In the past two issues of The Energy Letter, I provided an update on important renewable energy options: solar photovoltaic (PV), wind power, hydropower, and geothermal power. In upcoming issues of The Energy Strategist, I want to review the performance and financial condition of some of the market leaders in these sectors, and provide recommendations for investors looking for some exposure to these sectors. We will also be adding some of the sector leaders to our Energy Watch List. In this week’s issue, I begin by taking a closer look at the solar PV and wind sectors.

I generally advise investors to avoid companies that are dependent upon government subsidies for their survival. The vast majority of the companies in the renewable energy sector fall into this category, and as such I will continue to recommend that investors avoid this sector. However, that may change in the future, so it’s important for investors to understand these sectors, in order to be prepared to act if conditions warrant action.

The current situation in Spain provides a perfect example of the risks inherent in investing in industries that are created in response to government incentives. In 2007 the Spanish government pursued aggressive policies designed to incentivize renewable energy. These policies certainly jump-started Spain’s renewable energy industry, as numerous investors borrowed money and began work on projects. By the end of 2012, Spain ranked in the top three globally in both solar PV and wind power consumption.

However, the program began to put the country into deeper debt. The renewable energy subsidies were a major factor in Spain racking up $31 billion in power sector debt by the end of 2011. Adding to Spain’s woes was Europe’s financial crisis, and in response the country was forced to curtail the generous renewable energy subsidies. Payments to renewable energy developers were slashed, and many are finding it difficult to repay their loans. The share prices of the companies involved in the production of renewable energy plummeted. What the government gave to shareholders, the government took away.

Thus, I prefer to shield my portfolio from the vagaries of public policy to the greatest possible extent. But in specific niches and under specific conditions, some renewable energy companies are marginally competitive today, and may be well-positioned to ultimately thrive even in the absence of specific subsidies or mandates.

Solar PV

Certain materials, such as various types of silicon or cadmium telluride, are capable of producing electricity when struck by solar radiation. Solar PV cells are produced using materials that are susceptible to this photoelectric effect.

Solar PV cells are capable of converting solar radiation into energy at a much higher efficiency than plants can through photosynthesis. While most commercial solar PV cells convert solar radiation at efficiencies ranging from 10 percent to 15 percent, experimental cells have managed to increase the efficiency to more than 40 percent. For reference, most plants convert sunlight into biomass via photosynthesis at less than 1 percent efficiency. (On the plus side, biomass is a built-in energy storage mechanism for plants.)

The solar PV market is small relative to the overall electricity market, but it is growing rapidly. In 2012, solar photovoltaics crossed the 100 gigawatt (GW) mark for installed capacity. Installed capacity of solar PV grew by 42 percent in 2012, down from the annual five-year average growth rate of 60 percent. Consumption of power derived from solar PV advanced by 58 percent last year.

European Union countries dominate global solar PV capacity thanks to policies favoring renewable energy. In 2012, Germany was the world leader in the consumption of solar PV, using 28 terawatt hours (TWh) and accounting for 30 percent of the global total. Italy and Spain were the second- and third-largest consumers, and the European Union (EU) as a whole accounted for 76 percent of global solar PV consumption.
Much of the growth was delivered by new utility-scale systems (generally multi-megawatt facilities designed to serve hundreds or thousands of customers). There are presently more than 5,000 utility-scale systems accounting for nearly 25 percent of global solar PV capacity.

Source: REN21’s 2013 Renewables Global Status Report

While there are a number of ways to invest in the solar PV sector, the most direct is through the makers of solar PV panels. This is a highly competitive and fragmented marketplace, with the leading North American manufacturer, First Solar (Nasdaq: FSLR), commanding only 5.3 percent of the global market in 2012. Canadian Solar (Nasdaq: CSIQ) is the second-largest solar PV maker in North America with 4.6 percent of the 2012 global market, and SunPower (Nasdaq: SPWR) is third in North America with 2.6 percent of the 2012 global market.

Despite the explosive growth rates in the solar PV market, the five-year performance of all three of these North American solar PV makers has been abysmal. Canadian Solar was the “best” of the group, losing only 51 percent of its value over the past five years. SunPower saw its share price decline by 64 percent over the same time period, and First Solar’s shares fell 82 percent.

The past year has been an entirely different story for these companies, with all three notching triple-digit returns in that span. In the past 12 months FSLR has risen 232 percent, CSIQ is up 273 percent, and SPWR is up an amazing 489 percent.

Financially, First Solar is in a much stronger position than its two North American competitors. Despite the competitive nature of the business, it has managed to be consistently profitable and carries a low level of debt. Thus, it is probably the safest of the three for an investor.

On the other hand, this sector will continue to be very competitive, and any weakening of policies favoring renewable energy could have a devastating impact on the sector. In that event, First Solar is likely to be one of the last players standing, and we are adding it to the Energy Watch List this week.

Wind Power

The power of the wind has been used for thousands of years to propel ships with sails, pump water and grind grain. Wind was first used to produce electricity near the end of the 19th century, but it was only in the past two decades that global wind power capacity began to expand rapidly.

Most of us are familiar with electric motors. In an electric motor, electricity is used to generate a force by causing coils of wire to rotate in a magnetic field. In an electric generator, the opposite happens: a force typically moves coils of wire through a magnetic field and produces electricity. When the wind applies the force and rotates turbine blades, wind power is the result.

Installed wind power capacity has grown explosively around the world since the mid 1990s. From 6.1 GW in 1996, global wind power capacity grew by a factor of nearly 50 to some 283 GW by 2012. Over the five-year period through the end of 2012, global wind power capacity increased by an average of 25 percent per year.

The US led the world in consumption of wind power in 2012 with 141.5 TWh — 27 percent of the global total. China was second with 100 TWh, but its 34.6 percent increase over 2011 was more than twice the 16.3 percent increase in the US. Spain placed third with 49 TWh of consumption. Germany ranked in the top five for both solar and wind but actually lost ground in 2012, consuming 6 percent less wind power than in 2011.

Source: REN21’s 2013 Renewables Global Status Report

Wind power has attracted more controversy than solar power, with people protesting on the basis of aesthetics, noise, and/or risk to birds. The primary opposition to solar has been on the basis of cost, but organized opposition to new wind power projects has appeared in numerous countries.

Besides the fact that it is intermittent power, two oft-cited disadvantages of wind power are the noise from the turbines and the fact that birds and bats are sometimes killed by the turbines. The noise issue often results in opposition to wind farms from local residents — a standard and understandable NIMBY (Not In My Backyard) response.

The issue of bird and bat kills brings a broader level of opposition from many animal conservation and environmental groups. A frequently cited example is a 2008 study of a wind farm in Altamont Pass, California, that estimated the turbines there kill an average of 80 golden eagles and a total of about 10,000 birds annually.

Estimates of bird kills from wind turbines in the United States range from 150,000 up to about 500,000, according to the American Wind Energy Association (the U.S. lobby for the wind industry). For context, the US Forest Service has estimated that each year 550 million birds are killed in collisions with buildings, 130 million by power lines, 100 million by cats, and 80 million in collisions with automobiles.

So wind power is not immune to the trade-offs we must make with any of our energy sources. On the plus side, wind power has the potential to limit the use of fossil fuels by power plants, and that has distinct environmental benefits. On the negative side, wind power often requires a high level of firm power backing it up — an externality generally excluded from the reported cost of producing wind power. Further, the number of birds and bats killed by wind power is expected to rise as additional wind power capacity is installed.

The fortunes of global wind power companies have risen and fallen in recent years. After running up sharply in 2008, companies like Danish-based Vestas Wind Systems (OTC: VWDRY) have been on a long slide. This leading wind turbine producer is down 81 percent over the past five years. In the US, General Electric (NYSE: GE) is the leading producer of wind turbines through its GE Wind Energy subsidiary. This would be a much safer way for investors to gain exposure to the sector, but the performance of GE’s wind subsidiary is going to be a relatively small factor in the fortunes of the much larger parent company or the performance of its stock.

Like solar power, wind energy is highly dependent on subsidies for continued growth. In recent years, annual fights over the Production Tax Credit (PTC) program and various state-based Renewable Portfolio Standards (RPS) that mandate a certain percentage of electricity from clean-energy sources, created uncertainty for large-scale wind farm development. The PTC provides a tax credit of 2.2 cents per kilowatt-hour for wind power. The credit has existed since 1992 and has been renewed four times. But it has also been allowed to expire three times. Such uncertainties around tax laws create additional risk for investors in the sector.