Yet I was skeptical regarding the business model. I know that intense competition and large scale production have been driving down solar prices in the last couple of years, but I’ve still been reading total installation costs of about $6-8 per peak watt (pW). Yet it seems that prices are now even lower than that. Solarbuzz, a solar consultancy, reports that average retail module prices in May 2010 have fallen to around $4/pW, but that the lowest cost multi-crystalline modules are now $1.74/pW retail, while mono-crystalline is $2.07/pW. Inverters, balance of system, and installation add another $2.50 to $3/pW. Installation on parking canopies rather than rooftops adds another $1/pW or so.

Even with total installed costs as low as $4.50 to $5, and a 30% credit on capital costs thanks to the generosity of US taxpayers, the numbers still didn’t add up. What makes Apogee’s business model possible is the value of solar renewable energy credits (SRECs). US states that enact renewable portfolio standards (RPS) have created local markets for renewable energy credits, allowing utilities to meet their requirements by buying RECs. In order to stimulate solar, a number of states have created “solar carve outs”, i.e. a separate standard for solar energy with its own SRECs, which have initial market prices in the 30-60c/kWh range – Massachusetts has set a floor price of 30c/kWh (astute readers will observe that SREC is an anagram of SERC, our very own center for Center for Sustainable Enterprise and Regional Competitiveness here at UMass-Boston).  

This is a massive subsidy indeed, and raises significant policy issues. Even for those who are fervent advocates of renewable energy, does it make sense to provide such huge subsidies to solar, when modest subsidies for land-based wind power of around 2-3c/kWh serve to make it grid competitive in many regions? Would the money be better spent on research and development, and the development of local workforce skills and business clusters? Subsidizing installation at the retail level will generate a few local jobs for developers, electricians and installers, but the panels will mostly be imported. There is a serious risk of consumer backlash when people realize the extent of the subsidies and the impact on their utility bills – just as the proposed cost of offshore wind power from Cape Wind has shocked even some of its supporters. Perhaps these subsidies are needed to jump start commercial scale installations and overcome industry inertia and perceived risks, but in themselves they also constitute a barrier to scaling up new renewables beyond a few percent of grid supply.

In return for discussing the business and economics of SRECs, I promised to give David Weinberg a chance to explain Apogee’s business pitch, so here it is:

Imagine that you’re a business owner or a University president in the Northeastern United States.  Over the past 10 years you’ve watched your cost of electricity soar 69%, and it could double in the next ten years.  Compete with China?  You can’t even compete with most states here at home.  Those high prices will crimp your growth and extinguish your profits.  In fact, if you stay in the northeast, you probably won’t survive another 10 years.

What if you could use solar energy to cut your energy bill 30-40%?  “No way”, you’d respond.  “Not enough sun” or “too expensive to install upfront”. New England averages 4.3 hours of sun per day, almost double that of Germany, the world leader in solar power. As to the upfront cost, what if it didn’t exist? If there is no upfront cost and the solar power costs 30-40% less than what you are currently paying, would that be attractive?

Apogee Solar is a solar energy developer in New Jersey, Massachusetts or Pennsylvania, who harnesses the power of Solar Renewable Energy Credits (SRECs) to lower your energy bill. An SREC is an energy tariff that is amortized over everyone’s bill, so it is a tiny part of the rate base.  Every megawatt of energy that your installed system produces earns me one credit.  I can then take that credit and sell it into the marketplace.  The sale of the credit is what allows me to finance your system with no upfront costs.

How much are SRECs worth?  That depends on where you are located.  New Jersey has a current price of around $650 per credit.  Massachusetts has set a yearly floor of $300 per credit.  Energy systems are designed so the credits depreciate over time.  A system that is 10 years old will generate SRECs that are less valuable than a system that is two years old.  What does that mean to energy prices?  In Massachusetts and New Jersey I can negotiate a starting electricity price of 9 cents/kWh, and in 15 years your price will still be below 13c/kWh. At the end of 15 years you own the system, so for the next 15 years your cost of power is free.

Solar installations are financed with what are called ‘Power Purchase Agreements’ (PPAs).  I like to call them solar mortgages, except that your property and assets remain free and clear.  The collateral for the financing are the generated SRECS.  Like any mortgage, only businesses or universities that are in good health will qualify. You might be wondering if you can finance an installation on your own to save even more money.  That depends on how much time and effort you want to spend.  Because of the variability of SREC prices, most commercial banks won’t finance them. Assuming that you could find financing, you would then have to identify the right solar modules, the right inverters, hire the right design firm, hire a really good union electrical installation firm, and then take your system through the local planning and zoning board for approval. After you have your system installed, you’d have to maintain it. Apogee brings together the whole package: finance, design, installation and maintenance. We save you money and help the planet.

This is a second guest contribution by Tom Konrad Ph.D., CFA, an investment analyst and policy wonk specializing in clean energy.  This is an edited version of two articles that first appeared on AltEnergyStocks.com, where he blogs about investing.  He also writes about energy policy and economics on Clean Energy Wonk. It’s worth burrowing down into some of the links to find out more about prospects for specific sectors and companies.

A reader of my article on asset allocation for green energy investors brought up an important point: we may have green opportunities in our own lives, such as improving the energy efficiency of our homes, which will return much safer and higher returns than green stocks, especially when the market as a whole is as overvalued as I currently believe it is.

Homeowners typically have a large number of high-return energy efficiency investments they can make.  Since energy efficiency reduces energy use, it both produces returns and is very green, since pollution from fossil fuels is reduced.  Even reducing the use of renewable energy is green, because all energy production has some impact on the environment and uses resources.  Furthermore, energy efficiency reduces financial risk, because you are less subject to fluctuating energy prices if you use less energy.

Assess Your Opportunities

An energy audit is a good way to discover your opportunities.  Many utilities have programs to give customers free or subsidized energy audits.

Check with your utility (gas and electric) first to see if they have such a program.  If not, and you are a do-it-yourselfer, visit a website dedicated to helping you improve your home’s efficiency, such as the EnergyStar site. If you’re not a do-it your selfer, look for a RESNET certified energy auditor and pay for an energy audit.  Prices for audits vary a lot, but I’ve heard that $200 – $300 is a good ballpark figure.

You will be amazed, or even shocked, at how many opportunities for savings you find, even in a brand-new home. The improvements you make usually qualify for federal tax credits, as well as (possibly) rebates from your utility or state tax credits.

Any energy efficiency or renewable energy measure with a payback of less than 10 years is likely to be a better investment than green stocks or funds, especially in today’s overvalued markets.  Here are ten that almost always have great financial returns, many of which are good enough to perform even if you rent and plan to stay in one place for a year or two. 

1. Keep your car tires inflated to the proper pressure.
2. Change and clean your air furnace filter regularly. Take a hose and get the dirt off the coils in the outside heat exchanger as well.
3. Caulk air leaks.
4. Use Compact Fluorescent Lights.
5. Install a Water Heater Blanket.
6. If you have an old fridge in the garage or basement, unplug it.
7. Install low-flow showerheads.
8. Use an intelligent Power Strip to turn off standby mode.
9. Get a power meter to hunt for energy hogs around the home.
10. When replacing electronics, computers, cars, and appliances, get energy efficient ones, especially anything that’s often on or in standby when plugged in. (cordless phones, TVs and set-top boxes, clocks, etc.)

Lists like this abound on the internet. Consult several for ideas.

How Much to Invest

An informed decision of how much to invest in green energy is at least as important as how you make the investment.  The choice between green Exhange Traded Funds (ETFs) and green Mutual funds rests on a difference of about one percent per year, caused by differences in fees.  Yet in the first three quarters of 2009, the S&P 500 (general stocks) returned 17%, ICLN, a green ETF returned 21%, and my ten green stocks for 2009 returned 41%.  With differences between performance as large as 20-30% a year (green stocks did much worse than the market as a whole in 2008,) the decision between investing 10% of your portfolio or 60% of your portfolio in green stocks will make a large difference (8% to 12%) in your total returns for the year, far more of a difference than how you invest.  The other important factor will be sector selection within green energy.  I believe that the main reason my Ten Green Stocks for 2009 have done so much better than the benchmarks is because I emphasized sectors I believed would benefit from the stimulus package.  At that time, the stimulus was  only something that I (and other green commentators) were predicting as part of Obama’s response to the financial crisis (He had not yet been sworn in.)

Your Allocation Decision

How much of your savings you put into green energy will depend on two things:

1. Your risk tolerance and market expectations.
2. Why you are investing in green energy in the first place.

All further discussion in this article assumes that either:

1. You have chosen not to time the market.
2. You have faith in your own predictive ability, and believe the market will continue to rise, OR
3. Your portfolio will be hedged against major market moves.

Risk Tolerance

Many green energy investments are more volatile than other sectors.  This is because the majority of green energy stocks are not yet profitable, and do not have the internal cash to see them through hard times.  This can force companies to raise money from the financial markets when those markets have fallen, and will cause the stock prices to fall further in market declines.  Such stocks are especially concentrated in the domestic and specialty green ETFs, such as PBW, TAN, and KWT.  Most of the green energy mutual funds, and the international green energy ETFs such as ICLN and PBD are less volatile due to a higher concentration of established companies.

Investors can deal with the greater volatility of green energy in several ways:

1. Stick to the less volatile green energy investments.
   1. Stock investors can emphasize profitable green companies over unprofitable ones.  Almost all of my 10 for 2009 picks referenced earlier are profitable companies, and those that are not currently profitable had a history of profitability prior to the financial crisis.
   2. Stick to the less volatile ETFs that contain a broad base of profitable global companies, instead of the more volatile domestic ETFs.
2. When hedging your portfolio, use a larger market hedge than you would otherwise.  The method I outline in my hedging strategies article automatically incorporates this adjustment.
3. If replacing an allocation of normal stocks with an allocation of green stocks in a larger portfolio,
   1. Replace an equally volatile sector allocation with your green energy allocation, or
   2. If replacing an allocation to ordinary stocks, replace part of that allocation with less volatile bonds, and part with green energy stocks.

Investment Motivation

It makes sense that the more confident you are that green energy will outperform other sectors, the more money you should allocate to it.  Keep in mind, however, that almost everyone has a strong overconfidence bias. That is, we believe we are going to turn out to be right a lot more often than we actually do.  This bias persists even when we are aware of overconfidence bias.

Hence, we should only let our confidence in green energy have a small influence in our overall allocation decision.  Like market timing, this is another rule that I honor in the breach: my entire stock portfolio is in some way related to green energy.  In ten or twenty years, we’ll find out if I actually know what I’m doing, or am just overconfident like most everyone else.

Motivation: Doing the Right Thing

If your main motivation for investing in green energy is to be more environmentally responsible, you are faced with a trade-off: the more you invest in green energy, the more volatile your portfolio will become.  However, feeling better about your investments may make you more comfortable with the added volatility.  This may allow you to hold more green energy because of your increased risk tolerance.

However, if you don’t believe that green energy will outperform, there are less risky ways to do the right thing.  You could instead replace your stock holdings with companies that are more green than most companies in their sector.  In a recent paper by Meir Statman and Denys Gluskov entitled “The Wages of Social Responsibility”, the authors found that socially responsible investment managers were able to achieve higher returns by favoring “best of class” companies in each sector, a process they described as socially responsible “tilt.”  In contrast, they found that completely shunning sectors such as alcohol and firearms led to lower returns over time.  Based on theses results, there is a win-win available for environmentally responsible investors who want to do the right thing: they can rebuild their entire stock portfolio by keeping the same sector allocations they had made before the change, but replacing the stocks in each sector with the greenest stocks from lists such as Newsweek’s rankings of the 500 largest US Corporations that I wrote about in September.

Motivation: Fighting Climate Change

If your motivation for investing in green energy is to fight climate change, you must balance the trade-off of increased risk from concentration in one industry, with your expectation that that industry will produce higher long-term returns because of increasing regulation of greenhouse gasses, and support for alternative energy.  In general, I find it very difficult to predict which companies are going to benefit from climate change regulation.  Will politicians choose to subsidize solar, wind, biofuels, or energy efficiency?  Will carbon credit giveaways create a windfall for utilities and other large emitters of greenhouse gases.

Not being able to predict politicians, I instead choose to focus my investing based on the (clearly false) assumption that politicians will do (roughly) the right thing. How do we know what the ideal actions are?  We look at reports from relatively unbiased sources that recommend particular actions.  I recently wrote two articles based on an article from two economists that looked at what Modern Portfolio theory has to say about the best technologies for climate mitigation (here and here.)

In terms of how much of your portfolio you should devote to fighting climate change, it should depend on how quickly you expect the effects of climate change to occur.  The biggest gains from a climate change focused portfolio will occur as more and more political leaders stop being able to ignore the urgency of responding to climate change.  I personally feel that this will be triggered by the increasing frequency of climate-related disasters, caused by the increasing severity and frequency of unusual and dangerous weather events such as hurricanes, droughts, floods, and blizzards.  This is something that I already see happening, but I don’t expect it to be obvious to the many people who want to ignore the effects of climate change for another 5-15 years.

Based on your own belief of when you expect this political transition to occur, you should only allocate money to climate change mitigating investments if you do not need to withdraw that money before the expected political change is likely to occur.  In some ways, this political change has already begun, and money is being awarded to deserving green energy firms.  However, investors should not ask what has already happened, but what unexpected changes are likely to occur.  The unexpected (by most other investors) change that I expect is the realization that Climate Change will not only be a serious problem, but that it will be a serious problem in our lifetime, and that it’s worth risking damage to the economy by devoting massive resources to the project of combating it.

In my case, my investment horizon is about 20-30 years, which is longer than the 5-20 I expect for the political change, so I consider fighting climate change as a good motivation to increase my portfolio’s allocation to green energy.

Motivation: Peak Oil

The connection between fossil fuel prices and the performance of green energy stocks is tenuous at best.  Investors should not expect their solar stocks to go up or down with the oil price.  After all, we do not yet have a fleet of plug-in vehicles which might let us substitute electricity from solar for gasoline from oil.  Hence, investors motivated by peak oil should stick to green energy sectors which reduce the need for liquid transportation fuels.  These sectors include biofuels, hydrogen fuel cells, technologies which make transportation more efficient, and technologies such as batteries which enable the electrification of transport.

Like climate change, how soon you expect to see the effects of peak oil should affect how much money you invest.  I feel that the effects of peak oil in terms of the reduced affordability of gas and diesel are already upon us.  This does not just mean high oil prices (which we have), but decreasing ability to purchase oil due to the economic disruption and contraction caused by those prices.  Low oil prices make our economies vibrant, which provide the money needed to buy oil.  High oil prices cripple the economy, which in turn means that we’re less able to buy oil at any price.  This is what I mean be “reduced affordability.”

In a recent report, “The Peak Oil Market,” Deutsche Bank predicts that post peak, both oil prices and oil demand will fall due to the introduction of disruptive technology: plug-in vehicles (If they’re right, investing in oil or oil companies is not the best way to profit from peak oil, but rather the potential disruptive sectors.  Of the sectors I mention above, efficient transportation, hydrogen, and electrification are the only ones that can possibly scale to replace a significant portion of our fossil fuel demand.  Biofuels are limited by the available supply of biomass.  Biomass can more efficiently power a vehicle when burnt to produce electricity to charge an electric vehicle’s battery than when converted into liquid fuels for an internal combustion engine.  A similar efficiency argument applies to hydrogen, although breakthroughs in electrolysis and fuel cell technology could change this.  However, I don’t consider betting on possible technological breakthroughs a sound investment strategy.  After all, even if a breakthrough occurs, it’s at least as likely to come from a new player than an industry incumbent.

Batteries will need some technological breakthroughs in order to make plug-in vehicles economical enough to displace gasoline. However, the needed improvements to the electric grid needed to accommodate electrified transportation (as suggested in the Deutsche Bank report) can be accomplished with existing technology.  Hence, investors motivated by peak oil should be looking to investments in transport efficiency, transmission and smart grid stocks.

In terms of how much to invest in these strategies, it probably should be a lot (at least if you believe as I do that the peak in oil production has either already happened, or will happen soon), and it should probably be accompanied by a hedge using shorts in oil intensive industries such as airlines.  The hedge is necessary because a peak in oil supply will hurt the world economy, and is likely to make stock prices as a whole fall, quite possibly even the stock prices of the companies which are working to displace oil with disruptive technology.  However, it is a good bet that these companies are likely to fare better than companies whose economics depends on the large scale consumption of cheap oil.

Conclusion

Your goals, expectations, and risk tolerance will affect both how you invest in green energy, and how much you invest.  Before you make any decisions, answer these questions for yourself:

1. Do I believe investing in green energy is the right thing to do? Will this help me bear the pain of declines in my portfolio?
2. How soon will Climate Change reach the top of the political agenda?  Do I have the time to wait for the expected investment returns?
3. How soon will oil production peak?  Do I have time to wait for the expected returns?
4. How confident am I about my answers?  Do I have reason to be confident, or is my confidence based on self-delusion?

The urgency of Daniel Goldman’s proposal to create a The Clean Energy Accelerator Corp. (see previous post) is reinforced by an article in the Financial Times today,  Cash Crunch Could Stain Clean Technology. Richard Waters writes that:

The lack of capital, however, is preventing many companies in the alternative energy world from reaching the scale at which they claim they can start to drive down unit costs of production to a level that could eventually make them competitive with traditional sources of energy.

Even companies that have been able to find a market – often due to government subsidies or other mandates that guarantee them a market, in spite of a lack of direct cost competitiveness – are struggling because of the lack of capital.

Though venture capital investments in clean tech have been picking up recently, “traditional project finance markets are still largely closed, and the public equity markets….remain closed to companies that have yet to prove long-term viability.”

Government fiscal stimulus funds have significant sums for environmental goals, but the problem is that current government funding mechanisms are inadequate, temporary, and somewhat arbitrary. The investments required for a transition to a low-carbon economy amount to several hundred billion dollars a year over a more than a decade – far beyond the timescale and scope of current government projects. The proposed energy legislation in the US envisages a revolving clean energy loan fund of just $30 million, and that is being fought bitterly.

The FT article points to one company left on the sidelines:

Quallion, a private maker of cells for advanced batteries, was one of those passed over this month as the US government announced plans for $2.4bn in support for battery makers – one of the first signs that green stimulus money is finally starting to flow.

Quallion had sought $220m to build a factory for truck and car batteries, but must now contend instead with better-financed rivals that have been given a leg-up by the taxpayer.

“When someone comes along and slaps down $300m for a new factory for my competitor, that changes the dynamics of the market,” says Paul Beach, Quallion’s general counsel and head of business development.

The structure of the proposed The Clean Energy Accelerator Corp. would help leverage private capital to generate a larger investment pool and ensure its independence from political pressures, allowing it to focus on more commercial and scientific project criteria.

This guest contribution is by Daniel Goldman, Executive Vice President & Chief Financial Officer of GreatPoint Energy and co-founder of the early stage investment group, Clean Energy Venture Group. He has managed and invested over $4bn in energy technologies and projects and is a vocal advocate of financial solutions for overcoming technology commercialization challenges.

Commercialization of new low/zero carbon energy technologies is essential to addressing job creation, climate change, energy independence, economic competitiveness and long-term energy affordability. Historically, public sector dollars and venture capital investments have funded promising clean energy technologies from laboratory through demonstration scale deployment (i.e., in commercial-like conditions but not at the size necessary for economic commercial operation). Private equity and project finance debt capital markets have historically funded projects and manufacturing facilities once commercially proven.  However, neither government, venture capital firms nor capital markets have tended to bear the risks associated with providing equity capital, which can amount to hundreds of millions of dollars, for initial deployment of capital intensive new clean energy technologies at commercial scale – described here as “first project commercialization”

Courtesy of Paul Maeder, Highland Capital Management

Consequently, many promising clean energy technologies that have been proven at pilot or demonstration size are unable to secure financing for commercial scale deployment.  Examples include utility-scale concentrated solar projects, geothermal technologies, biomass and fossil advanced gasification with carbon capture and sequestration, cellulosic ethanol, other biofuels and clean energy manufacturing facilities (e.g. new wind turbine blade manufacturing).  Proving out such technologies at commercial scale would enable deployment of multiple, large-scale facilities, financed by existing market participants (equity and debt), leading to hundreds of billions of dollars of investment, a material and more rapid impact on climate change, and ability to address other essential policy goals such as energy security, job creation and global economic competitiveness.  Two examples of “shovel ready” technologies on the cusp of commercialization are shown below:

As one solution to this oft-recognized problem, often termed the “commercialization valley of death,” the federal government should establish a new corporation, proposed here as the “Clean Energy Accelerator Corp.”, or “CEAC”, as an agency of the US government on the model of the Overseas Private Investment Corporation (OPIC).  Just as OPIC successfully provides support for the creation of privately-owned and managed investment funds in response to the critical shortfall of private equity capital in developing countries, CEAC would support the creation of domestically-oriented, privately-owned and managed investment funds focused on providing critical equity capital that is otherwise unavailable for first project commercialization. Just as the impact of OPIC’s support of funds that invest in emerging market companies has a multiplier effect (attracting additional investment and financing in companies), so too would the CEAC’s support have a multiplier effect in the following ways:

• Attracting additional private capital to commercialization of clean energy technologies;
• Accelerating the deployment of clean energy technologies and promoting a large market opportunity for follow-on funding; and
• Addressing policy objectives, such as job creation, global economic competitiveness, climate change, economic development, re-tooling of the supply chain infrastructure and energy affordability.

CEAC would provide support for privately-managed funds in a manner similar to the approach of OPIC, which typically provides debt (10-12 year maturities) to funds and also earns a profit participation component; these low-cost loans provided by CEAC, which are backed by the full faith and credit of the US Government, are sold to US eligible institutional investors.  CEAC’s participation in multiple private sector funds, where a minimum of $5 billion could be deployed, would rapidly catalyze private sector investment.  Moreover, like OPIC, the CEAC would establish pre-defined “scoring criteria” for each fund so that Office of Management and Budget could readily ensure that appropriate reserves are maintained based on the risk profile inherent in the portfolio of projects.  Characteristics of the CEAC should include:

• Transparent investment criteria and an independent board that would include appropriate agency secretaries and other senior government officials as well as representatives from the private financial, technology and energy policy communities;
• Management stability, flexibility, agility and experience overcoming traditional federal agency obstacles and enabling effective fund management of complex financial transactions leading to rapid deployment and commercialization;
• Financially self-sustaining as returns on investments revolve to allow for continuing re-investment;
• Ability to accelerate and scale capital formation by mitigating risks facing investors in the deployment of clean energy technologies and increasing the amount and rate of private capital deployed in a time frame that is consequential;
• Use of a proven fund model with funds managed by highly qualified investment managers having a proven track record in equity investing and possessing deep sector expertise, private sector institutional/corporate investors providing equity, and governance over project investments enabling rational exit and liquidation strategies to be implemented; and
• Leverage historical precedent which indicates that the United States has customarily availed its balance sheet for long-term multi-generational national priorities.

A significant number of projects have been identified which would be appropriate for investment by privately managed funds leading to commitments of several billion dollars in a short time frame and providing an immediate springboard for implementation. The CEAC would address a distinct problem within the DOE loan guarantee program (Section 1703), which attempts to ensure pre-commercial projects with innovative technologies have access to private sector debt but leaves the challenge of attracting equity capital unresolved.

With the nation hungry for clean energy solutions and a large number of VC-funded technologies needing help to get through the commercialization bottleneck, the time is now for bold, intelligent and targeted government action to spur the private capital sector to invest in first commercial projects using the existing and successful OPIC model.  While the OPIC model appears to offer the best analogy, other options, such as the Small Business Administration’s SBIC loan structure could also be considered.

The CEAC concept, which has been widely vetted within the investment community and clean energy industry, has received strong support and will naturally attract a broad coalition of interested constituencies including venture capital funds, private equity/project finance market participants, environmental advocates, economic policy makers, industrial, commercial and retail consumers and national security policy makers.  Prominent members of the finance and clean energy technology community are committed to supporting policy makers to make this idea a reality through existing mandates or in new legislation as energy and climate change bills are introduced.