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November 17, 2011

Electric Vehicles; Ineptitude, apathy ... and piles of taxpayer money

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.

11.17.11 Berger Graph.png

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?

11.17.11 Money Pit.png
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.

November 15, 2011

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

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.

11.15.11 2010 Pair.png

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.

11.15.11 2010 Pair.png

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.