Alternative Energy Stocks

Vehicle electrification – sticker shocks, delays and manufacturing capacity forecasts

Fri, 19 Mar 2010 00:59:48 -0500

John Petersen

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

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

Sticker shock from Nissan

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

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

Delays from BYD

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

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

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

Capacity forecasts from Roland Berger Strategy Consultants

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

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

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

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

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

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

So Much for Peak Demand - try 134mb/d by 2030

Thu, 18 Mar 2010 00:01:00 -0500

No peak demand Eamon Keane

"So much for peak demand - try 134mb/d by 2030." That was the startling conclusion dispatched from the ivory tower recently by Joyce Dargay, a British transport econometrics professor, and Dermot Gately, an American economics professor. I'll present their conclusions and then discuss the implications.

Their report is available here (pdf). The main conclusion is that the low hanging oil fruit has already been picked after the 1970's oil shocks. From 1978-85 OECD fuel oil consumption dropped by 7mb/d and then from 2003-2008 by another 2mb/d. The share of fuel oil in OECD consumption has fallen from 44% to 16% today, so there is not much left to cut. The authors estimate the price and income elasticities of different components of oil consumption in the OECD and other blocs.

The OECD oil demand response to higher incomes over the last 40 years is shown in Figure 1. The equi-proportional growth lines indicate the slope oil demand should have if it is proportional to income growth. It can be seen that fuel oil dramatically drops off, however per capita transport & other oil remained reasonably correlated with income growth.

It shouldn't come as much of a surprise that transport oil consumption goes up with income. For example, Figure 2 shows a very high correlation between Irish transport energy and GDP:

The authors then estimated the price and income elasticities of oil in different blocks: China, Oil Exporters, Income Growers, and other countries. They combined these segments into a "rest of the world" umbrella. They then contrasted their 2030 oil demand projections with the various scenarios of the DOE, IEA & OPEC. For example, the DOE's projections are shown in Figure 3.

Figure 4 shows the authors' projections, in per capita daily oil consumption:

Can you spot the difference? The OECD and FSU (Former Soviet Union) projections are reasonably close. It's the rest of the world line that is much different in the DOE's projections. The DOE suggest that China, India, OPEC etc will grow at one fifth of their historic oil demand rate, despite higher income growth. Instead of the DOE's 0.56% growth rate, the authors' projections finds close agreement with the historical growth rate of 2.54%. It's not exactly unreasonable to expect the rest of the world to (attempt to) raise their consumption of oil from 1 liter per day to 2 liters per day, especially if their income is rising. The OECD slurps over 6 liters per day, after all.

The difference between the DOE's and the authors' projections is some 20mb/d, or two Saudi Arabias. So in 2030, a plausible buisness as usual scenario suggests world demand at 134mb/d. As for supply, well Figure 5 shows the IEA's flying pigs 105mb/d projection:

You can add in your favourite technology if you want: biofuels (currently 1.5mb/d), Coal-to-liquids (currently 0.15mb/d), Natural gas to liquids (currently 0.08mb/d), oil shale (0 mb/d), and sundry other technologies. They might give you several mb/d by 2030. The UK Peak Oil Task Force outlined future oil production as an undulating plateau at about 90mb/d (until 2020, at least). This leaves an approximately 40mb/d shortfall (134-90). How that 90mb/d gets allocated will be interesting. The authors don't give an explicit breakdown by region, but Figure 6 shows roughly how an unconstrained scenario would look, with the dashed line indicating a possible supply cap:

The OECD and FSU remain flat, but the rest of the world tries to get to 2 liters per capita per day. How will the 40mb/d supply-demand burden be shared? Will the new Chinese middle class buy an EV instead of a car? Perhaps. US passenger cars and light trucks consume about 9mb/d, and the fleet turns over every 20 years of so. If they were replaced with super efficient small cars (assuming folks can get credit), you might get the same number of miles with 6mb/d. We already drive small cars in Europe, but there is still some scope for higher efficiency in vehicles, and high prices should hold the Jevons Paradox at bay.

The authors show that the price elasticity of oil exporters is very low, obviously enough, since they heavily subsidise domestic consumption. In Saudi Arabia, over half of electricity generation is from oil. Courtesy of Royal Decree M/56, utilities purchase oil for $3/barrel, or 7c/gallon. Not surprisingly the grid is at break point from the demand. They plan to double installed capacity from 30GW to 60GW by 2020, although some of that will be gas-fired.

Another kicker is that in the Middle East, peak water has arrived. Saudi Arabia in 2009 cancelled their plans for agricultural self sufficiency due to lack of water. Their aquifer is depleting at 7 times the rate it recharges. Hence they are turning oil into water by desalination. Were they to replace the annual depletion (700bcf/yr) with desalinated water, that would require 0.3mb/d per year. By World Bank estimates desalination demand could rise to 1mb/d in coming years.

These anecdotes just reinforce what anyone who's followed oil knows - an export crisis is coming. Oil exporters will serve their citizens subsidised oil before exporting - it's part of the unwritten petropact.

The marginal utility of a barrel of oil is greater in India or China than in the OECD. People still dream of owning a car in Asia. Figure 7 shows Chinese car sales:

This suggests that the burden of adjustment will fall heavily on the OECD. Our ability to invest in solutions depends on the economy tolerating the high oil price. You can read a 70 page paper on this subject by economics professor James Hamilton here (pdf). His conclusion was:

"the evidence to me is persuasive that, had there been no oil shock, we would have described the U.S. economy in 2007:Q4-2008:Q3 as growing slowly, but not in a recession."

So triple digit oil prices are likely to hamper growth. This was also one scenario posited by the authors of the original study when they stated:

"Hence this imbalance [40mb/d] would have to be rectified by some combination of higher real oil prices, much more rapid and aggressive penetration of alternative technologies for producing liquids, much tighter oil-saving policies and standards adopted by multiple countries, and slower world economic growth."

It would be helpful if some governments actually recognised this reality. For now the response can be summed up as:

Eamon Keane is an Energy Systems Engineering masters student at University College Dublin with an interest in electric cars, rare earth metals and energy. He is looking for a job in the energy sector anytime after August 2010.

The Best Peak Oil Investments, Part I: Biofuels

Wed, 17 Mar 2010 00:09:12 -0500

Tom Konrad CFA

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

World oil supplies are stagnant, and in the not-so-distant future will begin to decline. If economic growth continues, demand for oil will increase as well. This will lead to a long term rise in oil prices, which will only stop if 1) high oil prices or other factors stop or reverse economic growth, or 2) we find some way to use much less oil for the same amount of economic activity. Each of these scenarios will have winners and losers. In other words, investment opportunities.

Substitution

The most obvious strategy for dealing with peak oil is substitution. If we can find another form of energy in place of oil, then our economy can grow without more painful adjustments. These strategies are among the most popular, because they hold out the hope that we'll be able to transition with a minimum of pain. That is wishful thinking. There will be a market for petroleum substitutes, but those substitutes are likely to be more expensive and supply-limited than oil currently is. We will have to adapt in other ways as well as using substitutes.

The leading substitutes include

Biofuels and Biochemicals
Electric vehicles
Hydrogen
Natural Gas

Biofuels and Bioplastics include a whole range of technologies which convert plant and animal matter into useful substances similar to the extremely useful transportation fuels, chemicals, and plastics that we currently get from oil.

Only some biomass is easy to convert into fuels, like sugars and starches into ethanol, and oils into biodiesel. But it is no coincidence that such biomass is also useful as food. We eat these things because our bodies can easily convert them into useful energy. We don't eat wood chips or grass because they are difficult to digest and convert into energy. Biofuels substitution strategies all essentially involve diverting biomass from somewhere else in the economy (or land on which to grow the biomass from other forms of agriculture) to producing oil substitutes. The more inputs we divert, the more expensive the products we might have used those inputs for become. This produces a commodity squeeze, when the inputs become more expensive but the price for the output is set by the oil price. Such a commodity squeeze led to the current problems in the corn ethanol and biodiesel industries.

Fortunately, we currently have a lot of biomass in our economy that is currently wasted. Waste oil can be easily converted into biodiesel, and companies are looking at ways to convert the various components of Municipal Solid Waste into ethanol or other biofuels. Municipal solid waste has a lot of biomass in it, but its uneven nature means that it's hard to convert into ethanol. Some of the best such waste is industrial food waste because it is othen quite uniform, and homogeneity makes it easier to convert into fuels.

Although we are an extremely wasteful society, the amount of waste that can usefully be converted into oil substitutes is small relative to the amount of oil we currently use. That means that as conversion technologies are developed, there will be a scramble for useful feedstock to convert to biofuels. Since the limiting factor for biofuels is likely to be feedstock, the companies most likely to benefit from a trend towards biofuels are the people who own the feedstock. For example, corn farmers have done much better out of the ethanol boom than the ethanol producers. Although many ethanol firms have filed for bankruptcy, and the ones that survived are barely profitable, corn acreage and prices are still high compared to 5 years ago.

Monthly corn price chart from tradingcharts.com

Conclusion

The best biofuels investments are likely to be the companies that own or can produce the feedstocks. I particularly like the companies that own or control municipal waste, since it's currently free or even has a negative price (i.e. people will pay you to take it off their hands.) That's why Waste Management (WM) was one of my Ten Clean Energy Stocks for 2010. I also like forestry companies, since they currently produce forestry waste that could become a valuable feedstock for cellulosic ethanol, or simply be co-fired in existing coal plants to generate electricity without net carbon emissions.

I'll take up some of the other substitution strategies in the next part of this series.

DISCLOSURE: Long WM.

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.

Plug-in Vehicles Combine Immense Risk With Insignificant Reward

Tue, 16 Mar 2010 00:05:05 -0500

John Petersen

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

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

PT Barnum would have been proud.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Yes, indeed PT Barnum would have been proud.

Implications for prudent investors

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

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

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

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

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

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

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

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

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

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

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

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

Disclosure: I plan to sit this one out.

Solar Headwinds, Part II

Sat, 13 Mar 2010 13:07:03 -0500

Tom Konrad, CFA

Prospective investors in solar manufacturers should consider the competitive forces that constrain the industry's long-term profitability.

In the first part of this series, I showed how a competitive analysis of the corn ethanol industry in early 2007 illuminated the forces that soon caused ethanol company stock prices to collapse in late 2007. I also implied that the solar cell manufacturers, including industry leaders such as Sunpower (SPWRA) and First Solar (FSLR) are vulnerable to these forces and may not be able to maintain high returns on capital over the long term.

I'm not predicting that solar stocks will collapse later this year, as happened with ethanol stocks in 2007. The dramatic timing of my article on ethanol companies with the quick collapse of ethanol stocks was coincidental. Competitive analysis of an industry can illuminate long term trends, but short term stock prices often have very little to do with long term trends or underlying economics. Given that solar stocks have fallen considerably over the last two years (see chart), a further drastic decline seems unlikely.

Solar ETFs KWT and TAN compared to market indexes Mar 2008 to Feb 2010.

Yet a recovery in solar stock prices that might bring solar indexes back into line with general market indexes is also unlikely, because the intense competition in the sector restrains the underlying profitability relative to companies in sectors with average levels of competition.

Returning to Micheal Porter's classic competitive forces model, each of the five forces are each composed of a number of factors. The more of these factors are above average, the greater the overall competitive contribution of that force. In the table below, I list above-average factors which contribute to competitiveness, and below average factors, which reduce competitiveness, and the resulting overall competition for each force.

Force	Factors increasing competition	Factors decreasing competition	Overall Competition
Industry rivalry	Large number of firms, High fixed costs, low switching costs, low product differentiation, specialized equipment, diverse companies	High market growth, nonperishable product	High
Threat of Substitutes	Electricity can be produced in may ways, and is usually more conveniently and cheaply available through the grid	Government requirements or subsidies for solar power	High
Buyer Power	Product is standardized	Many diverse buyers	Average
Supplier Power	Suppliers are concentrated (but becoming less so)	Commodity inputs, customers weak	Average to Low
Threat of new entrants	Constant innovation in solar technology, ability to purchase standardized manufacturing equipment, globally traded product, low minimum economy of scale, little brand franchise	Asset specificity	Very high

The key factors keeping competition high are the strong threat of substitutes and rapid innovation bringing new entrants into the industry. Electricity from other sources such as fossil fuels or other renewable generation is functionally indistinguishable from solar electricity, and may be available at night or on cloudy days. Hence there are not only readily available substitutes to solar panels, they are often more convenient to use.

I brought up the specter of innovation in solar technology as a risk factor for solar stocks in my recent article on risks for alternative energy investors. The great hope for the solar industry is that constant innovation will quickly bring down costs to the point where solar power is cost-competitive with electricity from the grid, or grid parity. But that same innovation, if it comes from outside the current industry, will undermine the economics of manufacturers using current technology. The advent of First Solar (FSLR) is a case in point. Because First Solar can produce its CdTe technology at much lower cost per peak watt than conventional silicon manufacturers are able to match, First Solar is able to expand its market share at the expense of other manufacturers while maintaining strong profitability.

But First Solar may only be in its current privileged position for a few years: other thin-film technologies such as Copper-Indium-Galium-diSelenide (Ascent (ASTI), DayStar (DSTI), and many private companies) or amorphous Silicon (Applied Materials (AMAT), Sharp (SHCAY.PK) and many others.) Beyond these up and coming thin-film technologies, there is a constant stream of new innovations such as organic PV and PV from abundant materials (IBM) that could potentially be manufactured at much lower cost than current thin film technologies.

There are also non-photovoltaic competitors. Bloom Energy is trying to present itself as an alternative to solar, but not very credibly. Concentrating Solar Thermal Power (CSP) has long had a cost advantage for large scale farms, and has the additional advantage of producing on-demand power because it is simple to integrate with inexpensive thermal storage. PV is not safe from encroaching thermal technologies even at the residential level. One potential challenger is startup Cool Energy. Cool Energy's combined heat and power system uses an array of evacuated solar thermal collectors to provide space heating in cold months, and then uses a Stirling engine to convert excess heat in warmer months into baseload or on-demand electricity.

Conclusion

Because of rapidly falling costs and a vast solar resource, solar PV is likely to produce a significant and growing portion of our electricity in years to come. But this growth trend is an industry trend, and the growth could easily come from new competitors at the expense of current solar stocks.

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.

Solar Headwinds, Part I

Thu, 11 Mar 2010 10:27:08 -0500

How Solar PV is like Ethanol

Tom Konrad, CFA

High levels of competition in the the solar photovoltaic (PV) industry mean that buy-and-hold investors should look elsewhere.

In May 2007, I published a competitive analysis of the corn Ethanol industry based on Michael Porter's classic Five Competitive Forces model. At the time, Ethanol stocks were flying high, but my conclusion was that "the prospective ethanol investor should be very careful about investing in corn ethanol producers at random." If anything, I understated the case.

This chart shows three ethanol stocks that have survived since 2007. As survivors, they are among the best performers in the industry; several others declared bankruptcy.

Corn ethanol is not a great business to be in; it's too competitive. If you buy assets at the right price, you can do well, but it's all about timing. A passive buy-and-hold strategy will under-perform the same type of strategy in a less competitive industry. Companies in less competitive industries can maintain higher returns on capital for longer periods.

Solar Manufacturers

It's not a secret that I'm no fan of investing in solar stocks, although I understand why enthusiasts are seduced by the sector. Unlike corn ethanol, solar PV will likely be a significant part of any future sustainable energy mix, but that is not the same thing as saying that today's solar stocks will be good long-term investments. Americans watch more television today than ever before, but were network television stations a good investment over the last 20 years? No, because new entrants came in and stole their audience: the industry has become much more competitive than it was 20 years ago.

Thinking that todays solar stocks will do poorly over the long term is not the same as thinking that the solar industry will flop. Rather, it is the belief that increased competition will drive down returns at existing companies. This will be great for buyers of PV panels, but not so great for owners of PV stocks.

Porter's five competitive forces model of competion bears this out, just as it did when I analyzed the corn Ethaonol Industry in 2007. The next article in this series will take a look at the five forces, and how they apply to solar PV manufacturers.

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.

Vehicle Electrification – a Bird in the Hand

Tue, 09 Mar 2010 10:49:34 -0500

John Petersen

Since I'm frequently chastised for holding old fashioned views when it comes to vehicle electrification, I'll start this article by quoting one of the oldest known versions of a common English proverb, "A byrd in hand - is worth ten flye at large." While this theme is not always clear in my writing, it's never far from my thoughts. In fact it's the foundation of my conviction that manufacturers of cheap energy storage products are better investments than developers of cool energy storage products and batteries are great at minimizing waste but miserable at replacing fuel tanks. Just for this week, I'm going to take the debate down a notch and focus on what I see as a bird in the hand in the energy storage sector.

I've written about new European standards that will require automakers to reduce CO2 tailpipe emissions to 130 g/km by 2015. I've also written about new U.S. CAFE standards that will require automakers to achieve an average fuel economy of 35.5 mpg by 2016. While I've never written about the rest of the world, many governments are jumping on the bandwagon and adopting emission standards based on the European model. The following chart from Tenneco (TEN), a global leader in automotive fuel efficiency and emission control systems, provides a summary overview of the current global regulatory landscape.

For the last couple of years, a huge amount of hype and media attention has focused on a new generation of plug-in vehicles that automakers plan to introduce soon. What these stories invariably fail to recognize is that one or two million plug-in cars may contribute to the cause, but the overwhelming bulk of the progress must come from efficiency gains in the 48 million cars that can't be built with plugs because the world can't make enough batteries. From my admittedly stodgy perspective, the 48 million cars are a plump bird in the hand while one or two million plug-ins are, at best, wild geese on the wing.

In mid-February, I wrote an article, Exploring Energy Efficiency in the Automotive Sector, that included the following summary table of efficiency technologies for cars without plugs:

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

While all these efficiency technologies are important, the only ones I'm qualified to write about are stop-start systems, mild hybrids and full hybrids.

In a presentation at last fall's IAA Investor & Analyst Conference at the Frankfurt Motor Show, Dr. Wolfgang Bernhart of Roland Berger Strategy Consultants predicted that automotive powertrain electrification would become a critical efficiency technology by 2020 and forecast high scenario market penetration rates as follows:

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

While some may find the distribution surprising, it actually fits nicely into the concept of the standard bell shaped curve that we all learned about in grade school when report card time rolled around. A few buyers will underperform and continue to buy vehicles with internal combustion engines; most average and above average buyers will buy vehicles with stop-start and HEV systems; and a few truly committed souls will buy vehicles with plugs. As an investor looking to minimize risk, I prefer mass-market certainty to early adopter potential.

The biggest impediment to the widespread adoption of stop-start systems is that stopping and restarting an engine several times during a typical daily commute is very hard on flooded lead-acid starter batteries. While stop-start systems don't need an exotic chemistry like NiMH or Li-ion, they do need a better grade of absorbed glass mat, or AGM, battery that can withstand heavier cycling. Where automotive OEMs have historically paid about $55 each for starter batteries, advanced batteries for stop-start applications can cost from $150 to $250 each. The price difference may be pocket change in the price of a car but it's a huge revenue opportunity for the companies that can make starter batteries for millions of stop-start vehicles.

Building top line revenue in any business is hard and the only ways I know are to sell more products or to sell higher value products. The same is true of bottom line profitability where the only options are to improve margins or cut costs. A business that can build revenue by increasing unit prices and simultaneously increase profits by selling at a higher margin is rare, but that's the direction the lead-acid sector is heading in. Assuming a modest price differential of $100 per vehicle, the incremental revenue to starter battery producers should be on the order of a billion dollars within five years and three billion dollars within ten years. Since the revenues will come from product upgrades rather than increased volumes, the stresses on capital spending budgets, supply chains and distribution networks should be significantly lower than they would be with a new product. The net result should be higher revenues and profits, which are always good things for low-priced stocks.

No matter how the stop-start market ultimately unfolds, starter battery manufacturers will thrive. If the OEMs bite the bullet and buy better starter batteries, revenues from original equipment sales will soar. If OEMs don't upgrade their starter battery specifications when they introduce stop-start systems, revenues from replacement battery sales will soar. It's just an updated version of the old Fram Oil Filter advertising campaign, "You can pay me now, or pay me later."

The three publicly traded U.S. companies that stand to benefit most from the widespread implementation of stop-start systems are Johnson Controls (JCI) Exide Technologies (XIDE) and Axion Power International (AXPW.OB).

JCI and Exide are global competitors in the OEM battery space and they each book billions in annual revenue from the starter battery business. JCI's Varta unit is selling batteries for over a million stop-start vehicles annually. Exide is using the proceeds of a $34 million DOE battery-manufacturing grant it received last August to build a new factory that will make batteries for up to 1.5 million stop-start vehicles per year. Both companies truly are bird in the hand investment opportunities that are certain to see significant revenue and profit growth over the next few years from market mechanisms that are already in place.

Axion is a more speculative microcap company that spent the last six years developing a lead-carbon battery technology that's ideally suited to the extreme cycling demands of stop-start systems. During the R&D stage, Axion's prototype PbC® batteries withstood over 1,600 cycles at a 90% depth of discharge while top quality AGM batteries made by others failed after 300 to 500 cycles. After entering into a worldwide supply agreement with Exide last April, the two companies sent pre-commercial PbC devices to several first tier automakers early last summer. Ten months later, the testing continues to yield positive results and negotiations are apparently in process for road testing of PbC batteries in pre-production stop-start vehicles. If the testing turns into orders, Axion will be able to leverage Exide's global manufacturing base by providing carbon electrode assemblies for co-branded products. It's not quite a bird in the hand, but it's a lot closer than the flock of wild geese.

I'm a former director of Axion and a big stockholder, so I'm clearly cheering for my home team. That being said I know several of Axion's directors well enough to feel confident that they wouldn't have closed a $26 million down-round financing in December if management wasn't preparing for a major capital spending program. I expect that we'll hear a good deal more about Axion's short-term plans when its annual report is filed at the end of the month. The one thing I can say for certain is that I feel much better about my risk/reward profile today than I did in October 2006 when I bought the bulk of my shares at a price that's within spitting distance of the current market.

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

Green Energy Investing For Beginners: How Many Stocks Should You Own?

Mon, 08 Mar 2010 16:38:10 -0500

Tom Konrad, CFA

In stock portfolios, deciding how many stocks to own involves weighing a trade off. A smaller portfolio can be built (and sold) with fewer commissions, and also requires less time to research. On the other hand, a portfolio with fewer stocks will gain fewer benefits of diversification, and likely be both more volatile and harder to sell in a crisis. These trade offs are also affected by the size of the portfolio, and the market capitalization and liquidity of the companies in the portfolio.

Diversification is widely accepted as a nearly costless way to reduce the risk of a portfolio. Diversification averages out the idiosyncratic risk that arises from unexpected events at particular companies, but it does nothing to remove market risk. When the market falls, nearly all stocks fall with it. The benefits of diversification from each new stock added to a portfolio are smaller than the diversification benefits of the prior one, but the costs of adding each new stock are nearly constant: transaction costs, and the cost of your time to do the research you need to decide this is the stock you want.

Most investors try to get the best of both worlds by buying mutual funds or exchange traded funds. I discussed the relative merits of these approaches in Part I of this series on Green Investing for Beginners. Green energy mutual funds are substantially more expensive than either green energy Exchange Traded Funds (ETFs) or stocks. The ETFs are much better than the mutual funds when it comes to costs, but brokerage commissions have fallen so low that stocks often have lower costs after just a few years.

Hence, the only good justification for buying a green energy mutual fund is because you believe the manager has superior skill, and the only good justification for buying a green energy ETF is simple diversification.

Where Mutual Fund Investors Go Wrong

If you are going to buy a mutual fund because you believe the manager possesses superior skill, you should buy just one. Countless studies have shown that the average actively managed mutual fund under-performs the similar index fund, and determining if a manager's track record is due to skill or luck is so statistically difficult that the only thing nearly everyone can agree on is that "past performance is not a reliable guide to future results." And, after they agree on that, most people go right back to studying past performance... because it's the only apparent indicator of a manager's skill that is easily quantifiable. Numbers make us feel like we know something, even if they are the result of completely random processes.

To make matters worse, most green mutual fund investors I have talked with about their holdings own small stakes in several mutual funds, so their money is being managed (very expensively) by the chronically-underperfoming "average manager." This is clearly taking diversification a couple steps too far.

Where ETF Investors go Wrong

In contrast, investors in green energy ETFs know that they cannot discern investment manager's skill, and so they opt for passively managed ETFs instead of the actively managed green energy mutual funds. (There are not yet any green energy index mutual funds I'm aware of.) Using ETFs is a much more internally consistent approach, and makes sense, especially in small portfolios where the investor does not want to take the time to research individual stocks. The problem with this approach is that the green energy sector is still very immature, and the indexes are dominated by growth companies with little or no earnings. In such an immature sector, the largest market capitalization firms (which dominate the ETFs) are not necessarily the most successful businesses. Rather, they are the companies which have caught investors' attention: the flavor of the moment. Buying and selling such companies may make sense for a speculator, but is probably not the best approach for a small investor who wants to invest money that will grow with the green economy.

When You've Eliminated Everything Else...

In short, investors in green energy mutual funds almost always under-perform, and investors in green energy stocks subject themselves to excessive volatility, the very thing that diversification was meant to protect against. That makes the best strategy in my mind to build a portfolio of green energy stocks that are not the minimally profitable or unprofitable flavors-of-the-moment that dominate ETF portfolios, but are instead profitable companies doing green work that has not yet caught investors' imagination. In Part IV, I discussed the green energy sectors where profitable but untrendy companies are most likely to be found, and at the end of last year I gave you a list of ten such stocks to consider.

But is ten stocks really the right number for a green energy portfolio? There's no reason to think so, since the number owes more to David Letterman than to financial theory.

How many stocks is the right number? The answer depends on the market capitalization and liquidity of the stocks in question.

Liquidity and Return Volatility

I decided to write this article after reading Has the U.S. Stock Market Become More Vulnerable over Time?, by Avraham Kamara, Xiaoxia Lou, and Ronnie Sadka in Financial Analysts Journal. The article looks at the trends over time for systematic risk (the tendency of stocks to move in the same direction as the market) and systematic liquidity risk (the tendency for the liquidity of all stocks to dry up or increase in a correlated fashion.)

This chart shows how excess liquidity volatility, and excess return volatility of equal-weighted portfolios of small and large companies have changed over time. Here, "small companies" are those with market capitalization in the lowest 20% of the researchers' sample, and "large companies" are the 20% with the highest market capitalizations.

The clear trend over time is for portfolios of small companies to have lower excess volatility, while portfolios of large companies have mostly higher excess volatility. The authors hypothesize that this trend is the result of greater institutional dominance of the markets, especially in the form of ETFs, other index funds and basket trading. These institutions have predictable and correlated trading patterns that create greater correlation in both liquidity and return among the stocks they trade. Since most indexes are dominated by large companies, these have seen the greatest increase in correlation. Meanwhile, small companies have become less correlated with the market as a whole.

Given that the trend towards greater indexing has continued since 1985 and has not yet reversed itself, I think it is likely that the trends shown have continued. If this guess is correct, then excess volatility for portfolios of small stocks in 2010 will fall somewhere below the dotted lines, while excess liquidity for portfolios of large stocks will be mostly above the dashed lines, except for small portfolios (less than 20 stocks) of large companies.

According to these charts, portfolios of large companies rapidly reach a point of diminishing returns, at around 10 stocks for return volatility, and 25 stocks for liquidity volatility. Small companies continue or show benefits of added diversification for the largest portfolios shown, and these portfolios become less volatile than the market as a whole (i.e. achieve negative excess volatility) when they contain more than 33 companies.

An Ideal Green Portfolio

Even for a full-time market watcher like myself, I find it impossible to keep track of more than 20 to 30 companies at one time. For part-time investors, I expect the maximum is no more than 5 or 10 companies. Yet even 30 companies is too few to gain the full benefits of diversification available with portfolios of small companies.

One solution is to meld indexing with a small portfolio of actively managed small companies. The index fund (either an index mutual fund or ETF) should provide similar volatility reduction as a portfolio of about 25 stocks. If we combine the index fund with a our individual companies so that the investment in the index fund is 20-30 times the investment in each of the individual stocks, we should have a less volatile portfolio than if we had invested in the index fund alone, something which we probably would not be able to acheive without the individual small stocks.

I've shown three examples below, with five, ten, and twenty small stocks. Note that the amount invested in any one stock falls as you add more stocks, but the total proportion invested in stocks rather than the index fund increases.

This method should always be superior to using the index fund alone in order to reduce volatility because of the greater diversification benefits of small stocks compared to the ones used in index funds.

This type of portfolio also works well if you only want to devote part of your portfolio to clean energy. The index fund could be a mix of a Renewable Energy ETF and a general market index fund. The research suggests that the best choice for a general market index fund would be one that focuses on small stocks, such as IWC or FDM. You could then adjust your exposure to clean energy by changing the proportions of the index funds in the portfolio.

Earlier parts of this series, Green Energy Investing for Beginners, provide ideas about how to select the individual companies in your portfolio and and other aspects of green energy investing.

Beyond Beginners

Note that this is a long-only stock portfolio. I personally combine my long positions in green energy with short positions and option hedges against broad market indexes and non-green companies. In this framework, the shorts and option hedges on index funds would slot in to the index fund portion of the portfolio, while the options in individual non-green companies would fit into the individual stock portion of the portfolio. Allocations to bond funds and other asset classes may also make sense in the "index fund" part of the portfolio if they are baskets of securities, while they should go into the individual stock part of the portfolio if they are securities of a single issuer.

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.

Will Surging Smart Grid Investments Result in Surging Electric Prices?

Sat, 06 Mar 2010 14:19:30 -0500

John Petersen

The electric power system in the U.S. is dirty, antiquated, stupid, unstable, and a security nightmare. After years of discussion and debate, consensus now holds that the generation, transmission and distribution infrastructure will need hundreds of billions in new investment to reduce emissions, improve reliability, minimize waste and inefficiency, improve security, and facilitate the integration of wind, solar and other emerging alternative energy technologies. Commonly cited capital spending estimates range from $200 billion globally by 2015 to $2 trillion overall. In his November 2008 report, "The Sixth Industrial Revolution: The Coming of Cleantech," Merrill Lynch strategist Steven Millunovich observed that cleantech markets will dwarf IT to the tune of two orders of magnitude. While there's plenty of room to debate how the future will unfold, there's little question that we're watching the emergence of an investment mega-trend that will endure for decades.

The elephant in the living room is that while some smart grid spending will be recovered through increased efficiency, consumers will ultimately pay for any excess costs in the form of higher electric bills.

In the early release overview for its 2010 Annual Energy Outlook, the Energy Information Administration forecast that over the next 25 years, the constant dollar costs price per million BTUs of energy would change as follows:

	2009	2035	Price	Percent
	Price	Price	Change	Change
Crude Oil	$10.24	$23.04	$12.80	125.0%
Natural Gas	$3.24	$7.84	$4.60	142.0%
Coal	$1.56	$1.44	-$0.12	-7.7%
Electricity	$28.07	$29.87	$1.80	6.4%

To put these seemingly benign price forecasts into historical context, I prepared the following graph to show what happened to constant dollar energy costs over the last 17 years expressed as a percentage of their April 1993 values.

When I look at the historical trend-lines and factor in what I know about the energy industry and global economics, my sense is that:

The estimate for crude oil prices is too low given likely economic development in Asia and elsewhere;
The estimate for natural gas prices is too high given the recent emergence of shale gas as a resource; and
The estimates for coal and electricity prices must assume continuation of the status quo into the indefinite future.

When I consider the costs of alternative energy from wind and solar, the storage required to make these inherently variable alternative resources stable, the carbon mitigation requirements that will almost certainly be imposed on the coal mining and electric power industries, initiatives to move transportation from fossil fuels to electricity, and the huge amounts of capital spending required for the transition to a smart grid, the only conclusion I can reach is that electricity prices will have to climb and the increase is likely to be dramatic, particularly in the early years of a smart-grid build out. I don't have the skills required to forecast the probable magnitude of the coming price escalations, but I don't believe for a second that a flat line on the price graph is either a possible long-term outcome or a rational expectation. In short, there is no free lunch.

Every industrial revolution in history has been driven by new technologies that proved their ability to do more beneficial work with fewer economic inputs. The fundamental dynamic will be no different in cleantech, however the need will be even more pressing as global demand for energy, along with water, food and every commodity you can imagine, continues to skyrocket. My friend and colleague Jack Lifton is fond of reminding readers that the "Green Road to a sustainable energy future begins in the black earth." We truly can't have a secure energy future without a security in raw materials supplies, which is why I'm an unrelenting critic of ideologically appealing but resource foolish notions like plug-in vehicles that promise to do less beneficial work while requiring far greater economic inputs. It's all about getting the energy we need at the lowest possible price. But discussing energy options without carefully considering the natural resource constraints for proposed solutions is a non-starter.

Many of the adjustments we'll be forced to make in coming decades will be quite painful, but the world has already moved on while we were paying attention to other things. I'm a firm believer that energy storage is a critical enabling technology for our energy future, but unless and until storage is cheaper than waste, the potential benefits of storage will remain unrealized. This truly is a sector where price is the only thing that matters and the technology that does the required work for the cheapest price will win the lion's share of the potential market.

Disclosure: No companies mentioned.

2010: The Year of the Strong Grid? Part VI: Will the Real Strong Grid Companies Please Stand Up?

Thu, 04 Mar 2010 16:06:41 -0500

Tom Konrad, CFA

For clean electricity to flourish, the electric grid needs not only to be smarter, but more robust. This is where my strong grid stocks come in. But stringing wires for power is a lot like stringing wires for telecommunications as well a large number of other businesses which do not have much to do with the energy trends I hope will boost the long term prospect of these companies. Knowing how much these companies earn from grid infrastructure helps predict how much they will benefit from the trend.

Unlike many of the financial statistics I've been looking at in this series, companies have a great deal of leeway in defining their operating segments. Not a single company I looked at has a electric grid infrastructure segment, let alone a "strong grid" segment. Hence the numbers presented in the following table are subjective, based on my judgment as to what constitutes grid or clean energy related activity.

The information on which I've based these judgment calls often comes from investor presentations, many of which tend to include a slide on business segments. When I was unable to find a suitable investor presentation, I looked at a company's most recent annual report, where segment data is often included in the notes to the financial statements.

In terms of what constitutes grid infrastructure, I attempted to exclude any non-electrical wiring, as well as any electrical work inside buildings. I made other judgement calls along the way, especially when I had to determine how much of a specific segment to attribute to grid infrastructure. I made a note "unhelpful segmant data" when I felt my guesses were particularly questionable.

That said, here are my guesstimates:

Company	% Grid Infrastructure	Notes
ABB, Ltd (ABB)	30-60%	Unhelpful segment data
American Superconductor (AMSC)	10-20%	Mostly a wind company (for now)
AZZ Incorporated (AZZ)	50-60%	Strong Grid Part III AZZ & EME
General Cable (BGC)	55-65%	Strong Grid Part IV: BGC
Hubbell, Inc (HUB-B)	20-30%	Strong Grid Part V: HUB-A & HUB-B
Jinpan International (JST)	40-70%	Unhelpful segment data
MasTec (MTZ)	20-30%	Plans to grow grid segment
MYR Group (MTRG)	65-75%
Pike Electric (PIKE)	90-100%	The closest to a "Pure Play"
Quanta Services (PWR)	50-60%
Siemens (SI)	10-20%	Unhelpful segment data
Valmont Industries (VMT)	20-30%
WESCO International (WCC)	10-20%

DISCLOSURE: Long BGC.

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.

What’s the Stock Play in Wake of the Over-hyped Story About Fuel Cell Developer Bloom Energy?

Wed, 03 Mar 2010 09:25:08 -0500

Bill Paul

Having been a Wall Street Journal energy and environment reporter, one of the first experts I would have called before running a story on privately-held solid oxide fuel cell (SOFC) developer Bloom Energy would have been Neal Dikeman, who in addition to being a prominent alternative energy investor and the writer of an authoritative blog on clean technology, was involved in developing a fuel cell company.

But as Dikeman posted lasted week – Saving Cleantech: Bloom town Silicon Valley? – he didn’t get a call from the folks at CBS’s 60 Minutes, so the raft of legitimate technical questions Dikeman raised in his column went unanswered even as breathless 60 Minutes correspondent Lesley Stahl all-but-declared the energy crisis over thanks to Bloom.

To its credit, CBS did include an interview with a Bloom skeptic; however, he was more-or-less a prop inserted to make the story look balanced. If you read Dikeman’s list of unanswered technical questions surrounding Bloom’s technology, you realize that CBS never should have aired this piece in the first place, at least not without a lot more on-camera independent expert testimony.

But if Bloom Energy is over-hyped, investors might want to look closer at two fuel cell companies Dikeman says “are arguably shipping commercial product today,” FuelCell Energy (Symbol FCEL) and SFC Smart Fuel Cell. (Symbol SSMFF).

In announcing last week that it was initiating coverage on FuelCell Energy, Liberty Analytics noted that the company is the “world leader in the development and production of stationary fuel cells for commercial, industrial, municipal and utility customers,” and that its direct fuel cells (DFC) are generating power at over 55 locations worldwide.

Although still in the red, FuelCell Energy recently hired a seasoned senior executive in a bid to accelerate market penetration. The company is scheduled to announce its first-quarter results on March 10.

Smart Fuel is a German company that EnergyTechStocks.com has previously suggested investors might want to look at more closely. While also still in he red, the company’s losses have been narrowing significantly. The company describes itself as the market leader in fuel cell technologies for mobile and off-grid power applications serving leisure, industrial and military markets. Importantly, the company, in partnership with DuPont (Symbol DD), recently got a glowing review from the U.S. Defense Department for its lightweight power packs that soldiers can use in the field. DOD said the power pack “could offer a significant advancement in the area of soldier portable power in the field. (For more see From Small Fries to Big Shots? CBD Energy and SFC Smart Fuel Cell Look Promising.)

DISCLOSURE: No position.

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

Bill Paul is Managing Editor of EnergyTechStocks.com.

How Aggregation Will Destroy Niche Markets for Smart Grid Energy Storage

Tue, 02 Mar 2010 11:42:38 -0500

John Petersen

Last week I introduced a new study titled "Energy Storage for the Electricity Grid: Benefits and Potential Market Assessment" that was commissioned by the DOE's Energy Storage Systems Program, identified seventeen discrete storage applications for the electricity grid, discussed the technical requirements of each application and summarized the potential economic benefits.

If the Yahoo! message boards are any indication, investors are already jumping to inaccurate and wildly optimistic conclusions because they don't understand that many storage applications are synergistic and every storage system purchaser will try to maximize the value of its investment by capturing as many value streams as possible. The process is called "aggregation" and while it will speed the implementation of storage on the smart-grid, it will ultimately destroy the high value niche markets for frequency regulation, short-duration wind integration, electric service reliability and similar ancillary services.

To truly understand the issues, investors need to stop looking at individual trees and focus instead on the forest.

One of the biggest challenges facing developers of grid-based energy storage systems is that electricity is cheap and abundant, and storage can be incredibly expensive. As a result, most of the grid-based applications identified in the new DOE study are not attractive as stand-alone value propositions. In the following table, the applications highlighted in blue make economic sense today as stand-alone value propositions. Conversely, the applications highlighted in yellow won't generally work unless a particular installation can capture and monetize several value streams. As utilities and other users begin installing significant storage capacity and aggregating value streams to maximize their returns, total system capacity will rapidly outrun demand for niche services, thereby eliminating the value premium. Over the long-term, the economics of grid-based storage will obey the laws of economic gravity. The only companies that will survive, much less thrive, are manufacturers of cheap, durable and dependable energy storage systems that can do the required work at the lowest cost.

A prime example of the prevailing "can't see the forest for the trees syndrome" is the wildly over-hyped idea that we can use plug-in vehicles to provide ancillary services while they're connected to a charging station. The silly values floating around for vehicle to grid, or V2G, services are all based on the theory that EV batteries can be used for frequency regulation and other high value ancillary services. While the theory sounds wonderful in the telling, the fundamental premise is fatally flawed and the promised benefits to plug-in vehicle owners will never be realized because they violate the law of supply and demand. The easiest way to demonstrate the point is with an example.

At last year's EESAT conference in Seattle, a representative of the PJM Interconnect estimated that total national demand for frequency regulation was on the order of 6,000 MW. Storage companies that are actively pursuing opportunities in frequency regulation include Beacon Power (BCON), Altair Nanotechnologies (ALTI) and A123 Systems (AONE). In general the battery companies that are working on fast response products claim their systems can provide two to four MW of frequency regulation service for each MWh of battery capacity. Beacon is claiming a 20-year life for its flywheel systems. Demonstration projects are currently under way to determine whether these performance claims will withstand the tests of time and intensive use. For purposes of this example I will assume that all systems perform up to expectations.

President Obama has established a policy goal of one million plug-in vehicles on the road by 2015. If that goal is reached and the average plug-in vehicle is equipped with 20 kWh of batteries, a figure that's mid-way between the GM Volt and the Nissan Leaf, then the total battery power available for V2G services will be roughly 20,000 MWh and the aggregate amount of frequency regulation those batteries could theoretically provide would be somewhere between 40,000 MW and 80,000 MW.

It doesn't take a PhD economist to know that if sellers try to force 40,000 to 80,000 MW of supply into a 6,000 MW national frequency regulation market, prices will collapse. Similar issues exist across the entire spectrum of grid storage applications.

In a 2007 "Guide to Estimating Benefits and Market Potential for Electricity Storage in New York" that was commissioned by the New York State Energy Research and Development Authority, Mr. Eyer and his colleagues identified and evaluated a number of potential synergies between different grid-based storage applications and concluded that users would need to carefully consider the potential value of the following complimentary uses when planning a new grid-based storage installation.

Electric energy time shift	Transmission and distribution (T&D) upgrade deferral; Transmission congestion relief; Electric service reliability; Electric service power quality; and Ancillary services.
Electric supply capacity	T&D upgrade deferral; Transmission support; Electric service reliability; Electric service power quality; and Electric supply reserve capacity.
Reduce transmission capacity requirements	Electric energy time shift; T&D upgrade deferral; Electric service reliability; Electric service power quality; Transmission support; and Ancillary services.
Transmission congestion relief	Electric energy time shift; T&D upgrade deferral; Electric service reliability; Electric service power quality; Transmission support; and Ancillary services.
T&D upgrade deferral	Electric energy time shift; Transmission congestion relief; Electric service reliability; Electric service power quality; and Ancillary services.
Operating reserves	Voltage support; Electric service reliability and Electric service power quality.
Regulation and frequency response	Limited.
Electric service reliability	Electric service power quality and Demand charge management.
Electric service power quality	Electric service reliability and Demand charge management.
Demand charge management	Electric service reliability and Electric service power quality.
Time-of-use energy cost management	Limited.
Renewables energy time shift	Generation capacity deferral; T&D upgrade deferral; Transmission congestion relief; Electric service reliability; Electric service power quality; and Ancillary services.
Renewables capacity firming	Electric service power quality; Electric energy time shift; T&D upgrade deferral; and Transmission congestion relief.

The point of the foregoing is not to pick winners and losers in the emerging market for grid-based storage solutions. Rather my goal is to highlight the immense differences between demonstration projects that establish whether a particular storage device can meet the technical requirements of a specific application and a detailed cost-benefit analysis that establishes whether a particular storage system will be cost effective for a particular user. As the market unfolds, I expect many demonstration projects to be impressive technical successes. Most of those technical successes, however, will be dismal economic failures because the cost of the storage system will be far too high for widespread implementation by potential users. The utilities all understand they can't buy a service for dime, sell it for a nickel and make it up on volume.

In a July 2008 report on its Solar Energy Grid Integration Systems–Energy Storage (SEGIS-ES) program, Sandia National Laboratories provided a summary table of current and projected capital costs for grid-quality manufactured energy storage systems. While commenters often criticize this table for conflicting with more the optimistic numbers that appear in corporate presentations and the mainstream media, I tend to believe Government studies are more reliable than public relations.

When I compare the capital cost figures in the SEGIS-ES table with the economic benefit per kWh values that I derived from the new DOE report on grid-based storage applications, the only companies I see that are within reasonable striking distance of a 10-year product life and a capital cost that compares favorably with the economic values are:

Enersys (ENS), a leading manufacturer of lead-acid batteries for commercial and industrial applications;
C&D Technologies (CHP), a leading manufacturer of lead-acid batteries for uninterruptible power systems;
Active Power (ACPW), an established manufacturer of flywheel-based uninterruptible power systems;
ZBB Energy (ZBB), which is scaling up manufacturing of a zinc-bromine flow battery system; and
Axion Power International (AXPW.OB), which is preparing to begin commercial production of its PbC line of asymmetric lead-carbon supercapacitors in cooperation with Exide Technologies (XIDE).

All of the other systems that I'm aware of suffer from crushing raw materials or capital cost constraints. I understand that every storage system developer is actively pursuing research and development programs that may significantly reduce costs at some future date. Unfortunately, experience has taught me that it's unwise to count chickens before they hatch and hope is not an investment strategy.

The grid-based energy storage sector is in its infancy and there is no reasonable way for an average investor to learn enough to pick individual stocks with any level of confidence. While I'm a stock picker when it comes to my personal holdings, I believe that a balanced portfolio of established and emerging energy storage companies is the only rational way for non-professionals to invest in the sector. Disproportionate investments in individual companies should be avoided unless you're prepared to do a whole lot of investigation and analysis.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its stock. He also has small long positions in Enersys (ENS), Exide Technologies (XIDE), C&D Technologies (CHP), ZBB Energy (ZBB) and Active Power (ACPW).

California Legislature to Consider Storage Portfolio Standards

Mon, 01 Mar 2010 15:05:51 -0500

John Petersen

The California Energy Storage Alliance just issued a press release that describes new legislation to require utilities to incorporate energy storage in their distribution networks. The rules will mandate storage equal to 2.25% of daytime peak power by 2014 and 5% of daytime peak power by 2020. The press release is available here.

A quick check of the California ISO website forecasts a peak load of approximately 29,000 MW for tomorrow. If one assumes an average peak demand of 30,000 MW, a 2.25% storage penetration would require an annual storage build of 135 MW per year in each of the next five years.

Using the average values reported in the Energy Storage for the Electricity Grid: Benefits and Potential Market Assessment report that I introduced last week, the incremental revenue to storage manufacturers from the sale of grid-scale storage systems in California would be worth roughly $200 million per year.

If the legislation is passed by the legislature and signed into law, the new storage portfolio standards will be great kick-off for the storage sector.

Disclosure: No companies mentioned

2010: The Year of the Strong Grid? Part V: Hubbell Inc.

Sun, 28 Feb 2010 12:35:58 -0500

Tom Konrad, CFA

Hubbell Inc. (HUB-B) is a strong grid stock that also has strong financials, signaled by a recent dividend increase.

I came across Hubbell Inc. (HUB-B) when researching General Cable (BGC) for my recent article on the company. Just one more example of when you start researching a sector, (in this case electrical transmission and distribution, or "strong grid") you never know what new companies you may find.

Hubbell is a diversified electrical supplier, serving electric utility, residential, commercial, and industrial markets worldwide. About a quarter (26%) of its revenue comes from the "Power Systems" segment, which is roughly what I am focusing on in this series on the "Strong Grid." I previously rejected EMCORE Group (EME) because it only has about 20% of its revenues from the strong grid, so the reader might reasonably ask, "What's so much better about Hubbell?"

The main advantage is that Hubbell's other divisions have exposure to the Smart Grid, and Energy Efficient lighting, which means that my best guess of the company's overall exposure to my favorite clean energy sectors is somewhere around 50%. Emcore also had some exposure to these sectors (it is a diversified mechanical and electrical construction group), but probably not so much.

The Dividend Increase

And then there's the dividend increase. As a value-oriented investor, I love dividends. I'm especially fond of companies that keep increasing their dividends. Dividends signal that management is confident about the solidity of their revenues going forward, and they are also a valuable source of return in the low-growth (or even no-growth) environment I'm expecting to prevail in coming years. The new quarterly dividend payment of $0.36 per share (vs. $0.35 previously) equates to a 3% dividend yield at $48 per share. Three percent is not much by historical standards, but it's pretty good in current markets.

The company's growth strategy is also one of acquisitions. With companies still finding it difficult to raise funds, companies like Hubbell that can fund acquisitions directly from their balance sheet are in a good position to scoop up bargains, and the company's long experience with such acquisitions gives us some assurance that they will be able to integrate the acquired companies successfully.

Share Structure
Both Hubbell class A (HUB-A) and class B (HUB-B) shares are traded on the NYSE, with B shares having much higher volume, and class A shares trading at a slight discount to B shares. Class A shares have 20 times the voting rights of class B shares, but only have about 1/100 of the trading volume. A long term, small investor would probably be better off holding A shares to take advantage of the discount (and the voting rights) but larger investors and traders will gravitate towards the B shares.

Valuation
On the other hand, despite the solid balance sheet and cash flow, the company is trading at too high a Price/Earnings ratio (15) for me to consider buying in what I expect to be a down market in 2010. But if the market decline I expect materializes, that high-ish P/E will give Hubbell some room to fall. If a market decline brings Hubbell into the mid-to-low 30's, I'll have my finger on the "buy" button.

Selected data as of 2-21-2010:

Stock Price (HUB-B/HUB-A)	$47.48/$46.67
P/E (trailing 12 month, HUB-B/HUB-A)	15.17/14.91
Cash per share	$4.41
Months to pay off net debt from cash flow	7 months
Current Ratio	2.2
Dividend yield (HUB-B/HUB-A)	3.03%/3.08%
Revenues from "Strong Grid"	26%
Revenues from Clean Energy and supporting sectors	roughly 50%
3 month average volume (HUB-B/HUB-A)	214,000 / 2,100

Grid-Based Energy Storage; A $200 Billion Opportunity

Fri, 26 Feb 2010 05:43:19 -0500

John Petersen

Yesterday a reader sent me a copy of an exhaustive new 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 prepared by Jim Eyer and Garth Corey. I've been following the work in progress on this report since last summer and have eagerly awaited an opportunity to shift away from the overhyped electric vehicle market and focus instead on a far larger market where cost, performance and substantive business merit will be the only drivers. It looks like my time has finally come. For technology aficionados that want a detailed understanding of what the various grid-based storage applications are, the entire report (232 pages including appendices) is a must read. Over the next few weeks I'll try to extract some high-level technical and market data and translate that information into a form that will be useful to energy storage investors.

The Eyer-Corey Report identifies 17 discrete grid-based energy storage applications, discusses the performance requirements of each application and assesses the 10-year economic potential for each application. The Report also includes a great summary that condenses a couple hundred pages of detail into a single table.

From an investor's perspective, the problem with the summary table is that it focuses on the needs of utilities instead of economic opportunities for storage device manufacturers. As a result the summary table uses a range of discharge durations, a range of power capacities and a range of economic benefits per kW of nameplate power capacity. Since investors typically think in terms of megawatt-hours of potential demand and economic benefit per kilowatt hour of storage, we have to take the Eyer-Corey calculations a couple steps further to arrive at a simple translation that fits an investor's perspective.

In an effort to translate the summary table data into terms investors will understand, I've calculated an average discharge duration and an average economic benefit for each grid-scale application identified in the Report. I've then used those averages to calculate potential demand in MWH, economic benefit per kWh and revenue opportunity to manufacturers. I've also reordered the data based on declining economic benefit per kWh to highlight the inverse relationship between economic benefit per kWh and potential demand in MWH. If you're interested in more detail, I've posted a copy of my Excel spreadsheet here. I've discussed this methodology with Mr. Eyer and feel comfortable that my potential demand, economic benefit per kWh and revenue opportunity calculations are at least in the ballpark. Since we're dealing with averages of values that covered a wide range to start with, my numbers are best characterized as rough estimates, but they're certainly good enough for a first pass. The summary results of my calculations are set forth below.

The color coding in the table represents my attempt to segregate economic benefit per kWh into cool technologies like flywheels, supercapacitors and lithium ion batteries, which are highlighted in blue, and cheap technologies like flow batteries, lead-acid batteries, compressed air and pumped hydro, which are highlighted in yellow.

Last summer I wrote about energy storage on the smart grid and said that in terms of potential demand, the market would be 99.45% Cheap and 0.55% Cool. Depending on how you want to classify the voltage support line that I've highlighted in orange, my estimate was either spot-on accurate or off by a half-point. Now that I can refer to a reasonable third-party estimate of storage system values, it's clear that revenue opportunities in smart grid storage will be about 90% cheap, 8% cool and 2% in-between. Any way you cut it, the substantial bulk of the revenue opportunity for energy storage on the smart grid will flow to companies that manufacture objectively cheap storage solutions. There will be meaningful 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 immense opportunities for cheap energy storage technologies.

The following table provides summary information on the pure play energy storage companies I track that are actively working on storage applications for the smart grid. To keep things as simple as possible I've used the same color coding to segregate their planned product offerings into objectively cool technologies and objectively cheap technologies.

For several years the market has been enthralled with gee-whiz energy storage technologies and references to potential markets that represent billions of dollars in potential for highly specialized niche applications like frequency regulation. In the process, investors have lost perspective on the question of how the niche applications fit into the overall market. This dynamic has led to inflated expectations for companies that are developing cool emerging technologies and unrecognized value in companies that manufacture the cheap established technologies that will do the yeoman's share of the heavy lifting for the smart grid. Unless I'm way off the mark, that dynamic will shift very rapidly as outsized revenue gains begin accruing to manufacturers of cheap solutions.

When I started writing this blog I believed energy storage would become a major investment trend over the next few years because cost efficient storage systems can reduce waste while enhancing the reliability of most alternative energy technologies. Since then, the fundamental market drivers have developed faster than I imagined and what I initially described as a rising tide is rapidly becoming a full-blown investment tsunami. While rising tides lift all boats, the critical points for investors to remember are:

Percentage gains in the stock market are largely dependent on entry price and it's easier to bag a double or triple in a cheap stock than it is to get the same result in an expensive stock;
While it's all well and good to look a decade down the road and dream of a brighter future, America has pressing energy storage needs that require solutions today;
In America we get up in the morning, we go to work and we solve our problems using the tools that we have in our toolbox, however we remain ready to embrace new tools as they are developed, perfected and proven; and
Successful investing requires diligent monitoring to adjust portfolio positions to a rapidly changing market and technical landscape, and emerging technologies that are not ready for prime time, but will be someday.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and has a large long position in its stock. He also has small long positions in Enersys (ENS), Exide (XIDE), C&D Technologies (CHP) and ZBB Energy (ZBB).