In late March I pre-ordered one of Apple’s (NSDQ: AAPL) new iPad tablet computers with third-generation (3G) wireless capability. The first iPads hit the streets in early April and have been hot sellers, but the 3G model isn’t scheduled to ship until the end of the month.
To be honest, I haven’t a clue what I’m going to do with my iPad–I already own a laptop, a desktop computer, a Kindle e-reading device and a Blackberry smart phone.
I love electronic gadgets, and Apple’s products carry an undeniable “cool” factor. The company makes electronics that look good, feel good in the hand and have all sorts of features that I didn’t know I needed but soon find indispensable.
Although I already own and enjoy several of Apple’s products, I find the stores and, to some extent, the website rather intimidating. I always get the impression that the Apple brand is too cool for me; die-hard Apple fans have a fanatical devotion to the company that’s tough to comprehend.
I get the same impression about clean tech and alternative energy. I’ve covered oil, natural gas, nuclear power, biofuels and a host of other industries for nearly a decade. None of these groups inspire as much emotional attachment as clean tech and, in particular, wind and solar power.
Make a negative comment about wind or solar energy, and you’re certain to get scores of e-mails deriding your outlook. Readers react as though you’re denying the future of humanity and the long-term promise of cheap, clean energy. I’m afraid that much like Apple products, clean energy is too cool for me.
But I do know one thing: Stocks related to wind and solar energy underperformed substantially over the past year. Although many commentators hyped the group as a play on Obama’s presidency and a global cap-and-trade scheme, savvy investors made real money last year in stocks related to dirty energy sources such as coal and oil.
And don’t expect wind and solar energy names to perform well this year. Even with demand likely to bounce back, both industries face massive overcapacity and falling profit margins. For solar energy stocks, a big drop in subsidies from the German government remains a major headwind. Check out the graph below.
Source: Energy Information Administration
This graph depicts data from the US Energy Information Administration (EIA) concerning the cost of various sources of electricity generation in the US. All costs are in dollars per megawatt hour and assume the plant is to be completed and put into service in 2016.
I’ve also broken down the data by costs, providing further granularity. For example, the graph reveals that nuclear and hydroelectric power facilities entail substantial capital costs in the construction phase.
Plants fired by natural gas are on the opposite end of the spectrum; both advanced and conventional combined-cycle facilities entail little up-front capital costs because they’re cheap and quick to build. Nevertheless, these power plants do involve large variable costs related to the purchase of natural gas.
Wind and solar energy plants carry significant transmission costs. As I explained in the Feb. 24, 2010, issue of The Energy Letter, Popping the Green Bubble, wind turbines must be sited in regions where there are significant and relatively steady winds. In many cases, the best wind resources are located a considerable distance from population centers. Moreover, both power plants likely require upgrades to transmission networks and systems to accommodate their inherently variable output.
As with any projection, the EIA makes certain assumptions about fuel costs and the regulatory environment; the exact figures likely wouldn’t translate to other countries. However, this graph is a useful point of departure if you’re seeking to understand why a utility might look to build a certain type of power plant.
A quick glance at the chart shows that both solar photovoltaic (PV) and solar thermal are expensive technologies, far more expensive than any other source of electricity listed. Wind power is a great deal more cost-competitive than solar but significantly more expensive than coal, natural gas and nuclear power.
The composition of costs is another important issue. Solar and wind power plants are both extremely capital-intensive; building such facilities involves significant up-front costs for installation and transmission capacity. High capital costs typically entail a reliance on financing and debt capital; the lack of credit is one of the major reasons that spending on new wind and solar facilities suffered during the financial crisis of 2008.
Some pundits claim that growth in wind and solar is related to crude oil prices. This is absolutely not the case; crude just isn’t an important source of electricity–it’s a transportation fuel. Oil, wind and solar are all energy sources but serve different end markets.
A far more valid comparison can be made between the price of natural gas and alternatives; gas is a fuel for electric power and natural gas plants are among the lowest-cost sources of electricity. The competitiveness of gas increases if we consider the possibility of cap-and-trade legislation or tighter emissions standards because gas emits less than half the carbon of coal and considerably less sulfur dioxide, nitrous oxide and other key pollutants.
As I noted earlier, the price of natural gas-fired power heavily depends on gas prices. Prevailing low gas prices and optimism about supply growth from US unconventional plays suggests that gas-fired power is even more economically attractive than the EIA data implies. This makes natural gas an even more formidable competitor for alternative energy.
The implication of all this is that neither wind nor solar power is economic or cost-competitive with conventional energy sources without government support. One could argue that wind power comes close in certain markets with good wind resources, but that logic doesn’t work for solar energy.
Of course, governments do support wind and solar extensively with subsidies. And some national and state governments have standards which require that a certain percentage of power come from alternative energy technologies within a specific timeframe. These subsidies and mandates offset the sizeable cost differences between solar, wind and conventional energy sources.
In short, any investment case for wind and solar power is essentially a bet that the government will aggressively push these technologies enough to offset their inherent cost and implementation disadvantages.
Weak Demand, Glutted Supply
Government support can attempt to shift the basic laws of supply and demand by changing the cost equation, but it cannot suspend these basic economic forces. The simplest explanation for the underperformance of the “Big Two” alternatives in recent quarters is simple: There’s a glut in supply and insufficient demand growth to alleviate that glut.
The world’s largest wind turbine manufacturer, Vestas Wind Systems (Copenhagen: VWS.Co), reported telling results on Feb. 10. The company missed its guidance for 2009 revenues, booking just 6.6 billion euros as opposed to its projected 7.2 billion euros.
Even more damaging to the stock, management cut its outlook for 2010 revenues to around 7 billion euros from prior guidance of 7 to 8 billion. The company also cut its profit margin guidance to 10 to 11 percent from 10 to 12 percent.
Granted, these revisions aren’t extraordinarily large. However, management is making some aggressive assumptions in these estimates; I suspect they’re still too optimistic about the global wind power market.
In 2007, Vestas received orders for around 6,000 megawatts (MW) of new turbines and in 2008, the company managed to book slightly more than 6,000 MW. But last year, weak financing conditions limited orders to around 3,000 MW.
Management’s updated guidance assumes that real demand is around 6,000 MW per year and that some of the orders the company failed to receive in 2009 will be booked in 2010. Accordingly, it’s guiding analysts to expect some 8,000 to 9,000 MW of new orders this year. Furthermore, management noted that it expects those orders to be back-end loaded, materializing in the second half of 2010. A lot can happen over the next 9 months, but a forecast for record orders is risky.
Management’s revenue targets likewise evince excessive optimism. At the end of 2009, the company’s backlog stood at 2.2 billion euros, roughly one-third of its annual revenue target of 7 billion euros. In the past, Vestas has entered the year with backlogs covering as much as three-quarters of its guidance, suggesting there’s more downside risk to its 2010 estimate.
Finally, the company’s expectations for margins are also dubious. Management noted during the most recent conference call that profit margins on orders should hold steady while admitting competition in the industry has increased significantly. Some industry analysts believe that turbine manufacturing capacity will exceed demand by nearly 50 percent in 2010.
This overcapacity is even evident in China, a country that added more wind capacity last year than any other nation. China plans to idle as much as 40 percent of its turbine plants this year because it has a surplus of manufacturing capacity. Part of the problem is that the Chinese electric transmission grid will need require upgrades before it can handle the growth in wind power installations. Other wind power companies have alluded to pricing pressure as a result of excess capacity; Vestas won’t be immune to these trends.
It’s not my intention to disparage Vestas; the company is a leader in the wind turbine business and will be a long-term winner in the industry. Rather, my intention is to note that wind power is not the sure-fire road to riches that many investors assume it to be. Despite strong government support, wind power is prone to the same bouts of overcapacity and pricing pressure that afflict any other cyclical industry. And government support can’t reverse the impacts of a global recession and credit crunch.
The situation with solar power is even worse. Solar is among the most expensive and economically unattractive sources of power in the world today, and the industry is even more dependent on subsidies and tax credits to grow. In some ways, a political science degree might be more useful for forecasting solar demand than a background in finance.
Germany is by far the largest market for solar power in the world. Private analysts suggest the total global market for solar capacity was around 5,500 to 6,000 MW in 2009. Of that total, more than half–around 3,000 MW–was demand from Germany.
Germany uses a feed-in tariff structure to promote solar energy. Under this system, solar power producers receive a higher tariff for electricity to compensate for the higher generation costs. That subsidized tariff declines over time as technological improvement occurs and the costs of producing solar energy fall. The idea is to encourage solar development and gradually push producers to bring down costs and become more efficient.
The first half of 2010 is likely to be strong for the German solar market as credit conditions normalize and producers push to complete plants by July. The reason for the rush is that Germany’s feed-in tariff rates will be reduced in July by as much as 16 percent; any projects completed after then will earn a significantly lower return. When you consider Germany’s importance to the global solar market, that feed-in tariff reduction is a major obstacle for the industry.
And later this year or in 2011, several other major solar markets–including Italy, the Czech Republic and Spain–either have plans to cap the size of their solar market eligible for the feed-in tariff or reduce the size of the subsidy. The result: 2010 will be heavily front-end loaded.
Even worse, as demand looks troubled, supply growth looks to be accelerating. Major solar panel producers are going ahead with plans to increase capacity, hoping to take advantage of the strong market in the first half of this year. This opens up the potential for a major glut in late 2010 and early 2011. Prices came down sharply during a bout of oversupply amid the global recession and credit crunch; I see no reason to believe we won’t see significant downside to pricing and margins this year as well.
Solar stocks could rally in the near term because valuations are undemanding and German demand in the first half may well surprise to the upside. But any rally would mark an opportunity to sell, as the second half of the year is shaping up to be a nasty environment for the group.
The Real Alternatives
Despite the hype surrounding “clean tech,” wind and solar energy stocks underperformed last year and are likely to perform poorly once again in 2010.
But that’s not to suggest that the industry doesn’t present significant investment opportunities. Instead, investors should focus on energy efficiency and grid modernization. Advanced materials are one of my favorite investment themes for 2010.
With oil prices on the rise, it’s only logical that major consumers would look for ways to cut costs by conserving fuel. Case in point: Airlines and airfreight companies are buying lighter aircraft that consume as much as one-third less jet fuel as older planes.
A desire to reduce costs is also powering demand for rail transportation; trains are as much as 4 times more fuel-efficient at carrying cargos compared to trucks. Even as solar and wind stocks languish, we’ve seen considerable upside in efficiency and advanced materials plays.
Current subscribers to The Energy Strategist can see my favorite plays on these trends in the March 24, 2010, issue, “Investing in Efficiency.”
And we offer a money-back guarantee for new subscribers. As soon as you sign up, you’ll be able to read that report as well as my latest issue, “The Search for More Oil,” which covers 10 global oil producers with the potential to significant increase production over the next few years.
My favorite oil plays all have key near-term catalysts in the form of major exploration programs for 2010 or plans to significantly ramp up production from hot oil plays that range from a new discovery in California to a series of new finds in Africa and a promising play in Arctic waters off Greenland. Last year we booked a 167 percent gain on one of my favorite exploration-oriented oil producers; with oil prices likely to touch $90 a barrel this month, I see the potential for even higher gains out of my latest crop.Investors interested in a risk-free look at The Energy Strategist can find out more about the service by clicking here.