regulatory approval issues.
  
• Enersys (ENS), which manufactures advanced lead-acid batteries for commercial and industrial power quality, load leveling and uninterruptable power supply systems.
• Axion Power International (AXPW.OB), which has joined with Viridity Energy to demonstrate a behind the meter energy storage system for commercial and industrial facilities that integrates utility revenue and demand response savings with conventional power quality, load leveling and uninterruptable power benefits to users.
• Active Power (ACPW), which is a world-leader in flywheel based power quality and reliability systems for data centers and other critical infrastructure facilities that require absolute reliability.
• ZBB Energy (ZBB), which recently completed a three-year validation test of its flow-battery system in cooperation with Australia's Commonwealth Industrial and Scientific Research Organization, is awaiting UL approval for its power control systems and is rapidly expanding its sales and marketing team.
  

My clearest takeaway from the Lux webinar is that regulated utilities will probably be among the last to invest heavily in grid-based storage because of their risk aversion and their need to justify capital spending to regulatory agencies that are charged with protecting the ratepayers.

On the power producer's end of the grid there are significant opportunities for storage systems to smooth and stabilize power output from wind and solar while optimizing revenue streams to the owners of the facilities. At the power user's end of the grid, the most readily quantifiable values will be derived by commercial and industrial customers who can aggregate the internal benefits of power quality and reliability with external monetary benefits from demand response programs and providing ancillary services to the utility side of the meter. Over time, the most successful technologies will build a long enough track record of reliability to take a direct run at utilities and transmission system operators, but it's not reasonable to expect the utility and transmission markets to develop rapidly over the next five years.

It's far too early in the game for me to try handicapping likely winners and losers, but most of the companies in the list are currently trading at lottery-ticket prices that will not be available once their competitive positions in this rapidly expanding niche are better understood.

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 10:07 AM | Permalink | Comments (0)

John Petersen

In my second quarter update I deleted China Ritar Power (CRTP.PK) from my energy storage tracking list because of its decision to terminate its SEC registration during a period when China-based companies with US listings were bogged down in a dense fog of suspicion. Since then the carnage in the energy storage sector has been far worse than I expected and it's time to permanently remove the companies highlighted in pink from my energy storage and vehicle electrification tracking list for the reasons described below.



Current Culls

In March of this year when its stock was trading in the low $3 range, I predicted that Ener1 (HEVV.PK) would be forced to come to grips with an improvident investment in Th!nk Motors and a pair of mushy balance sheet accounts including $11.7 million of intangible assets and $51.7 million of goodwill. Since then the collapse of Ener1's stock price has been catastrophic as it wrote off the Th!nk investment and said that it would impair the bulk of its goodwill and intangible assets. When I adjust Ener1's last reported balance sheet amounts for known write-offs and likely intervening operating losses, it's clear to me that stockholders equity has been completely wiped out and while Ener1's creditors may recover some portion of their investment, the holders of 197 million outstanding common shares own an empty bag.

Earlier this year I was hopeful that Beacon Power (BCONQ.PK) would gain enough momentum from the commissioning of their Stephentown frequency regulation facility and a favorable FERC ruling to keep the company afloat long enough to prove the technical and economic merit of their high-speed flywheel technology. Unfortunately, management concluded that bankruptcy reorganization was the only option and filed on October 31st. Beacon subsequently agreed to sell the Stephentown facility for the benefit of its principal creditor, the US Department of Energy. The impairments included in their Form 10-Q for the period ended September 30, 2011 were savage and like Ener1, Beacon's stockholders equity has been completely wiped out, leaving the holders of 32.2 million outstanding common shares with an empty bag.

C&D Technologies (CHHP.PK) has been a problem stock since the fall of 2010 when it unexpectedly took a $46 million impairment charge that resulted in a forced restructuring of the company's debt. While it appeared that the reorganized C&D would continue to operate as a public company, it announced in October that its principal stockholder would buy all remaining shares for cash at a price of $9.75 per share during the fourth quarter. Accordingly, the company is no longer of interest to me.

In March of this year several articles on Seeking Alpha challenged the accuracy of SEC reports filed by Advanced Battery Technologies (ABAT.PK) and while much of the criticisms seemed to be based on innuendo and conjecture, there were some questions that concerned me enough to back away from my prior support of the company. I wasn't troubled much by ABAT's aloof response to the accusations but I became concerned when a wholly-owned subsidiary needed a $6.3 million line of credit while the parent reportedly had cash balances in $75 million range. The subsequent abrupt departure of their CFO set off alarm bells. On Monday the company's chairman told shareholders that ABAT was unwilling to comply with the Nasdaq Stock Market's request for formal confirmations prepared by its banks in the presence of its auditors because the procedure was degrading. I understand the importance of "face" in Asian culture, but I can't condone, understand or abide by an abject refusal to provide bank confirmations to a stock exchange when the price of refusal is delisting. It may all be a grand xenophobic conspiracy as ABAT's chairman claims, but I'm not willing to assume that risk.

The final cull is the result of a surprise announcement this week that New Energy Systems (NEWN) had agreed to sell its two battery manufacturing subsidiaries to employees. It will apparently retain a consumer battery design and marketing operation as well as a solar panel business, but it will no longer manufacture batteries or components. Accordingly, the company is no longer of interest to me.

Overvalued Stock Watch List

I remain very concerned with the viability of Valence Technology (VLNC) which has been surviving from hand to mouth on open market sales of securities and loans from a principal stockholder for years. In its last Form 10-Q Valence reported a negative stockholders equity of $56.8 million, which means its current market capitalization of $146.1 million represents a whopping $203 million premium to book value. As a native English speaker who lives in a French speaking country, I know all about relying on the kindness of strangers. It may work as a lifestyle, but I've never seen it work as an investment philosophy. Unless and until Valence eliminates the Sword of Damocles threat of $66.7 million in related party debt, I think the stock is too risky to own.

While Tesla Motors (TSLA) is not facing an imminent threat, its working capital adequacy is troubling if you're willing to consider possibility idea that it might encounter an unanticipated delay or two with the launch of its Model S or maybe even fall short of ambitious sales targets for 2013. At yesterday's close Tesla's market capitalization was a stunning $3.4 billion, an amount that's 11.6 times its September 30th book value of $294 million. When world class companies like Bernstein Research and Ricardo agree that electric vehicles will not be a credible market force until 2025 but almost all analysts and talking heads are gushing over Tesla's prospects, it's a sure sign that a stock has reached the Peak of Inflated Expectations which is inevitably followed by an eye watering descent into the Trough of Disillusionment. I will be first to congratulate Tesla if they pull off an Exodus-class miracle and meet current expectations, but I've seen far too many cases where the herd went careening over Wall Street's buffalo jump to believe a happy ending is likely. After all, how many other vehicles can proudly bear the following truth in advertising sticker?


Disclosure: None.

Posted by John Petersen at 09:00 AM | Permalink | Comments (2)

John Petersen

John Lennon once quipped, "Life is what happens to you while you're busy making other plans." A classic example of the phenomenon is the quiet emergence of stop-start idle elimination as standard equipment on new vehicles while politicians, pundits, the media and mechanical monkeys beat the drum and played the kazoo for the amazing EV sideshow.

Stop-start is more than a vague promise of hope and change. It's a reality that's sweeping through the auto industry today and will conserve more gasoline in 2013 than all of the worlds HEVs and plug-in vehicles combined. It's proof positive that a huge number of baby steps cover more ground than a couple of giant leaps.

Stop-start is one of the most sensible ideas you can imagine. Turn off the engine while a car is stopped at a light and then restart the engine when the light changes. In heavy traffic, this simple economy feature can improve gas mileage by 5% to 15% while eliminating emissions from idling vehicles. It's a win for the driver, a win for the environment and a win for the people on the sidewalk who don't have to choke on exhaust fumes. There are no losers and no hidden costs.

While early versions of stop-start technology date back to the '70s, the first modern stop-start systems were introduced by Peugeot-Citroën in 2006 and BMW in 2008. What began as a modest baby step with little or no fanfare is taking the auto industry by storm. In its 2011 Power Solutions Analyst Day presentation, Johnson Controls (JCI) used the following graph to show how automakers plan to implement stop-start as standard equipment over the next five years. The subtext of their presentation was "we sure didn't see this one coming."



Regardless of how you judge the merit of an automotive efficiency technology, a production ramp from zero vehicles in 2005 to planned production of 15 to 22 million vehicles a year by 2015 is extraordinary. While most investors don't even know that stop-start exists, the technology has already crossed the chasm and is certain to have a significant impact on the future earnings of a handful of public companies that are currently trading at huge discounts from their 52 week highs.



Stop-start is a classic disruptive technology; a simple baby step that opens the door to improvements in fuel economy that nobody even considered a few years ago. The only fly in the ointment is the reality that yesterday's automotive batteries are simply not durable or robust enough for the immense electrical loads stop-start systems require them to carry.

The battery problem is easy to understand. In a conventional car the battery starts the engine when you leave for work and it has to recover enough charge during your commute to restart the engine when you head home at night. With a stop-start system, the battery has to start the engine when you leave for work, carry the accessory loads during engine-off intervals, restart the engine on demand, and recover its state of charge as quickly as possible in preparation for the next engine off opportunity. The pattern repeats on the trip home. The following table highlights the differences in battery duty cycles for a 15-mile commute with an average of one engine-off event per mile.

	Conventional	Stop-Start
Initial engine start	500 Amp Seconds	500 Amp Seconds
Engine-off accessory loads		45,000 Amp Seconds
Engine restart loads		4,500 Amp Seconds
One-way battery load	500 Amp Seconds	50,000 Amp Seconds
Round-trip battery load	1,000 Amp Seconds	100,000 Amp Seconds

Think about the table for a minute. An optimized stop-start system requires 100 times the work from its battery; two full orders of magnitude. This is not a simple problem with an easy fix.

Recent studies from BMW and Ford show that flooded lead-acid batteries start to degrade in a matter of weeks and more expensive AGM batteries start to degrade within a couple months, but the batteries don't simply die. Instead, their charge recovery time increases from 30 seconds with a new battery to four minutes or more after a few thousand miles. Since stop-start systems disable themselves until the battery regains an appropriate state of charge, longer charge recovery times make the mechanical systems less efficient and eat into potential fuel savings. In many cases, stop-start systems lose most of their functionality within six months. It's sure to become a huge problem when pollution control inspectors start testing for stop-start functionality. Finding a solution now is a major challenge for both automakers and the battery industry.

In an effort to compensate for the shortcomings of conventional lead-acid batteries, automakers are upgrading from flooded batteries to AGM batteries, or to dual battery systems that use flooded batteries for starter loads and AGM batteries for accessory loads. The first big beneficiaries of these battery upgrades will be Johnson Controls and Exide Technologies (XIDE). Both companies are building new AGM battery manufacturing capacity at a blistering pace and it's easy to see why. Historically the automakers spent about $60 per car on a flooded starter battery. AGM batteries in comparison cost about $120 and dual battery systems cost about $180. Anytime a manufacturer can double or triple its per vehicle revenue and widen its margins by selling premium products wonderful things happen to the income statement. So far the income statement impact has been small because production volumes have been small. Over the next couple years the impact will become dramatic and it's already baked in.

While AGM batteries and dual battery upgrades are the best the automakers can do with current technology, they're a still a compromise and there's a growing recognition that the automakers need a more durable solution for the basic stop-start systems they're selling today and a more powerful solution for the advanced stop start systems they want to sell tomorrow. That dynamic has created a compelling business opportunity for two technology developers whose products can integrate easily with existing battery manufacturing infrastructure and are better suited to the demands of stop-start systems.

The first advanced energy storage system for stop-start was introduced last year by Maxwell Technologies (MXWL) and Continental AG. It combines a supercapacitor module from Maxwell with an AGM battery from Continental to provide the extra cranking power required by stop-start diesels from Peugeot-Citroën. The dual device architecture complements current automotive battery technologies instead of competing with them. Shifting the starter loads to the supercapacitor slows the rate of battery degradation and extends AGM battery life by up to 30%. It's not a perfect solution because it can't address the accessory loads that are over 90% of the problem, but it's clearly a step in the right direction with a product that's available today in relevant scale.

A second advanced energy storage system for stop-start is the PbC® battery from Axion Power International (AXPW.OB). The PbC is an asymmetric lead-carbon capacitor that replaces the lead-based negative electrodes in a conventional AGM battery with carbon electrode assemblies. The end result is a hybrid device that offers extraordinary charge recovery times while eliminating negative electrode sulfation, the principal failure mechanism of conventional lead acid batteries. Like the Maxwell supercapacitor module, the PbC complements current battery technologies instead of competing with them because the PbC electrode assemblies have been designed to work as plug-and-play replacements in any AGM battery plant. The PbC hasn't scored a design win yet, but extensive data generated in over two years of bench and vehicle testing by first tier automakers shows that the PbC is a very promising solution for basic and advanced stop-start systems.

A dark horse energy storage system for stop-start vehicles was introduced this year by A123 Systems (AONE). This one kilowatt-hour lithium-ion battery pack offers the cold cranking power of a quality lead-acid battery, the exceptional charge acceptance of lithium-ion and a weight reduction of about 20 pounds. While A123 has not released pricing information on its Nanophosphate® Engine Start Battery, its average unburdened cost of goods sold for the quarter ended September 30th was $1,015 per kWh. Even with significant future economies of scale, I believe it will be difficult for lithium-ion batteries to compete effectively in the low-end stop-start market because automakers must carefully weigh the trade-off between battery cost and fuel savings. As you move to the high-end market with very heavy accessory loads, the A123 solution could be compelling.

Stop-start creates an unusual business dynamic in the battery industry because the additional revenue from doubling or tripling the battery capacity of every new car leaves plenty of room for the old line competitors and the new technology entrants to thrive. The following table provides summary market capitalization and stock price data on the five companies that are likely to compete in the stop-start market.



There isn't a stock in the table that I wouldn't feel good about buying at current prices.

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 03:40 AM | Permalink | Comments (0)

John Petersen

On September 26, 2011, Bernstein Research and Ricardo plc published a 450 page analytical report titled, "Global Autos: Don't Believe the Hype – Analyzing the Costs & Potential of Fuel-Efficient Technology," which combines best in class securities research from Bernstein with the deep automotive expertise of Ricardo, a global leader in engineering, product innovation and strategic consulting. The result is the most comprehensive, detailed and eminently reasonable forecast of short-, medium- and long-term trends in advanced automotive powertrain technology that I've had the pleasure to read.

It's devoid of axe grinding or cheer-leading and simply describes how the auto industry is likely to evolve over the next couple decades. The key takeaway is two themes I regularly stress – Cheap Beats Cool and Baby Steps Rule.

Since the "Black Book" is far too detailed and comprehensive to adequately explore in a blog like mine, I think the best approach will be to summarize the key conclusions and explain how the expected evolution of powertrain technology will impact the companies I write about.

Overview. Bernstein and Ricardo are bullish on gasoline and advanced diesel technology, but cautious on the near term or medium term prospects for electric vehicles. They believe advanced automotive technologies must be affordable before logical consumers will buy new-generation vehicles in significant quantities. They have concluded that improvements to conventional engines will be key over the next 10 to 15 years and HEVs will become viable on a large scale by 2020. They believe near-term mass market adoption of electric vehicles is unlikely given the tough financial comparison with ever improving combustion engine vehicles. While premium-priced plug-ins may become viable earlier, by definition they will be niche products.

Conventional engines can meet 2020 regulatory targets at low cost. While widespread adoption of several emerging technologies including downsized engines, turbocharging, advanced fuel injection, stop-start idle elimination, advanced transmissions and other technologies that reduce rolling losses will be needed to meet regulatory targets, a shift to more expensive hybrid and electric drive technologies is unnecessary and unlikely. Except for Nissan-Renault, automakers' electric drive ambitions point to high-profile concept cars coupled with vaguely modest production plans.

Current HEVs and Plug-in Vehicles have much higher TCOs than conventional powertrains. Bernstein and Ricardo estimate the total cost of ownership, or TCO, of a conventional C-segment car at €21,300 ($28,400) over a typical four-year ownership period for the first purchaser. Without exception electric powertrains fail to offer any cost savings with HEVs costing approximately €1,650 ($2,200) more over four years, PHEVs costing approximately €4,500 ($6,000) more over four years and EVs costing approximately €10,800 ($14,400) more over four years.

Aggressive downsizing and modest electrification will be needed after 2020. To move from niche to volume production, PHEVs and EVs require a breakthrough in battery performance (energy and power density) and cost to overcome range anxiety and TCO concerns. While aggressive downsizing and modest electrification will be required from 2020 on, Bernstein and Ricardo believe the auto industry can meet regulatory targets with a 10% market share for HEVs, a 4.5% market share for PHEVs with small battery packs and a 4% market share for full BEVs. They estimate that the current cost differential between manufacturing a conventional car and manufacturing the same car with an electric powertrain is on the order of €16,000 ($21,500) before incentives.

At current vehicle costs and tax rates, oil would need to cost $300/bbl in Europe, $500/bbl in China and $800/bbl in the US before plug-ins would break even with conventional vehicles. Bernstein and Ricardo believe market forces alone are unlikely to provide enough incentive for a demand pull in electrified powertrains. While electric vehicles are likely to benefit from sizable cost reduction opportunities, combustion engines will require more expensive technology upgrades. The combination of the two will lower the break-even point for fossil fuels by ±20% over the next five years and another 35-40% by 2020. By 2025, Ricardo and Bernstein expect EVs to be competitive with conventional vehicles.

Battery cost reductions will be a key driver of future vehicle electrification. Bernstein and Ricardo estimate that currrent battery pack costs range from €4,500 ($6,000) for PHEVs to €13,500 ($18,000) for full electric vehicles, or $750-$800 per kWh of pack capacity. Battery costs will need to halve if EVs are to break even with internal combustion. Historical trends indicate that battery costs will decline by roughly 5% per year, which should bring costs down into the $310-$350 per kWh range by 2025. Until then, governments will need to bridge the gap with subsidies of several thousand dollars per vehicle for electric powertrains to be competitive.

Hybrids, PHEVs and EVs require significant amounts of additional raw materials. Conventional cars are material intensive but batteries and traction motors for HEVs, PHEVs and EVs will require significant additional amounts of raw materials that are far less plentiful and recyclable than the principal metals used in conventional cars.

While lithium supplies are adequate, competing demands for rare earth metals and copper will be challenging. Global lithium supplies are adequate for the foreseeable future, but rare earth metal production is dominated by Chinese producers and prices have skyrocketed. As new mines become productive and recycling technologies are developed, the constraints will become less burdensome, but costs will remain significant. The biggest metal constraint will likely be copper because a conventional car needs 24 kg of copper while an HEV needs 34 kg, a PHEV needs 54 kg and an EV needs 94 kg. As a result the value of the copper in an EV will probably exceed the total value of the steel and aluminum combined.

Stop-start systems offer some of the best value for money CO2 reduction potential. Bernstein and Ricardo expect that virtually every conventional internal combustion powertrain in the mature markets will feature either simple or advanced stop-start systems by 2020.

Almost all widely hyped improvements to powertrain are based on old concepts. The fundamental chemistry and physics of powertrains have not changed significantly over the past 100 years, but design and combustion efficiency gains have provided continuous advances in power density while noise, emission and fuel consumption levels have decreased. The next 15 years will be characterized by an evolution of existing technologies and the co-existence of various powertrain options, rather than the emergence of a disruptive dominant new technology such as electric or fuel cell vehicles. Over the next 15 to 20 years electrification is expected to become commonplace, but Bernstein and Ricardo expect that three out of four vehicles will still have an on-board internal combustion engine.

While I am a frequent and relentless critic of lithium-ion and electric vehicle investments because I believe the investing public has unrealistic expectations about the amount of time that will elapse between introduction and commercial success Bernstein and Ricardo didn't reach any conclusions that I'd disagree with. They expect battery development timelines to be lengthy and improvements to be limited to ±5% per year. They expect manufacturers of electric vehicles and components to lose money for several more years as they try to overcome immense TCO disadvantages and establish a toehold in the mass market. These conclusions are entirely consistent with the industry's experience with HEVs which took almost a decade to achieve a 3% market penetration in the US. The process will be evolutionary rather than revolutionary and investors who pay premium prices for the stock of companies that won't hit their stride for another decade will suffer.

In the energy storage sector, the first big beneficiaries of powertrain improvements will be Johnson Controls (JCI) and Exide Technologies (XIDE) who make starter batteries. Since stop-start technology puts tremendous strain on the battery from starting the engine several times during a commute and carrying accessory loads during engine off intervals, the auto industry is rapidly increasing the per vehicle amount they spend on batteries. Historically a new car used a simple flooded lead acid battery that cost the automakers about $60. Because of the heavier battery demands of stop-start, automakers are rapidly shifting to AGM batteries that cost about $120 and dual battery systems that cost $120 to $180. On a per vehicle basis, JCI expects cars equipped with stop-start systems to generate twice the revenue and three times the profit margin.

While current battery technology may be good enough for basic stop-start systems, it is clearly inadequate for the advanced stop-start systems automakers want to implement to minimize emissions and maximize fuel economy. Those advanced systems will need far more robust energy storage devices like the battery-supercapacitor combination that Maxwell Technologies (MXWL) has introduced on diesel powered cars from Peugeot and the revolutionary PbC battery from Axion Power International (AXPW.OB) which is in advanced stages of vehicle testing by BMW and other automakers.

I continue to believe lithium-ion cell manufacturers including A123 Systems (AONE), Valence Technologies (VLNC) and Altair Nanotechnologies (ALTI) will be poor investments over the next seven to ten years because these companies are under immense pressure to reduce costs in an industry where materials represent 60% of pack level costs and heavily automated manufacturing methods keep labor and overhead in the 22% range combined. While there are some potential economies of scale to be realized in battery management systems and perhaps a more efficient use of raw materials, the gains are expected to be slow and painful during a period when profit margins are compressed to help heavily electrified vehicles overcome crushing TCO handicaps.

While I'm cautiously negative about battery manufacturers, I don't see any possibility that niche manufacturers like Tesla Motors (TSLA) can possibly live up to outlandishly inflated expectations and maintain clearly unreasonable stock market valuations by manufacturing niche products that can only appeal to a minute fraction of the car buying public. It took three years before Tesla sold its 2,000th Roadster. While there are a respectable number of reservations for the Model S that will debut next year, there is no reason beyond unbridled optimism to believe demand for a $60,000 electric passenger car is a well-spring rather than a puddle. Even NPR, a bastion of conservative thinking, has taken to pessimistic reporting on the near-term potential of the electric vehicle sector now that unlimited government spending on ideology seems to be going the way of the dodo bird. There will be some demand and Tesla may survive as a going concern, but I can't imagine how it will retain a market capitalization that's an eye-watering 11.2 times book value and 16.4 times sales. The law of economic gravity simply cannot be denied and it will not be mocked.

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 12:29 PM | Permalink | Comments (0)

John Petersen

The last few weeks have been a media and political circus in the US as a pair of high-profile Department of Energy loan guarantees wound up in bankruptcy court. In the first case, solar power innovator Solyndra filed two years after closing a $535 million loan for a factory that never quite made it into production. In the second case, flywheel storage innovator Beacon Power (BCONQ.PK) filed about a year after scoring a $43 million loan for a 20 MW frequency regulation plant that was commissioned in June. Both are black eyes for the Obama administration’s green energy policies.

Commentators are quick to note that loan guarantees to undercapitalized companies are indistinguishable from sub-prime mortgages for busboys — the ultimate “heads I win, tails you lose” opportunity for the chosen few. While they’re right, of course, I think a superficial analysis of individual outcomes obscures deeper and more disturbing policy choices that are having a disastrous impact on American innovation, particularly in energy storage.

The ancients taught that necessity is the mother of invention, which is why we have such a wide variety of energy storage technologies. They each serve different needs and they’re each important in their own right because we live in a world where there are no silver bullets and the best we can hope for is silver buckshot. Unfortunately, preferential governmental support for a specific technology or family of technologies is the equivalent of an intellectual abortion clinic. The mere act of choosing one technology group for favorable treatment stifles inquiry and innovation on other ideas that deviate from the government sanctioned path of righteousness.

It’s official, OTHERS NEED NOT APPLY!

Lithium-ion has been chosen as the golden child of energy storage and heaven help the innovator who has an idea for a second-generation nickel metal chloride battery, a new flow battery, an advanced lead-acid battery or any other energy storage device or system that doesn’t pay grovelling homage to the official orthodoxy. In the end, society suffers when government chases the pipe dreams and promises of politically connected demagogues, ideologues and snake oil salesmen. The only possible outcome is catastrophic malinvestment that subverts the stated policy goals. While the taxpayers usually get fleeced, investors invariably get gutted.

In August 2009, the US gave a stunning $1.2 billion of ARRA Battery Manufacturing Grants to a handful of battery companies on the theory that good intentions would trump economics and usher in a golden age of electric cars to free America from the tyranny of imported oil. The 95% allocation to emerging lithium-ion technology compared to the 5% allocation to all other battery technologies combined said it all. Pharaoh has spoken – So let it be written, so let it be done!

Nobody bothered to ask whether the world’s mines could produce enough raw materials to make the batteries at relevant scale. In most cases they’re still not asking, even though metal prices are climbing faster than energy prices. Power-drunk political appointees simply assumed there would be no critical supply chain or technology issues and staggered down the primrose path. Similar ill-conceived plans were adopted with reckless abandon by governments worldwide.

We live on a resource challenged planet where six billion people want a small slice of the lifestyle that one billion of us have and take for granted. Our world produces almost two tons of energy resources a year for every man, woman and child on the planet, but it only produces 8.5 kg of non-ferrous industrial metals. Given the stubborn and inflexible nature of metal production constraints, it doesn’t take much math skill to see the problem.

The stark reality is humanity can’t make enough machines to have a significant impact on global energy consumption and CO2 emissions because the world's miners can’t provide the necessary raw materials. It's not just a question of lithium. The physical constraints on global production of aluminum, copper, lead, nickel, cobalt and a host of scarcer metals are staggering and the six billion people who simply want electric lights, a washing machine and maybe a refrigerator will not sacrifice their basic needs so that Tesla Motors (TSLA) can sell electric cars in California financed by a $465 million ATVM loan that it can’t possibly repay without an Exodus-class intervention from the Almighty.

The first fruits are evident. Existing and planned lithium-ion battery plants will be able to manufacture cells for 2.4 million EVs a year by 2015, however, they can only expect 820,000 units of demand in a high penetration rate scenario. While the looming global glut of cell manufacturing capacity is widely recognized, a more pervasive and perverse dynamic exists in the supply chains for several critical components those factories will need if they hope to manufacture cells.

The following graph comes from an August 2011 presentation from Roland Berger Strategy Consultants. It shows that the global supply chain for anodes will be exhausted if cell production reaches 430,000 units per year while the supply chain for separators will be exhausted if cell production reaches 450,000 units per year. It also shows that the supply chain for cathodes and electrolytes will hit ceilings at 660,000 and 770,000 units respectively.



Since it’s impossible to manufacture cells without anodes, cathodes, separators and electrolytes, I have to wonder about the management teams that are building cell manufacturing facilities without first ensuring the integrity of their supply chains. The apparent lack of concern over supply chain issues is staggering. I can’t decide whether it’s reckless apathy or simply a childlike faith that the taxpayers, like doting first-time grandparents, are breathlessly waiting for any opportunity to provide whatever the golden child needs or wants.

How do you justify building cell-manufacturing capacity that’s three times greater than your best-case demand?

How do you justify building cell-manufacturing capacity that’s six times greater than your supply chain can support?

Is government somehow exempt from the duty to conduct reasonable due diligence before investing?

Seriously, where are the adults in this process?

While the media can’t begin to comprehend the magnitude of the impending catastrophe, the dominoes have started to fall.

Ener1 (HEVV.PK) spent about half of its $120 million ARRA Battery Manufacturing grant before an obscenely optimistic investment in Th!nk Motors brought the company to its knees. In the process its stock tumbled from a post-grant high of $7.53 to a current price of $0.11. Now Ener1’s third management team in eight months plans to change the business focus from automotive to heavy-duty transport and grid-based applications. Thanks to $80 million of improvident borrowing and $51.8 million of additional planned goodwill impairments that are buried in an attachment to its recent Notification of Late Filing, Ener1’s fate will probably be decided in a bankruptcy case controlled by its largest creditor Goldman Sachs, which put a $3.75 price target on the stock last March while I was warning readers to run for cover.

How the hell do you default on a grant?

A less dramatic but equally ominous surprise was the Johnson Controls (JCI) - SAFT divorce. Their ambitious plans to make automotive batteries together till death do us part couldn’t even survive the commissioning of a new factory that’s being built with $300 million of DOE grants. In the face of feeble automotive demand, JCI wanted to expand the joint venture's focus to encompass stationary and ancillary markets. SAFT wanted no part of that proposal because it didn’t want yet another competitor for its factory in Florida that was; you guessed it, built with $95.5 million in DOE grants.

While they’re keeping a stiff upper lip in public, I can’t help but feel a little sorry for A123 Systems (AONE), which is building a factory with $249 million in DOE Grants and wants to borrow hundreds of millions more under the DOE's ATVM loan program. Their IPO prospectus spoke of strong relationships with global automotive manufacturers and tier 1 suppliers, but their automotive design wins to date are limited to a $15,000 electric upgrade to the $15,000 GM Spark and the gorgeous but corpulent Fisker Karma, which is being financed with yet another $530 million from the public trough.

While it’s a decidedly pessimistic view I can identify over $3 billion in battery and electric vehicle projects funded by Federal money that have poor to dismal business prospects, including:

$299.2	ARRA Battery Manufacturing Grant to JCI-Saft
$249.2	ARRA Battery Manufacturing Grant to A123 Systems
$118.5	ARRA Battery Manufacturing Grant to EnerDel
$95.5	ARRA Battery Manufacturing Grant to Saft America
$528.7	ATVM Loan to Fisker Automotive
$465.0	ATVM Loan to Tesla Motors
$1,400.0	ATVM Loan to Nissan Motors

I’m a frequent critic of the headlong rush to build electric vehicle manufacturing capacity and infrastructure without any real proof that the planned wonder vehicles will satisfy customer needs, or that the facilities will be used for something other than homeless shelters for displaced green workers.

My fundamental problem arises from the fact that every industrial revolution in history started with a technology that proved its economic merit in a free market and then went on to change the world. Companies and indeed industries that cannot survive without government subsidies can’t thrive with them. Supporting the moribund with the lifeblood of the vibrant may be compassionate, but it can’t produce a good economic outcome.

Over a decade of experience in the HEV market shows that consumer demand ramped sharply for several early years, hit a market penetration rate of about 3% and then flatlined. Over the last three years, clean diesels and plug-ins have begun to cannibalize the HEV market, but they've done nothing to bring new buyers to the fold.

Once again, governments are pushing on a string and trying to force the market to embrace electric drive, the only vehicle class with an unbroken 100-year history of failure. Once again governments will fail, just like they did with other panacea energy solutions including fast breeder reactors, synthetic fuels, hydrogen fuel cells, clean coal and the ever popular corn ethanol and biodiesel that turn food into fuel and make both more expensive.

In late 2008 the world fell into the mother of all recessions as it reached the peak of a decades long debt supercycle. Now the piper is demanding his due and individuals, businesses and governments around the world are being forced to reduce their crushing debt burdens. In the midst of a global deleveraging, I don’t see how insolvent governments can continue to use public funds to subsidize the ideology-based personal consumption of eco-royalty. How many bottomless pits can one nation's taxpayers be expected to fill?


Even if our governments are willing to continue this foolishness, I don’t see how a vibrant market for EVs can possibly develop among real world consumers who can buy gasoline versions of a Lotus Elise, Ford Focus or GM Spark for half the price of their electric counterparts.

The transformer Optimus Prime is a big hit with little boys. Spending billions so big boys can pay twice the price for their very own Suboptimus Prime strikes me as a triumph of hope over experience.

This article was first published in the Fall 2011 issue of Batteries International and I want to thank editor Michael Halls and cartoonist Jan Darasz for their contributions.

Disclosure: None.

Posted by John Petersen at 02:15 AM | Permalink | Comments (2)

John Petersen

Last November I broke with tradition for the first time in over 30 years and suggested a paired trade that bought Exide Technologies (XIDE) and shorted Tesla Motors (TSLA). Over the following three months, investors who made the trade and bought four Exide shares while shorting one Tesla share pocketed the following gains.

	16-Nov-2010	16-Feb 2011	Net
	Entry	Exit	Gain
Buy Four Exide	-$29.76	$49.68	$19.92
Short One Tesla	$30.80	-$24.73	$6.07
Pair Trade Total	$1.04	$24.95	$25.99

While the paired trade hit its peak value in mid-February of this year, it didn't turn south until early June.



Since June, Exide has fallen to unsustainably low levels and Tesla has climbed to unsustainably high levels, which means it's once again time to recommend a paired trade that buys Exide while shorting Tesla. At yesterday's close the ratio works out to an 11.5 share Exide buy for each shorted share of Tesla. The results this time around should be even better than last year because the valuation disparities summarized in the following table are so immense.

	Exide	Tesla
Price Per Share	$2.87	$33.22
Market Capitalization	$244.2	$3,464.2
Working Capital	$512.1	$257.9
Book Value	$415.8	$294.1
TTM Sales	$3,092.9	$201.1
TTM Earnings	$8.8	-$224.3

A couple days ago I suggested that Exide's Recent Price Collapse Was Unjustified and explained how forced liquidations by a large Exide shareholder have crushed its stock price on two occasions during the last two years. Today I'll summarize a few of the headwinds that Tesla must face and overcome if it hopes to avoid a major price decline.

Battery Safety Questions. Over the last week there have been numerous news stories about an NHTSA inquiry into the safety of automotive lithium-ion battery packs after a GM Volt that had been used for crash testing spontaneously caught fire at an NHTSA facility. While the stories remain optimistic about the outcome, they overlook the inconvenient truth that safety testing of lithium-ion battery packs is not comparable to the procedures automakers used for other batteries.

In the late 90s Ford built a test fleet of electric delivery vans called the EcoStar that used sodium sulfur batteries. As part of their normal testing, Ford took a "Vlad the Impaler" approach to safety and used a hydraulic ram to drive a ten-inch long four-vaned arrowhead wedge into a fully charged 35 kWh battery pack. The sodium sulfur battery passed the test. As far as I know, safety testing for lithium-ion batteries is limited to driving an eight penny nail into a single cell. I have not been able to find any published reports of destructive pack level testing to determine how the failure of one cell might cascade through a battery pack that contains up to 6,800 cells.

To put the safety question into sharper perspective, Japan's NGK Insulators suspended its sodium sulfur battery production and asked its customers to stop using its products until an investigation uncovered the cause of an unexplained battery fire. Before the incident NGK had a flawless 10-year safety record, but it still asked its customers to suspend operations on an installed base of 305 Megawatts of power and over a gigawatt hour of energy storage at 174 locations worldwide because of a single incident where nobody was hurt.

If the NHTSA reaches an entirely reasonable conclusion that pack-level testing of lithium-ion batteries has been given short shrift in the headlong rush to bring electric vehicles to market, the delays and risks of thorough pack level testing and the associated news coverage could be catastrophic for specialty EV manufacturers.

Charging Infrastructure Issues. For several years China has been perceived as a global leader in vehicle electrification. Over the last several months, public statements from Chinese leaders have grown increasingly wishy-washy, suggesting that fuel efficiency and HEV technologies would be easier and less expensive to implement at relevant scale. Just this week Forbes reported that China’s power-grid giants – China Southern Grid and State Grid – may throw another monkey wrench into the works by insisting on battery exchange schemes instead of distributed charging infrastructure. While actions in Mainland China will probably not have much direct impact on Tesla, the risk of similar restrictive decisions by utilities in more important markets cannot be dismissed out of hand.

Resale Value Questions. One of the biggest unanswered questions in the electric vehicle space is resale value. Advocates assure us that EVs will retain their value better than conventional cars despite the fact that the battery packs that represent up to half of the vehicle cost are consumable and wear out over time. Yesterday's Wall Street Journal reported that vehicle leasing firms in Israel were having second thoughts about Project Better Place because of uncertainty over residual value. While leasing and residual value issues may not be critical to buyers of the Tesla Roaster, they're likely to be important to buyers of the upcoming Model S which is targeted to an upscale consumer market where vehicle leasing is commonplace.

The Valley of Death. There are no greater, crueler or more universal truths in the stock market than the hype cycle and the valley of death. While there are exceedingly rare exceptions like Google, substantially all new companies and new industries go through a cycle of inflated expectations followed by profound disillusionment. Substantially all cases where companies have avoided the hype cycle have involved a high level of business maturity and close to flawless execution. The following graph from the Gartner Group illustrates the typical stages.



Tesla's execution to date has been pretty good and as far as I can tell it hasn't encountered any significant delays or setbacks. Unfortunately its stock is priced to perfection and anything less than flawless execution going forward can be a catalyst that pushes the stock off the peak of inflated expectations and into the trough of disillusionment. Given the substantial external risks I've discussed above and the inherent risks discussed in Tesla's SEC filings, I think the downside risk in Tesla's stock outweighs the upside potential by an order of magnitude.

Disclosure: None.

Posted by John Petersen at 10:09 AM | Permalink | Comments (2)

John Petersen

After the market closed on Monday, Exide Technologies (XIDE) released surprisingly poor second quarter results, a $3.6 million loss that included a $5.7 million charge for several years of reporting irregularities at a small Portuguese recycling subsidiary. The market's reaction was absolutely savage as the stock collapsed from Monday's close of $4.48 to Friday's close of $3.01. In my view, the reaction was unjustified and has set up a tremendous buying opportunity for investors who are willing to look beyond the headlines and focus on core business fundamentals.

To put things in perspective, Exide's stock has closed at or below Friday's price on 24 days since October 2007, and 22 of those days were during the depths of the March 2009 market melt-down. The stock is currently trading at a 59% discount to its 200-day moving average of $7.32, a mere 7.6% of annual sales and about 57% of book value. Despite some obvious challenges Exide faces over the next year, this is a blood in the streets buying opportunity.

Since I started blogging in the summer of 2008 Exide's stock has seen more ups and downs than a high-tech roller coaster. The following chart overlays the 10-, 20-, 50- and 200-day weighted moving average price on the 200-day moving average volume since July 2008.



To a casual observer the chart looks absolutely chaotic, but most of the blame for bizarre price swings can be attributed to factors that have nothing to do with Exide's business. On December 31, 2009, a family of funds managed by Jeffrey Gendell owned 23,705,133 shares, or about 30% of Exide's outstanding stock. The following is table derived from holding reports and other SEC filings and summarizes the quarterly Gendell stock sales in 2010 and 2011. The timeframes marked with red bars in the chart coincide exactly with the periods of heaviest Gendell selling.

Date	Balance	Sales
31-Dec-09	23,705,133	-
31-Mar-10	20,738,399	(2,966,734)
30-Jun-10	15,089,230	(5,649,169)
30-Sep-10	12,312,410	(2,776,820)
31-Dec-10	10,295,260	(2,017,150)
31-Mar-11	9,489,476	(805,784)
30-Jun-11	9,489,476	-
26-Sep-11	7,799,476	(1,690,000)

Since the beginning of 2010 a single holder has pushed almost 16 million shares into the market with catastrophic results for the stock price. When the selling abated for a while in the first two quarters of 2011 the stock price tripled, only to crash yet again when the selling began anew. The bottom line reality is that no market can hold up under sustained selling pressure from large stockholders and it doesn't matter whether the sustained selling pressure occurs in an industry leader like Exide or a newcomer like Axion Power International (AXPW.OB). The result is always the same.

I'll not minimize the challenges Exide must face as it idles its flooded lead-acid battery plant in Bristol, Tennessee and restructures its domestic manufacturing and distribution network, but total restructuring costs over the next 12 months should amount to less than half of the average annual restructuring costs Exide incurred over the last three years and the positive impact on short- to medium-term earnings should be substantial. It's also important to note that Exide is just now entering its two strongest fiscal quarters and expects to report significant earnings for the current year.

As Exide gets its house in order over the next two years, its price to book ratio should climb into the 1.75 range and its price to sales ratio should climb into the 55% range, which implies an upside potential of 300% to 500%. The challenges Exide faces are serious, but they're ordinary course of business challenges, rather than existential challenges.

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 07:11 AM | Permalink | Comments (0)

John Petersen

Since June of 2009 I've been a voice in the wilderness proclaiming that stop-start idle elimination will become a dominant automotive fuel efficiency technology by mid-decade and represent a tremendous business opportunity for established lead-acid battery manufacturers like Johnson Controls (JCI) and Exide Technologies (XIDE) and emerging energy storage technology developers like Maxwell Technologies (MXWL), Axion Power International (AXPW.OB) and A123 Systems (AONE). In the process I've suffered more than a little abuse, scorn, derision and ridicule from EVangelicals who think it makes sense to propel up to 5,300 pounds of metal at highway speeds with quarter-ton battery packs. With each passing day, however, it becomes increasingly clear that my cautious assessment of electric drive and my optimistic outlook for cheap and simple fuel efficiency is spot-on accurate because, in the words of Vinod Khosla, "Economics matter and nothing that defies the law of economic gravity can scale."

The most recent confirmation that stop-start will leave all other vehicle electrification technologies in the dust over the next decade comes from a Pike Research report titled "Stop-Start Vehicles, Micro Hybrid Technologies, Batteries and Ultracapacitors; Market Analysis and Forecasts," which reports that while stop-start technology is not well known or understood in North America, stop-start vehicles, or SSVs, are already outselling hybrids by a factor of 3.5 to 1 and the stop-start advantage is expected to widen to 16 to 1 over the next few years because of low cost and easy integration.



In its discussion of the business opportunity Pike said, "Global revenue from the sales of stop-start batteries will grow from $827 million in 2011 to $8.9 billion in 2020, at a compound annual growth rate of 30%." The Pike report mirrors similar conclusions from Lux Research in their October 2010, report "Micro-hybrids: On the Road to Hybrid Vehicle Dominance." Both reports are a good deal more conservative than EPA forecasts that stop-start will be implemented in 42% of US light duty vehicles by 2016. In a weirdly ironic Halloween twist, Wunderlich Securities analyst Theodore O’Neill blamed the rapid adoption of stop-start for limiting demand for lithium-ion batteries and plug-in vehicles. “Where it went off the rails," said O'Neill, "is all the major car companies figured out in 2009 that they could use a different technology to meet the emissions standards in the U.S. and in Europe ... That technology is start-stop."

I've always argued lead-acid batteries would remain competitive for decades as the battery of choice for cars with internal combustion engines, but I never expected to read that stop-start technology and lead-acid batteries were crushing vehicle electrification. Score one for the home team!

Even though stop-start has had a hard time catching the mainstream media's attention, it's the most sensible and cost-effective fuel efficiency and pollution reduction technology imaginable. It automatically turns off the engine when your car isn't moving and instantly restarts the engine when you take your foot off the brake. The biggest problem with stop-start is that it's a battery killer because instead of starting the engine once when you begin a trip, it has to start the engine several times during the trip, carry accessory loads during engine off intervals and recover its charge very quickly to prepare for the next engine off opportunity.

The conventional flooded lead-acid batteries that we've all come to know and hate are simply not robust enough for stop-start. So the auto industry needs a better energy storage solution to accomplish the worthy goal of eliminating wasted fuel and useless pollution from idling vehicles.

The auto industry's widespread and rapid adoption of stop-start has come as a big surprise to most battery manufacturers and industry analysts. Historically almost all cars used flooded lead-acid batteries for starting, lighting and ignition. While AGM batteries have existed since the 70s, global production capacity was limited to a few million batteries a year and most AGM batteries were used in aviation, marine and other high-end applications where their sealed design avoided problems with electrolyte leakage, gas generation and maintenance. Simply put, the world's battery manufacturers were not ready for a surge in AGM battery demand from the auto industry which needs about 55 million batteries a year.

Since the world's battery manufacturers didn't have enough factory capacity to make AGM batteries for the auto industry, their first response was to introduce enhanced flooded batteries that don't perform as well as AGM, but can be made in existing plants. Their next response was to go on a huge capital-spending spree to build new AGM battery manufacturing facilities. Between 2002 and 2009, JCI averaged about a million AGM batteries per year. By 2015 it plans to make about 18 million AGM batteries a year. Exide is also expanding its AGM capacity from 500,000 batteries a year in 2010 to 5.5 million batteries a year by 2015. Other battery manufacturers are quickly following suit.

When Citroën and BMW introduced the first stop-start systems in 2006 and 2008, the technology was viewed as a modest advance with an uncertain future. The initial reviews were less than flattering because the systems performed fabulously in new cars but suffered sharp performance declines as the batteries aged. That gave rise to a concerted industry-wide effort to learn why lead-acid batteries failed in stop-start vehicles and find solutions to the problem.

At the 2010 European Lead Battery Conference, BMW and Ford explained the problem of dynamic charge acceptance to the world's lead-acid battery manufacturers and used the following graphs to show how AGM batteries used in stop-start systems begin to lose their dynamic charge acceptance almost immediately and become effectively worthless after a few months. They also explained that unlike traditional vehicle designs, engine starting was only a minor issue in stop-start because over 90% of the energy used during an engine off interval was attributable to accessories, rather than the starter.



While the graphs provide a lot of data the most important line has a burgundy highlight and shows how charge recovery time increases from 30 seconds with a new battery to several minutes with a battery that's been used for a few months. Since stop-start systems disable themselves until the battery has recovered, a battery that can recover in 30 seconds will invariably save more fuel than a battery that needs several minutes to recover.

Today the auto industry and the battery industry find themselves at an impasse over battery performance in stop-start. The automakers have made it clear that traditional AGM technology is not good enough for today's stop-start systems and can't possibly support future stop-start systems that will offer better fuel economy and put even greater strain on their batteries. The battery industry has responded by producing enhanced AGM batteries that are an improvement over traditional AGM technology, but remain inadequate for the demands of future stop-start systems. To solve the problems and accomplish their fuel economy and emissions reduction goals, most automakers are actively evaluating other technology alternatives.

Continental AG and Maxwell Technologies developed the first new approach to energy storage for stop-start. Their system combines a supercapacitor module with an AGM battery to ensure that stop-start diesels from Peugeot Citroën have enough cranking power to reliably restart the engine. In their second quarter conference call, Maxwell's CEO noted that the system would also increase AGM battery life by roughly 30%. While the Continental-Maxwell system can't do much to overcome the dynamic charge acceptance limitations of AGM batteries, Pike believes supercapacitors will be used to complement batteries in stop-start systems for diesel engines.

Axion Power International is presently completing the development of a second novel approach to energy storage for stop-start and preparing to launch their first product. Axion's PbC battery is a hybrid device that replaces the lead-based negative electrodes in an AGM battery with carbon electrode assemblies that eliminate sulfation, the chemical process that causes conventional AGM batteries to lose their charge dynamic acceptance capacity over time. Since the PbC is a third-generation lead-acid device, it can be assembled on any conventional AGM battery line. In over two years of exhaustive testing by BMW and others the PbC has demonstrated remarkably stable dynamic charge acceptance through several years of simulated use in a stop-start vehicle. While the PbC is not currently available for use in stop-start vehicles, the Pike report suggests that the PbC will be available for use in 2013 model year vehicles.

A123 Systems has recently announced the launch of a lithium-ion battery for stop-start vehicles. Their engine start battery combines sixteen of their 20 Amp hour cells with associated control electronics to deliver a kilowatt-hour of energy and the cold cranking amperage necessary for an automotive starter battery. Because of the high cost of lithium-ion batteries, Pike believes their market penetration will be "very limited" and restricted to expensive performance vehicles.

Stop-start presents a rare dynamic for the lead-acid battery industry because the new technology solutions from Maxwell and Axion will complement rather than compete with existing battery products. Supercapacitors from Maxwell will function as add-on component that improves the efficiency of today's AGM batteries. Similarly, carbon electrode assemblies from Axion have been designed for easy integration into existing AGM plants as a plug-and-play component that can make today's AGM batteries better. Both technologies can help established battery manufacturers better serve their customers needs without eating into their revenue from product sales. For both companies, the ability to leverage existing manufacturing facilities, distribution networks and customer relationships should facilitate a much faster ramp rate than one could expect from a new product that needs to overcome entrenched competitors, build manufacturing, distribution and customer service capabilities and divert staff from other lucrative markets.

JCI and Exide will be the first big beneficiaries of the global shift to stop start. Both companies are trading well off their historic highs and have attractive upside potential. As products from Maxwell and Axion prove their merit in stop-start vehicles and increase production capacity, their shares should perform well. Since Axion has a market capitalization of $40 million while Maxwell is valued $550 million, Axion has greater upside potential for risk tolerant investors.

Currently, the media hype is all about lithium-ion batteries and plug-in electric drive, but auto industry's production plans are all about stop-start and other fuel efficiency technologies. Given a choice between chasing sunshine, lollipops and rainbows or investing in an established automotive trend, I'll take the established trend any day.

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 02:54 AM | Permalink | Comments (5)

John Petersen

In their 1969 bestseller "The Peter Principle" Laurence Peter and Raymond Hull quoted a Latin-American student named Caesare Innocente who lamented, "Professor Peter, I'm afraid that what I want to know is not answered by all my studying. I don't know whether the world is run by smart men who are, how you Americans say, putting us on, or by imbeciles who really mean it." After watching the events of the last few weeks, I think most of my regular readers would agree that the imbeciles are clearly steering the ship.

Last March I went to the Geneva Motor Show on press day, which gave me a chance to see the cars up close and personal without fighting the crowds. While I'm generally skeptical when it comes to electric drive, I left Geneva convinced that the Fisker Karma was the most beautiful passenger car I'd ever seen. I even promised my inner geek that I'd secretly take one for a test-drive once production started. The last remaining hurdle was cleared in mid-October when the EPA issued its official fuel economy rating of 52 MPGe for the electric range of 32 miles and 20 MPG for gas powered trips using the 2.0 liter onboard generator.

I was crestfallen. How could something so gorgeous and green get such a horrible fuel economy rating?

The answer, it seems, is that when you put the Karma on a scale it weighs a few hundred pounds more than a Hummer H3 and a few hundred pounds less than a Cadillac Escalade. That's right folks: it's a 5,300 pound behemoth that was engineered in California with $169 million of ATVM loan guarantees from the Department of Energy. While most of the long-term economic benefits from manufacturing these shocking green monstrosities will be outsourced to Finland, at least the batteries will be made in the US by A123 Systems (AONE) which made a $23 million venture capital investment in Fisker to establish a strategic relationship and ensure the battery supply contract.

When journalists and political pundits questioned the reasonableness of the Fisker loan guarantee, the DOE explained:

"Fisker’s loan has two parts. In the first part, Fisker used $169 million to support the engineers who developed the tools, equipment and manufacturing processes for Fisker’s first vehicle, the Fisker Karma. That work was done Fisker’s U.S. facilities, including its headquarters in Irvine, California, which has 700 employees and plans to continue hiring. While the vehicles themselves are being assembled in Fisker’s existing overseas facility, the Department’s funding was only used for the U.S. operations. The money could not be, and was not, spent on overseas operations. The Karma also relies on an extensive network of hundreds of suppliers in more than a dozen U.S. states."

The sophistry of using taxpayer money to finance special project jobs in California while creating long-term manufacturing jobs in Finland is self-evident. The more troublesome questions in my mind are:

1. How many $100,000 Karmas will Fisker need to sell to earn enough profit to repay $169 million in DOE loans?
2. How many battery packs will A123 need to sell to Fisker if it wants to recover its $23 million investment?
3. Is either outcome even remotely possible given the lackluster sales and margins that Tesla Motors (TSLA) has realized from its equally sexy and expensive Roadster?

This was clearly a series of deals negotiated by imbeciles who really mean it. The most outrageous part of the DOE's defense was the penultimate paragraph which says:

"Remember that plasma TVs, cell phones, personal computers and many other common products were once fabulously expensive luxury items, but quickly became a staple for middle class Americans. These price declines wouldn’t have been possible without the first, commercial scale marketing as premium products."

BALDERDASH! I expect that kind of bafflegab from EVangelicals but not from government officials.

There is no possibility that electric vehicles will ever deliver the kinds of cost reductions we witnessed during the information and communications technology revolution because the fundamental science is totally different. There is no Moore's law for the physics of moving a 2.65-ton vehicle down the road. There is no Moore's law for electrochemistry. There is no fairy godmother to increase global production of non-ferrous metals or control commodity prices. But instead of rationally discussing science, supply chains and energy economics, we have the DOE deflecting reasonable questions with the time-honored wisdom that "facts don't matter because the essence of political debate is the plausible boldly asserted."

A little over three years ago I started cautioning readers that Ener1 (HEVV.PK) was a disaster in the making. My cautions got more strident when Ener1 made a substantial venture capital investment in Th!nk Motors to strengthen their strategic relationship and retain a battery supply contract that was jeopardized by Th!nk's insolvency. While some readers took my words of caution to heart, many did not. This week they learned that analyzing battery and electric vehicle companies through rose colored glasses is a great way to end up with a stock that's listed on the Pink Sheets. While I generally like to be right, I hate being this right.

I wonder how the DOE feels about that $118.5 million ARRA Battery Manufacturing Grant they gave Ener1 in August of 2009.

My graph for this week is courtesy of Lux Research and appeared in their recent report "Using Partnerships to Stay Afloat in the Electric Vehicle Storm." The graph is particularly instructive because it overlays their forecasts for the electric vehicle and lithium-ion battery markets in a single graph.



The yellow lines represent total demand for lithium-ion batteries in automotive applications through 2020 using three different oil price scenarios. The blue shaded area represents the total planned production capacity of the global lithium-ion battery industry for the same period. The inescapable conclusions are that (1) without $200 oil, growth in electric vehicle sales will be tepid at best and certainly not robust enough to justify nosebleed market capitalizations for companies like Tesla, and (2) the glut of lithium-ion battery manufacturing capacity will be a crushing burden for all but the most efficient and financially sound battery manufacturers.

While Pike Research recently reported that demonstration projects have deployed 538 MW of lithium-ion based storage on the grid, all of the facilities I've read about report power based on a 15 minute discharge. That means the demonstration projects have used about 135 MWh of batteries to date, or less than 1% of the expected annual capacity glut. While grid-based storage may have significant long-term potential, it's not a big enough short-term opportunity to make a difference.

The takeaway for investors who are willing to remove their rose colored glasses is that the industry leaders in the electric vehicle and lithium-ion battery sectors are run by imbeciles who really mean it and their companies are doomed to underperform the market for years. Molly Ringwald was Pretty in Pink, but it's an ugly color for stock listings.

Disclosure: None.

Posted by John Petersen at 12:48 PM | Permalink | Comments (4)

John Petersen
Earlier this month Deloitte Touche Tohmatsu Limited’s Global Manufacturing Industry group rained all over the plug-in vehicle parade when they published the results of a survey of over 13,000 individuals in 17 countries that concluded:

"The reality is that when consumers actual expectations for range, charge time, and purchase price (in every country around the world included in this study) are compared to the actual market offerings available today, no more than 2 to 4 percent of the population in any country would have their expectations met today based on a data analysis of all 13,000 individual responses to the survey."

While Deloitte's conclusions didn't surprise me, they did clarify my thinking about the market for ultra-high efficiency vehicles and the changes I've been following for the last three years. While I'm usually pretty opinionated, this article will focus more on uncertain market dynamics that aren't clear today but will become self-evident over the next couple years.

The niche market for ultra-high efficiency vehicles has only existed since 2000 when Toyota (TM) introduced the Prius. For the first nine years, the only real contenders were hybrid electric vehicles. Beginning in 2008, we saw demand emerge for new classes of ultra-high efficiency vehicles including "clean diesels" and plug-in vehicles like the Tesla Roadster (TSLA), which was recently joined by the Nissan Leaf (NSANY.PK) and the GM Volt (GM). The common characteristic of all ultra-high efficiency vehicles is a price premium that ranges from $4,000 in the case of a clean diesel to $15,000 or more in the case of a plug-in.

The following stacked graph shows total US sales of ultra-high efficiency vehicles since 2000 and estimates 2011 sales based on sales through September 30th.



Over the last three years, the niche market for ultra-high efficiency vehicles has basically stagnated, averaging about 3% of new car sales. While that number ties nicely to Deloitte's conclusion that plug-in vehicles would satisfy the expectations of 2 to 4 percent of the population, the more fascinating thing about the graph is that while the trendline for the ultra-high efficiency vehicle class isn't all that bad given the financial turmoil we've experienced since 2008, it's crystal clear that clean diesels and plug-ins are eating into the HEV market instead of attracting new converts to the ultra-high efficiency vehicle fold.

Logically it makes sense to me that only a small percentage of US car buyers would be willing to pay a $4,000 to $15,000 premium for an ultra-high efficiency vehicle, but we'll need to see at least a couple more years of data before drawing any definitive conclusions. Until we see a major upswing in the overall market penetration rate for the ultra-high efficiency vehicle class, however, I have to assume that plug-ins, clean diesels and HEVs will compete hammer and tong with each other for the 3% of the new car market that doesn't care about cost premiums and be politely ignored by the 97% of the market that thinks the green in their wallets is more important than the green in their cocktail party conversations.

Usually when I get to this point in an analysis, the EVangelicals start trotting out their subsidy arguments to justify the exorbitant costs. While a wide variety of subsidies and incentives have been adopted over the last couple years, I don't believe they have any long-term viability because the world has reached a tipping point where governments can no longer afford to throw public money at an ideology embraced by the 1% at substantial cost to the 99% who are finally taking to the streets in sheer unfocused frustration. While today's protestors lack the coherent goals that we had during the civil rights and anti-war movements of the 60s and 70s, public fury over government policies that benefit the new royalty at the cost of the masses is mounting and it's only a matter of time before people come to grips with the inherent immorality of taxing Peter to buy Paul a new car, particularly when Paul is part of the 1%. When you add in recent developments like a car dealer Congressman who fired an employee over the unauthorized purchase of a GM Volt for his dealership, I have to conclude that today's immense but wholly unjustifiable eco-bling subsidies will quickly become little more than footnotes in automotive history.

My favorite reader comments are the ones that breathlessly compare Tesla and other EV developers with Apple (AAPL). The comparisons are actually quite apt, but not in the way commenters intend. For the first 15 years that I used Apple's computer products they focused on the 3% to 5% of the market that was willing to pay a stiff premium for something different and clearly superior. The stock was one of the worst investments in the tech sector and those of us who loved Apple's computers spent a lot of time worrying that the company would fail. The dynamic didn't change until Apple rolled out its iPod line for the masses in late 2001. Since then serial successes with mass market products including the iPhone and iPad have Apple them the success story of the new millenium. The possiblilty that Tesla or any other EV developer will be able to make a comparable splash with four wheels, a massive battery and a 25 foot power cord is laughably remote.

The graph clearly shows that the ultra-high efficiency vehicle market has temporarily if not permanently flat-lined at a 3% market penetration. While it may be a fun place for technology geeks to marvel over the latest gee-whiz press release, it's not a market for serious investors because there's no upside unless the market penetration rates change significantly. For the next five years, the solid potential for market beating performance will be in un-loved battery industry stalwarts like Johnson Controls (JCI), Exide Technologies (XIDE) and Enersys (ENS) and emerging technology developers like Axion Power International (AXPW.OB) that are working on less dramatic fuel efficiency technologies for the 97% of the market that doesn't care about premium priced eco-bling and believes baby steps matter.

Since September 30th, the broad market indexes have gained an average of 6.7%. During that period JCI has gained 20.6%, Exide has gained 12.5%, Enersys has declined 0.4% and Axion has declined 1.9%. All four companies have rebounded convincingly from recent bottoms and appear likely to outperform the market on a go-forward basis.

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 06:09 AM | Permalink | Comments (4)

John Petersen

I'm often critical of public lithium-ion battery manufacturers based on objective investment metrics including their financial condition, their results of operations, their potential markets and the fundamental soundness of their business plans, but I don't usually drill down into thornier issues like technical merit and business execution because those questions are out of my depth and in the words of Harry Callahan, "A man's got to know his limitations."

Every once in a while, however, organizations that are competent to evaluate those issues publish analytical reports that can help investors cut through the hype and make better investment decisions. The following “Innovation Grid” graphic from Lux Research that first appeared in a June 2011 report titled, "Using Partnerships to Stay Afloat in the Electric Vehicle Storm," is a fine example.



In the underlying report, Lux explained that they:

• Evaluated the value of core technologies, the addressable market size, the competitive landscape, and IP position to rank companies along a vertical axis ranging from 1 (Low) to 5 (High);
• Evaluated management strength, profitability, partnership value, overall momentum, and the surrounding environment to rank companies along a horizontal axis ranging from 1 (Low) to 5 (High);
• Evaluated maturity by considering size, stage of development, and annual revenues to rank companies by dot size; and
• Provided a subjective overall ranking ranging from strong caution to strong positive.

Lux developed the Innovation Grid hierarchy of lithium-ion battery producers because its market analysis indicates that global lithium-ion battery manufacturing capacity will exceed demand by a wide margin for the better part of the next decade. Accordingly, it believes the looming capacity glut will force an inevitable consolidation where a handful of dominant manufacturers survive while weaker market participants fail.

Since I didn't create the Innovation Grid hierarchy, I'm not going to argue about the relative technical and business merits of the various companies. My primary goal today is to observe that some winners of headline grabbing ARRA battery manufacturing grants in August 2009 seem to be technical and/or business laggards, including:

• JCI-Saft, which was awarded $299.2 million dollars in ARRA battery manufacturing grants, recently became a wholly owned subsidiary of Johnson Controls (JCI), and is safely ensconced in the heart of mediocrity;
• A123 Systems (AONE), which was awarded $249.1 million dollars in ARRA battery manufacturing grants but received mediocre grades for technical merit and sub-par grades for business execution; and
• Ener1 (HEV), which was awarded $118.5 million dollars in ARRA battery manufacturing grants but received laggard grades for both technical merit and business execution.

All of them are apparently less attractive business opportunities than Advanced Battery Technologies (ABAT) which was savaged in a trio of articles from Variant View Research in March and April of this year, but is well positioned in the Lux hierarchy.

At Friday's close ABAT was trading at 30% of book value, 70% of annual sales and 1.9 times trailing-twelve-month earnings. If you want to own stock in a lithium-ion battery company ABAT seems like a far better choice than the subsidized laggards.

Disclosure: None.

Posted by John Petersen at 10:23 AM | Permalink | Comments (0)

John Petersen

I've been writing about micro-hybrid vehicles and stop-start idle elimination since May 2009. It's a cheap and simple fuel efficiency innovation that turns the engine off while a car is stopped at a light and automatically restarts the engine when you take your foot off the brake. It's not gee-whiz sexy, but it can boost fuel economy by 5% to 15% in city driving and dramatically improve urban air quality by reducing idling. What could be more sensible?

When I first wrote about stop-start in "Why Advanced Lead-acid Batteries Will Dominate the HEV Markets," the only market forecast I could find came from Frost & Sullivan, which predicted that global micro-hybrid sales would ramp from 800,000 units in 2008 to about 10 million units in 2015, a superb growth rate by almost anyone's standard.



By April 2010, expectations about the ramp rate for stop-start technology had increased significantly and the final rule release for new CAFE standards predicted that stop-start would be used in 42% of new US passenger cars by 2016. In its recent Power Solutions Analyst Day presentation, Johnson Controls (JCI) summarized automakers current plans and forecast a global penetration rate of 25 million stop-start vehicles per year by 2016, over 2-1/2 times the rate forecast by Frost & Sullivan in 2009.



By 2020, JCI expects global stop-start vehicle sales on the order of 50 million vehicles per year.

Regardless of what you believe automakers and consumers should do when it comes to fuel efficiency, it's clear that the automakers are implementing stop-start at a fevered pace and the technology will become standard equipment over the next five years. In response to surging demand from automakers, JCI is ramping its manufacturing capacity for absorbed glass mat, or AGM batteries, from four million units this year to an estimated 18 million units by 2015. Other manufacturers like Exide Technologies (XIDE) are following suit and it won't be long before cars equipped with stop-start systems are saving more fuel per year than all HEVs, PHEVs and BEVs combined.

Baby steps and low hanging fruit are important!

Despite their fuel economy advantages, stop-start systems are very hard on the batteries that need to restart an engine ten or even twenty times in a typical commute and carry accessory loads during engine-off intervals. In the real world, stop-start systems work great when the batteries are new but quickly lose their functionality as the batteries age. The following graph from the Department of Energy's Idaho National Laboratory illustrates the problem with shocking clarity.



With brand new batteries the test vehicles had great fuel economy. As the batteries deteriorated over a few months of use, the bulk of the fuel economy benefits vanished.  At last September's European Lead Battery Conference, BMW and Ford explained the problem in a joint presentation that focused on dynamic charge acceptance, the ability of a starter battery to recover the energy used during an engine-off cycle and get ready for the next engine-off cycle. The key take-away from the BMW-Ford presentation was that today's leading battery technologies, including flooded and AGM batteries, are not well-suited to the extreme power and charge acceptance demands of stop-start systems.

For stop-start to reach its full potential, the auto industry desperately needs a better energy storage solution.

Maxwell Technologies (MXWL) and Continental AG developed the world’s first enhanced energy storage system for stop-start vehicles with diesel engines manufactured by Peugeot-Citroën. The system uses a supercapacitor module from Maxwell and an AGM battery from Continental to ensure that there will be enough power to restart the engine at the end of a stop-start cycle. While the Maxwell-Continental system is a significant advance over AGM batteries, it does not address the core issue identified by BMW and Ford, which is the ability of the battery to recover the energy used by a vehicle's accessories during an engine-off interval. It does a great job of carrying a 300 amp-second starter load, but does very little to help the battery recover from a 3,000 amp-second accessory load.

A123 Systems (AONE) developed a second enhanced energy storage system for stop-start based on its lithium iron phosphate technology. The one kilowatt-hour battery pack offers the cold cranking amps of a high quality lead-acid battery, the high charge acceptance of lithium-ion batteries and a weight reduction of about 20 pounds.

Axion Power International (AXPW.OB) is currently completing the development of a third enhanced energy storage system for stop-start vehicles based on its PbC technology, a lead-carbon hybrid that does not suffer from negative plate sulfation, the primary failure mechanism for both flooded and AGM batteries in stop-start applications. At last September's European Lead Battery Conference, BMW and Axion presented test data confirming that the PbC retained its dynamic charge acceptance through the equivalent of four years of use in stop-start simulation. In a recently published white paper, Axion released more detailed information on the performance of a dual-battery PbC system.

Currently, the market for stop-start energy storage systems is wide open and there is very little clarity about the types of systems automakers will ultimately choose for their vehicles. The following table summarizes the alternative approaches automakers are actively testing and evaluating, and provides a rough estimate of the cost of each energy storage alternative.

Enhanced flooded batteries (single battery system)	JCI Exide	$75
Enhanced flooded batteries (dual battery system)	JCI Exide	$150
AGM batteries (single battery system)	JCI Exide	$150
Dual battery - flooded starter battery with AGM accessory battery	JCI Exide	$225
Dual device - supercapacitor starter with AGM accessory battery	Maxwell Continental	$250
Dual device - flooded starter battery with PbC accessory battery	Axion Power	$325
Lithium-ion battery	A123 Systems	$750

The emergence of stop-start as standard equipment presents a tremendous opportunity and a tremendous challenge for energy storage developers and manufacturers. Automakers are accustomed to paying $75 for a starter battery and there is intense pushback against dual battery systems and AGM batteries that will double the cost. Despite the automakers' resistance to cost increases, many have accepted the reality that they'll have to upgrade to single battery AGM systems or even dual battery systems that use an AGM battery for accessories and a flooded battery for the starter. To date only one automaker has made the decision to upgrade to a dual device supercapacitor and AGM battery system, however A123 systems has said that an undisclosed automaker has signed a production contract for its lithium-ion starter battery. The Axion system is currently being tested by BMW and several other automakers, but has not yet captured a design win.

I see the market for stop-start batteries as a knockdown drag-out brawl for the next couple of years. Consumers will not be happy with stop-start systems that offer great performance for a month or two and then deteriorate. While the automakers will resist upgrading to premium energy storage systems, customer demands coupled with constantly increasing regulatory pressure to improve fuel economy will force them to implement more sophisticated and expensive systems from Maxwell, A123 and Axion.

In the third quarter Maxwell gained 13% while the broader markets lost 13%. At yesterday's close, Maxwell had a market capitalization of $495 million and was trading at 4.7x book value and 3.5x trailing twelve month sales. Those metrics strike me as expensive compared to A123 Systems, which has a market capitalization of $381 million and trades at a discount to book value and 3.6x sales. Since it's still in the last stages of product development, Axion carries a very modest market capitalization of $42 million, or about 1.5x book value (after adjusting for bargain asset purchases) and trades at 4x to 5x anticipated 2011 sales.

While established lead-acid battery manufacturers like JCI and Exide will be the first beneficiaries of the stop-start market as their revenue per vehicle doubles and their margins triple, the energy storage system that offers the best combination of price and performance will ultimately win the lion's share of the market. While it’s impossible to pick a winner at this point, second, third or even fourth place in a $7 to $10 billion dollar market niche with no solidly entrenched competitors could be a company maker for any of the emerging technology developers.

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 09:57 AM | Permalink | Comments (4)

John Petersen

Tom Lehrer is frequently credited with a quip that perfectly summarizes my feeling about the financial markets in the third quarter, "Apart from that Mrs. Lincoln, how did you enjoy the play?" During the quarter we were given box seats to classic political opera in two acts. Act One was set in Washington DC while Act Two moved to Europe so we could hear the same tortured songs of woe in a different language. We all know the opera has to end with the immensely popular "Kick the Can Chorus," but we suspended disbelief, bought into the fear and held a massive liquidation sale. As a curtain call it looks like we've let our elected demagogues scare us into a new recession. Do you ever wonder if the system might work better if ballots included "None of the above" as an alternative and required the offices to remain vacant if nobody won a majority?

For the third quarter the Dow, S&P 500 and Nasdaq indexes were down an average of 13.1% and it was even uglier in energy storage where the best names in the business were beaten down by 35% to 50%. The following table summarizes the price performance of my tracking list for the year and the quarter ended September 30, 2011.



It was a bloody time that's creating a great buying opportunity. While it's still a little early to buy the biggest companies in the sector, it's a wonderful time to do some homework, map out a strategy and prepare for the inevitable bottom.

For reasons I can't explain, several energy storage companies move in the same direction as the S&P 500, but react more violently to changing market sentiments. To illustrate the phenomena I've created a graph that compares percentage price movements for Johnson Controls (JCI), Enersys (ENS), Exide Technologies (XIDE) and Active Power (ACPW) against the S&P 500 using 10-day volume weighted moving averages instead of daily prices.



While the pattern is less obvious over longer periods, the following graph that tracks the percentage price movements since April 1, 2009 shows that the pattern holds in both up and down markets, which suggests that buying storage at the next bottom should have a significantly greater upside potential than buying the broader market at the bottom.



The next bottom may well be the buying opportunity of a lifetime as energy storage emerges as an investment mega-trend and the market realizes that cool has no place in an industrial sector where cost matters and the law of economic gravity reigns supreme. Core positions in Johnson Controls, Enersys and Exide Technologies are a must have for all serious storage investors. Depending on your risk appetite, more speculative companies like Active Power, Axion Power (AXPW.OB), Maxwell Technologies (MXWL) ZBB Energy (ZBB) and perhaps Beacon Power (BCON) also merit serious consideration.

For the last three years I've cautioned investors that the media circus around plug-in vehicles and exotic batteries was a transitory phenomenon driven by ill-conceived ideology instead of common sense. The upcoming recession will force the government and the markets to recognize that plug-in vehicles are unconscionable waste masquerading as conservation and a luxury no nation can afford, much less subsidize at relevant scale.

My last chart for the day compares the market capitalizations of my tracking list companies on September 30, 2009 and September 30, 2011. While Axion Power and Exide are far stronger today than they were in the fall of 2009, most of the companies that lost a lot of market value have also lost a lot of ground.



The simple but undeniable reality is everybody wants better batteries but nobody wants to pay a premium price for them. The green in an ordinary consumer's wallet will always take priority over the green in his cocktail conversation. Manufacturers of objectively cheap products that can do the required work are certain to thrive over the next five years. Developers of exotic batteries for plug-in vehicles and other uneconomic applications are likely to follow the same tragic path as Ener1 (HEV).

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 10:04 AM | Permalink | Comments (4)

John Petersen

A comment from maxkilmachina recently drew my attention to an article in the Proceedings of the National Academy of Sciences titled Valuation of plug-in vehicle life-cycle air emissions and oil displacement benefits. While it costs $10 to download the article and supporting documentation, I believe it's worthwhile for all serious energy storage and electric vehicle investors because the underlying study is the first comprehensive total cost of ownership analysis I've seen that includes both direct end-user costs and identifiable externalities like emissions, military and other indirect costs arising from oil consumption in the US. While all studies leave room to quibble, the bottom line conclusion is clear:

"[T]oday’s HEVs and PHEVs with small battery packs offer more emissions reduction and petroleum displacement per dollar spent with less of a need for new infrastructure and with lower uncertainty about future costs ..."

The detail is a bit dense for an investment blog, but two summary graphs from the article go a long way toward reducing glittering generalities to hard economics. They summarize the direct and indirect costs for five types of vehicles under three possible scenarios. The term CV refers to conventional vehicles with internal combustion engines. The term HEV refers to conventional hybrid electric vehicles. The terms PHEV20 and PHEV60 refer to plug-in hybrids with electric drive ranges of 20 km and 60 km, respectively (12.5 and 37.5 miles). The term BEV240 refers to a battery electric vehicle with a 240 km range (150 miles).

The first graph deals exclusively with unpriced externalities including emissions, military and global supply and demand impacts of US oil consumption. While bigger battery packs offer modest advantages in the wildly optimistic case of a zero emission grid, they're not as cost effective as HEVs and PHEV20s in either real world scenario.



The second graph ties it all together in a unified total cost of ownership analysis that accounts for all direct and indirect costs including purchase price, fueling, maintenance and unpriced externalities. Once again, bigger battery packs offer modest advantages in the Pollyanna case but are 50% to 100% more expensive in both real world scenarios.



The message for investors is clear. When you cut through the hand waving and glittering generalities plug-in vehicles with big batteries have been weighed in the balance and found wanting. They promise the worst possible combination of facile emotional appeal and dismal economics. They can only be attractive to the philosophically committed or the mathematically challenged. As the ugly truth becomes apparent to congressmen, businessmen and consumers that are staggering under crushing debt burdens and facing an immediate need to balance revenues and expenses, the hype induced euphoria over companies like Tesla Motors (TSLA) that make plug-in vehicles and battery companies like A123 Systems (AONE) and Valence Technologies (VLNC) that make big battery packs for toys must fade because immutable laws of economic gravity won't permit any other outcome.

As a child of the 1950s I once believed Superman could leap tall buildings in a single bound. As a mature adult of the 2010s I know the only way to reach a mountaintop is by climbing a slippery slope one step at a time. When I consider the magnitude of the economic sophistry underlying current government policy, I'm not sure that I'd want to be a Congressman or Senator standing for election next year and explaining how subsidized toys for the politically favored eco-elite benefit the voting public. Green jobs that cost consumers money instead of saving it simply aren't worth having.

I'm a securities lawyer, accountant and investment writer, not a futurist. My only concern is whether a particular company will prosper over the next five years or struggle. Anything beyond that is unknown and to my way of thinking largely unknowable. While investors are constantly bombarded with shimmering mirage-like visions of what might happen in a decade or two, they're largely ignorant about the concrete steps automakers are taking today to improve fuel economy and reduce emissions now. The following graph is a great example because it shows how the auto industry is responding. It begins with 2010 plans for the rollout of stop-start technology, layers on new plans that were announced this year and offers a conservative estimate for likely future additions. Stop-start is only a baby step toward a more fuel-efficient future, but it's an immediate step that will save more fuel over the next decade than all HEVs and plug-ins combined.



The first beneficiaries of the rapidly evolving implementation of stop-start as standard equipment will be established battery manufacturers like Johnson Controls (JCI) and Exide Technologies (XIDE) that will see their revenue per vehicle double and their margin per vehicle triple as automakers upgrade their starter batteries from flooded lead-acid to valve regulated AGM batteries. Second tier beneficiaries include Maxwell Technologies (MXWL) which has partnered with Continental AG to offer a system that pairs a supercapacitor module with an AGM battery to improve performance; A123 Systems which is offering a 1,100 watt hour lithium-ion battery for stop-start applications; and Axion Power International (AXPW.OB) which is completing the development of a third generation lead-carbon battery that promises lithium-ion class performance for stop-start applications at an advanced lead-acid price point.

It will be a horse race, or a knock-down drag-out brawl, as established manufacturers and emerging technology developers compete for their share of a $5 to $10 billion market that didn't exist three years ago. We probably won't be able to identify the ultimate winners with any degree of confidence for another three to five years. In the interim the stock prices of all the credible competitors are certain to climb because they're in the race for a major business prize. While it's hard to find much good in current market conditions, the stock prices for most of the credible competitors have recently been beaten down to very attractive levels. In a period of transition it's only natural for the more timid element to run for cover, but these are the days elephant hunters dream of when the broader market is distressed but the universe of likely players is small.

Talking about what the vehicle fleet might look like in a decade or two is fun for futurists but it's very dangerous ground for investors because of intervening business and technical risks, overwhelming and unavoidable natural resource constraints, the time value of money and the inherent unreliability of forecasts that extend for more than a few years. For my money, today's sure thing is far more attractive than a wildly uneconomic technological long shot.

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

UPDATE: I just received an e-mail message advising that the lead author of the PNAS report has posted a free copy on his faculty web page at Carnegie Mellon University.

Posted by John Petersen at 10:40 AM | Permalink | Comments (5)

John Petersen

After eight years of rarely speaking above a whisper, Axion Power International (AXPW.OB) has found its voice, taken the scientific wraps off its PbC® battery technology and shown potential customers, competitors and investors that it's carrying a big stick and is poised to dominate energy storage for stop-start idle elimination – a cheap and sensible fuel efficiency and emissions reduction technology that's expected to grow at spectacular rates for the rest of the decade as shown in the following forecast of battery demand in vehicles equipped with stop-start systems.



In a new white paper on dynamic charge acceptance that's available in the Investor section of its website, Axion has thrown down the technology gauntlet and shown why flooded and valve regulated lead-acid batteries from Johnson Controls (JCI), Exide Technologies (XIDE) and others aren't good enough for today's stop-start systems and won't be good enough for even more demanding second generation systems. In the process it's also shown why a dual device system from Maxwell Technologies (MXWL) and Continental AG (CTTAY.PK) that combines a supercapacitor module with a valve regulated AGM battery can't be an optimal solution either.

The basic problem is that stop-start systems require their batteries to operate at a partial state of charge and conventional lead-acid batteries rapidly deteriorate if they're not kept fully charged. There's a fundamental mismatch between the needs of the application and the capabilities of the battery. With flooded lead-acid batteries the deterioration is obvious within weeks. With valve regulated AGM batteries it takes a few months. As the battery deteriorates, the mechanical systems just stop working. Stop-start systems that lose their functionality over a few weeks or a few months because of feeble batteries aren't efficiency technologies at all - they're greenwash. Automakers desperately need a better solution, but it has to be easy to manufacture, easy to scale and cheap enough for a price sensitive mass market.

In simple terms, the PbC is a battery-capacitor hybrid that loves operating at a partial state of charge and doesn't deteriorate rapidly with age. While the basic chemistry is pure lead acid, Axion replaces the lead-based negative electrodes found in conventional batteries with carbon electrode assemblies that eliminate battery deterioration and pave the way for second-generation systems that will offer even better performance. Since the white paper does a fine job of explaining the science, I'll focus on the business dynamics that favor rapid launch and widespread implementation of the PbC technology.

The PbC offers 10x the dynamic charge acceptance and 20x the cycle-life of conventional lead acid batteries for one reason – it's a third-generation device that takes valve regulated AGM battery technology to a whole new level. While the science underlying the PbC technology was patented in 2002, the challenge was developing production methods and equipment that could leverage existing manufacturing and distribution infrastructure instead of replacing it. Axion spent eight years developing PbC electrode assemblies that can be used as plug-and-play replacements for the lead-based electrodes used by battery manufacturers worldwide. The last step is earning OEM certification for its automated electrode manufacturing processes. Once the OEM's have certified Axion's electrode manufacturing processes, it will be easy for an AGM battery manufacturer to substitute PbC electrode assemblies for their conventional lead electrodes and offer a better battery to customers without having to requalify their factories or their products.

Unlike other battery manufacturers that want to build new factories and develop new customers, or wrestle business away from entrenched competitors, Axion plans to pursue a platform technology strategy where it will focus on manufacturing a high value component for sale to existing manufacturers that want to offer a better product to current customers. Axion's strategy was lifted from the Intel playbook. They don't care who manufactures the battery for a particular customer as long as it uses Axion's electrodes. With a strong intellectual property estate that will keep new entrants away from its sandbox, Axion is well positioned to forge a variety of cooperative relationships with battery manufacturers worldwide.

The only battery technology on the market that can offer comparable performance in stop-start applications is lithium-ion. While lithium-ion developers like A123 Systems (AONE) are actively developing products for the stop-start market, their batteries are more expensive than the PbC and harder to scale because they can't leverage existing infrastructure. They also suffer from significant cold weather performance issues and have limited potential for future cost reductions while the PbC is at the upper left-hand corner of the learning curve. There's a reason that first tier battery buyers like BMW and Norfolk Southern publicly aligned themselves with the PbC technology before there was a PbC product.

In his seminal book The Innovator's Dilemma, Dr. Clayton Christensen uses the term disruptive technologies to describe low-cost innovations that satisfy new customer needs, improve over time and eventually displace established technologies. The following graph illustrates the phenomenon.



If you believe Dr. Christensen's theory it's impossible to believe that lithium-ion batteries that were developed for the most demanding uses will be the ultimate winner in energy storage for stop-start idle elimination. Technologies simply do not transition downstream from high quality uses to low quality uses. Disruptive technologies always start at the bottom and work their way to the top. Given a choice between embracing the PbC technology and working with Axion or losing critical market share to more expensive lithium-ion products, the lead-acid battery industry will do the only sensible thing.

At yesterday's close Axion had a $48 million market capitalization and a serially patented technology that holds the price and performance keys to a multi-billion dollar market. The math seems obvious to me. In less than two weeks Axion will present at the Rodman & Renshaw conference in New York. It's stock had a strong run in February and March of this year after similar presentations at lower tier cleantech conferences sponsored by Piper Jaffray, Jefferies and Kaufman Bros. While the first run was crushed by selling pressure from a couple of large stockholders, cumulative trading data leads me to believe that the willing sellers are effectively out of stock and can't cause a comparable reversal of the next run.

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 06:51 AM | Permalink | Comments (4)

John Petersen

I was recently invited to prepare a memorandum on the battery industry for the electric mobility working group of the World Energy Council, a global thought leadership forum established in 1923 that includes 93 national committees representing over 3,000 member organizations including governments, businesses and research institutions. Since my memorandum integrated several themes from this blog and tied them all together, I've decided to publish a lightly edited version for readers. To set the stage for the substantive discussion that follows, I’ll start with an 1883 quote from Thomas Edison:

“The storage battery is one of those peculiar things which appeals to the imagination, and no more perfect thing could be desired by stock swindlers than that very selfsame thing. Just as soon as a man gets working on the secondary battery it brings out his latent capacity for lying.”

At the time, Edison was a customer who wanted to buy batteries to improve the reliability of the Pearl Street Station, the first coal-fired utility in North America. An essential truth even Edison failed to recognize is that battery developers don't lie, but potential customers consistently lie to themselves. They hear about gee-whiz inventions, overestimate the practical importance of the innovations and then make quantum leaps of imagination from the reasonable to the absurd. Therefore, the most important task for investors is to critically and objectively examine their own assumptions and avoid hopium induced hallucinations.

Cleantech, the Sixth Industrial Revolution

I believe we are in the early stages of a new industrial revolution, the Age of Cleantech. The cleantech revolution will be different from all prior industrial revolutions because the IT revolution forever changed a dynamic that has existed since the dawn of civilization. It gave the poor and the ignorant access to the global information network, proved that there was more to life than deprivation and sparked a burning desire for something better in billions of people who were once content with mere subsistence. It's long-term significance will be more profound than the discovery and settlement of North America.

The inescapable new megatrend is that six billion people have been awakened to opportunity and are striving to earn a small slice of the lifestyle that 600 million of us enjoy and typically take for granted. If the six billion are even marginally successful and attain a paltry 10% purchasing power parity, global demand for everything must double. Therefore, the most important challenge of our age will be finding new ways to satisfy insatiable demand for water, food, construction materials, energy and every commodity you can imagine.

The first and easiest step will be to eliminate waste in all its pernicious forms to make more room at the economic table. After that, the challenges become far more daunting.

The Everything Shortage

There is a widely held but grossly inaccurate belief that energy prices and CO2 emissions are the most pressing problems facing humanity. The reason is simple – in advanced economies everybody buys energy commodities in minimally processed form several times a month. Each of those purchases reinforces a belief that energy prices are an intolerable burden. While few of us purchase other minimally processed commodities beyond energy and food, the following graph compares the prices of non-ferrous industrial metals with the price of crude oil and highlights an inescapable and highly inconvenient truth that almost nobody understands –

METAL PRICES ARE MORE VOLATILE AND INCREASING MORE RAPIDLY THAN ENERGY PRICES.



To compound the problem, global production of energy resources is several orders of magnitude greater than global production of critical metals, as the following table based on data from the U.S. Geological Survey clearly shows.



Metric tons per person vs. kilograms per person is an insurmountable disparity.

Most alternative energy and electric drive technologies can’t be implemented without large quantities of scarce metals. All of the metals in the table have critical competitive uses in other essential products and significantly increasing global production of any of them is problematic if not impossible. While improved recycling practices have the potential to help alleviate shortages of critical metals, a recent UN study of global recycling rates for 60 industrial and technology metals found that only 18 had end of life recycling rates over 50% while 34 had end of life recycling rates under 1%. The metals that are most important to alternative energy and electric drive are very difficult and expensive to recycle. So with the exception of lithium, which is a plentiful resource that only represents 5% or 6% of the metal content in Li-ion batteries, the world cannot produce enough technology metals to permit a widespread transition to alternative energy or electric drive.

Any alternative that can't be deployed at relevant scale isn’t an alternative at all. It’s merely an expensive distraction for the masses, a bit like the circus in ancient Rome.

The Diminishing Marginal Utility of Batteries

Once you understand that metal supplies are far more constrained than energy supplies, every evaluation of electric drive becomes a simple exercise in optimizing the fuel savings from each unit of metal used. The five generic levels of electrification and the typical fuel savings at each level are summarized below.

Vehicle configuration	Battery	Savings
Stop-start systems use lead-acid batteries to eliminate idling while a vehicle is stopped but do not provide any electric boost.	1.0 kWh	10%
Mild hybrids like the Honda Insight use NiMH batteries to recapture braking energy and provide up to 20 or 30 horsepower of acceleration boost.	1.5 kWh	25%
Full hybrids like the Toyota Prius use NiMH batteries to recapture braking energy, offer electric launch and provide up to 80 horsepower of acceleration boost.	1.5˚kWh	40%
Plug-in hybrids like the GM Volt use Li-ion batteries to offer 40 miles of electric range before a range extender engine kicks in to power the electric drive.	16 kWh	75%
Battery electric vehicles like the Nissan Leaf use Li-ion batteries to offer up to 100 miles of electric range under optimal conditions.	24 kWh	100%

While NiMH has been the preferred battery chemistry for mild and full hybrids since they were introduced in the late 90s, it is a terribly resource constrained chemistry because the “M” most commonly used in NiMH batteries is the rare earth metal lanthanum. With per capita global lanthanum production running at a rate of 5 grams per year, significant expansion of NiMH battery production is effectively impossible, which is the main reason that Li-ion is gaining traction for use in electric vehicles. While not free from doubt, many industry observers believe NiMH and Li-ion will be the preferred batteries for full hybrids while mild hybrids will use NiMH, Li-ion and advanced lead-acid batteries.

There are important technical differences between the high-power batteries required for hybrid drive and the high-energy batteries required for electric drive. The differences, however, are relatively insignificant when it comes to raw materials requirements. Therefore, it’s not unreasonable to use battery capacity as a rough proxy for metal consumption in a fuel economy optimization analysis. The following comparisons assume that a new car with an internal combustion engine will use 400 gallons of fuel for 12,000 miles of annual driving. For the sake of simplicity, they assume a total of 96 kWh of batteries are available to reduce societal fuel consumption. The numbers are easily scalable.

• 96 kWh of batteries would be enough for a fleet of 64 Prius-class hybrids that will each save 160 gallons of fuel per year and generate a societal fuel savings of 10,240 gallons per year;
• 96 kWh of batteries would be enough for a fleet of six Volt-class plug-in hybrids that will each save 300 gallons of fuel per year and generate a societal fuel savings of 1,800 gallons per year; and
• 96 kWh of batteries would be enough for a fleet of four Leaf class electric vehicles that will each save 400 gallons of fuel per year and generate a societal fuel savings of 1,600 gallons per year.

This example highlights the fundamental flaw in all vehicle electrification schemes. When batteries are used to recover and reuse braking energy that would otherwise be wasted, a single kWh of capacity can save up to 107 gallons of fuel per year. When batteries are used as fuel tank replacements, a single kWh of capacity can only save 19 gallons of fuel per year and most of the fuel savings at the vehicle level will be offset by increased fuel consumption in power plants.

Using batteries to enable energy efficiency technologies like recuperative braking is sensible conservation.

Using batteries as fuel tank replacements is a zero-sum game that consumes huge quantities of metals for the sole purpose of substituting electricity for oil. Since roughly 45% of domestic electric power from coal fired plants and that percentage will decline very slowly, the only rational conclusion is that electric drive is unconscionable waste and pollution masquerading as conservation.

The Green Power Sophistry

EV advocates invariably paint an appealing picture of EVs being charged by wind or solar power and claim that the combination of the two is wondrous beyond reckoning. Beyond the impossibility of charging an EV from home solar panels and driving it to work at the same time, the reality is that the presumptive virtue of wind and solar power arises from generating green electrons, not using them. Once green electrons exist, it makes no difference whether they’re used to power an EV or a toaster oven. Since green electrons that are consumed in an EV can't be used to clean up a toaster oven, there can be no double counting of virtue. In fact, since wind and solar power impose their own burdens on materials supply chains there's a solid argument that the pretty picture is doubly wasteful.

The Fixed Cost Conundrum

In a conventional vehicle, the fixed vehicle cost is relatively low and the variable fuel cost per mile is relatively high. In electric drive the dynamic is reversed and the fixed vehicle cost is relatively high while the variable fuel cost per mile is relatively low. While few financial metrics are more shrouded in secrecy, intrigue and speculation than Li-ion battery manufacturing costs, A123 Systems (AONE) includes enough hard data in its quarterly and annual reports to the SEC to permit a reasonable estimate. The following graph compares A123’s reported quarterly revenue, their adjusted cost of goods sold (after backing out unabsorbed manufacturing costs) and their gross margin per kWh of batteries shipped.



A123’s direct battery production costs have averaged over $1,000 per kWh for the last two years. By the time A123 adds a reasonable profit margin for its effort and an automaker adds another layer of markup, the only possible outcome is an end-user cost of $1,500 per kWh or more.

Since most advocates insist that battery costs will decline rapidly, I’ll assume end-user battery pack costs of $1,000 and $500 per kWh to keep the peace. I'll also use several other charitable assumptions including stable electricity costs of $0.12 per kWh, no loss of battery capacity over time, no cycle-life limitations and a 15% second-life value. 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 red and green 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 that don't need much range flexibility, the curves show that high-mileage drivers who presumably need more flexibility will derive the most value. 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. Since the GM Volt has an effective electric range of 40 miles per charge and the Nissan Leaf has an effective range closer to 80 miles, it's clear that high mileage users will need to charge more than once a day to get the maximum benefit. Since nobody has claimed a useful life of more than about 100,000 miles for a battery pack, it seems likely that sustained and frequent recharging will impair the economics for high-mileage users who will need to replace their battery packs more frequently.

Moore’s Curse

The IT revolution set the stage for fatally flawed assumptions in cleantech because we all got accustomed to the phenomenon known as Moore’s Law, which describes exponential improvements in the speed and processing power of electronics. In the Moore’s Law world, electronic devices doubled their capacity every 18 to 24 months while requiring the same or smaller natural resource inputs. As a result, we’ve seen decades of falling prices for exponentially better products.

Unfortunately, Moore’s Law has no relevance to electric drive because the energy needed to move a given mass a given distance at a given speed is constrained by the laws of physics. Likewise, the number of electrons in a given mass of chemically active material is constrained by the laws of chemistry. These laws cannot be violated and in practice the theoretical limits can never be achieved. The best we can possibly hope for is highly efficient systems that take us most of the way there.

In the IT world of Moore’s Law the generational progression was 2, 4, 8, 16 etc.

In the cleantech world of Moore’s Curse the generational progression will be 50%, 75%, 87.5% etc.

The following graph is a bit dated, but it shows that current expectations respecting future advances in battery technology are completely out of touch with historical reality.



When Edison was bitching about batteries specific energies of 25 wh/kg were common. A hundred and thirty years later specific energies of 150 wh/kg are pushing the envelope. A six-fold improvement over 130 years does not provide a rational basis for prevailing expectations.

Investment Conclusions

It's an Iron Law of Nature – things that can't happen won't happen. The world does not and cannot produce enough metals to permit the deployment of electric drive at a rate that approaches relevant scale. Chinese wind turbine producers are reeling from skyrocketing rare earth metal prices that are scuttling wind power deployment plans. Beijing is backing away from its aggressive vehicle electrification policies. If China can't make the numbers work in a command economy that produces over 95% of the world's rare earth metals, nobody can. The inescapable conclusion for investors is that resource dependent alternative energy and vehicle electrification schemes must fail.

Let's face it folks, it's time to kill the electric car, drive a stake through its heart and burn the corpse.

Companies like Tesla Motors (TSLA) are doomed because their vanity products can't possibly make a difference and have all the environmental and economic relevance of pet rocks. The only companies that stand a chance of long term survival are manufacturers of efficiency technologies that reduce aggregate resource consumption. If lithium-ion battery manufacturers like A123 Systems, Altair Nanotechnologies (ALTI) and Valence Technologies (VLNC) can stop chasing rainbows and focus on sensible applications like electric two-wheeled vehicles that reduce natural resource waste, they may have long and prosperous futures. Manufacturers of fundamentally cheap energy efficiency technologies like Johnson Controls (JCI) and Exide Technologies (XIDE) are certain to thrive in any event. The surprise winners in a resource constrained world will most likely be disruptive innovations like the PbC® battery from Axion Power International (AXPW.OB) which uses a third less metal while promising a ten-fold improvement in battery cycle life to optimize the performance of efficiency technologies like stop-start systems, stationary applications and hybrid drive for everything from passenger cars to freight trains.

This article provides a summary overview of several topics I’ve examined in detail over the last three years. A complete archive of my work is available on Seeking Alpha. Most of the resource materials I’ve relied on are available through the numerous hyperlinks I’ve embedded in my articles.

Given the nature of the investing process I don't expect anyone to accept my logic without independently verifying the facts. I sincerely hope that this article will give at least a few investors reason to question their own assumptions in a hopium free environment. Most of us grew up in a rare period of privilege, prosperity and plenty that has seriously distorted our worldview. If we don't accept the reality that our supply chain assumptions are fatally flawed, we can’t possibly identify realistic solutions that can be implemented at relevant scale.

My perspective is very different from the views held by many alternative energy and vehicle electrification analysts. Some readers will no doubt find my thinking reactionary if not heretical. But even the Catholic Church requires a Devil's Advocate to argue against the canonization of proposed saints and gives that advocate fair and equal consideration before making a decision.

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 09:31 AM | Permalink | Comments (4)

John Petersen

The last couple weeks remind me of the adage that history never repeats itself, but it frequently rhymes. As I watched the awesome market volatility my mind drifted back to October 1987 when I cleared SEC comments on a client’s registration statement a week before Black Monday. As a result of the market break, the planned IPO didn’t happen, the client and its underwriter both went broke and I didn’t get paid. It was an expensive education that’s paid for itself many times over.

The market is always fickle, often brutal and sometimes downright vindictive. But it’s times of maximum ugliness, volatility and fear that give rise to the greatest opportunities. Barron Rothschild is credited with saying, "buy when there's blood in the streets, even if the blood is your own." A similar line of reasoning from Warren Buffet says investors "should try to be fearful when others are greedy and greedy when others are fearful."

While I usually avoid specific stock picks and focus on groups of companies that are likely to outperform or underperform the broader market, sometimes prices get far enough out of line with reality that I have to prepare a short list of specific companies that I think energy storage investors should seriously consider.

Exide Technologies (XIDE) is an easy double if not a triple over the next 12 months. The stock trades at 11.7 times trailing twelve-month earnings of $30.3 million. What the market fails to recognize is that Exide has finished a major restructuring that savaged its historic earnings and is not expected to impact future earnings. If you adjust Exide's historical net income to eliminate restructuring costs, you'll find it earned $69,098 in FY 2011 and $68,782 in FY 2010. On a go-forward basis, Exide is trading at 5 times earnings and 12% of revenue. With $3 billion in annual revenue and a heavy focus on the replacement battery market, Exide is well positioned to thrive even if the economy slows.

Enersys (ENS) is not as undervalued as Exide, but its current price represents 8.1 times earnings and 48% of revenue. The stock is down 42% from its June 30th close in spite of a strong quarter and favorable outlook. The stock is 50% down from its 52-week high while the broader markets are down about 15%. It all adds up to opportunity for investors who want to position themselves in an established company with solid fundamentals, a good chance for short-term appreciation and a likely double over the next year.

A123 Systems (AONE) doesn't have the immediate upside potential of Exide and Enersys, but the stock is trading at a 33% discount to the $6 per share A123 received in a public offering earlier this year. I was a critic when A123's stock was trading in the $20s, but now that the stock is trading at $4 it's a different story. My opinion on electric cars hasn't changed because the application is a foolish waste batteries and can never be economic. I have a different outlook, however, when it comes to electric two-wheeled vehicles, electric drive for buses and commercial vehicles and grid-based storage to smooth minute-to-minute variations in the power output of wind turbines and solar panels. A123 makes a fine battery and there are several substantial markets for products from its new plant. Given its solid financial foundation, fine products and modest premium over book value, I think A123 is the best bet by far in the lithium-ion battery space.

Axion Power International (AXPW.OB) is the most speculative stock on the list, but it also has the most potential. Axion has a very ugly price chart, but the last 18 months of trading have been dominated by huge supply and demand imbalances.

For calendar 2009, Axion's reported trading volume was 7 million shares and in December of that year it sold 45 million new shares (over 6 years of trading at historic volumes) in a private placement and agreed to promptly register the shares for resale. When the resale registration went effective in April 2010, the price plunged as investors who bought with short time horizons started selling. During calendar year 2010, reported volume ramped to 22 million shares and the price languished. The price started to recover in February and March of this year, which kicked off another round of selling from the 2009 investors. Total volume for 2012 now stands at 53 million shares.

After adjusting for the OTCBB double-count, the total number of shares that have moved from willing sellers to new buyers since April 2010 is just a hair over 36 million. Since Axion's stock is not volatile enough to attract day-traders, the only rational conclusion is that most of the shares sold in the 2009 private placement have been resold into the market. The one nice thing about investors who buy with short time horizons is that they eventually become small stockholders and then they become irrelevant when they run out of stock to sell.

I've been to this rodeo before and I've learned that the only stockholders that really matter are the buyers because they'll be around until their investment goals are met or they get tired of waiting. Based on trading patterns over the last 18 months I believe the 36 million shares of buying came from thousands of retail investors who have been educated by my blog, view Axion as a speculative investment and are willing to give the company time to mature and flower. Based on the available information, I think Axion is within weeks or even days of an inflection point where the price will begin a transition from undervalued to overvalued. I don't think many of the retail investors who bought over the last 18 months are likely to sell for 25%, 50% or even 100% gains. Instead I think most will wait for multi-bag returns on their investment. Then the question becomes "How far and how fast is up?" I can't even venture a guess.

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 03:06 AM | Permalink | Comments (2)

John Petersen

Last week I stumbled across a link that led to a 2010 report from the National Research Council titled "Hidden Costs of Energy, Unpriced Consequences of Energy Production and Use." This free 506-page book takes a life-cycle approach – from fuel extraction to energy production, distribution, and use to disposal of waste products – and attempts to quantify the health, climate and other unpriced damages that arise from the use of various energy sources for electricity, transportation and heat. After studying the NRC's discussion of the unpriced health effects, other nonclimate damages and greenhouse gas emissions of various transportation alternatives, and thinking about what the numbers really mean, I've come to the conclusion that the electric vehicle advocates are playing liars poker with their cost and benefit numbers – emphasizing a couple areas where electric drive is superior and de-emphasizing or completely ignoring a far larger number of areas where electric drive is clearly inferior. The result, of course, is unfounded and wildly optimistic claims of superiority based on four sevens in a ten digit serial number that don't mean a thing if your goal is to evaluate the entire serial number.

The first graph from the introduction summarizes the unpriced health and other nonclimate damages arising from the use of thirteen different vehicle fueling technologies over the entire cycle life of an automobile and quantifies the unpriced mine to junkyard cost per vehicle mile traveled, including well or mine to wheels costs of manufacturing the vehicle and fueling it over its operational life.



The thing I found most surprising was the relative consistency of the numbers across all thirteen classes, both for today and for the future, and the fact that many advanced drive train technologies score lower than their conventional cousins because the unpriced costs of manufacturing the vehicle or processing the fuel exceed the claimed operating benefits. When you look at the realities from a cradle to grave perspective there are no clearly superior choices and the values are all clustered within ±15% of a $1.25 average. While I derive some personal satisfaction from the idea that the low cost winners are a Prius-class HEV or an internal combustion engine with a CNG fuel system, and that electric drive is just a smidgen cleaner than a diesel engine burning fuel produced from Fischer Tropsch coal liquifaction, the reality is that none of the advanced technologies are inherently better. They're just more expensive.

The game is simply not worth the candle. It’s certainly not worth the enormous expenditures of public funds that governments worldwide don't have. There’s nothing electric drive can accomplish that CNG and fuel efficiency can’t accomplish cleaner, faster and cheaper.

The second graph from the introduction summarizes the unpriced greenhouse gas damages arising from the use of the thirteen different vehicle fueling technologies over the cycle life of an automobile. While the range of variation around a current average of about 450 grams of CO2 per vehicle mile traveled is a little wider at ±25%, once again it's just not worth getting worked up over inconsequential differences that entail substantial incremental costs.



One of the most intriguing take aways from these two graphs is the inescapable conclusion that the differences today are modest and as technologies mature and improve the differences will become less important, not more. By 2030, plug-ins will have no advantage over internal combustion when it comes to greenhouse gasses and be significantly worse than internal combustion when it comes to health and other nonclimate costs.

Over the years I've suffered endless abuse from commenters who decry my appalling lack of vision when it comes to lithium-ion superstars like Ener1 (HEV), A123 Systems (AONE), Altair Nanotechnologies (ALTI) and Valence Technologies (VLNC) that are certain to drive battery performance to new highs while driving manufacturing costs to new lows and enabling a paradigm shift to electric cars from Tesla Motors (TSLA), Nissan (NSANY.PK), General Motors (GM) and a veritable host of newcomers that are positioning for future IPOs and certain to change the world. While the following graph is a little dated, it shows why the electric pipe dream can’t happen unless some genius in a garage comes up with an entirely new way to store electricity.



Liars poker can be a fun way to fritter away the hours in Wall Street watering holes like Fraunces Tavern, but it creates enormous risk for investors who hear about four sevens but never hear about the other six characters in the serial number. I've seen this melodrama before. For the period from 2000 through 2003 fuel cell developers like Ballard Power (BLPD) and FuelCell Energy (FCEL) carried nosebleed market capitalizations based solely on dreams. From 2005 through 2007, it was the age of corn ethanol kings like Pacific Ethanol (PEIX). Lithium-ion battery developers have already taken it on the chin and there's no question in my mind that Tesla will be the next domino to fall. Its demise is every bit as predictable and certain as Ener1's was.

It's frequently said that those who do not learn from history are condemned to repeat it. There isn't much I can add.

Disclosure: None.
Posted by John Petersen at 04:49 PM | Permalink | Comments (12)

John Petersen

In three years of writing about investing in energy storage, I’ve learned that most public relations nightmares encountered by battery companies are self-inflicted wounds. They do an appalling job of managing the expectations of investors and potential customers. Then, when the inevitable delays, disappointments and cost overruns arise, everybody suffers. It may not be their fault, but it is most certainly their problem.

Most of my long term readers have seen this timeless and blistering 1883 Thomas Edison quote:

“The storage battery is one of those peculiar things which appeals to the imagination, and no more perfect thing could be desired by stock swindlers than that very selfsame thing. Just as soon as a man gets working on the secondary battery it brings out his latent capacity for lying.”

Edison understood innovation problems well, but he didn’t understand innovation problems in the battery industry until he tried to develop a better battery for use in electric cars and failed to win the hearts and minds of a grateful nation.

The essential truth most battery developers fail to recognize is that the problem isn’t their products or even their development plans; it’s the fertile imaginations of investors and potential users who read about gee-whiz discoveries in research laboratories, overestimate the importance of the developments and make wildly optimistic leaps from the possible to the absurd. Battery developers don’t lie to investors and potential users; but the investors and potential users lie to themselves and then blame the industry for failing to meet their patently unreasonable expectations.

My first job after law school was in the Houston office of a Big-8 public accounting firm that had a substantial oil and gas tax practice. On my first day at work, the partner in charge of our group hauled me into his office and explained that every oil project in history could be explained with a simple Venn diagram.



Over the last 30 years I’ve learned to my chagrin that this Venn diagram is not just an overview of the oil industry, it’s a fundamental truth that applies to every form of human interaction and endeavor from sex to science to business to politics, especially politics. Over the years I’ve worked with some of the finest minds on the planet, but I’ve never been involved in a project that didn’t take twice as long, cost twice as much and deliver half the expected result – and that’s when everything went right.

A truly bizarre twist that I’ve only encountered in the energy storage industry is that developers report modest results, but a hyper-imaginative public adds a couple layers of expectations, eliminates all time and materials constraints, assumes a roll-out speed that would make Steve Jobs jealous and fabricates outlandish promises developers didn't make and can’t possibly keep.

I think it all boils down to the fact the world desperately wants better batteries but doesn’t understand the magnitude of the challenge and isn't really willing to pay the price. At last year’s ELBC I spoke with an executive from India, who described batteries as “a grudge purchase.” The sad part is he’s right. We don't buy batteries because we want them. We buy them because we need them. In most cases, we don't even think about batteries unless they need to be recharged or replaced. Is it any wonder that the adjective most commonly associated with batteries is “damned?”

The finest examples of horrible expectations management are found in the advanced battery space where Secretary Chu of the US Department of Energy frequently says things like this:

"And what would it take to be competitive? It will take a battery, first that can last for fifteen years of deep discharges. You need about five as a minimum, but really six- or seven-times higher storage capacity and you need to bring the price down by about a factor of three. …

Now, how soon will that be? Well, we don't know, but the Department of Energy is supporting a number of very innovative approaches to batteries and it’s not like it’s ten years off in the future, in my opinion, it might be five years off in the future. It's soon.”

This is a fair statement of the DOE’s goals. They’re pushing very hard to develop new technologies that will leapfrog the state of the art in the battery business. What the DOE never explains, however, is that any major advance will make all of today’s spiral-wound batteries obsolete before their developers have a chance to become profitable.

The data in the following graph was taken from quarterly and annual reports that A123 Systems (AONE) has filed with the SEC over the last 30 months. It compares their quarterly revenue per kWh of batteries shipped with their adjusted cost of goods sold (after backing out unabsorbed manufacturing costs) and their gross margin per kWh.



The purchase prices paid by A123's customers have been gradually declining, but their manufacturing costs have climbed and their gross margins have turned sharply negative. Without gross income, net income isn't even a pipe dream. I expect the dynamic to change when A123's new factory is brought on line, debugged, optimized and ramped to reasonable capacity utilization rates. But that transition is not going to happen quickly and until it occurs A123's stock price will continue to languish.

My next graph comes from the current issue of Science and shows why the spiral-wound lithium-ion battery can never be a viable long-term solution.



It doesn’t take a rocket scientist or electrochemist to see that lithium-ion batteries can’t ever meet Secretary Chu’s goals of six or seven times more energy at a third of the cost. That will require a different kind of battery and a different kind of battery manufacturing infrastructure. No matter what you believe the next big thing will be, it’s clear that today's lithium-ion batteries are a dead end – the 8-Track tapes of the battery world and little more than a transition technology from what we have to what we need. This Jan Darasz cartoon from the current issue of Batteries International Magazine is too true to be funny.



Readers frequently assume I’m a Luddite who can’t or won’t see the future. The fact is I see the future all too clearly and know to a certainty that lithium-ion batteries are the barest of beginnings, not the Holy Grail. The true Luddites are the EVangelicals who are so enthralled with the EV dream that they refuse to see that our very best batteries are not good enough for the short term and can never be good enough for the long term.

The global fleet of 800 million cars and light trucks all depend on lead-acid batteries for starting, lighting and ignition functions. Within a few years, all new cars will come with stop-start idle elimination systems as standard equipment. No matter what happens in the sexy battery space over the next five to ten years, that fleet will need replacement batteries for decades to come. Established lead-acid battery manufacturers like Johnson Controls (JCI), Enersys (ENS) and Exide Technologies (XIDE), together with advanced lead-acid battery innovators like Axion Power International (AXPW.OB), will have a long and profitable run regardless of what happens in the sexy space.

While I can’t make any predictions about timing, it is only a matter of time before one of the scientists in one of the labs that are working on better batteries has a Eureka! moment. When that moment arrives, the new technology will become the darling of EVangelicals, automakers and maybe even utilities, and the market potential of lithium-ion batteries will be capped forever at the number of vehicles that are made between now and then using a bridge technology.

As a broker friend of mine once observed, a bridge that only connects with land at one end is more properly called a pier.

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 02:58 PM | Permalink | Comments (0)

John Petersen

Last Friday President Obama and executives from thirteen leading automakers gathered in Washington DC to announce an historic agreement to increase fleet-wide fuel economy standards for new cars and light trucks from 27.5 mpg for the 2011 model year to 54.5 mpg for the 2025 model year. While politicians frequently spin superlatives to describe mediocre results, I believe the President's claim that the accord "represents the single most important step we've ever taken as a nation to reduce our dependence on foreign oil" is a refreshing example of political understatement. After three decades of demagoguery, debate, dithering and delay, meaningful policy change has finally arrived, and not a moment too soon.

The economic impact will be immense – a staggering $1.7 trillion in fuel cost savings that will flow directly to consumers. As those savings begin to work their way through the economy and kick-start secondary fiscal multiplier effects, the boost to GDP will be closer to $7 trillion. I believe Friday's agreement will ultimately be seen as the biggest economic stimulus event in human history.

The following graph from a new White House report titled, "Driving Efficiency: Cutting Costs for Families at the Pump and Slashing Dependence on Oil" says it all.



The most surprising aspect of this agreement isn't the aggressive goals; it's the fact that the auto industry has helped forge the goals and plans to achieve them by implementing "affordable technologies that are on the road today." The new goals are not based on the electric dreams of a Tesla Motors (TSLA). They're based on the automaker's hard-nosed evaluation of the cumulative gains that can realistically be achieved with existing ICE technologies like engine downsizing, stop-start idle elimination, turbocharging, optimized cooling, low friction, direct fuel injection and variable valve timing.

Individually the fuel economy gains from advanced ICE technologies will only be baby steps toward energy independence. Collectively they'll give American consumers passenger cars with lower well-to-wheels CO2 emissions than a 2012 Nissan (NSANY.PK) Leaf plugged into the typical wall socket. They'll change the world without a budget busting paradigm shift.

In early July The Boston Consulting Group released a new report titled "Powering Autos to 2020; The Era of the Electric Car?" that evaluated the combined potential of baby-step fuel efficiency technologies and considered their likely impact on wildly expensive and impractical proposals to convert the world's transportation infrastructure from liquid fuels to electricity. In the report BCG concluded that:

• Conventional technologies have significant emissions-reduction potential, but OEMs will need to pull multiple levers simultaneously to meet emissions targets.
• Advanced ICE technologies can reduce gasoline consumption by 40% at a cost to the consumer of $50 to $60 per percentage point of reduction – roughly half what BCG predicted three years ago.
• Advanced ICE technologies are likely to become standard equipment worldwide during the next decade.
  
• Electric cars will face stiff competition from ICE and will not be the preferred option for most consumers.
• Battery costs will probably fall to about $9,600 per vehicle, but become increasingly uneconomic as the potential fuel savings per kWh of battery capacity plummets.
• In addition to dismal economics, plug-ins will face substantial go-to-market challenges including battery durability concerns and the absence of adequate charging infrastructure.

In my view the BCG report is a must read for investors who want to profit from this fuel efficiency mega-trend and avoid heavy losses in vehicle electrification schemes that will become increasingly uneconomic over time. The fundamental flaw is simple. Today an EV with a fully charged 24 kWh battery pack can save a consumer the equivalent of 3 gallons of gas. By 2025, the savings will be closer to 1.5 gallons of gas. Even with falling battery prices the value proposition can only get more challenging with each passing year.

For the last couple years I've been cautioning investors that gee-whiz vehicle electrification technologies are transitory, a flash in the pan, and the biggest business opportunities in energy storage involve cheap, simple and effective baby-step technologies like stop-start idle elimination that will slash fuel consumption by 5% to 15% for a few hundred dollars. The BCG report and the newly announced fuel economy goals are yet another proof of that principle.

The future is all about getting more from less and has absolutely nothing to do with increasing consumption of one class of scarce natural resources in the name of conserving another.

While I can't identify the component manufacturers that will thrive from the widespread implementation of advanced ICE technologies like turbocharging, direct fuel injection and variable valve timing, picking the winners in energy storage is easy. Johnson Controls (JCI) and Exide Technologies (XIDE) will be the first beneficiaries as automakers upgrade their electrical systems to withstand the strains of stop-start idle elimination. As stop-start systems become standard equipment worldwide and the inherent limits of current AGM battery technology become obvious, more powerful energy storage solutions from emerging technology developers like Maxwell Technologies (MXWL) and Axion Power International (AXPW.OB) will ascend to prominence if not dominance.

The new fuel efficiency standards are not an omen of doom for lithium-ion battery solutions from A123 Systems (AONE), Ener1 (HEV) and Valence Technologies (VLNC) which will no doubt gain a toehold among the 6% to 13% of consumers who say they'd purchase an environment-friendly car even if they had to pay a premium over the life of the vehicle. I'm just not certain how significant that toehold will be in light of the incontrovertible reality that less than 2% of consumers actually buy environment-friendly cars.

On balance I believe that survey-based uptake forecasts will be just another example of a painful lesson I learned in the biodiesel business – that individual buying decisions speak louder than surveys and the green in a consumer's wallet always takes priority over the green in his cocktail party conversation.

For several years the mainstream media, financial press and sell-side analysts have been publishing irrationally optimistic stories and reports about the end of the ICE age and the dawn of a golden electric era. On Friday the Obama Administration and the automakers put the world on notice that IC Empire is striking back and plans to bury the now generation of electric wannabes like it has all of their predecessors.

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 05:31 AM | Permalink | Comments (5)

John Petersen

Today is the third anniversary of my blog on investing in energy storage. While the last three years have been profoundly troubled by a market crash, a slow recovery and more ups and downs than a roller coaster, energy storage has been surging to prominence as investors realize that batteries, products we all love to hate, are a critical enabling technology for wind and solar power, efficient transportation, the smart grid and hundreds of other applications that make life more pleasant. With each passing day it's increasingly clear that energy storage is an investment mega-trend that will endure for decades. Most of the smart money is still on the sidelines looking in, which explains the popularity of my blog. As the smart money transitions from analyzing opportunities to making investments, the sector should encounter rising tides that lift all boats.

Thomas Edison was the first to identify the biggest risk of energy storage investing a century ago when he complained:

“The storage battery is one of those peculiar things which appeals to the imagination, and no more perfect thing could be desired by stock swindlers than that very selfsame thing.”

The problem isn't really the batteries, which haven't improved all that much over the last century. Instead, the problem lies in the fertile imaginations of investors, ideologues and demagogues who read about scientific discoveries in research laboratories, overestimate the value of those discoveries and then make a wildly optimistic leap from the reasonable to the absurd.

The two most common forms of batteries are carry-over relics of the 19th century. Lead-acid batteries have been around for 150 years and spiral wound batteries have been popular for almost as long. While battery chemistry has changed over the years and manufacturing methods have been modernized, the energy storage capacity of today's best batteries is only four or five times greater than the energy storage capacity of the batteries Edison complained about. Regardless of what you read in the paper or hear on the news, making a better battery is very hard work and the vast majority of exciting new discoveries never make it from the laboratory bench to the factory floor because they're just too expensive.

It's fun to daydream about the technical possibilities of portable power, but the market will only pay for cheap, reliable and safe portable power. The chasm between technical possibility and economic viability is both wide and deep.

Today's most common myth in energy storage is that exponential performance gains will be accompanied by rapidly falling prices. The current issue of Science includes an article titled "Getting There" that offers a classic example of how the mythology grows and spreads. The article's centerpiece is the following graph that compares the theoretical potential of battery materials and the best results obtained in working cells.



A quick read through the article and a glance at the graph would be enough to convince any reasonably imaginative person that a golden age of battery powered everything is just around the corner. The undeniable facts the article and the gee-whiz graph don't explain with any force are:

• All lithium-ion batteries in commercial production are in the first category;
• The performance differences between today's lithium-ion chemistries are minor;
• Current technologies offer little room for improvement because the theoretical limits are absolute;
• The first category are the only batteries we know how to manufacture in bulk;
• All advanced battery technologies will require the development of completely new manufacturing methods and equipment;
• All advanced technologies will require the construction of different infrastructure from the ground up;
  
• All advanced technologies are five to ten years from production if everything goes right; and
• The companies that own the best current technologies do not own their advanced counterparts.
  

In other words each step forward will make all the science and all the manufacturing infrastructure required for the prior generation of lithium-ion batteries obsolete. It's the epitome of creative destruction where the future poses an existential threat to the past, but the future can't leverage, build upon or even use the massive infrastructure investments of the past. Progress in IT was immense and rapid because every step along the path built upon and leveraged the past. Progress in energy storage is agonizingly slow because innovation that builds upon and leverages the past is rare.

In my first Seeking Alpha article, I wrote that the market prices for Ener1 (HEV) and Altair Nanotechnologies (ALTI) resulted in "nosebleed market capitalizations based on little more than dreams." In September 2008, I added Valence Technologies (VLNC) to my list of dangerously overvalued lithium-ion battery developers because like Jacques Cousteau it was under water to the tune of $68.4 million at mid-year. In October 2009, I added BYD Co. Ltd. (BYDDF.PK) to my list and wrote that it was "a classic example of why it's never a good idea to make investment decisions based on simple questions like "What did Warren do?" In November 2009, I added A123 Systems (AONE) to the list observing that it was "well up the hype cycle curve and approaching the Peak of Inflated Expectations." Last November, I added the magical gravity defying Tesla Motors (TSLA) to my list and suggested a paired trade that would short Tesla and buy Exide Technologies (XIDE). In every case the reader outrage over my criticisms was palpable. You'd have thought I was torturing kittens. Subsequent price performance tells a very different story. The following table summarizes the market price of each of these companies when I first openly criticized them, their closing price last Friday, and the percentage decline in the interim.

Company	Symbol	Initial Price	Friday's Price	Change
Ener1	HEV	$5.91	$0.79	-87.6%
Altair Nanotechnologies	ALTI	$7.92	$0.96	-87.9%
Valence Technologies	VLNC	$3.59	$1.03	-71.3%
BYD Co. Ltd.	BYDDF.PK	$11.12	$2.86	-74.3%
A123 Systems	AONE	$15.88	$5.68	-64.2%
Tesla Motors	TSLA	$30.80	$27.58	-10.5%

My record at picking winners isn't perfect, but I'm batting a thousand when it comes to identifying over-hyped stocks near the peak of inflated expectations.

Since I first criticized them, A123 and BYD have fallen to levels where they're beginning to look attractive for long-term investors who believe in the future of electric transportation and are not concerned about a looming glut of lithium-ion battery manufacturing capacity that will increase losses and force marginal manufacturers out of business without reducing material, manufacturing or finished battery costs. In spite of the happy talk from Silicon Valley and buy-side cheerleaders, Tesla hasn't even started to bleed. Ener1, Altair and Valence may survive, but only if they can negotiate massive capital infusions on terms acceptable to new money.

I've been bullish about the lead-acid battery sector for years because the major battery manufacturers including Johnson Controls (JCI), Exide and Enersys (ENS) have global manufacturing footprints, established product lines, strong customer relationships, billion dollar revenue streams and rust-belt market capitalizations. My favorite in the group is Exide because it trades at a significant discount to its peers and is well-positioned to out-perform market expectations on a go-forward basis.

In light of recent forecasts that stop-start idle elimination will be deployed in almost a hundred million cars over the next five years, I think JCI and Exide are facing a dream scenario where unit volumes remain stable but per unit revenues double and margins ramp sharply as customers gravitate to their premium AGM products.

My old company Axion Power (AXPW.OB) has not been a stellar stock market performer over the last couple years, but the delays have arisen from the stringent manufacturing and quality control requirements of it's principal potential customers. Since I can't remember another instance where huge companies like BMW and Norfolk Southern have publicly aligned themselves with a nano-cap technology developer that hasn't even launched its first product, I can live with delays that disappoint the market but please them.

The last three years have been a lot of fun and intelligent comments from knowledgeable readers have provided a balance and breadth that I could never have achieved on my own. New readers in particular may find it helpful to peruse my article archive, but be sure to spend enough time reading the comments to understand where the views of others differ from mine. I always try to explain the factual basis for my opinions and provide links to relevant source documents, but in the end I'm only human and I can only speak from the shoes I stand in. I want to thank everyone for their respective contributions, even those who haven't learned how to disagree without being disagreeable.

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 12:27 PM | Permalink | Comments (2)

John Petersen

I hate being wrong, but Mother always taught us, "if you have to eat crow don't nibble."

In February 2010 I wrote an article titled "Why I Don't Expect A Lithium-Ion Battery Glut" that's shaping up as one of the worst predictions in the history of my blog. This week Lux Research published a report titled "Using Partnerships to Stay Afloat in the Electric Vehicle Storm" that has me convinced that the capacity glut in lithium-ion batteries will be massive for at least a decade.

I humbly and sincerely apologize to any readers who bought shares in lithium-ion battery developers based on my starry-eyed optimism for the EV battery market.

The basic premise of my February 2010 article was that while plug-in electric vehicles would almost certainly die a slow and agonizing death from the congenital birth defects that have doomed every generation of EVs to the scrap heap of history, booming sales of electric two-wheeled vehicles, or E2Ws, and Prius-class hybrid electric vehicles, or HEVs, would be enough to absorb the slack. With eighteen months of history to look back on, it's just not working out the way I thought it would.

As I expected, plug-in vehicles are drawing breathless reviews from the press and EVangelicals, and indifference or outright scorn from the car buying public. Automakers are toying with plug-in vehicle concepts that may go into production over the next few years if the plans aren't scrapped due to customer apathy, but they're all rushing to make new fuel efficiency technologies like stop-start idle elimination standard equipment. With the exception of Advanced Battery Technologies (ABAT) which makes both ebikes and the batteries that power them, E2W manufacturers are letting their customers decide and the overwhelming majority of E2W buyers are voting with their wallets and deciding that cheap and reliable lead acid batteries are better suited to their needs despite a little extra weight.

Can you believe it? Cheap is beating cool. Who could have predicted such an outcome in the depths of the worst financial crisis since the 1930s?

In all seriousness, Lux forecasts a catastrophic supply and demand imbalance in the lithium-ion battery sector over the next decade. On the supply side it predicts that global manufacturing capacity will ramp to about 21,000 MWh by next year (875,000 Leaf-class BEVs) and climb to almost 30,000 MWh (1.25 million Leaf-class BEVs) by 2015. On the demand side, Lux's optimistic case based on $200 oil predicts annual battery sales of about 6,000 MWh in 2015 (250,000 Leaf-class BEVs) ramping to 22,500 MWh (937,500 Leaf-class BEVs) by 2020. Under their more conservative $140 oil price scenario, demand won't hit 6,000 MWh until 2020. The low oil price scenario is aggressively ugly. Is it any wonder that France has recently withdrawn €100 million of subsidized loans for a planned Renault battery plant?

The Lux forecast is bad news for diversified first tier manufacturers like LG Chem, GS Yuasa, SB LiMotive, AESC, and Sanyo; terrible news for financially sound second tier manufacturers like Toshiba, Hitachi, and JCI-Saft; and an "existential threat" for emerging third tier battery developers like A123 Systems (AONE), Ener1 (HEV), Valence Technologies (VLNC) and Dow Kokam that were counting on transportation markets that are unlikely to develop.

Now you know why so many lithium-ion battery developers are suddenly talking trash about using their batteries for grid-scale storage. In the near future, that myth will be buried along-side its brother the electric car because the world's utilities can't possibly soak up 20,000 to 25,000 MWh per year of excess lithium-ion battery manufacturing capacity.

Last February, the Department of Energy released a comprehensive study on the economic potential of grid-based storage titled "Energy Storage for the Electricity Grid: Benefits and Market Potential Assessment Guide." It was commissioned by the Energy Storage Systems Program and written by Jim Eyer and Garth Corey. Based on the conclusions of that study, which I discussed in "Grid-Based Energy Storage; A $200 Billion Opportunity," I cobbled together a table that identifies the principal grid-based energy storage applications, quantifies the potential national demand and quantifies the 10-year economic value for a kilowatt-hour of grid-based storage dedicated to an application. The table is mine, but the baseline numbers are Sandia's.



The color coding in the table represents my attempt to segregate system value per kWh into cool technologies like flywheels, supercapacitors and lithium ion batteries, which are highlighted in blue, and cheap technologies like flow batteries, lead-acid batteries, compressed air and pumped hydro, which are highlighted in yellow. If you total up the potential demand for all of the blue highlighted applications and throw in the orange for good measure, you get to a likely US demand of 11,500 MWh spread over a period of several years. It won't make a dent in 20,000 to 25,000 MWh per year of excess lithium-ion battery manufacturing capacity.

Like bloggers, outfits like Lux want every dark cloud to have a silver lining and their new report is no exception. In addition to forecasting doom, gloom and bust for the lithium-ion battery space, it focuses on the expected development of a $300 million annual market for supercapacitors in the transportation markets. In that market, Lux identified Maxwell Technologies (MXWL) as the dominant competitor and took pains to observe that "For the numerous supercapacitor technology developers to gain market share in transportation, they will need to validate products with a clear edge over Maxwell's incumbent technology, and not rely on growing demand to create ripe opportunities for new entrants."

While I'm a fan of Maxwell's products and business potential, I'd be remiss if I didn't point out that its stock trades at 4.3 times book value and 3.3 times trailing twelve-month sales of $131 million. Even if you assume that Maxwell will walk away with the lion's share of the $300 million transportation supercapacitor market that Lux is forecasting for 2016, its upside potential will be limited as it negotiates the transition out of the valley of death and begins trading on the basis of sales, growth and profitability.

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 04:00 PM | Permalink | Comments (14)

John Petersen

Last week Societe Generale published a thematic research report titled "A new world order, when demand overtakes supply" which examines the macro-economic and demographic trends that will transform the global economy over the next 20 years. It mirrored the theme of Jeremy Grantham's April 2011 quarterly letter titled "Time to Wake Up: Days of Abundant Resources and Falling Prices Are Over Forever" and did a great job of summarizing an issue I touched on in "How PHEVs and EVs Will Sabotage America's Drive For Energy Independence."

In the words of Societe Generale:

"So, while up until now less than one billion people have accounted for three-quarters of global consumption, over the course of the next two decades, the new Chinese, Indian, Indonesian, Latin American and African middle classes will bring an additional two billion consumers with similar needs and aspirations as today's North American, European and Japanese consumers." (Page 12)

"Beyond growth in demand for finished products, the most spectacular effect likely to be brought about by the stronger development of the emerging economies will be the enormous rise in demand for raw materials." (Page 14)

"A structural increase in raw materials prices is in fact an inevitable consequence of chronic resource insufficiencies, whether we're talking about industrial, energy or agricultural resources." (Page 19)

The following table from Mr. Grantham's quarterly letter summarizes China's current consumption of key energy, industrial and agricultural commodities as a percentage of total global consumption and drives the point home with the subtle clarity of a sledge-hammer.



If we've seen this kind of demand dislocation as a result of a few decades of growth in China, what's going to happen when the surging middle class populations of India, Indonesia, Latin America and Africa decide to show up for the dinner party? The answer, of course, is that we'll be thoroughly screwed unless we stop wasting time, money and materials on pipe dreams, toys and panacea solutions, and focus instead on finding relevant scale solutions to persistent global shortages of water, energy, food and every commodity you can imagine. We all face a clear, present and persistent danger that can’t even be addressed until we accept the entire ugly reality with all its vulgar implications!

One of the most disturbing conclusions in the Societe Generale report is that while per capita energy demand in advanced economies will remain stable at 5,463 kg of oil equivalent, or maybe even decline to 5,000 kg per person by 2030, global average demand will increase from current levels of 1,818 kg per person to 3,312 kg per person in the low case and 4,228 kg per person in the high case. All of the increased demand will come from emerging and developing economies.

Our fundamental problem is that per capita global production of energy resources is 100 to 200 times greater than per capita global production of the technology metals that underlie all alternative energy schemes. To make things worse, all of those metal resources have critical competing uses that cannot be set aside or ignored in the name of advocacy. At a recent grid-based energy storage conference in Brussels I used the following table to emphasize the point. The orange highlight quantifies available energy resources while the green highlight quantifies technology metal resources.



The mathematically challenged optimists in our midst earnestly believe we can solve our energy problems with cool toys like wind turbines, solar panels, electric cars and other materials intensive energy schemes that fire the imagination but can never be sustainable. These aren’t solutions! They’re the energy and transportation equivalent of graphic novels and just a half-step removed from warp drive. In the final analysis, the dreamers who want to waste metals and other natural resources in the name of conserving coal, oil and natural gas are not saviors. They're unwitting saboteurs who can only make the problems worse!

Whether we like it or not, the only technology that has a prayer of generating enough new energy to satisfy even a small fraction of anticipated global demand is nuclear, a point that was forcibly driven home by Bill Gates in a recent interview at the WIRED Business Conference 2011. The naive idea that we can cut hydrocarbon consumption for the laudable goal of saving the planet is sophistry. Given a choice between freezing in the dark and burning hydrocarbons human beings will always choose the later because immediate personal need will always trump long term societal goals, especially fuzzy green goals.

I'm an unrelenting critic of obscene raw materials users like Tesla Motors (TSLA), A123 Systems (AONE), Ener1 (HEV) and Valence Technologies (VLNC) that want to build a future out of making toys for our emerging eco-royalty because I've read about the French Revolution and remember how 'Madame Le Guillotine' put a uniquely sharp edge on popular discontent over conspicuous consumption. These business models are doomed to fail because they're diametrically opposed the needs of society.

The only alternative energy investments that stand a chance of survival, much less profitability, are basic efficiency technologies that slash waste and deliver real savings for every ounce of natural resource inputs. Nuclear power, idle elimination, fuel efficiency, demand response, building efficiency, ebikes, recycling and a host of other technologies that do more with less are the only possible future. Wind turbines, solar panels, electric cars and all of the other feel-good graphic novel schemes are merely pleasant distractions, a bit like Nero's fiddle.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock because Axion's disruptive third generation lead-acid-carbon battery technology uses 30% less lead to deliver impressive gains in power, cycle-life, charge acceptance and overall real world utility.

Posted by John Petersen at 04:20 AM | Permalink | Comments (8)

John Petersen

On June 27th Johnson Controls (JCI) hosted their 2011 Power Solutions Analyst Day and unveiled their expectations for the future of stop-start idle elimination systems. After noting that all automakers are developing a range of powertrains, JCI used this graph to emphasize their view that the overwhelming bulk of alternative powertrain vehicles over the next five years will have simple, cost effective and fuel efficient stop-start systems.



You don't see much about stop-start systems in the mainstream media because politicians and reporters are too enchanted with plug-in vehicles and other exotica to deal with mundane issues like purchase prices and payback periods, but JCI has made it crystal clear that its meat and potatos business over the next five years will be cheap, not cool.

JCI's estimates for market growth over the next ten years were equally impressive, particularly when you realize that the advanced energy storage systems required for stop-start generate twice the per unit revenue and three times the per unit margins of flooded lead-acid batteries. It's a manufacturer's dream come true, stable unit volumes with rapidly increasing revenues and margins.

In their presentation JCI explained that the three key attributes of energy storage systems for stop-start are:

• Cycling – reliable system charge/recharge cycles over time;
• Useable energy – range of stored energy that can be used to optimize the system; and
• Charge acceptance – rate of recharge to maximize opportunity capture.

It ties perfectly to a joint presentation from BMW and Ford at last fall's European Lead Battery Conference where the two automakers explained why the stop-start duty cycle is so hard on conventional batteries. In a normal vehicle, you start the engine at the beginning of the trip and turn it off at the end. In a car equipped with stop-start, the engine turns itself off automatically every time the car is stopped and restarts automatically when the driver takes his foot off the brake. While the difference between one start per trip and one start per mile is enormous, a more critical problem arises from the fact that stop-start systems require the battery to carry all accessory loads during frequent engine off intervals.

In the segment of the BMW-Ford presentation that quantified a typical stop-start duty cycle, the accessory load was 50 amps for 60 seconds, or about 3,000 amp seconds while the starter load was 300 amps for one second. In other words, the accessories accounted for a whopping 91% of total load. Their graph of AGM battery performance over time shows that charge acceptance (the downward curving blue line) plummets as the battery ages while the time required to recover from an engine off event (the upward curving red line) soars from 30 seconds to three minutes or more.


Since all systems are designed to disable the stop-start functionality until the battery has recovered an acceptable state of charge, system efficiency falls off rapidly as the battery ages. The automakers want and need something better than AGM batteries, the principal solution that old line auto battery manufacturers like JCI want to provide.

The first advanced technology introduced for stop-start systems was developed by Continental AG in cooperation with Maxwell Technologies (MXWL) for use in diesel stop-start systems from Peugeot. In this dual device configuration an AGM battery carries the accessory load and a supercapacitor module carries most of the starter load. It insures a reliable engine restart, but can't do much about the bigger problem of accessory loads. Contiental and Maxwell expect that their system will be installed in up to a million Peugeot vehicles in the next three years. If the system works well for Peugeot and stop-start vehicle sales ramp as rapidly as JCI expects them to, implementation rates will probably be higher.

A second advanced technology solution for stop-start systems is a third generation lead-acid-carbon hybrid that's being developed by Axion Power International (AXPW.OB), which hopes to begin a commercial roll-out of its PbC battery later this year. In a joint presentation by BMW and Axion at last fall's ELBC, the performance differences were obvious. The graph that tracked PbC's performance over time using the BMW-Ford test protocol showed that charge acceptance (the flat blue line) stayed stable at 100 amps, or twice the charge acceptance of a new AGM battery, while recovery times (the flat black line) remained stable at 30 seconds.



The BMW-Ford graph shows that AGM batteries fade very rapidly over the first 5,000 miles of use in a stop-start equipped vehicle. The BMW-Axion graph shows that the PbC offers optimal performance through 40,000 miles. In a recent presentation at the 2011 Advanced Automotive Battery Conference in Mainz, Germany, Axion unveiled an updated graph of follow-on testing through 80,000 cycles, or approximately eight years of use, with only modest degradation.



I've been bullish about the future of stop-start idle elimination technology for a couple years. If the JCI forecasts are even close to accurate, I've been seriously understating the potential. Since JCI is the largest lead-acid battery manufacturer in the world and has a 36% share of the global automotive OEM and battery replacement markets, it will undoubtedly be the biggest beneficiary of the rapid worldwide implementation of stop-start idle elimination systems. The second biggest beneficiary will probably be Exide Technologies (XIDE), which is emerging from several years of tough restructuring and trades at a significant discount to JCI on a forward looking earnings basis. Emerging technology developers like Maxwell and Axion also have significant opportunities to grab a sizeable share of what's shaping up as $6 to $12 billion market niche. Their respective market capitalizations are summarized below:

Johnson Controls	JCI	$26.8 billion
Exide Technologies	XIDE	$569 million
Maxwell Technologies	MXWL	$442 million
Axion Power	AXPW.OB	$54 million

As former Axion director, I'm all too aware that it's a very little fish in a very big pond. I also understand why the PbC's extreme cycling performance and charge acceptance can be crucial to the future development of stop-start, a world-class fuel efficiency technology that's already being produced at scale and will become dominant in this decade. It's easy to dismiss my ramblings because I have a large stake in Axion. It's harder to dismiss BMW, a first tier automaker that joined Axion as a co-presenter at last year's ELBC. It will be darned near impossible to dismiss a big three US automaker that's apparently signed on as an Axion subcontractor in a pending DOE grant application.

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 10:12 AM | Permalink | Comments (0)

John Petersen

In 2009, the world produced some 13.2 billion metric tons of hydrocarbons, or about 4,200 pounds for every man, woman and child on the planet. Burning those hydrocarbons poured roughly 31.3 billion metric tons of CO2 into our atmosphere. The basic premise of alternative energy is that widespread deployments of wind turbines, solar panels and electric vehicles will slash hydrocarbon consumption, reduce CO2 emissions and give us a cleaner, greener and healthier planet. That premise, however, is fatally flawed because our planet cannot produce enough non-ferrous industrial metals to make a meaningful difference and the prices of those metals are even more volatile than the prices of the hydrocarbons that alternative energy hopes to supplant.

The ugly but undeniable reality is that aggregate global production of non-ferrous industrial metals including aluminum, chromium, copper, zinc, manganese, nickel, lead and a host of lesser metals is about 35 pounds for every man, woman and child on the planet. All of those metals are already being used to provide the basic necessities and minor luxuries of modern life. There are no significant unused supplies of industrial metals that can be used for large-scale energy substitution. Even if there were, the following graph that compares the Dow Jones UBS Industrial Metals Index (^DJUBSIN) with the Amex Oil Index (^XOI) shows that industrial metal prices are more volatile and climbing faster than hydrocarbon prices, which means that most alternative energy schemes are like jumping out of the frying pan and into the fire.



For all their alleged virtues and perceived benefits, most alternative energy technologies are prodigious consumers of industrial metals. The suggestion that humanity can find enough slop in 35 pounds of per capita industrial metals production to make a meaningful dent in 4,200 pounds of per capita hydrocarbon production is absurd beyond reckoning. It just can't happen at a relevant scale.

I'm a relentless critic of vehicle electrification schemes like Tesla Motors (TSLA) because they're the most egregious offenders and doomed to fail when EV hype goes careening off the industrial metals cliff at 120 mph. Let's get real here. Tesla carries a market capitalization of $2.8 billion and has a net worth of less than $400 million, so its stock price is 86% air – a bubble in search of a pin. Tesla plans to become a global leader in the development of new electric drive technologies that will use immense amounts of industrial metals to conserve irrelevant amounts of hydrocarbons. Even if Tesla achieves its lofty technological goals it must fail as a business. Investors who chase the EV dream without considering the natural resource realities are doomed to suffer immense losses. Tesla can't possibly succeed. Its fair market value is zero. The stock is a perfect short.

I won't even get into the sophistry of wind turbines and solar panels.

Next on my list of investment catastrophes in the making are the lithium-ion battery developers like A123 Systems (AONE), Ener1 (HEV), Valence Technologies (VLNC) and Altair Nanotechnologies (ALTI) that plan to use prodigious quantities of industrial metals as fuel tank substitutes, or worse yet for grid-connected systems that will smooth the power output from inherently variable wind and solar power facilities that also use prodigious quantities of industrial metals as hydrocarbon substitutes. Talk about compounding the foolishness.

I can only identify one emerging battery technology that has a significant potential to reduce hydrocarbon consumption and industrial metal consumption at the same time while offering better performance. That technology is the PbC® Battery from Axion Power International (AXPW.OB), a third generation lead-acid-carbon battery that uses 30% less industrial metals to deliver all of the performance and five to ten times the cycle life. There may be other examples, but I'll have to rely on my readers to identify them.

Humanity cannot reduce its consumption of hydrocarbons by increasing its consumption of industrial metals. The only way to reduce hydrocarbon consumption is to use less and waste less.  There are a world of sensible and economic fuel efficiency technologies that can help us achieve the frequently conflicting long-term goals of reduced hydrocarbon consumption and increased industrial metals sustainability. They include but are not limited to:

• Better buiding design and insulation;
• Smarter power management systems;
  
• Telecommuting;
• Denser cities with shorter commutes;
• Smart transportation management to reduce congestion;
• Buses and carpooling;
• Bicycles and ebikes;
• Shifting freight to rail from trucks;
• Smaller vehicles that use lightweight composites to replace industrial metals;
  
• Deploying solar and wind with battery backup for remote power and in developing countries;
  
• Shipping efficiency technologies, such as better hull coatings, slow steaming, etc.; and
• Recycling, recycling and recycling
  

My colleague Tom Konrad wrote a 28 part series on "The Best Peak Oil Investments." While I'm skeptical about the future of biofuels after suffering major losses in the biodiesel business, Tom's work provides an exhaustive overview of the energy efficiency space and a wide variety of investment ideas that have the potential to make a real difference. Since we can't simply take a couple of giant leaps into the future, we'll just have to get out of our current mess the same way we got into it – one step at a time.

We live in a cruel world. There is no fairy godmother that can miraculously accommodate the substitution of scarce industrial metals for hydrocarbons that are a hundred times more plentiful. We can and we must do better, but we can't solve humanity's problems until we accept the harsh realities of global resource constraints without the filters of political ideology and wishful thinking.

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

Posted by John Petersen at 09:28 AM | Permalink | Comments (26)

John Petersen

I'm a cynic and a heretic when it comes to plug-in vehicle schemes because most defy the laws of economic gravity and violate a cardinal rule that Ford engineers developed for the EcoStar light delivery vehicle program in the early '90s:

– The unloaded weight of a plug-in vehicle should never exceed 70% of its loaded weight.

Investors who pay attention to this simple rule can easily distinguish between pipe-dream vehicle electrification schemes that are nothing more than feel-good eco-bling and realistic vehicle electrification projects that make economic sense.

For the last few weeks I've been studying a technology partnership between Norfolk Southern (NSC) and Axion Power International (AXPW.OB) that is developing cost effective battery and hybrid electric drive retrofit systems for railroad locomotives. After extensive research I've decided that battery and hybrid electric locomotives are applications that even a heretic can love because:

• Vehicle weight to cargo weight ratios range from good to extraordinary;
• Expected payback periods are in the three to four year range;
• Electric retrofits can avoid emissions abatement costs mandated by EPA regulations; and
• Axion's PbC technology appears likely to overcome the battery problems that plagued earlier efforts.

Like e-bikes, stop-start idle elimination and hybrid electric vehicles, battery and hybrid electric locomotives are clean fuel efficiency technologies that just make sense.

The Green Goat

The first hybrid electric switching locomotive was introduced in 2004 by Railpower Technology and called the "Green Goat." It replaced the 1,750 hp diesel engine in a General Motors EMD GP9 locomotive with a 290 hp diesel generator and 60,000 pounds of lead-acid batteries that offered a combined power output of 2,000 horsepower. The Green Goat's core strengths were a $750,000 price tag that compared favorably with the $1.5 million price of a new switching unit and a battery dominant hybrid electric drive promised fuel savings of 40% to 60%. Subsequently, Railpower launched a smaller version called the "Green Kid" that offered a combined power output of 1,000 horsepower.



In a year long field trial by IDC Distribution Services, the operator of an inter-modal port facility in British Columbia, the Green Kid logged 3.6 million feet of switching operations over 2,347 hours, saved 10,450 gallons of diesel fuel, and reduced CO2, CH4 and N2O emissions by 53% compared to a conventional switching locomotive.

Initially, the Green Goat was well received and railroads including BNSF, Union Pacific (UNP) and Canadian Pacific (CP) ordered a combined total of 175 units. Despite the initial marketing successes, the Green Goat had significant battery problems and only 55 units were delivered before Canadian Pacific returned four units and canceled the balance of a 35-unit order citing unsatisfactory performance. The company went bankrupt in 2009 and emerged as a subsidiary of the RJ Coleman Co. that no longer builds the Green Goat.

The NS 999

In 2009, Norfolk Southern unveiled an experimental electric switching locomotive that it built in cooperation with the Department of Energy, the Federal Railroad Administration and Penn State University with the aid of a $1.3 million Federal grant. Unlike the Green Goat, the NS 999 draws all its power from an array of 1,080 lead-acid batteries that provide a power output of 1,500 horsepower. The project's goal was to demonstrate the feasibility of a plug-in battery powered locomotive that would eliminate direct rail yard emissions and save up to 50,000 gallons of diesel fuel per year.



During initial trials with 80% of its batteries connected, the NS 999 "operated a full switcher shift, at one point pulling 2,200 tons of rail cars on an uphill track – without using a sanding system, which helps locomotives gain traction. After the shift, the four-axle locomotive had enough juice in its 12-volt batteries to run two more eight-hour shifts." Like the Green Goat, however, the NS 999 ran into battery performance issues that had Norfolk Southern evaluating lithium-ion batteries, nickel-based batteries and advanced lead-acid batteries in a matter of weeks. In June of 2010 Norfolk made its battery technology selection and recruited Axion Power to develop a new battery management system and integrate its disruptive PbC battery technology into the NS 999. The project is scheduled for completion later this year.

In addition to the NS 999 project, Norfolk Southern is working with Axion to develop a retrofit hybrid drive system for multi-purpose locomotives that will use 1,600 to 1,700 PbC batteries to improve fuel economy in long distance freight transportation. A prototype is expected by next spring.

The Battery Problem

The fundamental battery problem encountered by both the Green Goat and the NS 999 is a chemical process known as negative electrode sulfation. During discharge, a lead-acid battery's electrodes are partially dissolved and lead sulfate is created. During charging, the bulk of the lead sulfate gets dissociated and redeposited on the electrodes. In practice complete dissociation of lead sulfate never happens. Instead, a portion of the lead sulfate is deposited on the negative electrode in the form of hard crystals. As the number of cycles increases so does the level of crystallization. When the crystal build up is extreme, the battery fails. The following electron micrographs show how sulfation increases over time in a shallow-cycle partial state of charge environment.



The PbC Solution

Axion's patented PbC battery is a hybrid device that uses conventional lead plates for the positive electrodes and carbon electrode assemblies for the negative electrodes. The PbC is technically classified as an asymmetric ultracapacitor. Due to its unique architecture, the PbC does not experience negative electrode sulfation. It also offers significantly higher charge and discharge currents than a conventional lead-acid battery. In a shallow cycling environment like the Green Goat, prototype PbC batteries have demonstrated the ability to withstand tens of thousands of cycles without degradation. In a deep cycling environment like the NS 999, prototype PbC batteries have demonstrated the ability to withstand up to 2,000 cycles at a 100% depth of discharge without battery damage.

After several years of working with alpha and beta prototypes of its PbC electrodes and electrode fabrication processes, Axion is just now completing the installation, optimization and certification of its first commercial electrode fabrication line. While it has not launched a commercial product yet, that launch is expected later this year.

The Business Opportunity

North America's Class I Railroads operate a combined fleet of approximately 1,500 switcher units that each burn about 50,000 gallons of diesel fuel per year. The average switching locomotive is 30 to 40 years old and was manufactured during an era when emissions control regulations were far less stringent than they are today. As a result of new EPA regulations and a variety of state air quality initiatives, the railroads are under intense pressure to reduce N2O and particulate emissions in their switching yards, which are often located in heavily populated urban areas.

Based on a recent report to the California Air Resources Board, it appears that the cost of bringing an old locomotive up to current standards is roughly equivalent to the cost of converting an old locomotive from diesel-electric to battery powered electric. While an emissions abatement upgrade will improve fuel economy through the application of newer technology, a battery retrofit can eliminate all direct emissions and fuel consumption. Based on a current off-road diesel price of $3 per gallon and an estimated fuel consumption of 50,000 gallons per year, a battery retrofit should offer a payback period in the three to four year range. In comparison, the payback period for an emissions abatement upgrade will be closer to ten years. The long-term revenue potential of retrofitting a portion of the switcher fleet to run on batteries isn't a company maker, but it's a darned good start.

The Voting Machine

Over the last year Axion's stock price has stagnated in the $0.50 to $0.75 range as shares that were sold in December 2009 moved from relatively weak hands to stronger hands. While I've responded to countless comments and questions from readers, many have missed the crucial fact that Axion is focused on completing the development of its technology, rather than marketing a fully developed product. It's never had a marketing team and except for the odd technical presentation at industry events, its selling efforts have been non-existent.

Despite a lack of marketing for a development-stage product that wasn't ready for commercial use, Norfolk Southern found the path to New Castle because it was looking for a cost-effective solution to a critical performance problem that could not be solved with conventional lead-acid batteries. Based on its own technical evaluation of the prototype PbC batteries Axion was able to make in 2009, Norfolk Southern hired Axion to design and build a new battery management system that would facilitate the integration of PbC batteries into the NS 999. After about eighteen months of working with the technology, the refurbishing project for the NS 999 continues apace. If there was any substantial reason to believe the PbC would not stand up to the rigors of the NS 999, Norfolk Southern would have terminated its relationship with Axion long ago. The same can be said for BMW which also found the path to New Castle because it was looking for a cost-effective solution to a crucial performance problem that could not be solved with conventional lead-acid batteries.

In its last quarterly report, Axion disclosed that it had received notification from the Department of Energy that a grant application under the Vehicles Technology Program had passed the first round of criteria testing and advanced to the final round of review. In its last conference call, management told participants that the grant application identified Axion as the prime contractor, and included a top-three US automaker, a research university and a national laboratory as subcontractors. While details of the application will remain confidential until a funding decision is made, it appears that this time around a first tier US automaker has found the path to New Castle because it was looking for a cost-effective solution to a critical performance problem that could not be solved with conventional lead-acid or lithium-ion batteries.

Given the mainstream media's infatuation with lithium-ion batteries, the voting machine that is the market does not want to believe the PbC will be a disruptive energy storage technology. When I consider the growing parade of world-class companies that found the path to New Castle before Axion even had a product to sell, I have to believe there is more substance to the PbC than even I understand.

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 11:44 PM | Permalink | Comments (2)

John Petersen

One of the most pervasive and enduring myths in the energy storage sector is that a robust recycling infrastructure for used lithium-ion batteries will be built before the wonder-batteries that are being manufactured today for the first generation of plug-in vehicles reach the end of their useful lives. In the worst case scenario, advocates suggest used lithium-ion batteries will be stockpiled until there are enough used batteries to justify the build-out of recycling infrastructure.

The numbers tell a very different story.

For several years the single minded obsession of all lithium-ion battery developers has been reducing costs to a point where using batteries as a substitute for a fuel tank makes economic sense. Most of the progress has come from substituting cheap raw materials like iron, manganese and titanium for the more costly cobalt and nickel that were used in first generation lithium-ion batteries. Unfortunately, when you slash the cost of the materials that go into a battery you also slash the value of the materials that can be recovered from that battery at the end of its useful life.

Using Material Data Safety Sheets from Powerizer and current LME Prices from MetalPrices.com, I've calculated the value of the metals that can be recovered from recycling a ton of used batteries and summarized them in the following table.

Battery Chemistry	Metal Value Per Ton
Lithium cobalt oxide	$25,000
Lead acid	$1,400
Lithium iron phosphate	$400
Lithium manganese	$300

Given the extremely high metal value of used cobalt-based lithium batteries it seems strange that only one company in the world, Unicore of Belgium, has bothered to develop a recycling process. When you take the time to read and digest Umicore's process description, however, the reason becomes obvious. Recycling lithium-ion batteries is an incredibly complex and expensive undertaking that includes:

• Collection and reception of batteries;
• Burning of flammable electrolytes;
• Neutralization of hazardous internal chemistry;
• Smelting of metallic components;
• Refining & purification of recovered high value metals; and
• Disposal of non-recoverable waste metals like lithium and aluminum.
  

The process is economic when a ton of batteries contains up to 600 pounds of recoverable cobalt that's worth $40 a pound. The instant you take the cobalt out of the equation, the process becomes hopelessly uneconomic. Products that cannot be economically recycled can only end up in one place, your friendly neighborhood landfill.

Lead-acid batteries are the most widely recycled product in the world because they're 70% lead by weight, the recycling process is simple and a robust global recycling infrastructure already exists. Many leading lead-acid battery manufacturers including Johnson Controls (JCI) and Exide Technologies (XIDE) view their recycling operations as major profit centers that also insure continuity of raw materials supply.

Despite their extremely high metal value, cobalt-based lithium batteries are rarely recycled because process is so difficult and expensive.

In light of their appallingly low metal values, lithium iron phosphate batteries from A123 Systems (AONE) and Valence Technologies (VLNC), lithium manganese batteries from Ener1 (HEV) and lithium titanate batteries from Altair Nanotechnologies (ALTI) will never be reasonable candidates for recycling, which effectively guarantees that buyers will ultimately be required to pay huge up-front disposal fees – think tires with a few more zeros.

In the final analysis, the recycling mythology is just another glaring example of unconscionable waste and pollution masquerading as conservation.

Disclosure: None

Posted by John Petersen at 07:36 PM | Permalink | Comments (3)

Eiad Asbahi, CFA

In this article, I’m going to analyze Advanced Battery Technologies, Inc. (ABAT) and provide evidence that the company is inflating its financial statements.

This article summarizes key points that we have put together in a longer report available here (.pdf). An alternative copy for backup purposes is available here.

A video summary of the findings, along with discussions with certain customers, are available at the following links:

• ABAT Analysis Video 1 of 2
  
• ABAT Analysis Video 2 of 2
  
• ABAT Customer Interview 1
  
• ABAT Customer Interview 2 (Video 1 of 2)
  
• ABAT Customer Interview 2 (Video 2 of 2)

Our customer interviews feature recorded conversations with ABAT customers. After visiting one of ABAT’s plants, one customer called the facility “absolutely the biggest joke I’d ever seen”.

Some of our arguments have been discussed in prior Seeking Alpha articles by other authors, including here, here, here, and here. For instance, in our report, we discuss how ABAT’s SAIC filings show that the company’s actual revenue and profit are a fraction of what is reported in SEC filings. We also show that ABAT’s $20 million acquisition of a Shenzhen battery company appears to be a sham, and that ABAT paid $20 million in 2010 for an entity that they had previously bought in 2008 for $1 million, but had not disclosed to public investors.

In this article, we’re going to highlight new information that ABAT is inflating its financial statements, including:

• A comparison of the profit margins of ABAT to 106 global battery makers as provided by Bloomberg and a list Chinese battery makers as provided by Research and Markets in its “Global and China Rechargeable Lithium Battery Industry Report: 2009-2010” industry report. ABAT shows the highest profit margins out of any global and Chinese battery maker, despite having no technological advantage, limited operating experience, an unrecognized brand name, and production facilities too small to claim economies of scale.
• Site visits show underutilized facilities lacking in quality control. We hired investigators to visit both the Harbin and Wuxi facilities, and provide photos as well as commentary from our investigators in our report. Our investigators concluded that both facilities produce commodity, low-margin products that are highly unlikely to be generating industry-leading margins or return on capital.
• Extensive discussions with customers and partners that confirm our beliefs that ABAT is fabricating its financial statements.

Impossible Economics

Selling a commodity product into a competitive market with no technological advantage is difficult. It's especially difficult for a small business without economies of scale, limited customer relationships, and no distinguished brand name. But ABAT purports to be not just surviving, but thriving with industry-leading margins and an ROIC that warrants explanation.

A company with an EBITDA margin of 45% in 2010 must have some uniquely special competitive advantage. Yet ABAT itself recognizes that it has no special technology for its main products. The following is taken from its 2010 10-k (.pdf):

The technology utilized in producing polymer lithium-ion batteries is widely available throughout the world, and is utilized by many competitors, both great and small. ZQ Power-Tech’s patents give it some competitive advantage with respect to certain products. However, the key to competitive success will be ZQ Power Tech’s ability to deliver high quality products in a cost-efficient manner. This, in turn, will depend on the quality and efficiency of the assembly lines that we have been developing at our plant in Harbin.

In choosing a set of comparable companies for ABAT, we’ll use companies listed by Bloomberg in its “Batteries/Battery Systems” industry classification.

The results are startling. In terms of EBIT margin, ABAT ranked #1 out of 106 global companies, with an EBIT margin of 39%, compared to 23% for the next closest competitor Exide Industries Ltd of India, a $40 billion revenue business.

click to enlarge

Out of the 106 companies provided by Bloomberg in the “Batteries/Battery Systems” classification, Bloomberg records the EBIT margins for 79 of them (the remaining companies’ margins are shown as “N.A.”). ABAT reports a 39% EBIT margin. Only three other companies report EBIT margins above 20%, one of which is NEWN, another suspect Chinese reverse merger company. Only 10 companies report EBIT margins above 15%. ABAT, a company with less than $100m of sales and a relatively tiny player in a commodity industry, is an extreme outlier in our analysis. ABAT also comes up top in other profit margin metrics, with the #1 ranking in EBITDA margin and #2 ranking in net income margin.

Out of the 106 companies provided by Bloomberg in the “Batteries/Battery Systems” classification, Bloomberg records the EBIT margins for 79 of them (the remaining companies’ margins are shown as “N.A.”). ABAT reports a 39% EBIT margin. Only three other companies report EBIT margins above 20%, one of which is NEWN, another suspect Chinese reverse merger company. Only 10 companies report EBIT margins above 15%. ABAT, a company with less than $100m of sales and a relatively tiny player in a commodity industry, is an extreme outlier in our analysis. ABAT also comes up top in other profit margin metrics, with the #1 ranking in EBITDA margin and #2 ranking in net income margin.

Is it possible that a company with only about 5 years of operating experience is generating higher margins than a company such as Energizer (ENR) with its 15% EBIT margins, based on the “quality and efficiency of the assembly lines”?

Perhaps it's ABAT's position in China and access to cheap labor that gives it such an amazing edge in the global arena. We can test this hypothesis by comparing ABAT to a handful of other Chinese battery manufacturers. The independent third party research organization Research in China publishes an annual report titled “Global and China Rechargeable Lithium Battery Industry Report”. In the 184 pages of the 2009-2010 edition, no mention is made of ABAT or its subsidiaries. The report does, however, make mention of China BAK Battery Inc. (BAK), BYD Company (BYDDY.PK), SCUD Group Ltd, and Tianjin Lishen, which generate respective revenue of $222m, $5,805m, $185m, and $295m.

Other Chinese battery manufacturers which are not active in the lithium polymer market can also be compared to ABAT. Examples include the Coslight Technology International Group Limited and Tianneng Power International Limited, with $352m and $330m of revenue respectively in 2009. Gross margins and operating profit margins for all six of these companies, as well as ABAT, have been summarized in the table below for the most recent available fiscal year:

Company	Gross Margins	Operating Profit Margins
China BAK Battery, Inc.	10.6%	-9.7%
BYD Company	17.7%	7.3%
SCUD Group Ltd	18.1%	5.8%
Tianjin Lishen*		5.4%
Coslight Technology	26.6%	9.1%
Tianneng Power	28.5%	14.3%
ABAT	47.3%	39.0%

*This is a subsidiary of CNOOC (CEO) and financial statements were not readily ascertainable, although it is evident that the Research In China report is using numbers specific to Tianjin Lishen.

ABAT’s operating margin is nearly triple that of its closest competitor and six times that of the median operating margin of our Chinese battery makers.

Obviously, strong operating performance alone would not normally be cause for concern. But when a company is doing as well as ABAT, investors need to understand why or how. ABAT clearly states in its annual report that it has limited (if any) technological advantage, and is competing in what is predominantly a commodity market. We have spoken to a customer who has visited ABAT’s Harbin battery manufacturing plant, and he has stated that there was nothing uniquely special about the Harbin facility. We also hired investigators to visit the Harbin facility and their findings are discussed later in this article.

The founder of ABAT, Zhiguo Fu, established it in 2002 despite having experience in construction and real estate, as opposed to battery manufacturing (see here (.pdf)). Furthermore, this company didn't begin manufacturing until 2004 (see here (.pdf)).

ABAT has limited operating experience, an unrecognized brand name, and production facilities too small to claim economies of scale.

Yet it seems like no matter how we compare ABAT to its competitors, ABAT’s financial figures come out ahead despite the numerous causes for concern discussed elsewhere in our report.

Wuxi ZQ and Heilongjiang ZQPT Site Visit

As part of our investment research process, we sent an experienced factory inspector to both the Wuxi electric vehicle facility and the Harbin battery facility. What we found was not encouraging.

Summary points from the Wuxi visit included:

• Out of four assembly lines, only three were operational.
• Staff included 200+ workers, but only 20 are office workers, indicating likely weaknesses in R&D, engineering, QC, and sales.
• Factory management indicated 20,000 unit sales for 2010, with prices ranging from $450-$920 USD. This compares to 90,000 units reported to us by ABAT VP of Finance Dan Cheng on a conference call, a number which can also be backed into using data provided in ABAT’s 10-k.
• The facility does not have a motorcycle manufacturer’s permit issued by the Chinese government.
  • Management claims to use the VIN of a partner, which is illegal.
• Our investigators’ greatest concern was the lack of quality control (QC).
  • No line inspector or inspection of finished products.
  • No inspection list attached to each bike.
  • No testing center inside the factory.
  • The facility lacked basic equipment to test different parts for new product development.
  • Motor speed and efficiency testing machines were present, but no noise, temperature, or salt-fog testing machines.
  • No incoming parts inspection.

Photographs of the Wuxi facility are available in our report.

As lacking as the facilities were in the Wuxi facility, the Harbin site visit was even more disturbing in light of the world-class margins and the company’s reliance on this facility to support the bottom line.

Our investigators concluded the following:

It appears that the Harbin plant is in operation, does produce cells, and has sales. The semi-automated processes… are more advanced than some of the battery companies of China, and far less advanced than battery companies of international standing such as ATL, Lishen, Samsung, LG Chem. It appears that they do some things well, and have some potential great strength, but appear to have limited ability and concepts in the marketing and sales of their product. Selling cells to packagers is a common business model for Asian battery factories, but not one that realizes as much profit. And I note that the CTO acknowledged that the packagers and trading companies were making the entire margin and he was not. Again, normal for Asian cell makers – but not a way to gain success.

A proprietary BMS (Battery Management System) is essential for a successful battery company in the Light Electric Vehicle space. And the lack of such is a major handicap for Harbin. It appears to me that this company has a tiny business selling Li Ma or LFP (Lithium Iron Phosphate) cells to packagers for use in low priced battery packages sold to the domestic China market. This is the least profitable business they could have. The LI-Polymer cells are apparently not really in production (the normal issue with Li poly) due to high cost of materials and resulting high cost of the cells making them uninteresting to most applications. The LFP cells cannot be exported due to patent issues… So the only apparent product for any significant sales would be Lithium Manganese cells, and for that to make money for Harbin they would, probably, need to develop their own BMS, become their own packager, and compete with Phylion, Zhenlong, AEE, MGL, LG Chem, Lishen, HYB, and others.

Conversations with ABAT Customers

Since Advanced Battery's inception, management has made numerous claims regarding relationships with suppliers, distributors, research partners, and other related parties. As part of our due diligence process, we attempted to contact most of the relevant parties that ABAT has mentioned having a relationship with. In many cases, the parties we have contacted have been nonexistent, non-locatable, unwilling to speak, or had something strongly negative to say about ABAT.

In multiple cases, we found customers who either came away from their visits to the company’s factories unimpressed or confident that the company was inflating its financial figures. In this section, we provide a recording with one such customer, but have concealed and modified his voice.

This customer had signed a contract to receive scooters from ABAT’s Wuxi facility in 2009. After receiving a defective product, the customer demanded to visit the Wuxi facility that had supposedly been manufacturing the scooters. During our conversation, the customer indicated that he had visited numerous other Chinese manufacturing facilities to which Wuxi could be compared, and he described the Wuxi facility as a “joke” multiple times. The facility was described as “four empty walls”, the inadequacy of which made him suspect Wuxi was some sort of distributor operation rather than a manufacturing facility. Furthermore, the customer stated that he thought about contacting the SEC to report ABAT for fraudulent claims made in press releases. He said that “none of the stuff they put out was accurate”.

Other customers we’ve been in touch with have voiced similar opinions of ABAT. For example, in 2010, ABAT touted an agreement to re-enter the US market, expecting to deliver 200,000 electric scooter units to All-Power America for $1.1 million. Only half the delivery was taken before serious issues surfaced regarding quality control and licensing. The following comprises one excerpt from the long conversation we had regarding these issues and more with an All-Power executive:

All-Power:	Every step of the way we had some serious QC issues… The licensing is the official word that we gave out to everybody because that was a very tangible problem that the retailer used to return the products. But licensing was a major part of it, they should have checked for licensing compliance before they sent it.
Prescience:	So Wuxi, which is the company that you got the cycles from, they sent you sh**** product, am I reading you right? I’m not sure if I follow you?
All-Power:	Yeah, and that caused a major loss of confidence with our customer. Plus, we missed a lot of deadlines, and the customer said “you missed a lot of deadlines plus you have licensing issues, we’re going to send you all of them back”. So they put them on trucks and sent them back. Now we’re stuck with the inventory that I don’t know how the hell to move.

Wuxi ZQ mentions additional customers in its February 3, 2010 press release and in this excerpt (.pdf) from ABAT's 2010 10K. We reviewed our diligence with many of these customers in our report.

Conversations with ABAT Partners

Alongside numerous ruined or strained customer relationships, we have also uncovered a number of failed partner relationships. In our report, we discuss our conversations with ZAP (ZAAP.OB) and Altair Nanotechnologies (ALTI), as well as our attempts to contact numerous other ABAT partners. Our conversations, as well as our inability to locate many of ABAT’s obscure or hard-to-locate partners, reinforced our belief that ABAT’s business is much smaller than its SEC financial statements indicate.

Conclusion

Our longer report elaborates on the evidence discussed in this article. Our evidence that ABAT is inflating its financial statements includes:

• SAIC filings show that ABAT is reporting significantly lower revenue and operating losses to the authorities in China. For 2009, SAIC filings showed less than $2 million of revenue, compared to $64 million in SEC filings.
• ABAT has unreasonably high margins in an established industry with strong competitors. The Company’s SEC-reported margins and return on capital are virtually impossible. Out of 106 global battery manufacturers as classified by Bloomberg, ABAT has the highest operating profit margin by a wide margin. When compared to six leading Chinese battery makers, ABAT’s operating margin is triple that of its closest competitor and six times that of the median operating margin of the comparable companies.
• Site visits show underutilized facilities lacking in quality control. We hired investigators to visit both the Harbin and Wuxi facilities, and provide photos as well as commentary from our investigators. Our investigators concluded that both facilities produce commodity, low-margin products that are highly unlikely to be generating industry-leading margins or return on capital.
• In December 2010, ABAT announced that it was acquiring a Shenzhen battery maker for $20 million. We believe this acquisition is a sham, and that ABAT paid $20 million in 2010 for an entity that they had previously bought in 2008 for $1 million, but had not disclosed to public investors.
• Confirmation from former customers and partners that the company is likely a fraud. After visiting one of ABAT’s plants, one customer called the facility “absolutely the biggest joke I’d ever seen”.
• Low quality auditors and high turnover. The company has had 4 auditors in the past 7 years, with no auditor being ranked in the top global 100 auditors at the time of hire.
• Unqualified CFOs and high turnover. A CFO or auditor has resigned at least once a year. The company’s past three CFOs have included: (i) a company insider who has been general manager of the company’s main operating subsidiary since 2004, and is therefore not remotely independent, (ii) a 29-year-old who was formerly VP Finance at China Natural Gas, another fraud, and (iii) a candidate whose primary experience comprised of being a financial adviser at Smith Barney.
• Continuous share dilution through secondary offerings, despite having more than adequate cash reserves. Through repeated share issuances, the company has grown its outstanding shares from 10.0 million following the 2004 reverse merger to 76.4 million today.

Disclosure: I am short ABAT.

Additional disclosure: Please read the full disclaimer at the end of our report.

Eiad Asbahi, CFA, is the founder and Managing Partner of Prescience Investment Group. Prescience is a research-driven, performance-oriented investment and advisory firm specializing in extensive, independent research on companies in order to develop unique insights and identify singular investment opportunities. Prescience manages a private investment partnership as well as separately managed accounts.  This article is reprinted with permission from the author.

Posted by Guest Contributor at 11:30 AM | Permalink | Comments (0)

John Petersen

Bartenders are smarter than most investors because they know what dilution is and they never get it wrong. Unfortunately, the markets have made such a bogeyman out of the word 'dilution' that public companies often suffer extreme backlash from financing transactions that should have existing stockholders on their feet and dancing in the aisles.

Today I'll try to clear up some of the profound confusion that runs rampant in the minds of retail investors.

Every bartender knows you can't dilute a beer by adding a shot of whiskey. The boilermaker is always stronger. The same is usually true when a public company sells new stock for cash. The company is stronger and better funded after the transaction than it was beforehand. Frequently, however, the existing stockholders recoil in terror from a vague threat of  dilution and bail out instead of celebrating.

For astute investors, these are great buying opportunities.

Most readers know I'm rarely bullish about A123 Systems (AONE), or for that matter any pure-play lithium-ion battery developer. Since I believe that it's critically important for my readers to understand what dilution is, I've decided to break away from tradition, jump to A123's defense, and explain why A123 is a far better risk today than it's ever been.

Every IPO prospectus is filled with dire warnings of dilution because IPO investors always pay a price per share that's higher than the book value of the stock owned by the pre-IPO stockholders. In A123's IPO, its pre-offering book value was $2.34 per share, the IPO investors paid $13.50, and its post-IPO book value was $5.13 per share. Investors who bought stock in the IPO were the whiskey and they suffered dilution of $8.27 per share. The pre-offering stockholders, on the other hand, were the beer and the book value of their shares increased by $2.79 each through the magic of corporate finance.

During its first 15 months of operations A123 suffered a series of expected operating losses and by December 31, 2010, the summary year-end balance sheet in its Form 10-K looked like this:

	(thousands)
Cash and equivalents	$ 216,841
Working capital	191,892
Total assets	576,158
Long-term debt	9,982
Capital lease obligations	20,226
Stockholders' equity	398,198

On March 28, 2011, after its stock closed at $7.82 for the day, A123 announced concurrent underwritten public offerings for $125 million in convertible debentures and 18 million shares of common stock. The stock price fell to $6.35 per share within three days because somebody somewhere whispered the word dilution and the stockholders went into a panic.

On the morning of April 1st, A123 announced that the stock offering would be priced at $6 per share and the debentures would be convertible at $7.20. Both offerings were well received and A123 ultimately sold 20,184,067 shares of common stock and $143.75 million in debentures. The net cash proceeds of the offerings were $253.9 million. After giving effect to the offering proceeds, a pro forma summary year-end balance sheet would have looked like this:

	(thousands)
Cash and equivalents	$ 515,741
Working capital	445,792
Total assets	830,058
Long-term debt	9,982
Capital lease obligations	20,226
Convertible subordinated debentures	143,750
Stockholders' equity	508,348

At December 31, 2010, each of A123's common shares had a book value of $3.77. After giving pro forma effect to the offering each of A123's common shares had a book value of $4.04. Just like we saw in the IPO, the new investors were the whiskey and they suffered dilution of $1.96 per share while the pre-offering shareholders were the beer and the book value of their shares increased by $0.27 through the magic of corporate finance. If you take the analysis a step further and assume the debentures will ultimately be converted, the value accretion to the old shareholders will be closer to $0.70 per share. More importantly A123 is now in a position where it has plenty of cash to complete the build out of its facilities and pursue the development of its business. I thought it was a masterful piece of corporate finance work.

The stock market, however, interpreted the facts differently. As soon as retail investors began reacting to the dilution bogeyman the stock price tanked. Over the next two weeks the market price of A123's stock plunged to a post-offering low of $5.29. It finally broke back up through the $6 threshold on Tuesday.

The easiest way to prove the silliness of the over-reaction is to note that A123's market capitalization was $826.4 million at the close of business on March 28th. The offering added $253.9 million in cash and $110.2 million in stockholders' equity to its balance sheet. Because of the market's over-reaction, its current market capitalization is $766.5 million.

At the end of last year A123 had some serious financial weaknesses that jeopardized its ability to finance ongoing losses and continue its planned expansion. The offering obliterated those weaknesses and left A123 in a very strong position. If its stock was fairly priced prior to the offering, the post offering market capitalization should be at least $936.7 million ($826.4 million in pre-offering market capitalization plus $110.2 in additional stockholders equity), or $7.44 per share.

A123 has a first quarter conference call scheduled for May 9th and I won't be surprised if its revenues and earnings fall short of expectations, but if you liked A123 Systems at $7.82 you should love it in the $6.00 range.

It's a far better investment today than it was a month ago.

Disclosure: None.

Posted by John Petersen at 01:56 PM | Permalink | Comments (0)

John Petersen

One of the most seductive and dangerous stock market myths is the immensely popular but demonstrably false notion that the rapid cost reductions and performance gains we enjoyed during the information and communications technology revolution will be repeated in the age of cleantech. The persistence of the mythology is astonishing when you consider that the entire history of alternative energy proves that cost reductions and performance gains are extraordinary events, rather than common occurrences. Investors who buy into economies of scale mythology without carefully considering the fundamental differences are in for a world of disillusionment and pain as they watch their portfolio values erode.

Everybody above the age of twelve has heard about economies of scale – they're the reason products tend to get better and cheaper over time. Most of us, however, don't take the time to consider the forces that give rise to economies of scale. As a result, we blithely assume that experience in one sector will carry over to another. Unfortunately, it's not that simple.

Wikipedia identifies the following basic economies of scale:

• Purchasing economies – bulk buying of materials through long-term contracts;
• Managerial economies – increasing the specialization of managers;
• Financial economies – obtaining lower-interest rates and having access to a wider range of financial instruments;
• Marketing economies – spreading the cost of advertising over a greater range of output in media markets;
  
• Manufacturing economies – taking advantage of larger scale in the manufacturing function; and
• Experience economies – learning by doing.
  

Each of these factors reduces long run average costs (LRAC) and shifts the cost of production down and to the right.

The ugly truth most investors fail to recognize is that economies of scale occur in specific companies and diminish as a company or product matures. While specific companies can benefit from economies of scale that drive their production costs down, industries frequently suffer from diseconomies of growth and competition that drive production costs up while product prices are falling – a combination that invariably compresses profit margins. The principal diseconomies include:

• Constraints on raw material and component availability;
• Cannibalization of market opportunities by competing firms;
• Duplication of efforts on "secret sauce" differentiation within product classes;
• Ownership of critical technological advances by emerging market participants;
• Economic gravity, which favors cheaper products over more costly alternatives; and
• Human inertia, which favors established products and practices.

When I was young, the best performing battery technology was lead-acid, which had specific energy in the 30-50 watt-hours per kilogram range. The next step was nickel cadmium (NiCd) batteries with specific energy in the 45-80 wh/kg range. Then came nickel metal hydride (NiMH) batteries with specific energy in the 60-120 wh/kg range. Today's pinnacle of performance is lithium-ion batteries with specific energy in the 90-190 wh/kg range.

My inner optimist considers a four-fold improvement in battery technology and calls it progress. My inner pragmatist compares a four-fold improvement in battery technology to a billion-fold improvement in information technology and knows that something is very different. Our need for better batteries was no less urgent than our need for better electronics. In fact, many of the companies that drove gains in electronics were also active in the battery industry. Where progress in IT was immense, the battery industry was basically stagnant. Even the cast of Sesame Street can look at these facts and say with confidence “One of these things is not like the other.”

The reasons for the disparity are really quite simple. Where electronics are governed by the laws of physics, energy storage is governed by the laws of chemistry. When you make an electronic device smaller you reduce its material content and improve its performance at the same time. When you make an energy storage device smaller, you get fewer chemical reactions and less storage potential. More importantly, battery manufacturing is a mature industry and we use the same basic processes, equipment and product architecture today that we used 35 years ago. Albert Einstein taught that “doing the same thing over and over again and expecting different results” was insanity. There’s a lesson there for investors.

While it would be an oversimplification to suggest that the only major differences between battery types are changes in the chemistry manufacturers put into their can or pouch, it wouldn't be gross oversimplification. In many cases energy and power are declining as manufacturers try to optimize safety and cycle life. The major performance gains the world so desperately needs are not going to arise from minor modifications to chemistry in a can. If they arise, they'll come from entirely new approaches based on fundamentally different chemistries, manufacturing processes and product architectures.

In the lithium-ion space there is precious little substantive differentiation between the various chemistries and form factors. There are differences, but they're usually fine tuning to optimize energy, power, safety or cycle life. In general, the chemistries with the highest energy and power have the lowest safety and cycle life. Conversely, manufacturers who are willing to dial energy and power down a notch have been able to realize impressive safety and cycle life gains. When it comes to manufacturing costs, however, nobody has a significant advantage over the old line lithium-ion battery producers like Sony, Panasonic-Sanyo and LG Chem who've been in business for decades and have already optimized their economies of scale. Any way you look at it, new market entrants like A123 Systems (AONE), Ener1 (HEV), Valence Technologies (VLNC) and Altair Nanotechnologies (ALTI) will be playing catch-up ball for years.

The lead-acid space is a lot like the lithium-ion space when it comes to product differentiation. Leading lead-acid battery manufacturers like Johnson Controls (JCI), Enersys (ENS) and Exide Technologies (XIDE) produce high quality products that are basically fungible commodities. While there are modest differences, there's nothing that's truly unique about any of their products.

To the best of my knowledge, Axion Power International (AXPW.OB) is the only publicly held battery technology developer that's doing something completely different. Where its competitors are fooling around with additives that offer modest improvements in cycle-life and charge acceptance, Axion is replacing traditional lead-based negative electrodes with patented carbon electrode assemblies that boost cycle-life and dynamic charge acceptance by 1000% or more. The chemistry stays the same, but the electrode fabrication methods are completely different and so is the final device – a hybrid that's half battery and half supercapacitor and can be assembled on any conventional AGM battery production line.

Axion's carbon electrode assemblies have never been manufactured on a commercial scale. Its first generation electrode fabrication line produced enough electrode assemblies to support its testing, demonstration and validation projects with automakers, railroads and other potential customers, but the production capacity and quality control were not high enough to meet customer needs. Last month, Axion completed the installation of a second-generation automated electrode fabrication line that promises to significantly improve both. Axion is currently engaged in manufacturing process, quality control and product performance validation with its potential customers. Until that work is completed, a design win or production contract would be premature. Once Axion introduces its first commercial product, it will be at the top left-hand corner of the total cost curve. As near as I can tell, Axion is the only battery manufacturer in the world that has a reasonable opportunity to realize true and significant economies of scale in its future operations.

Disclosure: Author is a former director of Axion Power Internatinal (AXPW.OB) and owns a significant long position in its common stock.

Posted by John Petersen at 06:16 PM | Permalink | Comments (5)

John Petersen

On March 30th, Lux Research released an update on the vehicle electrification market titled "Small Batteries, Big Sales: The Unlikely Winners in the Electric Vehicle Market" that predicts:

• E-bikes and micro-hybrids carry minimal storage, but compensate with high volume. E-bikes show strong unit sales, as they sustain a 157 GWh storage market totaling $24.3 billion in revenues in 2016. Micro-hybrids benefit from increasingly stringent emissions limits, supporting 41 GWh and $3.1 billion in storage sales.
• Hybrid electric vehicles (HEVs) like Toyota's Prius grow steadily while PHEVs and EVs are at the mercy of external factors. Both PHEVs and EV sales are sensitive to oil prices, but catalyze growth for Li-ion batteries, along with HEVs powering a $2.3 billion market in our base case scenario.
  
• Advanced lead-acid batteries will dominate the storage market now and in the future, resulting in a 165 GWh and $16.1 billion market in 2016.  Lithium-ion follows, showing strong growth from 4.1 GWh and $2.7 billion in 2011 to 32.2 GWh and $11 billion in 2016.
  

Since the report echoes several themes I frequently discuss in this blog, it seems like an opportune time to back away from the minutiae and revisit the broad opportunities for growth in the vehicle electrification sector.

The basic drivers of all vehicle electrification initiatives are the desire to break the economic stranglehold of increasingly expensive petroleum, reduce CO2 emissions and improve air quality in big cities. The major countervailing force is the economic reality that consumers will not sacrifice the flexibility and reliability of internal combustion engines for a more expensive alternative that doesn't offer a compelling value proposition. Governments and EVangelicals are pushing hard for flashy EV solutions with miserable economics, but Lux believes cheap will beat cool over the next five years.

Electric Two-wheeled Vehicles

In Lux's view, the runaway winner over the next five years will be e-bikes – the most energy efficient transportation in the world. It expects battery sales for e-bikes to double from $12 billion in 2011 to $24.3 billion in 2016. While roughly 85% of today's e-bikes use lead-acid batteries because they cost less, Lux expects lithium-ion batteries to garner an 18% market share in China by 2016, which implies a global market share of closer to 30%. As an avid cyclist who understands the impact of extra weight on a bicycle, I think Lux's market penetration forecast for lithium-ion is low. Lead-acid may retain its dominance in China, the world's biggest e-bike market, but I'm convinced that lithium-ion will be the battery of choice in North America and Europe where e-bikes are rapidly gaining ground.

Lux expects a limited market for e-bikes outside of China, but I think it's a market that could surprise people who haven't really considered the mobility needs and transportation budgets of young adults and cost-conscious commuters. E-bikes are not an all weather solution, but on a pleasant day a $1,000 e-bike is far more attractive than alternatives that cost thirty to fifty times more and can't come close in the fun per mile category.

I've been following Advanced Battery Technologies (ABAT) for a couple years and have been impressed by its cost control and business strategy. It began as a low cost manufacturer of commodity lithium-ion batteries and then expanded into e-bike manufacturing. It's growth rates and profit margins are impressive enough that I've often said ABAT is too cheap to be cool. ABAT's stock price recently tumbled by over 40% when Variant View Research, an acknowledged short seller, published three "hatchet-job" articles that were highly critical of its operations, financial reports and corporate governance. Since I don't want to jump into the middle of a dogfight, I'll simply note that ABAT is the only publicly held pure play in the e-bike space and seems to have a bright future as a vertically integrated manufacturer of e-bikes, the most popular electric vehicles in the world.

Micro-hybrids

The second biggest market over the next five years will be micro-hybrids, conventional internal combustion vehicles that simply turn the engine off when the car is stopped and restart the engine when the driver takes his foot off the brake. In an earlier report titled "Micro-hybrids: On the Road to Hybrid Vehicle Dominance," Lux forecast that the micro-hybrid market would grow from three million units this year to 34 million units a year by mid-decade. The primary drivers of growth will be strict new European CO2 emissions rules and ambitious new CAFE standards that will be phased in over the next few years. According to Lux "micro-hybrids sit in an enviable position as a cost effective approach to improve fuel efficiency, since their start-stop and regenerative braking capabilities can be implemented in the OEMs' current stable of vehicles, without the more drastic redesigns needed to create a full EV, PHEV, or HEV." Overall, Lux believes the market for advanced batteries in micro-hybrid vehicles will grow from $495 million this year to $3.1 billion by 2016.

Competition in the micro-hybrid battery space is intense and diversified. Johnson Controls (JCI) and Exide Technologies (XIDE) are both offering a variety of advanced lead-acid batteries for micro-hybrids that range from enhanced flooded batteries to valve regulated absorbed glass mat batteries. With their global manufacturing footprints, established OEM relationships and proven manufacturing competence both companies should benefit from impressive growth in OEM battery sales over the next five years.

While advanced lead-acid batteries currently dominate the micro-hybrid battery market, there is a growing body of proof that advanced lead-acid batteries are ill suited to the demands of micro-hybrids. In a 2007 Journal of Power Sources article, a team of battery researchers from Ford described the problem as follows:

"Charge acceptance, particularly at low temperatures, is a battery requirement that determines the charge balance of the power supply system. The more the battery has to contribute to supplying electrical loads, the more essential it becomes that it can be recharged quickly. ... [A]dvanced HEV applications will require good charge acceptance in a dynamic discharge/charge micro-cycling operation. We call this feature dynamic charge acceptance (DCA). In the particular case of lead/acid batteries, DCA capability is extremely sensitive to the short-term previous charge/discharge exposure of the battery."

At last September's European Lead Battery Conference in Istanbul (the ELBC) Ford and BMW jointly proposed a new battery testing protocol for micro-hybrids. Under the protocol a 60-second engine off cycle will require 39,600 watt-seconds of energy. Of that total, 36,000 watt-seconds will be used to support accessory loads during engine off interval and the remaining 3,600 watt-seconds will be used to re-start the engine. Until the 39,600 watt-second discharge is recovered, the stop-start system will be disabled. Since a disabled stop-start system can't save fuel by turning off the engine at a stoplight, dynamic charge acceptance is rapidly emerging as one of the important battery performance requirements for micro-hybrids, if not the most important one.

The big drawback of using enhanced flooded batteries and AGM batteries in micro-hybrids is that their dynamic charge acceptance degrades over time. While a new battery needs about 30 seconds to recover from an engine-off event, it can take three minutes or more when a battery's been in service for a year. Since city driving typically offers one or two engine-off opportunities per mile, pushing the battery recovery time from 30 seconds to three minutes or more has a very negative impact on fuel economy.

The following graphs come from the BMW-Ford presentation at the ELBC and show how the dynamic charge acceptance of an AGM battery degrades over time. The graph on the left shows what happens if the generator is disabled for seven seconds after restart to maximize the engine power available for acceleration. The graph on the right shows what happens if the generator kicks in immediately. The downward curving blue lines show the amount of current the battery can accept as the number of stop-start cycles increases. The upward curving black scatters with red overlays show the time required for the battery to regain an acceptable state of charge. The simple summary is that both batteries performed poorly and lost most of their dynamic charge acceptance capacity in a matter of months.



While advanced lead-acid batteries are currently the best available choice for micro-hybrids, their market dominance is vulnerable because dynamic charge acceptance is so critical. As the market matures, I believe automakers will choose batteries for micro-hybrids on the basis of detailed cost benefit analysis that includes lifecycle fuel economy. When all costs are accounted for, I believe emerging energy storage technologies will gain the upper hand.

Three advanced battery developers have disclosed alternative approaches to the micro-hybrid market.

The first design win from Peugeot-Citroën went to a three-component system from Continental AG and Maxwell Technologies (MXWL) that combines an AGM battery and control electronics from Continental with a small supercapacitor module from Maxwell. In this system, the AGM battery carries the 36,000 watt-second accessory load and the supercapacitor picks up the 3,600 watt-second starter load. While this three-component approach will reduce battery strain by shifting the starter load to the supercapacitor, it can't eliminate the gradual loss of dynamic charge acceptance in the AGM battery that does the yeoman's share of the work.

A second design win from an undisclosed OEM has reportedly gone to A123 Systems (AONE), which has been testing a lithium-ion micro-hybrid battery solution for the last few years. Given the charge acceptance characteristics of A123's lithium-ion chemistry, I believe its stop-start solution will perform well and avoid the dynamic charge acceptance issues that plague advanced lead-acid batteries. The big questions will be cost and cold weather performance. Until A123 releases more details on its micro-hybrid solution, it will be hard to assess its competitive position.

The third contender for a share of the micro-hybrid market is Axion Power International (AXPW.OB), which is working with several automakers and has progressed far enough in its relationship with BMW that the two companies made a joint technical presentation at last year's ELBC. While it's not unusual for an automaker to enter into a development contract or supplier relationship with a micro-cap, I'm not aware of another case where an automaker shared the podium with a battery developer at an industry conference. A more surprising development was a brief conference call reference to a grant application under the DOE's Vehicle Technologies Program that Axion filed as a co-applicant with a major automaker. To the best of my knowledge, this is the first time an automaker has joined in a DOE grant application with a component developer. While the details remain sketchy, the DOE plans to make its award decisions by late June and fund in the third quarter.

Axion is not currently producing PbC batteries for commercial sale to customers. It has recently installed a second-generation automated production line for its patented carbon electrode assemblies and is engaged in manufacturing process, quality control and product performance validation activities with potential customers. Until that work is completed, a design win or production contract will remain out of reach.

EVs, PHEVs and HEVs

While Lux forecasts that EVs, PHEVs, and HEVs will command a solid chunk of storage revenue because of their high per vehicle battery costs, Lux doesn't "expect EVs or PHEVs to take the world by storm, and sees steady but not explosive growth from HEVs." Lux said that consumer acceptance of the GM Volt and Nissan Leaf is "anything but a certainty" and noted that early results indicate only 40% of the non-binding pre-orders for the Nissan Leaf are turning into purchases. It cited high battery costs as a major obstacle to making electric vehicles cost effective. Overall Lux believes that light and heavy PHEVs will depend on high oil prices and "EVs will disappoint in all scenarios." As a product class, Lux predicts that battery sales for EVs, PHEVs, and HEVs will grow from $710 million this year to $2.1 billion in 2016. Since there are so many competitors in the EV, PHEV and HEV markets, it's hard to pick likely winners and I'd rather watch from the sidelines.

Heavy Vehicles

The last class of vehicles considered by Lux was delivery trucks, city buses and railroad locomotives. It forecast that sales in the heavy vehicle segment would grow from $110 million in 2010 to $642 million in 2016. A number of energy storage technology developers are active in the heavy vehicle segment including:

• Maxwell, A123, Ener1 (HEV), Altair Nanotechnologies (ALTI) and Valence Technologies (VLNC), which are actively marketing energy storage systems for hybrid and electric buses and delivery trucks; and
• General Electric (GE) and Axion Power, which are developing battery systems for hybrid locomotives and retrofit solutions for the existing locomotive fleet.

While there are too many competitors to pick likely winners in the highway vehicle markets, I'll continue watching the railroad market with interest because the existing locomotive fleet includes 24,000 units nationwide and implementing hybrid drive in a train is relatively simple because of the ability to mix and match conventional diesel locomotives and retrofitted electric locomotives to meet the power and recuperative braking needs of a specific load and route.

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 08:17 PM | Permalink | Comments (2)

Green money managers' stock picks after the Japanese nuclear crisis.

Even as the nuclear disaster in Japan unfolds, it's clear that the world's energy industry will be forever changed. Russian reactors were never considered safe, but a Japanese to have a nuclear meltdown is an entirely different story.

Market Reaction

Since Monday, nuclear stocks and ETFs have been plummeting. As of Wednesday night, The Market Vectors Uranium + Nuclear Energy ETF (NYSE:NLR), the iShares S&P Global Nuclear Energy Index (NASD:NUCL), PowerShares Global Nuclear Energy Portfolio ETF (NYSE:PKN), and the Global X Uranium ETF (NYSE:URA) are down 17%, 14%, 16%, and 29% respectively.

Yet we still need energy, and when the dangers of traditional energy once again rise in our awareness, the safety of renewable energy gains appeal. Over the same three days, the most liquid of the Clean Energy ETFs, the Powershares Wilderhill Clean Energy ETF (NYSE:PBW), the First Trust ISE Global Wind Energy ETF (NYSE:FAN), and the Guggenheim Solar ETF (NYSE:TAN) gained 1%, 2%, and 11%, respectively, even as the S&P 500 fell 3%.

The market thinks that the outlook for clean energy in general and solar in particular, has improved greatly. This makes sense, because as the Japanese rebuild their energy infrastructure, they will stay away from nuclear, and focus on electricity that's safe, and quick to deploy. Green energy fits the bill.

Stock Picks

If green energy will do well in general, which stocks will do the best? I emailed my contacts among green investment fund managers, and asked them each to pick one stock they thought was particularly well positioned. Here are their picks.

Garvin Jabusch: LDK Solar

Jabusch manages the Sierra Club Green Alpha Portfolio. He thinks that, in the long run, solar will be the big winner, followed by wind. His top pick is LDK Solar (NYSE:LDK), which his fund holds. He also blogs about green investing, and has just finished an article on Japan, Nukes, and Solar.

John Segrich CFA: Capstone Turbine

Segrich manages the top-performing Gabelli SRI Green Growth Fund (SRIGX). Like many contrarian investors, he's not great at following instructions (I asked for no more than three sentences), but he has interesting things to say:

The big beneficiary in the aftermath of the Japan nuclear crisis will be natural gas related companies. In particular Japan is likely to rebuild generation infrastructure with natural gas and in particular liquid natural gas (LNG). The pushback against nuclear will not necessarily be the boon to renewable that many are suggesting. Renewables are not failsafe in a disaster scenario (look at how many solar panels were shattered in the quake) and they cannot replace baseload power. Gas is the logical and cleanest and safest solution and we would expect Japan, Italy, and Germany to build more gas vs increase emphasis on renewable. … one interesting way would be to look at companies whose business model is gas based and can handle local based generation with rapid deployment:

Capstone Turbine (NASD:CPST) makes gas powered microturbines that can be locally installed and can provide immediate efficient and clean power generation for stand alone facilities (hospitals, schools, hotels, critical infrastructure) – we are already seeing deployment on infrastructure in the US to provide constant, reliable, failsafe power. I would expect to see adoption of these solutions for rapid deployment in disaster areas such as Japan at the moment to provide critical power on a local level as needed. Longer term, integrating these turbines as a backup/distributed power solution also makes sense for future emergency planning.

Sam Healey: MEMC Electronic Materials

Sam Healey manages a Cleantech stock portfolio at Lamassu Capital. He thinks MEMC Electronic Materials (NYSE:WFR) has two chances to benefit from the disaster. First, the nuclear renaissance stalls, it will boost to the Solar industry, and MEMC will benefit. By year end WFR will be vertically integrated from Poly [silicon] production through installation via Sun Edison and will be able to capitalize on any global expansion of solar power. Second, and more important in the near term, Japan accounted for 10-20% of the global Poly manufacturing of Semi[conductor] Wafers. Therefore, MEMC, will be able to gain share in the near term as it absorbs some of the demand for Semi Wafers, and perhaps will also have better pricing. MEMC does have one plant in Japan that is currently off line as a result of the earthquake.  The plant does not produce raw poly but was one of MEMC's 8 plants that manufacture 300 MM wafers and 1 of 3 MEMC plants that engage in wafer polishing and slicing.  The risk is that they will not be able to replace this production at their non Japan plants.

Tom Konrad CFA: NGK Insulators

My own pick is NGK Insulators (Tokyo:5333, Pink:NGKIF). NGK has fallen along with the Japanese market, but stands to benefit from the rebuilding of the northern Japanese grid. NGK's manufacturing is located in the central and southern part of the country, so the company should not have been too badly hurt by the earthquake and tsunami. NGK also sells the most mature, high capacity grid-based electricity storage technologies: the Sodium-Sulfur (NaS) battery. Especially on a small island like Japan, electricity storage is very helpful for integrating the variable power from solar and wind, and the Japanese are likely to favor this home-grown technology over foreign rivals.

Solar, distributed Natural gas, Electric grid & storage: they could all be winners. What do you think? The comments are open. I've also started a poll.

This article was published on Tom Konrad's Green Stocks blog on March 18th.

DISCLOSURE: No Positions. I did not ask the money managers interviewed if they own their picks, but we can assume they do.

Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

Posted by Tom Konrad at 03:56 PM | Permalink | Comments (1)

John Petersen

Last Friday I breathed a sigh of relief as my core position in Axion Power International (AXPW.OB) regained the price level it established in the first quarter of 2010. The last 12 months have been a stockholder's worst nightmare as supply and demand dynamics pushed Axion's stock price down into the $0.50 range and kept it there. Since it looks like new buyers have finally eaten their way through the excess supply, now seems like an opportune time to unwrap my crystal ball and lay out an elephant hunter's thesis for Axion's stock price outlook over the next few months.

Axion went public through a reverse merger in December 2003. Like many reverse merger companies, its market was illiquid in the early years and the stock traded by appointment. The following table summarizes the reported annual trading volume during Axion's first seven years as a public company. It shows the total reported volume for each year and the percentage derived by dividing the reported volume by the fully diluted common shares outstanding at year-end.

Year	Shares Traded	Percentage
2004	243,255	1.8%
2005	325,882	1.9%
2006	1,092,755	4.6%
2007	835,030	3.3%
2008	1,888,865	5.4%
2009	7,176,200	8.5%
2010	22,015,900	25.8%

So far this year, Axion's cumulative trading volume is 18.4 million shares. That means 2011 is likely to be the first time in its history that annual trading volume will exceed 50% of the issued and outstanding shares, a level of activity that most investment professionals believe is required for a healthy liquid market.

In December 2009 Axion closed a $26 million private placement that is properly classified as a venture capital investment in public equity, or VIPE, transaction. Four purchasers including Blackrock, the Special Situations Funds, Manatuck Hill Partners and one individual, bought 31.4 million shares in blocks of 7.2 to 8.8 million shares each. In addition, 47 small funds and individuals bought 14.4 million shares in smaller blocks. The offering was priced at $0.57 per share and the 45.7 million shares that were sold in the offering represented about 55% of the company.

In a September 2010 study of 1,655 VIPE transactions between 1995 and 2008, the authors reported that VIPE investors typically buy at a 47% discount to market, which meshes well with my experience that large private placements are typically priced at a 50% discount to market. The reasons for the deep discount are obvious. In a market transaction, an investor will buy a few hundred to a few thousand shares with the expectation that he can change his mind, liquidate and move on whenever he feels like it. In a VIPE transaction, an investor cannot have any reasonable liquidity expectations for months or even years. In cases where several large investors participate in a VIPE transaction, the liquidity assessment is performed at the transaction level, rather than the investor level. In cases where there's a big gap between historical trading volumes and the size of the VIPE transaction, the discount will usually be more than 50% to offset the liquidity deficiencies.

If one assumes that 50% was a proper discount for Axion's VIPE transaction where the investors bought shares that represented six and one-half years of historical trading volume, the transaction should have put a $1.15 baseline trading value on Axion's stock. If one assumes that a 60% discount would be more appropriate in light of the liquidity deficiencies, a baseline trading value of $1.50 per share would have been more reasonable. Those two numbers bracket the range – $1.15 on the low end and $1.50 on the high end – that I believed Axion's stock would trade in when I wrote a December 2009 article titled "Why I'm Thrilled by Axion's Financing Transaction."

While I believed in December 2009 that Axion's stock price would stabilize in the $1.15 to $1.50 range, and it did exactly that during the first quarter of 2010, liquidations that were unrelated to business fundamentals began in the second quarter and continued into the summer. As a result, the price was beaten down to an all time low of $0.46 before stabilizing in the $0.60 range by year-end. Since then, the stock price has doubled.



I've always believed the plateau from February through April 2010 represented fair value and the slump that began in late April was based on supply and demand dynamics instead of business fundamentals. While Axion's stock price was swooning, the following key corporate and regulatory events were unfolding.

March 30, 2010	Annual Earnings Release
April 1, 2010	The EPA and NHTSA adopt new CAFE standards for cars and light trucks
May 5, 2010	Announced upgrade to first generation electrode line and plans for second generation line
May 18, 2010	Announced presentation at 2010 Advanced Automotive Battery Conference & Symposia
June 9, 2010	Announced development program with Norfolk Southern Railroad
September 20, 2010	Announced joint technical presentation with BMW at the European Lead Battery Conference
February 14, 2011	Announced foundation patent on PbC electrode assembly
March 8, 2011	Announced order for $3.5 to $8 million of flooded batteries
March 8, 2011	Confirmed first quarter commissioning of second generation electrode line

A couple of these events were nothing short of extraordinary.

Many small companies in the battery and power electronics space decide to develop their own battery management system expertise, but I'm not aware of another situation where a transportation giant like Norfolk Southern hired a micro-cap company like Axion to develop a battery management system as the first step in a project geared toward the potential retrofit of a portion of its diesel electric locomotive fleet to hybrid diesel electrics.

Many small companies in the battery space are engaged in development projects with automakers, but the identities of the automakers are closely guarded secrets until the automakers announce a production decision. Several recent reports that other battery manufacturers have won production contracts from automakers but declined to publicly identify their customers are prime examples of the normal course of business. I've spent several months searching for a comparable example of a joint technical presentation by an automaker and a battery developer at a major industry conference. So far my effort has been unsuccessful.

Axion was not dealing with a normal market in 2010 and is just now getting back to the baseline trading value it established in the first quarter of 2010. While it's hard to say what the 2010 developments would have been worth in the in the context of a more normal trading market, I think most people who invest in small company stocks would have expected at least a double from the Norfolk Southern and BMW relationships and perhaps a good deal more.

I don't know what the fair value of Axion's stock is or where the price will go from here. However my experience with small companies in the valley of death has taught me that over the long-term market prices tend to oscillate around a fair value line, but only touch fair value as they transition from one extreme to the other. In cases where the market price has been undervalued for an extended period of time, the next stage is a roughly equivalent overvaluation for a similar period of time. If you want to assume that $2.40 would have been a reasonable fair value in December 2010, you can pretty well count on an eventual peak in the $4.20 range. If you believe $2.40 would have been low in a normal market then your outlook for the next peak should probably be higher.

Over the last year I've been frank in expressing my opinion that Axion was undervalued. As long as the market price was within spitting distance of the price paid in the 2009 VIPE transaction, it was easy to take that position. Now that Axion's market price has returned to a level that represents reasonable parity with the 2009 VIPE pricing, we should begin to see how the market values the events that have transpired over the last year. Axion's year-end earning call is scheduled for Thursday of this week and I'm hoping management will add color to their recent disclosures and better explain their outlook for the coming year.

I wrote this article because several readers have asked me what my expectations are for Axion's future stock price. While I don't usually make price predictions, I thought a detailed explanation of my opinions and outlook would be more valuable than stony silence. I will probably be more restrained in my future discussions of Axion's market price, but the elephant hunter in me thinks the fun is just beginning.

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

Posted by John Petersen at 08:59 AM | Permalink | Comments (2)

John Petersen

The most widely misunderstood subject in the field of energy storage is the potential for grid-based applications. They fire the imagination because the grid is so pervasive and the need is so great. They also present immense challenges to storage technology developers because the fundamental economic value per unit of grid-based energy storage is very low. While the subject of grid-based storage provides rich fodder for media reports and political posturing, the reality bears little relation to the perception. On March 9th, Lux Research published a sorely needed reality check in a new report titled "Grid Storage – Islands of Opportunity in a Sea of Failure," which concluded that "Amongst the sea of possible scenarios, there are few combinations that offer an acceptable payback, while endless potential pitfalls exist."

Lux analyzed the business scenario for 14 emerging energy storage technologies across 23 applications to identify the best investments for utilities, transmission operators, independent power producers and building operators in California, Germany, and China. The report was based in large part on data from a December 2010 study published by the Electric Power Research Institute, "Electricity Energy Storage Technology Options – A White Paper Primer on Applications, Costs and Benefits." While the Lux report and the EPRI study both offer detailed insight for institutional investors that are contemplating investments in energy storage, they're too detailed for individual investors who are mainly concerned with managing their personal portfolios.

The first thing individual investors need to understand is that while global electric power generating capacity is roughly 4,000 GW, total installed energy storage capacity is less than 128 GW, or 3.2% of generating capacity. The second thing they need to understand is that substantially all of the existing storage facilities are pumped hydro. The following graph from the EPRI report provides additional color on how much installed capacity really exists for the exciting new energy storage technologies the press is gushing over.



While EPRI's installed capacity graph should be enough to make cautious investors pause to check their assumptions, another graph from the EPRI report is far more useful. It shows the estimated size of the potential market for 15 key energy storage applications on the horizontal axis and then shows the maximum price per kWh of storage capacity an end-user would be willing to pay on the vertical axis. The red annotations are mine.



Wholesale frequency regulation, the application that's getting the bulk of the media attention, is shown on the left-hand side of the graph. It's the primary target for cool storage technologies like flywheel-based systems from Beacon Power (BCOND) and lithium-ion battery based systems from Altair Nanotechnologies (ALTI), A123 Systems (AONE), Ener1 (HEV) and others. Despite the media's excitement, the reality is wholesale frequency regulation represents less than 1% of potential demand for grid-based storage. The other 99% can only be served by cheap energy storage technologies. Less than a half of the potential market will ever be addressable by manufactured energy storage devices. The rest will remain out of reach without widespread deployment of pumped hydro, compressed air and other large-scale electro-mechanical systems.

There's little question that the potential markets for manufactured energy storage devices in grid-based applications are big enough to support several successful companies. They're just not as easy as the media reports would have us believe. Wholesale frequency regulation in the US is probably limited to something on the order of 400 MW, which works out to about $1.6 billion in domestic revenue potential. The bigger prize is the $16 billion of potential demand for manufactured systems that can be installed at a price point of $500 to $1,700 per kWh. Globally, those target markets are closer to $5 billion and $50 billion, respectively.

Of the electro-chemical energy storage technologies discussed in the EPRI report, conventional and advanced lead-acid batteries and flow batteries usually offered the best cost profiles for the work of transmission and distribution upgrade deferral in both fixed and transportable formats. The economics remain challenging when you include the costs of containerization, interconnect equipment and control electronics, but they are within the realm of reason. Once you get beyond short-duration frequency regulation, however, cool technologies don't stand a chance of being competitive.

The universe of publicly traded US companies that can respond to the need for cheap grid-based energy storage is small. It includes Enersys (ENS), Exide Technologies (XIDE), and C&D Technologies (CHHPD.PK)  in the established manufacturer ranks with Axion Power International (AXPW.OB) and ZBB Energy (ZBB) in the emerging company ranks. Cool technologies will probably continue to claim the lion's share of the headlines, but cheap technologies will almost certainly claim the lion's share of the revenues and profits. From an investor's perspective, those are the only metrics that really matter.

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 11:50 AM | Permalink | Comments (16)

John Petersen

On March 4, 2011 the Pacific Northwest National Laboratory published a comprehensive review of "Electrochemical Energy Storage Technologies for Green Grid" that is a must-read for serious investors who want to understand the technical and economic intricacies of the energy storage sector. It explains why storage is a key enabling technology for wind and solar power, the smart grid, efficient transportation and a legion of high-technology manufacturing and service enterprises that can't survive without reliable power. It also explains why energy storage is an investment mega-trend that will endure for decades. While I normally try to provide links to materials that are available for free, this particular review is only available from the American Chemical Society website and their charge for non-members is $35. If you own stock in a battery company or are thinking about investing in one, it's the best $35 you'll ever spend.

Conceptually, a battery is nothing more than a bottle that stores electricity. The term "energy" describes the total amount of electricity you can put into the bottle. The term "power" describes how quickly you can empty or fill the bottle. The basic problem with energy storage is that batteries are thousands of times more expensive than the electricity they store. You may be able to buy a kilowatt-hour (kWh) of electricity for a dime, but a battery to store that much electricity will set you back $150 to $1,000. Once you include battery depreciation in the equation, the cost of electricity from a battery is always higher than the cost of electricity from a wall-socket. If you only need to store a few watt-hours of energy for a cell phone or laptop computer, convenience will usually outweigh battery cost. If you need five, ten or twenty thousand watt-hours of battery capacity so that you can use electricity from solar panels at night or drive a plug-in vehicle 40 to 80 miles, battery cost quickly becomes a major issue, if not an insurmountable obstacle.

In its report, the PNNL explains that capital cost and life-cycle cost are the most important and fundamental issues in the energy storage sector. Capital costs are usually expressed in terms of dollars per kilowatt ($/kW) for power applications and dollars per kilowatt-hour ($/kWh) for energy applications. Cycle-life cost is calculated by dividing the sum of the capital cost and expected maintenance costs by the number of cycles a battery can deliver over its useful life. In general, the authors of the PNNL report believe the following attributes are essential for grid storage applications:

• Capital cost of $250 per kWh or less;
• Long calendar life (e.g. > 15 years);
• Long cycle-life (e.g. > 4,000 deep cycles);
• High safety standards; and
• Low maintenance costs.

It's a tall order and most energy storage technologies fall short of the mark. The following graph from the PNNL report shows the estimated capital cost per cycle of various storage technologies before project financing costs, operation and maintenance costs, and replacement costs.



After studying the PNNL report in detail, I believe flow battery and lead-carbon battery technologies have the best shot at meeting these high standards in the short term. Others will no doubt disagree. The only way for a serious investor to make an informed decision is to download the report, study the PNNL observations and draw his own conclusions.

There is one publicly-held pure-play energy storage company in the flow battery space. ZBB Energy (ZBB) is the owner of a zinc-bromine technology that was invented by Exxon, developed by Johnson Controls and ultimately sold to ZBB. Over the last few years, ZBB has developed a modular system architecture for its technology and successfully completed a three-year validation test by Australia's Commonwealth Scientific and Industrial Research Organisation (CSIRO). ZBB has also devoted considerable resources to an open-platform power management system that facilitates the integration of diverse power sources and diverse energy storage device types to meet the needs of a particular customer. ZBB has been a poor market performer since its IPO in 2007 and currently trades at one-fifth of the IPO price. Its market capitalization of $33 million is the lowest of the 18 pure-play energy storage companies I follow. ZBB hasn't had a particularly strong balance sheet for several years and it will need to raise additional capital. Given the proven status of its technology and its low market capitalization, I believe ZBB has limited downside risk and attractive upside potential.

The section of the PNNL report that I found most illuminating was their discussion of lead-acid batteries in general and lead-carbon batteries in particular. While I've been writing about lead-carbon battery technologies for a couple of years, the PNNL review is the first major report from a national laboratory that does not require A to B to C analysis to integrate information from several sources. The following schematic from Furukawa Battery shows the three primary lead-acid battery electrode configurations that are presently being developed.



In its discussion of conventional lead-acid batteries the PNNL report noted that lead-acid has historically suffered from limited cycle life (e.g. 1,000 cycles), limited depth of discharge (e.g. less than 30%), low round-trip energy efficiency (e.g. 50% to 75%) and low charge acceptance capacity (e.g. 7% of the one hour discharge rate). In combination, these technical factors have made large-scale applications problematic from an economic perspective.

The first innovation PNNL discussed in the field of advanced lead-acid batteries involves the use of carbon additives to improve cyclability while inhibiting the formation of hard lead sulfate crystals on the negative electrodes. In the graphic, a carbon additive design will replicate the conventional lead-acid battery configuration shown on the upper left. Johnson Controls (JCI) and Exide Technologies (XIDE) are both actively developing carbon enhanced lead-acid batteries in both flooded and absorbed glass mat, or AGM, form factors. Both companies claim performance improvements of 100% or more, which can reduce the capital cost per cycle by 50% or more.

The second innovation PNNL discussed is an asymmetric lead-carbon capacitor that uses a carbon electrode assembly to replace conventional lead-based negative electrodes. In the graphic, an asymmetric lead-carbon capacitor is shown on the upper right. The key advantages noted by PNNL include a higher operating voltage for the cell as a whole, greater utilization of negative electrode capacitance, the elimination of negative electrode sulfation and reduced swings in acid concentration. The asymmetric lead-carbon capacitor was patented in 2001 and is owned by Axion Power International (AXPW.OB) which has trademarked the name PbC® and filed a suite of protective patents around the core technology. In exhaustive performance tests over the last three years, Axion has demonstated that the PbC battery:

• Offers a depth of discharge of up to 70%, as compared to 30% for conventional lead-acid;
• Offers stable round-trip energy efficiency of 85%, as compared to 50% to 75% for conventional lead-acid;
• Offers cycle life improvements of 400% or more;  and
• Offers dynamic charge acceptance rates that are a 10x improvement over conventional lead-acid.

In combination, these unique features of the PbC battery can reduce capital cost per cycle by an order of magnitude and make the PbC the most cost-effective electrochemical storage system in the industry. Axion's PbC battery is almost ready for commercial roll-out. The company has taken delivery of its second generation electrode fabrication line and expects to commission the line by the end of this month. Once the line is commissioned, potential customers who have been testing first generation products for over a year will need to conduct extensive process and equipment validation evaluations before placing orders. Barring unforeseen difficulties, that process should be completed this year. Axion has enough capital to finance its activities over the next year, but will need additional capital to build new electrode production capacity if demand for its product develops. Given the unique attributes of the PbC technology and Axion's relatively low market capitalization of $70 million, I believe Axion has limited downside risk and attractive upside potential.

The last innovation PNNL discussed in the field of advanced lead-acid batteries was the Ultrabattery, a half-measure developed by CSIRO that represents an improvement over conventional lead-acid batteries but does not offer all the performance advantages of the PbC. In the graphic, Ultrabattery is shown on the bottom. The PNNL report was the first detailed discussion I've seen of the Ultrabattery technology and it highlights a couple of issues that strike me as potentially problematic. During a discharge cycle the Ultrabattery does not begin to access the capacitance of its carbon electrode until the lead electrode has been depleted. Likewise during a charge cycle, the carbon electrode charges first which results in significant hydrogen production at the lead electrode.

Several lithium ion battery companies including A123 Systems (AONE), Ener1 (HEV) and Altair Nanotechnologies (ALTI) have sold high profile demonstrations of their technologies in grid- connected applications. After reading the PNNL report I'm more convinced than ever that these demonstrations will not turn into sustainable businesses until those manufacturers are able to overcome a variety of hurdles relating to system cost, safety, durability and cycle life. They may be successful, but when I compare their market capitalizations with the market capitalizations of ZBB and Axion, I have to believe that the greater upside potential lies in the companies with the lower current market capitalizations.

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

Posted by John Petersen at 11:09 AM | Permalink | Comments (0)

John Petersen

In his 2006 State of the Union Address, President George W. Bush said:

"Keeping America competitive requires affordable energy. And here we have a serious problem: America is addicted to oil, which is often imported from unstable parts of the world. The best way to break this addiction is through technology."

What a crock of balderdash! If you compare US fuel prices with those in other industrialized countries, gasoline is a screaming bargain and the same can be said for electricity. It's not the energy we use that's a problem. The problem is the immense amount of energy we waste, and that problem will keep getting worse until higher prices force us to change.

The world can't stop using oil without immeasurable suffering. Since we can't simply quit, the best we can do is accept the ugly truth that we're all wasteful petroleum gluttons who need to cut our consumption to more sensible levels. You don't cure drug addiction with better and cheaper drugs, and we can't cure our oil addiction with magic technologies mandated by Congress. We must accept personal responsibility and change our wasteful habits instead of blaming others or looking for a painless solution. In the final analysis, the solution to our problems is visible in every looking glass we pass.

Three weeks ago I wrote "Alternative Energy Technologies and the Origin of Specious," an article that examined the serial failures of panacea energy policies that promised independence without pain. Since then I've seen a number of reports that strike me as cracks in the EVLand looking glass, including:

• A February 28th earnings release from A123 Systems that reported 69.2 million watt-hours of battery shipments, $73.8 million of battery sales, and $94.3 million of production costs for the year ended December 31, 2010; which pencils out to an average customer price of $1,067 per kWh and an average production cost of $1,363 per kWh.
• A March 2nd report from hybridcars.com that cumulative sales of the GM Volt and Nissan Leaf for the first two months of this year were a whopping 756 units, as compared to cumulative HEV sales of 42,726 units.
• A March 3rd Bill Ford Jr. interview at the ECO:nomics Conference where he characterized the Volt and Leaf as "talismanic vehicles" and expressed grave reservations about meaningless sales projections, the lack of charging infrastructure and the grid's ability to support electric vehicles if they ever became mass market products.
  

Many readers assume that I have an irrational hatred of electric vehicles and the companies that make them when in truth my only concern is whether those companies are good investments at current prices. During his recent presentation at the United Nations Climate Change Conference in Cancun, Dr. Steven Chu, the Secretary of Energy, said:

"And what would it take to be competitive? It will take a battery, first that can last for 15 years of deep discharges. You need about five as a minimum, but really six- or seven-times higher storage capacity and you need to bring the price down by about a factor of three. And then all of a sudden you have a comparably performing car; let's say a mid-sized car which has a comparable acceleration and a comparable range."

***

Now, how soon will that be? Well, we don't know, but the Department of Energy is supporting a number of very innovative approaches to batteries and its not like its 10 years off in the future, in my opinion. It might be five years off in the future. It's soon. Meanwhile the batteries, the ones we have now, will drop by a factor of two within a couple of years and they're gonna get better. But if you get to this point, then it just becomes something that's automatic and I think the public will really go for that."

When Dr. Chu tells the world that battery manufacturers won't have a competitive product unless their prices fall into the $300 per kWh range and A123's annual earnings release reports that their production costs overshot that goal by a whopping $1,000 per kWh last year, I don't see a lot of upside potential. When a poorly capitalized company like Tesla Motors trades at 11.5 times book value and 20.4 times last year's sales I wonder what the markets are smoking. When more than half of Ener1's equity is in mushy balance sheet categories like intangible assets, goodwill and investments in money losing subsidiaries, I can't help but think back to the asset impairment charges that crushed C&D Technologies last year. I'm completely baffled by the valuation disconnect at Valence Technologies which is upside down to the tune of $67 million but sports a $243 million market capitalization.

I hate to be the bearer of bad news, but these companies are just starting their journey into the valley of death. They may survive the trek, but their bloated stock prices can't. The EV dream may be beautiful, but for the next decade EV investments will be ugly as sin.

Each of us knows that we need to go on a petroleum diet, but none of us is willing to starve in the process. For the next decade, at least, the only real solution will be aggressive steps toward increasing fuel efficiency. Observant investors saw the writing on the wall when the EU and the US adopted stringent new CO2 emissions and fuel economy regulations that will start taking effect this year. I saw the impact last week in Geneva where the press headlines gushed over grand plans for plug-in cars but the vehicles on display proved that manufacturers are turning to diesel and natural gas fuel systems, direct fuel injection, dual clutch transmissions and stop-start systems as their mass market solutions. We all know that actions speak louder than words. I'm here to tell you the automakers' actions don't have plugs.

Two weeks ago I identified a list of five fuel efficiency stocks that should outperform the market by a wide margin over the next couple years because the die is cast and the solutions are being implemented today. To keep things interesting, I'll use last Friday's closing prices to formalize that list in a hypothetical $25,000 long portfolio structured as follows:

Company	Symbol	Shares	Investment
Johnson Controls	JCI	121	$4,998.51
Enersys	ENS	139	$4,984.54
Maxwell Technologies	MXWL	281	$4,993.37
Exide Technologies	XIDE	431	$4,995.29
Axion Power	AXPW.OB	6,172	$4,999.32
Cash			$28.97
Total			$25,000.00

I'll also use last Friday's closing prices to formalize my long-standing and oft-repeated position on vehicle electrification with a hypothetical $25,000 short portfolio structured as follows:

Company	Symbol	Shares	Investment
Tesla Motors	TSLA	-200	-$4,990.00
A123 Systems	AONE	-599	-$4,995.66
Ener1 Inc	HEV	-1,428	-$4,998.00
Altair Nanotechnologies	ALTI	-1,953	-$4,999.68
Valence Technology	VLNC	-3,144	-$4,998.96
Cash			$49.982.30
Total			$25,000.00

In coming months I’ll revisit both hypothetical portfolios on a regular basis and either gloat or eat crow as the circumstances dictate. It will be fascinating to see whether the cracks in the looking glass spread or heal themselves.

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

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

John Petersen

In 1789 Benjamin Franklin wrote "in this world nothing is certain but death and taxes." Today he probably would have written "in this world nothing is certain but death, taxes and rising oil prices." There's no escaping the misery, but astute investors who take the time to understand the fundamental trends can profit as the misery unfolds. For the short term, I'm convinced the biggest opportunities will be in fuel efficiency technologies for cars and light trucks.

After 20 years of complacent stagnation, the US started to get serious about light-duty vehicle fuel efficiency in 2005 and has made solid progress with improvements in the 14% to 18% range. The rate of change will ramp rapidly over the next five years as aggressive new CAFE standards that were adopted in April 2010 take effect. The following graph provides an at a glance summary of new light-duty vehicle fuel efficiency over the last 30 years and new fuel efficiency standards for the next five years.



In their 2010 adopting release for the new CAFE rules, the NHTSA and EPA identified three fuel efficiency technologies that would play crucial roles in automakers' efforts to meet the new standards (page 484):

Efficiency Technology	Fuel Savings	Penetration
Gasoline direct fuel injection	4%	60%
Dual clutch transmissions	7%	55%
Stop-start idle elimination	8%	42%

The usual diversified group of first tier manufacturers of automobiles and component systems will control two of the three technologies. Only one, stop-start idle elimination, offers a pure-play opportunity with a certain outcome.

Stop-start is the most sensible fuel efficiency technology you can imagine – turn off the engine while the car is stopped in traffic. While the concept is simple, implementation is a beast because drivers typically want their sound systems, climate control, lights and other accessories to keep working when the engine is off. Therefore, the key enabling technology for start-stop systems is a better starter battery.

Traditionally, a battery had to start a car once during a normal trip. With a stop-start system, however, the battery has to start the engine an average of once per mile and carry critical accessory loads while the engine is off. For a one-minute engine-off cycle, the accessories will demand ten times as much energy as the starter. For a 15-mile commute with one engine-off cycle per mile, the battery will have to deliver 165 times the energy that it would in a car without stop-start. The battery load is immense, but an optimized stop-start system can slash fuel consumption in city driving by up to 15% and do it for an incremental capital investment in the $400 to $800 range.

The normal flooded lead-acid batteries we've used for decades simply can't stand up to the demands of stop-start systems. That reality has forced automakers to rely on cut-out systems that disable the stop-start function when the battery's state of charge falls below a minimum level, and won't re-enable the stop-start function until the battery recovers an acceptable state of charge. The result is stop-start systems that don't function anywhere near peak efficiency. To minimize problems, automakers are currently using dual battery systems and upgrading to absorbed glass mat, or AGM, batteries.

In recognition of the shortcomings of flooded batteries, the leading battery manufacturers are building new AGM battery production capacity at a blistering pace. In 2007, Johnson Controls (JCI), the world's biggest battery manufacturer, had global production capacity for 400,000 AGM batteries per year. Their announced expansion projects will boost that capacity to 11.2 million AGM batteries per year by 2014 and further expansions in the US are being discussed. Exide Technologies (XIDE) is also on an expansion spree that will boost its AGM battery capacity from 500,000 units in 2009 to 3.5 million units in 2013. On a worldwide basis, Lux Research forecasts that AGM battery demand will soar by 800% over the next five years, from three million units in 2010 to 27 million units in 2015. As they substitute higher margin AGM batteries for lower margin flooded batteries, the revenues and margins of leading battery manufacturers including JCI, Exide and to a lesser extent Enersys (ENS) will soar. Their stock prices will follow suit.

While AGM batteries are currently the best available technology for stop-start systems, they are far from ideal because their ability to recover an optimal state of charge deteriorates rapidly as the battery ages. Using simulation protocols from BMW and Ford, researchers have learned that the time required for an AGM battery to recover from an engine-off event increases from 50 to 60 seconds with a new battery to 4 or 5 minutes with a battery that's been in service for six months. The bottom line is automakers need a better solution than AGM batteries. Until a better solution comes along, however, the AGM battery will reign supreme as the battery of choice for the stop-start market.

The two principal contenders for "better solution" honors are:

• A multi-component system from Continental AG and Maxwell Technologies (MXWL) that combines an AGM battery, a small supercapacitor module and associated control electronics in a system that eliminates the voltage drops and black screens that commonly occur when the starter engages at the end of an engine-off cycle; and
• The third generation lead-carbon battery from Axion Power International (AXPW.OB) that replaces the lead-based negative electrode in a conventional AGM battery with a carbon electrode assembly that boosts cycle life by 400% and provides consistent charge recovery times of about 35 seconds through four years of simulated use.

The Maxwell - Continental system is available now and was recently selected by PSA Peugeot Citroën for use in Citroën C4 and C5 diesels featuring PSA's e-HDi second generation micro hybrid system. With an estimated three-year value in the $50 million range, this design win should provide a significant boost for Maxwell's top-line revenue. Despite its advantages, however, the Maxwell - Continental system is not an ideal solution because the supercapacitor can slow but it can't stop the deterioration of the AGM battery it's paired with. So over time, vehicles equipped with the Maxwell-Continental system will suffer the same kind of performance degradation that all other stop-start systems exhibit.

The most promising solution to the challenges of stop-start, the PbC® battery from Axion, is in the final development stages and won't be ready for a large-scale commercial rollout until 2012. Axion is currently installing a second-generation fabrication line for their serially patented carbon electrode assemblies and potential customers should begin validation testing on the new fabrication processes and equipment soon. Once its potential customers validate the fabrication process, the last major step will be to build additional electrode fabrication capacity so that Axion can manufacture PbC batteries on its own AGM battery line and sell electrode assemblies to other AGM manufacturers. Since the PbC electrodes are designed to work as plug-and-play replacements for traditional lead-based electrodes, Axion should be uniquely positioned to leverage existing AGM battery manufacturing capacity while giving other battery manufacturers the opportunity to sell a premium product to their existing customers.

While the PbC battery is still a development stage technology and Axion is just barely out of the nano-cap range with a $60 million market capitalization, its roster of disclosed industry relationships is extraordinary. Axion has longstanding relationships with both East Penn Manufacturing and Exide, the second and third largest AGM battery manufacturers in North America; it has a service contract to develop a battery management system for Norfolk Southern (NS) which wants to retrofit a portion of its 3,500 unit locomotive fleet with hybrid drive; and the PbC battery has demonstrated exceptional performance during 18 months of testing by BMW, the industry leader in stop-start with over a million EfficientDynamics vehicles on the road today. In over 30 years as a small company securities lawyer, I've never seen another company that was able to generate a comparable level of interest and involvement from the giants in its industry.

The energy storage sector offers a wide range of fuel efficiency pure plays. The following table provides summary data on key financial (in millions) and market metrics that I consider important. While JCI is not technically an energy storage pure play because of its diversified operations in auto parts and building efficiency, I've included it in this list because 14.6% of its revenues and 52.5% its earnings are derived from battery manufacturing operations.



While I closely follow the energy storage and vehicle electrification sectors and am convinced that every manufacturer who can bring a cost-effective product to market will have more demand than it can handle, these five companies have the clearest paths to market beating growth over the next five years and are my favorites for that reason. JCI, Enersys, Exide and Maxwell have been stellar performers since December 31, 2008 with market crushing gains of 126% to 264%. Axion has been the laggard of the group, losing 39% of its market value it raised new capital in a brutal market and worked to complete the development of its promising PbC technology and start climbing out of the valley of death. For the next few years, I expect the entire group to outperform the market by a wide margin because the die is already cast.

Fuel efficiency has been a hot topic in the automotive world for the last five years and new regulations in the US and EU will provide a massive impetus for immediate change. Increasing political turmoil in oil producing regions can only add to the sense of urgency. There is a wide variety of potential long-term solutions, but short-term solutions to immediate problems are very limited. For the next five years, stop-start will be at or near the top of the list.

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 05:43 AM | Permalink | Comments (2)

John Petersen

Thanks to a recent comment from JLBR, I've found a new hero in Dr. Peter Z. Grossman, an economics professor from Butler University who cogently argues that government attempts to force alternative energy technologies into an R&D model that was created for the Manhattan Project and refined for the Space Program will always result in commercial disaster because "the goal of the Apollo Program was the demonstration of engineering prowess while any alternative energy technology must succeed in the marketplace." In a recent article titled "The Apollo Fallacy and its Effect on U.S. Energy Policy" Dr. Grossman summarized the problem as follows:

"The Apollo fallacy has been detrimental to the development of effective energy policies in the US [and] instead of asking what kinds of programs might be useful, the government holds out the promise of a technological panacea to be delivered simply by an act of Congress. The prospect of an energy panacea actually has some political benefits. It allows politicians to claim that they can provide simultaneously the two outcomes most Americans seek from energy policy: low energy prices and energy independence. In fact, with conventional resources these goals are mutually exclusive. To get low prices, the government should provide incentives to drill for oil and gas not just in the US but also in places where they might be exploited more cheaply – of course making the nation more dependent on outside sources. To lessen dependence (true energy autarky is not a feasible goal) on foreign resources, the only method government can use with conventional resources is to raise prices through taxes. But a new technology presumably can to both at once: provide cheap, US-made energy. Unfortunately, the history of energy programs argues that the pursuit of a technological-commercial panacea will fail."

In a 2008 white paper titled "The History of U.S. Alternative Energy Development Programs: A Study of Government Failure," Dr. Grossman started with the Eisenhower Administration's wildly optimistic plans to commercialize nuclear fission reactors for civilian electricity and offered a brief history of serial energy policy failures including:

• The Nixon and Ford Administrations' support for synthetic fuels from coal and oil shale;
• The Carter Administration's support for synthetic fuels, nuclear fusion and ethanol; and
• The Clinton Administration's "Partnership for a New Generation of Vehicles" that failed miserably while privately funded initiatives from Toyota and Honda were remarkably successful.

My additions to Dr. Grossman's list would include Bush the Younger's support for fuel cells, the hydrogen economy and corn ethanol, and the Obama Administration's support for vehicle electrification and alternative energy in general.

These ambitious energy policies all shared three fatal flaws:

• An inability to distinguish between the technologically possible and the economically desirable;
• A belief that intervention can force innovation and overcome technical challenges on time and within budget; and
• A failure to recognize that generous subsidies invariably lead to increased demand for more generous subsidies.
  

The end result has always been grandiose, unrealistic and extravagant mandates that resulted in catastrophic losses for naive and credulous investors who bought the hopium.

For over sixty years, the government has consistently and predictably failed to understand that industrial revolutions arise from technologies that are perfected by entrepreneurs and prove their value in a free market. The government can accelerate advances in basic science and engineering when cost is not an object, but it can't make technologies cost-effective or ignore the realities of a resource-constrained world. The following cartoon from Jan Darasz appears in the most recent issue of Batteries International Magazine and may overstate the problem a bit, but only a tiny bit.



During the "Sputnik moment" discourse in his recent State of the Union Address, President Obama promised to spend billions of taxpayer dollars to put a million plug-in vehicles on the road by 2015. Back in the business world, Johnson Controls (JCI) and Exide Technologies (XIDE) are spending their own money, together with a $34 million ARRA battery manufacturing grant, to build factories that will make AGM batteries for 14.7 million micro-hybrids a year by 2014. The President's plan will save up to 400 million gallons of gas per year by 2015. The 56 million micro-hybrids that will be built during the same time frame using AGM batteries from JCI and Exide will save 1.6 billion gallons of gas per year. Last time I checked, spending millions to save billions of gallons of gasoline was more sensible than the inverse.

I've frequently argued "Alternative Energy Storage Needs to Take Baby Steps Before it Can Run." A favorite quote from William Martin's novel "The Lost Constitution" says it all – "In America we get up in the morning, we go to work and we solve our problems." Unfortunately government programs never use the tools that are readily available to do the work. Instead they impede sensible actions like using compressed natural gas instead of gasoline and let urgent problems fester while new, exotic and politically popular technologies are invented and refined, but never commercialized. A cynic might suggest that it's a great way for a politician to kick the can down the road while deferring blowback from policy failures and unintended consequences until his successor takes the oath of office.

We have 60 years of experience that proves well intentioned but ill-conceived government alternative energy technology initiatives aren't doing the job. Investing $46 of capital to save a gallon of gasoline with a plug-in vehicle is foolish when you can save that same gallon of gasoline with a $24 capital investment in an HEV. Taxing Peter to underwrite the cost of Paul's new car will impoverish the masses instead of empowering them. Using imported metals to make non-recyclable batteries for the purpose of conserving more plentiful petroleum has all the intellectual integrity and economic appeal of using cocaine as a weight loss supplement.

There are solid growth opportunities in the domestic energy storage sector. JCI and Enersys (ENS) both trade at about eighteen times earnings while Exide trades at about twelve times earnings. In the more speculative small company space, Axion Power International (AXPW.OB), ZBB Energy (ZBB) and Beacon Power (BCON) all present intriguing value propositions as they emerge from the trough of disillusionment and begin to build industry relationships and revenue by proving the value of their products one baby step at a time.

I'm convinced that every manufacturer of energy storage devices that brings a cost-effective product to market will have more business than it can handle as dwindling global energy supplies make storage more cost-effective than waste. That conviction, however, does not extend to market darlings like Tesla Motors (TSLA), A123 Systems (AONE) and Ener1 (HEV) who owe their high profiles and huge swaths of their balance sheets to government largess and glittering promises of an all-electric future once they prove that their wonder products work in the hands of normal consumers and learn how to manufacture better than Toyota Motors (TM), Sony (SNE), Panasonic (PC) and a host of lesser industrial luminaries that have proven their capabilities with decades of successful execution.

Over the last several months I've become convinced that a transition from gasoline to compressed natural gas may be one of the great opportunities of our age. Natural gas is abundant and clean, and an easy domestic substitute for imported oil. While I don't know as much as I'd like to about fiscal multipliers, I have to believe a massive shift from imported oil to domestic natural gas would reduce energy costs to consumers, slash CO2 emissions, generate trillions in additional GDP and go a long way toward ameliorating the looming deficit spending crisis many observers predict.

Just yesterday, the 2011 Honda Civic GX, a conventional vehicle with a CNG fuel system, tied with the all-electric Nissan Leaf for top honors in the American Council for an Energy-Efficient Economy's list of the Greenest Vehicles of 2011, a position it's held for eight years in a row. The Toyota Prius came in fourth, well ahead of the GM Volt, which came in seventh. I can only imagine what the ACEEE ratings would look like if Honda added a hybrid drive to the Civic GX or Toyota added a CNG fuel system to the Prius.

Mark Twain observed that "history doesn't repeat itself but it does rhyme." When it comes to specious and ill-conceived alternative energy technology initiatives that originate on the banks of the Potomac and rapidly mutate into bad investments, I can't help but wonder whether we're just hearing another chorus from the same old song – 99 Bottles of Energy on the Wall.

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 10:36 AM | Permalink | Comments (4)

John Petersen

We all love to whine and complain about oil prices because we buy gasoline regularly and that makes the price changes obvious. To solve this overwhelming problem, myopic visionaries with rose colored glasses propose a simple solution – convert personal transportation from vehicles powered by oil to vehicles powered by clean, free and renewable electricity from the wind and sun. Like most fairy tales, it can't happen in real life which means it won't. This is not a technology issue. It's a raw materials issue and electric vehicles cannot solve the problem.

In the first three quarters of 2010, the world produced an average of 86 million barrels of crude oil per day. That works out to 0.65 metric tons, or 200 gallons per year, for each of the planet's 6.6 billion inhabitants. There's no doubt about it, oil is a scarce resource – at least until you compare it with metals that are two to five orders of magnitude scarcer. To put oil in its proper perspective, the following table summarizes global production data for several critical natural resources.

Natural	Global Production	Per Capita
Resource	(Metric Tons)	Production
Crude Oil	4,282,736,000	648.9 kg
Iron & Steel	2,400,000,000	363.6 kg
Aluminum	41,400,000	6.3 kg
Copper	16,200,000	2.4 kg
Lead	4,100,000	0.7 kg
Nickel	1,550,000	0.2 kg
Rare Earths	130,000	20 g
Lithium	25,300	4 g

For every thousand pounds of global oil production, we produce ten pounds of aluminum, four pounds of copper, one pound of lead, six ounces of nickel, a half-ounce of rare earth metals and a tenth of an ounce of lithium. No thoughtful investor can compare per capita production of oil and essential metals and rationally conclude that we can increase metal consumption in the name of conserving oil. The resource sophistry can't work in anything beyond technical puppet shows for lazy, impressionable or childish minds.

To make matters worse, metal prices are anything but stable. We ignore changes in metal prices because they're usually buried in the cost of other products. That doesn't mean that metals are a bargain compared to oil or that their prices are any more stable. The following graph tracks market prices for oil and three of our most important metals over the last 20 years. The trend lines are remarkably similar.



If we even try to significantly increase metal consumption in an effort to conserve oil, the inevitable supply and demand imbalances will quickly eliminate any advantage and simply make the situation worse. In the final analysis, any energy policy or business model that increases metal consumption in an effort to conserve oil must fail. We've already seen the disastrous results of using food to make ethanol for fuel. There will be blood if we follow the same foolish path with metals.

I am a relentless and unrepentant critic of plug-in vehicle hype and propaganda because any plan to use hundreds of pounds of metal to replace a fuel tank must fail. There aren't enough metals in the world to make a dent in global oil consumption and using scarce metal resources to make non-recyclable components like batteries and motors for plug-in vehicles can only make the problem worse. It's sabotage masquerading as a solution.

The only transportation technologies that stand a chance of survival in a resource-constrained world are those that use tiny amounts of metals to conserve large amounts of oil. Electric two-wheeled vehicles work as long as the empty vehicle weight is less than twice the passenger weight. For automobiles, resource effective technologies range from simple stop-start idle elimination at the low end to Prius class HEVs at the high end, although even these technologies can be marginal if the primary components are not easily recycled. The instant you add a plug the resource balance goes to hell in a handbag along with the investment potential.

All the political will, good intentions and happy-talk forecasts in the world cannot change the ugly facts. We’re driving toward a natural resource cliff at 120 mph and fiddling with the dials on the navigation system.

With the exception of Advanced Battery Technologies (ABAT) and Kandi Technologies (KNDI), which have the common sense to focus on entry-level two- and four-wheeled electric vehicles with minimal natural resource inputs, the entire electric vehicle sector is a bug in search of a windshield. It doesn't matter how cool the products are if there will never be enough affordable raw materials to make them in meaningful volume.

Several companies that I follow have no chance of survival when their business models are analyzed from a resource sustainability perspective. The list includes Tesla Motors (TSLA), Ener1 (HEV), A123 Systems (AONE), Valence Technologies (VLNC) and Altair Nanotechnologies (ALTI). In each case their products have extreme natural resource requirements and little or no end-of-life recycling value. They will compound our problems, not solve them.

Several other companies that I follow have good resource sustainability profiles because their products can make major contributions to oil conservation without putting undue strain on global metal production. My list of sustainable companies includes Johnson Controls (JCI). Enersys (ENS), Exide Technologies (XIDE), Beacon Power (BCON), ZBB Energy (ZBB) and Maxwell Technologies (MXWL). In each case their products have moderate resource requirements and high end-of-life recycling value.

There is only one energy storage company that can offer better performance and lower resource requirements in the same product – Axion Power International (AXPW.OB). Its serially patented PbC battery technology uses 30% less lead than a conventional lead-acid battery, boosts cycle life and dynamic charge acceptance by an order of magnitude, and retains the recycling advantages of lead-acid batteries, the most recycled product in the world. The unique performance characteristics of the PbC technology are proven and the principal remaining risk is further refining fabrication equipment and processes for Axion's carbon electrode assemblies. When Axion's equipment, processes and products complete the final stages of validation testing by its principal potential customers, the technology can be easily ramped to a global footprint within a few years for a fraction of the cost of other emerging energy storage technologies.

Axion has never been a stock market darling because its management speaks in the past tense and focuses on challenges overcome, milestones passed and goals accomplished. As a result of its low key approach to the financial markets, Axion carries a $54 million market capitalization despite the fact that its disclosed industry and customer relationships include East Penn Manufacturing and Exide Technologies, the second and third largest lead-acid battery manufacturers in North America, Norfolk Southern (NSC), the fourth largest railroad in North America and BMW, one of the most highly regarded automakers in the world. Any time a tiny company with a transition stage technology can quietly build relationships with several world-class companies, astute investors should pay attention.

Seven years ago I believed Axion had an honest shot at the big leagues. Today I think I may have set my sights too low. The progress I expect won't happen overnight, but it will happen long before we see a million plug-in vehicles on the road in the United States.

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

Posted by John Petersen at 11:04 AM | Permalink | Comments (9)

John Petersen

One of the most fervently debated and poorly understood topics in energy storage is the subject of battery recycling. What percentage of the raw materials that go into a battery can be economically recovered from used batteries with existing recycling technology and infrastructure? While the details are quite complex, this article will offer a high-level overview of the economics of battery recycling for energy storage investors.

Lead-acid batteries are the most recycled products in the world. The process is both straightforward and cost-effective. When batteries arrive at the recycling plant, they're put through a shredder and then sent to a water bath. The shredded plastic floats to the top where it's cleaned and reprocessed like any other recycled plastic. The shredded metals sink to the bottom where they're transferred to a blast furnace for further processing. The output from the blast furnace is mostly molten lead with small amounts of copper and other metals that are skimmed from the surface for disposal or further processing. The lead is then poured into ingots and returned to manufacturers for use in making new batteries.

Because of the inherent efficiency of the recycling process, over 97% of all lead-acid batteries in the US and Europe are recycled and almost 80% of the lead used in the US comes from recycling rather than mining. Many major lead-acid battery manufacturers, including Johnson Controls (JCI), Enersys (ENS) and Exide Technologies (XIDE), operate company-owned recycling facilities for the dual purpose of protecting the environment and stabilizing their raw materials supply chains.

Nickel Metal Hydride [NiMH] batteries present a more complex recycling challenge than lead acid batteries. First the electrolyte is evaporated using a thermal process and the batteries are then shredded and put into a blast furnace. The output from the blast furnace is a simple alloy of nickel (~60%) and steel (~40%) that requires moderate post-recycling processing before the metals can be reused to make stainless steel. All rare earth metals in NiMH batteries end up in a slag that's either sent to a landfill or used for construction material.

Using material recovery estimates published by Umicore Battery Recycling and average annual metal prices from the US Geological Survey, I've calculated that roughly two-thirds of the raw materials that go into a NiMH battery are recoverable through recycling while one-third of those materials are lost forever.

Lithium-ion batteries are a couple steps beyond NiMH in terms of recycling complexity and cost. The closed loop Umicore recycling process that will be used to recycle batteries for Tesla Motors (TSLA) includes the following steps.

• Step 0: collection and reception of batteries (worldwide, Hoboken (Belgium)
  
• Step 1: smelting + energetic valorisation (in Hoboken, Belgium)
• Step 2 & 3 : refining & purification of metals (in Olen, Belgium)
• Step 4 : oxidation of Cobalt chloride into Cobalt oxide (in Olen, Belgium)
• Step 5: production of Lithium metal oxide for new batteries (in South Korea)

The electrolytes, plastics and carbons used in lithium-ion batteries are burned off and destroyed in the recycling process. The output from the blast furnace is a complex alloy of cobalt (~37%), steel (~37%), Copper (~22%) and Nickel (~4%) that requires extensive post-recycling processing before the metals can be reused. The lithium and aluminum end up as slag that is either sent to a landfill or used as construction material.

Using material recovery estimates published by Umicore and average annual metal prices from the US Geological Survey, I've calculated that about half of the raw materials that go into a lithium-ion battery are recoverable through recycling while the other half the materials are lost forever.

In a press release last week Tesla announced a new battery-pack recycling program with Umicore. A related blog from Tesla's Director of Energy Storage Systems spoke in glowing terms of how the recycling would provide "a high margin of return." The claims may defensible in Tesla's case since (a) they use lithium cobalt oxide batteries and roughly 75% of the economic value recovered through the use of Umicore's process is attributable to the recovered cobalt, and (b) even $1 in recycling revenue would be a "high rate of return" when compared with the alternative of paying a landfill tipping charge. It's certain, however, that Tesla's potential recycling revenue won't be more than a low single digit percentage of the cost of a new battery pack. For chemistries like lithium-iron-phosphate from A123 Systems (AONE), lithium-magnesium-phosphate from Valence Technologies (VLNC), lithium-iron-sulfate and lithium-magnesium-oxide from Ener1 (HEV) and lithium-titanate from Altair Nanotechnologies (ALTI) that use cheaper electrode materials, recycling is likely to be a major cost burden instead of an insignificant revenue source.

Disclosure: None.

Posted by John Petersen at 08:40 PM | Permalink | Comments (2)

John Petersen

Hardly a day passes without some talking head breathlessly describing electric vehicles as the opportunity of the decade. The fine point most investors miss, however, is that the decade they're describing won't begin until 2020 and for the next seven to ten years electric vehicle manufacturers like Tesla Motors (TSLA) and lithium-ion battery manufacturers like Ener1 (HEV) and A123 Systems (AONE) will hemorrhage cash as they try to traverse the trough of disillusionment that runs through the cruel black heart of the valley of death.

The following graph is a stylized view of the valley of death from Osawa and Miyazaki with a red overlay that highlights the trough of disillusionment. This is the most difficult period in the life of a product when its manufacturer must identify and eliminate any defects, optimize manufacturing processes, minimize production costs, establish a market presence and earn market share. For big-ticket items like cars, the failures and mediocre performers outnumber successes by a wide margin.



Today we're witnessing the first product launches for the Tesla Roadster, the GM Volt and the Nissan Leaf. Despite their gee-whiz glamor and sex appeal, the crushing economic reality is that it takes $46 of incremental capital investment to save a gallon of gasoline per year with a plug-in while it only takes $24 of incremental capital investment to save the same gallon of gasoline per year with an HEV. Under those circumstances, the tyrannical laws of economic gravity dictate that the time between the "Product launch" and "Success as a new product" will be five to seven years under optimal conditions and a decade or longer under likely conditions. Let's be honest, an 8-year payback on an HEV premium is nothing to write home about but a 15-year payback on a plug-in vehicle premium is absolutely atrocious.

My optimistic self wants to believe that plug-in vehicles will eventually offer a sensible value proposition for the average consumer, but my rational self knows that it won't happen quickly because paradigm shifts never do.

In 2000 Toyota introduced a new fuel efficiency technology to the US market called a hybrid electric vehicle, or HEV. The idea was to improve fuel economy by capturing braking energy and immediately reusing it for electric launch and acceleration boost. While HEVs didn't require drivers to change their driving habits or their behavior, they were met with polite skepticism until they proved their value and performance over a period of several years in the hands of consumers. The following graph summarizes annual HEV sales by manufacturer from 2000 through 2010.



In 2010, HEVs accounted for a miniscule 2.4% of light-duty vehicle sales in the US. It took eight years to sell the first million units because an eight-year payback was hard for consumers swallow and manufacturers were fighting a constant uphill battle with the laws of economic gravity. It took Toyota six years to top the 100,000 vehicle a year mark. Last year Toyota booked 69% of domestic HEV sales, Ford and Honda each booked 12%, GM and Nissan each booked 2.5% and the rest were insignificant. The only HEV model that can fairly be classified as a commercial success is the Toyota Prius.

President Obama may dream of a million plug-ins on the road by 2015, but a 15-year payback will be a non-starter for most buyers. Unless and until the technology premium falls to a point where the incremental capital investment per gallon of annual gasoline savings is competitive with an HEV, plug-ins will only appeal to a niche market of philosophically committed and mathematically challenged buyers.

The crucial fact that talking heads fail to grasp is that plug-in vehicles are not an incremental advance in automotive technology. They're a paradigm shift that will force consumers to change their driving habits and their behavior. Those realities bring human inertia into play along side the laws of economic gravity. It's not an easy market dynamic.

Since paradigm shifts are very rare, it's hard to find a current and directly comparable example. Instead we need to study historical paradigm shifts to see how they unfolded and how long the process took. One of the best examples I could find was the paradigm shift from draft animals to tractors on US farms. In that paradigm shift, the new technology was clearly superior to the legacy technology. The only real drawbacks were higher capital costs and less flexibility. Even so, this graph from Wessels Living History Farm shows that the paradigm shift occurred very slowly and it took 35 years for the new technology to earn a dominant market position.



The decade from 2020-30 may prove to be a golden age for plug-in electric drive if reliability, performance, consumer behavior and cost issues can be overcome during the next 10 years. Until then, the knock down drag out marketing battles will focus on direct competition between HEVs and plug-ins because it's extremely unlikely that electric drive will be cheap enough to compete head-to-head with internal combustion engines before 2020.

Under all reasonably foreseeable scenarios, the major business opportunity for the next decade will be improving efficiency for the 90% to 95% of new vehicles that won't have electric drive. In Europe, existing regulations require automakers to achieve an average fuel economy of 42 mpg for gasoline engines and 48 mpg for diesel engines by 2015. In the US, existing regulations require automakers to achieve an average fuel economy of 37.8 mpg for passenger cars and 28.8 mpg for light trucks in the same time frame. Stricter rules are already being discussed for 2020 and beyond. The specific fuel saving technologies automakers choose to meet these new fuel economy standards will not be offered to consumers as options. Instead they'll be standard equipment. Given a choice between relying on marketing and relying on government regulation, I'll bet on government regulation every time.

While emerging mechanical efficiency systems are a bit out of my depth, the leading electrical efficiency system for the next decade will be stop-start idle elimination. If you think about it for a second, it's the most sensible idea around - turn the engine off while your car's stopped in traffic. For simple systems that improve fuel efficiency by 5% the cost is only a couple hundred bucks. For more complex systems that improve fuel efficiency by 10%, the cost is still under $1,000. The one thing that both types of stop-start systems need is better starter batteries, which sets up a wonderful business dynamic for old line lead-acid battery manufacturers like Johnson Controls (JCI) and Exide Technologies (XIDE) and emerging lead-acid technology developers like Axion Power International (AXPW.OB). They may not sell any more batteries, but they'll sell better batteries that have higher prices and higher profit margins. Once you understand that an estimated 34 million new cars a year will need better batteries by 2015, the top line revenue impact and the bottom line profit impact will be stunning. It's a bird in the hand and nobody's paying attention because the application isn't sexy.

I've spent the last 30 years working as securities counsel for companies that were trying to traverse the valley of death. While it's always a miserable time for management teams, it's a disastrous time for investors and it's not unusual to see equities lose 90% of their value before the price begins to recover. Despite the media hype, investors in electric drive are in for a decade of unrelenting pain as plug-in vehicles experience slow uptake rates and have to compete with simpler and cheaper HEVs for market share. With slow plug-in vehicle uptake rates, it will be at least seven to ten years before widely heralded but vaguely defined economies of scale kick in.

If we learned anything from Microsoft and Apple, it's that the objectively cheap technology is the place to be for the first ten to fifteen years of a technological revolution and the objectively cool technology is only a reasonable investment when they figure out how to make cool cheap.

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

Posted by John Petersen at 11:27 AM | Permalink | Comments (0)

Tom Konrad, CFA

NiMH battery company that's going to "make coal and oil obsolete" sleuthed out.

I can't help but chuckle at the hyperbole of some promoters of alternative energy stocks.  We can wish that coal and oil will be obsolete tomorrow all we want, but it ain't gonna happen.  That's just what Nick Hodge was claiming in a recent teaser for Highpower Technology (HPJ). 

How do I know it's Highpower that Hodge is hailing as the answer to all our hopes?  Because Travis Johnson, the Stock Gumshoe told me so.  Travis is the same guy who sleuthed out Magma Energy (MGMXF.PK) for us in a guest article a year ago, and that the "Sunless solar" stock Green Chip Stocks was using to stir up the interest of potential subscribers was New Energy Technologies (NENE.OB).

NiMH to save the day?

I'm actually a fan of looking at the stocks of companies using battery chemistries other than Li-ion, since they're less likely to be overpriced because they get less hype (at least until now.)  But I doubt a few improvements to Nickel-Metal Hydride (NiMH) technology are going to allow it to become an economical way to store solar power.  The Gumshoe may claim to not know much about battery technology, but I think he's spot on when he says, "It’s hard to believe that Sanyo or Panasonic or even China BAK or BYD is quaking in its boots."

If you want to know more about Highpower's advances in NiMH technology (or just want a chuckle), here's the full article on StockGumshoe.

You can also look in the comments here for AltEnergyStocks' battery expert John Petersen's answer to my question:

John, what's your opinion on Highpower's technology?  Will it make EVs affordable and oil obsolete?

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 09:32 PM | Permalink | Comments (1)

John Petersen

Sometimes I think bloggers like me are the real dummies. We spend so much time delving into the minutiae of a stock or sector that we manage to obscure the big picture with too much detail. I've certainly been guilty of that particular flaw over the last couple years and want to offer an apology to readers I've confused rather than enlightened.

Yesterday a reader sent me a copy of a presentation that Exide Technologies (XIDE) used in its December 2010 Investor Meetings. The slide on page 6 of the presentation did a great job of separating the wheat from the chaff on the subject of vehicle electrification and clarified my thinking on several points I've been trying to make for a long time. Using Exide's presentation data as a guide, I'm going to see if I can finally nail down the economics in terms everybody can understand. I'm sure we'll hear from those who don't want to understand in the comment section.

The following table summarizes the operating capabilities, incremental costs, expected fuel savings and expected CO2 emissions abatement of the leading vehicle electrification technologies. For the baseline case I used a new car with 30-mpg fuel economy and anticipated usage of 12,000 miles per year, which works out to a basline gasoline consumption of 400 gallons per year. The numbers aren't spot-on accurate, but they're certainly in the right range. Since subsidies distort comparisons by shifting the cost of consumption from the buyer of a plug-in vehicle to the taxpayers who pay for the subsidies, I'll ignore them for purposes of this article.



My next graph uses the table data to show the comparative capital cost of leading vehicle electrification technologies per gallon of annual fuel saving and per kilogram of annual CO2 abatement. You can download an Excel file with the calculations here.



It doesn't matter whether you use fuel savings or CO2 abatement as your preferred metric. Vehicles with plugs simply can't deliver anywhere near the bang for the buck that their simpler and cheaper hybrid cousins offer.

• In the four hybrid categories, the average capital cost per gallon of annual fuel savings is $24 and the average capital cost per kg of annual CO2 abatement is $2.24.
• In the two plug-in vehicle categories, the average capital cost per gallon of annual fuel savings is $46 and the average capital cost per kg of annual CO2 abatement is $7.25.

Cars with plugs may feel good, but until somebody repeals the laws of economic gravity they will never be an attractive fuel savings or emissions abatement solution.

Lead-acid batteries from Exide and Johnson Controls (JCI), supercapacitors from Maxwell Technologies (MXWL) and lead-carbon batteries from Axion Power International (AXPW.OB) are the only rational choices for stop-start systems and micro-hybrids. Lux research has recently forecast global production of up to 34 million vehicles per year by 2016. Since the growth of stop-start and micro-hybrids is being driven by pollution control and fuel economy regulations in Europe, the US and elsewhere, it's as close to a bird in the hand as most investors will ever find.

Mild and full hybrids have historically used NiMH batteries for their electric drive functions and lead-acid batteries for their starters. Unfortunately, the "M" in NiMH is the rare earth metal lanthanum and production restrictions in China will limit global ability to ramp NiMH battery production until alternate sources of lanthanum come on line. Due to the rare earth metal crisis, I'm convinced that mild and full hybrids will be a competitive market where lead-acid and lead-carbon batteries vie for a share of the down-market offerings while lithium-ion batteries and supercapacitors vie for a share of the up-market offerings. Since design and production decisions will ultimately be made by the automakers, I won't even try to forecast potential market penetration rates for the competing technologies.

Lithium-ion batteries from A123 Systems (AONE), Ener1 (HEV), Altair Nanotechnologies (ALTI), Valence Technology (VLNC) and a host of foreign manufacturers are the only technically feasible choice for plug-in vehicles. Since the basic economics of plug-in vehicles don't make sense to me, neither do the basic economics of their manufacturers and battery suppliers. I'm sure we'll hear from commenters who hold different views.

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 05:24 PM | Permalink | Comments (5)