The energy sector has lagged the broader market over the past year. According to Morningstar’s rankings, only the 15 percent return in Basic Materials was worse than Energy’s 17 percent return over the past 12 months.

At the top of the heap for sector performance were Consumer Cyclicals, which registered a 51 percent return, followed by Technology, which rose 49 percent. Based on the performance of these sectors, one could easily conclude that the energy sector was not the place to be over the past year.

I would agree with that assessment if you were putting your money into a sector-oriented mutual fund. But the energy sector is incredibly diverse, and there were many energy stocks that outperformed the top-performing sectors.

Refiners, for instance, have had a spectacular year. Despite the recent correction, Phillips 66 (NYSE: PSX) and Marathon Petroleum (NYSE: MPC) both outperformed the Consumer Cyclicals average by gaining 62 percent and 53 percent, respectively, over the past 12 months.

US oil and gas drillers also fared well relative to the sector average. EOG Resources (NYSE: EOG), the top oil producer in the Eagle Ford shale, gained 44 percent over the past year. Whiting Petroleum (NYSE:WLL) and Continental Resources (NYSE: CLR), the #1 and #2 producers in the Bakken formation, returned 21 percent and 38 percent, respectively. Cabot Oil and Gas (NYSE: COG), a major natural gas producer in the Marcellus shale, saw its shares advance 84 percent over the past year.

On the other hand, if you were invested in the advanced biofuel sector over the past year, you probably lost money. KiOR (Nasdaq: KIOR), perhaps the most prominent of the advanced biofuel companies, saw its share price drop 40 percent. The share price of Gevo (Nasdaq: GEVO) slid 56 percent. Nearly every publicly-traded advanced biofuel company got discounted over the past 12 months.

The point is that the energy space is so diverse that many sub-sectors can be very attractive even when the overall sector lags. Energy investors can invest in oil production, gas production, refining, energy service providers, solar power, wind power, hydropower, geothermal power, nuclear power, coal production, biomass production, or advanced biofuels.

Source: REN21’s 2013 Renewables Global Status Report

In the last two issues of The Energy Letter, I reviewed the recent trends in wind power, solar PV, hydropower, and geothermal power. Today I would like to review the state of solar thermal and ocean energy technologies for power production.

Concentrating Solar Power

Solar photovoltaics (PV) produce electricity when solar PV cells are struck by solar radiation. A major disadvantage of solar PV is that output can drop rapidly during periods of cloud cover, and power is only produced during daylight hours.

A different solar power technology called concentrating solar power (CSP) can continue to produce power during periods of intermittent sunlight. CSP systems use lenses or mirrors to concentrate the sun’s rays, much like a magnifying glass. The concentrated rays are then used to produce heat. The heat may be used to generate steam directly, which is then passed through a turbine to produce electricity. Alternatively, the heat may be used to produce molten salt, which retains heat when the sun doesn’t shine and can enable these plants to run 24 hours a day.

In 2012, CSP was the fastest growing of the major renewable energy technologies. Last year global capacity increased by 61 percent, and has increased at an average annual rate of 43 percent over the past five years. Total global capacity at the end of 2012 was 2.55 GW. (For comparison, solar PV has 100 GW of global capacity.)

CSP capacity is presently concentrated in two countries. Spain leads the world with 1.95 GW of capacity, followed by the US at 0.5 GW. The US has another 1.3 GW under construction that is scheduled to begin operation within two years. Outside of the US and Spain, most of the remaining capacity is located in the North African countries of Algeria (25 MW), Egypt (20 MW), and Morocco (20 MW).

However, a number of countries are either building or planning CSP systems, including several countries across North Africa and the Middle East, as well as Australia, South Africa, Mexico and Italy.

Globally, growth rates for CSP are expected to remain high. The International Energy Agency has estimated that in sunny countries, CSP can become competitive for peak and intermediate power by 2020, and for base load power by 2030. The IEA also estimates that CSP could provide more than 11 percent of global electricity by 2050.

Ocean Energy

The ocean has tremendous potential for renewable power production, and there are several ocean-based technologies that are at the experimental stage or presently have limited commercialization. There are more than 100 ocean energy projects currently in development with a cumulative capacity of over 1 GW.

Tidal power is a form of hydropower that accounts for the bulk of the world’s commercial ocean energy. As tides rise and fall, the water moving inland and back out can be passed through a turbine, utilizing the same principles as hydroelectric power plants at dams. A 240 MW tidal power system has been operated in France since 1966. In 2011, a 254 MW tidal power project came online in South Korea. Smaller tidal plants operate in Nova Scotia, Canada (20 MW) and in Zhejiang, China (3.9 MW). The United Kingdom also has tidal current and wave energy projects of about 9 MW.

Wave energy harnesses the power of ocean waves to produce electricity. Some installations use floating buoys that produce electricity as the waves rise and fall. Others face perpendicular to the waves and capture the force of the wave as it strikes the surface. The world’s first commercial wave power plant was commissioned in Scotland in 2000 and has been operating continuously since. Plant capacity is 500 kW and plant availability is reported to be over 90 percent. In the US, Ocean Power Technologies (Nasdaq: OPTT) has successfully completed several small projects using buoys to capture and convert wave energy into electricity. The company is currently developing a commercial wave park off the coast of Oregon with a potential output of 1.5 megawatts.

Ocean thermal energy conversion (OTEC) utilizes the temperature differences between the deep ocean and the water’s surface to drive a heat engine. Because of the relatively small temperature differences (~35°F), the maximum theoretical efficiency of these systems is below 10 percent. Japan, India and the US are among the leading countries working to advance the development of OTEC, but commercialization is unlikely in the near-term.

Conclusions

The key to winning in the energy sector is not to invest too broadly, because the long-term outlook for some of the sub-sectors may vary greatly. You don’t want underperforming groups pulling down your portfolio.

Because fossil fuels account for nearly 80 percent of the world’s energy consumption, it stands to reason that most of the investment opportunities will be in the fossil fuel sectors such as oil, coal and natural gas production. But investment opportunities may arise in other sub-sectors, so it’s important that investors understand the basic principles involved. The current issue and previous two issues of The Energy Letter have attempted to familiarize readers with some of the renewable energy technologies.

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

Portfolio Update

Cabot Pumps Upside From Marcellus

In the energy sector, you can have very rapid  production growth or capital spending within the limits of free cash flow. But very seldom do you get both from the same company, much less one with a track record of delivering on a variety of other operational and financial metrics.

When you find a unicorn like that, you’ve got to ride it as far as it will go. This is why Cabot Oil & Gas (NYSE: COG) remains not just a Growth Portfolio Best Buy but our favorite idea in the entire energy universe.

The quarterly results reported last week continued to exceed those high expectations. The leading gas driller in Pennsylvania’s Marcellus shale formation reported adjusted second-quarter earnings of 45 cents a share, 6 cents above the consensus estimate, along with a 52 percent year-over-year increase in production and a near-doubling of cash flow from operations.

Those results don’t even reflect the recent startup of a compression station that appears to have given a 15 percent production boost to the connected Cabot wells, encouraging the company to lift its annual production growth forecast to a range of 44 to 54 percent, up from 35 to 50 percent previously. Cabot also continued to see strong flows from “step-out” wells outside its main production area in northeast Pennsylvania, and as a result is bringing in a sixth drilling rig and possibly a seventh one next year, providing a further boost to its already bright outlook for 2014 and beyond.

Meanwhile, total unit costs were down 28 percent year-over-year, so growth will continue to be financed by the swelling cash from operations. While natural gas prices have been weak of late, Cabot is well hedged in the near-term and is unlikely to sustain a material hit so long as prices stay above $3 per thousand cubic feet (Mcf). At the same time, the company retains the upside exposure to a long-term move above $5 per Mcf, expected by many analysts once exports of liquefied natural gas (LNG) begin in 2016.

Cabot celebrated its recent good fortune by doubling the quarterly dividend to 16 cents a share as part of the forthcoming 2:1 stock split.

The company also reported strong oil drilling results in the Eagle Ford shale in south Texas, and is shifting a rig there from its Marmaton Oklahoma play. But this remains primarily a natural gas story, one that is already strongly profitable and is poised to get more lucrative still.

In the aftermath of the report, the stock shot up to a record high, moving well above our buying point. Stifel raised its price target up to $85, while Howard Weil raised its sights to $91 and Oppenheimer bid $100, suggesting upside into triple digits should natural gas get significantly more expensive.

The stock is likely to oblige, barring another collapse in natgas prices that seems like a remote possibility at this point. This is a position still very much worth building and we’re raising our price target accordingly. Buy COG below $85.

— Igor Greenwald