Tuesday, November 28, 2006

Green Skeptics

My holiday schedule precluded addressing The Economist's cover story on alternative energy when it came out last week, but I still feel obliged to comment on several of its points. The title reveals the article's conclusions: "Green Dreams, The risky boom in the clean-energy business." (Subscription may be required.) While extolling clean energy from a societal perspective, they conclude that it isn't such a good deal for those investing in the companies that make it happen. They are right to point out the serious risks involved, as well as some of the ways that government incentives are distorting the market, but I believe they exaggerate the downside and minimize the upside. We are a long way from a ticking Dot-Bomb, here.

As my regular readers know, I think some skepticism is appropriate, at least with regard to the scale of alternative energy's contribution to the global energy market in the next decade or so. Even at current prices, oil, gas and coal won't be easily dislodged from the dominance they've achieved, and non-hydroelectric alternatives start from a very small base, supplying less than 10 of the roughly 450 quadrillion BTUs the world uses every year. But from an alternative energy investor perspective, that looks like a much bigger opportunity than a problem. It suggests it will be a long time before wind, solar, or biofuels approach market saturation, or start to compete seriously with each other, rather than just with traditional energy.

Take solar as an example. The Economist worries that if photovoltaic module production capacity doubles by 2010, as they indicate Goldman Sachs expects, this could lead to a glut of photovoltaic panels (PV). The International Energy Agency reported total global PV capacity at the end of 2005 at 3700 MW installed, with 2005 additions of just over 1000 MW. But in order for solar additions to continue to grow at the roughly 25% annual rate they've experienced in the last several years--which is presumably built into the current valuations of solar companies--then production capacity must at least double by 2010 to maintain that pace, with extrapolated additions in 2011 calculating out to 2800 MW. Moreover, at that rate by 2010 total cumulative PV capacity would still only be about 12 GW, or less than 3% of projected global electrical generation capacity for that year. Now that's what I call headroom.

If a correction in the alternative energy sector is coming, it is much likelier to flow from the vagaries of government policies, rather than from any lack of market opportunities. The longer countries such as Germany subsidize green power by multiples of the cost of conventional power, the greater the likelihood of an unpleasant surprise, later. Investors should focus on technologies and markets that don't depend on unsustainable subsidies continuing in perpetuity, but neither should they ignore the implicit future value of greenhouse gas emissions reductions, which the article mentions only in passing. And while the rapid changes in clean energy technology increase the risk of backing the wrong horse, that's no different than any other start-up in an immature sector. Ultimately, I'd have thought The Economist's skeptical advice would have been better aimed at governments than investors, who have learned a few things since the 1990s.

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