The Future Looks Bright for Alernative Energy and Clean Tech Amidst a Dismal Economic Environment

Jun 09, 2008
Author: SCP Editor

June 9, 2008 – The markets are set to open cautiously this morning after closing last week’s session on a tear of bad news: unemployment rate jumping unexpectedly to 5.5% coupled with oil prices jumping $17 in two days to close at an adjusted-for-inflation level higher than the prices we saw back in the 1980s.  To put Friday’s gain in oil prices of $11.93 in perspective, consider that as recent at December, 1998, oil traded in the $10 range per barrel.

As for the labor market, this is the fifth straight month of job losses. Optimists point out that the numbers still don’t mirror the classically-accepted definition of recessionary losses at about 400,000. But the 5.5% number has to make even the most resolute cheerleaders for the economy choke.

The reaction in the markets was a sell-off of about 394 points. We would put an asterisk on that number since the markets rallied by a couple hundred points the day before, for reasons that we couldn’t understand. So you might look at the recalibration in Friday’s session as an adjustment back to reality by the Street that was, simply put, getting ahead of itself with optimism.

Oil Prices

·         Oil set a new record at $139.13 per barrel on Friday, spurred on by strong-talking from the Israeli government about the increasing likelihood it will have to attach Iran. Some experts predict that if this happens, oil prices could spike to $300. Other factors play into the mix on Friday as well, including a sell-off on the dollar on the heels of an announced increase in rates by the ECB the day before.


Not only Wall Street, Washington and the U.S. consumer, but the entire world is reeling. Higher oil prices are dominating the discussions in the media and throughout political forums. This next week, the G-8 will be meeting to discuss the current situation. The G-8 , which includes the US, Japan, Canada, Germany, France, UK, Italy, and Russia - and China, India and South Korea, account for about 65% of global energy demand. The discussion is expected to focus on climate change and reduction of carbon emissions but no doubt the surge in oil prices will get quite a lot of play at the meeting. Meanwhile, Congress continues to beat the drum that so much of the cause for higher oil prices is the result of speculation. While we agree that speculation is likely playing a role, we maintain that the fundamental supply-demand environment – namely, the fact that production on a global basis is not keeping up with consumption – is the reason that there is so much less elasticity in the pricing of oil these days. Production has basically stalled since 2005 at about 85 billion barrels per day, while demand is surging. And it will continue to surge. Consider the fact that for every 100 persons in the U.S. more than 70 own and drive cars, while for every 100 persons in China, less than 4 own and drive cars. The underlying fundamentals are so unforgiving that when we do get a surprise, or when there is some disruption in production at a refinery of a key producer, or when there is speculation about instability in a region, oil prices react that much more violently. Scapegoating speculation is missing the fundamental issue.

Heavier Headwinds Ahead

Looking at the data, it is pretty clear that we are far from that scenario harkened by so many pundits and economists, and cheerleaders in the financial media as well as on Wall Street that the economy is going to rebound in the second half. We just don’t buy it. Again:

·         Unemployment is now at 5.5%;

·         Consumer credit remains at record levels;

·         Personal savings remain firmly negative;

·         The percentage of mortgage borrowers behind on their payments, 6.35%, is the highest since the Mortgage Bankers’ Association began tracking this number back in 1979;

·         The dollar continues to slide, exacerbating inflationary pressure everywhere;

·         The housing market continues to unravel, with home prices falling 14% in the first quarter, and according to Moody’s, the decline in home prices has cut $2.5 trillion from household wealth (about $25,000 per homeowner);

·         The national debt continues to surge and no one is having a serious discussion about addressing it;

·         The Fed clearly is out of step, turning its focus too little too late this past week to the importance of a strong dollar but without any indication it is actually going to support the dollar;

·         Consumer confidence is at 16 year lows; and

·         It looks like the $120 billion or so stimulus package is getting soaked up by higher oil and food prices.

Against all of this, at best, the future is uncertain. And Wall Street hates uncertainty. Our outlook then, for stocks is that the broader markets are staring into heavy headwinds and volatility. And if the Fed actually backs up its rhetoric that it is standing behind the dollar at his point, a raise in rates is on tap which will undoubtedly depress traders and signal an acknowledgement that even after the Fed had thrown everything but the kitchen sink at the economy to stem recessionary pressures and stimulate growth, the economy just might have to recess anyhow.

In terms of near-term strategies to address the higher oil prices, Energy Secretary Samuel Bodman will be asking those at the G-8 meeting to consider cutting their subsidies for fuel, which presently don’t create any sense of urgency for consumers in these countries to change their consumption habits. Sounds good on paper, but first, we doubt Bodman will have much sympathy in making this request to his peers and second, it is unclear how much of an impact this would make.

But The News Isn’t All Bad

Even though the writing is on the wall that the markets are going to have tough sledding ahead, there are still some fantastic areas to invest, in our opinion. As we noted above, the G-8 is set to meet this week to discuss carbon emissions reduction. In May, the G-8 environment ministers pledged to reduce emissions by 50% by 2050. Japan’s Prime Minister Yasuo Fukuda is expected to unveil a set of measures today, including a target for Japan to cut emissions by 60-80 percent by 2050. The International Energy Agency has recently published a report where it recommends $22 trillion to be invested in energy supply infrastructure to meet increased demand, while also developing alternative energy resources. According to New Energy Finance, global investment in clean energy grew 60% in 2007 to $148.4 billion. In terms of the investments in new projects:  

·         Wind investments accounted for $38 billion;

·         Biofuels investments accounted for $16.4 billion;

·         Biomass & waste investments accounted for $9.6 billion; and

·         Solar accounted for $18.2 billion. 

Looking at performance on Wall Street, given the rise in fossil fuel-based energy prices and the increasing pressure for development and distribution of alternative energy resources, it shouldn’t surprise anyone to see the sector outperform:

·         Thomas Weisel reports that over the last three months, on average alternative energy/cleantech stocks are up 13.8%, compared to the Nasdaq, up (11.1%) and the S&P 500 (up 5.2%); and

·         Since January 2007, the median performance for alternative energy/cleantech stocks is 42.2%, compared to the Nasdaq (up 4.5%) and the S&P (down 1.3%).

Even if a fraction of the recommended investment the IEA proposes for the development of alternative energy resources materializes, the trend should continue to drive alternative energy stocks.

Despite the heated debate currently taking place in Washington over the Warner-Lieberman bill, called the “Climate Security Act of 2008” (S.3036) which would set an annual cap on the volume of carbon emissions (a reduction of about 66% by 2050), there is clearly a bipartisan agreement that additional investment in alternative and cleantech is both needed and inevitable. The question is really just how deep the commitment will be. The presidential candidates are also making clear calls for investment in alternative energy/cleantech:

·         McCain supports a cap and trade policy similar to the Warner-Lieberman bill that would target reduction of greenhouse gas emissions by 66 percent below 2005 levels by 2050;

·         Obama’s plan calls for a reduction in carbon emissions 80 percent by 2050 with $150 billion in investments into clean energy over the next 10 years; the establishment of 25 percent federal Renewable Portfolio Standard (RPS) by 2025; the requirement of 36 billion gallons of renewable fuels to be included in the fuel supply by 2022 and an increase in that to at least 60 billion gallons of next generation biofuels by 2030; resulting in oil consumption by at least 35 percent, or 10 million barrels per day by 2030; a goal of making all new buildings carbon neutral by 2030 with the goal of improving new building efficiency by 50 percent and existing building efficiency by 25 percent over the next ten years; investment in a smart grid.

And other mass markets are also mandating investment and adoption of alternative energy/cleantech companies. For example, China enacted the Renewable Energy Law which mandates that at least 5 percent of electricity must be generated from renewable sources by 2010 and 10 percent by 2020.

The Take-Away

Amidst a lot of bad news out there, and even more uncertainty with respect to when the economy will turn for the better, the alternative energy/cleantech sector remains poised to outperform. The industry, as well as secular trends all favor its continued growth at aggressive rates. In terms of our thoughts on each sector:

·         Biofuels – biofuels represent one of the greatest opportunities for alternative energy investors, but at the same time, are presently challenged by (i) a backlash in the ethanol sector related to corn as a feedstock; (ii) shrinking gross profit due to rising feedstock costs and (iii) a still extremely nascent position for next generation biofuels (e.g., cellulosic) that will likely be more promising than corn-based ethanol  but a few years out from any meaningful contribution on a commercial basis. We think the best model in the world for biofuels is in Brazil, where the industry realized the key to competing at the pump on a non-subsidized basis with gasoline and diesel was to push prices down and production up.  We continue to think that if Washington was really serious about addressing high fuel costs and rising food prices (that are unfairly blamed on corn-based ethanol) then it would eliminate the $0.54 tariff on Brazil ethanol.  

In the U.S. biofuels represent 52% of total renewable energy production and 5% of total energy production while it is 53% of total renewable energy consumption and 3.4% of total energy consumption.  

·         Geothermal – like solar thermal, it passes the “Chindia” test, which is Vinod Khosla’s test that any solution to be a climate change solution, India and China must be on trajectory to adopt the solution. Simply put, geothermal is capable of scaling to mass production and consumption levels on a global scale. New technologies are emerging that enable geothermal plants to produce at lower levels of heat, which is a promising development to broader adoption and contribution to the grid. However, geothermal remains only about 5% of total renewable energy production and about 0.04%of total energy production while it is about 5% of total renewable energy consumption and 0.03% of total energy consumption.  

·         Wind – with noted oil investors like Boone Pickens touting the virtues of wind in the media on a daily basis and with the firepower of firms such as Johnson Controls and General Electric manufacturing the turbines, wind has probably got the greatest amount of momentum at this point. China’s Renewable Energy Law is also going to be a major driver of wind production and consumption in the near term and for the foreseeable future.  

In the U.S. wind represents about 5.5% of total renewable energy production and 0.05% of total energy production, while it is 5.5% of total renewable energy consumption and 0.03% of total energy consumption.  

·         Solar – as noted above, solar thermal passes the “Chindia Test” and we are seeing some impressive solar thermal projects underway both here in the U.S. and overseas. Meanwhile photovoltaics (PV) and thin-film technologies have also been gaining momentum. Consider this: the energy in sunlight striking the earth for 40 minutes is equivalent to global energy consumption for a year.  

However, despite all the promise, and there is a lot of it for solar, until solar can deliver at a price closer to grid parity, about $0.10 per kWh (kilowatt hour), uptake will likely be modest. Thin film technologies promise lower cost, but lower efficiency. PV offers higher efficiency but higher cost. Solar thermal appears to have the edge in both departments, but the challenge is that solar thermal plants aren’t cheap, and with raw material prices running higher they aren’t getting any cheaper.  

In the U.S. solar/PV represents about 2% of total renewable energy production and 0.01% of total energy production while it is about 1% of total renewable energy consumption and 0.007% of total energy consumption. On the whole, renewable energy production represents about 9.6% of total energy production in the U.S., while it is about 6.5% of total consumption. Contrast this with coal, which represents about 33% of total energy production and 22% of total consumption. To be sure, coal isn’t going away anytime soon, which means that with the coming mandates and legislation to clean up the emissions from coal plants, NOx reducing technologies and clean coal (or “less dirty coal”) technologies should do well also.

Our Conclusion:

Trillions of dollars are scheduled to be invested in alternative energy/cleantech businesses over the coming years, and the expectations are that the contribution of alternative energy/cleantech to the grid increases to 20 to 30% by the year 2030, up from about 6% to 7% today. The time has never been better to invest in clean tech, and given the alternatives on Wall Street (discretionary stocks, financial stocks, retail stocks, housing stocks, healthcare stocks, etc.) where the prevailing economic headwinds are strong, the alternative energy/cleantech sector actually benefits from many of these same headwinds.

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