Charles Morand

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

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

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

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

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

4) Extent your analysis to five years or greater

New Analysis, Same Difference

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

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

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

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

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

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

Conclusion

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

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

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

DISCLOSURE: None

The post Oil & Alt Energy Redux appeared first on Alternative Energy Stocks.

Charles Morand

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Conclusion

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

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

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

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

The post Crude Oil & Alt Energy: The Non-Relationship That Just Won’t Go Away appeared first on Alternative Energy Stocks.

Charles Morand

Peak Oil is a term that has become common currency in energy debates in last three years, due in large part to the spectacular rise in the price of crude between 2005 and the end of 2008. But what does Peak Oil actually mean and, more importantly, what do I mean when I use it in my articles?

In the purest and original sense of the term, Peak Oil refers to the point in time at which the rate of oil production (as measured, for instance, in barrels per day) peaks. This peak, according to the original theory, is then followed by a rapid and irreversible decline as attempts to extract more oil out of the ground run into the absolute geological limits of the resource. Wikipedia, as always, does a great job of explaining the theory of Peak Oil and provides a wealth of resources for those who would like to expand their knowledge further.

I do, on occasion, refer to Peak Oil in my articles, including one I wrote last week where I claimed that Peak Oil would be a powerful driver of gasoline prices in the next few years. Given how contentious this theory is, I wanted to clarify where I stood on it and how readers should interpret what I mean when they see those two words side-by-side in my posts.

Are we about to run into the absolute geological limits of oil in a way that won’t allow us to increase production going forward? I don’t know and I have nowhere near the appropriate level of knowledge to truly judge the data I see on this weekly. And frankly I don’t particularly care; humanity will hit that peak at one point or another and the exact timing is of very little relevance to me.

What is far more relevant is the price point (and time) at which we hit the economic – rather than the geological – peak: let’s call that Effective Peak Oil (EPO). EPO occurs where the marginal barrel of oil, which sets the price for all barrels of oil in the market, is so expensive that: (1) it triggers a process whereby governments, people and firms search for and find substitutes in a way that alters the structure of the economy and demand for oil forever and; (2) in the process, it also triggers a substantial economic shock. Does EPO look like a nice, smooth bell-shaped curve? Probably not, or at least not when plotted on a timescale relevant to most human beings (i.e. 60 to 90 years).

In the following interview he gave on CNBC last week (thanks to the Infectious Greed blog), Jeff Rubin, former Chief Economist at CIBC World Markets and author of the new book Why Your World Is About To Get A Whole Lot Smaller, sums up my thinking on this issue better than I ever could. His most memorable quote: “What we are running out of is oil we can afford to burn.”

DISCLOSURE: None

The post What Is Peak Oil? appeared first on Alternative Energy Stocks.

Charles Morand

On Monday morning, I received an e-copy of a new research note by BofA Merrill Lynch arguing that disclosure by publicly-listed companies on the issue of climate change was becoming increasingly “important”. The note claimed: “[w]e believe smart investors and companies […] will recognize the edge they can gain by understanding low carbon trends.” I couldn’t agree more with that statement.

It was no coincidence that on that same day the Carbon Disclosure Project (CDP), a non-profit UK-based organization that surveys public companies each year on the state of their climate change awareness, was releasing its latest report at event organized by BofA/ML in NYC.

I am fairly familiar with the CDP, having worked on one of the reports in 2006. In a nutshell, the CDP sends companies a questionnaire covering various topics such as greenhouse gas (GHG) emissions, programs to manage the identified risks of climate change, etc. (you can view a copy of the latest questionnaire here). The responses are then aggregated and made into a publicly-available report.

The CDP purportedly sends the questionnaire on behalf of institutional investors who are asked to sign on to the initiative but have no other obligation. The CDP currently claims to represent 475 institutional investors worth a collective $55 trillion. Not bad!

Putting Your Money Where Your Signature Is?

Despite their best efforts, initiatives like the CDP or the US-based CERES are mostly inconsequential when it comes to where investment dollars ultimately flow. Investors are asked to sign on but are not required to take any further action, such as committing a percentage of assets under management to low-carbon technologies or avoiding investments in companies with poor disclosure or that deny the existence of climate change altogether.

Case in point, the latest Global Trends in Sustainable Energy Investment report found that, in 2008, worldwide investments in “sustainable energy” totaled $155 billion. That’s about 0.28% of the $55 trillion in assets under management represented by CDP signatories. A mere 1% commitment annually, or $550 billion for 2008, would substantially accelerate the de-carbonization of our energy supply, probably shrinking the time lines;we’re currently looking at in several industries to years rather than decades.  

And that’s ok. By-and-large, investors are investors and activists are activists. In certain cases, investors can be activists, either from the left side of the political spectrum with socially-responsible funds or from the right side with products like the Congressional Effect Fund. But overall, most sensible people want investors to be investors.

That’s because the function that investors serve by being investors rather than activists is a critical one in a capitalist system – they force discipline and performance on firms and their management teams. By having to compete for capital with other firms in other sectors, clean energy companies have an incentive to crank out better technologies at a lower cost, and that process will have positive implications for all of society in the long run.

The problem with the CDP is that it’s really an activist organization parading as an investor group. If the Sierra Club were to go around and ask Fortune 500 companies if they wanted to be hailed as environmental leaders in a glossy new report with absolutely no strings attached, I bet you anything they would get 475 signatures in a matter of days. And so it goes for CDP signatories – institutional investors the world over get to claim that climate change keeps them up at night while not having to deploy a single dime or alter their asset allocation strategies.

Approaching Climate Change Like An Investor

Someone approaching climate change like an investor – that is, as a potential source of investment outperformance (long) or underperformance (short or avoided) – isn’t likely to care for activist campaigns aimed at forcing large corporates to disclose information on the matter; in fact, they may prefer less public disclosure to more.

That is because one of the greatest asset an investor can have is an informational advantage. In the case of climate change, those of us who believe that it’s real and who think they can put money to work on that basis have a pretty good idea where to look and what to look for – we don’t need the SEC to mandate disclosure. Those who think it’s one giant hoax couldn’t care less – they don’t need the SEC to get involved, either. Yet this is where such campaigns are going, according to the BofA/ML report.

I like to think of climate change as an investment theme in terms of three main areas: (1) Physical, (2) Business, and (3) Regulatory. All three areas present investment risks and opportunities.

This categorization provides a high-level framework for thinking about what may be in store for investors as far as climate change goes. However, with the exception of Business/Opportunity and Regulatory/Opportunity, the investment case is not necessarily clear-cut and requires some thinking.

For instance, oil would seem like a perfect candidate for the Business/Risk category were it not for another major and more powerful price driver: peak oil. As for Regulatory/Risk, the European experience thus far has shown how open a cap-and-trade system is to political manipulation, and firms there have been able to withstand the regulatory shock more because of achievements on the lobbying side than on the operational side. That is why I have stressed in the past that understanding emissions trading was more about understanding the rules and the politics than about understanding the commodity.

Nevertheless, these trends are worth following for people who: 1) like investing and 2) think that climate change is not the greatest hoax ever perpetrated on the American people. For instance, CVTech Group (CVTPF.PK), a small Canadian electrical network services company, reported that in fiscal 2008 around 58% of its annual revenue increase (C$23.0 MM) was due unscheduled electricity infrastructure repairs as a result of hurricanes in Texas, Louisiana, North Carolina and South Carolina. In the annual report, management noted: “Since 2005, an increase in the occurrence of hurricanes has resulted in growing demand for our services in these states.”

Conclusion

I have nothing against the concept of activist organizations going after corporations with various demands, be they influenced by left- or right-wing thinking; after all, we live in a free, open society and it’s everyone’s right to do so within the confines of the law.

What I don’t like quite as much is hypocrisy and greenwashing. As far as I go, if an institutional investor truly believes that climate change can be a worthwhile investment theme, they should put a couple of analysts on it and figure out how to put money to work. If they don’t believe that it is, then they should just go on doing what they do best: manage money.

What they shouldn’t do is pretend to see an investment risk or opportunity where they really don’t just to appease a handful of vocal stakeholders. Lobbying to get the SEC to force disclosure on climate change is nothing more than window dressing; investors who think this is real already know where to look and what to look for and – surprise, surprise – it’s not rocket science!

DISCLOSURE: None

The post Climate Change & Corporate Disclosure: Should Investors Care? appeared first on Alternative Energy Stocks.

Charles Morand

This is the third installment of my review of the book book “Investment Opportunities for a Low Carbon World“. The second installment covered geothermal power and energy efficiency and the first installment covered wind and solar.

This post reviews three interrelated chapters on the world of cleantech and alt energy indices, funds and ETFs. Two of these three chapters are my favorite in the book so far –  they provide very useful information for the novice investor with an interest in alt energy investing but limited time and knowledge for successful stock picking. 

Cleantech and alt energy are challenging sectors to invest for several reasons: (1) pure-plays tend to be risky investments because substantial technology and business risks often exist; (2) when pure-plays are not so risky (i.e. wind power), stocks tend to trade at outrageous multiples, with several years of strong growth already fully priced in; (3) the stocks of non-pure plays with some exposure to alt energy trade, more often than not, based on what happens in other parts of the company, requiring investors to own businesses they might have little interest in or understanding of (e.g. General Electric (GE) and Siemens (S)).        

The alternative to equities is to invest in one of the alternative energy and cleantech ETFs (either long or short) or purchase one of the alt energy mutual funds. I generally believe the latter option to be less desirable than the former, mostly because of high expense ratios and other fees. ETFs, in my view, provide an excellent way for retail investors to gain exposure to the sector – although overpricing and volatility issues still exist, firm-level risk is eliminated and risk is spread over a large number of securities at a relatively low cost.

Measuring the Performance of Environmental Technology Companies

David Harris, FTSE Group

This chapter provides an introduction to cleantech and alt energy stock indices. Early on in the chapter, the author notes:

“Active managers claim they can identify those companies with above market average growth potential, but at this stage in the sector’s evolution it is impossible to know which environmental technology companies will be the winners”

While I don’t think this assessment applies equally to all sub-sectors of the environmental technology market, this statement still sums up relatively well the landscape for most retail investors and, as mentioned above, provides a strong argument for index-based investing.  

The chapter then moves on to provide a methodology for breaking down the environmental technology sector into sub-sectors, based on the approach used by FTSE in making its Environmental Technology Index Series. It then lists out the main environmental technology indices available and their key characteristics.

Overall, this is a useful chapter for investors in understanding how index makers approach the process of index creation. Since indices form the backbone of ETFs and are the single most critical determinant of ETFs’ relative performance, this is a process worth understanding. However, the author could have provided more technical information to increase the chapter’s usefulness to investors with an intermediate level of knowledge.

Investment Approaches and Products for Investors

Clare Brook, WHEB Asset Management

This chapter provides a review of the following investment vehicles: socially responsible (SRI)/ethical funds, cleantech mutual funds, private equity cleantech funds and environmental hedge funds.

We learn that the largest holdings in most ethical/SRI funds are often in industries unrelated to environmental tech such as financial services. That is because such funds, unlike cleantech and alt energy mutual funds, do not invest in anything specific – they merely avoid investing in companies and industries that violate pre-determined ethical standards. For cleantech investors, those funds are generally useless.

As far as real cleantech and alt energy mutual funds go, the author discusses the problem of over-valuation mentioned above – in her view, valuations often reflect more a scarcity of investment options in pure-play cleantech stocks than realistic expectations for future growth.

The criteria provided by the author to evaluate different investment options are the most part of this chapter. The one thing that the author stresses across different actively-managed investment products is the quality of the management team, its experience and its track record. I would tend to agree – if someone decides to invest in mutual funds, these factors should arguably weigh more than the expense ratio, as they help put the expense ratio into perspective.

Exchange Traded Funds as an Investment Approach

Lillian Goldthwaite, Friends Provident  

This chapter provides a detailed overview of ETFs and makes the case well for using them in a portfolio. I particularly liked this chapter.

According to the author, some of the main strengths of ETFs are: they are traded on exchanges and can be bought and sold (and priced) throughout the day; they can be sold short, bought on margin and loaned; the portfolio can be viewed in its entirety at all times and the index construction process is transparent; and the process by which institutional investors can acquire and redeem shares by trading in the stocks of companies in the index ensures that no sizable gap emerges between net asset value and portfolio value.

As with the previous chapter, the author provides a checklist of items to research when doing the due diligence on an ETF. The chapter concludes with a list of ETFs in cleantech and alt energy, but also in nuclear energy, carbon emissions, timber and water.

The author does not delve particularly deep into cleantech  per se, keeping the discussion focused instead on ETFs more generally. 

Overall, I found this chapter interesting and quite useful. As is the case with the preceding two, there is less to say about this chapter than there was about the ones on environmental technologies that I reviewed in the first couple of installments,
mostly because these chapters are shorter.

The more seasoned investor is unlikely to learn much from this section of the book. But so it goes for such books in general; they are ideally suited for novice investors who want to get started investing into the sector and want a framework to approach the process.

For those interested in cleantech and alt energy ETFs, the following articles might be of interest:

Wind
Solar
General alt energy and cleantech 
Carbon emissions   

DISCLOSURE: None 

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

The post Book Review: Investment Opportunities for a Low Carbon World (Cleantech Indexes, Funds and ETFs) appeared first on Alternative Energy Stocks.

Charles Morand

Last Thursday, I reviewed two chapters from the recently published book “Investment Opportunities for a Low Carbon World“*. This post reviews two more.

 Geothermal Energy

Alexander Richter, Glitnir Bank (now Íslandsbanki)

Geothermal is one of the most interesting forms of clean power generation there is. As noted by the author, the most convincing argument for geothermal electricity is the fact that it operates at capacity factors in the upper 90s. This makes it the only renewable technology suitable for baseload power with the exception of dam-based (i.e. large-scale) hydro.

However, as the chapter demonstrates, global potential is unevenly distributed, with Asia, North America and Latin America having around three to four times more potential than Europe, Africa and Oceania. Besides a brief review of the global picture, the book focuses largely on the US, which will most likely remain the most active market for a few more years (the US currently accounts for a third of global installed geothermal electric capacity).

The author does a good job of breaking the geothermal development business model into its main phases (exploration, pre-feasibility, feasibility and design & construction) and explaining the various types of capital flows required at each stage, as companies move from a mining exploration business model (exploration, pre-feasibility, feasibility) to a power generation utility model (design & construction). What’s missing, however, is a discussion of the probability of project success at each stage, with risk typically culminating in the feasibility phase with important sums of cash being spent on exploration drilling with no guarantee that the resource will materialize.

The chapter’s strength is undeniably its assessment of the current state of the US market. The author uses data from a number of different sources to show the future potential of the market. California is expected to lead the way with Nevada coming in second. Based on a database of where the overall pipeline of US projects was at at the end of 2008, the author estimates that several projects will reach the feasibility and design & construction phases in 2011 and 2012, which should lead to greater demand for capital by the industry.

The chapter also touches on direct use geothermal, although the discussion is far less detailed than that on geothermal electricity. This despite the fact that the author writes: “[t]he biggest potential and prospects for the shorter term are in the direct use of geothermal energy, particularly for heating and other applications that use heat directly.”

As with the first two chapters I reviewed, I would have liked a few stock picks, and I believe a sub-section on opportunities in the equipment sector might have been interesting. However, this chapter fulfilled its purpose well; it provided a good introduction to the sector and can serve as reference material for later on. The US data was also very useful.

Energy Efficiency as an Investment Theme

Zoë Knight, Cheviot Asset Management

Energy efficiency is the most straightforward way of cleaning up our electricity supply and, given the right incentives, could also be the cheapest one (up to a point, as efficiency investments eventually run into diminishing marginal returns). We learn that in 16 IEA countries with strong efficiency profiles, efficiency measures resulted in aggregate savings worth US$180 billion in 2005 – not bad!

Incentives is thus exactly what a large part of this chapter focuses on. The author provides a thorough review of European policies and US efficiency targets outlined by the Obama administration to date. In both cases, it appears evident now that a trend toward greater energy efficiency incentives and regulations is well underway.

The author also provides a breakdown of global fuel consumption by category and identifies sectoral investment opportunities that could arise in each category. On the manufacturing side, the greatest opportunities are in machine drives (refrigeration, fans, pumps, compressors and materials processing). For households, hot water and central heating are key areas. 

However, as with other chapters I’ve reviewed so far, there are no specific stock picks. I did learn, however, that Merrill Lynch created an energy efficiency equity index. However, because all substantive info on the index seems to be accessible only to clients, this won’t help retail investors much.

I found the review of US and EU policies very useful, but would have appreciated a greater focus on some of the main technologies that are currently commercially available (with the exception of LED lighting which is well covered), as well as some stock picks.

The author makes the following useful point about large companies with exposure to efficiency (most of the opportunities currently available to investors in this area are large conglomerates): “investors need to identify whether the theme is a large enough driver to warrant stock selection or whether there may be other factors that will drive valuation of the stock […], outweighing the positive structural drivers from increased investment at a government level into energy efficiency. As with any equity investment, positive long-term structural drivers may differ from short-term trading cyclicality.”

DISCLOSURE: None 

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

The post Book Review: Investment Opportunities for a Low Carbon World (Geothermal + Efficiency) appeared first on Alternative Energy Stocks.

Charles Morand

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

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

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

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

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

Wind Power

By Mark Thompson, Tiptree Investments ltd

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

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

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

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

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

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

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

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

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

Solar Power          

By Matthias Fawer, Bank Sarasin

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

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

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

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

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

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

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

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

DISCLOSURE: None

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

The post Book Review: Investment Opportunities for a Low Carbon World (Wind + Solar) appeared first on Alternative Energy Stocks.

Charles Morand

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

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

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

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

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

Understanding Wind Energy Costs

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

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

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

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

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

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

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

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

       
The Levelized Cost of Wind Energy

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

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

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

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

The Market For Wind Generators

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

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

Conclusion

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

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

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

DISCLOSURE: The author is long ABB

The post Rarer Rare Earths Are Not Going To Sink The Wind Power Sector appeared first on Alternative Energy Stocks.

Charles Morand

In an upcoming article in the journal Resources Policy, David Humphreys, former Chief Economist at Rio Tinto and Norilsk Nickel, argues that skeptics are right to question the notion that mineral prices in the 2003 to 2008 period were rapidly uptrending as part of an emerging multi-decade supercycle.

He argues that the rise in demand underpinning steep mineral price increases had two distinct causes: (1) an “extended economic upswing” driven by an ample supply of cheap credit (we know now where that got us); and (2) a “deeper-rooted structural shift in the economy” resulting from the growing industrialization and urbanization of emerging markets, driven in large part by a labor cost advantage.

While Humphreys agrees that mineral resource prices may not continue to increase sharply – once the world emerges from recession – for the next 20 or 30 years as would be the case if we were engaged in a supercycle, he nonetheless disagrees that once supply catches up to demand things will go back to “normal”.

Supply catching up to demand means prices reflecting the industry’s marginal production costs, or the costs of extracting each incremental unit of resource. Although the increase in  mineral prices may not go on for decades, the author argues, there is nonetheless a high probability that the new “normal”, when marginal production costs stabilize, will mean substantially higher prices than the old “normal”, and that this will become the new reality.

The insight provided by Humphreys applies equally well to oil and gas. Unconventional  resources such as oil sands, shale gas and deep offshore drilling, while they will certainly help alleviate the supply-side impact on prices of declining production in conventional fields, will appreciably raise the industry’s marginal production costs, thus contributing to higher long-term prices even if stabilization occurs in a matter of years rather than decades.

Either way – whether we are engaged in a supercycle or not – we can now be fairly certain that we are entering a world where some of the natural resources that were essential to our becoming industrialized and wealthy will no longer be cheap, save for the odd recessionary period.   

The impact on the prices of final goods will vary based on how labor-intensive they are; for many manufactured goods, cheap labor in emerging markets will continue to limit the price impact of more expensive commodities, whereas for goods where commodity costs account for the bulk of final price the impact will be much more direct.

One of the industries that will be most heavily impacted by this is the car industry because of high gasoline prices. Given all of the hurdles that currently stand in the way of electrification, there is a good chance that we reach, within the next few years, a point where drivers are hit really hard in the wallet by high gas prices but not quite hard enough to justify the much higher expense – both in terms of money and foregone conveniences like trunk space and unlimited range – of an EV or PHEV.

The most likely winner from this, in my view, will be mass transit. As I argued in an earlier article on Obama’s high-speed rail plan, mass transit is to transportation what efficiency is to energy; although a renewable kWh is good, an avoided one is even better, and so it goes for EVs/PHEVs.

There are three stocks that I see as potentially major beneficiaries from a growth in mass transit – two rail stocks and one bus stock. The two rail stocks are Bombardier (BDRBF.PK) and Alstom (AOMFF.PK), which I profiled earlier this year. The bus stock is New Flyers Industries (NFYIF.PK), which Tom profiled last year. All three stocks will see material positive earnings impacts from growing expenditures on mass transit, unlike Siemens (SI) that, despite a strong position in rail, is highly diversified outside of transit and unlikely to see success in rail move the needle substantially on the earnings front.

As Tom pointed out in his article on New Flyers, it will take a lot for Americans to change their lifestyles and driving habits. However, all signs point to the fact that “a lot” is what we have coming our way – in fact, it will become the new reality and will have crippling economic impacts if we don’t find a way to adjust. Moreover, Americans are no longer the only consumers that matter – North American cities are growing more slowly than Asian ones, our population will most likely begin to decline sometime in the next few years and wealth creation is increasingly shifting to Asia. Many emerging markets are already embracing mass transit and will have a much bigger stake than we do in trying to limit the impact of secularly high oil prices on their economic development.

DISCLOSURE: None                      

The post Supercycle Or Not, Expensive Oil Is Unavoidable appeared first on Alternative Energy Stocks.

Charles Morand

A couple of weeks ago, I noted the importance of examining parameters other than module costs when gauging the economic competitiveness of solar PV energy. I noted how multiple factors influence the levelized cost of energy produced by solar PV systems, and thus its relative cost position on the grid. Nothing new here.  

However, besides standard test conditions (STC) conversion efficiency, or nameplate conversion efficiency, public data on parameters other than cost per watt-peak is not always easy to come by. That’s why I found reading “Potential of photovoltaic systems in countries with high solar irradiation“, a paper about to be published in the journal Renewable and Sustainable Energy Reviews, particularly interesting.

The Study

In the authors’ own words, the paper reports the results of the following study (funded by the German Federal Ministry for the Environment, Nature Conservation and Nuclear Safety (BMU)): 

This study thus examines the performance of the main commercially-available solar PV cell technologies under the same real-world conditions, rather than in the lab. The annual solar irradiation measured on-site at the ideal inclination was 1997 kWh/m2 in Cyprus and 1460 kWh/m2 in Germany. This equates to roughly 5.5 kWh/m2/day and 4.0 kWh/m2/day, respectively. The NREL Photovoltaic Solar Resource map provides a rough guide to equivalent US locations, while Solar4Power’s global maps do the same for the rest of the globe.    

The systems were initially deployed in June 2006 and the data reported is for the first year of operation, so until June 2007.

The systems under study are as follows:

The study uses energy yield – kWh produced divided by nameplate kWp – to directly compare the performance of each system. Theoretically, this should normalize out conversion efficiency differences between the various systems and, because other key factors such as inclination are kept equal, the performances of the systems should be roughly equal.

The figure below displays the annual energy yield for the Cyprus location. Ignoring the tracker-equipped system, we note some non-trivial differences in AC energy yields between the various systems, with the Suntechnics (SunPower), Wurth, Sanyo and First Solar systems performing best, and the BP Solar and Schott a-Si systems performing worst.    

The figure below depicts the energy yield by season for the Cyprus location. As can be noted, the thin-film technologies (a-Si, CIGS and CdTe) tend to have higher energy yields in the summer months than most crystalline technologies, but perform in roughly similar fashions or even slightly worse in winter months.

The seemingly wider variations between summer and winter months for thin-film systems are not actually due to the properties of thin-film materials, but rather to the properties of crystalline materials. The table below displays deviation from the average AC energy yield across all systems, as well as the MPP power temperature coefficient. The latter metric shows the drop in system power per one kelvin increase in temperature.

As can be noted, overall, the crystalline technologies tend to experience much greater performance declines under warmer conditions than do their thin-film brethrens. The authors note that the technologies with the lowest MPP power temperature coefficients showed the highest average energy yields during the summer period. 

The phenomenon discussed above is perhaps best captured by the graph below, which displays seasonal module efficiency for the Cyprus systems. Once again, by-and-large, thin-film technologies tend to experience much lower drops in efficiency with higher temperatures than do crystalline technologies, with the First Solar CdTe system showing the most stability.

The authors note that the systems installed in Cyprus showed a lower average measured performance ratio than those installed in Germany because of higher temperatures.

Conclusion

A couple of fairly obvious insights emerge from this article.

First, at least for the time being, crystalline technologies retain an edge over thin-film for applications where available space is an issue. Lower efficiencies in thin-film are forcing much larger system sizes, as depicted in the first table above. The urban roof-top market thus remains crystalline technologies’ domain.

However, and far more interestingly in my opinion, thin-film technologies’ relative performance stability in warm weathers, as demonstrated by lower MPP power temperature coefficients, makes them superior alternatives for areas where temperatures between seasons range from very hot to hot, and where module temperatures are likely to be fairly high year-round. In Cyprus, according to data in the study, average monthly temperatures stood near or below 15 degrees Celsius (~60 degrees Fahrenheit) during six months out of the whole year. Several potenially large markets will show much higher temperatures throughout the year.    

Incidentally, such regions could become, because of their solar irradiation r
egimes, very attractive solar PV markets. Areas such as India, North Africa, the Middle East and Australia all come to mind (the scale shows kWh/m2/day).

India recently announced it would be targeting 20 GW installed by 2020, and it was reported that it would institute a production-based incentive, which generally takes the form of a production tax credit or a feed-in tariff. In regions of Southern India with very hot summers and hot winters, thin-film technologies would probably offer the best alternative for ground-mounted installations, which will likely spring up in fields across the region if the incentive is generous enough.

DISCLOSURE: None                   

The post The Performance Of Solar PV Systems appeared first on Alternative Energy Stocks.