Publications

- May 1, 2017: Vol. 4, Number 5

Energy Market Winners and Losers: The need for power is essential and eternal, but which form or market will win the day if energy is not expensive?

by Benjamin Cole

With much anticipation in oil markets, in January the Organization of the Petroleum Exporting Countries (OPEC) enacted production ceilings for members, with supposed voluntary participation of non-member Russia, the globe’s largest crude exporter.

Since then, oil has sunk below $50 a barrel.

The lessons in OPEC’s floundering effort to budge crude prices north are many, but perhaps foremost is that energy markets have evolved since OPEC’s successful price hikes of the 1970s.

As students of economics would predict, decades of artificially high, cartelized oil prices have led to matching decades of development in alternative fuels and conservation.

Car dealer lots bulge with autos capable of 50 miles per gallon or more, while fleet vehicles globally are switching to natural gas. To be sure, the costs and benefits of corn-ethanol are controversial, but there is no denying that 10 percent of gasoline sold in the United States today is ethanol. Meanwhile, light-emitting diode (LED) bulbs, which burn just 15 percent of the power used by incandescent bulbs of yesteryear, can be bought off the retail shelf.

Be it bio-fuels or batteries, wind or solar power, or other more exotic conservation technologies, the world is charged with energy sector innovation — and the venture capital funds to push new ideas forward.

The innovation translates into caution for investors, and an energy-market outlook radically revised from even eight years ago, when “Peak Oil” gripped many an imagination. Indeed, in 2008 Goldman Sachs thought $200-a-barrel oil a real possibility, a reminder of how quickly adaptation and innovation can overtake markets.

Today, a more disciplined, perhaps even reduced, allocation of dollars to energy is warranted, and one that anticipates not energy scarcity but relative abundance.

In shorthand, the energy-sector investment bar could be: “Will this stock or investment make money if oil stays at roughly $50 a barrel for the next 10 years?”

THE TESLA MICROCOSM

One of the most electrifying corporate stories in decades is playing out at Tesla, the famed Palo Alto, Calif.–based battery car, energy
storage and solar panel makers. Thanks to recent diversification, Tesla also has become a window into broader energy markets, and a microcosm of the whole alternative sector.

The Tesla story became only more intriguing in late March when China-based tech giant Tencent bought another $1.7 billion of Tesla stock, bringing its stake to 5 percent of common shares outstanding.

The outsized Tesla founder, CEO and chairman Elon Musk makes for good media coverage, and the sex-appeal of his vehicles undeniable. But with the 45-year-old Musk’s merger of solar-panel maker Solar City in late 2016, Tesla became less a pure-play on battery cars and more of a cipher along the lines of, “Will e-cars, residential solar power and house-scale battery-storage become commercially viable, and in one corporate package at that?”

In the first quarter, the stock market largely answered, “Probably so,” with Tesla stock up 30.4 percent. Remarkably, Tesla’s market cap around mid-April was $50.9 billion, slightly eclipsing GM's market cap.

Tesla financials furrow the brows of even experienced CPAs, and the company reported a GAAP loss of $674.9 million in 2016, on revenues of $7.0 billion. Yet Wall Street trusts Tesla, and in mid-March the company easily raised another $1.2 billion in stock and convertible bonds.

Whatever the financials, Tesla already has accomplished what has long seemed nearly impossible, and that is launching a new automobile manufacturer in Europe or the United States that did not crash quickly.

The world has not embraced auto-
manufacturing startups. The auto-brand “DeLorean” still evokes appreciative gushes for its gull-wing doors and stainless steel bodywork, but the company produced less than 9,000 vehicles and succumbed to bankruptcy in 1981 after a couple of years of production. The auto industry not only sent DeLorean to the junkyard, but Bricklin (1976) and Hummer (2010), and recently more than a few once-established large brands, including but not limited to American Motors (1987), Mercury (2010), Oldsmobile (2004), Plymouth (2001) and Pontiac (2010).

Defying the odds, Tesla has delivered more than 180,000 cars since 2008, and it recently announced ambitious plans to sell 500,000 vehicles a year starting in 2018, on the strength of its to-be-introduced mid-priced Model 3, planned with a sticker price of $35,000 before government subsidies.

But for Musk, launching a new auto company — and a battery-car manufacturer at that — is not enough. In November 2016, Tesla announced a radical diversification move in its $2.6 billion buyout of Solar City, a maker of rooftop solar panels.

Tesla claimed business and operational synergies in the merger, such as cross-selling; yet solar roof-top panels have little to do with the making and selling of cars, even e-cars, save possibly to the most green-inspired consumers.

It appeared to some analysts that Tesla was actually after Solar City’s cash-flow in future years, which will increase from the growing number of leased solar-roof installations in place, while some existing corporate debts are paid off. The stated Tesla vision of an e-car buyer also buying the solar roofs to complement the new vehicle, or vice versa, strains credulity in most circles.

But it turns out there may be more light to shed on the Solar City story.

Musk asserted in late 2016 that soon Solar City will make conventional-in-appearance solar roof-tiles that will be cheaper, better and more attractive than ordinary house roof-tiles. Thus homeowners will have an option to the perhaps unsightly, utilitarian solar-panels seen today, and can instead choose relatively attractive Solar City solar-tiles that will make a functional roof (that is, keep the elements out) besides.

If Musk can successfully produce and market the new roof-tiles, the Solar City marriage still might not make sense in terms of a strategic merger, but would at least be accretive to earnings, and there is no gainsaying a profitable investment.

Musk in late March reported Tesla would start taking orders for the Solar City roof-tiles in April, but an actual production date is not yet specified, nor did Tesla release information on tile prices.

Adding to the complexity of Tesla, the company also is touting what are essentially battery-packs for houses. Tesla battery-pack houses, in theory, could effectively run on solar power after the sun has gone down. That is, the battery-packs would charge up during sunlight hours, and then be drawn down when residents return home in evening. The battery-pack and solar-tile businesses do appear complementary, but whether there is synergistic crossover to merchandizing autos remains to be seen.

CHEAP FOSSIL FUELS

The market cap of Tesla and the vision and verve of its founder Musk are undeniable. But a rather mundane sentiment intrudes on the sensational story: Tesla is worth a lot more when crude is at $100 a barrel than at $50 a barrel.

And cheap natural gas is making electric-grid power inexpensive as well.

As utilities switch to better power plants and cheaper natural gas, consumer electricity rates have not kept up with the general rate of inflation in the United States since the mid-1980s.

Grid-power in the United States is reliable and cheap, and consumers have low-tech ways to use less of it, such as awnings, shutters and ceiling fans, or better insulation. Tesla’s solar roofs and battery-packs must be compelling to consumers who face relatively smaller electrical bills than years ago, and who can conserve electricity without much in the way of capital outlays.

As for Tesla’s e-cars, the cheap electricity is a boon, but the battery-car field is becoming crowded, and there are inexpensive high-mpg cars glutting the market. GM has its Bolt and Volt e-cars, Nissan its battery-powered Leaf, and Volvo plans a mid-priced battery car to compete with Tesla in 2018.

Then there is the Toyota Prius, a hybrid that gets more than 50 miles a gallon, and does not take time to recharge.

Visitors to Thailand note the large number of compressed natural gas (CNG), or liquefied natural gas (LPG) vehicles on the road, and related filling stations, a situation that T. Boone Pickens’ Clean Energy Fuels Corp. (CLNE) wishes to reproduce in the United States.

Battery-powered cars do not, and will not, have a clear field globally, and likely they will face more crowded markets.

Tesla in many ways reflects the challenges facing all players in the energy market: Oil and natural gas are not scarce, thus limiting traditional energy-sector profits. And as a result, the alternative-energy sector is competing against not only relatively inexpensive fossil fuels, but against itself and the plethora of excellent technologies becoming commercialized.

The energy-sector winners may be those companies with the best technologies, but obviously much still rests on old-fashioned fundamentals of marketing, servicing customers, adroitly arranging finance, and hiring and retaining good employees. Government subsidies, or the lack thereof, could pay a vital role — for example, the entire corn-ethanol fuel industry in the United States is a creature of mandates and subsidies, yet it appears as permanent as the U.S. Department of Agriculture.

But government or not, certainly winning for energy-sector investors would be easier if oil would hit $100 a barrel again.

DO E-CARS NEED $6 PER GALLON GAS?

Maybe not. Battery costs are continuously dropping, unlike the undulating price of oil.

At present, in general the bean-counters say e-cars do not pencil out for consumers, due to the main variables of gasoline prices, government subsidies, the cost of the battery and electricity rates. There may be exceptions, such as those with lengthy commutes in California, where gasoline is more expensive and state subsidies larger. But in general, economizers are better off with small, high-mpg econo-cars.

However, Bloomberg New Energy Finance took a long look at e-cars in February and concluded that by 2025 the battery vehicles will in fact be the best buy, even for consumers with a pure “me-first” attitude. Better and cheaper batteries will be the main reason. The advantages of e-car ownership will trigger an explosion of demand for battery vehicles, to one-third of total light-vehicle production in 2040, predicted Bloomberg.

The economics are changing quickly, with battery costs in 2017 off by 65 percent since 2010, noted Bloomberg.

Barring an emergent better rival technology, such as hydrogen fuel-cell cars, it appears the battery car will become commonplace, through still not dominant, in the decades ahead.

It too soon to call on whether Tesla emerges triumphant in the fray, or even survives. An auto company can die for lack of marketing vision, ugly cars or an association with a prominent lemon. Gone are the Pontiacs, the Studebakers, the Ramblers.

But battery cars appear to be a live and growing industry, and Tesla, at least for now, is in a fair fight for the driver’s seat.

YIELD FROM YIELDCOS

While Tesla’s exposure to competition and energy markets is very broad and thus challenging to gauge and predict, there are energy-
sector companies with limited profiles that are perhaps easier to gauge.

The so-called “yieldcos” made a splash in the sustainable energy world, looking like a way for investors to lock in solid yields as solar- and wind-power grew. In concept, yieldcos are simple. For example, a listed company owns wind-power projects and sells power to utilities bound by long-term contracts. The predictable revenues are funneled back to shareholders (technically, unit-holders) in the listed yieldco. Yieldcos are similar to REITs, in that the transfer of revenues to shareholders is tax free. No double taxation.

Some public energy yieldcos hit the skids in 2015 on soft oil prices, the outlook for higher interest rates, and investor skepticism toward new yieldco equity. Without fresh capital, yieldcos are challenged in acquiring new assets.

There has been some yieldco sector recovery since 2015, but share prices remain lower, and thus interesting to ponder.

The Pattern Energy Group (PEGI) was up 7.75 percent year-over-year in late March, and pays an 8.1 percent dividend, and has increased its dividend steadily in the last 12 quarters. The company owns 18 utility-scale wind-power farms and plans to double its portfolio by 2020. If interest rates do not rise too much, PEGI could execute on its plans, thus paying a good and possibly rising dividend.

And who knows? Maybe utilities will need more wind-farms to charge up the growing fleets of e-cars of the future.
Benjamin Cole (7continents7@gmail.com) is a freelance writer based in Thailand.

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