On Oct. 11, 2011, I sent out a Flash Alert to The Energy Strategist readers closing out our short position in First Solar (NSDQ: FSLR), a leading manufacturer of thin-film, photovoltaic equipment for a 55 percent profit. My rationale for booking gains: The risk of a short-term snap-back rally in the stock outweighed the potential gain of an additional 10 to 15 percent.

In hindsight, my assumptions proved too conservative; the outlook for First Solar deteriorated much faster than I’d expected. First Solar CEO Robert Gillette, lured away from industrial giant Honeywell International (NYSE: HON) in October 2009 with a lucrative compensation package and $5 million signing bonus, abruptly stepped down on Oct. 26, 2011.

That surprise decision, announced in a terse press release, convinced many investors the firm was hiding something. In particular, First Solar has been criticized by some investors for the way it accounts for solar projects; some speculated Mr. Gillette refused to sign off on the firm’s financial statements.

Although I have no reason to suspect First Solar has accounting irregularities, investors should question the propspects of a company that has lost two other high-level executives since last April. I tend to regard insider selling as a vastly overrated indicator of a stock’s future performance, but founder and interim CEO Michael Ahearn has sold shares regularly in recent quarters.

At the very least, investors should question the wisdom of Gillette’s pay package, which enabled him to take home almost $30 million in his first 15 months on the job and included a severance package worth $9 million.

ExxonMobil Corp (NYSE: XOM) CEO Rex Tillerson earns an annual salary of only $6 million–apparently, the fat cats of the energy industry are in solar power. Whereas ExxonMobil produces oil and gas worldwide, most companies involved in solar power simply collect government subsidies. First Solar, for example, has already collected a cool $3.07 billion in loan guarantees from the US government. 

Am I bitter that we abandoned our short position in First Solar? Yes. I’ve warned investors against sinking their money into overhyped solar stocks for more than a year. My decision to cover our short position in First Solar was a tactical call; short interest accounts for about 40 percent of First Solar’s float, leaving us exposed to a potential short squeeze.

A short squeeze occurs when traders decide to cover their short positions by buying back shares, forcing the stock higher. Ironically, names with some of the weakest growth prospects post dramatic rallies in bear markets–usually because of a short squeeze.

But the solar-power industry’s woes extend beyond one company. The glowing reports about futuristic solar projects and green energy amount to meaningless blather. Predictably, some pundits have blamed Chinese companies for the industry’s recent ills.

Here’s the truth: The speculative bubble in green-energy and clean-tech plays has burst, with solar power names bearing the brunt of the pain.

Some of the weakest solar-power companies have already crumbled, including the infamous Solyndra, which received a $535 million loan guarantee by the Dept of Energy in September 2009 and recently declared bankruptcy. Evergreen Solar, a high-flyer that traded for over $103 per share in late 2007, filed for bankruptcy in August 2011. Energy Conversion (NSDQ: ENER) likewise doesn’t appear long for this world.

Although some solar-power companies will survive and may prove profitable for investors, industries recovering from a speculative bubble take time to heal.

Solar Glut

The proximate cause of the solar industry’s troubles is a glut of solar-power equipment and declining government subsidies, particularly in Europe.

Source: International Energy Association

This graph breaks down installed photovoltaic (PV) power capacity by country. Europe dominates the list, with Germany leading the way. EU nations have long subsidized alternative energy to encourage adoption of these technologies. Many governments patterned their subsidies after Germany’s feed-in tariff (FiT) scheme.

The media often lauds Germany’s focus on renewable energy and suggests that the US and other nations follow the country’s lead in aggressively promoting green energy. But Germany’s policies to promote renewable energy inflict substantial costs on electricity producers and consumers.

An article in the January issue of Bloomberg Markets illustrates these points. This must-read story by Jeremy van Loon relays the experience of Tommy Clever, a 39-year old environmental consultant who lives in Berlin. Clever has installed enough solar panels on his home to run his washing machine and other basic appliances–at least when the sun is shining. But Clever’s real motivation isn’t self-sufficiency: He receives EUR0.51 (USD0.73) for each kilowatt-hour of electricity he sells to the German grid. That rate is about 10 times the wholesale power cost, but it’s mandated and guaranteed by the German government under the country’s FiT structure.

FiTs are special rates given to any business or individual generating power from renewable energy. New installations of renewable energy capacity lock in these above-average rates for a period of 20 years. Changes in future FiT rates have no impact on projects that have already been completed and put into service. Regardless of the price of natural gas, oil and coal, Clever and others like him will earn a safe, government-guaranteed return on their investment.

According to Bloomberg Markets reporter Jeremy van Loon, Clever earns an annualized return of about 9 percent on his investment. With yields on traditional safety-first investments such as bank certificates of deposits and high-quality corporate and government bonds near multidecade lows, a 9 percent government-guaranteed return on investment is almost too good to be true.

With incentives likes these, you can’t blame individuals for installing additional solar capacity. But someone has to pay for these subsidized electricity rates. In 2008 total fees paid under the FiT scheme amounted to EUR9 billion. However, in 2012 the total could top EUR20 billion. The German government doesn’t pick up this tab, and industrial customers like manufacturers are sheltered from the rising costs; retail customers will bear the brunt of these expenses.

Source: Energy EU, Energy Information Administration

This table lists retail electricity prices in various European countries and a handful of US states. As you can see, Germany is second only to Denmark in terms of power costs. Denmark has also promoted substantial subsidies for alternative energy over the years.

For now, polls of German consumers indicate that the public supports the government’s energy policy. But renewable-energy subsidies have more than doubled since 2008. Concerns about these mounting costs have prompted German policymakers to slash the FiT rates. Earlier this month, Germany announced that it will cut its FiTs for solar by 15 percent in 2012. That’s on top of major cuts implemented in 2011.

Germany isn’t alone in these efforts. UK Energy Minister Greg Barker announced that the government would cut its subsidy for photovoltaic power because some installers were earning “unacceptable returns” at a time when the government can ill-afford additional costs.

The solar-power industry’s recent woes also remind me of an energy conference I attended in 2007. One speaker highlighted three countries–Greece, Spain and Italy–as the most promising growth markets for the photovoltaic power industry over the ensuing five years. All three fiscally weak governments have slashed their solar subsidies to reduce yawning budget deficits.

Reduced subsidies for solar power have translated into less demand for photovoltaic panels; the embattled alternative-energy industry now faces a supply glut and excess manufacturing capacity. First Solar and other manufacturers have stepped up rebates offered to distributors to help clear out excess inventories. Profit margins have tumbled throughout the industry, pushing suppliers with higher cost bases to the brink of collapse.

Some analysts had hoped the US would pick up the slack, but there are signs of trouble stateside. First Solar’s 550-megawatt Topaz Solar project in California recently failed to secure the $1.9 billion Dept of Energy loan guarantee for which the company received preliminary approval in June. Although First Solar plans to sell the project, a lack of loan guarantees will shrink the pool of potential bidders.

In the wake of the Solyndra bankruptcy scandal , don’t expect the US government to step up with loan guarantees and subsidies for solar power–especially with Congress increasngly focused on deficit reduction.

Alternative-energy companies often cite the cost of wind or solar power per watt generated in their investor presentations. These costs will vary from country to country. This graph examines the US Energy Information Administration’s (EIA) assumptions about the cost efficiency of various power plants slated to come online by 2016.

Source: Energy Information Administration

Solar power installations that use PV cells and thermal power are among the least cost-efficient sources of electricity. Without government subsidies, not utility CEO would consider building a solar-energy farm.

The industry would argue that these subsidies are required to encourage companies to develop technologies that will reduce the cost of solar power to the point that it can compete with coal and natural gas–a daunting task. Based on the EIA’s cost estimates–which already factor in substantial improvements in PV technology–this power source is more than three times as expensive as a natural gas-fired power plant. Reaching parity with thermal power sources will take time.

On the other hand, onshore wind-power installations are almost as cost efficient as traditional coal-fired plants. But discussions of cost-per-watt don’t tell the whole story in this case.

Solar and wind power suffer from intermittent outages and therefore can’t be relied upon as a source of baseload power. The wind doesn’t blow at a consistent, predictable rate at all times, nor does the sun shine all the time.

According to the EIA, the average solar PV plant operates at a capacity factor of 18 percent and the average wind plant at a capacity rate of about 34 percent. That is, these alternative-energy installations only produce power at a small percentage of their rated capacity. Even worse, average wind velocity tends to slow in many regions during heat waves–a period of peak electricity demand.

Electricity grids have little capacity to store energy, so power demand and supply must balance at any given point in time. Transmitting power over long distances also results in higher loss rates.

In short, the intermittent nature of wind and solar power limits the capacity of these alternative energies to replace thermal and nuclear power–the cost-per-watt argument is largely irrelevant.

Proponents of alternative energy argue that some countries have managed to integrate wind and solar power into their grid successfully. Denmark, for example, claims to generate about 20 percent of its power from wind.

This statistic is a half-truth. With a population of about 5.5 million, Denmark is roughly one-third the size of nearby Norway and Sweden. Denmark’s larger Scandinavian neighbors generate the majority of their electricity from nuclear power and hydroelectric plants. Denmark, Norway and Sweden’s electricity systems are connected, allowing Denmark to import or export power to the other two nations on the grid as a means of balancing supply and demand.

Norway and Sweden effectively serve as a giant battery for Denmark. A recent study by Danish think tank CEPOS shows that on average Denmark exports about 45 percent of the wind power it generates in the eastern part of the country and 57 percent of the wind power generated in the western portion of the country.

This power is exported because Denmark’s wind turbines at times generate more power than the domestic market requires. Sweden and Norway can turn their hydroelectric plants on or off with relative ease, so they’re able to soak up Denmark’s excess supplies. In effect, Nordic lakes are used as a repository for Danish wind power.

At first blush, this sounds like a positive for Denmark. But the country receives nothing or even a negative price for its wind-generated power during periods of peak productivity. In other words, Denmark sometimes pays Norway and Sweden to accept this electricity. Meanwhile, Denmark supports the wind-power industry with a substantial FiT. In fact, Danish consumers pay the highest rates in Europe. The government has effectively mandated that Danish consumers subsidize the rates of their much more populous Nordic neighbors. 

The widely cited statistic that wind generates 20 percent of Denmark’s power doesn’t account for imports and exports. The real figure depends on weather conditions in a particular year. According to CEPOS, wind power has accounted for between roughly 5 and 12 percent of Denmark’s electricity mix in recent years.

The situation will only worsen. Germany and Denmark now plan to increase their share of intermittent wind and solar power capacity and reduce baseload power sources such as nuclear reactors and coal-fired plants.

At some point this beggar-my-neighbor policy of using imports and exports to balance supply and demand will cease to function; the amount of variable wind and solar power output will be too large.

Regardless of the cost per watt, the current reliance on massive subsidies to build variable energy capacity isn’t sustainable. European consumers eventually will weary of paying higher electricity costs.

Around the Portfolios

Over the long term, oil and gas services outfit Weatherford International (NYSE: WFT) stands to benefit from the end of easy oil, or the reality that producers must step up drilling in complex plays to offset declining production from the world’s mature, onshore oil fields.

This search for incremental output growth has prompted oil and gas producers to invest heavily in exploring and developing the Canadian oil sands, deepwater fields, and tight oil and gas formations such as the Bakken Shale in North Dakota and the Marcellus Shale in Appalachia.

Extracting hydrocarbons from these challenging fields requires producers to spend heavily on services and technology from the Big Four providers: Baker Hughes (NYSE: BHI), Halliburton (NYSE: HAL) Schlumberger (NYSE: SLB) and Weatherford International.

Although the product and service lines offered by the Big Four tend to overlap, each company’s relative performance depends on its specialties and geographic emphasis.

Weatherford International’s North American operations accounted for about 40 percent of the firm’s annual revenue in 2010, but that percentage has declined steadily in the past five years. The company now operates in more than 100 countries and generates about 60 percent of its earnings outside North America. Of the Big Four, Weatherford International also has the most exposure to the Canadian market.

Weatherford International, however, should enjoy additional upside because of its industry-leading suite of artificial-lift solutions that enhance output from oil and gas reservoirs in which the natural geologic pressures have dissipated. Horizontal wells drilled in oil and liquids-rich shale plays generate twice the artificial- lift sales as traditional North American wells. Expect robust drilling activity in these unconventional plays to support fast-rising demand for artificial lift.

Meanwhile, any slowdown in North American revenue growth should be offset by recovering demand and pricing power in international markets. During a recent conference call to discuss third-quarter earnings, Weatherford International CEO Bernard Duroc-Danner reiterated his bullish outlook for revenue growth in Mexico, South America and Russia.

A bargain at current prices, shares of Weatherford International rate a buy up to 28.

Meet Me at the Summit

Don’t miss out on this unique opportunity to hear me, Roger Conrad, Yiannis Mostrous, Benjamin Shepherd, David Dittman and Jim Fink share their latest insights on the markets and economy. Join us at Investing Daily’s 2012 Wealth Summit at the luxurious Four Seasons Hotel in Palm Beach, FL on May 4-5, 2012.

With the US economy likely to grow at a lackluster pace over the next few years, expect the stock market to suffer through a period of extreme volatility as investors adjust to the new normal. The EU’s ongoing sovereign-debt crisis will also continue to enervate investors. Throw in “Black Swan” events such as the civil war in Libya, and it’s easy to see why investors are on edge. A fearmongering media that focuses on worst-case scenarios rather than the likely outcomes doesn’t help matters.

But Investing Daily’s 2012 Wealth Summit will give you the edge in these uncertain times. This year’s event will focus on winning investment strategies that generate profits in both up and down markets. To learn more about this must-attend Wealth Summit, go to InvestingSummit.com or call 1-800-832-2330 for more details.