John Petersen

During the fourteen years that I've lived in Switzerland, the Germans have been the world's staunchest supporters of green power and alternative energy. Their aggressive development of wind power was breathtaking, as was their warm embrace of photovoltaic power. Over the last few weeks, however, there has been an ominous change in the mainstream German media's tone as the political class finally comes to grips with the unpleasant reality that rooftop solar panels are worthless on short, grey winter days and "For weeks now, the 1.1 million solar power systems in Germany have generated almost no electricity." Three recent and highly negative articles from Der Spiegel Online include:

• Solar Subsidy Sinkhole; Re-evaluating Germany's Blind Faith in the Sun;
• Solar Subsidy 'Insanity' Will Cost Consumers; and
• Solar Energy Row is an 'Undignified Spectacle'

As recently as last year, articles like these would have been unthinkable. Today they're viewed as reasonable discussions of critical issues as the laws of thermodynamics and economic gravity assert their absolute primacy.

The Germans have been trailblazers in all things green since the emergence of the Green Party in the 1980s. In fact, it's hard to name an alternative energy technology that Germany hasn't welcomed with open arms. When it comes to green power and alternative energy, the Germans have been on the far left of the technology adoption curve for a very long time.



If the tone of the recent Der Spiegel articles is a reasonable indicator of public sentiment, the innovators are getting ready to throw in the towel on green panacea solutions and get down to the serious work of conserving energy instead. They're weighing the costs and benefits, and reaching an entirely predictable conclusion that it's impossible to depend on variable and inherently unreliable power sources as the backbone of an industrial economy. As Germany goes, so goes the world.

If the world's standard-bearer for green power and alternative energy abandons the quest and chooses a more sensible path of conservation and energy efficiency, the backlash against the solar power industry will be immense and risks to the wind power industry will skyrocket. After all, it's hard to argue the merits of "One for the Price of Two" power solutions; which is exactly what you get when wind and solar power have to be fully backed up by conventional power plants. If the solar and wind power dominoes fall, they'll almost certainly take out the emerging electric vehicle industry that demands huge amounts of money and natural resources to simply substitute one fuel source for another.

Currently all eyes are on Germany as the epicenter of European efforts to restore fiscal balance in an age of profligate and unsustainable government spending. The apparent German surrender on green power and alternative energy may just be an unfortunate victim of that broader effort. Until the dark clouds dissipate and we have a clearer view of the landscape, I'd minimize my exposure to solar, wind and electric drive and focus instead on less costly energy efficiency technologies that work with the laws of thermodynamics and economic gravity instead of fighting them.

Disclosure: None

Posted by John Petersen at 08:41 AM | Permalink | Comments (5)

Tom Konrad CFA

It's not often that I come across a new type of renewable energy and think, "This could really work."  But that's what I thought when I heard the concept for the downdraft tower proposed by Clean Wind Energy Tower (CWET.OB.)

First, a couple caveats.  The concept is not new, it's been around 25 years in draft form.

The physics is simple.  Build a very tall, hollow tower in a hot, dry climate; cool the air at the top with a mist of water (even salt water will work), and capture the resulting energy from the downdraft with an array of wind turbines arranged around the bottom.  Most of the water is condensed at the bottom of the tower, and (since it has been effectively distilled) used as fresh water, a valuable commodity in the dry regions that are appropriate for downdraft towers.


Because the tower needs to be extremely tall in order to make the downdraft strong enough to generate electricity economically, the tower also features vanes designed to direct prevailing winds down to the base to be captured by the same turbines.

The company expects that the combination of generation from prevailing winds and the induced downdraft wind will combine to give the tower a capacity factor in excess of 60%, much higher than typical solar or wind capacity factors, while most of the power will be produced in the afternoon and evening during spring, summer and fall, meaning that this power is likely to be more valuable to utilities than either wind or solar photovoltaic. 

The reason no one has attempted to build a downdraft tower before is that we did not have the technology to build a tall enough tower.  Now we do.  In particular, the Kroll self-erecting cranes used to build such skyscrapers as the Burj Dubai, along with other construction methods used to keep such extremely tall skyscrapers upright in strong winds and earthquakes.

I spoke briefly with Ron Pickett, CWET's President and Stephen Sadle, the firm's Chief Operating Officer at the Modern Energy Forum in Denver in early September, and I got the impression that the two men are used to success.  They, and two others of their team have worked together on four successful start-ups, from telemedecine to the incineration of municipal solid waste recycling.

This time they're thinking bigger: The commercialization of a new clean energy technology.  Although they are careful to stress that they are simply combining and commercializing proven technologies, I find it hard to believe that they will be able to raise the funding necessary to build their demonstration tower in the current environment.  Bond investors are generally unwilling to fund anything that seems even remotely new, a problem that might have potentially been overcome  by a program like the DOE loan guarantees, but it's unlikely that anything resembling that program will be authorized in the next few years considering the current Solyndra brouhaha.

I hope I'm wrong and they do get the money they need to succeed, since this downdraft tower concept has the potential to be a valuable addition to our clean energy arsenal, but at this point, I can't recommend small investors buy the stock.

DISCLOSURE: No Position.

DISCLAIMER: 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 01:24 PM | Permalink | Comments (0)

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

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)

Debra Fiakas

Angela Merkel’s coalition government may not have looked at the nuclear power question for anything more than a “cover your behind” solution.  Nonetheless, the wind industry sees last month’s decision to phase out Germany’s nuclear power generation industry by 2022 as  -  no pun intended  -  a windfall.  Policy makers say as much as half of the deficit left by the shutdown of nuclear power plants will need to be made up from other power sources, principally wind power.

This is no small undertaking.  A total of 21,607 wind turbines with an overall capacity of 27,214 MW were in service in Germany at the end of 2010.  To replace half of the nuclear power capacity going off-line by 2022, wind installations need to increase by as much as 40% by 2022.  German Wind Energy Institute (DEWI) reports that 1,551 MW of new wind power capacity was installed in 2010, well below goals for 1,900 MW installations.  The German wind power industry will need to maintain if not accelerate its current pace of development in order to meet Merkel’s nuclear replacement goal.  This means many new wind turbines sprouting up across the German countryside.

The most logical winner in this turn of events is Germany’s own Siemens AG (SI).  Siemens has dedicated considerable investment in developing its line of seven wind turbines models.  The company boasts 7,800 turbines installed around the world, producing over 8,800 MW of power a year.  For U.S. investors Siemen’s ADR has some appeal as it is priced at a multiple of 11.4 times forward earnings and offers a 2.8% dividend yield.  However, the stock trades not on its wind power business but on the relative strength of worldwide earnings against currency fluctuations and other macroeconomic factors.

Germany’s Nordex (NRDXF.PK) lays claim to first-mover status in the wind power world.  In 1995 with already a ten year track record in the wind business, Nordex was the first to put a megawatt system on the market.  Since its inception Nordex has installed more than 4,400 Nordex wind turbines with a total rated output of more than 6,500 megawatts in 34 countries around the world.  Of its large turnkey projects only a small portion are located in Germany.  Expect Nordex to make some aggressive moves to get a larger part of the domestic market.

Denmark’s Vestas Wind Systems (VWDRY.PK) is not in the least intimidated by the Siemens/Nordex home advantage.  That is because Vestas has installed over 43,000 turbines around the world with capacity to produce over 44,000 MW of power.  Over 5,800 of those turbines are in German and Vestas is likely to use its track record in Germany to get another big bite of the strudel so-to-speak.  That fact that Vestas does not report its financial results in the U.S. should not be a deterrent for U.S. investors.  The company provides financial information in English on its corporate web site.  Vestas ADRs trade on the Pink Quote system in the U.S. with fairly good volume and the bid/ask spread is reasonable.  Otherwise it is necessary to pick up shares on the Danish exchange.

For small-cap sector purists it will be necessary to consider at PNE Wind (PNE3.DE) and REpower Systems AG (RPW.DE).  Both are Germany-based wind technology companies that are likely beneficiaries of domestic wind power policies.  

With a knack for developing and installing wind power projects, PNE Wind recently broke into the U.S. market with the sale of a wind farm to Black Hills Power near Belle Fourche, South Dakota.  (As a native, I can vouch for the fact that there are a lot of Germans in South Dakota.)  

REpower Systems is another wind turbine producer with a full product portfolio that ranges from wind turbines with an output from 1.8 MW up to 6.15 MW and rotor diameters from 82 up to 126 meters.  It boasts the ability to install workable solutions even in areas with weak wind experience.

In scrutinizing these company’s investors will need to take a magnifying glass to cash flows and capital expenditures.  Even a whiff of inadequate resources for investment would be a tip to stay away from long positions.  Also a good look at product portfolios would be helpful as sites for eventual wind power installations are identified.  Not all turbines are created equal and some may not be the right configuration for Germany’s landscape.

Debra Fiakas is the Managing Director of Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries. 

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.  All stocks mentioned in this article are included in Crystal Equity Research’s Earth, Wind and Fire Index in the Wind Group.

Posted by Debra Fiakas at 12:12 PM | Permalink | Comments (0)

Tom Konrad CFA

What is AMSC stock worth?



American Superconductor Corporation (AMSC) investors panicked yet again on June 1st when the company said it would delay filing its annual report, needing additional time to review its recognition of revenue from Sinovel Wind Group (601558.SS) in the last three quarters of their fiscal 2010 (July 2010 thru March 2011.) 

The stock promptly dropped another 20+% and is trading for around $8 as I write, down over 70% since the start of the year. 

The Story So Far

The delayed annual report should not have caught investors by surprise.  When AMSC first announced that Sinovel had not paid for previously delivered product and was refusing to accept deliveries in early April, it was fairly clear that some revenue recognition would have to be restated.  That, after all, was the main grounds for the several class action lawsuits which promptly sprang up.  So investors are selling simply because of the increased uncertainty of not having new financial statements, not because of new negative news.

The other piece of recent news was the announcement on May 24 that Daniel McGahn, AMSC's former President and COO, would be taking AMSC founder Gregory Yurek's place as CEO.  Although the board attempted to pass this off "as part of the CEO succession plan that has been discussed with the Board of Directors since late 2010", I'd be willing to bet that the succession plan in question was significantly accelerated due to recent events.  In any case, Yurek will stay on as board chairman, and McGahn is a company insider, so while this may represent a change in emphasis for the company, it's no revolution.

When I first looked at AMSC after the Sinovel announcement, I thought the company was a speculative buy below $12, but quickly changed my mind when I found out that Sinovel had been working to establish a China-based competitor to AMSC.  With the recent sell-off I'm looking at the stock again, but with the immediate risk of dilution as the company attempts to raise funds in order to complete their acquisition of The Switch Engineering Oy ("The Switch"), it's difficult to point to any price as a bottom, even if the company's fundamental value is much higher.

Back of the Envelope Calculations

One reader suggested that AMSC's Dec 31 cash on hand of $4.79 might serve as a useful floor for the stock price.  However, that amount represents only $243M, and any amount not needed to maintain operations will almost certainly be used as part of "The Switch" acquisition.  The rest will either be raised in the form of debt, or additional share offerings.  At the current share price, I expect that management will attempt to fund the rest of the acquisition with debt, if they can find a bank or banks willing to make the loan. 

The company's book value per share was $9.86 on Dec 31, a number which represents the cost paid to acquire the company's assets, minus any depreciation.  Book value is a notoriously inaccurate guide to the current replacement cost of assets, and to the extent that these assets are dedicated to servicing the needs of Sinovel, they may in fact be worth much less than the company paid for them.  Hence, it is also difficult to place a floor under the possible stock price based on book value.

Finally, we should consider future potential earnings as an indicator of the company's value.  In the June 1st press release, AMSC said it "currently expects to reverse the recognition of a material amount of revenue that it had included when estimating revenues of "less than $355 million."  With shipments to Sinovel having not yet resumed two months into fiscal 2011, I think it is reasonable to expect much lower revenues this year. 

My current guess is that Sinovel will again accept shipments from AMSC this year, but they will never return to former levels, and could easily decline over time.  I'm far from confident in this guess, but given that Sinovel previously accounted for 70% of AMSC revenues, I think a reasonable guess for revenue in FY 2011 would be on the order of $150M (not including revenues attributable to "The Switch.")  Those revenues will come from any resumption of sales to Sinovel, revenues to other customers (Sinovel was only 70%, after all) and growth, especially from AMSC's eponymous superconducting wire business.

If AMSC maintains their previous gross margin of 29%, $150M revenues will translate into an operating profit of $43M, or an EBITDA of $28M.  If overhead were not reduced from last year, net loss would be about $7M.  But the company is working to reduce overhead, and said that they had already reduced headcount by 10% in the June 1st press release.  Therefore, we can reasonably expect overhead to fall, leaving the company near break-even or at a tiny profit.

If AMSC does not achieve a significant profit in 2011 as I'm guessing, a reasonable way to value the company would be based on sales.  Here are the price/sales ratios of other publicly traded wind industry players:

Company	Price/Sales (ttm)	P/E (ttm)
Broadwind Energy (BWEN.OB)	1.15	42
Gamesa (GCTAF.PK)	2.79	129
Kaydon Corp (KDN)	2.55	22
Vestas Wind Systems (VWDRY.PK)	0.58	38
Zoltek (ZOLT)	1.23	N/A

Given the uncertainly currently surrounding American Superconductor, Broadwind and Zoltek are probably the better comparables than the established companies Kaydon, Gamesa, and Vestas, so I will use a prospective Price/Sales ratio of 1.0 to 1.3.  Using my $150M revenue estimate, we get a market capitalization of between $150M and $200M. 

The Switch acquisition was valued at € 190-million, or about $273M at current exchange rates, and was supposed to be immediately accretive to AMSC's sales. It seems reasonable that, to the extent that the acquisition can be funded without outside funds, it should increase AMSC's market cap.  Given AMSC's cash on hand at the end of the year of $243 million, I'm comfortable attributing another $200M market cap to The Switch, for a total market capitalization of between $350M and $400M.  This translates to a stock price of between $6.90 and $7.90. 

Conclusion

Given the uncertainty in all my guesstimates and calculations, it may already be time to pull the trigger on AMSC, given that the company seems relatively fairly valued even if we assume (as I did in my back-of-the-envelope calculation above) that most revenue from Sinovel is gone for good.  The recent response to their delayed annual report has the feel of panic selling. 

Yet panicking sellers do not pay much attention to valuations, back-of-the-envelope or otherwise.  Are you brave enough to try and catch a falling knife?

DISCLOSURE: Long Gamesa.  Considering a near-term purchase of AMSC.

DISCLAIMER: 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 11:45 AM | Permalink | Comments (0)

Tom Konrad CFA

Owning a wind farm is about to become a lot less risky.

Wind power is cheap, clean, uses no water, and emits no pollutants.  Yet wind is far from a perfect source of electricity, since the wind blows when and where it will. 

While wind power will never be as constant as baseload power, geographic diversification and better dispatch procedures can go a long way to mitigate the problems to utilities caused by wind's variability.  Yet wind farm developers and financiers are at the mercy of the weather in their particular location.  Not only does wind output swing significantly from day to day and season to season, wind output can also vary greatly from year to year.  Farm owners also have to worry that some of their turbines might need maintenance just when the winds are at their best.  This can lead to unpredictability of wind farm revenues, which in turn makes wind farms more expensive to finance.

Two recent announcements go a long way to solving these problems for wind farm developers and owners.

First, on May 19th, energy risk analysis leader 3TIER and weather risk management firm Galileo announced that they would be offering financial products to hedge the risk of wind variability.  With cash payouts based on 3TIER's leading wind resource data, Galileo can offer to mitigate the cost to wind farm developers for a premium which can be expected to be much less than the risk premium charged by project financiers who do not have the expertise to assess wind resource risk as well as Galileo and 3TIER, and who also seldom have large and geographically diverse enough portfolios of wind investments to accept such risks at a price that is affordable for many wind farm developers.

Second, General Electric (GE) announced on May 23rd that they will be offering production based availability (PBA) guarantees as an option for new and existing operations and maintenance contracts on all GE 1.5 and 2.5 megawatt series wind turbines.  Not only will this remove a level of risk and make wind farms cheaper to finance, but it is also likely to be a competitive advantage for GE Wind, which recently slipped into third place by market share behind Chinese manufacturer Sinovel Wind Group (601558.SS).  While first place Vestas Wind Systems (VWDRY.PK) might be able to offer comparable guarantees, I can't see bankers putting much faith in the strength of a production guarantee from the Chinese firm, especially after their recent dust-up with American Superconductor (AMSC).

Together, these two financial innovations could do as much to reduce the cost of wind power and increase the pace of wind farm development as years' worth of technical innovation developing better wind turbines.

This article was first published on the Green Stocks blog at Forbes.com.

DISCLOSURE: None

DISCLAIMER: 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 04:28 PM | Permalink | Comments (0)

Tom Konrad CFA

Sinovel's recent refusal to accept shipments from American Superconductor (AMSC) may be due to more than just a slowdown in the Chinese wind market.

Many of my best ideas come from readers.  When American Superconductor (AMSC) announced that their largest customer, the Chinese Wind Power company (and the world's second largest wind turbine manufacturer) Sinovel (601558.SS) had refused shipments, and not yet paid for some previous deliveries, my first thought was that Sinovel's reasons would likely remain an enigma for several months.  I did not write anything, knowing that anything I said would be mostly guesswork.  However, a couple persistent readers pointed out that AMSC had been one of my Ten Clean Energy Stocks for 2011, and so I should really follow up on this important news.

The result was my attempt to decipher the news announcements and press releases from Sinovel and AMSC last week.  While I felt I was able to provide a good picture of the background, I could only guess at the most important question: Is Sinovel just trying to work off excess inventory due to a slowdown in the Chinese Wind marke, or are they beginning to shift some of their business to other suppliers?

This question is crucial because Sinovel accounted for about three quarters of revenue in 2010, although the AMSC has been moving to lessen its dependence on the Chinese wind giant.  The worry is that if Sinovel were to find another supplier for the power converters AMSC sells, AMSC's considered goal of reducing their dependence on Sinovel may become a premature fait accompli. Then Sinovel's share of revenue might drop not because AMSC has other sources of revenue, but because they lose Sinovel as a major customer.

GT Electric

That brings me back to my readers, among whom were a hedge fund analyst and fund manager in Palo Alto.  Their fund is short AMSC, so they have two important incentives: They have an incentive to dig through the Chinese press to figure out what is going on, and they want US investors to find out about any bad news.  If they found any good news I don't know about, they kept it to themselves.

They found that Sinovel affiliate Dalian Guotong Electric (GT Electric) started producing frequency converters in 2010, and is ramping up production at the typical Chinese breakneck pace.  Sinovel owns a 22.5% share in GT Electric, giving them a strong incentive to prefer their frequency converters over AMSC's.

GT Electric's product website (Chinese only) is here, and much of the other information they found is in the August 2010 China Wind Power newsletter, which said GT's factory will be "capable of import substitution." 

GT does not have the capacity to replace AMSC yet, and Sinovel will likely want to have more field experience with GT converters before abandoning AMSC.  But the contract Sinovel signed with GT electric for 2011 gives them 4% of their total... in GT's second year of operation. 

Final Thoughts

I still believe that Sinovel will resume purchases from AMSC later this year, but I think it is unlikely that those purchases will grow in coming years.  Further, AMSC still needs to raise $100-$200 million to complete the (revenue-diversifying) purchase of "The Switch" I discussed in the previous article.  The fear of dilution will likely depress AMSC's share price over the next couple of months, meaning that I no longer think that AMSC is a good speculation where it currently stands in the $11.50 to $12 range. 

These events are unlikely to bankrupt AMSC, and I think many of the company's other businesses have great potential for growth, but from a very low base.  For now, I've sold my stake, but I will be looking for opportunities to buy again at lower levels. 

I may not be the only one looking for bargains.  I shot a quick email off to John Segrich, whose Gabelli SRI Green Fund (SRIGX) holds "a little" of the stock.  He thinks AMSC is a lot more interesting now that it has fallen so far, and speculates that it could be a buyout target for someone wanting to own the technology.

DISCLOSURE: None.

DISCLAIMER: 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 09:29 AM | Permalink | Comments (0)

Tom Konrad CFA

I published my rebuttal to John Petersen's recent article "Gone With The Wind – Debunking Geographic Diversity" on November 1st last year.  It was titled Alternative Energy: The Paradigm is the Problem. 

That article had two parts.  The first part focused on electric vehicles, and argued that the problem with the electric car was not electric propulsion, but the car paradigm.  I concluded that electric propulsion makes considerably more sense for electric bikes, trains, and buses.  John clearly understood that section, because he published an article just last week "Lux Research Confirms that Cheap Will Beat Cool in Vehicle Electrification," showing how a recent report from Lux Research confirmed my ideas that electric bikes, and heavy vehicles (delivery trucks, buses, and train locomotives) would be the dominant electric vehicles for the next decade.

Trapped in an Invalid Paradigm

The second part of my Paradigm article was headed "Wind and the Grid," and it appears that John stopped paying attention at this point.  He certainly missed the sentence where I said "critiques of wind power's variability implicitly assume that nothing can be done to make the electric system more accommodating to wind, when in fact there is much that can be done," as well as the steps I outlined to address the problem.

Let's dissect how John's paradigm leads him to invalid conclusions.

John analyzed wind production data from five widely dispersed regions, finding that his model grid produced less than 12.5% of rated capacity 18.5% of the time, less than 6.25% of rated capacity 1.6% of the time.

That sounds pretty bad, doesn't it?  He clearly thought it was bad, because he concluded, "wind power will never be stable or reliable enough to serve the needs of an industrialized society."

I find this conclusion a little hard to swallow.  If he had said "never be stable or reliable enough to serve all the needs of an industrialized society," I would not have a problem with his statement.  But he's trapped by the paradigm that says the only useful electricity is either always on (baseload) or dispatchable (on-demand.)  Even with geographic diversification, wind and solar are neither, but they do serve the highly useful function of allowing us to conserve precious dispatchable resources (hydropower, some biomass, natural gas, energy storage, and demand response) to fill in the gaps when they are not available.  This function does not serve all the needs of society, but it does free up valuable resources to serve those needs at other times.

Rated Capacity: The Wrong Yardstick

John's use of "rated capacity" of wind farms to measure shortfalls in production is also an artifact of the conventional power paradigm that exaggerates the lows in wind power production.  With baseload resources such as coal and nuclear, which are often operating at full rated capacity, measuring output in comparison to rated capacity makes a certain sense, although even coal would not stand up to the test that Petersen expects wind to pass.  A typical coal plant has a capacity factor of 80% to 90%.  About 10% of the time, the coal plant is not operating at all (it may be down for maintenance, coal supplies may be delayed, or there may be some mechanical problem which forced it to shut down.)  By Petersen's apparent logic, if coal plants are not operating at all 10% of the time, they must not be stable or reliable enough to serve the needs of an industrialized society. 

This, of course, is bogus.  Coal plants are useful, because most of the shutdowns are predictable enough that other resources can be made available to fill the gap in electricity supply.  With planning, coal plants can even be shut down during periods when seasonal electricity demand is low, and electricity production from wind is high. 

Wind is less predictable than coal, but weather is not random, especially over large regions a few hours in advance.  With good weather prediction, the gaps in wind power can also be filled with other resources.

Maximum Production

Returning to "rated capacity," wind power produces on average between 20% and 40% of rated capacity, while a coal plant's average production (capacity factor) is between 80% and 90%.  Comparing actual production to average production might bias the numbers in favor of wind, just as comparing actual production to rated capacity biases the numbers in favor of coal.  A fairer comparison falls in between: comparing actual production to maximum production.  For dispatchable and baseload resources, maximum production and rated capacity are the same.  For a diversified portfolio of variable resources, maximum capacity is considerably lower than rated capacity. 

For the portfolio of four widely dispersed wind turbines I discussed in my article "Why Geographic Diversification Smooths Wind Power" the maximum production was 93% of rated capacity.  That was for a portfolio of four widely dispersed turbines. 

Petersen collected much better data than my own, so I asked him for a copy of his spreadsheet.  He gathered wind production data for five widely dispersed regions, each of which contains hundreds of turbines.  Over such a large region and so many turbines, maximum production will be far below the rated capacity of the system.  In particular, the maximum production from his 16 GW-rated supergrid was only 7 GW, well below half the rated capacity.

Compared to the maximum output of 7 GW, the electricity production from Petersen's supergrid looks much more stable.



The two graphs above show distributions of the wind power production during six hour intervals over the two months for which Petersen collected the data.  I created them by sorting each month's worth of intervals by total power production during the interval.

As we can see from the graph, wind power production in January is fairly well behaved.  Minimum production was 900 MW, or 13% of the system's maximum production.  July production falls well short of 1 MW for two six hour periods, when it is 468MW and 356MW, or 5% and 7% of maximum production.  While these lows in production are not good, comparing them to notional rated capacity (more than twice maximum production) creates the illusion of a much greater shortfall in production than actually exists.

Below, I've prepared a histogram of wind output for Petersen's supergrid.  I found the relative consistency of wind output in January 2010 particularly striking, with wind production being between 3 GW and 4 GW over 40% of the time.


Conclusion

Variable resources like wind cannot substitute for dispatchable power, but they can produce valuable energy cheaply when they are available.  The less variable the wind power resource is, the less dispatchable power is needed to back it up, and the most economical way to reduce variability is geographic diversification.

To see just how effective geographic diversification can be, compare the above histogram of the wind power output of Petersen's supergrid with the equivalent histogram below of one of the supergrid's five components: the wind output from the Bonneville Power Association (BPA) region.


If we want to see large-scale integration of inexpensive wind power, producing no global warming emissions and requiring no water, we'll also need to greatly enhance our electric grid.  Wind power investors should also be transmission investors.

Data & Charts

The spreadsheet I used to create all the charts above is available here as an Open Office spreadsheet and here in Excel.

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 08:09 PM | Permalink | Comments (13)

Tom Konrad CFA

American Superconductor (NASDAQ:AMSC) dropped 52% since their profit warning on April 6th.  Is it a screaming bargain, or does it have farther to fall?



Two readers asked me to take a look at American Superconductor Corporation (AMSC) after the company issued a profit warning on April 6th.  Although the stock was included in my list Ten Clean Energy Stocks for 2011, (which has produced more buying opportunities than profits so far this year) I did not own the stock in any of my managed portfolios, and so the research had to take a backseat to taxes. 

I spent a few hours catching up with the company this week, and, now that it's trading below $12, I consider the stock a good, if very speculative, buying opportunity. 

What Happened

On April 6, AMSC shocked investors with an announcement that their largest customer, the Chinese Wind Power company (and the world's second largest wind turbine manufacturer) Sinovel (601558.SS) had refused shipments, and not yet paid for some previous deliveries.

The first hint of problems had come three weeks earlier, in the press release announcing AMSC's "The Switch" Acquisition  on March 14th.   In that release, the company said that organic growth would slow, and 2010 revenue would be at the "lower end" of the previous $430-$440MM guidance range.

At this point, AMSC management most likely knew there was a problem, but may still have expected Sinovel to continue paying for deliveries.  Sometime in the next three weeks that changed.  In the profit warning they said that Fiscal 2010 revenues (through March 31st) would be $355MM, a full $75MM (17.5%) lower than the previous estimate.  Since AMSC's revenues in the first three quarters had been $313MM, they were saying that 4th quarter revenues would be 64% below previous guidance, and they would show a quarterly loss.

AMSC also said that they expected that Sinovel would continue to refuse deliveries until the company had run down inventory in a slowing Chinese wind market before accepting future shipments.

Without the expected revenue from their largest customer, analysts now expect that AMSC will need to raise between $100MM and $200MM in order to complete The Switch buyout.  This is somewhat ironic in that one of the main reasons for the acquisition was to diversify AMSC's revenue and make them less reliant on a single customer (Sinovel.)   The need for that revenue diversification is now even more obvious, but it leaves investors wishing that AMSC had done more to diversify, sooner.

As is to be expected with any large negative surprise, the class action lawyers have leapt into action, with Levi & Korsinsky filing on April 15, and Wolf Haldenstein Adler Freeman & Herz LLP on April 18th.

Although wind is the largest part of AMSC's business, and Sinovel is by far their largest customer, the company does have other business.  Their eponymous superconducting wire seems to be gaining traction in more markets, with RenewGrid reporting that AMSC superconducting wire was used in Electrical Substation in China on April 21st.

What's Next?

In the short term, the need to raise capital for "The Switch" acquisition will put pressure on the stock price, most likely leading to excellent buying opportunities.  But knowing if those buying opportunities will appear when the stock drops below $12, as it is as I write, or possibly at much lower levels greatly depends on what is really happening at Sinovel.

If the company is right that Sinovel will resume accepting shipments after they have worked off their excess inventory, then we might expect revenues to return to previous levels, and possibly even grow.  If, on the other hand, Sinovel decides it no longer needs AMSC as a supplier, they may not be a significant source of revenue for AMSC at all going forward.  These scenarios account for the wide range in analyst's revenue expectations for 2011: between $160M and $456M. 

If the low estimates are correct, AMSC has much farther to fall.  If, on the other hand, Sinovel reduces its inventory in a quarter or so, and then begins accepting (and paying for) shipments at something near the previous pace, we may see revenues for FY 2011 somewhere near the higher end of the range.

In either case, confidence in AMSC management has suffered long term damage, and so we cannot expect AMSC to trade at the same multiples at which it was trading at the start of the year.  If we assume that FY 2011 revenues will be $350-$400MM, and give the stock a 30% discount on previous Revenue multiples, the stock should be worth $20-$23.  If we expect only $160MM revenues with the same discount, then the stock is  worth $9 or even less.

Since I think the more optimistic scenario is more likely, the stock seems like a good speculative buy below $12.  More cautious investors might consider buying calls rather than buying the stock outright.  I'm doing a little of both.

DISCLOSURE: Long AMSC.

DISCLAIMER: 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 08:05 PM | Permalink | Comments (3)

John Petersen

Earlier this month I wrote a pair of articles (here and here) that questioned the reasonableness of the near universal assumption that the wind is always blowing somewhere and wind power infrastructure with a wide enough geographic dispersion would offer a relatively stable power output. I presented graphs from the Bonneville Power Administration and a study by the John Muir Trust that raised substantial doubt in my mind. The articles drew a well-reasoned response from my colleague Tom Konrad (here).

While many commenters understood the point I was trying to make, many others argued that the sample areas were too small or they didn't fairly test the geographic dispersion theory. Since I hate unresolved questions, I went looking for a better answer and found it in historical wind power production data from five power authorities:

• The Bonneville Power Administration, which serves 3.5 GW of installed capacity in the Pacific Northwest;
• The Australian Energy Market Operator, which serves 1.8 GW of installed capacity in New South Wales;
• The Independent Electricity System Operator, which serves 1.2 GW of installed capacity in Ontario;
• The Alberta Electric System Operator, which serves 0.8 GW of installed capacity in Alberta; and
• The EirGrid, which serves 1.4 GW of installed capacity in Ireland;

Most people would agree that a sample of five major systems spread over 17 timezones and two hemispheres has enough geographic diversity to provide a reliable basis for analysis. To simplify the process I took the following steps:

1. I downloaded detailed production data from each power authority for the months of January and July 2010 and then calculated an average wind power output for each six hour interval;
2. I then calculated a maximum and an average power output for each system during January and July 2010;
3. I used the average power output of the systems to calculate a conversion factor that would bring all five systems up to the average power output of the BPA;
4. To compensate for time zone differences I shifted Australia by three intervals (6 hours each) the BPA by two intervals and Alberta and Ontario by one interval; and
5. I constructed a stacked graph to show what the combined power output of the five systems would be if they were each built-up to the point where their effective production capacity was equivalent to the BPA.

While the model is not a perfect representation with spot on accuracy, it's certainly close enough to provide a reasonable representation for the purpose of testing the geographic dispersion theory. When all the calculations and adjustments were done, my model wind supergrid produced the following combined output for the month of January 2011.



It produced the following combined output for the month of July 2011.


Overall, the model wind supergrid would include over 16 GW of installed capacity. In January 2010, it would have had 16 intervals where it was unable to provide 2 GW of reliable power and two intervals where it was unable to provide 1 GW. In July 2010 it would have had 30 intervals where it was unable to provide 2 GW of reliable power and two intervals where it was unable to provide 1 GW.

My undergraduate degree was in accounting and while my first two articles on this topic were only enough to raise a question about the fundamental validity of the geographic dispersion theory, I believe a five power authority model that's about as dispersed as anyone could imagine does far more than raise an inference.

It proves the theory of geographic dispersion is complete and unadulterated balderdash! The harsh reality is that wind power will never be stable or reliable enough to serve the needs of an industrialized society.

I continue to believe that investments like the First Trust ISE Global Wind Energy Index ETF (FAN), the PowerShares Global Wind Energy Portfolio ETF (PWND) and a host of publicly traded wind power stocks should be avoided.

Disclosure: None.

Posted by John Petersen at 05:16 PM | Permalink | Comments (0)

Debra Fiakas

Most investors when they consider the alternative energy sector think about the big solar photovoltaic manufacturers or the ethanol producers.  Engineering firms like Kaydon Corporation (KDN:  NYSE) rarely come to mind.  With special expertise in fluid processes, Kaydon is an indispensable partner in a variety of alternative energy projects such as wind, renewable diesel and ethanol plants.

The company earned a 12% net profit margin on $4645 million in total sales in the year 2010.  As impressive as that might be the really bright spot in Kaydon’s financial picture is its ability to generate cash  -  $93.9 million in 2010.  This implies a cash conversion rate of 20.2%.

Kaydon is not a high profile company with flashy investor relations outreach.  Its corporate web site is static and is directed primarily toward customers who might happen by looking for custom bearings or rings and seals.  Perhaps this customer-centric orientation is why Kaydon is growing in a field that is challenging for others.

The company just announced a key acquisition in German adding springs and dampers to the product line.  Kaydon is buying HAHN-Gasfedern GmbH for an undisclosed sum.  HAHN-Gasfedern is doing approximately $20 million in annual sales and is reportedly profitable.  The new product line should be interesting to customers all across Kaydon’s base in the energy, renewable energy, pharmaceutical and other process manufacturing industries.

The stock is selling at 23.5 times trailing earnings and 20.8 times forward earnings, suggesting analysts following the company see earnings growth ahead.  The consensus rating at this time is hold.  However, we believe investors should consider company’s like Kaydon that have been consistently delivering profits for a play on the alternative energy industry.  KDN also offers a 2.0% dividend yield at the current price level, suggesting that even at even with a forward earnings multiple near its growth rate, the stock offers value.


Debra Fiakas is the Managing Director of Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.  

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.  KDN is included in Crystal Equity Research’s Earth, Wind and Fire Index in the Wind Group.

Posted by Debra Fiakas at 02:31 PM | Permalink | Comments (0)

Tom Konrad CFA

Canadian weather data shows the variability-smoothing potential of a robust continental electric grid.

Intelligent skepticism is valuable to me as an investor when it makes me question my assumptions.  When I'm wrong, it makes me find out sooner (and hopefully get out of a bad trade sooner, or never get into it.)  When I'm right, I emerge with my thesis tested, which leads to the confidence needed to stick to a trade when the stock market voting machine moves against me in the short term, before it comes around in the longer term.

Over the last month or so, John Petersen and I have been going back and forth regarding the potential to smooth wind power output.  Most recently, he latched onto a study and some graphs from the Bonneville Power Association which he felt demonstrated that geographical dispersion does not work.  He wrote, "I am unwilling to assume that integration across multiple regions will do the trick without seeing a compilation and overlay of the hard data from those regions and a plan that lays out how the interconnections will work."

Methodology

Actual wind output data is usually kept private by wind farm operators and utilities, so instead I turned to publicly accessible wind speed data.  I found data in usable form from Canada's Weather Office.  I then selected four widely dispersed Canadian weather stations which had hourly historical data available, and copied the wind speed data into a spreadsheet for the week of April 1st to 7th, 2011.  In selecting weather stations, I chose one each in British Colombia, Yukon Territory, Newfoundland, and Nunavut that seemed to have enough wind to be suitable locations for wind farms.

I then converted these wind speeds into simulated power output using a wind power curve, shown here.   This takes the wind speed data, and replaces it with the likely power output (expressed as a percentage of rated output) for a wind turbine.  Wind turbines don't produce any power at very low wind speeds, ramp up quickly to their full rated power output as wind speed increases, and cut off suddenly to protect themselves in extremely high winds.

Over the week selected, the simulated wind output from my four weather stations was basically uncorrelated between the widely dispersed sites, as you can see from the following correlation matrix:

Correlation	Dease Lake (AUT) British Columbia	Argentia (AUT) New- foundland	MAYO A (Yukon)	Cambridge Bay A Nunavut	Wind 4 Sites	ERCOT North	ERCOT 2010
Dease Lake (AUT) British Columbia	1	-0.05	-0.03	-0.19	0.35	0	0.02
Argentia (AUT) New- foundland		1	-0.06	-0.15	0.53	-0.04	-0.09
MAYO A (Yukon)			1	0.10	0.49	0.07	-0.10
Cambridge Bay A Nunavut				1	0.40	0.01	-0.12
Wind 4 sites					1	0.01	-0.16
ERCOT North						1	0.74
ERCOT 2010							1

The "All 4 sites" column represents the sum of the simulated output from the four sites, while the ERCOT North and ERCOT 2010 columns contain demand statistics for the Texas grid for the same week in 2010 (I did not know where to find 2011 data.)  ERCOT North is one of eight Texas sub-regions.  I'm using ERCOT data for load simply because that was the load data I found most readily available.

Note that the correlation between "All 4 sites" and each individual wind site is approximately 50% in each case.   This is what we would expect if the wind sites were truly independent and uncorrelated.

ERCOT North is similarly highly correlated with ERCOT because not only is it is part of the larger region, but because the distances involved are smaller and because electric loads tend to be much more highly correlated across regions than weather patterns.

Diversification

The low correlation in wind output is key because when low or uncorrelated variables are added, the deviation of the average of all the variables is lower than the deviation of the individual variables.  The calculations are simplest for uncorrelated variables, but diversification has some use whenever variables are not perfectly correlated. 

In the case of n uncorrelated variables with the same standard deviation s, the standard deviation of the average of all n is s / sqrt(n).  Since I am using 4 basically uncorrelated sites in this example, the standard deviation of the average of all four sites is approximately half the standard deviation of each of the individual sites, as shown in the blue bars of the following chart and table.

	BC	Newfoundland	Yukon	Nunavut	Wind 4 Sites	ERCOT North	ERCOT (2010) load
Std Dev	36%	48%	35%	39%	19%	11.4%	11.1%
min	0%	0%	0%	0%	7%	55%	59%
max	100%	100%	100%	100%	100%	100%	100%
avg	35%	41%	40%	60%	48%	80%	79%
Percent = 0	30%	55%	27%	19%	0%	0%	0%

Not Baseload

A quick glance at the following chart showing wind output from the four sites demonstrates that while there may be some value to diversification, we're not talking about anything like baseload power here.  It's not necessary for wind to produce baseload power in order to be effectively integrated into the grid.  Aggregate wind power needs only to be reasonably predictable and not so volatile that utility systems cannot keep up.  After all, utilities have been coping with variations of demand, which is neither entirely predictable, nor flat.

The following chart compares the output from the average volatility simulated wind site (Cambridge Bay, in British Columbia) with the output from an average of all four sites, and ERCOT load data from Texas. 


Here it is clear to see that the average wind output (blue line) is much less volatile than the wildly swinging green line.  If we wanted to reduce average wind output volatility to the same level as we see in the ERCOT North demand curve, it would require 12 uncorrelated wind sites [39.5% / sqrt(12) = 11.4%], or a larger number of partially correlated sites.  Given my experience with the data so far, I think it would not be difficult to find a sufficient number of partially correlated sites within Canada, and the exercise would be simple if the area were expanded to cover both the US and Canada.

Such a large grid would have the added benefit of smoothing the volatility of demand.  We see this on a small scale when comparing the volatility of the ERCOT North sub-region to ERCOT as a whole, but, as with weather, correlation in demand curves will fall with distance due to different working habits, industries, weather conditions, and time zones. 

Lower volatility in overall demand compared to local demand would free up dispatchable resources to help compensate for the remaining volatility of wind output.

In the Real World

In theory, we can reduce the volatility of wind output to less than the volatility of demand by building a North American continental grid.  In practice, such a grid is unlikely to be built anytime soon.  But we do not need a continental grid to achieve many of the benefits of diversification. Shorter connections, especially when chosen to maximize differences in weather patterns can be of great benefit in smoothing wind output and demand. 

Complete lack of correlation is not necessary to reduce overall volatility, although there would be benefits in not only siting new wind farms to maximize power output, but to also consider the correlation of local winds to the output of other wind farms and local electric demand.  Such steps could do much to reduce the strain that the variability of wind puts on the electric grid, and in the end allow greater wind penetration.

The addition of solar resources can also greatly reduce the overall variability, given that solar output is somewhat correlated with demand and not particularly correlated with wind.  The output of solar sites tends to be much more correlated with that of other solar sites than for wind, but solar sites are not completely correlated, since output varies with cloudiness, latitude, orientation, temperature, and solar technology. 

The fact that summer electric loads tend to peak in the evening just as the sun is setting can also be alleviated with transmission and planning.  The output of West- and North-west facing panels is more correlated with load, and, even without storage available from technologies such as Concentrating Solar Power, traditional PV panels in the desert Southwest are producing power long after the sun has set in New York.

Conclusions for Investors

Wind farms are currently overly clustered in areas with good wind and access to transmission.  As a result, we see graphs of actual wind output that are much more variable than the technology need be inherently. 

While electricity storage is effective for smoothing short term volatility in electric supply and loads, long distance transmission, especially High Voltage DC transmission is the most cost-effective technology for smoothing long-term variations.  Prospective wind investors should also be considering companies involved in building, maintaining, and supplying transmission, especially leading HVDC suppliers Siemens (SI) and ABB (ABB). 

Calculations and Data

For those interested in my data and methodology, I have uploaded the spreadsheet I used for my calculations to Google Docs in both native Open Office Calc and MS Excel formats.

DISCLOSURE: No Positions.

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 06:10 PM | Permalink | Comments (5)

John Petersen

Last Wednesday I stirred up a hornets nest with an article titled "A Reality Check for Wind Power Investors" that included two graphs from the Bonneville Power Administration, or BPA, which manages a four state, 300,000 square mile service region that's home to over 40% of the installed hydro capacity and roughly 12% of the installed wind capacity in the US.

The first graph tracks the BPA's regional load and power production from hydro, thermal and wind facilities over the last seven days and shows why the region is one of the largest power exporters in the country.



The second graph provides stand-alone tracking data for wind power in the BPA region over the last seven days.



My concern was that the BPA graphs clearly contradict widely accepted notions that:

• Wind turbines will generate on average 30% of their rated capacity;
• The wind is always blowing somewhere and geographic dispersion will eliminate instabilities;
• Periods of widespread low wind are infrequent; and
• The probability of very low wind output coinciding with peak electricity demand is slight.

Until I saw the BPA graphs I assumed that wide geographic dispersion of facilities would ameliorate the erratic nature of wind power. The graphs proved my assumption wrong. Once it became clear that broad regional dispersal wasn't enough, I began looking for comparable data on a nationwide basis and couldn't find it – ANYWHERE.

Yesterday, Jack Lifton pointed me in the direction of a March 2011 "Analysis of UK Wind Power Generation" that was commissioned by the John Muir Trust, Britain's premier wildlands conservation charity, and found that:

1. Average output from wind in the UK was 27.18% of capacity in 2009, 21.14% in 2010, and 24.08% between November 2008 and December 2010 inclusive.
2. There were 124 occasions from November 2008 through December 2010 when total generation from the windfarms metered by National Grid was less than 20 MW from an average capacity of over 1,600 MW.
3. The average frequency and duration of a low wind event of 20 MW or less between November 2008 and December 2010 was once every 6.38 days for a period of 4.93 hours.
4. At each of the four highest peak demands of 2010 wind output was low being respectively 4.72%, 5.51%, 2.59% and 2.51% of capacity at peak demand.

The study's most startling conclusions were that:

• The nature of wind output has been obscured by reliance on “average output” figures. Analysis of hard data from National Grid shows that wind behaves in a quite different manner from that suggested by the study of average output ... or from wind speed records which in themselves are averaged.
• It is clear from this analysis that wind cannot be relied upon to provide any significant level of generation at any defined time in the future. There is an urgent need to re-evaluate the implications of reliance on wind for any significant proportion of our energy requirement.

While the complete set of 28 monthly tracking graphs that accompany the UK Analysis are less colorful than the BPA's, the erratic and wholly unreliable character of the UK's wind resource is remarkably similar to the BPA's resource.



My undergraduate degree was in accounting and I understand statistics well enough to know that data from a single region does not disprove the theory that geographic dispersion of wind facilities will solve the intermittency problem. However, my accounting professors taught me that when two substantial samples from regions as diverse as the UK and the Pacific Northwest leave room for reasonable doubt, prudence requires a larger sample and a more granular analysis.

The idea of geographic dispersion is so inherently plausible that it's accepted without question. What if it's a lie? We know it doesn't hold water in the BPA region and we know it doesn't hold water in the UK. The raw data almost certainly exists. Compiling the hard data into a national landscape would require little more than an Excel spreadsheet, particularly if we assume away the need for a robust and flexible interstate transportation grid. The only reason I can imagine why nobody has published results from such a study is that the results are dreadful and they disprove the theory.

I would love to be proven wrong on this point because my preliminary conclusions are damned inconvenient. The time for platitudes and calm assurances from advocates and promoters is past. We need detailed analysis of hard day to day data if we ever hope to have a sensible energy policy that works in the real world.

In light of the clear data from the BPA and confirmation from comparable analysis in the UK, I continue to believe that investments like the First Trust ISE Global Wind Energy Index ETF (FAN), the PowerShares Global Wind Energy Portfolio ETF (PWND) and a host of publicly traded wind power stocks should be avoided like the plague.

Disclosure: None.

Posted by John Petersen at 09:19 AM | Permalink | Comments (17)

A Great Deal for Plutonic Shareholders, Not bad for Magma

Tom Konrad CFA

As a shareholder of Magma Energy Corp. (MGMXF.PK), I'm reading through the joint information circular [PDF] on the proposed merger of Plutonic Power Corp (PUOPF.PK) and Magma to form "Alterra Power Corp." I'm not thrilled with the merger, although I plan to vote for it, now that it's arranged.

Overall, I think the merged Alterra will be a stronger company than either company alone. Both companies are in capital intensive niche Renewable Energy industries, so the added scale and diversification of Alterra should better enable the merged company to borrow money to finance projects at lower rates. Obtaining financing at favorable rates is essential to the profitability of renewable energy projects.

My misgivings about the merger arise from the price. Magma shareholders will have a controlling stake of 66.5% of the merged company, with current Plutonic shareholders owning the balance. Plutonic shareholders are being paid a 32% or 17.5% premium, based on pre-merger market capitalization or book value, respectively. That would be a normal buyout premium, except that Magma was a much stronger company, and so Plutonic shareholders also gain more as part of the merged entity. Although the two companies work in different renewable energy industries, their projects have much in common. In addition to raising finance, environmental permitting, grid interconnection, and negotiating with utilities are crucial to the success of any renewable power producer, and a larger company with more projects may be able to make more effective use of employees with specialized local knowledge or skills in these areas.

Before the merger, I considered Magma shares a good buy, but I would not have bought Plutonic shares, because the company would have needed to either do a deal like this or raise money in the next year or so. This put Magma in the stronger bargaining position, and so I would have liked to see a smaller premium paid for Plutonic shares. That said, since two thirds of Plutonic shareholders will need to vote for the merger in order for it to be a success, this premium is probably necessary to gain sufficient support. Passage by Magma shareholders is a virtual certainty, since the owners of 38.7% of Magma shares have already committed to vote for the deal, and only 50.01% support is needed.

As a Magma shareholder, I think the deal is acceptable, and will be a way for Magma to pursue opportunities for growth beyond Geothermal power, part of the company's current strategy. I also like Plutonic's Run of River and Pumped Hydroelectric assets, although until this proposed merger, I was unwilling to buy the company's shares because I felt its balance sheet wasn't strong enough.

Overall, I'm in favor of the deal. Too bad they couldn't have come up with a better name. Apparently "Alterra" means "Other Earth" or "Other land" in Latin, but it doesn't do much for me. I liked both Plutonic and Magma better.

Plutonic shareholders will gain an instant 32% premium on their shares, while the shareholders of both companies can look forward to steadier growth.

DISCLOSURE: Long MGMXF.

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 04:24 PM | Permalink | Comments (0)

John Petersen

Epic is the only word I can use to describe an evolving tragedy that killed tens of thousands of people, inflicted hundreds of billions in property damage, destroyed 3.5% of Japan's base-load power generating capacity in a heartbeat and will cause recurring aftershocks in the global electric power, transportation and energy storage sectors for decades. While I'd love to believe the worst is behind us, I fear the times of trouble have just begun.

Since it's clear that Japan will have to turn inward and serve the urgent needs of its own population first, the following direct and immediate impacts seem all but certain:

• Lost electric power from Japan's ruined nuclear plants must be replaced with oil, natural gas and coal because alternative energy technologies like wind and solar can't possibly take up the slack;
• Cleanup and reconstruction must increase total Japanese demand for liquid motor fuels;
• Japanese demand for industrial metals and construction materials must skyrocket; and
  
• Crushing limitations on Japan's base-load power generating capacity must:
• complicate supply chains for equipment, components and materials from Japan;
• increase the cost of Japanese exports;
  
• increase demand for all types of electric efficiency technologies;
  
• increase demand for HEVs and other fuel efficiency technologies;
• increase demand for grid-based energy storage systems; and
• force utilities to shed non-essential loads and abandon their support for plug-in vehicles.

Some years from now, I expect to see rows of headstones in the EV graveyard that read "Lost to the Tsunami."

While I'm still trying to puzzle my way through the primary, secondary and tertiary impacts, it's a virtual certainty that nuclear power will be immensely unpopular even if things go spectacularly well in Japan. Switzerland has suspended pending applications for two planned nuclear plants and anti-nuclear activists are on the offensive in France. Germany just declared a moratorium on nuclear power and ordered the "temporary" cessation of operations at seven reactors that were built before 1980. Other jurisdictions, including earthquake prone California, can expect immense public pressure to follow suit. In time things will stabilize at a new normal, but that new normal will be very different from the normal that existed two weeks ago.

Some readers will be offended by my offhand dismissal of wind and solar as viable solutions. Others will be enraged by the suggestion that utilities will abandon their support for distributed and inherently unpredictable power demand from plug-in vehicles. All I can say is that reality is inconvenient that way. Japan just lost 7.6 gigawatts of base-load capacity. The German moratorium slashed their base-load capacity by 8.3 gigawatts. As the nuclear dominoes continue to fall, the strain on power grids everywhere will get far worse than any of us can begin to imagine. The last thing the world needs in times of plummeting base-load capacity is rapid expansion of demand. We simply can't have it both ways.

Nuclear power plants typically operate at 90% of nameplate capacity while wind and solar operate at something closer to 25% of nameplate.  The nuclear reactors that have recently gone off-line in Japan and Germany accounted for roughly 125 TWh of electricity production last year. In comparison, global electricity production from wind and solar power in 2009 was 269 TWh and 21 TWh, respectively. In other words, we just lost base-load power that represents 43% of the world's renewable electricity output. The gap cannot possibly be filled by new wind and solar power facilities.

There is no question that Japan will be forced to use conventional fossil fuels to replace its destroyed nuclear plants and unless its residents choose to endure extreme hardship for the sake of principle, Germany will be forced to do the same. Comparable power shortages will arise in every industrialized country that decides the risks of vintage nuclear plants outweigh their benefits. When you start stripping base-load power out of the grid, plug-in vehicles become wildly extravagant. My cynical side is tickled that Armageddon Entrepreneurs will finally be forced to choose between stoking fears over (A) imported oil and turmoil in the middle east; (B) global warming; and (C) nuclear power plants. My practical side foresees an immensely difficult time when reality finally sinks in and people are forced to come to grips with their own wasteful behavior. The panacea possibilities were washed away in the tsunami. Now we have to get serious about conservation and abandon the childish notion that we can waste one class of natural resource in the name of conserving another.

Over the last few months the mainstream media has been abuzz with stories about high-profile demonstration projects that will use battery-based systems to help stabilize the grid and smooth power output from wind and solar installations. As usual, the mainstream is getting it wrong and creating expectations the energy storage industry can't possibly meet.

A classic example of overblown media hype is Southern California Edison's plans to spend $55 million to demonstrate a battery-based solution from A123 Systems (AONE) that will provide 32 MW of power and 8 MWh of energy to smooth power output from the Tehachapi wind complex. The following graph from the California ISO highlights the variability issue that's the bane of alternative energy facilities everywhere.

While the new energy storage system will probably do a fine job of smoothing minute-to-minute variability, it will be absolutely worthless in the context of Tehachapi's average daily power production swing of over 200 MW. Tehachapi needs several gigawatt hours of storage, not a few megawatt hours.

I'm convinced that grid-based energy storage is an immense opportunity, but it won't be in the form of the headline grabbing projects the media is fixated on today. Two weeks ago the Pacific Northwest National Laboratory published a review of "Electrochemical Energy Storage for Green Grid" that describes the need for grid-based storage, identifies the leading storage technologies and explains the baseline economic requirements. Copies of the PNNL review are available from the American Chemical Society for $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.

In their discussion of storage economics, the authors said:

"Cost is probably the most important and fundamental issue of EES for a broad market penetration. Among the most important factors are capital cost and life-cycle cost. The capital cost is typically expressed in terms of the unit cost of power ($/kW) for power applications (e.g., frequency regulation) or the unit cost of energy capacity ($/kWh) for energy applications (e.g., load leveling). The life-cycle cost is the unit cost of energy or power per cycle over the lifetime of the unit.

...  In the authors' opinion, the cost of electricity storage probably needs to be comparable to the cost of generating electricity, such as from natural gas turbines at a cost as low as 8-10 ¢/kWh per cycle. Thus, to be competitive, the capital cost of storage technologies for energy applications should be comparable or lower than $250/kWh, assuming a life cycle of 15 years or 3900 cycles (5 cycles per week), an 80% round trip efficiency, and “zero” maintenance. A capital cost of $1,250/kW or less is desired if the technology can last 5 h at name-tag power. ..."

A123's demonstration project at Tehachapi will cost $1,720 per kW and $6,880 per kWh for a 15 minute solution. It's a highly profitable project for A123, but light-years from cost-effective. The same is true of another high profile project where Ener1 (HEV) will sell power quality systems with a combined capacity of 3 MW and 5 MWh to the Russian Federal Grid for $40 million, or $13,300 per kW and $8,000 per kWh. These projects are great headline events, but they'll never be the basis for a sustainable business.

In February and March of last year I wrote a series of articles that focused on grid-based storage. The first summarized a study titled "Energy Storage for the Electricity Grid: Benefits and Market Potential Assessment Guide" that was commissioned by the DOE's Energy Storage Systems Program and conducted by Jim Eyer and Garth Corey. For that article, I calculated an average economic benefit for each of the 17 grid-scale storage applications discussed in the report and then used those averages to calculate the potential demand in MWh, the potential economic benefit per kWh and the potential revenue opportunity for storage system manufacturers. The following table summarizes my results.



The color coding is simply my attempt to separate high-value applications that need objectively cool technologies like flywheels, supercapacitors and lithium ion batteries from low-value applications that need objectively cheap solutions like flow batteries, lead-acid batteries, compressed air and pumped hydro. The bottom line is that revenue opportunities in grid-based storage will be 90% cheap, 8% cool and 2% in-between. Any way you cut it, the lion's share of the revenue opportunity will flow to companies that manufacture objectively cheap storage solutions. There will be niche markets in the $1 billion to $6 billion range for cool technologies like flywheels, supercapacitors and lithium ion batteries, but those niche markets will pale in comparison to the opportunities for cheap energy storage.

Until last week, I believed global demand for grid-based storage would ramp slowly over the course of a decade. Today it's beginning to look like grid-scale storage will rapidly eclipse all other potential markets. The universe of companies that can effectively respond to urgent global needs for large-scale storage is very small. It includes General Electric (GE), Enersys (ENS), Exide Technologies (XIDE), and C&D Technologies (CHHPD.PK)  in the established manufacturer ranks, and Axion Power International (AXPW.OB) and ZBB Energy (ZBB) in the emerging technology ranks. Companies like A123, Ener1, Active Power (ACPW), Beacon Power (BCON) and Altair Nanotechnologies (ALTI) will undoubtedly have exciting revenue opportunities, but the cost of their products will exclude them from the competitive mainstream.

In November of 2008 I wrote, "what I initially described as a rising tide is now looking more like an investment tsunami as a handful of micro-cap and small-cap companies gear up to compete for $50 to $70 billion of rapidly developing annual demand for large format energy storage systems." While it took a real tsunami to bring things to a head, I'm more convinced than ever that every company that brings a cost-effective energy storage product to market over the next few years will have more demand than it can possibly handle. EVs may be dead men walking but grid-scale storage looks like the opportunity of a lifetime.

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 03:07 AM | Permalink | Comments (10)

Dana Blankenhorn

Most renewable energy companies specialize.

Solar companies do solar. Wind companies do wind. Geothermal companies do geothermal. Biomass companies do biomass.

But a small Canadian merger challenges that assumption.

Magma Energy (MGMXF.PK), a geothermal company, said it will spend about $100 million in stock to buy Plutonic Power (PUOPF.PK), which has wind and hydropower projects, and ambitions to get into solar. The combined companies will go by the name Alterra Power.

Both companies are based in Vancouver.

Size really does matter, crowed Magma CEO Ross Beatty on a conference call announcing the deal. Their merger presentation calls the resulting company "a dominant renewable power developer in Canada."

True, but is this truly size?

Plutonic has only two projects operating at present, with three more under construction. The solar play is, for now, an ambition.

What the deal may really speak to are the prospects of the geothermal industry. "Geothermal is a small energy sector and has real limits to its growth since it only occurs in specific places on earth and many of the world's best geothermal assets are already developed," Beatty said on that same conference call.

Is that true? Last time I heard the Earth was round, and its thermal assets are beneath all of us.

What Beatty is doubtless referring to are the current requirements of geothermal plants. They need to be relatively close to warmth, so they can reach it at low drilling cost, but they can't be so close that the ground they are drilling through will be unstable, prone to earthquakes.

The question I'm asking of my friends in the business today is, then, are these limits absolute? We can drill miles down into the Earth, and slant that pipe so it goes horizontally. We already do this for natural gas. Why not for heat? And I know you don't want to tap directly into magma (despite the company's original name) but aren't there ways to tap heat that don't require absolute stability?

The floor's yours on this one.

There's a second question asked by this merger. Should renewable energy companies specialize in one form of energy, or is consolidation in the whole space inevitable? What is really gained by combining wind, solar, hydro and geothermal assets under one corporate umbrella, other than financing power?

Good questions for this week of the Renewable Energy World show in Tampa.

DISCOLSURE: No positions.

Dana Blankenhorn first covered the energy industries in 1978 with the Houston Business Journal. He returned last month after a short 29 year hiatus because it's the best business story of our time. In between he covered PCs, the Internet, e-commerce, open source, the Internet of Things and Moore's Law. It's the application of the last to harvesting the energy all around us he's most excited about. He lives in Atlanta.

Posted by Dana Blankenhorn at 12:20 PM | Permalink | Comments (0)

by Michael Giberson

American University’s Investigative Journalism Workshop has published reports detailing the extensive political connections in the United States developed by Chinese wind power company A-Power Energy (APWR) in its effort to build a 600-MW wind farm in West Texas. A-Power (APWR) and their Chinese and American partners were seeking $450 million in section 1603 grants and U.S. Department of Energy loan guarantees to help fund the project. New York senator Charles Schumer objected to the idea that stimulus funds would flow to Chinese workers and sought to block the project’s access to the funds. A-Power chose to fight politics with politics, announcing a turbine factory in Nevada (home of the Senate Majority Leader Harry Reid, project being developed in conjunction with prominent Reid supporters in Las Vegas) and making friends with the United Steelworkers union which had initially opposed the project.

The key U.S. partner to A-Power on the project is U.S. Renewable Energy Group, described in the article as “a Dallas investment firm with strong ties to Washington and the Democratic Party.” On its website, US-REG describes itself as a developer of “renewable energy projects throughout the nation,” but the only project specifically mentioned anywhere on its website is the proposed project with A-Power (here is the US-REG summary touting the benefits of the proposed project). Reading the “About the Team” materials on the website suggests a group of very well-connected lawyers and investors with little direct experience in developing renewable energy projects.

In this particular story, a key company is Chinese and the well-connected movers and shakers are Democratic, but there is nothing especially “Chinese” or “Democratic” about the practice of political capitalism revealed here.

Earlier reports from the Investigative Journalism Workshop detailed that about 88 percent of the section 1603 grant money went to non-U.S. based companies, including companies from Spain, Germany, Japan, and Portugal. (Note that the location of the corporate headquarters likely has little to do with where the money gets spent or who ends up better off because of the subsidy.) Another report indicated that $1.3 billion in stimulus funds went to wind power projects built before the stimulus bill was passed.

A US-REG press release issued in response to the article complains that it “contained a number of biased statements and inaccuracies about US-REG and its Texas wind farm project.” But they don’t do a point by point rebuttal, mostly just reaffirm what a wonderful thing the project will be.  Well, to be fair, their response specifically claims: no U.S. government money has been received (they WANT a lot, but they haven’t received any yet and it begins to look unlikely unless the Section 1603 program is extended), and no U.S. government official has been asked to intervene with the DOE loan guarantee application.

The response also specifically claims “Without these federal incentives, most American wind projects would be forced to lay off workers, go out of business or sit idle until energy prices rise, further stalling much needed growth in the American renewable sector.”

I think they could have been clearer: without the incentives, the wind power companies would not have hired workers in the first place, so those workers would have been engaged in other kinds of productive work instead, perhaps even self-sustaining lines of work not dependent on continuing federal incentives.

NOTE via Seeking Alpha: Recent financial filings by A-Power suggest that the West Texas project will not get built. If the project does not receive Section 1603 grants and the DOE loan guarantee by December 31, 2010, A-Power’s partners have the right to dissolve the partnership. They report, “In our view, it is not likely that Spinning Star [the project's name] will be able to arrange the requisite construction financing by December 31,2010….”

Added: HT to the Dallas Morning News Texas Energy and Environment blog.

Michael Giberson teaches Energy Economics and Energy Policy at the Center for Energy Commerce in Texas Tech University's Rawls College of Business. This post is a revised version of an article that first appeared at the Knowledge Problem blog.

Posted by Guest Contributor at 08:34 PM | Permalink | Comments (1)

by Kidela Capital Group

In spite of the recent global economic slowdown, the growth of new wind energy developments has so far continued unabated. Wind turbine technology has evolved considerably in the last decade, and new wind farms are steadily popping up across the globe. To meet rising demand for renewable, clean sources of energy, the push for more efficient wind energy technologies has moved from a proverbial light breeze just a few years ago, to a steady gale today.

The Global Wind Energy Council (GWEC) recently predicted that the world’s wind power capacity will increase by 160 percent in the next five years, with global installed wind capacity estimated to reach 409 GW by 2014, up from 158.5 GW in 2009.¹ This surge in wind energy projects can be attributed to increased demand as governments look for cleaner sources of energy to reduce greenhouse gas emissions and meet growing energy needs.

Yet experts warn of a front of high pressure blowing in from the East, which could effectively calm this storm of development — at least in the short term. The newest wind turbine technologies largely depend on rare earth metals, quirky elements that are used to make special magnets that dramatically increase conversion efficiency. Yet the corresponding demand for these materials is hampered by the fact that almost all of the world’s supply is concentrated in China, where strategic investments in rare earth element extraction and refining in the 1980’s has given it cost advantages in the production process and an effective monopoly of the industry.

The GWEC’s prediction indicates the generation of an additional 250.5 GW of wind energy will require 167,000 tonnes of rare earth metals.² To put that in perspective, China, which currently produces 95 percent of the world’s rare earth elements, only produced 150,000 tonnes of rare earth metals in 2009.

China has shown that it is willing and able to control exports in rare earth metals by restricting supply. This market power is resulting in significant price instability, and is affecting a wide range of industries that rely on the astonishing properties of these elements to produce everything from smart phones to hybrid vehicles.

“Even in the face of a global recession and financial crisis, wind energy continues
to be the technology of choice in many countries around the world. Wind
power is clean, reliable and quick to install, so it is the most attractive
solution for improving supply security, reducing CO2 emissions,
and creating thousands of jobs in the process.”
Steve Sawyer, GWEC Secretary General

China and North America remain the largest two potential markets for wind power expansion.  Despite the lagging global economy, this has hit US markets particularly hard, government grants and incentives have kept wind energy growth on track, albeit at a conservative rate.  Although there are a number of large-scale projects in the regulatory approval stage In Canada, the adoption rate and scale of investment is amongst the provincial governments can be described as inconsistent.

Conversely, China’s wind energy developments have expanded at an incredible rate.  In 2009, China accounted for one third of the world’s new wind farm development. That year, the country generated 25.9 GW of wind power, overtaking Germany as the world’s largest producer.

China has announced that in the next ten years it will construct an additional 133 GW of wind turbine generated electricity.  This plan will inevitably contribute to a steep rise in demand for use of Chinese neodymium and other rare earth metals just to service the country’s domestic wind turbine market.³ To account for this, China will be forced to either ramp up production or slash exports.  This increased internal demand could be at the heart of much of the recent tightening of export quotas and shipments by China.  The effect of their actions has fundamentally shaken the countries around the world out of their slumber with respect to the stability of their REE supplies.

Neodymium is one of the rare earth metals typically used in permanent magnets. Modern high-efficiency neodymium magnets for wind turbines use close to half a metric tonne of the element per  turbine. Other rare earth metals used in wind turbines include praseodymium, dysprosium, and terbium.

Earlier versions of wind turbine technology relied on electromagnets, which use copper coils fed with electricity from the generator itself.  While effective, these generators were bogged down with excess weight. Companies such as Siemens (SI) and General Electric (GE) later developed turbines that use direct drive generators using permanent magnets. The motors turn at the same speed as the rotors and therefore have to be much larger to develop the same power. Yet the weight of the larger unit is significantly less. By using neodymium in the magnets, the weight of the generator can be further reduced. According to experts at Holland’s Delft University of Technology, a 15-mm-thick segment of permanent magnets can generate the same magnetic field as a 10- to 15-cm section of copper coils.⁴

Europe was an early adopter of wind power technology, and European governments have focused strongly on sustainable energy policy in recent years. But Europe’s capacity is expected to remain somewhat stagnant in the near future.  By 2014, it is expected that Asia will surpass Europe in total wind energy generation. South Africa has also recently disclosed plans for an aggressive foray into the wind power industry, with two huge projects in the assessment stage.

The reality is that China, despite backing off from earlier suggestions that it will limit exports, will be forced to adjust if it hopes to meet its domestic targets. New wind projects currently in the assessment stage in the US alone could soon outstrip the supply of Chinese rare earth exports. Therefore it is incumbent on the industry to identify, secure and develop new non-Chinese sources of these valuable materials. “That’s a serious issue,” says Henrik Stiesdal, chief technology officer of Siemens’s wind power unit.⁵

The reality is wind turbines can be built without rare earths, but the older permanent magnet technology is dramatically less efficient than those built with neodymium-based magnets, and depending on the project, their return on investment may be too far off to be considered.

Not everyone is convinced the drop in the supply of neodymium will halt the wind turbine industry. Though rare-earth magnets will be employed for a significant percentage of the large electrical generators used in wind turbines, smaller units may be engineered using other technologies that do not use rare earths. Ferrite magnets, for example, while much less efficient than neodymium magnets, are also considerably cheaper and in some cases may close the efficiency gap.⁶

It is clear that while direct drive technology using neodymium is superior to older wind turbine technology, its potential is ultimately dependent on the ability of the industry to develop and secure new sources of supply rare earth metals.

——

^{1, 2} – Global Wind Market Hits 155 GW
³ – The Battle Over Rare Earth Metals
^{4, 5} – Wind Turbines Shed Their Gears
⁶ – Magnetics Business & Technology – Summer 2009 Edition (PDF)

Related articles: Rarer Rare Earths Are Not Going To Sink the Wind Power Sector
Can America Regain the Rare Earths Crown?

Posted by Guest Contributor at 06:27 PM | Permalink | Comments (0)

Bill Paul

As it scrambles to develop an offshore wind power industry that potentially may generate as much as 200 gigawatts of electricity, China has decided to hamstring all would-be foreign developers, which should provide a big lift to certain Chinese companies.

As reported last week by Environmental Finance magazine in its online edition, Beijing has effectively shut out international operators with new regulations requiring any foreign offshore developer to enter into a joint venture with a Chinese company under which the foreign firm must be a minority partner. “In reality, most of the international developers cannot, or are not willing to, do a joint venture with (a) Chinese partner,” Environmental Finance quoted the policy director of the Global Wind Energy Council as saying.

The wind council official called the new regulations “shocking,” but for investors they may be inviting.

With China expected to rapidly ramp up offshore wind generation, certain Chinese wind power companies could see their underlying valuations rise the more Beijing’s new offshore policy becomes apparent.

One in particular is China Longyuan (Symbol CGYG.OB), which just went public in December. Another possible beneficiary is Xinjiang Goldwind, which trades locally under the symbol 002202. Goldwind has announced plans to ramp up production of offshore turbine machines.

Still another potential beneficiary is Datang International Power (Symbol DIPGY). World wind-power leader Vestas of Norway (Symbol VWDRY) has called Datang an important wind development company.

DISCLOSURE: No position.

DISCLAIMER: This is a news article.  Please read terms and policy.

Bill Paul is Managing Editor of  EnergyTechStocks.com.

Posted by Bill Paul at 08:28 PM | Permalink

Part 2 of 2

Bill Paul

Neither Daewoo Shipbuilding & Marine Engineering Co. Ltd., which trades OTC under the symbol DWOTF, nor Ener1 Inc., which trades on NASDAQ under the symbol HEV, is an obvious candidate for having hidden potential.

Heck, Daewoo isn’t even a green energy stock. Or is it?

Lost in the hubbub of Copenhagen and Congress, there’s been important news about both these companies that strongly suggests – at least to me – that each has plenty of undiscovered potential that will really start paying off over the next 18 to 24 months.

South Korea’s Daewoo Shipbuilding was just awarded a contract by German utility RWE AG’s (Symbol: RWEOY) renewable energy unit for up to three vessels specially designed to install offshore wind farms. The contract reportedly could be worth upwards of half a billion dollars, depending on whether RWE picks up the option on the second and third ships. The first ship is scheduled to be completed in 2011.

A couple things: at present, offshore wind power is going gangbusters thanks to healthy project returns that one European investment bank puts at around 15%. But installing the new large wind turbines under often harsh conditions requires a special kind of vessel. Daewoo’s reportedly will be the first – quite possibly the first of many. (Simultaneously, Daewoo just said it may build a wind power equipment plant in China.)

As for Ener1, seasoned green investors may think they know everything about this lithium-ion battery manufacturer. If Pike Research is correct, the future is bright for all li-ion battery manufacturers, Pike having just forecast that the global li-ion transportation battery market will total nearly $8 billion by 2015, compared with $878 million in 2010.

But the big li-ion winners should be those companies whose batteries also meet the critical need of providing energy storage for power grids. The really big winners should be those companies whose li-ion batteries also go into cars whose manufacturers can provide the rapid recharging infrastructure that consumers have indicated they want.

Tuck this away: Ener1 is the battery supplier in the world’s first project linking grid storage, electric vehicles, rapid recharging infrastructure and solar power. Other participants in the just-announced Japanese project include Mazda Motor Corp. (Symbol MZDAY) and Kyushu Electric Power, which trades in Tokyo under the symbol 9508.

Footnote: in Part 1 of this series, we explored the undiscovered potential of PFB Corp. (Symbol PFB), Vodafone Group (Symbol VOD), and Telefonica S.A. (Symbol TEF). For more please see: http://energytechstocks.com/wp/?p=2194.

Bill Paul is Managing Editor of EnergyTechStocks.com

DISCLOSURE: None

DISCLAIMER: This is a news article. Please read terms and policy.

Posted by Bill Paul at 05:21 PM | Permalink | Comments (0)

A Bet on Wind Industry Growth

Tom Konrad, CFA

Wind Works Power Corporation (WWPW.OB) presents investors in publicly traded wind power stocks a new type of opportunity with the potential for high reward, and a complementary risk profile to existing plays.  

In the past, I've lamented the dearth of choice in publicly traded wind power stocks on North American markets, but both the number and types of opportunities are growing, allowing investors to diversify risk or to make more narrowly focused bets on how they expect the sector to evolve.

I classify wind stocks into three types:

1. Wind turbine manufacturers
2. Wind industry suppliers
3. Wind farm developers and owners

Each type comes with its own risks and rewards.  

Turbine Manufacturers

Turbine manufacturers are either large, established firms or feisty startups.  The large firms (Vestas (VWSYF.PK), Gamesa (GCTAF.PK), GE Wind (GE)) are capable of producing steady profits, but unlikely to see large multiple returns because of their large size and increasing competition.  They are also well known and followed by industry analysts, so a small investor has little chance of gaining an informational edge.  Small turbine manufacturers AAER, Inc. (AAERF.PK) and A-Power (APWR) hold the promise of large potential rewards if they manage to break in and get their products accepted.  However, breaking in to an established industry, even with superior technology is always extremely risky, and has become more so since the industry swung from turbine undersupply to glut between early 2008 and now.

Suppliers

Wind industry suppliers were a good bet when the industry could not build enough turbines.  A good rule of thumb is that the companies most likely to benefit when supply is tight are the suppliers of critical components and services very high up the value chain.  Since these suppliers do not often account for a large percentage of the cost of a turbine, they can earn extremely high margins without destroying the industry's overall economics.  In contrast, when the industry is in oversupply, these same companies often feel the squeeze much more than turbine manufactures who use their increased bargaining power and ability to switch suppliers to squeeze prices.

Wind Farm Developers and Owners

In the current state of oversupply for wind turbines, wind farm developers are in the best position.  If they have financing and all the permits and agreements in place needed to build a wind farm, the most expensive part of wind farm development, wind turbines are readily available at reduced prices.  To date, the vast majority of wind farm developers are also wind farm owners: they develop and build their own farms, and plan to profit from the sale of power and associated tax incentives.  Such companies range from Babcock and Brown Wind Partners (BBWF.PK) and the Algonquin Power and Utilities (AQUNF.PK, until recently known as the Algonquin Power Income Fund) at the established end, to Western Wind Energy (WNDEF.PK) in the middle to Sky Harvest Windpower (SKYH.OB) and NaiKun Wind Energy (NKWFF.PK), each with a single project in the early development stage at the startup end of the spectrum.

The more established developers have the most stable business model, because the revenues from existing farms allow them to fund new investments (At least in part) from the revenues of their established farms.  Once built, a wind farm is a stable business, with some fluctuation in revenues due to changes in weather conditions from one year to the next, and some risk of maintenance problems, but very little market risk for the power sales, since nearly all wind energy is sold under a pre-negotiated Power Purchase Agreement (PPA) to a local utility.  The flip side of this stability is slower growth, and less opportunity for outsized gains, since the expected revenues from the farm are well known far into the future.

Startup developers with only early projects are much more risky bets, since they have no ongoing source of income and must return to the capital markets periodically for funds.  Their advantage lies in the fact that the amount of capital needed in these early stages is much less than what is actually needed to build a wind farm.  If they are able to negotiate the hurdles of assembling a land package, navigating through the permitting process, signing an advantageous PPA, and establishing a grid connection, they can acheive outsized returns on their relatively small capital investment as successive levels of risk are removed from the process.  They can then go about the more certain and capital intensive business of actually erecting their wind turbines and collecting the revenue from the electricity generated, graduating into the ranks of wind farm owners.

Wind Works Power

Wind Works Power Corporation (WWPW.OB) focuses solely on the early, low capital, high risk, high reward stages of wind farm development.  Their strategy is to work on shepherding  several early stage projects through the hurdles of land package assembly, permitting, PPA negotiation, and site preparation with the intent of selling the projects to later stage developers who actually build and operate the wind farms. By working on several projects at once, Wind Works is able to diversify much of the project-related risk away, giving them a somewhat less risky profile than single-project companies such as Sky Harvest and NaiKun.

Rather than being capital-intensive, the early stages of wind farm development are very people-intensive.  Wind Works' key employee is CEO Dr. Ingo Stuckmann.  Dr Stuckmann has decades of experience developing wind farms around the world.  Surrounding him are people with strong connections to the power industry of Ontario, where Wind Works' first farms are located, and a former general manager at Nordex, a leading turbine manufacturer.  In other words, the team has the experience and connections necessary to manage wind farm development from start to finish.

Risks

While the potential gains of Wind Works' model are enticing, there are also substantial risks.  The source of the foremost risk is the same as the source of the potential reward: Investors are staking their money on a very people-intensive process that relies on just a few key people.  Wind Works does not have any proprietary technology, patents, or manufacturing capacity that might give them an edge in the market place.  Investors need to believe that this team will  be able to bring project development forward at a reasonable pace while dealing with unpredictable changes in regulations, environmental permitting, and managing the sometimes capricious sentiment of local residents and landowners.  While this is a process that Dr. Stuckmann in particular understands and has managed many times before, his experience is in no way unique in the industry, and better capitalized players with more resources could out-compete Wind Works for the best development locations, spots in the interconnection queue, and PPAs with utilities.

Even if the development process goes smoothly, investors are making a bet on the market conditions for wind farm development at unknown points in the future.   For the last year, there has been very little demand for ready-to-build wind farms because development companies have had trouble getting the necessary financing due to the financial crisis.   That is beginning to change, and is being helped by regulatory encouragement.   Ontario has passed North America’s first Feed-in Tariff, a generous incentive structure for encouraging renewable energy development that was pioneered in Dr. Stuckmann’s native Germany.  The United States has given wind developers the option of receiving an up-front cash payment for up to 30% of a wind farm's cost in lieu of the former Production Tax Credit, which tied payments to electricity production.  Assuming continuing support, these and other such incentives should make ready-to-build wind sites more valuable than they have been in the past.

The Payoff

In essence, Wind Works is positioning itself high up in the Wind Farm value chain.  When wind turbines were in short supply, the companies to own were suppliers of wind turbine components.  The credit crisis lead to a near halt in wind farm development, which is just starting to ease, but government policies such as Ontario's Feed In Tariff, Renewable Electricity Standards in many US States, and possible regulation of carbon emissions are all driving demand for completed wind farm, even while supply is constrained by lack of credit.  North America is building up unmet demand for wind farms.  If the credit situation improves, or governments step in to fill the gap, we may see ourselves in a situation where wind farm developers have all the turbines and credit they need, but not enough approved sites to build on.  Wind Works' business plan is ideally suited to take advantage of just that situation.

DISCLOSURE: This article is paid research.  The author was paid a flat fee by Resultz Media Group for researching, writing and publishing this article.  The opinions expressed here are the author's own, and neither payment nor publication could be withheld based on those opinions.

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

Posted by Tom Konrad at 10:34 AM | Permalink | Comments (1) | TrackBacks (0)

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

Tom Konrad, Ph.D., CFA

Good Info, Not Enough Analysis

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

A Portfolio Approach

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

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

Data

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

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

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

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

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

Results

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

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

 

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

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

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

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

Forestry

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

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

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

Hydropower

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

Biofuels

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

Wind

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

Efficiency, in all its Forms

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

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

Geothermal

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

Other Thoughts

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

DISCLOSURE: None.

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

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

Charles Morand

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

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

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

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

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

4) Extent your analysis to five years or greater

New Analysis, Same Difference

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

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









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

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

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

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

Conclusion

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

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

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

DISCLOSURE: None

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

Charles Morand

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

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

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

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

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

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

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



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

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

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



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




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

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

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

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

Conclusion

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

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

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

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

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

Tom Konrad, Ph.D., CFA

The Algonquin Power Income Fund (AGQNF.PK) has been one of my star performers in an excellent year.  Is it still a good investment at these prices?

 Since I recommended the Algonquin Power Income Fund (AGQNF.PK/APF-UN.TO) in January as a renewable energy income stock for 2009, the company is up 69%, in addition to the C$0.02 monthly dividend, worth approximately another 8% through August on the US$1.82 purchase price, making it the second-best performing of my ten picks (after Cree, Inc (CREE).)  However, since the major basis for my recommendation at the time was the stock's extremely cheap valuation and high yield, I thought it was worth revisiting, on the occasion of the company's Q2 update [pdf]. 

Major events in the first half  were Algonquin's planned acquisition of a 50% stake in California Pacific Electric Company (Calpeco), the former California assets of NV Energy (NVE), and the fund's plan to convert into a corporation and acquire some tax loss assets through a deal with Hydrogenics Corporation (HYGS).

Calpeco

The Calpeco deal gives Algonquin some exposure to electricity transmission and distribution (in which their partner Elmira has management expertise) in addition to their current exposure to renewable energy generation.  Since I like the potential opportunities in electricity transmission, I think this was a step in a good direction for Algonquin.  Furthermore, about half of Algonquin's stake in Calpeco will be financed with an equity investment in Algonquin from Elmira at C$3.25 per unit.  Since this is only slightly below the current price, and well above the price at which I recommended the stock, the transaction will be non-dilutive for both me and my readers, and a reasonable exchange for more recent investors.

Hydrogenics

In July, a reader worried that the deal with Hydrogenics was a bad idea because Hydrogenics is a fuel cell company, an alternative energy sector neither of us is enthusiastic about.  In fact, this is a short term deal, and shareholders need not be concerned with ending up owning a fuel cell company when they thought they owned a renewable energy power producer.  Despite the legal complexity, this deal is not a tie-up with Hydrogenics, but rather a way for Algonquin to acquire corporate status, and Hydrogenics' tax loss assets at the same time.  Because Algonquin is profitable, and Hydrogenics is not, these tax loss assets are valuable to Algonquin, but not Hydrogenics, allowing both companies to benefit. Algonquin will gain the benefit of Hydrogenics previous losses in exchange for a cash payment, which will allow the cash-poor, unprofitable company to continue operations. The transaction has been approved by Algonquin unitholders and Hydrogenics shareholders, and awaits regulatory approvals.

Results

The Trust's first half revenue was down compared to 2008, which management attributes to lower natural gas prices.  Gas prices affect the trust's revenues through lower contract prices for the heat from their thermal generation units.  I find this to be a good sign, since I expect that low current natural gas prices will rebound because they do not provide sufficient incentive for natural gas companies to drill and replace the gas supply from depleting wells. Although I expect that low natural gas prices will depress revenues in the short term, Algonquin's operating cash flow and earnings should continue to be easily sufficient to fund distributions to unit holders with plenty left over to fund Algonquin's growth plans.

At current prices of C$3.32 for APF-UN.TO and US$3.07 for AGQNF.PK, with a yield of 7.2%, I consider Algonquin to be reasonably valued, and continue to hold my positions.  However, because I currently expect a market decline, I would only suggest buying Algonquin today if you also hedge your position against general market moves.

DISCLOSURE: Tom Konrad and/or his clients have long positions in AGQNF.

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

Posted by Tom Konrad at 12:42 PM | Permalink | Comments (5) | TrackBacks (0)

Charles Morand

Tom and I recently received complimentary copies of a new book called "Investment Opportunities for a Low Carbon World", edited FTSE Group's Director of Responsible Investment Will Oulton*. 



The book is a compendium of articles by 31 different authors broken down into three main categories: (1) environmental and low-carbon technologies; (2) investment approaches, products and markets; and (3) regulation, incentives, investor and company case studies.

While Tom will provide a comprehensive review of the book once he's finished reading it in its entirety, I will instead review a few selected chapters over the course of the next couple of weeks.

I decided on this approach as that is how I generally use such a resource; I select the chapters and authors that I am interested in and I read only what I selected. That said, the majority of chapters in this book were of interest to me and I ended up selecting 19 out of 27 that I'm going to read (I won't be reviewing them all!) Truth be told, reviewing the contents section made me feel like a kid in a candy store and I suspect that most alt energy investing aficionados would feel the same. If I like what I read, I will most likely finish the book.    

This first post provides reviews of Chapters 1 and 2 on the wind and solar sectors.

Wind Power

By Mark Thompson, Tiptree Investments ltd

I tend to consider myself pretty well-versed in all things wind power, and so I was especially eager to read this chapter. Overall, I was very pleasantly surprised.

The author provides a good review of the wind turbine and wind turbine component industries. I especially enjoyed the technical discussion on turbine size and optimizing turbine output, which will become a critical competitive element for turbine makers.

For instance, we learn that because of the relationship between diameter and surface area for a circle, the power of one machine can be increased to match that of several smaller machines by simply lengthening the blades, thus lowering requirements for a range of other components and materials (for instance, two turbines with rotor diameters of 40 meters will have a power output of about 1000 kW, whereas one turbine with a rotor diameter of 80 meters can power 2500 kW.) Because of the mathematics of this, power output increases acheived through longer blades should further improve the economics of wind, so this is definitely a trend worth keeping an eye on.  

We also learn that while the turbine market has been chronically under supplied for the past few years, conferring the incumbents an appreciable amount of market power - the author estimates that the top six makers hold a combined 84% market share -, barriers to entry remain high and very difficult to surmount for would-be suppliers. Concerns over quality, durability, track-record and the strength of the balance sheet to support warranties are all factors that make it very difficult to secure funding for projects using a newcomer's technology. It is fair to say that Thompson is bearish on new market entrants.

Finally, we learn that the trend toward turbine makers internalizing sub-component design and manufacturing is restricting investment opportunities in pure-play supply chain opportunities.

However, what I enjoyed the most about this chapter was the detailed overview of how wind projects are built and what factors make them successful. When it comes to wind power, investment commentators tend to focus on turbines and turbine components, even though very interesting opportunities exist in the project development and operation space. In the author's words: "the development process offers some of the best returns in the sector [...]."

One key point made by the author in that regard is that headline figures about the size of various developers' portfolios are rarely - if ever - comparable given the various developments stages involved in bringing a project into operation. The risk-return profile for pure-play wind power developers is far more driven by the quality of the projects than by the size of the portfolio. However, disclosure tends to be weak in that regard, making it difficult for small investors to gauge the real value of a portfolio.

Overall, I thoroughly enjoyed this chapter. In my view, the information would be most useful to a fundamentally-driven investor looking to really understand how wind power and the wind power industry really work. While the chapter does not answer every question an investor might have, it nonetheless provides the right balance of technical and business information to set someone on the right path. It is a reference to which I will go back.  

Those looking primarily for stock picks, however, will be disappointed. The lack of stock picks is probably the chapter's weakest point, especially given that the book is purportedly about investment opportunities. Having said that, investment ideas abound on the Internet these days and books focused too heavily on providing stock picks at the expense of more general information risk having very short shelf-lives.

Solar Power          

By Matthias Fawer, Bank Sarasin

Writing a book or a book chapter on solar power, especially solar PV, is always a risky endeavor as the information could be outdated 12 months after publication. I thus salute the effort of those who undertake to do it, but in my view this sector is best left to specialist consultancies and sell-side analysts because they can easily update their analysis when conditions change, something that happens frequently in the world of solar PV.

Matthias Fawer's chapter does, in a lot of ways, read like a sell-side report. It covers three broad sub-sectors of solar: (1) solar photovoltaic; (b) solar thermal; and (c) solar collectors. Other than for solar thermal, the way in which the chapter is written assumes the reader already has a fair bit of solar knowledge. For instance, unlike your typical generalist piece on solar PV, few if any details are provided on what the main solar PV cell technologies are, how they compare in terms of price and performance and which company makes them.

The advantage of this approach is that it allows the author to jump straight into industry-level dynamics and not waste precious space explaining what many people already know. For instance, we learn fairly early on that Bank Sarasin sees silicon cell production appreciably outpacing module production until about 2012, potentially providing module makers with a margin expansion opportunity. We also learn that the plant engineering firms that had done so well when every cell manufacturer and their grandmother was adding production capacity during 2007 and 2008 could underperform in the next few years.

Of course the drawback from not providing a lot of technical background is that it makes the chapter a lot less useful for the novice solar investor, or even for the investor who knows a little bit but does not follow the industry closely. The author does, however, provide a ranking of the "strategic positioning" of 27 solar PV firms based on a proprietary model, with his top pick being Q-Cells (QCLSF.PK) from Germany.

The section on solar thermal, also known as concentrating solar power (CSP), contains more basic information on the technology, and provides an overall very good introduction to the sector. Unfortunately, there is a dearth of CSP investment options, and this sector is thus effectively off-limit to most retail investors.

The section I liked the most in the chapter was the one on solar collectors for building and water heating, an industry I knew about but had never researched. I learned, much to my amazement, that by the end of 2008 there was 142 GW of solar collector capacity installed worldwide, versus 12 GW of solar PV and 1.3 GW of CSP.

China is by far the largest market for solar collectors and, unlike in other industries, it absorbs, according to the author, 90% of its own production. Fawer expects annual growth to be about 25% until 2011 and to settle at 18% between 2011 and 2020. However, the much larger installed base currently means that the absolute level of new installations could be quite massive. Although the section on solar collector does not provide stock picks, it most definitely poked my interest and convinced me to look further into this.

Overall, while I was a bit underwhelmed by the solar PV section, I found the CSP section useful and the section on solar collectors very interesting. A greater technical focus would have strengthened the chapter given how technologically complex solar is, and more stock picks would have been appreciated. However, I will definitely go back to the chapter when I do research on solar collectors and even CSP.

DISCLOSURE: None

* We are always interested in reviewing books and reports in the areas of alternative energy, cleantech or other environmental industries, especially where they add value to the investment decision-making process. If your organization would like a new book or report reviewed, please contact us.     

Posted by Charles Morand at 06:03 PM | Permalink | Comments (3)

Charles Morand

Once the electric and plug-in hybrid vehicle frenzy fizzles out, as cleantech frenzies typically do when reality comes knocking (i.e. corn ethanol and solar PV), the next hot thing to hit the world of alternative energy investing could very well be rare earths, or the lack thereof. Rare earth metals are used in a number of technologies, most importantly for alt energy investors in NiMH HEV batteries and in permanent magnets for wind turbine generators and electric motors (made with the element neodymium). This article, as its name indicates, will focus on the wind sector.

Consider the following two quotes on the significance of rare earths to the wind power industry (I got them from articles I found on the Climateer Investing blog, which has been keeping on top of this issue for the past few months. Click on the link above to access a number of articles on that topic):

"To make the most efficient, lightest weight, lowest service wind turbine generator of electricity takes one ton of the rare earth metal, neodymium, per megawatt of generating capacity." (Jack Lifton, 5/07/09)

"Let's take a look at wind turbines. In certain applications, two tons of rare earth magnets are required in the permanent magnet generator that goes on top of the turbine. If the permanent magnet is two tons, then 28% of that, or 560 lbs, is neodymium." (Mineweb, 5/13/09)

Why does this matter? Because China, which accounts for around 95% of global output, is purportedly planing on severely curtailing the export of rare earth minerals. Naturally, this has some people worried. Given the total tonnage of neodymium that goes into each utility-scale wind farm, some may wonder whether this trade ban will throw a spoke in the wheel of wind power development; a wheel, as industry observers know, that has been spinning incredibly fast over the past five years.

Understanding Wind Energy Costs

Perhaps the single most important metric in power generation is the levelized cost of the energy produced. The levelized cost includes all of the costs over the lifetime of the facility (capital and operating) plus a pre-determined return on capital. All of these costs (capital costs, operating costs and cost of capital) are then expressed in present value terms and amortized over the facility’s total lifetime production (generally expressed in $ per kWh or MWh).

When assessing the cost competitiveness of electricity generation fuels, the levelized cost approach yields a true apples-to-apples comparison. Thus, when trying to gauge the impact of various events (e.g. higher natural gas prices, higher cement prices, a trade ban on neodymium) on the relative cost positions of different generation technologies, the  impact on the levelized energy cost provides the best measure.

Last Friday, I read a recently-published study by Maria Isabel Blanco, former Policy Director at the European Wind Energy Association (EWEA) and now an academic in Spain, on the economics of wind power. In a nutshell, the study examines, based on survey of EWEA members (EWEA's membership accounts for around 80% of global wind turbine manufacturing) and a review of the literature, the generation costs of wind energy in Europe.

Because there are no fuel expenditures for wind, capital costs make up the vast majority of the levelized cost of wind energy. According to the study, capital costs make up around 80% of the total cost of wind energy over the lifetime of a typical onshore facility (offshore wind is not addressed in this article). The wind turbine ex works - meaning the machine itself plus the tower, transportation to the site and installation - makes up around 70% of capital costs, or 56% of the total lifetime cost. Balance of plant costs include grid connection and site preparation (e.g. roads and other civil engineering work), among others.

The first figure below comes from an article on the wind power supply chain by BTM Consult published in the January/February 2007 edition of Wind Directions (see pages 5 and 6 for the full-size image). The second figure comes from a September 2007 report written by Garrad Hassan for the Canadian government on wind turbine manufacturing (see page 33 for the original figure).       






Both figures show the approximate contribution of each core component to the final cost of a wind turbine. There is, of course, variation around the percentages shown here based on the turbine model, the manufacturer, the location of the turbine assembly plant relative to where components and sub-components are manufactured, etc. However, taken together, these two figures yield a good ballpark estimate of how the cost of a wind turbine is broken down between its main parts. 

Both sources agree that the generator, the component that requires significant amounts of neodymium, represents around 3.4% of the total cost of a turbine. The generator thus accounts for around 2.4% of the total capital cost of a typical wind project.

The table below looks at the impact of generator costs on the installed cost (i.e. capital cost) of a fictional wind project. The data comes from EERE's 2008 Wind Technologies Market Report, where capacity-weighted average installed wind costs in the US are reported at around $1,915/kW, and capacity-weighted average turbine costs ex works are reported at around $1,360/kW, or approximately 71% of installed costs (in line with the European numbers above). The calculations assume that all other costs remain constant.

Original Generator Cost @ 3.4% of Turbine Cost ($/kW)	% Increase In Generator Cost	New Generator Cost ($/kW)	Installed Cost  Following The Increase In Generator Cost ($/kW)	% Increase In Installed Cost
46	50%	69	1938	1.2%
46	100%	92	1961	2.4%
46	150%	116	1984	3.6%
46	200%	139	2007	4.8%
46	250%	162	2031	6.0%
46	300%	185	2054	7.2%
46	350%	208	2077	8.5%
46	400%	231	2100	9.7%
46	450%	254	2123	10.9%
46	500%	277	2146	12.1%

       
The Levelized Cost of Wind Energy

Using a model she built, the author of the European study discussed above calculated the levelized cost of wind energy in Europe, based on actual capital, operating and financing costs and ignoring all incentives and taxes - she therefore computed the "true" cost of wind power.

She found that the single most critical variable impacting the levelized cost of wind energy was full load hours, or the average annual production divided by the facility's nameplate capacity (the more often cited capacity factor is equal to full load hours divided by total hours over the measurement period). Capital costs came in second.

A drop of 10% in full load hours, according to the author's model, leads to a cost increase of 8.5%. In comparison, a 10% increase in capital costs, all else equal, triggers a 7.7% increase in total lifetime costs. As can be noted in the table above, generator costs would have to increase by over 400% to trigger a 7.7% increase in levelized energy costs - while 7.7% is not a trivial number, especially if the increase is sudden, it probably does not constitute a project killer in most cases.

Of course, the costs and calculations presented here are rough estimates and will differ across installations and regions. Nevertheless, they provide a good approximation of the potential impact of higher generator costs on the cost of wind energy.

The Market For Wind Generators

Over the past three years, the supply of many core components for wind turbines has been incredibly tight, leading to a reversal of the long-term trend toward lower levelized wind energy costs (for a recent analysis this reversal in the US, see the EERE's 2008 Wind Technologies Market Report). Generators, however, were not one of those rare components. Bearings and gearboxes are the two parts for which the most severe shortages exist (or did, pre-crisis), while the market for generators is relatively well supplied by the likes of Siemens (SI) and ABB (ABB).

Even though increases in copper prices have put upward pressure on generator costs in the past few years, it is fair to say that generators have not been a problem component in the wind supply chain.

Conclusion

It is too early to tell what impact Chinese restrictions on rare earth exports will have on the price of wind generators and, ultimately, on the levelized cost of wind energy. However, as shown above, the wind industry is an position to bear substantial cost increases in this one component before the overall economics of wind projects are affected. 

More generally, I believe it's premature to conclude that limits on the export of rare earths mean that China will also limit the export of value-added manufactured goods such as permanent magnets. The main idea here is, most likely, to bolster the country's manufacturing sector - the very same manufacturing sector that acts as a giant job creation machine and prevents China from experiencing widespread social unrest. As recently pointed out by The Economist, all of emerging Asia's consumers consume about 40% of what Americans do and, although this is gradually changing, it wouldn't be in China's interest to strain that trade relationship by depriving the West of a whole host of technologies that consumers here have gotten used to.

While rarer rare earths may materially impact certain sectors of the economy, the wind industry, by-and-large, should do just fine.

DISCLOSURE: The author is long ABB

Posted by Charles Morand at 09:49 PM | Permalink | Comments (3)

Michael Giberson

Market-oriented policy analysts have not been shy about cataloguing the problems surrounding windpower development. But in the enthusiasm to oppose the government interventions accompanying wind generation, market-based analysts sometimes have strayed beyond principled defense of markets and unwittingly offered support to anti-market NIMBYism and other meddlesome sentiments. Policy analysts examining wind power issues should consider more carefully which issues ought to be pursued through the policy process.

Two Images

Wind power has two images. In one view, wind power is glamorous, hi-tech, future oriented and almost sexy. Advertisements for products from automobiles to watches to banking services casually feature tall, slowly spinning wind turbines in the background, hoping to suggest that the advertised product, too, is glamorous, hi-tech, and future oriented, and maybe a bit sexy.

A second view shows wind power in a much less favorable light: the product of misguided environmentalism twisted into government-funded corporate welfare. No hi-tech glamour in this view. Instead, destruction and waste becomes emblematic of a windpower industry, which has blighted farm and ranch lands with industrial towers and power lines, killed bats and birds, raised the cost of electricity, and squandered tax dollars.

The second view dominates among policy analysts with a libertarian or conservative policy bent. Market-oriented policy shops have produced several critiques of wind power: the Cato Institute, Heritage Foundation, Competitive Enterprise Institute, Reason magazine, the Heartland Institute. Each has issued policy papers or published editorials or articles about wind power. The details vary, but the overwhelming verdict is negative: wind is more costly than conventional power even with subsidies, it wastes land, the turbines are ugly, the power output is unreliable and requires fossil-fuel backup generation, it produces the most power when it is least needed, the spinning blades are dangerous to both wildlife and human health, and construction damages the local environment.

In addition, wind power development often requires substantial investment in electric transmission lines, which consumes more land and adds to the expense. The Texas Public Policy Foundation has produced a fairly comprehensive critique of wind power development that touches on all of these points and a few more (see links below).

Business versus Policy Issues

The first view contributes to a few policy problems — the hi-tech glamour of wind power gains it unearned public support and therefore special political favor. As one wind energy association analyst has said, windpower “polls extremely well” and has support of both Republicans and Democrats.

But the second, negative view also contributes to policy problems when the analysis goes beyond issues of appropriate public policy and gets involved in a seemingly indiscriminate piling on of negatives. Renewable power policy in the United States has involved the government in heavy-handed subsidies, which is wasting taxpayer monies, distorting investment into electric generation and raising consumer costs. But these points represent about the limit of the market-based objections to windpower development. Most of the technology and resource-use concerns listed above are, for the most part, nobody’s business but the business owners. When analysts encourage negative attention to decisions that naturally fall within a business’s scope of actions, they end up encouraging further unconstrained expansion of public policy.

Let’s sort through that catalogue of complaints about windpower one at a time:

Wind power is more costly than conventional power generation. This claim is not always true, but probably true in many cases and for most of the time. But so what? It may cost more to make a Ferrari than it costs to make a Subaru, but so long as the consumer is free to choose which price it wishes to pay, no real policy issue emerges. Sure, many states mandate that consumers purchase a certain amount of renewable power, but the objection here is to the government picking winners in the marketplace. The mandate would be just as objectionable in principle if renewables were cheaper than conventional generation, so let’s leave cost out of it.

Wind power development often requires substantial investment in electric transmission lines. Wind power development can require investment in electric transmission lines to get the power from the wind farm to the frequently-distant major power consuming regions. (Of course this is not too different for other forms of power generation, only in those cases the fuel frequently moves by pipeline or railroad before being converted to power.) Transmission remains a government-regulated business, even in regions and states with restructured markets, which makes it a public policy concern.

For years the rules governing transmission investment were intimately tied to the needs of the monopoly electric utility. As independent power generation became important to the industry, the rules governing transmission investment had to change too. Accommodations for renewable power are of a similar nature. If policies in fact unduly favor renewable generators, then market-based policy analysts may have a complaint. But development of the transmission grid can be useful in reducing the generator market power that is a legacy of years of government-protected monopolies. It is at least possible that most of the value of transmission investment to support renewable power will come from the encouragement of competition and the resulting more efficient operation of the grid. Consumers should favor such transmission development.

Windpower development is land-intensive. This claim is true in some respects, but greatly exaggerated. It is certainly the case that windpower projects blanket thousands and thousands of acres, but such production is consistent with many other uses of the land – excepting a rather small footprint for the turbine itself and associated facilities. And, again, so what? Agriculture also uses a lot of land, but that is no reason to oppose farming. Landowners are generally considered capable of deciding how much, if any, land they wish to devote to various opportunities. Public policy involvement in these private decisions should be limited, not encouraged.

Wind power output is unreliable. Three parties should be concerned with the variability of windpower output: the company selling the wind power, the company buying the wind power, and the transmission network operator providing responsible for reliable operation of the power grid.

Other power market participants using the grid have a secondary interest, but this interest should be limited to ensuring each power transaction pays an appropriate share of the costs of operating a reliable transmission grid. There are important and difficult issues here, but for the most part they are technical grid operation and market design issues only passingly related to public policy. The various regional power markets are working out the issues, and progress will probably be faster if Congress doesn’t get too interested. Market-oriented policy analysts ought not to encourage politicians to think wind power variability is a public policy issue that politicians need to address.

Wind power requires fossil-fuel backup generation.  In a point related to the variability of wind, it is sometimes claimed that each new megawatt of wind power capacity requires the support of a new megawatt of fossil-fuel generation.  There is, maybe, a grain of truth here, but as stated the point is greatly exaggerated.  First, to an extent every generation unit supplying the grid has to be supported by backup generation in the case that the unit under produces or fails altogether.  Reliable grid operation requires the presence of units kept in reserve.  But not every single unit supplying the market is matched by a unit kept in reserve – since independently operated generators are unlikely to fail at the same time, the system just needs a few units in reserve at any one time.  For this reason, most regional transmission grids have already had sufficient reserve capacity available to accommodate the level of wind power that has been added. 

Wind power presents some new challenges – unexpected output variations across wind farms in the same area will be correlated rather than independent.  But this is a technical issue to be handled by the parties involved, and the main technical issue is assigning wind power developers an appropriate share of the costs of the necessary reserves.

Wind power produces the most power when the power is least needed. On average this claim is true for most existing installed wind power capacity. For example, in West Texas, where the boom in windpower investment is most pronounced, wind speed and wind power output is higher during Spring and Fall than it is in Summer, but the demand for electricity is highest during the Summer. In addition, windpower output tends to be higher overnight, while demand tends to be highest on late summer afternoons. (On the other hand, coastal and off-shore wind power developments tend to produce more power during the day and less power at night.)

An issue related to these last two items concerns references to wind power’s capacity factor. A generator’s capacity factor is calculated by dividing the unit’s power output over a period of time by the amount of power that would have been generated by the unit operating at maximum output. It is frequently noted that wind power generators will have capacity factors that range between 20 and 40 percent, while coal, natural gas, and nuclear power plants tend to have capacity factors that range from 70 up to 95 percent. But capacity factors have substantially different meanings for wind power and the other forms of generation. And once again, the policy significance is limited. If the “capacity factor” of a Subaru plant is higher (or lower) than that of a Ferrari plant, then … so what?

Wind turbines are dangerous to both wildlife and human health. Obviously coming into contact with fast-spinning blades can be dangerous – to humans as well as to birds and bats. Turbines sometimes fail in dramatic and hazardous fashion, as easily findable YouTube videos will show. But producing and burning coal is probably more hazardous to humans, birds and bats as well, and even natural gas is not without risks to animals. Any balanced analysis would at least seek to put the risks of wind power in appropriate context.

It also seems somewhat disingenuous when a think tank usually given to complaining that the endangered species act or similar policies interfere with private property rights starts holding up injured birds in the attempt to discourage private rights to develop property, simply because government subsidies are involved.

Windpower construction damages the local environment. If wind power development is damaging your property, first try negotiation with the developer and if that doesn’t work, then existing property law provides various opportunities for you to pursue a remedy. To the extent that wind power development is damaging other people’s property, they should pursue their rights. It usually is not a public policy concern.

Wind power turbines are ugly. Of course, no policy analysis calls turbines ugly as a serious policy argument; the name-calling just tries to detract a bit from wind power’s glamorous image. But making the claim in the context of a policy argument tends to align the analyst with a NIMBY crowd. If the development of someone’s property is going to spoil a historic view or other community value, the market-based approach would be for members of the community to negotiate purchase of an easement.

My main point is that much of the litany of negative factors surrounding wind power is of limited relevance to a policy analysis grounded in a political philosophy of limited government. Yes, the government intervention into the economy in support of favored kinds of power production is objectionable. But it is just the intervention that is the problem, not the way that the businesses and property of other persons are being developed.

Of course it isn’t just wind power that benefits from intervention, other resources and technologies also see various government supports. It turns out that tallying up subsidies for different resources gets surprisingly complicated, but it is clear that renewable power is the recipient of substantial government support at the moment, particularly on a per-MWh generated basis. Defenders of wind power would also point out that it produces no direct air emissions when producing power, and therefore should be encouraged relative to fossil-fueled generators that do emit pollution. The claim has some validity, but as I have suggested elsewhere, the current set of subsidies for wind is a very inefficient way of pursing those policy goals.

A Suggestion to the Free-Market Community

Now that I have made my main point, let me suggest a principled way to violate it and bring some of these factors back into policy analysis. As any market-oriented person who engages in policy debates has realized, not everyone shares their viewpoint on the role of markets and the value of limited government. In such cases an appeal to principles will not be persuasive. Winning policy arguments appeal to more pragmatic considerations. Cost-benefit analysis is the standard approach.

A serious cost-benefit analysis of public policies supporting wind power would have reason to examine the costs of windpower and the value of its output. For such an analysis, some, but not all, of the negative factors surrounding wind become relevant. Even here a market-based analysts should exercise care to keep issues that should be primarily matters of private choice out of the policy discussion, lest politicians and other less-discriminating analysts become encouraged to further intervene in the market.

For the most part, these market-oriented policy papers and essays are not pursuing a balanced assessment of costs and benefits, just trying to make a case against windpower interventions. I support making a principled case against intervention; I urge policy analysts to refrain from arguments which miss the mark and thus may inadvertently give support to interventionists.

Michael Giberson is an instructor and research associate at the Center for Energy Commerce at Texas Tech University's Rawls College of Business, blogs on energy economics (including wind power) and other topics at Knowledge Problem.  This article was first published on Master Resource.

Appendix: Market Think Tank Critiques of Windpower

Most of these are fairly short commentaries; Drew Thornley’s study for the Texas Public Policy Foundation is probably the most thorough).

Cato Institute: Jerry Taylor, “Picken’s Plan to Rig the Market,” 2008; Robert L. Bradley, Jr., “Eco-dilemmas of Renewable Energy,” 1997.

Competitive Enterprise Institute: Steven J. Milloy, “The Wind Cries ‘Bailout’,” 2008; Neil Hrab, Baptists, Bootleggers and Wind Power, 2004.

Heartland Institute: Cheryl K. Chumley, “Questions Plague Efforts to Grow Wind Power Use,” 2008.

Heritage Foundation: Ernest Istook, “Hot air about wind power,” 2008.

Reason magazine: Ron Bailey, “Wind Breaks,” 2002.

Texas Public Policy Foundation: Drew Thornley, “Texas Wind Energy: Past, Present, and Future,” 2008.

Posted by Guest Contributor at 03:34 PM | Permalink | Comments (1)

John Petersen

Last week I had the pleasure of participating as a panelist in Infocast’s Storage Week and attending four days of presentations by industry executives, national thought leaders and policymakers. While most of the presentations were too detailed and specific for a blog about energy storage stocks, there were a few high-level discussions that may be interesting to readers and while I'll never qualify as a journalist I can at least share some of the thoughts I jotted down.

Storage for Integration of Renewables

Two of the most important presentations came from Dr. Imre Gyuk, the DOE's Program Manager for Energy Storage Research, who explained that the unbuffered grid is vulnerable to collapse, noted that power outages cost American business an estimated $79 billion per year in lost productivity, and described grid-based energy storage as "a disruptive technology that will induce a paradigm shift in the utility industry." He further explained that storage has become a national priority as an integral subset of the smart grid program because of the multiple benefit streams it offers utilities in the form of frequency regulation, peak shaving, energy management, and transmission and distribution system upgrade deferral.

In his presentation, Dr. Gyuk specifically asked participants to support S. 1091, the Wyden Bill, which will provide a 20% investment tax credit for grid connected storage facilities that have at least 2 MW of capacity and can deliver 500 kWh for a period of 4 hours; makes utility-owned storage facilities eligible for clean renewable energy bonds; and provides a 30% investment tax credit for residential energy storage equipment. When the new subsidies are coupled with existing provisions that provide investment tax credits for storage system manufacturing facilities; ultra-rapid depreciation on eligible projects; and a short-term program that will offer cash subsidies to renewable energy storage projects in lieu of tax credits, the potential impact is massive.

In his discussion of the challenges associated with integrating intermittent renewables into the power grid, Dr. Gyuk explained that the peak-efficiency hours for both wind and solar do not mesh well with periods of peak demand for electric power. In the case of wind, the peak efficiency is usually at night when customer demand is lowest. In the case of solar, peak efficiency is usually around noon. Since peak demand typically occurs at about 4 P.M., Dr. Gyuk explained that short-term storage to shift power availability from off-peak to peak hours significantly increases both the usefulness of intermittent power sources to utilities and the economic returns to owners of those generating assets.

Community Energy Storage

Another important presentation came from Ali Nourai, AEP's manager of distributed energy resources who provided an overview of AEP's new Community Energy Storage (CES) program. In discussing the CES program, Dr. Nourai explained that the concept is "technology neutral" and emphasized that system reliability and "commodity priced batteries" would be critical drivers. He also noted that if PHEVs and EVs follow their expected development path, the batteries used in CES installations would likely be the same batteries used for automotive applications because widespread adoption in the auto industry would drive battery prices down to a level where they would likely be attractive to utilities. The key factors that Dr. Nourai stressed as critical for the CES program were:

• Improved safety and security;
• Increased customer reliability and value;
• Optimized realization of multiple value streams;
  
• Simplified integration of distributed power generation;
• Simplified budgeting for smaller neighborhood projects; and
• Simplified purchasing decisions by lower-level personnel.
  

Since the CES proposal contemplates installing batteries in a standard sized transformer box and assumes that Li-ion batteries will become a dominant technology for PHEVs and EVs, it clearly gives a short-term advantage to Li-ion battery developers who can make products that will fit in a limited volume. I remain skeptical about whether Li-ion battery technology will ever be robust enough or cheap enough for widespread adoption in the automotive industry and I wouldn't be surprised to see the volume constraints relaxed over time to facilitate the substitution of flow batteries and advanced lead-acid batteries. Seriously, does anyone really care whether the ugly green box hiding behind the shrubs is 3' by 3' instead of 4' by 4'? For the time being, the CES program favors Li-ion technology by imposing size constraints that have nothing to do with performance. It will be interesting to see how the program evolves as the cost and performance profiles for various battery technologies become clearer.

Energy Storage Heretic

On the third day I had an opportunity to play devil's advocate during a presentation by Mark Peters, the Deputy Associate Laboratory Director for the Li-ion battery development program at Argonne National Laboratories. During the question and answer session, I explained that for several months I've been suggesting that the inflection point for Li-ion batteries seems to be when you put a plug on a car because until you get to an all-electric drive train, the weight and volume differences don't justify the additional cost. Mr. Peter's response came as a pleasant surprise to me because he basically said "While there are members of my staff who would probably disagree with you, I tend to personally believe that your assessment is reasonable and the sweet spot for Li-ion batteries arrives when you add a plug."

By the afternoon of the fourth day, I had lapsed into full heretic mode for a panel discussion on the future of vehicle to grid technology. I think it came as a bit of a shock when I said "I don't believe V2G will happen because I don't believe PHEVs and EVs will happen in anything that even remotely resembles current plans." I then laid out the simple case against PHEVs and EVs as follows:

• The principal goal of the smart grid is the minimization of waste in the electric power industry;
• The most wasteful activity I personally engage in is using gasoline to power 4,000 pounds of car and 300 pounds of passengers at highway speed;
• The only activity I can imagine that would be more wasteful is using batteries to power 4,000 pounds of car and 300 pounds of passengers at highway speed;
• While most of the conference participants can afford the $40,000 cost of an eco-bling PHEV or EV, that option is not available to over 90% of the car buying public who need to worry about things like budgets and car payments;
  
• There are 6 billion people who live in crushing poverty and for the first time in history most of them understand that there is more to life than subsistence farming;
• As the 6 billion become consumers, our biggest challenges will be finding relevant scale solutions to shortages of water, food, energy and virtually every commodity you can imagine;
• Last year 23 million electric bikes and scooters were sold in China and those E2Ws used the same battery capacity that one million American style PHEVs would have required;
  
• From the perspective of a foreign government planner, providing mobility for a million wasteful Americans is not as important as providing mobility for 23 million locals who have more reasonable demands and aspirations; and
• From the perspective of raw economics, a purchaser who needs a small battery pack can afford to pay a higher price per watt-hour than a purchaser who needs a large battery pack, which will leave PHEVs, EVs and grid-connected applications at the bottom of the food chain rather than at the top.

I wonder if they'll invite me back as a panelist for next year's conference.

Posted by John Petersen at 03:43 AM | Permalink | Comments (0)

Charles Morand

The DOE made public earlier today the amount of money that will awarded to clean power projects in lieu of the usual tax breaks: $3 billion.

This will allow project proponents to receive a direct cash grant now instead of a Production Tax Credit or an Investment Tax Credit later on. The guidance document notes the following:

"Section 1603 of the Act’s tax title, the American Recovery and Reinvestment Tax Act, appropriates funds for payments to persons who place in service specified energy property during 2009 or 2010 or after 2010 if construction began on the property during 2009 or 2010 and the property is placed in service by a certain date known as the credit termination date (described more fully below in the Property and Payment Eligibility section). Treasury will make Section 1603 payments to qualified applicants in an amount generally equal to 10% or 30% of the basis of the property, depending on the type of property."
 
This is the cherry on a sundae of cash handouts announced over the past few months for the alt energy and cleantech industries. Solar and wind installations - which account for the lion's share of alt energy investments - have yet to come back to life in any significant way. It is hoped by both government and industry people that this new measure will provide sufficient impetus in the near term to carry the sector through the remainder of the recession.

To be continued... 

Posted by Charles Morand at 09:45 PM | Permalink | Comments (1)

Charles Morand

I received a press release yesterday about a new Emerging Energy Research (EER) study on wind power installations in the US for 2009 and beyond.

EER argues that US installations could be down as much as 24% in 2009 from a record 8.55 GW in 2008. While utility-led projects remain mostly on track, smaller IPPs and developers that rely on project finance or other forms of external financing are finding the current market environment challenging.

However, record growth could return as early as 2010 with 9 GW installed, driven in large part by the stimulus package. EER sees the following encouraging signs:

• Near-term growth could be helped by fiscal incentives, most notably the 30% Investment Tax Credit (ITC). Unlike a Production Tax Credit (PTC), an ITC does not require the existence of a tax liability and should lessen the industry's reliance on tax equity investors - there are far fewer of those kicking around these days 
• The possible enactment of a Federal renewable portfolio standard would provide a substantial long-term boost for the industry, and momentum is building in this direction
• New interstate transmission lines aimed at unlocking high-potential wind resources are being built or at the very least discussed 
• Investments in manufacturing capacity by OEMs remain on track, indicating that the industry sees the crisis as only temporary
• Regulated utilities - with the ability to finance wind projects on-balance sheet - are making a growing commitment to wind (recently exemplified by Berkshire Hathaway's MidAmerican Energy)

Although the wind power sector is decidedly more 'global' than most other forms of renewable energy - meaning there is greater geographical diversity to the industry's aggregate revenue base - the US remains, according to Ernst & Young, the top-ranked market in the long and near terms. In the near-term, defined as the next two years, the US and China are far ahead of the pack.        

The health of the global wind power sector has, in the space of a few short years, become very much tied to the health of the US wind power sector, with traditionally strong European markets such as Germany and Denmark gradually loosing their influence. What happens in the US over the next two years will thus be consequential for how wind power stocks perform.

It seems as though investors are already looking past the difficult year 2009 will almost certainly prove to be for the industry, having pushed both wind power ETFs, FAN and PWND, for beyond the rest of the market over the course of the latest bull run.



But investors beware! Just as the market was pricing in Armageddon for the clean technology/alt energy sectors just a few months ago, now might be a bit premature to get over-excited:

• Although credit conditions are normalizing, no one yet knows for certain what the future will look like, but many people agree that the financing environment will almost certainly remain challenging for a long time. Should inflation kick in as a result of fiscal and monetary incentives, interest rates could shoot right up in response, which would prove disastrous for any sector using large amounts of leverage
• The Federal RPS portion of the Waxman-Markey bill remains controversial and the bill will most certainly continue to undergo changes on its way to becoming law. Unless and until this happens - the bill becoming law with a Federal-level RPS in it - I am inclined to discount this entirely as a potential factor in future growth
• Transmission has certainly been on the agenda to a greater extent than at any other time in the past few decades, but we are still far - very far, in fact - from the investment levels required to truly unlock wind's potential in America. Governance systems around grid investments remain complex, with key areas of decision-making split between various actors whose incentives are not always aligned. I would venture to say that many people still see this as a major barrier to wind development, not as an enabler
• The latest run in wind stock has been very impressive, with the ETFs outperforming the S&P 500 by 25-30%. Last fall, their relative decline was equally formidable. As pointed out earlier this week by Tom, the magnitude of gains we've experienced over the past three months should probably be be viewed with some caution. I'm not sure whether we're headed for an imminent decline and, if so, how pronounced it will be (I'm a lousy market timer). But if we are, you can certainly expect wind stocks to fall further than the market as a whole. Any risk-averse investor should probably stay away at this point, or consider taking some profit   

Wind continues to be among my favorite alt energy technologies and there are several years of strong growth left; the sector's expansion is not about to normalize. However, these are uncertain times and caution is of essence. Just as an onslaught of negative sentiment pushed wind stocks further south than they should have gone a few months ago, the current onslaught on positive sentiment - which is not justified, in my view - is doing the opposite.

DISCLOSURE: None             

Posted by Charles Morand at 10:24 AM | Permalink | Comments (0)

Charles Morand

Last week, I added a little to my position in AAER (AAERF.PK). I first took a long position in AAER, the Canadian-based MW-size wind turbine maker, over two years ago. I've since pared down it significantly, both because I wanted to take some profit after a meteoric rise in share price in Q4 2007 and later because of the company's seeming inability to get orders for more than a couple of turbines at a time.

Although there was, before the credit crisis hit, a severe shortage of wind turbines and wind turbine components, barriers to entry have remained high: (1) average order size has been growing and scale is becoming more critical; and (2) quality considerations are top-of-mind for funders as defective machines can throw off project economics. Both factors play against small emerging turbine makers with no quality records to show for. Getting a first large order has thus been the key milestone investors in AAER have been waiting for.

Finally, last October, as global markets were in the eye of the storm, AAER reached an agreement with a mid-size Canadian independent power producer, Northland Power, for 61 1.65 MW turbines for a total order size of 100.65 MW. This contract is valued at approximately C$142 million (~$152 million or $~1.5 million/MW) by the company and is structured as a cost-plus agreement, meaning that AAER is guaranteed to recoup its costs and earn a profit on the deal. However, the agreement was only that - an agreement - with a formal contract to be signed when both parties met a number of conditions. After being pushed back twice, this moment came on May 9 when the turbine supply agreement was finalized and signed...sorta. The contract is subject to a "notice to proceed" by the developer contingent "on final permitting, approvals and financing [being] obtained by both parties."

This could mean that Northland is having difficulty securing financing on acceptable terms. It could also mean that Northland anticipates permitting delays - a previous project not too far from this one was delayed by two years because of permitting hold-ups - and doesn't want to commit before it's certain it can get the regulatory green light. It could also mean nothing - according to the contract Northland signed with Hydro-Quebec, the utility buying the power, the developer is not required to show proof that it has secured financing until June 2010, so Northland might want to wait for credit markets to ease out a bit. However, with a contractual deadline obligating Northland to start producing power by December 2010 (failing which the developer must pay a penalty of C$55 per MW per day up to a max of C$2.01 million), the order will have to be initiated soon if the turbines are to be delivered on time.  

In the clearest indication yet that the market's risk appetite is far from back, the stock finished the week down over 15%. While investors are not yet pricing a worst-case scenario, it is fair to say that they feel overall very skittish about the apparent blanket option for the buyer to delay the turbine order as long as it pleases.

Last Friday (May 15), a glimmer of hope appeared after markets closed: AAER increased the size of an upcoming best effort unit offering - one unit is made up of one common share and one common share purchase warrant - from a minimum of C$2 million and a max of C$5 million, to a min of C$3 million and a max of C$7.5 million. Although small in absolute terms, this is an appreciable relative increase in the size of the offering of 50% at both tails. The company's bankers, it seems, are seeing increased appetite for the stock.

I'm liking the contract and added a little to my position. My thesis behind this is two-fold: (1) if the notice to proceed is given within a reasonable time frame - and I believe that it could be - the share price could experience a nice pop, following which I would take a little profit; and (2) although this order falls well short of the plant's theoretical capacity of 400 turbines per year (AAER has only 6 other turbines currently scheduled for delivery in 2009), it might just be enough to keep the firm alive through the end of the worst part of the credit freeze and until US renewable power policies kick-start the sector. Management has taken many of the right steps over the past two years and, with a large order in hand, the firm would be well positioned to fill the order book.     

A Risky Bet

This is a risky play that essentially amounts to a bet on the Northland contract going through. If it doesn't and AAER fails to secure another large order in the next few months, I would be very worried and would pull my money. This is why:

Liquidity: 2009 promises to be a punishing year liquidity-wise, with $14.9 million in contractual obligations and $9.5 million in payables and debt payments due. Meanwhile, AAER has a cash ratio of only 0.19 with C$2.6 million in cash and equivalents. This will be partly counterbalanced by cash coming through from a 2009 order book of around 9.65 MW (something in the neighborhood of $15 million), the money raised through the current unit offering and an unused line of credit worth $1 million. The liquidity crunch exists because AAER is in the process of tooling up its factory, purchasing inventory and paying off licensing fees to the companies from which it is licensing its turbine technologies.

Limited financing options: The credit crisis has made equity financing incredibly expensive for small alt energy companies - they are often forced to raise equity at a fraction of the price investors were willing to pay a year-and-half or two years ago. AAER is a prime example: it raised equity in November 2007 at $1.15 per share but, a year later in December 2008, had to do the same at $0.15. Investors typically don't like dilution, and AAER won't be able to optimize its capital structure by raising significant debt until it shows it can fill the order book. Eventually, too much dilution leads investors to bail, creating yet more pressure on the stock price and raising the cost of equity capital further. As at December 31, 2008, AAER had 122.4 million shares outstanding, a 48% jump on 2007.  

The credit crisis: There is no doubt that the credit crisis has seriously shaken the renewable power sector. Perhaps ironically, the more mature technologies such as wind are amongst the hardest hit because of their relative capital intensity - the disappearance of tax equity investors coupled with the dearth of reasonably-priced debt has led to a marked slowdown in US wind installations. Many of the turbine majors have laid off employees in order to cut costs and reduce capacity. It will probably be a few more months before definite numbers to come out on the state of the industry so far in 2009, but if anecdotes one hears at conferences or reads in the paper are any indication, it ain't gonna be pretty! Needless to say, this is isn't exactly the best time to try to turn a start-up into an established firm in an already-crowded industry struggling to cut capacity. Luckily, this situation will be short-lived.

UPDATE (May 22, 2009): The company just announced that it fully sold its unit offering (~C$7.5 million) and issued another C$1.5 million worth of units to "suppliers and other business partners". This is positive news in my view as it indicates increased market appetite for the firm.

DISCLOSURE: Charles Morand is long AAER.

Posted by Charles Morand at 10:31 PM | Permalink | Comments (2)

Wind advocates like to say "The wind's always blowing somewhere" to counter concerns about the variability of wind power.  This is true, and it means that wind can always be relied on to produce some power, but that does not mean that wind can always meet demand.  In the United States' Great Plains wind belt, wind is typically anticorrelated with demand, meaning that, unless we can shift demand to times when the wind is strong, either through time of use rates or demand planning, overall energy production from wind will not be able to exceed 25-35% of overall demand without completely overwhelming the system when demand is low and the wind is strong.

However, even getting to 25% will be tricky without careful planning and a more robust transmission grid which will be capable of bringing wind power from where wind happens to be blowing (which could be hundreds of miles away in any direction) to where it is needed, or by investing in more expensive grid-based storage.

Potential for Low Variability

Lena Hansen and Bryan Palminter at the Rocky Mountain Institute, and Jonah Levine at CU Boulder have been doing some excellent work to show that portfolio theory can inform how to optimally combine a diversified portfolio of wind and solar sites to dramatically reduce the overall variability of a combined wind-solar portfolio. 

Source of Images: Spatial and Temporal Interactions of Solar and Wind Resources in the Next Generation Utility

This demonstration goes a long way towards alleviating concerns about any unreliability concerns for wind or solar, but answering that one question leads to another: Are we actually getting anything like an optimal wind/solar portfolio?

Overly Concentrated Portfolio

The answer to that question is unfortunately, "no."  Current incentives for wind, such as the production tax credit (PTC) and state Renewable Electricity Standards (RES) both reward energy produced, not the true economic value of energy produced.  The PTC is functionally a payment of 2.1 cents for each kWh of wind energy produced, while RES's require that a certain percentage of energy produced come from renewable sources.  An added complication is that many state RES include added incentives to produce renewable energy in-state, which reduces geographical diversity further.

This emphasis on total energy produced leads wind developers to "optimize capacity factor," according to Jim Himelic, and Associate Analyst at Xcel Energy (NYSE:XEL), the US's largest utility seller of wind energy.  Mr. Himelic spoke about Xcel's Wind Integration project to tackle the problem I recently called the "Dumb Grid:" the fact that grid operators do not use much weather forecasting information when trying to integrate wind onto the system.  This is not only from a lack of incentives and tools allowing utilities to integrate weather data, but also simply from a lack of good data.  Most wind farm operators currently have no incentive to provide even turbine-by-turbine production information to grid operators, data which would be valuable for forecasting of short term wind fluctuations.

According to Himelic, because most Colorado wind capacity is clustered in the Northeast of the state, and the above incentives along with constrained transmission means that new additions to wind capacity will also likely be in the Northeast, meaning that, at least in the short term, geographic diversity is likely to decrease rather than increase over time.  This both increases the overall variability of the wind resource, and will also increase the frequency and size of large wind ramp events, when power from wind turbines rises or falls extremely quickly over a very short period.  The worst such ramp events from a grid operator's perspective often come when wind speeds rise so far as to require the turbines to shut down to avoid damage.  This can cause a large number of turbines to go off-line at once, leading to a quick drop in overall power production.

Concentrating a majority of wind farms in a small area means that such wind over-speed events are likely to affect many farms at once, exacerbating the problem for grid operators.

A Gust of Hope

It's ironic that government incentives for renewable energy are adding truth to wind's only partially deserved reputation for unreliability.  Fortunately, recent changes in national policy may help to alleviate some of the pressure to cluster wind farms in small areas.  

First, wind developers now have the option to take a 30% Investment Tax Credit (ITC), comparable to the one available for solar, rather than PTC.  This has the advantage that wind developers receive a portion of their investment costs back, independent of total production, which will reduce some of the disincentive to build wind farms at relatively low capacity factor sites.  Similarly, a national RES would be unlikely to encourage local production of renewable energy, which might improve wind diversity.

Tom Konrad, Ph.D.

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 03:46 PM | Permalink | Comments (7) | TrackBacks (0)

Two months ago, Tom told us how he'd dipped a toe into the black stuff (i.e. bought the OIL etf) on grounds that current supply destruction related to the depressed price of crude oil would eventually lead to the same kind of supply-demand crunch that led oil to spike during the 2004 to mid-2008 period.

If you need evidence that the current price of crude is wreaking havoc in the world of oil & gas exploration, look no further than Alberta and its oil sands. The oil sands contain the second largest oil reserves in the world after Saudi Arabia, but more importantly will account for the lion's share of incremental supply as conventional oil production continues to decline. The province's economy, which had been growing at a breakneck pace for the past five years, has come to a grinding halt: employment insurance claims grew by twice the Canadian average over the past year; personal bankruptcies jumped by 61%; and home foreclosures are on the rise. This is the result of significant project cancellations that will no-doubt limit Alberta's ability to ramp-up output once prices climb back again.

It is thus no surprise that Cambridge Energy Research Associates and others are warning about the economic hazards of curtailing investments into conventional and alternative energy.  

Alt Energy & Fossil Energy

Oil being the most followed of the energy commodities, it is no surprise that it is receiving most of the media attention. Arguably, natural gas and coal prices should matter more to alt energy investors than oil prices: according to REN21, of the $71 billion invested in renewable energy in 2007, 47% went into wind and 30% into solar PV. Both technologies are used for power generation (investments into transportation alternatives are comparatively small) and, in the US, coal and natural gas are the dominant fuels in power production. The relentless focus of the popular press and other pundits on the the economic case for alternative energy being closely tied to the price of crude oil is thus mostly misplaced.

Case in point, last November, a reader wrote me with a correlation analysis conducted over a 5-year period (or, where there wasn't five years' worth of data, since inception). The correlation coefficients between the returns on crude oil and those on alt energy securities were as follows: GEX, 0.19; PBW, 0.14; TAN, 0.18; and the index underlying FAN, 0.19. These are, by most measures, pretty low correlation coefficients. Given the reader's reputation, I trusted the numbers. 

Nevertheless, in alt energy investing as in life, perception is often reality. Given the many signs pointing toward a rapid escalation in crude prices - demand can and will rebound far quicker than supply - I decided to re-explore the relationship between fossil and alt energies. If a strong positive correlation can be found between alt energy investments and crude oil, natural gas and coal investments, there may not be a need to dip a toe into the black (or colorless) stuff at all - one can focus on alt energy alone and still enjoy the ride up.

In order to verify this, I ran a basic correlation analysis with the daily returns on the KOL (coal), OIL (crude) and UNG (nat gas) ETFs/ETN on the one end, and the daily returns on the alt energy ETFs on the other. I got the return data from Yahoo Finance using the Adjusted Close prices that include dividends and splits. Given the results above from our reader's analysis, I only went back six months to see if the (lack of a) relationship still held.   

OIL and UNG track the prices of futures contracts in the underlying commodities, so they are pretty decent securities to use to estimate the returns on crude and nat gas investments. KOL, on the other hand, tracks a basket of coal company stocks. It's the closest thing I could find but it's not ideal as stock returns don't necessarily track commodity returns. For instance, large mining firms will often sell a high proportion of their output through fixed-price contracts, preventing them from benefiting from sudden surges in spot prices. 

The boxes delineate general alt energy ETFs (ICLN to GEX), the solar ETFs (TAN, KWT) and the wind ETFs (FAN, PWND). There aren't any notable differences between the ETF categories, with the most significant differences being between the fossil fuel ETFs/ETN and the alt energy ETFs.   

The relationship between alt energy stocks and coal stocks appears relatively strong. However, in the absence of return data on coal, it's hard to tell whether investing in alt energy stocks (or coal stocks for that matter) is an optimal way of playing increasing coal prices. Given the structure of the coal market, with significantly less involvement by purely financial actors than in oil or natural gas markets, this is a hard one to play for retail investors, although data appears to suggest there is a play.

Though the correlation appears to have strengthened somewhat between crude oil and alt energy investments in the last six months, it remains weak enough that if someone wants to play a return to expensive oil they are still better off dipping a toe (or even an entire foot!) in the black stuff. The same holds for nat gas.

This quick and dirty analysis wouldn't withstand close methodological scrutiny. My only intent here was to see whether these relationships were worth exploring further - they are not. If you want to benefit from crude oil and nat gas price increases and have no ethical qualms about it, invest in them directly!

DISCLOSURE: Charles Morand has a long position in TAN.

DISCLAIMER: I am not a registered investment advisor. The information and trades that I provide 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 Charles Morand at 09:35 PM | Permalink | Comments (3)

On February 26, 2008, a drop in wind generation by about 1400 MW over ten minutes, coupled with an increase in demand of 4412 MW due to colder weather, and lower-than scheduled production from other power suppliers, led ERCOT, the Texas grid operator to cut 1100 MW of power to interruptible customers for about 90 minutes.  

Misconceptions

All these facts come from a Reuters article misleadingly titled "Loss of wind causes Texas power grid emergency."  I was dismayed a few weeks ago when this misleading reporting led the generally insightful Master Resource Report to conclude "This is a clear example of why solutions to storage and transmission are going to become increasingly critical as sources such as wind and solar become increasing parts of the generation mix.  This doesn't invalidate renewable power; it just means that the country has plenty of work to do and that there are plenty of investment opportunities besides just wind turbines and solar cells." [link to pdf]

It may be surprising to readers that I find anything objectionable in a call for more storage or transmission, although I'm a stronger proponent of transmission, which I consider more cost effective, even if there are far fewer barriers to adding storage.  

However, the lesson of the 2008 Texas emergency is that while we need more transmission, and, eventually, storage, there are other, cheaper and easier steps we can take to integrate wind and solar to considerably higher levels of penetration..

Not A "Wind" Emergency

The first thing to note about the incident is that the increase in electric demand was more than three times as large as the decrease in supply from wind.  Presumably, ERCOT had been dealing with such fluctuations in demand since long before wind came onto the system.  Part of the problem was that other power suppliers (presumably natural gas and coal, usually considered "reliable") were not delivering what they had promised.  Hence, the drop in wind production was probably only 20% of the overall problem, not 100%, as the headline led readers to believe.

Hero: The Smart Grid 

The next conclusion we can draw is that Demand Response (DR), in the form of interruptible service to large customers, prevented power outages.  Demand response an early form of the Smart Grid which is already working today.  It allows the grid operator to cut power consumption by other users who have previously agreed to such cuts in return for lower electricity rates or cash payments.  According to a 2005 study of DR programs from the American Council for an Energy Efficient Economy, the median cost of DR programs studied was $29 per kWh, and the average cost was $86 which compares quite favorably to the $500 or more per kW cost of a peaking gas turbine.   Demand Response was the hero of February 6, 2008, even if wind was not the villain.

Before we look for investments in energy storage or even transmission, we should be looking to even more cost effective resources for the integration of variable energy sources, such as Demand Response and other variations of the Smart Grid.  Both EnerNOC (ENOC) and Comverge (COMV) provide demand response services to utilities, and this is also one use for Smart Grid technology from such companies as Echelon (ELON), RuggedCom (RUGGF.PK), Telvent (TLVT), and Itron (ITRI).

Villain: The Dumb Grid

During the discussion at a January 21 seminar sponsored by the National Renewable Energy Laboratory and the National Oceanic and Atmospheric Administration, featuring speakers from wind forecasting companies 3Tier, WindLogics, and AWS Truewind, the speakers mentioned that the weather forecasters had been telling the system operator of the incoming cold front and likely drop in wind production, but that the system operators chose to make no preparations before the fact.  Had they done so, they could have ramped up standby generation before the cold front hit, and would not have needed to call on the interruptible power resources.

Given that much of the heating in Texas is electric, system operators must have known that a cold front would raise demand.  Why would system operators choose not to heed forecasters' warnings?  There may be many reasons, but in the end, they all probably come back to incentives.  Preparing for a predicted increase in demand would have been the intelligent response, but regulated utilities have very little incentive to use their resources intelligently.  After all, a regulated utility makes most of its profits based on an authorized return on capital based on the investments it can justify to the regulator as necessary to keep the system up and running.  If the utility is, for whatever reason, unable to use those resources effectively, it becomes easier to argue that more resources are needed, which will lead to more profit for utility shareholders, and a less stressful job for system operators..

In other words, regulated utilities have an incentive to use as little brainpower (for which they do not earn a return on capital) and as much capital investment as possible.   They have an incentive to be dumb.  Given such incentives, is it any surprise that they ignore warnings, and then blame the problem on the variability of wind?

Tom Konrad, Ph.D.

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

Posted by Tom Konrad at 08:44 AM | Permalink | Comments (7) | TrackBacks (1)

Dedicated legislations have been at the core of some of the most impressive regional growth stories in alternative energy, most notably in Germany with the Renewable Energy Sources Act or in California with the various legislative solar initiatives. On Monday, the Canadian province of Ontario became the latest jurisdiction to join the fray as lawmakers introduced the Green Energy and Green Economy Act. Why should investors care? Because such legislations have been at the core of some of the most impressive regional growth stories in alternative energy. 

As a bit of a backgrounder on Ontario, there is currently about 800 MW of installed renewable power capacity (~95% wind) in the province with around 2,500 MW under power purchase agreement (PPA) and scheduled to be brought into commercial operations in the next few years. In late 2006, the province introduced a renewable power feed-in tariff incentive, the first one in North America. This incentive was suspended in May 2008 due to transmission constraints. By then, there were about 500 MW of solar capacity under PPA linked to the incentive, including one of the world's largest solar PV farms.

To put these numbers into perspective, California, the largest solar PV market in the US by quite a stretch, had around 500 MW of PV installed by the end of '07. Next came New Jersey at 69 MW and New York at 32 MW. None of the 500 MW under PPA in Ontario has yet reached commercial operation, and at least some of it will probably be cancelled given current credit conditions. Nevertheless, these figures provide a good idea of the market's potential is. The Canadian Solar Industries Association estimates that Ontario could install up to 16,000 MW of solar PV by 2025, with the potential on Toronto's rooftops alone estimated at 3,600 MW.   

The Green Energy and Green Economy Act

The Act targets three main areas: (1) renewable power generation; (2) energy efficiency; and (3) the smart grid.

1) Renewable Power Generation

Perhaps the most significant measures here are aimed at removing what had proven to be critical barriers to renewable energy projects reaching commercial operation in the province:

1. Renewable energy projects meeting certain criteria will be guaranteed a connection to transmitters and distributors' networks and will be given priority access over other forms of power generation
2. Transmitters and distributors will have to make the necessary network upgrades to allow for the connection of renewable power projects and the eventual expansion of renewable power capacity
3. Renewable power projects will be exempt from all forms of municipal permit requirements to counter a growing trend of NIMBY groups lobbying their municipal councils to block renewable energy projects  
4. A new office of Renewable Energy Facilitation has been created to help speed up the permitting process (e.g. environmental assessments, etc.)

On the revenue side, the legislation does the following:

1. The feed-in tariff that had been suspended in May 2008 will be reintroduced once new rules have been designed (no timeline provided but Q2 2009 has been thrown around)
2. A system of PPA auctions for large-scale renewable power projects that has been in operation since 2004 will be maintained 

Analysis

The measures aimed at removing barriers to renewable projects are significant. However, until the new rules around the feed-in tariff are released (e.g. pricing, eligible fuels, etc), the exact impact of the law will remain unclear. My own guess is that the government will be very aggressive with ramping up renewable energy installed capacity over the next five years as, as its name indicates, this law is also about the economy. If you believe the government, this bill is as much about creating a counter-cyclical effect as it is about cleaning up the environment. If my thesis is correct and this turns out to be a boon for developers, the following stocks should be watched:

Name	Ticker	Description	Potential Upside Related to Legislation
Algonquin Power Income Fund	AGQNF.PK	Ontario-based renewable power developer with exposure to Ontario (income trust)	V. High
Boralex	BRLXF.PK	Canadian renewable power developer with exposure to Ontario	V. High
Canadian Power Developers	CHDVF.PK	Canadian renewable power developer with significant exposure to Ontario	V. High
Great Lakes Hydro Income Fund	GLHIF.PK	Ontario-based hydro power developer (income trust)	V. High
Innergex Renewable Energy Inc.	INRGF.PK	Canadian renewable power developer with exposure to Ontario	V. High
Macquarie Power & Infrastructure Income Fund	MCQPF.PK	Ontario-based renewable power developer (income trust)	V. High
ARISE Technologies Corporation	APVNF.PK	Ontario-based silicon and PV cell manufacturer with a module installation segment. The module installation segment is focused on the Ontario residential market	V. High
Northland Power Income Fund	NPIFF.PK	Ontario-based power developer with some exposure to renewables (income trust)	High
Brookfield Asset Management	BAM	Infrastructure development firm with exposure to Ontario renewables	Medium
FPL	FPL	FPL Energy unit is one of the world's largest wind park owners and has exposure to Ontario wind	Low

2) Energy Efficiency

The Act introduced a number of energy efficiency measures with a focus on building efficiency:

1. No real property can be sold or leased for an extended period of time without undergoing an energy audit
2. Public agencies will be required to come up with an energy conservation and demand management plan
3. Public agencies will be required to consider energy efficiency when making capital investments or when acquiring goods and services (although the devil will be in the details here with more precise rules to come)
4. Energy distributors will be required to meet efficiency and demand management targets (see the brackets above about the devil)
5. The Building Code will be reviewed to include stronger efficiency measures

Analysis

Energy efficiency measures are clearly targeted at the building stock. There aren't really any good direct plays on this, and won't be until the government releases further information on what it intends to do with its own buildings. Building efficiency firms such as Johnson Controls (JCI) could benefit, although its unclear whether this would be needle-moving. 

3) The Smart Grid

Ontario has been somewhat of a leader in smart grid, with legislation passed back in 2005 requiring every home and business in the province to be equipped with a smart meter by 2010. Hydro One, the largest transmitter, has also begun smartening its network by embedding communication equipment from RuggedCom (RUGGF.PK). The Act contains provisions to expand smart grid capex. The Ontario Smart Grid Forum estimates that C$1.6 billion could be spent on a smart grid ramp up in Ontario over the initial five years of such a program. As I mentioned in a past article, while the absolute amount isn't huge, it is still a fair chunk of change for this emerging industry.

The smart grid measures are:

1. A timeline for rolling out the smart grid and apportioning spending responsibilities to different players (e.g. transmitters, distributors, retailers) will be released
2. Communication standards and other technical aspects will de defined through regulation
3. The regulator (called the Ontario Energy Board, the equivalent of a PUC in the US) will be directed to take actions related to the implementation of the smart grid, although these actions aren't yet defined

Analysis

Once all the rules are released, the legislation will have the effect of formalizing a patchwork of initiatives already underway. In my view, significant smart grid capex can be expected in Ontario over the next few years with a focus on the transmission and distribution infrastructure (rather then end consumers). There are several companies large and small entering the world of smart grid. My personal favorite play on this legislation is RuggedCom (RUGGF.PK): (1) it has already won contracts here; (2) it is part of the home team (based in Ontario); (3) it already generates EBITDA; and (4) even though its stock has withstood the latest storm in equity markets, it's still trading at a reasonable trailing PE compared to peers.   

Conclusion

Many people in the investment world loathe government intervention into anything. However, alt energy has been and continues to be primarily driven by regulation and government policies. In the absence of government support schemes, industry growth rates would be a fraction of what they currently are, and solar PV would not be on the steep cost decline curve it's currently on. It is therefore critical to keep an eye on the policy side to know where growth opportunities will emerge next.

With this new Ontario legislation, my favorite play is the Canadian clean power IPP sector (stocks listed above). The smart grid initiatives will also be worth watching, although more clarity on the rules is required before potential winners can be identified.

DISCLOSURE: Charles Morand does not have a position in any of the stocks discussed above.

DISCLAIMER: I am not a registered investment advisor. The information and trades that I provide 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 Charles Morand at 10:05 AM | Permalink | Comments (0)

Last week, Tom brought you a piece on the Algonquin Power Income Fund (AGQNF.PK), in which he opined that shift in investor attention away from capital gains toward yield might eventually provide a catalyst for the prices of yield-focused securities such as income trusts to rise. So-called utility trusts, or income trusts where the underlying corporation is engaged in utility activities such as power generation, are a common feature of the Canadian income trust sector (the mother of all income trust sectors). A sub-set of utility trusts is the clean power utility trust, where the power generation assets consist of technologies such as wind, small hydro, biomass and waste-to-energy (WtE). Though new tax rules have effectively made it impossible for new income trusts to be brought to market (barring certain exceptions such as REITs), existing clean power utility trusts (existing as of Oct. 31, 2006) get to operate under the old tax regime until 2011.

The clean power utility trust model is similar to the clean power Independent Power Producer (IPP, see definition) model, whereby firms are pure-play clean power generators (i.e. they own only generation assets) that sell their electricity to utilities, with the exception that the tax treatment awarded to income trusts allows them to pay higher yields by avoiding double taxation.

While changes in legislation mean that this investment vehicle is dying a slow death, Tom was correct to point out that in times where the prospects for strong capital gains are uncertain and interest rates low, income trusts provide a good way for investors to access high yields. What's more, clean power utility trusts, this most unique of Canadian investment sub-sector, allow investors (including US investors) to play North American clean power in a way that does not entail a risky bet on a technology play but is rather much more akin to a utility investment.

Clean Power Utility Trusts             

Name	Ticker	Related Corp. Entity (Ticker)	Yield (%)*	Assets
Algonquin Power Income Fund	AGQNF.PK	N/A	9.16	Hydro, Cogen, WtE, Wind, Water/Wastewater
Boralex Power Income Fund	BLXJF.PK	Boralex (BRLXF.PK)	19.77	Biomass (wood residue), Hydro, Nat Gas Cogen
Macquarie Power & Infrastructure Income Fund	MCQPF.PK	N/A	18.88	Nat Gas Cogen, Wind, Biomass (wood residue), Hydro, Long-term Care Home
Innergex Power Income Fund	INRGF.PK	Innergex Renewable Energy (INGXF.PK)	10.81	Hydro, Wind
Northland Power Income Fund	NPIFF.PK	Northland Power (not public)	9.44	Nat Gas Cogen, Wind
Great Lakes Hydro Income Fund	GLHIF.PK	N/A	8.01	Hydro

*As at close on Friday Jan. 9, 2008

One of the major risks facing income trusts is distribution cuts, something that generally happens when the fundamentals of the underlying business are severely diminished or distributions were set too high to begin with (in order to attract investors). As can be noted from the table, the yields on some of these trusts (i.e. Boralex Power Income Fund and Macquarie Power & Infrastructure Income Fund) appear to indicate that investors are anticipating distribution cuts and are demanding a risk premium. Yet preliminary screens on both funds don't uncover much evidence that distribution cuts are in the cards (caveat: these were very preliminary screens).  

While growth will be challenging as long as credit conditions remain tight (individual projects typically use over 50% debt), the underlying business model and existing assets of these funds remain largely immune from a slowing economy - they are utilities with a clean twist. Barring another major round of indiscriminate selling in equity markets, investments in one or more of the clean power utility trusts is a good way of generating returns in the form of cash yields (something that's worth a lot more than the promise of future capital gains in this economic environment) from a comparatively low-risk sector.

Some of the things to look for as red flags in assessing these trusts are: liquidity position (cash on hand; quick ratio) and ability to borrow for emergency purposes (undrawn line of credit); leverage level (debt-to-capital ratio) and the need to roll over debt in the next 12 months; any signs that operating conditions have deteriorated (e.g. for wood biomass, indications that pulp/saw mill closures related to the bad economy are decreasing fuel supply).

DISCLOSURE: Charles Morand does not have a position in any of the securities discussed above.

DISCLAIMER: I am not a registered investment advisor. The information and trades that I provide 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 Charles Morand at 10:00 PM | Permalink | Comments (0)

As I've discussed previously, things haven't been easy of late for alt energy stocks, especially those of the pure-play kind. A few days ago, I was asked which, if any, alt energy stocks I could recommend in this environment. My answer was: none. While people continue to go on television claiming that alt energy's problem has to do with falling oil prices, in my view the real risk at the moment has do with financing - financing for the companies producing the technologies and financing for their customers. The two business models are simultaneously under attack: for technology firms, the model whereby a company burns through loads of cash in the hopes of eventually commercializing  a homerun application is dead, and for power producers and households installing solar panels and wind turbines current credit costs don't permit the necessary high degrees of leverage. As I've argued before, a temporary (i.e. 12 to 18 months) drop in oil prices will not phase policy-makers, and most of the demand right now is policy-driven.

So, for now, I would stay away from most pure-play alt energy stocks, at least until capital markets settle down and credit markets really normalize. However, as we've pointed out on many occasions, there are a wealth of companies out there with diversified revenue streams and appreciable market capitalizations that are moving into alt energy and cleantech. The dramatic drop in equity markets over the past few months has made the dividend yield on some those firms look quite attractive. For long-term investors, the advantage of purchasing a stock with a high dividend yield is that, provided the company can continue paying the dividend, you lock in an attractive yield on your security and you get to benefit from capital appreciation once markets recover.              

The table below lists a few diversified stocks with exposure to alt energy that currently have an attractive dividend yield (>4%). The next step would be to look into the ability of the firm to maintain this yield throughout the bad economy. 

Name (ticker)	Div. Yield (%)	Main Alt Energy Areas
General Electric (GE)	7.20	Wind turbine manufacturing; wind park ownership
Otter Tail Corporation (OTTR)	6.30	Power generation; wind turbine components (DMI)
Portland General Electric Co. (POR)	5.40	Power generation with strong exposure to wind
Xcel Energy Inc. (XEL)	5.10	Power generation with strong exposure to wind
The Timken Company (TKR)	5.00	Bearings for wind turbines
Koppers Holdings (KOP)	4.10	Railways ties and utility poles (treated wood)

Besides Otter Tail, the names in this table are not typically labelled "green energy" or "alternative energy" stocks. Most of the pure-plays pay no dividend. As stated above, a necessary next step would be to look into these firms to see if they will be able to maintain this dividend.

DISCLOSURE: Charles Morand does not have a position in any of the securities discussed here.

DISCLAIMER: I am not a registered investment advisor. The information and trades that I provide 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 Charles Morand at 08:37 PM | Permalink | Comments (3)