Alternative energy: If not now, when?

www.iht.com Erika Kinetz IHT Saturday, March 8, 2003   Two weeks ago, the price of oil flirted with $40 a barrel, a level not seen since Iraq invaded Kuwait in 1990. The surge in energy prices - driven by the promise of war in the Gulf, political upheaval in Venezuela and a cold winter in the United States - has taken a bite out of economic growth. Consumers, who are spending almost 50 percent more on gasoline now than they were a year ago, do not have extra cash on hand to spend on other goods and services, and companies have been postponing capital investment. Even the president of the United States - whose country consumes 25 percent of the world's oil - has started to question the high cost of oil dependency. "It jeopardizes our national security to be dependent on sources of energy from countries that don't care for America, what we stand for, what we love," George W. Bush said in a speech last month. The case for alternative energy seems stronger now than ever. "It is a question of when, not if," said Richard Stuebi, president of NextWave Energy Inc., a consulting firm in Denver, Colorado. When remains a big question. Rising oil prices and the pending war with Iraq are unlikely to provide a sustained boost to the battered alternative energy sector. "Oil price spikes in the past have increased attention on alternative energy stocks and driven them up temporarily, but it's never been a sustainable trend," said Eric Becker, a portfolio manager and alternative energy analyst at Trillium Investment Management Corp., a socially responsible investment firm in Boston. "It's something only short-term traders have taken advantage of. It hasn't been anything long-term investors can use to make money." Even as the price of oil has surged, the alternative energy sector has tanked. The price of oil has risen almost 60 percent in the last year, while Reed Global Research's Distributed Generation Index, which tracks fuel cell, microturbine and hydrogen fuel companies in North America, has fallen 56.5 percent, exceeding the Nasdaq's 26.6 percent plunge by an uncomfortably wide margin. Historically, alternative energy technologies have been subject to cycles of hype and disappointment, most recently in 2000, when the mania for promising technology stocks with no earnings reached a fever pitch and many expected the United States to be hobbled by a major energy crisis. "The California energy crisis was a huge catalyst for the energy technology companies," said Young Jin, the energy technology analyst at Reed Global Advisors LLC, a global merchant bank based in Bellevue, Washington. "This caused a huge hype for the sector, raising the valuations of fuel cell and other energy companies to levels unjustified by their operational performance and product commercialization timelines." Despite past disappointments, some maintain that this time around things will be different. Globally, government regulations have been getting greener. The European Union has set a goal of obtaining 22 percent of its electricity and 12 percent of all energy from renewable sources by 2010. Britain is even stricter, calling for 20 percent of power to come from renewable energy by 2020. Last month, the White House proposed dedicating $1.2 billion over the next five years to develop hydrogen-powered fuel cell technology and infrastructure. While the United States has no federal quotas, in the last three years 13 states have put renewable energy standards in place. Moreover, technological advances are driving down the cost of wind and solar power. "Conventional prices are at best flat and maybe rising upwards," Stuebi said. "Renewable energy sources are on a downward slope." The big question for investors is when alternative energy will become cost-competitive. "The world only buys a green idea if it is equal cost," said Simon Baker, who manages the Jupiter Ecology Fund and the Jupiter Environmental Opportunities Fund for Jupiter International Group PLC in London, a subsidiary of Commerzbank AG. "Subsidies are needed to get over that hump while the cost is higher." Wind power is the closest to parity. According to Stuebi, on average, it has cost about 2.5 cents a kilowatt hour to generate power from coal or gas for the last 30 years. Wind power, in contrast, now costs just under 4 cents a kilowatt hour, down from 10 cents in 1980. It cost a dollar to produce one kilowatt hour of solar power in 1980; now it costs 20 to 25 cents. The tipping point for alternative technologies depends on geography. The average retail price of power from conventional sources is 8 cents a kilowatt hour in the United States, far lower than retail prices in Europe. According to the U.S. Department of Energy, the average retail cost of electricity in 1999 in Germany was 15.2 cents a kilowatt hour, in Japan it was 21.2 cents, in Britain it was 11.7 cents, in Denmark it was 20.7 cents and in France in 1998 it was 12.9 cents. Not surprisingly, countries with high energy costs have been more eager to adopt alternative technologies. "The relative economics are more favorable to alternative energy," Stuebi said. While about 1 percent of energy in the United States comes from alternative sources, according to Stuebi, Denmark gets more than 10 percent of its electricity from wind power, and Germany gets about 5 percent of its electricity from renewable sources. That still leaves a lot of room for growth, and as the cost of wind and solar power has declined, demand has surged. According to Stuebi, while demand for traditional fossil fuels has grown less than 2 percent a year over the last decade, sales of wind turbines have grown more than 30 percent annually and sales of photovoltaic modules have grown 15 percent annually. "That's why I play in this space," he said. "It has got such long-term sustained growth opportunities. Sometime in the next 20 or 30 years, it is going to be a very big deal." Big companies have already jumped on board. In May 2001, General Electric Co. bought Enron Corp.'s wind power division out of bankruptcy for $285 million. BP PLC is one of the world's largest manufacturers of photovoltaic cells. Royal Dutch/Shell Groupestablished a hydrogen division in 1999 and last year announced it would build the first hydrogen refueling station in Tokyo. There are few pure plays in alternative energy. "You've got some big players, and you've got a million little guys," Stuebi said. "There are very few midsize businesses that are healthy, robust companies. The majority of renewable energy businesses are venture-capital backed or totally mom and pop." But there are options, which to some investors look appealingly cheap. "There has really been a shock to valuations in the last two years," said Roland Pfeuti, a fund manager at SAM Sustainable Asset Management in Zurich. "A lot of the stocks we look at are quite a bit below a reasonable valuation. The broad investor universe is not looking at this sector at the moment. Most institutions have stopped covering these little companies." Pfeuti said two of the world's largest wind turbine manufacturers, Vestas Wind Systems A/S and NEG Micon A/S, both in Denmark, were trading below fair value. "If you look at the medium- to long-term potential of these two major players, they could be attractive." He said he would buy REpower Systems AG, a German manufacturer of wind turbines, and Evergreen Solar Inc., a U.S. manufacturer of solar power products, at current valuations. He also likes Echelon Corp., an American company that makes metering equipment to maximize energy efficiency. Pfeuti also said investors have not been paying enough attention to emerging markets, especially China. "China will have an enormous demand for power over the next 10 years, in terms of demographics and population growth," Pfeuti said. The fastest-growing market for wind last year, he said, was Germany, where 3,300 megawatts of new wind power went online. In contrast, he said, China could have demand for 250,000 megawatts of wind power. Maxwell Technologies Inc. recently formed an alliance with Yeong-Long Technologies Co. to manufacture and market Maxwell's proprietary ultracapacitor products in China. Pfeuti said IMPCO Technologies Inc., an American company that makes fuel management systems for cars, and Westport Innovations Inc., a Canadian company that has a joint venture with Cummins Inc., a large diesel manufacturer, to convert diesel motors to natural gas and propane, also stand to benefit from growing demand in China. Andrew Preston, head of socially responsible investments at Aberdeen Asset Management PLC in Scotland, is less sanguine. "My outlook is a bit cautious," he said. He holds only one company in the sector, Gamesa Corporacion Tecnologica SA, a Spanish company that produces windmills and manages wind farms. He likes the modest multiple - right now Gamesa is trading at about nine times earnings - and its diversified revenue stream. In the solar arena, Becker likes Spire Corp., an American microcap that makes manufacturing equipment as well as solar panels and modules. He noted that the company has neither profit nor debt but does have a promising medical device business. The company, which has a market cap of $18 million, recently sold partial rights to its innovative dialysis catheter to C.R. Bard Inc., a medical device company, for up to $16 million. "That's the kicker on the story," Becker said. "It may prove to be the better investment within the business." Becker also owns AstroPower Inc., a U.S. company with a market cap of $140 million that makes solar cells, modules and systems. "The stock is quite attractive," he said. "They are in a turn around phase." Becker expects earnings per share to grow 20 percent to 25 percent over the next five years. "That's the difference between fuel cells and solar and wind," he added. "Solar and wind companies make money. AstroPower is a high-risk stock because it is a small company in a competitive market, but I think it is considerably lower-risk than any fuel cell stocks." Fuel cells are farther from commercialization than wind or solar power. "They have a lot of the aspects of early-stage technology companies," Becker said. None turns a profit. They are high-risk, require high capital investment and must keep pace with rapidly evolving technologies. "There are a number of players going for the same golden ring," Becker said. "It's not clear who is going to get there." Ballard Power Systems Inc., a Canadian manufacturer that focuses on building fuel cells for cars, is probably the best-known player, but Becker says the stock is too expensive. "Whenever people have been optimistic about fuel cells, they have bought Ballard," he said. "It is a big name, but I haven't liked it. More recently they've begun to cut costs and reduce their cash burn." Young Jin, the energy technology analyst at Reed Global Advisors LLC, has a "sell" recommendation on Ballard. "They have the ability to become the 500-pound gorilla of the industry, but in the past they've spent too much money," he said. "I'm skeptical." Becker prefers stationary fuel cells, which provide continuous, high-quality power in one location, because, he said, they face fewer technological hurdles and are closer to commercialization than the much-hyped hydrogen-powered prototypes coming out of Ford Motor Co., Toyota Motor Corp., General Motors Corp. and DaimlerChrysler AG. He invests in FuelCell Energy Inc., a U.S. company that specializes in stationary fuel cells. Last month, a Michelin tire plant in Karlsruhe, Germany, began operating on electricity and steam generated by fuel cells made by FuelCell Energy and its European partner, MTU CFC Solutions GmbH, a subsidiary of DaimlerChrysler. Jin has a hold recommendation on FuelCell Energy. "With the poor economic conditions and low capital expenditures, many companies are not willing to spend multimillion dollars on fuel cells to run a facility," he said. Becker likes Hydrogenics Corp., a fuel cell manufacturer that also produces fuel cell testing equipment. "Their idea is to fund their own development through this profitable equipment business instead of taking all the money from investors," said Becker, who does not own the stock. Even optimists sound a cautionary note when it comes to alternative energy. "They are either high risk or speculative - higher than high risk," Becker said. "Own a portfolio that has more stable companies in it before you dip your toe into this area."