a mass market.r World-class sales and marketing capabilities to ensure sales traction.r Sufficient financial and human resources to take a product all the wayto the commercialized stage.r Management focus on creating profits and value for public shareholders and not on simply burning cash indefinitely or granting themselvesbig pay packages.The stock market graveyard is littered with small companies thatthought they had a business but failed due to the following causes:1. Insufficient financing.2. An inability to translate a promising technology into a commercially
attractive product or service.3. An inability to execute on sales and marketing.4. An inability to compete against competitors or a large company, among
many other reasons.Less-experienced investors would be well advised to take a lower-riskstrategy of choosing companies that are already profitable and that haveproven that they have a product or service that is already succeeding inthe marketplace. The potential upside for the stock may be lower than anearlier stage company, but the risks are also significantly lower, meaningthe risk-return profile may still be very attractive. Investors that have moreexperience in analyzing and selecting small-cap companies, on the otherhand, will find that the clean energy industry can offer them a host of opportunities.
VALUATION AND BUBBLESA cautionary word is in order about excess valuation and speculative bubbles. As with any new, hot industry, the clean energy industry is subject tospeculative excess, bubbles and overvaluation. Certain subsectors of the
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clean energy industry have already gone through speculative bubbles andbusts. The fuel cell industry, for example, has seen periodic stock runups and sell-offs since 2000, and fuel cell stocks on average were veryweak from mid-2006 through mid-2007 and traded down to five-year lows.Ethanol stocks soared in early 2006 but then fell sharply later in 2006 andin early 2007. This volatility creates trading opportunities (long and short)for traders with short time horizons, but makes it difficult for the long-terminvestor to enter a long-term, profitable position.A long-term investor in the clean energy sector would be well advisedto patiently wait for buying opportunities in strategically attractive stocks,put in a good-til-canceled stop for safety well below the entry price, andthen just forget about the stock and plan to hold it for three to five yearsor more. Having a long-term investment horizon means not worrying aboutthe week-to-week fluctuations in the stock, but instead investing in an industry that is likely to do very well in coming decades, knowing there willbe various bumps and corrections along the way.
CLEAN ENERGY STOCK PERFORMANCEIn order to look at the stock performance of the clean energy sector, wewill use clean energy indexes produced by Melvin & Company, an institutional research and trading brokerage firm based in Chicago. The MelvinClean Energy IndexTM tracks about 50 U.S.-listed clean energy companies.The graph in Figure 1.1 summarizes the annual performance seen from2003 to 2006. The index performed very poorly in 2002 (–35.6 percent) dueto the U.S. economic recession and broad stock market correction but thenperformed very well in 2003 (+116.2 percent), 2004 (+37.4 percent), and2005 (+29.8 percent). In 2006, the index rose +8.0 percent, which was below the Russell 2000 gain of +17.0 percent, as clean energy stocks sawsome profit-taking pressures. In the first half of 2007, the index was up+9 percent year-to-date.Figure 1.2 illustrates the performance of the Melvin Securities CleanEnergy IndexTM relative to the S&P 500 and Russell 2000 over the past fiveyears. The chart illustrates the strength of the clean energy sector from2003 through the first half of 2006. The clean energy sector then fell back inthe second half of 2006 because of weakness in ethanol stocks (due to therise in corn prices that started in September 2006) and due to profit takingin the other sectors.The clean energy sector is actually a collection of about 10 completelydifferent industries. It would be a big mistake to assume that these subsectors move together in lockstep. Indeed, Figure 1.3 tracks the Melvin Clean
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116.2%
120%
Left bar: Clean EnergyRight Bar: Russell 2000
100%80%60%
45.4%
40%
37.4%
29.8%
17.0%
20%
3.3%
17.0%8.0%
0%–20%–40%
–21.6%–35.6%
–60%2002
2003
FIGURE 1.1 Melvin Clean Energy2000 Small-Cap Index
2004
IndexTM
2005
2006
Annual Performance versus Russell
Energy subsector stock indexes. The chart illustrates the disparate performance of the various clean energy subsectors. The Fuel Cell and Power Efficiency subsectors have been relatively weak over the past five years. TheEthanol sector soared in the first half of 2006 when ethanol prices surged
400Melvin Clean Energy Index
300
200Russell 2000Indexed 100 = 31-Dec-2001S&P 500
100
02002
2003
2004
2005
2006
2007
FIGURE 1.2 Melvin Clean Energy IndexTM vs. S&P 500 and Russell 2000
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800Ethanol700600500Solar Power400300Melvin Clean Energy Index200Indexed 100 = 31-Dec-2001Power Efficiency100Fuel Cells2002
2003
2004
2005
2006
2007
0
FIGURE 1.3 Melvin Clean Energy IndexTM and Subsector Indexes
on the switch to ethanol from MTBE, but ethanol stocks then fell back inlate 2006 and early 2007 as corn prices surged and threatened profit margins for corn-based ethanol producers. The solar sector broke out startinglate 2004 and has since remained generally strong.
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CHAPTER 2
Catalysts for theClean EnergyIndustry
n this chapter, we examine the drivers and catalysts behind the cleanenergy industry. Every industry has drivers that determine demand andgrowth rates and, by extension, industry revenues, profits, and stockprices. It is important to examine these drivers to analyze whether the underpinnings of the industry are solid and sustainable, or whether the entireindustry is built on a house of cards.Products and services succeed in the marketplace if they can solvebuyers’ problems. One of the first rules of sales is to identify the prospective customer’s problems so that the sales person can then explain howthe product will solve the customer’s problems. In the case of clean energy, we need to examine the underlying problems to see if there is a needfor a solution and whether clean energy companies can provide that solution. If clean energy technologies can in fact solve serious world problemsin a cost-effective manner, then we have indeed found an industry that willhave legs for decades to come.
I
FOSSIL FUEL NEGATIVES: POLLUTION, CO2EMISSIONS, CARTELS, PRICE SPIKES, ANDRISING PRICESIn the past two centuries, fossil fuel in the form of coal, petroleum, andnatural gas has served the world very well in providing a cheap supply offuel to drive the age of industrialization. The energy derived from burning27
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700
600
Quadrillion Btu
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500
400
300
2001980
1990
2000
2010
2020
2030
FIGURE 2.1 World Fossil Fuel Consumption: EIA Forecast to 2030
fossil fuels has powered the world’s factories, homes and vehicles for manydecades. Fossil fuels have helped make citizens in the industrialized worldrich beyond the dreams of any person living prior to the modern age.The U.S. Energy Information Administration fully expects the age offossil fuels to continue through its forecast period of 2030, with overall fossil fuel consumption by 2030 doubling from the level seen as recently as1995, as seen in Figure 2.1. Yet the problems caused by fossil fuel are already coming home to roost. The simple fact is that burning fossil fuels,whether in power plants or in internal combustion engines, releases CO2 ,other greenhouse gases, and various contaminants into the atmosphere,causing pollution and global warming problems. Energy needs to be derived from cleaner sources that avoid these problems.Fossil fuels not only pollute the earth’s atmosphere but also make theworld’s economy vulnerable to supply shocks and the price of fossil fuels.Coal prices have remained remarkably inexpensive over the years. However, crude oil prices have been highly volatile in the past several decades,as seen in Figure 2.2. Crude oil prices can single-handedly threaten worldeconomic growth. For example, an upward spike in crude oil prices wasthe direct cause of three of the last five recessions in the United States(1973–1975, 1980, 1990–1991). The deep 1973–1975 recession was largelycaused by the Arab Oil Embargo, the 1980 recession was caused by anoil price spike related to the Iranian revolution against the Shah of Iran,and the 1990–1991 recession was caused by an oil spike tied to SaddamHussein’s invasion of Kuwait and the first U.S.-Iraq War (Operation Desert
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$80
$60
US$/barrel
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$40
$20
$01970
1975
1980
1985
1990
1995
2000
2005
FIGURE 2.2 Crude Oil Prices: West Texas Intermediate
Storm). Those recessions directly caused unemployment, business failures, personal bankruptcies, mortgage defaults, and various other typesof misery for citizens.Crude oil prices are in fact controlled to a significant degree by theOPEC cartel, which restricts the supply of crude oil in order to ensure thatoil prices stay high and thus maximize revenue for the OPEC states. Theextra revenue that OPEC member states acquire through their anticompetitive behavior comes straight out of the pocket of the average citizen in theU.S., Europe, Asia, Australia, South America, and Africa. Yet the U.S. andEuropean governments have never made a serious effort to break the control of the OPEC cartel, mainly because the Western nations do not want torisk another oil embargo and because they want to ensure that pro-Westerngovernments such as Saudi Arabia stay in power. Yet the price for that subservience to OPEC is that Western consumers and businesses are forced topay exorbitant prices for petroleum products, which in turn leads to lowerconsumer income and corporate profits and subpar economic growth.There is little doubt that the long-term direction of oil prices will be upward, thus providing more pain for global consumers down the road. Crudeoil prices over the short-term can go up or down, depending on short-termdemand and supply factors. However, crude oil prices from 2004 through2006 more than doubled from $30 per barrel to a record high of $78 perbarrel and have since fluctuated between about $50 to $70 per barrel. Themain reason for this rally was strong new demand from China, India, andother emerging countries.
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In a well-functioning market, new supply would emerge to meet a surgein demand and that new supply would allow prices to fall back to morereasonable levels. However, the crude oil market is far from being a wellfunctioning market. OPEC has been pleased with the surge in oil pricesand particularly with the fact that oil prices of $70 per barrel have notcaused a world recession, contrary to the earlier predictions of virtually alleconomists. Since the world proved it could absorb high oil prices, OPECsimply raised its effective target price for crude oil from $40 per barrel toabout the $60 per barrel area. In fact in autumn 2006, when it became clearthat crude oil inventories were excessive and that oil prices were headedto $50 per barrel, OPEC members mobilized to cut production by an overall 5 percent, causing oil prices to rally back up to and above the $60 perbarrel level.The crude oil supply problem has been exacerbated by the fact that thenon-OPEC oil producers and global oil companies have not stepped up production significantly despite high prices. Part of that problem is tied to thenew nationalism among oil producing countries such as Russia, Venezuelaand others. These countries are engaging in a thinly-veiled confiscation ofassets from the big global oil companies. The end result of this nationalismis usually lower overall oil production because politically controlled national oil companies are more interested in providing immediate revenueto government coffers to be used for political purposes, rather than usingcash flow to invest in new exploration to expand reserves and maximizerevenue over the long-term.The world’s oil companies are not only losing control of assets and reserves through nationalism, but are also reluctant to expand investmentbecause they are not sure whether oil prices will remain high enough togive them a sufficient return on investment on the massive quantity of capital that is now required to develop major oil fields. The reality is that virtually all of the world’s cheap and easy-to-extract oil has already been found.There is plenty of crude oil left in the world’s crust, but it is deep in theearth, far below the ocean or in inhospitable and hard to reach locations.Major oil companies, for example, found huge oil reserves on the order of3 to 15 billion barrels in the Wilcox formation in the Gulf of Mexico, butthe oil is in very deep water some 175 miles off the coast of Louisiana. Theoil is under 7,000 feet of water and is then down another 20,000 feet belowthe sea floor. Major oil companies are developing the technology to drill insuch deepwater locales, but the costs are far higher than old onshore oilfields where the oil is close to the surface and cheap to extract.The reality is that huge amounts of capital are necessary to extract theoil reserves that are being discovered today. The only way that oil producers will spend such large sums of capital on new investment in expensiveto-extract oil is if oil prices are high enough on a sustained basis to allow
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them to turn a profit on those oil extraction expenses. If they cannot turna profit, then they will not extract that oil until prices are high enough. Inother words, oil prices must stay high or else producers will not bring thenew supply to market. This is the main reason why oil prices are likely tostay high and rise further over the long run.Regarding the cost of coal, coal-fired plants are currently the cheapest way to generate electricity. However, that does not consider the external costs of coal-fired plants. If coal-fired plants were required to capturethe CO2 they emit into the atmosphere, it would cost 40 percent more tobuild and operate and the plants would produce 20 percent less electricity,according to an MIT study, The Future of Coal: Options for a CarbonConstrained World.1 If these costs were loaded into the effective cost ofcoal, then coal-generated electricity no longer looks so cheap and renewable electricity generated by solar and wind power becomes more economical by comparison.
ENERGY SECURITYThe concept of “energy security” has made its way into public discussion ina big way in recent years. Washington politicians even try to get the phrase“energy security” into their proposed bills to make their bills sound moreattractive. For example, a recent bill introduced into Congress was calledthe Biofuels Security Act of 2005.The dependence of the United States on foreign oil imports is dramatically illustrated in Figure 2.3. U.S. oil production peaked in 1970 at 3.52 billion barrels and has fallen steadily ever since.2 Meanwhile, U.S. petroleumconsumption has steadily risen for the past two decades. The gap betweenfalling production and rising consumption has been filled by a sharp increase in net imports of foreign oil. In 2006, the United States importeda net 4.48 billion barrels of oil, which represented 60 percent of U.S. oilconsumption.3 As things stand now, the U.S. economy simply could notfunction in any reasonable way without foreign oil imports.The term “energy security” refers to both economic security and physical security. In an economic sense, western economies would see a hugebenefit if they could eliminate their economic dependence on petroleumprices, which are highly volatile and likely to rise over the long run. However, the energy security also refers to geopolitical and physical security.The United States has gone to war over oil in the past and may decide doso again in the future. When Saddam Hussein invaded Kuwait in 1990 andappeared destined to march on to Saudi Arabia, the United States hastilyarranged a coalition to go to war with Saddam. The United States and its
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U.S. Consumption6Billion Barrels
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2
U.S. Production
01950
1960
1970
1980Production
Consumption
1990
2000
Net Imports
FIGURE 2.3 U.S. Petroleum Import DependenceSource: U.S. Energy Information Administration, Annual Energy Review 2006, May2007, Table 5.1, http://www.eia.doe.gov/emeu/aer/txt/stb0501.xls.
allies in Desert Storm quickly pushed Saddam’s troops out of Kuwait andback to Baghdad.The reason why the United States went to war to reverse Iraq’s invasion of Kuwait was because America’s “vital national interests” were atstake. Everyone knows that “vital national interests” often refers to theneed for the United States to protect the global supply of oil, without whichthe U.S. economy would be brought to its knees. The first President Bushused high-minded language such as “aggression will not stand” to justify thefirst U.S.-Iraq war. But it is doubtful that the U.S. government would havesent its troops into full-scale battle if Saddam Hussein had seized a verysmall neighboring desert nation with no oil and no strategic importance.There are frequently wars in Africa involving aggression and even genocide, and yet the United States does not go to war there because America’s“vital national interests” are not involved.Regarding the possibility of future wars over oil, there is not muchdoubt that the United States would be at war within a matter of weeks(regardless of whether the Republicans or the Democrats were in power)if Iran were to blockade the Straights of Hormuz, through which one-fifthof the world’s daily oil consumption flows.4 Oil prices would likely soarabove $150 per barrel and gasoline prices could reach at least $5 per gallonon even a temporary shutdown of the Straights of Hormuz. “Vital Americaninterests” would once again be at stake.
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The fact that Iran could cut off one-fifth of the world’s oil supply, atleast for a period of time, highlights the fact that much of the world’s oil reserves can be threatened or controlled by countries that are either hostileto the United States or that have serious internal stability problems. TheMiddle East is a tinder box with low-grade wars going on in Afghanistanand Iraq, with Iran trying feverishly to build a nuclear bomb, with radical Islamists threatening moderate Arab governments in the region, andwith hostility toward Israel in the region as high as ever. In Nigeria, rebelactivity and political instability have caused a 20 percent reduction inNigeria’s oil output, which is particularly important since Nigeria is theworld’s eighth largest oil exporter and exports the light, sweet crude thatis the easiest to refine into gasoline.5 Nigeria is particularly important tothe United States since Nigeria exports 42 percent of its oil to the UnitedStates.6 In Venezuela, President Hugo Chavez has full control over nationaloil production and regularly threatens to cut off oil exports to the UnitedStates. Venezuela accounted for 11 percent of total U.S. imports in 2005.In Russia, the Russian government over the past several years has usedvarious bare-knuckle tactics to take over private oil and gas operationsand consolidate those operations under Russian government ownershipand control. In China, government officials have been busy traveling theworld to dole out foreign aid and favors in order to lock up sources of oilfor direct export to China.When it comes to “energy security,” Brazil is one of the few countries inthe world that has it right. Twenty years ago Brazil’s government began anaggressive campaign to build its domestic ethanol business. Brazil has nowreached its goal of energy independence and no longer needs to import anyforeign oil. Brazil’s economy and foreign policy are now insulated from oilprice shocks and the vagaries of oil politics and threats.
GROWING GLOBAL ENERGY DEMANDThe world could perhaps live with the current energy situation if therewere no economic growth in the world and no population growth. However, world demand for energy is growing very rapidly. The supply of energy has to keep pace, not only with current demand, but also with thesubstantial new demand that will emerge in coming decades.World energy consumption will increase by a total of 57 percent from2004 to 2030, according to forecasts by the U.S. Energy Information Administration (EIA), a unit of the U.S. Department of Energy.7 The EIAbreaks down its forecast between the world’s industrialized OECD nations(i.e., the 30 industrialized countries that belong to the Organization for
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800
Quadrillion Btu
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400
200
2004
2010
2015OECD
2020
2025
2030
Non-OECD
FIGURE 2.4 EIA Forecasted Primary Energy Consumption: OECD vs. non-OECDSource: U.S. Energy Information Administration, International Energy Outlook 2007,May 2007, p. 1, Table A1, p. 83, www.eia.doe.gov/oiaf/ieo/index.html.
Economic Cooperation and Development) and non-OECD nations. TheEIA’s forecast is that energy demand will increase by an extraordinary95 percent through 2030 in the emerging non-OECD countries, as compared with a 24 percent increase in the OECD countries. Regarding annualgrowth rates, the U.S. Energy Information Administration is projecting thattotal energy consumption in the OECD countries will grow at an averageannual rate of +0.8 percent, but that annual growth will be more than threetimes as large at +2.6 percent for the non-OECD emerging countries. Theseforecasts are illustrated in graphical format in Figure 2.4.The takeaway from this analysis is to recognize how the world’s energy outlook is driven far more by new energy demand from emergingnon-OECD countries than from the OECD industrialized countries. Muchof this demand can be tied directly to the fall of the socialist economic system in the 1980s and 1990s. When the socialist economic system fell, some2.6 billion people (just in China, Russian, and India) were suddenly asking for rapid economic development.8 India was never officially a socialistcountry, but nevertheless suffered from heavy statist government intervention in the economy until free market reforms started to be implementedin the 1990s. These countries, and many other developing countries, nowhave a voracious energy appetite in conjunction with their full-throttle economic development policies.The alarming extent of non-OECD energy demand is also seen whennarrowing the focus to electricity consumption instead of overall energy
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Trillion kilowatt hours
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01980
1990
2000
2010OECD
2020
2030
Non-OECD
FIGURE 2.5 EIA Forecasted Electric Power Generation: OECD vs. Non-OECDSource: U.S. Energy Information Administration, International Energy Outlook 2007,May 2007, p. 8, http://www.eia.doe.gov/oiaf/ieo/excel/ﬁgure 61data.xls.
consumption. The EIA forecasts that world electricity generation in 2030will nearly double to 30.364 trillion kilowatt-hours from the 2004 level of16.424 trillion kilowatt-hours, as seen in Figure 2.5. The EIA is projectingannual growth for electricity consumption in the non-OECD countries of3.5 percent versus 1.3 percent in the OECD countries.9 This will cause electric power generation supply in the non-OECD countries to cross abovethat of OECD countries in about 2015, as seen in Figure 2.5. The EIA says,“Robust economic growth in many of the non-OECD countries is expectedto boost demand for electricity to run newly purchased home appliancesfor air conditioning, cooking, space and water heating, and refrigerationand to support expansion of commercial services, including hospitals, office buildings, and shopping malls.”10It is extremely important to recognize the scale of energy demand indeveloping countries. The population of just China, India, and Russia is2.6 billion (not to mention the rest of the developing world), which is morethan eight times larger than America’s population of 301 million people.11Many of the people in the developing world aspire to eventually havingthe same type of homes, electric appliances, and vehicles as Americans,Europeans, and Japanese.Right now, people in the developing world use a fraction of the electricity used in the developed world. Even though China has more than fourtimes as many people as the United States, for example, it uses one-third
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less electricity.12 If China’s per capita electricity usage reached the currentU.S. level of 12,343 kilowatt-hours, China’s national electricity consumption would increase by more than six times from the current level of 2.494trillion kilowatt-hours to about 16.3 trillion kilowatt-hours. China is alreadystruggling to meet its current electricity demand, let alone meet potentialdemand running as high as six times the current level.The enormous size of potential electricity demand in China—and, indeed, from the developing world as a whole—thus becomes clearer. Chinais already choking on its coal-fired power plants, which are also sendingpollution all the way across the Pacific Ocean to the United States.13 Every7 to 10 days, China brings another coal-fired power plant on line that is bigenough to serve all the households in Dallas or San Diego according to theNew York Times.14 Yet the situation can get worse as per capita electricityusage in the developing world rises even further.The increase in energy demand from the developing world stems fromthe transportation sector as well as the electricity sector. In the transportation sector, the energy demand takes the form of gasoline rather than coaland natural gas for the electricity sector. For the OECD countries, the EIAforecasts that energy demand for transportation will grow by an overall27 percent from 57.9 quadrillion Btu (British thermal units) in 2004 to 73.4quadrillion Btu by 2030.15 By contrast, the EIA forecasts that in the nonOECD countries, energy demand for transportation will more than doublefrom 39.8 quadrillion Btu in 2004 to 63.1 quadrillion Btu in 2030, swampinggrowth in the OECD developed world.16The bottom line is that there is extremely strong demand for both electricity and transportation energy coming mainly from the developing countries where there are several billion people who aspire to substantially raising their living standards. The fossil fuel industry might be able to deliveron this demand, but it would take a lot of coal and crude oil extraction,and even then the impact on the environment in terms of greenhouse gasemissions and other environmental damage would be substantial.
GREENHOUSE GAS EMISSIONS ANDCLIMATE CHANGEThe American public in 2006 seemed to wake up to the issue of global climate change. Al Gore’s book, An Inconvenient Truth, was on the NewYork Times bestseller list and his film of the same title won an AcademyAward for Best Documentary. Al Gore and the Intergovernmental Panelon Climate Change then won the Nobel Peace Prize in October 2007. AlGore’s book and film certainly had something to do with public awareness
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of global warming, but so did observable facts such as melting icecaps,shrinking glaciers, and observations by people