Sunny days for an alternative power play

The Independent: Sunny days for an alternative power play

“As with wind power, some very well known companies are interested in solar power – Shell, BP and Sharp, for example, all have operations – while smaller companies are specialising on niches of the sector.”

Saturday 20 August 2005

Funds to get you into alternative energy

Published: 20 August 2005

There’s a simple explanation for the seemingly ever-upwards march of the oil price: while demand for black gold keeps rising, supply is failing to keep pace.

Political uncertainty and setbacks at various refineries around the world may be behind this month’s increases to a record-breaking $67 (£37) a barrel – analysts think the price could even hit $70 before 2006 – but in the long run, as oil supplies dwindle, there is little prospect of sustained price falls.

Enter alternative sources of energy – from wind power to biomass. As the world looks for ways to reduce its dependency on oil, gas and coal, those industries that are able to offer other ways to produce energy should be in a position to reap much richer rewards than even the short-term profits that are currently being earned by the oil companies.

It seems like a no-brainer. Even if consumers and business don’t have plans to cut back on oil voluntarily, in much of the developed world legislators are committed to forcing them to do so. As a signatory to the Kyoto Protocol, for example, Britain is committed to cutting emissions of greenhouse gases.

As part of plans to hit its Kyoto targets, the Government has said that by 2010 it wants to see 10 per cent of the country’s energy needs generated by alternative means. The figure is supposed to rise to 15 per cent by 2015.

Yet while the economic and political climate is perfect for alternative energy suppliers, the sector has made only modest progress in terms of commercial success. Most of the large energy companies have divisions that are exploring areas such as wind and solar power – often very tentatively – but there are very few household names in this sector.

For investors interested in alternative energy, this is a dilemma. The case for the sector is strong in terms of potential profit. And many investors would rather put their money into “ethical” producers of clean energy than dirty polluting oil companies. Yet identifying possible investments is difficult – and the risk of putting money into unproven technologies is always high.

Certainly, since 2000, investors have struggled to make money from green companies. The Environmental Technology 50 Index, a benchmark for the sector, shows shares in green companies have underperformed the global stock market as a whole by about 70 per cent since the turn of the century.

Given that equities have been such disappointing assets, this underperformance hardly inspires confidence in companies with an environmental bent.

Ben Yearsley, an investment analyst at independent financial adviser Hargreaves Lansdown, warns that for investors, alternative energy can be a similar gamble to the high-risk end of the biotechnology sector, where the theoretical story is more attractive than reality.

“This is a fascinating area that clearly has huge potential, but the trouble is that it’s all very idealistic,” he says. “Pick the right company and shares could rocket, but that hasn’t happened yet because no one seems to be converting potential into sales.”

When companies lack hard results, investors are very vulnerable to changes in market sentiment. Merrill Lynch, for example, launched the New Energy Technology investment trust in October 2000. Although the companies in which it began investing had nothing to do with the dotcom boom, the fund immediately got caught up in the bursting of the technology bubble. As a result, within three years, the fund had lost three-quarters of its value.

Poppy Buxton, one of the two managers of Merrill Lynch’s fund, says investors must be cautious. “Things are coming together,” she says, “but this is a very early-stage sector – most of the companies in our universe are very small and not yet profitable, which means the shares tend to be volatile.”

However, there are reasons to be optimistic. In the US, generally regarded as a basket case on environmental issues, the latest energy bill passed by Congress is actually very supportive of alternative energy, Buxton says.

The legislation includes tax breaks for companies developing fuel cell technology, for example, support for wind farms and investment in better power distribution networks. All these measures are viewed as positive for supporters of alternative energy.

“The cost of renewable energy is falling and many of these technologies are now cost effective,” she says. “The US Department of Energy calculates that producing up to 600 gigawatts of electricity is competitive when the gas price is at $4 – it’s currently above $9 and the United States installed just a third of a gigawatt of wind capacity last year.”

Moreover, the alternative energy sector is wider than many analysts realise. Merrill Lynch’s fund, for instance, is split into four distinct subsets.

In addition to renewable energy, the fund makes investments in companies involved in producing cars that don’t rely on petrol. Here, the alternative energy is used to power transport rather than housing or business needs.

The third focus is on developing more efficient transmission of electricity. One way to reduce consumption of any energy resource – renewable or otherwise – is to find ways to better deliver the power it generates. Cut down on the amount of power that is wasted and you will reduce overall demand for energy resources.

The same principle underlies Merrill Lynch’s final area of interest, energy storage. It is currently very difficult to store electricity that is not immediately needed, so energy resources are very often wasted. A way to store excess power until it actually required would thus be very attractive.

Ian Simm, the managing director of Impax Asset Management, which specialises in “environmental markets” is also positive about the prospects for many of these sectors. “There are definitely established industries where companies are already making money,” he says.

In the renewable energy arena, the wind-power industry is the most developed area, mainly because such large parts of the world could potentially use the technology. Windmills are a tried-and-tested way to generate power – all you need is wind and some land which to site a turbine.

The development of the wind energy industry is reflected by the maturity of some of the companies involved. In addition to specialist wind companies, leading players include divisions of General Electric and Siemens, which have huge resources.

Solar energy is also a potential investment opportunity. “Solar power is still too expensive to compete in areas with conventional, developed electricity grids,” says Simm, “but in sunny areas, where grids have not been developed or there are sudden spikes in demand, the technology is more competitive.”

As with wind power, some very well known companies are interested in solar power – Shell, BP and Sharp, for example, all have operations – while smaller companies are specialising on niches of the sector.

Several companies are also investigating biomass projects – generating power from sources such as straw, wood chips, willow coppice, mildewed grain, chicken litter and even sewage sludge. Millions of people in developing countries already use biomass power sources – the challenge now is to safely produce power this way on a wider scale.

Finally, there is wave power – harnessing the power of the ocean to produce electricity. “Wave power benefits from the predictability of its source and its availability to many of the world’s most populated areas,” says Andy Crossley, manager of Invesco Perpetual UK Smaller Companies Growth Fund, which holds several renewable energy investments in its portfolio.

“It also has favourable environmental advantages because it produces no noise, is not unsightly and also poses no threat to marine life.”

Like Buxton, Simm is anxious to point out that alternative energy can be defined loosely by investors who want exposure to different sorts of shares. Impax invests in several companies that produce alternative fuels for transport, including natural gas and hydrogen fuel cells.

It also focuses on power grids, with investments in companies, for example, that can monitor usage remotely. One interesting area is the supply of uninterrupted power in buildings such as hospitals, which can’t afford to be without electricity.

Beyond alternative energy, investors could consider companies in the waste and recycling sector, where industries exist to generate power from waste and to produce new materials from rubbish.

Finally, remember that there are more general funds run with an ethical or environmental brief. “These funds will have some exposure to the renewable energy sector, as well as to other investments, to spread risk,” says Ryan Hughes, an investment analyst at independent financial adviser Chartwell.

* Impax Environmental Investment Trust: Launched in February 2002 by specialist fund manager Impax, this fund lost 60 per cent of its value during its first year. The trust’s share price is now back above 90p, however, only 10 per cent down on where it began. It invests in companies active in the markets for cleaner and more efficient delivery of basic services of energy, water and waste.

* Merrill Lynch New Energy Technology Investment Trust: New Energy shares fell from 100p at launch in October 2000 to 13.25p by March 2003 – they have since recovered to about 36p. The fund invests in four sectors (see above). As an investment trust, it has shares that may trade at a discount or premium, to the value of its underlying assets – they currently sit on a discount of about 10 per cent.

* Morley Sustainable Futures range: Morley runs a group of funds that invest on an ethical basis, including one that buys corporate bonds rather than shares. All the funds back companies that either promote or benefit sustainable economic development, including some alternative energy stocks. Morley defines sustainable as “meeting the needs of the present without compromising the needs of future generations”.

* Keydata VCT:

This trust invests in the wind-power sector. But note that venture capital trusts are limited to investments in small companies. However, in return for the higher-risk profile of such companies, they offer generous tax breaks, as long as you invest when new shares are issued and hold onto the stock for minimum periods.

* Ventus VCT: Ventus has a similar brief to Keydata. Both trusts are expected to issue new shares in the run up to the end of the 2005/6 tax year next April.

Stocks to get you into alternative energy

* Azure Dynamics: A Canadian company listed on the UK’s Alternative Investment Market (AIM), Azure makes hybrid-electric vehicles for the light-vehicle market – primarily delivery vans. Although Azure is currently loss-making, it has contracts to produce buses for use in New York, and vehicles for Toronto’s local authority.

* Clipper Windpower: Clipper is a privately owned US company that is tipped for a £250m flotation in the UK later this year. The company, set up by the team that launched General Electric’s wind-power business, makes turbines for wind farms.

* Evergreen Solar: As a developer and manufacturer of “photovoltaic modules”, the engines of solar-electric systems, Evergreen is one of the leading players in the solar-energy market. The stock is listed on Nasdaq, the US market for technology-oriented companies, where its value has more than doubled over the past 12 months.

* Gamesa: Spain is one of the world’s leaders in the production of wind energy, along with the US, Germany and Denmark, and Gamesa is Spain’s biggest wind-farm operator. Earlier this year, the company said it expected profits to fall in 2005 before hitting £150m in 2006. Gamesa is listed in Spain, but is currently in talks to build wind farms in the UK.

* Ocean Power Technologies: Ocean, another AIM-listed stock, implements wave-power technologies, using an ocean-going buoy to capture and convert wave energy. The company has signed agreements to develop wave-power stations off the coasts of France, Spain and the US.

* SolarWorld: Germany’s SolarWorld is Europe’s best-known solar-power company. The German government offers subsidies to companies that produce solar energy.