Investment Thesis
Rapid economic growth in developing countries has placed pressure on the global energy infrastructure. Although oil and coal demand continues to build, global concerns about climate change and energy independence/security have offered alternative forms of energy production a chance to compete.
Alternative forms of energy present competition with traditional fossil fuels through grid pricing.
Currently, most of these alternative techniques result in premium pricing vs. the grid and require some form of financial support to attract investment. As we discuss throughout this report, new technologies and efficiency developments are beginning to narrow the gap between alternatives and fossil-fuels.
Various technological improvements have improved the relative economics of alternative energy over the past few decades. This has encouraged large global corporations to develop and implement various alternative energy projects. Despite continued reliance on governmental incentives and high oil prices, we believe the alternative energy industry now stands ready to become a legitimate, commercial industry capable of providing clean, renewable energy at competitive prices.
Future Grid Parity
Investing in alternative energy companies at this stage of development brings risk as well as opportunity. Attaining grid parity is the primary goal of each technology we are investigating and we believe the industry, for its part, continues to narrow the gap. Yet, remaining at grid parity could be the most difficult objective facing the industry. Fraught with longer-term exogenous risks, grid parity can be derailed by two familiar industry aspects: politics and oil.
Political forces dictate policy and the seemingly whimsical nature of changing incentive programs presents an unquantifiable risk to our thesis. A suspension or permanent revocation of governmental incentives due to a lack of political will would substantially reduce our confidence in the industry’s outlook. Solar energy companies are particularly exposed to this risk due to the large premium currently paid for solar.
Oil pricing remains the other exogenous factor in determining future grid pricing spreads. A sustained reduction in energy prices precipitated by excess supply, reduced economic demand, or a confluence of other factors would impair the industry’s ability to compete. Lower grid pricing and the relative increased premiums for alternative energy would hamper R&D investment and create a negative feedback loop as capital would move away from the alternative energy industry to more profitable investment opportunities.
The Wal-Mart example
Big multinational corporations are responsible for dictating much of the world’s energy consumption. Wal-Mart recently announced a pilot solar project in which 22 retail outlets are expected to “achieve savings over current utility rates immediately, as soon as the first day of operation” according to Wal-Mart’s director of energy, David Ozment. Not surprisingly, the locations are in California and Hawaii, two of the most expensive energy markets in the United States. Wal-Mart and other companies have been accused of “green washing” their corporate image in a bid to gain customer loyalty. Yet in this very concrete example, the company is doing it for the most obvious reason of all, the program will reduce current and future energy expenses. The fact that Wal-Mart, an efficiency machine for decades, can squeeze additional operating savings out of solar energy generation goes a long way in exemplifying our thesis that alternative energy generation is a viable investment opportunity.
Incentives
Returning to the present state of the industry, we can now look at the various governmental incentives that are enabling solar energy’s current growth rate. Japan has been actively supporting solar energy deployment since 1994. Japan’s average annual investment of $100+ million over the past 10 years has led to a 94% grid-connection rate for all residential solar generation. The incentive program ended in 2005. Currently, net metering remains as the country’s only subsidy for solar. Japan is considered by many to be a mature market for solar, leaving Germany and the U.S. as the two primary industry growth engines.
Germany also began its incentives in the early 1990’s, beginning with a modest “1000 roof program” in 1992 and moving to 100,000 roofs in 1999. Completed in 2003, the 100,000 roofs program ended successfully and the feed-in tariffs began in earnest. The renewable energy law (EEG) in Germany, amended in mid-2003, provided increased feed in tariffs for smaller PV systems and an elimination of system size limitations. This new program, providing fixed pricing for utility purchases of solar residential energy up to $0.70 per kWh, has created the largest market in the world for PV.
The United States, the third largest PV market, offers a fragmented, poorly constructed incentive program, with individual states leading the federal government in execution. California, New Jersey, New York, Florida, Arizona, and many other states are expanding efforts to support solar energy. California recently announced an initiative that earmarks $3.35 billion over 11 years for solar, while the federal government currently caps the rebate at $2,000 per residential system and 30% for commercial installations.
However, the Securing America’s Energy Independence Act, HR 550, contains some new, federal level incentive packages. If passed by Congress, the investment tax credit will be extended for eight years (currently set to expire in December of 2008), modifies the credits for PV to $1,500 per half kilowatt and removes the aforementioned caps. Passage of this legislation, we believe, would provide a stable environment for continued growth of the industry. Otherwise, a reduction or expiration of the federal incentive programs would greatly reduce the investment potential of the United States PV market short-term.
Political influences can sometimes be overstated in relation to an industry outlook, but we believe this qualifies as an extremely important element in the analysis of the domestic solar energy market.
Conclusion
Global demand for power generation will begin to place enormous pressure on all facets of the energy industry. China, India and other developing nations are now competing in the marketplace for energy supply directly and have the potential to create world-wide energy shortages in the future. Oil and coal will, by default, continue to lead supply for many decades to come, but we believe alternative energy’s cost proposition improves on a daily basis. Alternative pricing premiums are narrowing vs. the grid as technological innovations drive pricing down and expand choice.
We conclude that the signals emanating from large global companies, such as Wal-Mart’s investment in solar generation, are providing the needed enterprise level momentum to bring alternative energy into the mainstream. Investment powerhouse Goldman Sachs Group, has built an entire portfolio of alternative energy investments spanning wind, biomass, solar and carbon trading. Goldman’s Environmental Policy Framework provides us with the eloquent convergence of capitalist endeavor and altruistic intent, “…we will work to ensure that our people, capital, and ideas are used to help find effective market-based solutions to address climate change, ecosystem degradation and other critical environmental issues and we will seek to create new business opportunities that benefit the environment…In pursuing these objectives we will not stray from our central business objective of creating long-term value for our shareholders…”
Non-financial considerations and altruistic intent are routinely avoided when discussing alternative energy’s investment potential. We believe, despite the difficulty in pricing out such considerations, the new post-fossil fuel, global zeitgeist has moved the entire industry beyond the tipping point.
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