Earth, Wind and Fire
If there’s one segment of the energy industry that’s often overhyped, it’s alternative and renewable technologies. Proponents speak of these technologies as the key to solving both the world’s dependence on increasingly scarce, expensive fossil fuels and reducing pollution.
Although alternative energy has a role to play, none of these technologies represents a magic solution for global energy issues. In fact, one of the factors that surprised me most at this year’s Energy Information Administration (EIA) energy conference in early April was how little was said about alternative energy technologies, such as wind and solar. The reality is that neither of these technologies can replace oil-, natural gas-, nuclear- and coal-fired facilities.
Although these technologies won’t quench the world’s thirst for oil, there are still some compelling investment opportunities in the space. Wind and solar are two of the fastest-growing subsectors within my coverage universe. Not surprising, the alternatives field bet—my diversified play on the group—has been among the best-performing plays in The Energy Strategist, returning nearly 75 percent on average since inception in early 2007.
Although certainly factors in global energy, renewables aren’t the silver bullet to solving all the problems with fossil fuels. The former is often unable to generate the type of capacity necessary to meet demand, or if such a source is able, it needs the added support of fossil fuels to truly be effective on a larger scale. See The Trouble with Alternatives.
Alternative energy doesn’t have to be the end-all, be-all energy solution, though, to be a good investment. Government incentives and increasingly efficient technology are helping to increase the use of such sources. See Investing Opportunities.
I introduced an alternatives field bet about 18 months ago to play some of the varied companies in this sector. Wind power companies continue to perform well. But several factors look to impede growth in solar cell companies, so I’m taking some profits off the table in that area. I’m also adding some new plays to the field bet. See Wind over Solar.
Uranium mining stocks are selling off, but it’s supposedly created takeover interest in two of my uranium field bet recommendations. See Portfolio Update.
I’m recommending or reiterating my recommendation in the following stocks:
Demand for energy is rising globally. Although the fastest growth is found in emerging markets, the developed world also needs more power. China must build one new coal-fired power plant every seven to 10 days just to keep pace with rapidly rising demand; that’s the size equivalent to building the entire UK’s annual capacity. And despite these Herculean efforts, the country still suffers from periodic blackouts.
And consider the case of the US. Short-term economic slowdowns aside, as I pointed out in the April 23 issue, Electric Charge, US demand for electricity is rising at a faster pace than capacity. This threatens the reliability of America’s electric grid.
The North American Electric Reliability Council (NERC) is charged with ensuring the reliability of the US and Canadian power and transmission systems. NERC divides North America into eight sections when analyzing the grid and provides a long-term reliability assessment for each of those regions annually. NERC’s 2007 long-term reliability assessment makes for some troubling reading.
One of the more important statistics to monitor is capacity margin, a measure of how much spare generation capacity a particular region has at times of peak demand. So, for example, if a particular region has a capacity margin of 15 percent, electricity generation capacity (electric supply) exceeds demand by 15 percent at times of peak usage. The higher the capacity margin, the more reliable the grid.
Margin acts as a sort of cushion against problems such as temporary shutdowns at certain plants or sudden spikes in demand because of a heat wave. Peak electricity demand typically occurs in the summer months; this is when capacity margins tend to shrink to their lowest levels for the year.
In evaluating future capacity margins, NERC looks at likely future electricity demand and new power plant construction. NERC divides proposed capacity into two parts: committed capacity resources and uncommitted resources. To make a long story short, committed resources are plants that have already been approved or are under construction; these are highly likely to be available as forecast. Uncommitted resources are less assured.
Consider that, by 2016, NERC estimates New England will have a summertime capacity margin of minus 2.3 percent, even including uncommitted resources. That means demand will actually exceed available supply in the summer months. The region will drop below what’s considered a safe, reliable capacity margin starting in 2009.
The same basic picture is true in many western states. For example, California will see a capacity margin of 9.8 percent in 2016, including uncommitted capacity, and just 3.5 percent calculated on committed capacity alone. New Mexico and Arizona will actually see negative capacity margins by 2016.
Although the US and Canada don’t need to build power plants as quickly as China to meet growing demands, it’s ridiculous to assume that these nations’ existing base of plants will be sufficient to meet demands forever. Electricity demand is growing, and if grid reliability is to be maintained, new capacity is sorely needed. And the same basic situation is repeated in many countries the world over.
But if these factors define the problem, the solution is less obvious. And the situation is made more complex by environmental issues. For years, most developed countries have regulated power plant emissions, such as sulphur dioxide and nitrous oxide. And in China, pollution is becoming an ever-larger problem; the nation is home to seven of the world’s 10 most polluted cities.
The Chinese government has become increasingly concerned about pollution because it has begun to impact the nation’s economy in meaningful ways. In addition, China doesn’t want to look polluted during this year’s Summer Olympic Games.
Then there’s the issue of climate change. Opinions vary greatly as to the importance of climate change and the speed at which these shifts are occurring. I’m not a climate scientist, and there are others far better qualified to assess those questions than I. The good news is that, as investors, we don’t really need to inject ourselves into this argument.
The important point is that regulations on carbon emissions have been imposed in many regions of the world, and it’s highly likely that the US will eventually put an emissions reduction scheme in place. As investors, we can’t ignore these shifting political trends and public sentiment; carbon regulations will have an effect on energy-related stocks.
As I explained at length in the April 23 issue, the potential for new carbon regulations is one major factor governing utilities decisions regarding new plant construction. The need to build new power plants to maintain an efficient, reliable grid is balanced by the need to choose technologies that reduce carbon emissions.
In the midst of this complex interplay of supply, demand and environmental considerations, the unfortunate temptation of many pundits is to search for a silver bullet, some technology that will solve all the world’s energy needs in one fell swoop. The bad news is that technology simply doesn’t exist.
The real solution to the global energy puzzle is manifold: Traditional fossil fuels, nuclear power, renewable energy and energy efficiency all have important roles to play. And the solutions to the energy puzzle are likely to be different for the US, China and Europe.
Unfortunately, renewable, or alternative, energy is the solution most often proposed. Various proponents of wind, solar and/or geothermal power will tell you that their technology can reduce pollution and break dependence on imported energy commodities. This is naive at best and potentially quite dangerous. For example, as I pointed out in last week’s issue of The Energy Letter, Coal Investors Take Their Lumps, feckless opposition to new coal plant construction can have the perverse effect of drastically increasing emissions of pollutants from sulphur dioxide to greenhouse gases.
The truth is that wind, solar and other technologies all have a role to play in the global energy pie. But these technologies won’t replace traditional fossil fuels and nuclear power plants. It’s important to recognize the limitations inherent in many alternative energy technologies. Chief among those is their variability.
Electrical power isn’t stored on the grid; the grid must, therefore, balance at any given time with supply meeting demand. Unfortunately, most alternative energies, including wind and solar, are inherently variable.
I’ve discussed this problem on a few occasions, including in the June 29, 2007, issue of The Energy Letter, Tilting at Windmills. To summarize, power output from a wind turbine is related to the cube of wind speed. Therefore, a doubling in wind speed produces an eightfold increase in power output; even minor changes in wind speed have major impacts on the power supplied to the grid.
A recent article in the Oil & Gas Journal offered a few interesting facts about wind power. The generating capacity—the maximum power output—of wind turbines is rated assuming a wind speed of roughly 30 to 32 miles per hour. If the wind speed drops to 80 percent of that level, the actual output from a wind turbine will be just half its rated capacity.
And anyone who lives near a wind farm will tell you that, oftentimes, many of the turbines aren’t turning at all. That’s because a minimum wind speed of around 10 miles per hour is required to power the plant. At that minimum wind speed, the turbines power output is just 3 percent of rated capacity.
Consider the impact of this variability across a large array of turbines. According to the Oil & Gas Journal, Texas will have 10,000 megawatts of installed wind capacity by 2011; new wind farms planned for the next few years will add 10,000 turbines. The wind corridor between Amarillo, Texas, and Dodge City, Kan., represents one of the regions in the lower 48 states with wind conditions most suitable for the large-scale rollout of wind farms. See the chart below for a look at total US wind power generation.
Source: Energy Information Administration (EIA)
The Oil & Gas Journal also notes, using actual wind data collected in 2003, that capacity factors for wind power plants in the region routinely rise or fall by 60 percent within a 12-hour period. Keep in mind that power generated during times of ideal wind conditions can’t be stored on the grid to offset the calmer times. To balance these surges and lulls would require 15 to 20 large-scale natural gas peaking plants that can be started or stopped quickly to feed power into the grid.
Not surprising, this is the same problem that Germany, the world’s largest single wind power market by capacity, has experienced in recent years. Check out the chart of Germany’s wind power capacity below.
Source: Global Wind Energy Council, Global Wind 2007 Report, Second Edition, May 2008
This chart shows Germany’s total wind power generating capacity since 2000 in megawatts. Growth in the German market has been tremendous, with capacity soaring by more than 3.6 times over this period. Germany remains the world’s largest wind power market just ahead of the US, which has around 17,000 installed megawatts.
As I highlight later on in this issue, the main impetus for this growth has been a generous feed-in tariff structure that subsidizes wind power with generous guaranteed rates.
But recall the difference between capacity and generation. As I highlight above, wind turbines rarely operate at their full rated capacity. Check out the chart of Germany power sources.
Source: International Energy Agency (IEA)
These data are from 2005, the last year for which the IEA supplies actual data on electricity generation. But the picture here is obvious. Despite rapid growth in installed wind capacity in Germany, wind is a comparatively minor contributor to actual electricity supply, accounting for only 4.3 percent of generation in 2005. Coal, nuclear and natural gas remain the real workhorses of the grid, accounting for a combined 87 percent of Germany’s grid in 2005.
And that’s only the beginning. Germany’s major grid operator, E.ON Netz, has published a series of reports over the past few years that highlight some of the problems it’s experienced integrating wind energy onto the grid.
To summarize, E.ON states that expanding wind’s contribution to the grid also means building new traditional (fossil fuel) power plants. These new plants are used to supply additional power to the grid during periods when wind power lulls because of low wind speeds. This reserve shadow capacity is the equivalent of the 15 to 20 gas peaking plants Texas will need to maintain reliability as it expands wind capacity.
E.ON estimates that shadow fossil fuel capacity covering 90 percent of new wind capacity installed is necessary to maintain grid integrity. Therefore, increasing wind power capacity actually increases demand for fossil fuels and, in particular, natural gas; wind and gas are two power sources absolutely joined at the proverbial hip.
In its 2005 wind report, E.ON proposes an objective measure of wind’s contribution to the German power grid and the extent to which wind can replace traditional plants. E.ON examined what contribution wind can make to guaranteed power capacity. In other words, because the output from wind plants is variable by definition, the capacity of that plant isn’t guaranteed. In contrast, coal and nuclear plants can run at close to their capacity for long periods of time; this capacity is guaranteed.
E.ON noted that two major studies of Germany’s power system indicated wind made roughly an 8 percent contribution to Germany’s power capacity. Ironically, however, this contribution falls as wind capacity rises. Check out this excerpt from E.ON’s report:
Source: E.ON Netz, Wind Report 2005
What E.ON is saying is that, as Germany adds more wind power capacity to its grid, the surges and lulls in power from those plants will have an ever-greater impact on the system’s reliability. To offset that will require more dependence on traditional plants; wind won’t be able to replace fossil fuel capacity.
In fact, E.ON went on to estimate that, by 2020, Germany’s wind power capacity will top 48,000 megawatts, more than double the current level. But that 48,000 megawatts of wind capacity will only be able to truly replace 2,000 megawatts of traditional power production. To put that into context, after years of aggressive build-out of wind capacity and heavy subsidies, wind farms in Germany will only replace the equivalent of one to two large-scale nuclear facilities.
My point in highlighting these examples isn’t to disparage wind or renewables. Instead, I want to underline the need to appreciate the complexity of the world’s energy problem. Renewables can play a role in solving these issues, but they aren’t a perfect alternative.
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The prime driver of that growth is governments. In Europe, the US and even developing countries such as China, governments offer subsidies, tax breaks and other incentives to encourage the development of non-fossil-fuel alternatives.
These subsidies take many forms. For example, in the US, the production tax credit (PTC) covering wind and other renewables gives producers a 2-cent-per-kilowatt-hour tax credit for electricity generated with wind turbines over the first decade of a project’s operation. The PTC is set to expire at the end of 2008; it wasn’t renewed and extended beyond 2008 as part of the Energy Independence and Security Act of 2007.
That said, it’s likely the PTC will be renewed and extended at some point this year. And even if that fails to pass, most believe that the PTC will be renewed retroactively in 2009. There isn’t much resistance to the PTC on either side of the political spectrum; it’s tough for any politician to oppose alternative energy.
In addition to this federal policy, several states have enacted additional renewable energy mandates and incentives. The most common is a renewable portfolio standard (RPS). Under an RPS, the state actually mandates that a certain percentage of electricity is produced from renewable sources. Usually, this required contribution rises gradually over time.
A total of 25 states and the District of Columbia have some sort of RPS requirement, and three states have enacted less-formal goals. The form of the RPS deals varies wildly.
Some states have imposed fines and other “sticks” to attempt to meet their goals, while others’ RPS legislation is relatively toothless. Some states appear to be enacting unrealistic RPS goals without offering any real path for achieving those targets—classic politics. At any rate, on the margin, RPS standards do encourage faster growth in alternative energy installations.
In Europe, a more common structure is the feed-in tariff. Such a law has existed in Germany since 1991 and is widely credited with that nation’s rapid wind power build-out. Under Germany’s latest Renewable Energy Resources Act (Erneuerbare-Energien-Gesetz), passed in 2000, renewable energy is given preferential access to the grid.
In addition, the law provides for a fixed, generous feed-in tariff for each kilowatt-hour of energy produced from renewable sources. The exact subsidy depends on the efficiency of the installed plant and the type of renewable energy being supported.
Typically, over time, that feed-in tariff is gradually reduced. With solar, for example, Germany’s feed-in tariff structure becomes gradually less generous in coming years, with the idea that this declining subsidy preserves economic incentives to continually reduce costs and enhance efficiency over time.
Feed-in tariffs can be expensive. In 2004, for example, E.ON estimates that the subsidy amounted to EUR2.35 billion (USD3.8 billion) for wind generators alone. More recently, the subsidy for solar power suppliers has come under political attack; some in Germany are calling for an immediate 30 percent cut in tariffs to help offset the rapidly rising cost.
You often hear politicians speak of using subsidies for alternatives as a means to help these technologies achieve “grid parity.” The idea is that, over time, the cost of generating power from alternatives has a tendency to fall. Wind plants become more efficient, and solar cell efficiency increases. Eventually, the cost of generating power from these sources will fall in line with the average cost of power from the grid or grid parity.
Broadly speaking, wind has already achieved grid parity in many markets thanks to improvements in turbine efficiency and construction techniques. Solar is several years away from grid parity, though progress is being made. Even the most-promising technologies probably won’t achieve that yardstick until at least 2012. And that timetable is based on some aggressive, optimistic assumptions.
But achieving grid parity isn’t the same as replacing traditional fossil-fuel capacity. As I noted above, the main problem with renewables is the inherent variation in their output. In addition, there are regional variations in the cost of producing power from wind and solar; weather conditions certainly aren’t ideal in all locations.
Bottom line: The combination of generous subsidies and improving efficiency is powering significant growth in renewable energy despite its drawbacks. For example, according to the US Energy Information Administration, US wind power generation will grow at 6.7 percent annualized between 2005 and 2030, while solar pholtovoltaic (PV) will grow at close to 20 percent annually over the same time period. For reference, total US electricity generation is expected to grow at 1.2 percent between 2005 and 2030.
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For those unfamiliar with my field bet concept, it’s designed to be a diversified mini-portfolio aimed at playing major multiyear trends in the energy markets. Instead of recommending just one or two high-risk plays, I offer a list of five to 10 specific picks in each sector. I recommend that subscribers place a small amount of capital in each stock.
Although each pick may be risky on its own, as a whole, the list offers a safer, more-diversified play. This general strategy has paid off handsomely for us in the past.
For example, within the alternatives recommendations, the overall field bet is up sharply thanks to a handful of stocks that have gained more than 50 percent. These big winners have more than balanced out the laggards in the table. Here’s the current alternatives field bet table.
Source: The Energy Strategist
As this table shows, the alternatives field bet has performed well since inception, with the average recommendation up a healthy 75 percent in just under 18 months. Also, I cut my recommendations and recommended taking partial profits on three big winners—SunPower Corp, US Geothermal and Vestas Wind Systems—in the Jan. 2 issue, Taking Stock of 2007. If you followed that advice, your total return is closer to 90 percent since inception.
As highlighted above, there’s plenty of growth to come from the alternatives space in coming years. With the growing global trend toward regulating carbon emissions, I suspect the subsidy impetus behind the groups is likely to remain strong.
That said, it’s time to shift the focus of the field bet slightly. I prefer exposure to wind power over solar power at this time for a few key reasons:
Potential Supply Glut
Currently, demand in the solar power industry remains rock solid, particularly in Europe. In its first quarter conference call, for example, SunPower actually raised its guidance for the rest of the year and mentioned that its customers remain optimistic about growth.
However, the problem is that a significant amount of solar cell manufacturing capacity has been coming online in recent months or will soon come online. Therefore, the industry’s capacity to produce cells is growing rapidly.
Early projections are that cell manufacturing capacity will grow by roughly 80 to 100 percent in 2009. Although it’s too early to know for sure, there’s potential for this cell supply to overwhelm demand near term, even with demand growing at greater than 40 percent annualized.
If that scenario unfolds, the likely response in the industry would be to cut prices in an attempt to compete. That would negatively impact profit margins. SunPower is forecasting a double-digit drop in average selling prices for 2009.
Subsidy Uncertainty
As I noted earlier, there’s been talk of late in Germany about decreasing the subsidies for solar to cut the cost of promoting the technology. In Spain, the feed-in tariff structure that promotes solar is scheduled for review later this year. And in the US, there remains uncertainty regarding the renewal of the PTC.
Although some of these issues affect wind as well as solar, their impact on solar would likely be more profound because solar remains far more expensive than grid-supplied power and is, therefore, more reliant on subsidies and incentives for growth. Firms looking to invest in solar may look to wait until there’s clarification about the potential size of subsidies.
Residential Markets Slowing
Not all solar cells are used in large-scale power plants. A significant part of this market is the sale of individual power modules to be placed on homes to help supplement power from the grid.
Because the US is a significant market for residential-installed solar cells, rapidly falling housing starts and declining real estate trends could well have a significant negative impact on growth. Akeena Solar already warned of this problem in its most recent quarterly conference call.
Price of Polysilicon
The key raw material in the most widely used type of PV solar cell is polysilicon. Poly has been in extremely short supply lately; the shortage of this material has actually meant that producers haven’t been running close to full capacity.
As a result of this shortage, the price of poly has risen dramatically. For solar cell firms buying poly outside of long-term contracts, that spells rising costs and tighter margins.
Another factor to watch with polysilicon is that a good deal of additional supply is due on the market heading into 2009. This supply is scheduled to come from producers starting up new production facilities for the key raw material. As poly supply constraints ease, it may have the positive effect of offsetting rising raw material costs.
However, there’s a dark side to that argument. Many producers have been cutting back on their solar cell production because of poly shortage. As that shortage eases, these producers will likely push up their solar cell production toward maximum levels. There’s a good chance this will further exacerbate a potential glut in the industry starting next year.
None of these factors spells an end to growth in solar. But, for the first time in years, there’s real risk of an important slowdown in solar-related firms toward the end of 2008.
Slowing growth could be a problem because these stocks are still pricing in strong growth through 2009 and are valued accordingly. If that growth slows or disappoints, there’s room for considerable downside in these stocks.
In contrast to solar, I see little evidence of a slowdown in demand or interest in wind-power generation. Further, this market looks to remain tight over the next few years. The rising costs of natural gas, oil and even coal make wind more competitive from a strict cost standpoint, encouraging build-out even with relatively small subsidies.
Vestas Wind reported stronger-than-expected first quarter results. The company’s net income doubled in the first quarter over the same quarter a year ago. At the same time, the firm’s backlog of unfinished projects rose a further 20 percent; a rising backlog is a sign that demand continues to outstrip supply.
Vestas’ management commented that, despite its build-out of turbine construction capacity, it would be “some years” before capacity in the industry rises far enough to meet demand. The company further noted that there’s such an acute shortage of components for wind turbines that lead time for those sensitive components has lengthened to as long as 15 months.
To adjust the field bet portfolio to reflect these trends, I’m upgrading Vestas Wind Systems from a hold back to a buy. The company’s first quarter report suggests there’s further upside in the stock. And Vestas remains a global leader in wind turbines, owning a stake in roughly a third of the market.
I’m also encouraged that Vestas has scope to continue to boost profit margins. Management is targeting earnings before interest and taxation (EBIT) profit margins of 10 to 12 percent, up from 9.1 percent last year.
I’m also downgrading Germany-based solar play SolarWorld from a buy to a hold and recommending all subscribers take half their profits in the stock off the table. Based on my initial recommended entry point on Jan. 24, 2007, total profits in SolarWorld are more than 45 percent.
Although SolarWorld remains a key player in the solar market, my recommendation to take profits has nothing to do with stock-specific issues. Rather, this is an industry call: I’m worried about risks to overall growth in the solar power market in the near term.
I recommended taking a third of your profits off the table in SunPower back in the Jan. 2 issue. At that time, SunPower was up 208 percent from my original recommendation; since that time, the stock has pulled back.
What attracted me to SunPower originally was that the company’s solar cells are the most efficient in the business when it comes to converting the sun’s energy into electricity. SunPower’s cells have a 22 percent efficiency rate, compared to an industry average in the teens. This means SunPower’s cells can produce the same amount of power as competitors’ offerings using a smaller cell. That advantage has helped SunPower grow faster than the industry at large.
Given the potential for more widespread weakness in solar firms, I recommend using the recent rally in SunPower to further lighten up on the stock. I recommend selling a third of your remaining position in SunPower Corp to book a 115 percent gain from my original recommendation. SunPower Corp remains a hold in the alternatives field bet.
My only buy-rated recommendation on solar power is MEMC Materials. This company produces polysilicon wafers that are used primarily by two industries, semiconductor chipmakers and solar power firms.
To make a long story short, the semiconductor market has been weak lately, a trend that continued in MEMC’s first quarter report. The company mentioned that demand indications from semi customers were a bit weaker than normal, leading to additional price declines.
However, the weakness in polysilicon and wafers for semiconductor markets has been more than offset by strength in solar. MEMC Material’s management team was unambiguous in stating that it’s seen no signs of weakness when it comes to selling raw polysilicon or wafers into the solar industry.
Several analysts on the company’s first quarter call asked, in one way or another, about the potential for weakness in pricing, and MEMC stated it sees no sign of that, either.
The main concern hanging over the company is the same as the solar industry at large—rapidly rising polysilicon production capacity. The fear is that, as this new material comes online, MEMC will see margins pressured. But I see two main factors offsetting this risk.
First, MEMC warned earlier this year that first quarter earnings would miss expectations. The problem amounted to MEMC’s inability to bring new production online as quickly as expected. If a major producer like MEMC has a tough time bringing new capacity to bear, you have to wonder about startup producers scheduled to open new plants in coming years. Simply put, poly supply growth is less assured than the raw numbers might suggest.
Second, MEMC has lowered risk by selling poly under long-term supply deals at attractive pricing. In many cases, these supply deals cover production over a 10-year period. This lowers the risk of pricing decline.
Finally, MEMC’s recent conference call struck a conservative note. Management was careful to note that it missed expectations in the first quarter because of problems ramping up capacity; the company seemed to suggest that it doesn’t want to disappoint again and, therefore, is taking a conservative, overly pessimistic tact.
And it appears the production problems that plagued the firm in the first quarter are firmly in the rearview mirror. In fact, new production facilities are coming online sooner than initially planned.
This all suggests that MEMC has scope to exceed estimates later on this year. Buy MEMC Materials.
In this issue, I’m also adding First Solar to the alternatives field bet as a buy recommendation. First Solar is a leader in the so-called thin-film solar market.
Thin-film solar differs from the type of solar cells used by the likes of SunPower. First Solar’s cells are less than half as efficient as SunPower’s. Although that may seem a disadvantage at first glance, that’s not necessarily the case.
First Solar’s cells also don’t require polysilicon; therefore, the company hasn’t been negatively impacted by the major poly shortage that’s impacted the industry in recent years. Moreover, First Solar’s cells are cheaper to produce than typical polysilicon-based solar cells.
It’s likely this technology will achieve full grid parity before traditional poly PV cells. Even if the overall solar industry sees a downturn, First Solar should be relatively insulated, thanks to its low-cost base.
In First Solar’s first quarter conference call, management stated that the company is about 80 percent contracted in 2008 under long-term deals. Although management wouldn’t indicate its contract position for 2009, the firm suggested that it does layer in significant long-term contracts to help guarantee revenues. This further lowers First Solar’s risk even if the solar market does slow down. Buy First Solar.
To add to our wind exposure, I’m also adding Hansen Transmissions. Hansen is the world’s second-largest manufacturer of gearboxes used to make wind turbines; as such, the company serves all of the world’s main wind-turbine manufacturers. Gearboxes are an absolutely crucial part of wind turbines, and demand for these components rises with demand for wind power.
That said, Hansen is close to three-quarters owned by India’s Suzlon, one of the world’s largest wind-turbine manufacturers. Suzlon sold a minority stake in Hansen last December in an initial public offering (IPO) on the London exchange.
Hansen is based in Belgium and currently has capacity to manufacture 2.2 gigawatts of gearboxes there. The company has plans to increase that factory’s capacity to 6 gigawatts this year, nearly tripling capacity.
And Hansen is also building additional plants in India and China, with total capacity of roughly 8 gigawatts combined. These plants will help Hansen more effectively serve these fast-growing, emerging wind power markets. That capacity is due online in 2011.
In its most recent quarterly report, Hansen showed a 59 percent jump in profit against the year-earlier period and growth should remain on track as Hansen brings its new plants online over the next three years. Buy Hansen Transmissions.
And Hexcel Corp remains a play on both the growth of wind power and the global drive toward higher energy efficiency. Hexcel manufactures carbon fiber and related components.
Wind-turbine blades are typically made from carbon fiber rather than fiberglass. Carbon-fiber blades are lighter and stronger, which allows manufacturers to build larger turbines without the risk of the blades bending or cracking.
Larger turbines are far more efficient at producing electricity. The industry is trending toward using bigger blades, playing right into the hands of Hexcel.
In addition, Hexcel’s main market remains building carbon-fiber parts for the aircraft industry. Traditionally, airplanes have been made mainly of aluminum and related alloys; however, that’s changing as aircraft manufacturers seek to lower the overall weight of planes in an effort to increase fuel efficiency.
The most efficient commercial aircraft in the world today is Boeing’s new 787 Dreamliner—roughly 40 percent more efficient than existing airplanes its size. With jet fuel trading at sky-high levels, airlines are lining up to buy planes from Boeing; the company has a multiyear order backlog.
The main way Boeing drove fuel efficiency in the plane was to reduce the use of aluminum in favor of lighter, stronger carbon-fiber parts. The plane is truly revolutionary in its design. Hexcel is a primary supplier of these key components.
Hexcel recently released first quarter earnings that significantly topped analysts’ expectations, and the stock jumped the most in four years on the news.
One cloud hanging over Hexcel has been the delays in the release of the Dreamliner. In total, the plane has already been delayed roughly 14 months from Boeing’s original production schedule, and we can’t rule out further push-backs. Hexcel’s management admitted this clouds the firm’s near-term outlook.
But judging from the stock’s positive reaction to the conference call, the worst of the Boeing 787 delay news is already priced in to Hexcel. In addition, Hexcel announced it has more leverage to the 787 program than originally assumed: Management stated that each plane will contain about $1.6 million worth of Hexcel parts against its prior estimates of $1.3 million.
A play on both increased energy efficiency and rising demand for wind power, Hexcel Corp rates a buy.
I’m also adding exposure to a brand new alternative energy sector as of this issue: waste-to-energy. Covanta Holding Corp builds and runs plants that burn municipal solid waste—common household waste—to produce energy.
Waste-to-energy offers two key advantages. First, burning waste reduces the total volume of trash that must be permanently buried in landfills. Landfill capacity is extraordinarily limited in most developed countries, including the US. This is particularly true in certain regions of the US such as the Northeast; landfill capacity in the region is highly limited and is typically located relatively far away from population centers, increasing transport costs.
With landfill capacity limited, waste disposal companies have been able to increase the disposal—or tip fees—they charge to municipalities for landfill waste.
The other advantage of waste-to-energy is that it produces energy from waste, taking an otherwise useless commodity and putting it to good use. A side benefit from an environmental perspective is that rotting waste produces methane gas, a greenhouse gas many times more powerful than carbon dioxide. Waste-to-energy plants, therefore, reduce the carbon emissions of landfills; this may qualify such facilities for carbon credits.
Covanta is a leader in the US waste-to-energy market. The company owns a total of 34 waste-to-energy facilities in the US located in 15 states. Covanta’s largest area of operation is the Northeast US, the area with the most acute shortage of landfill capacity.
Twenty-four of Covanta’s waste-to-energy plants operate on a fixed-fee structure, where the firm gets a fee for handling waste. That fee increases over time because of a pre-set formula.
In addition, Covanta operates 10 plants under a tip-fee structure, through which the company receives per-ton revenues and keeps most or all the revenues generated by selling electricity produced at the plants.
All of Covanta’s projects were originally built and contracted under long-term deals. However, a number of these contracts are due for renewal over the next few years. That said, waste firms have been successful recently in actually raising prices for disposal services. There’s no reason to believe Covanta won’t be able to roll over longer-term contacts at attractive rates.
There are also plenty of growth opportunities abroad. The company is part of a joint venture in China that owns a stake in two operating waste-to-energy plants. And in Europe, Covanta owns a stake in a smaller waste-to-energy plant in Italy.
China has expressed interest in increasing the amount of waste it disposes in such plants in the coming years. In Europe, the UK and Germany—among others—have been passing laws that will require reductions in landfill waste volumes. Several contracts for new plants are in the works and will likely be awarded over the next two years.
As a world leader with proven technology, Covanta is considered a lead bidder on such deals. Covanta Holding Corp is added to the alternatives field bet as a buy.
Rounding out my alternatives field bet are EDF Energies Nouvelles and US Geothermal. EDF Energies Nouvelles is Electricite de France’s renewable energy unit; the company primarily owns a portfolio of wind power farms in Europe and the US. The firm is still 50 percent owned by EDF, France’s dominant electric utility.
Energies Nouvelles recently reported a doubling in revenues over the same quarter a year ago. About half the company’s income comes from actually operating wind farms and other renewable energy assets. The other half comes from developing and selling wind farms to other operators.
For example, EDF was recently selected to build five major wind farms in Quebec. Buy EDF Energies Nouvelles.
Finally, US Geothermal has completed its Raft River geothermal plant and is now working on a new geothermal project, the Neal Hot Spring play in Oregon. I’m particularly pleased to see that the firm managed to move its listing from the over-the-counter market to the American Stock Exchange; typically this is a sign of improving financial stability.
US Geothermal remains a high-risk, volatile play; I’m retaining my hold recommendation on the stock for now until we see more signs of progress on its newest project.
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In particular, Paladin Resources is rumored to be of interest to Cameco. With its portfolio of producing and near-producing uranium mines, Paladin would represent a low-cost way for Cameco to add to reserves and production near term. Paladin Resources remains a buy within my nuclear field bet.
Beleaguered miner Uranium One has also been in the news lately. The company stated that it’s interested in selling its Honeymoon mine in Australia to focus attention on its more-advanced projects, such as the Dominion mine in South Africa and its smaller projects in the US. Uranium One is also considered a possible takeover target for Cameco. Uranium One remains a buy in the nuclear field bet.
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Neil, Roger and I will discuss infrastructure, partnerships, utilities, resources and energy, and tell you what to buy and what to sell in 2008.
Click here or call 800-970-4355 and refer to priority code 011361 to attend as our guest.
Although alternative energy has a role to play, none of these technologies represents a magic solution for global energy issues. In fact, one of the factors that surprised me most at this year’s Energy Information Administration (EIA) energy conference in early April was how little was said about alternative energy technologies, such as wind and solar. The reality is that neither of these technologies can replace oil-, natural gas-, nuclear- and coal-fired facilities.
Although these technologies won’t quench the world’s thirst for oil, there are still some compelling investment opportunities in the space. Wind and solar are two of the fastest-growing subsectors within my coverage universe. Not surprising, the alternatives field bet—my diversified play on the group—has been among the best-performing plays in The Energy Strategist, returning nearly 75 percent on average since inception in early 2007.
In This Issue
In this week’s issue, we’ll review the alternatives industry and my alternatives field bet, recommending some changes and new additions to take advantage of current trends.Although certainly factors in global energy, renewables aren’t the silver bullet to solving all the problems with fossil fuels. The former is often unable to generate the type of capacity necessary to meet demand, or if such a source is able, it needs the added support of fossil fuels to truly be effective on a larger scale. See The Trouble with Alternatives.
Alternative energy doesn’t have to be the end-all, be-all energy solution, though, to be a good investment. Government incentives and increasingly efficient technology are helping to increase the use of such sources. See Investing Opportunities.
I introduced an alternatives field bet about 18 months ago to play some of the varied companies in this sector. Wind power companies continue to perform well. But several factors look to impede growth in solar cell companies, so I’m taking some profits off the table in that area. I’m also adding some new plays to the field bet. See Wind over Solar.
Uranium mining stocks are selling off, but it’s supposedly created takeover interest in two of my uranium field bet recommendations. See Portfolio Update.
I’m recommending or reiterating my recommendation in the following stocks:
- Covanta Holding Corp (NYSE: CVA)
- EDF Energies Nouvelles (France: EEN, OTC: EDFEF)
- First Solar (NSDQ: FSLR)
- Hansen Transmissions (UK: HSN, OTC: HSNTF)
- Hexcel Corp (NYSE: HXL)
- MEMC Electronic Materials (NYSE: WFR)
- Paladin Resources (Australia: PDN, TSX: PDN, OTC: PALAF)
- Uranium One (TSX: UUU, OTC: SXRZF)
- Vestas Wind Systems (Denmark: VWS, OTC: VWSYF)
- SolarWorld (Germany: SWV, OTC: SRWRF)
- SunPower Corp (NSDQ: SPWR)
- US Geothermal (OTC: HTM)
The Trouble with Alternatives
It’s human nature to seek an easy solution to complex global problems. The world’s energy problem is just one example.Demand for energy is rising globally. Although the fastest growth is found in emerging markets, the developed world also needs more power. China must build one new coal-fired power plant every seven to 10 days just to keep pace with rapidly rising demand; that’s the size equivalent to building the entire UK’s annual capacity. And despite these Herculean efforts, the country still suffers from periodic blackouts.
And consider the case of the US. Short-term economic slowdowns aside, as I pointed out in the April 23 issue, Electric Charge, US demand for electricity is rising at a faster pace than capacity. This threatens the reliability of America’s electric grid.
The North American Electric Reliability Council (NERC) is charged with ensuring the reliability of the US and Canadian power and transmission systems. NERC divides North America into eight sections when analyzing the grid and provides a long-term reliability assessment for each of those regions annually. NERC’s 2007 long-term reliability assessment makes for some troubling reading.
One of the more important statistics to monitor is capacity margin, a measure of how much spare generation capacity a particular region has at times of peak demand. So, for example, if a particular region has a capacity margin of 15 percent, electricity generation capacity (electric supply) exceeds demand by 15 percent at times of peak usage. The higher the capacity margin, the more reliable the grid.
Margin acts as a sort of cushion against problems such as temporary shutdowns at certain plants or sudden spikes in demand because of a heat wave. Peak electricity demand typically occurs in the summer months; this is when capacity margins tend to shrink to their lowest levels for the year.
In evaluating future capacity margins, NERC looks at likely future electricity demand and new power plant construction. NERC divides proposed capacity into two parts: committed capacity resources and uncommitted resources. To make a long story short, committed resources are plants that have already been approved or are under construction; these are highly likely to be available as forecast. Uncommitted resources are less assured.
Consider that, by 2016, NERC estimates New England will have a summertime capacity margin of minus 2.3 percent, even including uncommitted resources. That means demand will actually exceed available supply in the summer months. The region will drop below what’s considered a safe, reliable capacity margin starting in 2009.
The same basic picture is true in many western states. For example, California will see a capacity margin of 9.8 percent in 2016, including uncommitted capacity, and just 3.5 percent calculated on committed capacity alone. New Mexico and Arizona will actually see negative capacity margins by 2016.
Although the US and Canada don’t need to build power plants as quickly as China to meet growing demands, it’s ridiculous to assume that these nations’ existing base of plants will be sufficient to meet demands forever. Electricity demand is growing, and if grid reliability is to be maintained, new capacity is sorely needed. And the same basic situation is repeated in many countries the world over.
But if these factors define the problem, the solution is less obvious. And the situation is made more complex by environmental issues. For years, most developed countries have regulated power plant emissions, such as sulphur dioxide and nitrous oxide. And in China, pollution is becoming an ever-larger problem; the nation is home to seven of the world’s 10 most polluted cities.
The Chinese government has become increasingly concerned about pollution because it has begun to impact the nation’s economy in meaningful ways. In addition, China doesn’t want to look polluted during this year’s Summer Olympic Games.
Then there’s the issue of climate change. Opinions vary greatly as to the importance of climate change and the speed at which these shifts are occurring. I’m not a climate scientist, and there are others far better qualified to assess those questions than I. The good news is that, as investors, we don’t really need to inject ourselves into this argument.
The important point is that regulations on carbon emissions have been imposed in many regions of the world, and it’s highly likely that the US will eventually put an emissions reduction scheme in place. As investors, we can’t ignore these shifting political trends and public sentiment; carbon regulations will have an effect on energy-related stocks.
As I explained at length in the April 23 issue, the potential for new carbon regulations is one major factor governing utilities decisions regarding new plant construction. The need to build new power plants to maintain an efficient, reliable grid is balanced by the need to choose technologies that reduce carbon emissions.
In the midst of this complex interplay of supply, demand and environmental considerations, the unfortunate temptation of many pundits is to search for a silver bullet, some technology that will solve all the world’s energy needs in one fell swoop. The bad news is that technology simply doesn’t exist.
The real solution to the global energy puzzle is manifold: Traditional fossil fuels, nuclear power, renewable energy and energy efficiency all have important roles to play. And the solutions to the energy puzzle are likely to be different for the US, China and Europe.
Unfortunately, renewable, or alternative, energy is the solution most often proposed. Various proponents of wind, solar and/or geothermal power will tell you that their technology can reduce pollution and break dependence on imported energy commodities. This is naive at best and potentially quite dangerous. For example, as I pointed out in last week’s issue of The Energy Letter, Coal Investors Take Their Lumps, feckless opposition to new coal plant construction can have the perverse effect of drastically increasing emissions of pollutants from sulphur dioxide to greenhouse gases.
The truth is that wind, solar and other technologies all have a role to play in the global energy pie. But these technologies won’t replace traditional fossil fuels and nuclear power plants. It’s important to recognize the limitations inherent in many alternative energy technologies. Chief among those is their variability.
Electrical power isn’t stored on the grid; the grid must, therefore, balance at any given time with supply meeting demand. Unfortunately, most alternative energies, including wind and solar, are inherently variable.
I’ve discussed this problem on a few occasions, including in the June 29, 2007, issue of The Energy Letter, Tilting at Windmills. To summarize, power output from a wind turbine is related to the cube of wind speed. Therefore, a doubling in wind speed produces an eightfold increase in power output; even minor changes in wind speed have major impacts on the power supplied to the grid.
A recent article in the Oil & Gas Journal offered a few interesting facts about wind power. The generating capacity—the maximum power output—of wind turbines is rated assuming a wind speed of roughly 30 to 32 miles per hour. If the wind speed drops to 80 percent of that level, the actual output from a wind turbine will be just half its rated capacity.
And anyone who lives near a wind farm will tell you that, oftentimes, many of the turbines aren’t turning at all. That’s because a minimum wind speed of around 10 miles per hour is required to power the plant. At that minimum wind speed, the turbines power output is just 3 percent of rated capacity.
Consider the impact of this variability across a large array of turbines. According to the Oil & Gas Journal, Texas will have 10,000 megawatts of installed wind capacity by 2011; new wind farms planned for the next few years will add 10,000 turbines. The wind corridor between Amarillo, Texas, and Dodge City, Kan., represents one of the regions in the lower 48 states with wind conditions most suitable for the large-scale rollout of wind farms. See the chart below for a look at total US wind power generation.
Source: Energy Information Administration (EIA)
The Oil & Gas Journal also notes, using actual wind data collected in 2003, that capacity factors for wind power plants in the region routinely rise or fall by 60 percent within a 12-hour period. Keep in mind that power generated during times of ideal wind conditions can’t be stored on the grid to offset the calmer times. To balance these surges and lulls would require 15 to 20 large-scale natural gas peaking plants that can be started or stopped quickly to feed power into the grid.
Not surprising, this is the same problem that Germany, the world’s largest single wind power market by capacity, has experienced in recent years. Check out the chart of Germany’s wind power capacity below.
Source: Global Wind Energy Council, Global Wind 2007 Report, Second Edition, May 2008
This chart shows Germany’s total wind power generating capacity since 2000 in megawatts. Growth in the German market has been tremendous, with capacity soaring by more than 3.6 times over this period. Germany remains the world’s largest wind power market just ahead of the US, which has around 17,000 installed megawatts.
As I highlight later on in this issue, the main impetus for this growth has been a generous feed-in tariff structure that subsidizes wind power with generous guaranteed rates.
But recall the difference between capacity and generation. As I highlight above, wind turbines rarely operate at their full rated capacity. Check out the chart of Germany power sources.
Source: International Energy Agency (IEA)
These data are from 2005, the last year for which the IEA supplies actual data on electricity generation. But the picture here is obvious. Despite rapid growth in installed wind capacity in Germany, wind is a comparatively minor contributor to actual electricity supply, accounting for only 4.3 percent of generation in 2005. Coal, nuclear and natural gas remain the real workhorses of the grid, accounting for a combined 87 percent of Germany’s grid in 2005.
And that’s only the beginning. Germany’s major grid operator, E.ON Netz, has published a series of reports over the past few years that highlight some of the problems it’s experienced integrating wind energy onto the grid.
To summarize, E.ON states that expanding wind’s contribution to the grid also means building new traditional (fossil fuel) power plants. These new plants are used to supply additional power to the grid during periods when wind power lulls because of low wind speeds. This reserve shadow capacity is the equivalent of the 15 to 20 gas peaking plants Texas will need to maintain reliability as it expands wind capacity.
E.ON estimates that shadow fossil fuel capacity covering 90 percent of new wind capacity installed is necessary to maintain grid integrity. Therefore, increasing wind power capacity actually increases demand for fossil fuels and, in particular, natural gas; wind and gas are two power sources absolutely joined at the proverbial hip.
In its 2005 wind report, E.ON proposes an objective measure of wind’s contribution to the German power grid and the extent to which wind can replace traditional plants. E.ON examined what contribution wind can make to guaranteed power capacity. In other words, because the output from wind plants is variable by definition, the capacity of that plant isn’t guaranteed. In contrast, coal and nuclear plants can run at close to their capacity for long periods of time; this capacity is guaranteed.
E.ON noted that two major studies of Germany’s power system indicated wind made roughly an 8 percent contribution to Germany’s power capacity. Ironically, however, this contribution falls as wind capacity rises. Check out this excerpt from E.ON’s report:
As wind power capacity rises, the lower availability of the wind farms determines the reliability of the system as a whole to an ever increasing extent. Consequently, the greater reliability of traditional power stations becomes increasingly eclipsed.
As a result, the relative contribution of wind power to the guaranteed capacity of our [Germany’s] supply system up to the year 2020 will continuously fall to around 4 [percent].
As a result, the relative contribution of wind power to the guaranteed capacity of our [Germany’s] supply system up to the year 2020 will continuously fall to around 4 [percent].
Source: E.ON Netz, Wind Report 2005
What E.ON is saying is that, as Germany adds more wind power capacity to its grid, the surges and lulls in power from those plants will have an ever-greater impact on the system’s reliability. To offset that will require more dependence on traditional plants; wind won’t be able to replace fossil fuel capacity.
In fact, E.ON went on to estimate that, by 2020, Germany’s wind power capacity will top 48,000 megawatts, more than double the current level. But that 48,000 megawatts of wind capacity will only be able to truly replace 2,000 megawatts of traditional power production. To put that into context, after years of aggressive build-out of wind capacity and heavy subsidies, wind farms in Germany will only replace the equivalent of one to two large-scale nuclear facilities.
My point in highlighting these examples isn’t to disparage wind or renewables. Instead, I want to underline the need to appreciate the complexity of the world’s energy problem. Renewables can play a role in solving these issues, but they aren’t a perfect alternative.
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Investing Opportunities
Although it’s important to recognize the shortcomings of alternative energy technologies, that doesn’t mean there aren’t opportunities for the investor in the group. Alternative energy may not be a solution to the world’s energy problems, but it is the fastest-growing subgroup in the energy patch. For investors, where there’s growth, there’s opportunity.The prime driver of that growth is governments. In Europe, the US and even developing countries such as China, governments offer subsidies, tax breaks and other incentives to encourage the development of non-fossil-fuel alternatives.
These subsidies take many forms. For example, in the US, the production tax credit (PTC) covering wind and other renewables gives producers a 2-cent-per-kilowatt-hour tax credit for electricity generated with wind turbines over the first decade of a project’s operation. The PTC is set to expire at the end of 2008; it wasn’t renewed and extended beyond 2008 as part of the Energy Independence and Security Act of 2007.
That said, it’s likely the PTC will be renewed and extended at some point this year. And even if that fails to pass, most believe that the PTC will be renewed retroactively in 2009. There isn’t much resistance to the PTC on either side of the political spectrum; it’s tough for any politician to oppose alternative energy.
In addition to this federal policy, several states have enacted additional renewable energy mandates and incentives. The most common is a renewable portfolio standard (RPS). Under an RPS, the state actually mandates that a certain percentage of electricity is produced from renewable sources. Usually, this required contribution rises gradually over time.
A total of 25 states and the District of Columbia have some sort of RPS requirement, and three states have enacted less-formal goals. The form of the RPS deals varies wildly.
Some states have imposed fines and other “sticks” to attempt to meet their goals, while others’ RPS legislation is relatively toothless. Some states appear to be enacting unrealistic RPS goals without offering any real path for achieving those targets—classic politics. At any rate, on the margin, RPS standards do encourage faster growth in alternative energy installations.
In Europe, a more common structure is the feed-in tariff. Such a law has existed in Germany since 1991 and is widely credited with that nation’s rapid wind power build-out. Under Germany’s latest Renewable Energy Resources Act (Erneuerbare-Energien-Gesetz), passed in 2000, renewable energy is given preferential access to the grid.
In addition, the law provides for a fixed, generous feed-in tariff for each kilowatt-hour of energy produced from renewable sources. The exact subsidy depends on the efficiency of the installed plant and the type of renewable energy being supported.
Typically, over time, that feed-in tariff is gradually reduced. With solar, for example, Germany’s feed-in tariff structure becomes gradually less generous in coming years, with the idea that this declining subsidy preserves economic incentives to continually reduce costs and enhance efficiency over time.
Feed-in tariffs can be expensive. In 2004, for example, E.ON estimates that the subsidy amounted to EUR2.35 billion (USD3.8 billion) for wind generators alone. More recently, the subsidy for solar power suppliers has come under political attack; some in Germany are calling for an immediate 30 percent cut in tariffs to help offset the rapidly rising cost.
You often hear politicians speak of using subsidies for alternatives as a means to help these technologies achieve “grid parity.” The idea is that, over time, the cost of generating power from alternatives has a tendency to fall. Wind plants become more efficient, and solar cell efficiency increases. Eventually, the cost of generating power from these sources will fall in line with the average cost of power from the grid or grid parity.
Broadly speaking, wind has already achieved grid parity in many markets thanks to improvements in turbine efficiency and construction techniques. Solar is several years away from grid parity, though progress is being made. Even the most-promising technologies probably won’t achieve that yardstick until at least 2012. And that timetable is based on some aggressive, optimistic assumptions.
But achieving grid parity isn’t the same as replacing traditional fossil-fuel capacity. As I noted above, the main problem with renewables is the inherent variation in their output. In addition, there are regional variations in the cost of producing power from wind and solar; weather conditions certainly aren’t ideal in all locations.
Bottom line: The combination of generous subsidies and improving efficiency is powering significant growth in renewable energy despite its drawbacks. For example, according to the US Energy Information Administration, US wind power generation will grow at 6.7 percent annualized between 2005 and 2030, while solar pholtovoltaic (PV) will grow at close to 20 percent annually over the same time period. For reference, total US electricity generation is expected to grow at 1.2 percent between 2005 and 2030.
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Wind over Solar
In the Jan. 24, 2007, issue, Another Alternative, I inaugurated my alternatives field bet as a means to play the growth in the alternative energy industry.For those unfamiliar with my field bet concept, it’s designed to be a diversified mini-portfolio aimed at playing major multiyear trends in the energy markets. Instead of recommending just one or two high-risk plays, I offer a list of five to 10 specific picks in each sector. I recommend that subscribers place a small amount of capital in each stock.
Although each pick may be risky on its own, as a whole, the list offers a safer, more-diversified play. This general strategy has paid off handsomely for us in the past.
For example, within the alternatives recommendations, the overall field bet is up sharply thanks to a handful of stocks that have gained more than 50 percent. These big winners have more than balanced out the laggards in the table. Here’s the current alternatives field bet table.
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Alternatives Field Bet
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Company Name (Exchange: Symbol)
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Entry Price (USD)
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Total Return Since 01/24/07 (%)
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Total Return for 2008 (%)
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Advice
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| Covanta Holding Corp (NYSE: CVA) | 28.23 | NEW | NEW | Buy |
| First Solar (NSDQ: FSLR) | 289.36 | NEW | NEW | Buy |
| EDF Energies Nouvelles (France: EEN, OTC: EDFEF) | 49.86 | 43.6 | 2.8 | Buy |
| Hansen Transmissions (UK: HSN, OTC: HSNTF) | GBP2.89 | NEW | NEW | Buy |
| Hexcel Corp (NYSE: HXL) | 20.01 | 31.0 |
-5.0 | Buy |
| MEMC Electronic Materials (NYSE: WFR) | 45.70 | 50.4 |
-22.3 | Buy |
| SolarWorld (Germany: SWV, OTC: SRWRF) | 37.51 | 44.7 |
-11.3 | Buy |
| SunPower Corp (NSDQ: SPWR) | 41.34 | 111.2 | -33.1 | Hold, SELL Add’l One-Third |
| US Geothermal (OTC: HTM) | 1.40 | 76.3 | -39.7 | Hold, SOLD One-Third |
| Vestas Wind Systems (Denmark: VWS, OTC:VWSYF) | 45.24 | 180.2 | 18.5 | Buy, SOLD One-Third |
As this table shows, the alternatives field bet has performed well since inception, with the average recommendation up a healthy 75 percent in just under 18 months. Also, I cut my recommendations and recommended taking partial profits on three big winners—SunPower Corp, US Geothermal and Vestas Wind Systems—in the Jan. 2 issue, Taking Stock of 2007. If you followed that advice, your total return is closer to 90 percent since inception.
As highlighted above, there’s plenty of growth to come from the alternatives space in coming years. With the growing global trend toward regulating carbon emissions, I suspect the subsidy impetus behind the groups is likely to remain strong.
That said, it’s time to shift the focus of the field bet slightly. I prefer exposure to wind power over solar power at this time for a few key reasons:
Potential Supply Glut
Currently, demand in the solar power industry remains rock solid, particularly in Europe. In its first quarter conference call, for example, SunPower actually raised its guidance for the rest of the year and mentioned that its customers remain optimistic about growth.
However, the problem is that a significant amount of solar cell manufacturing capacity has been coming online in recent months or will soon come online. Therefore, the industry’s capacity to produce cells is growing rapidly.
Early projections are that cell manufacturing capacity will grow by roughly 80 to 100 percent in 2009. Although it’s too early to know for sure, there’s potential for this cell supply to overwhelm demand near term, even with demand growing at greater than 40 percent annualized.
If that scenario unfolds, the likely response in the industry would be to cut prices in an attempt to compete. That would negatively impact profit margins. SunPower is forecasting a double-digit drop in average selling prices for 2009.
Subsidy Uncertainty
As I noted earlier, there’s been talk of late in Germany about decreasing the subsidies for solar to cut the cost of promoting the technology. In Spain, the feed-in tariff structure that promotes solar is scheduled for review later this year. And in the US, there remains uncertainty regarding the renewal of the PTC.
Although some of these issues affect wind as well as solar, their impact on solar would likely be more profound because solar remains far more expensive than grid-supplied power and is, therefore, more reliant on subsidies and incentives for growth. Firms looking to invest in solar may look to wait until there’s clarification about the potential size of subsidies.
Residential Markets Slowing
Not all solar cells are used in large-scale power plants. A significant part of this market is the sale of individual power modules to be placed on homes to help supplement power from the grid.
Because the US is a significant market for residential-installed solar cells, rapidly falling housing starts and declining real estate trends could well have a significant negative impact on growth. Akeena Solar already warned of this problem in its most recent quarterly conference call.
Price of Polysilicon
The key raw material in the most widely used type of PV solar cell is polysilicon. Poly has been in extremely short supply lately; the shortage of this material has actually meant that producers haven’t been running close to full capacity.
As a result of this shortage, the price of poly has risen dramatically. For solar cell firms buying poly outside of long-term contracts, that spells rising costs and tighter margins.
Another factor to watch with polysilicon is that a good deal of additional supply is due on the market heading into 2009. This supply is scheduled to come from producers starting up new production facilities for the key raw material. As poly supply constraints ease, it may have the positive effect of offsetting rising raw material costs.
However, there’s a dark side to that argument. Many producers have been cutting back on their solar cell production because of poly shortage. As that shortage eases, these producers will likely push up their solar cell production toward maximum levels. There’s a good chance this will further exacerbate a potential glut in the industry starting next year.
None of these factors spells an end to growth in solar. But, for the first time in years, there’s real risk of an important slowdown in solar-related firms toward the end of 2008.
Slowing growth could be a problem because these stocks are still pricing in strong growth through 2009 and are valued accordingly. If that growth slows or disappoints, there’s room for considerable downside in these stocks.
In contrast to solar, I see little evidence of a slowdown in demand or interest in wind-power generation. Further, this market looks to remain tight over the next few years. The rising costs of natural gas, oil and even coal make wind more competitive from a strict cost standpoint, encouraging build-out even with relatively small subsidies.
Vestas Wind reported stronger-than-expected first quarter results. The company’s net income doubled in the first quarter over the same quarter a year ago. At the same time, the firm’s backlog of unfinished projects rose a further 20 percent; a rising backlog is a sign that demand continues to outstrip supply.
Vestas’ management commented that, despite its build-out of turbine construction capacity, it would be “some years” before capacity in the industry rises far enough to meet demand. The company further noted that there’s such an acute shortage of components for wind turbines that lead time for those sensitive components has lengthened to as long as 15 months.
To adjust the field bet portfolio to reflect these trends, I’m upgrading Vestas Wind Systems from a hold back to a buy. The company’s first quarter report suggests there’s further upside in the stock. And Vestas remains a global leader in wind turbines, owning a stake in roughly a third of the market.
I’m also encouraged that Vestas has scope to continue to boost profit margins. Management is targeting earnings before interest and taxation (EBIT) profit margins of 10 to 12 percent, up from 9.1 percent last year.
I’m also downgrading Germany-based solar play SolarWorld from a buy to a hold and recommending all subscribers take half their profits in the stock off the table. Based on my initial recommended entry point on Jan. 24, 2007, total profits in SolarWorld are more than 45 percent.
Although SolarWorld remains a key player in the solar market, my recommendation to take profits has nothing to do with stock-specific issues. Rather, this is an industry call: I’m worried about risks to overall growth in the solar power market in the near term.
I recommended taking a third of your profits off the table in SunPower back in the Jan. 2 issue. At that time, SunPower was up 208 percent from my original recommendation; since that time, the stock has pulled back.
What attracted me to SunPower originally was that the company’s solar cells are the most efficient in the business when it comes to converting the sun’s energy into electricity. SunPower’s cells have a 22 percent efficiency rate, compared to an industry average in the teens. This means SunPower’s cells can produce the same amount of power as competitors’ offerings using a smaller cell. That advantage has helped SunPower grow faster than the industry at large.
Given the potential for more widespread weakness in solar firms, I recommend using the recent rally in SunPower to further lighten up on the stock. I recommend selling a third of your remaining position in SunPower Corp to book a 115 percent gain from my original recommendation. SunPower Corp remains a hold in the alternatives field bet.
My only buy-rated recommendation on solar power is MEMC Materials. This company produces polysilicon wafers that are used primarily by two industries, semiconductor chipmakers and solar power firms.
To make a long story short, the semiconductor market has been weak lately, a trend that continued in MEMC’s first quarter report. The company mentioned that demand indications from semi customers were a bit weaker than normal, leading to additional price declines.
However, the weakness in polysilicon and wafers for semiconductor markets has been more than offset by strength in solar. MEMC Material’s management team was unambiguous in stating that it’s seen no signs of weakness when it comes to selling raw polysilicon or wafers into the solar industry.
Several analysts on the company’s first quarter call asked, in one way or another, about the potential for weakness in pricing, and MEMC stated it sees no sign of that, either.
The main concern hanging over the company is the same as the solar industry at large—rapidly rising polysilicon production capacity. The fear is that, as this new material comes online, MEMC will see margins pressured. But I see two main factors offsetting this risk.
First, MEMC warned earlier this year that first quarter earnings would miss expectations. The problem amounted to MEMC’s inability to bring new production online as quickly as expected. If a major producer like MEMC has a tough time bringing new capacity to bear, you have to wonder about startup producers scheduled to open new plants in coming years. Simply put, poly supply growth is less assured than the raw numbers might suggest.
Second, MEMC has lowered risk by selling poly under long-term supply deals at attractive pricing. In many cases, these supply deals cover production over a 10-year period. This lowers the risk of pricing decline.
Finally, MEMC’s recent conference call struck a conservative note. Management was careful to note that it missed expectations in the first quarter because of problems ramping up capacity; the company seemed to suggest that it doesn’t want to disappoint again and, therefore, is taking a conservative, overly pessimistic tact.
And it appears the production problems that plagued the firm in the first quarter are firmly in the rearview mirror. In fact, new production facilities are coming online sooner than initially planned.
This all suggests that MEMC has scope to exceed estimates later on this year. Buy MEMC Materials.
In this issue, I’m also adding First Solar to the alternatives field bet as a buy recommendation. First Solar is a leader in the so-called thin-film solar market.
Thin-film solar differs from the type of solar cells used by the likes of SunPower. First Solar’s cells are less than half as efficient as SunPower’s. Although that may seem a disadvantage at first glance, that’s not necessarily the case.
First Solar’s cells also don’t require polysilicon; therefore, the company hasn’t been negatively impacted by the major poly shortage that’s impacted the industry in recent years. Moreover, First Solar’s cells are cheaper to produce than typical polysilicon-based solar cells.
It’s likely this technology will achieve full grid parity before traditional poly PV cells. Even if the overall solar industry sees a downturn, First Solar should be relatively insulated, thanks to its low-cost base.
In First Solar’s first quarter conference call, management stated that the company is about 80 percent contracted in 2008 under long-term deals. Although management wouldn’t indicate its contract position for 2009, the firm suggested that it does layer in significant long-term contracts to help guarantee revenues. This further lowers First Solar’s risk even if the solar market does slow down. Buy First Solar.
To add to our wind exposure, I’m also adding Hansen Transmissions. Hansen is the world’s second-largest manufacturer of gearboxes used to make wind turbines; as such, the company serves all of the world’s main wind-turbine manufacturers. Gearboxes are an absolutely crucial part of wind turbines, and demand for these components rises with demand for wind power.
That said, Hansen is close to three-quarters owned by India’s Suzlon, one of the world’s largest wind-turbine manufacturers. Suzlon sold a minority stake in Hansen last December in an initial public offering (IPO) on the London exchange.
Hansen is based in Belgium and currently has capacity to manufacture 2.2 gigawatts of gearboxes there. The company has plans to increase that factory’s capacity to 6 gigawatts this year, nearly tripling capacity.
And Hansen is also building additional plants in India and China, with total capacity of roughly 8 gigawatts combined. These plants will help Hansen more effectively serve these fast-growing, emerging wind power markets. That capacity is due online in 2011.
In its most recent quarterly report, Hansen showed a 59 percent jump in profit against the year-earlier period and growth should remain on track as Hansen brings its new plants online over the next three years. Buy Hansen Transmissions.
And Hexcel Corp remains a play on both the growth of wind power and the global drive toward higher energy efficiency. Hexcel manufactures carbon fiber and related components.
Wind-turbine blades are typically made from carbon fiber rather than fiberglass. Carbon-fiber blades are lighter and stronger, which allows manufacturers to build larger turbines without the risk of the blades bending or cracking.
Larger turbines are far more efficient at producing electricity. The industry is trending toward using bigger blades, playing right into the hands of Hexcel.
In addition, Hexcel’s main market remains building carbon-fiber parts for the aircraft industry. Traditionally, airplanes have been made mainly of aluminum and related alloys; however, that’s changing as aircraft manufacturers seek to lower the overall weight of planes in an effort to increase fuel efficiency.
The most efficient commercial aircraft in the world today is Boeing’s new 787 Dreamliner—roughly 40 percent more efficient than existing airplanes its size. With jet fuel trading at sky-high levels, airlines are lining up to buy planes from Boeing; the company has a multiyear order backlog.
The main way Boeing drove fuel efficiency in the plane was to reduce the use of aluminum in favor of lighter, stronger carbon-fiber parts. The plane is truly revolutionary in its design. Hexcel is a primary supplier of these key components.
Hexcel recently released first quarter earnings that significantly topped analysts’ expectations, and the stock jumped the most in four years on the news.
One cloud hanging over Hexcel has been the delays in the release of the Dreamliner. In total, the plane has already been delayed roughly 14 months from Boeing’s original production schedule, and we can’t rule out further push-backs. Hexcel’s management admitted this clouds the firm’s near-term outlook.
But judging from the stock’s positive reaction to the conference call, the worst of the Boeing 787 delay news is already priced in to Hexcel. In addition, Hexcel announced it has more leverage to the 787 program than originally assumed: Management stated that each plane will contain about $1.6 million worth of Hexcel parts against its prior estimates of $1.3 million.
A play on both increased energy efficiency and rising demand for wind power, Hexcel Corp rates a buy.
I’m also adding exposure to a brand new alternative energy sector as of this issue: waste-to-energy. Covanta Holding Corp builds and runs plants that burn municipal solid waste—common household waste—to produce energy.
Waste-to-energy offers two key advantages. First, burning waste reduces the total volume of trash that must be permanently buried in landfills. Landfill capacity is extraordinarily limited in most developed countries, including the US. This is particularly true in certain regions of the US such as the Northeast; landfill capacity in the region is highly limited and is typically located relatively far away from population centers, increasing transport costs.
With landfill capacity limited, waste disposal companies have been able to increase the disposal—or tip fees—they charge to municipalities for landfill waste.
The other advantage of waste-to-energy is that it produces energy from waste, taking an otherwise useless commodity and putting it to good use. A side benefit from an environmental perspective is that rotting waste produces methane gas, a greenhouse gas many times more powerful than carbon dioxide. Waste-to-energy plants, therefore, reduce the carbon emissions of landfills; this may qualify such facilities for carbon credits.
Covanta is a leader in the US waste-to-energy market. The company owns a total of 34 waste-to-energy facilities in the US located in 15 states. Covanta’s largest area of operation is the Northeast US, the area with the most acute shortage of landfill capacity.
Twenty-four of Covanta’s waste-to-energy plants operate on a fixed-fee structure, where the firm gets a fee for handling waste. That fee increases over time because of a pre-set formula.
In addition, Covanta operates 10 plants under a tip-fee structure, through which the company receives per-ton revenues and keeps most or all the revenues generated by selling electricity produced at the plants.
All of Covanta’s projects were originally built and contracted under long-term deals. However, a number of these contracts are due for renewal over the next few years. That said, waste firms have been successful recently in actually raising prices for disposal services. There’s no reason to believe Covanta won’t be able to roll over longer-term contacts at attractive rates.
There are also plenty of growth opportunities abroad. The company is part of a joint venture in China that owns a stake in two operating waste-to-energy plants. And in Europe, Covanta owns a stake in a smaller waste-to-energy plant in Italy.
China has expressed interest in increasing the amount of waste it disposes in such plants in the coming years. In Europe, the UK and Germany—among others—have been passing laws that will require reductions in landfill waste volumes. Several contracts for new plants are in the works and will likely be awarded over the next two years.
As a world leader with proven technology, Covanta is considered a lead bidder on such deals. Covanta Holding Corp is added to the alternatives field bet as a buy.
Rounding out my alternatives field bet are EDF Energies Nouvelles and US Geothermal. EDF Energies Nouvelles is Electricite de France’s renewable energy unit; the company primarily owns a portfolio of wind power farms in Europe and the US. The firm is still 50 percent owned by EDF, France’s dominant electric utility.
Energies Nouvelles recently reported a doubling in revenues over the same quarter a year ago. About half the company’s income comes from actually operating wind farms and other renewable energy assets. The other half comes from developing and selling wind farms to other operators.
For example, EDF was recently selected to build five major wind farms in Quebec. Buy EDF Energies Nouvelles.
Finally, US Geothermal has completed its Raft River geothermal plant and is now working on a new geothermal project, the Neal Hot Spring play in Oregon. I’m particularly pleased to see that the firm managed to move its listing from the over-the-counter market to the American Stock Exchange; typically this is a sign of improving financial stability.
US Geothermal remains a high-risk, volatile play; I’m retaining my hold recommendation on the stock for now until we see more signs of progress on its newest project.
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Portfolio Update
Takeover speculation is now running rampant in the uranium mining industry. That’s good news for many of my recommended plays in the nuclear field bet. Much of the speculation appears centered round recent comments by uranium mining giant Cameco that the selloff in uranium miners has made the group far more attractive as acquisition candidates.In particular, Paladin Resources is rumored to be of interest to Cameco. With its portfolio of producing and near-producing uranium mines, Paladin would represent a low-cost way for Cameco to add to reserves and production near term. Paladin Resources remains a buy within my nuclear field bet.
Beleaguered miner Uranium One has also been in the news lately. The company stated that it’s interested in selling its Honeymoon mine in Australia to focus attention on its more-advanced projects, such as the Dominion mine in South Africa and its smaller projects in the US. Uranium One is also considered a possible takeover target for Cameco. Uranium One remains a buy in the nuclear field bet.
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Speaking Engagements
Be sure to wear a flower in your hair when you venture west to San Francisco. I’ll be heading to “The City” with Neil George and Roger Conrad Aug. 7-10, 2008, for the San Francisco Money Show.Neil, Roger and I will discuss infrastructure, partnerships, utilities, resources and energy, and tell you what to buy and what to sell in 2008.
Click here or call 800-970-4355 and refer to priority code 011361 to attend as our guest.
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