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-- Posted Tuesday, 31 August 2010 | | Source: GoldSeek.com
Wellington West Analyst Sean Peasgood covers the geothermal, plasma gasification and "Smart Grid" subsectors of the alternative energy (AE) market. He believes there's room to make some dough in each of them but believes investors may need to be patient as these growing markets gain traction. "As these (geothermal) projects come online and are proven out, the reward to investors is going to be large," Sean says. He even reveals some names to help you earn your reward in this exclusive interview with The Energy Report.
The Energy Report: Sean, can you tell us a little about yourself and your coverage area at Wellington West?
Sean Peasgood: I've been covering the technology and clean-technology sectors with Wellington West now for about 10 months. Before this, I was with a bank-owned dealer for about four years covering the technology sectors as an associate analyst. I now cover the alternative energy space, focusing on geothermal, plasma gasification and the Smart Grid markets.
TER: Could you give us an overview of those alternative energy subsectors and their respective outlooks?
SP: Let's start with geothermal. While the stocks in this sector have been relatively weak over the last few quarters, we have a positive long-term view on the space. It takes significant capital and time for these projects to come online. I believe that early stage investors will benefit as projects generate significant free cash flow in the future. Eventually, they will look more like utilities and less like exploration companies. Investors who get in today will benefit from capital gains in the short term as projects come online and then from dividend-yielding equities in the future.
Given the baseload nature of geothermal, we believe utilities are more interested in signing attractive power purchase agreements (PPAs) than relying on more intermittent sources of renewable power, such as wind and solar.
We also cover the Smart Grid market, which is essentially the deployment of Internet protocol (IP)-based communication networks across the existing power grid. The goal is to increase efficiency, enhance control and provide visibility across the grid for utilities. The lack of infrastructure and maintenance upgrades over the last several decades, along with increasing demand for power, have reduced the reliability and quality of power not only in the U.S. but around the world. This problem is only being exacerbated as the world looks to add renewable energy sources to the grid. While some of these upgrades have already begun, we believe this deployment will take place over the next 5–10 years. This should translate into strong revenue and earnings growth for a variety of IP communications-infrastructure companies both wireless and wired.
Finally, as I stated, we cover the plasma-gasification market, which is an emerging alternative technology being used in waste-to-energy projects, as well as producing cellulosic ethanol. Plasma gasification reduces emissions and produces a synthetic gas that can be used to generate power. In cellulosic ethanol production, this synthetic gas is fermented and converted to ethanol. There are a number of projects getting underway in North America, and we're seeing interest for this technology in India and China, as well.
TER: Given the speculative nature of these alternative energy plays, what type of investor should be looking at this sector?
SP: I think investors should look to balance their traditional energy exposure by adding newer alternative energy companies to their portfolios. In many cases, these new technologies are just emerging; so, while they have more risk than more traditional energy plays, when they begin to gain traction, investors could be handsomely rewarded. That said, there are ways investors can reduce this risk exposure. For example, investing in early stage geothermal companies is, obviously, more risky than investing in some of the larger players that have a portfolio of projects and stronger balance sheets. We believe risk-averse investors should look to the larger players in the market to gain exposure to these growing markets.
Investors in the geothermal market need to have a multiyear time horizon, as development can take several years. As these companies bring projects online, I expect the share prices to continue to increase as a reflection of lower exploration and development risk. Then, as they start generating stable free cash flow, they will trade more like utilities and, eventually, provide dividends.
TER: What's the timeframe on that?
SP: Generally, projects take about three to four years to develop. Depending on who you're looking at in the space, most companies that we cover have a portfolio of projects that will come online over the next few years, leading to a steady increase in megawatts (MW) online. For the geothermal space, while we are bullish long term, investors need to understand the risks involved in these projects. There's financing risk, which has recently been improving, and political risk, as government grants can enhance the value of projects and some of the projects are in foreign jurisdictions. As projects advance and get de-risked, then I will become less conservative. But I think at this point, it's fair to provide investors with the full set of risks and that's reflected in my forecasts and price targets.
TER: You've mentioned Smart Grid: everyone has heard of the grid, but what's a Smart Grid? And why should investors look specifically at this alternative energy subsector?
SP: Essentially, the Smart Grid is the deployment of a communications backbone over the existing power grid—all the way from power generation out through transmission and distribution, and then into the home. Most of the infrastructure out there really hasn't changed in 100 years. What we have now is significantly higher demand for electricity across a decaying grid infrastructure that is becoming less reliable and efficient. The idea of the Smart Grid is to deploy a communications backbone, so utilities have full visibility across that grid.
Over the last few years, there's been a real focus on putting smart meters in homes. Smart meters provide the user with visibility and the ability to switch their habits to use more power at off-peak times and also provide the utility with information about electricity demand patterns. For example, with a smart meter, the utility can charge a little bit more for running your dishwasher during peak times and try to encourage you to run that dishwasher at night. That's the first phase.
But we believe the next phase is the more important part of the Smart Grid, where communication infrastructure is being placed in substations across the grid, so utilities have even greater visibility and control. Right now, if power goes down, the utility has no visibility and must wait until customers contact them to let them know. The Smart Grid provides the opportunity to put a communications network in place, so utilities know if they've just lost a whole block and immediately take action. This should reduce power outages, which negatively impact GDP and are becoming more frequent.
TER: What countries are deploying this technology at a rapid rate?
SP: There's been a lot of attention on smart meters in North America and Europe. Substation automation is happening globally; however, the upgrade process has been one or two substations at a time, rather than the mass smart-meter deployments we have seen to date. When utilities upgrade a substation, they'll upgrade all the communications equipment inside at the same time. Given utilities' risk aversion and new technology, the sales cycle for these products can be 12–18 months. To put this in context, last year the market for substation automation-communications infrastructure was roughly $150 million. If you just look at all of the substations in the world and assume that 20% of those have been upgraded, which is probably a conservative view, to upgrade the rest of the substations would be about a $4 billion opportunity.
TER: That's not an overly huge market though.
SP: That's just the substations—just one piece of the overall Smart Grid opportunity. It shows you where the market could go. I mean it's very, very small right now as utilities are really only upgrading a few substations at a time. Could it multiply significantly over time? We believe it will, but it's really going to be about how quickly these utilities adopt this technology across their footprint.
TER: You mentioned Asia earlier. In other sectors like mining, China has changed the way businesses operate. Last year, according to an alternative energy report that came out earlier this week, $34 billion was spent on solar and wind projects in China. What sort of impact is China having on the AE sector?
SP: As one of the world's fastest-growing economies, China is going to be an important part of this market for many years to come. Right now, about 90% of China's energy is from nonrenewable sources. The Chinese government wants to get that to 18% by 2020. Electricity demand there is growing significantly, so you know this is going to require significant investment. We're already starting to see that in wind and solar. We believe all of the markets we have spoken about so far should benefit from that region.
TER: Another statistic in that same report was that investments in geothermal power fell from $2.2 billion in 2008 to $1.5B in 2009. What accounts for that drop, and how should investors interpret that 31% decrease?
SP: I will start by saying we continue to see strong demand and development both here in North America, and all around the world in the geothermal market. There's a lot of development going on in Africa, Indonesia, the Philippines and Australia, to name a few. We continue to see new projects being explored with companies and governments promoting the development of geothermal projects.
I think the drop in 2009 was largely due to the tightening of the credit markets following the credit crisis. These projects need significant amounts of debt financing to get across the finish line. Before the credit market seized up, geothermal companies needed to have 50%–60% of the resource proven out before getting construction financing. This increased to 100% in the height of the crisis. Good news for investors and the market, in general, is that we are beginning to see the credit markets loosen up, which is nice because geothermal is so capital intensive that this was a barrier to development. As long as the credit markets continue to behave, then I would expect those investment numbers to reverse.
TER: Do you have some final thoughts on the sector?
SP: Investors in the geothermal space are going to have to be patient while projects come online. That said, the rewards for early stage investors are likely to be higher than for those who wait until the companies are spitting out strong cash flow. At this point, a new set of income-seeking investors will likely look to take advantage of utility-like stocks that will generate stable free cash flow and are likely to produce dividends.
The other question is: Will large utilities step in and potentially buy these companies in order to meet their renewable targets? We believe that utilities are unlikely to take on exploration risk today; however, as projects come online, we believe these companies could be strong acquisition targets.
Sean Peasgood is an equity analyst at Wellington West Capital Markets, covering the clean-technology sector. Before joining Wellington West, Peasgood worked in the equity research department of a bank-owned dealer covering the technology space as an associate analyst for four years. Sean has a HS.Bc. from McMaster University and an MBA from Saint Mary's. Streetwise - The Energy Report is Copyright © 2010 by Streetwise Reports LLC. All rights are reserved. Streetwise Reports LLC hereby grants an unrestricted license to use or disseminate this copyrighted material (i) only in whole (and always including this disclaimer), but (ii) never in part. The Energy Report does not render general or specific investment advice and does not endorse or recommend the business, products, services or securities of any industry or company mentioned in this report. From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise. Streetwise Reports LLC does not guarantee the accuracy or thoroughness of the information reported. Streetwise Reports LLC receives a fee from companies that are listed on the home page in the In This Issue section. Their sponsor pages may be considered advertising for the purposes of 18 U.S.C. 1734. Participating companies provide the logos used in The Energy Report. These logos are trademarks and are the property of the individual companies.
-- Posted Tuesday, 31 August 2010 | Digg This Article | Source: GoldSeek.com
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