We look at wind, solar and other alternative energy sectors.
Last week I wrote about the theme of investment in the nuclear sector. This week it is the turn of alternative and renewable energy.
Renewable energy includes solar and wind power, and a host of other technologies including tidal, hydro and geothermal power, biofuels, and biomass, the raw materials from which biofuels are derived. Clean or alternative energy -- at least as far as index providers are concerned -- also includes natural gas.
The growth of renewable energy and the resurgence of nuclear power are driven by similar global forces.
Growth in the global population and improved standards of living are expected to increase world energy demand by 34% over the next 20 years according to the International Energy Agency, requiring investment of €800 billion each year over that period.
At the same time supplies of fossil fuels are running out, or at least getting more difficult and expensive to extract. In addition, governments are grappling with two challenges: guaranteeing energy security and reducing carbon emissions.
Chalk and Cheese... and Gold
Nuclear and renewables both offer solutions to global energy needs, but as far as investment is concerned they are chalk and cheese.
The nuclear sector is highly concentrated. Governments are its customers, and the barriers to new entrants are very high. In contrast the renewable sector is characterised by numerous alternative technologies within each segment, populated by a large number of competitors, varying in scale from small to large.
And whilst governments also act to stimulate the renewable sector, they do so primarily by offering incentives rather than by ordering plant themselves. The fickle nature of this generosity can play havoc with the profitability of the renewable sector. Both Spain and Germany have seen reductions in the feed in tariffs (the payments for privately-generated electricity) and concerns about similar moves were voiced in the UK ahead of the comprehensive spending review.
The end result for investors is that the renewable sector compared to nuclear is somewhat like gold mining compared to coal: you have to search hard to find a nugget, but the outcome of a lucky strike is potentially much more rewarding.
Companies in the wind sector are larger, reflecting the large scale of investment required in establishing off-shore and on-shore wind farms. Major players are the Danish Vestas, Spanish Gamesa, Siemens and GE.
Increasingly turbine manufacture is shifting to Asia, driven by the huge Chinese market. There is fear of over-capacity which will drive down margins and hit profits.
The solar sector is more fragmented. These companies are less vertically integrated, and domestic and commercial scale installations do not require massive levels of investment. Domestic solar generation is far short of generating electricity as cheaply as conventional power stations (so-called grid parity) and so the market is highly geared to government subsidy, generally in the form of feed-in tariffs.
Generous subsidies which fed growth in Spain and Germany have been reduced. But new incentives have been announced by the Italian government and by the UK, through the Clean Energy Cashback scheme, which has stimulated the UK sector.
Increasingly the commodity end of the photovoltaic market is likely to consolidate around the large US and Chinese manufacturers. However that might make some of the more technologically interesting UK companies tempting acquisition targets.
ETFs provide a way of capturing the global sector theme.
The ETFS DAX Global Alternative Energy Fund (LSE: ALTP) tracks the 15 largest companies worldwide which generate more than half their revenues from one of five sub-sectors: natural gas, solar, wind, ethanol (a biofuel) and geothermal/hybrids/batteries. Each sub-sector comprises roughly 20% of the index. The inclusion of natural gas means that BG Group (LSE: BG) and the giant Russian gas producer Gazprom form significant holdings.
iShares S&P Global Clean Energy (LSE: INRG) has a broader remit, tracking the 30 largest companies globally that are primarily engaged in clean energy related business.
Finally Powershares Global Clean Energy Fund (LSE: PSBW) tracks the Wilderhill New Energy Index. This is even more broadly spread, with 87 constituents engaged in energy conservation and efficiency as well as generation and use of cleaner energy, none of which can comprise more than 5% of the index.
Whilst most of the major companies in the sector are foreign, there are a host of smaller UK players in the sector. David Holding has recently highlighted some interesting companies including PV Crystalox (LSE: PVCS), Romag (LSE: ROM) and Alkane (LSE: ALK), but there are many others.
There is also scope to invest in the unlisted sector through the Foresight Solar VCT which so far has raised 19% of a target £40m.
To use the gold mine analogy, it's time to start prospecting!
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