Energy: What's the Alternative?

The chart above is from Exxon's strategy unit, and you don't have to be a Big Oil apologist to see that no combination of alternatives, plus a renaissance in nuclear, can plug the energy gap yawning before us. Nonetheless, the market oppurtunity for all forms of alternative energy, and especially wind and solar, will be enormous, constrained mainly by supply side issues. Europe has made huge strides to develop a major alternative energy industry using feed in tariffs that guarantee alternative energy sources like solar and wind a profitable market. However, the private sector in the US is now investing billions of risk capital in the industry, ranging from oil tycoons like Boone Pickens (the world's biggest wind farm in Texas) to Google (next generation solar arrays) and the leading Silicon Valley venture capitalists. In 2007 more silicon went into solar panels than into chip making; in aggregate alternatives are already generating revenues of $55bn, and potentially $200bn plus with a decade. Two dozen US states now mandate that a proportion of electricity come from renewable sources, with Federal legislation inevitable under a new President. There is now a confluence between US national security priorities, an energy crisis, and a climate change crisis that combined make replacing fossil fuels one of the biggest thematic investment opportunities. Let's not kid ourselves though; the unbeatable energy efficiency of fossil fuels and the huge infrastructure in place to deliver and distribute them mean that oil and its derivatives will still be a dominant fuel source for at least the next couple of decades, even if we see some spectacular technological breakthroughs. Five years ago there were just 35 companies globally with their core business in clean energy valued over $100m; now there are 160. For investors, alternative energy has already provided huge returns. The Jeffries Global Clean Tech Energy Index lists the biggest pure play clean energy stocks worldwide, weighted by market capitalisation, and is up over 700% since 2004. A balanced investment exposure is offered by the PowerShares WilderHill Clean Energy ETF; it tracks the WilderHill Clean Energy index, which is composed of 40 companies involved in alternative energy production or technology. Let's look at how the key alternative energy sources stack up.

Biofuels: A complete scam by the US farming lobby, and increasingly recognised as such. About 18% of the world grain harvest this year will be diverted to this purpose, which is about the most wasteful thing you can do with grain apart from feeding it to livestock. US ethanol production is equivalent to just 4% of gasoline demand, and has already sent food prices soaring. The Energy Return on Investment (the amount of hydrocarbon fuel required to produce a unit of ethanol) is 1-to-1.3 whereas for sugar cane ethanol the ratio is 1-to-8. Corn-based ethanol is only marginally energy positive, and a futile distraction that is simply exacerbating a global grains shortage and wasting $5.5bn in US taxpayers money in annual subsidies. If that money were spent by the Federal government to match private investment in alternative technologies dollar for dollar, the payback would be dramatically higher. Politically, Europe and Asia are now on the verge of scaling back mandatory plans to expand biofuel production. If you want a profitable biofuels investment look to Brazil, which leads sugar cane production of ethanol (and is my favourite emerging market with India), or wait until switch grass and other next generation feed stocks become viable in the US.

Solar: As the chart indicates, the solar PV industry has exploded in the last five years, driven by guranteed market access and premium pricing in markets like Germany and Spain through the so called 'feed in tariff'. Dedicated solar stocks like SunPower have appreciated several fold over than period as investors chase an alternative energy bonanza. However so far, solar accounts for just 1% of total global power capacity and just 5% of installed wind generating capacity. A key problem lies in the scarcity and expense of the raw materials required. There are several elements used in thin film PV production. Among the elements used include cadmium and tellurium (CdTe), copper, indium, and selenium (CuInSe), and copper, indium, gallium, and selenium (CIGS). These various elements are used to improve operating efficiencies and lower production costs of PV devices. In general, crystalline PV devices have higher solar efficiencies, but cost more due to their material thickness of 200-to-300 microns, whereas, thin film PV are usually about 3 microns deep offering significantly lower production costs. The best solar efficiency acheived so far is 22.7% from SunPower, the leading polycrystalline silicon PV supplier, leaving the unsubsidised cost of solar energy prohibitively high at about $0.45 per kilowatt-hour (KWH) for an installed system. In comparison, hydrocarbon fuels, even at $120 a barrel, would work out at about $0.11 per KWH. So there remains a significant, albeit narrowing disparity. Furthermore, not only have silicon prices soared as a result of solar demand, but several key materials are in limited supply. For instance, Tellurium, a rare element byproduct from refining gold, copper and other ores, is in very finite supply. In fact, with global production pegged at about 3oo tonnes, CdTe devices are probably capped at 2,400 MW of annual output unless a breakthrough is achieved in film depth using techniques such as nanotechnology. Solar will be constrained by supply going forward rather than demand, as with so many energy sources, conventional or alternative.

Hydrogen Fuel Cells: Fuel cells have been around a long time in specialist applications, but have failed to reach mass market due to a variety of technical and cost factors. This is the most exciting alternative energy in potentially offering a revolutionary breakthrough. They are devices that convert chemical to electrical energy - in essence; it’s an electrochemical energy conversion device. In the chemical process of a fuel cell, hydrogen and oxygen are combined into water, and in the process, the chemical conversion produces electricity. Hydrogen fuel cells offer tremendous opportunity for storing and transporting energy enabling broad applications for home, business, motor vehicle and large-scale energy projects. One of the most practical fuel cell technologies for motor vehicle use include Proton Exchange Membrane (PEM) because it operates at normal ambient temperatures and offers high electrical efficiency. We are also seeing progress on fuel cell vehicles that could ultimately replace the internal combustion engine, all with no carbon dioxide or other harmful emissions. Most major automakers are developing hydrogen powered fuel cell vehicles such as the Honda FCX but as a PR exercise; they are not viable commercially at present because of the prohibitive manufacturing cost ($70-100k per car) and the absence of hydrogen refuelling infrastructure for consumers. Plug-in hybrids using lithium ion rechargeable batteries being developed by GM and others offer the next evolutionary breakthrough in car fuel efficiency, before fuel cell technology matures to become commercially viable in the next decade.

Wind: Wind power accounted for 30% of all new generating capacity in the US in 2007; driven by a Federal tax production credit that reduces the cost/KwH to about 6c (more like 8c/KwH unsubsidised). Production costs have dropped 50% in a decade as bigger turbines and farms have been developed, and economies of scale in manufacturing have been achieved. The expectation from leading manufacturers like Vestas is that each new generation of turbine will reduce costs another 5%. This is the 'killer' alternative energy with far fewer technology or supply constraints than solar, and closest to being competitive on a KwH basis with conventional sources. Last year wind generated 94Gw (1Gw = 1000 Mw) of energy globally, a 27% increase on the year before, with Germany accounting for 25% of global capacity despite less than ideal geography and climate. The US has a corridor running through the Mid West from the Canadian border to Texas which would be one of the most productive wind energy areas in the world, and could with the right incentives generate 25% of all US power needs within 20 years from under 1% currently. Germany and Spain are now at 10% and Denmark 20%. Even China has managed to build 6Gw of wind capacity, although much of this lies unconnected to the grid because of poor planning (so what's new?). Remember though that wind turbines operate at about 30-35% average capacity ie a 1Gw farm will only generate 300Mw of power, and it is impossible to know when that power will hit the grid unlike with conventional sources. In terms of growth potential, the main restriction on supply is a shortage of turbines, and lack of transmission lines in the remote areas where wind farms are sited, but these issues can be addressed relatively easily compared to the constraints facing say nuclear.