The world is facing harder times. In the US and increasingly the UK, over-indebted consumers are in terror of falling house prices and a recession.
While analysts cross their fingers and hope the rest of the world can ‘decouple’ from US woes, you’d have to be very optimistic to believe that export-dependent Asia can ignore America.
None of this is good news for investors. But one sector looks set to do well in the long term, regardless of any slow-down: energy.
After all, we might stop having meals out if the economy takes a turn for the worse this winter. But things will have to get really bad before we turn off the lights and heating too. Not that it would change the outlook for global energy use even if we did – according to the International Energy Agency, the world’s energy demands are set to jump by 50% over the next 20 years, largely due to the growth of emerging countries such as India and China, where industrialisation is changing the pattern of world demand for fossil fuels.
Oil prices have risen to near-$100 a barrel and Morgan Stanley reckons they could hit $115 a barrel next year. Coal use is booming – China and India burn 45% of the world’s coal, a figure that could reach 80% by 2030, says the Department of Trade and Industry. This demand growth may be slowed by a global recession, but all that would do is buy us more time – it cannot change the fact that pressure on limited energy resources has increased drastically.
Another pressing issue is the environment. While coal is a great source of energy, it also produces something much less welcome – pollution. Beijing is the world’s most polluted city; and China has another 15 cities in the top 20. And it’s not just the smog that’s a problem – carbon emissions are now firmly on the political agenda.
Regardless of your take on climate change, as the Kyoto agreement and this week’s gathering of 10,000 bickering delegates in Bali illustrate, politicians worldwide are being swayed by research suggesting burning fossil fuels is irretrievably damaging the environment.
Even in the US – the world’s worst carbon emitter per capita and one of only two countries that ducked out of the 1997 Kyoto protocol – companies such as Google are promising to invest “hundreds of millions” of dollars in alternative energy, while a bill is being proposed that would require US utilities to take 15% of their energy from renewable sources.
Put all these factors together – spiralling demand for energy and politicians with publicly-funded pockets who are willing to back “clean” power – and you have the ingredients for a boom. But in what?
The first part of the answer is nuclear power (see below) and the second is the so-called “renewables” – technologies that convert wind, wave or solar energy into electricity, plus more obscure options, such as turning algae into oil (more on this below).
France has shown what can be done – nearly 80% of French power comes from nuclear energy and a further 13% from renewables, including a hydroelectric dam at La Rance. Now that most countries are under pressure to achieve targets for emissions reduction, a wave of capital, much of it government subsidies, is flooding into both the nuclear and renewables markets – and that offers some great investment opportunities.
Wind power
The Earth might be running low on oil, but it certainly isn’t short of wind – Stanford University estimates that if just 20% of global wind power could be captured, it would satisfy all of the planet’s energy demands in total and over seven times its electricity needs. What’s more, wind turbine technology is proven and, according to The Guardian, the cost per kilowatt-hour for electricity (a major measure of energy efficiency) is among the lowest of any renewable power source.
As a result, some countries have already adopted it with enthusiasm – in Germany, a world-beating 5% of all electricity is created by 19,000 onshore turbines as part of a drive to meet a target of 30% of all electricity being generated from renewable sources.
Here in the UK, wind power is the fastest-growing renewable energy sector, says The Independent, with power group E.On planning 83 wind turbines off the coast of Yorkshire. Food producer McCains is even proposing to use onshore technology to power chip-making factories.
The trouble is on shore wind power is constrained by geography – there are a finite number of viable sites to locate turbines, particularly in smaller countries, such as the UK. This limits the total amount of power that can be delivered. As a result, research in Europe is now focused on offshore, sea-based wind farms. But these are much more costly to build as they need to be incredibly robust.
However, in the US there is still plenty of scope for new onshore projects. In fact, analyst John-Marc Bunce of Ambrian Partners believes that the US alone could supply most of the world’s wind-farm growth over the next five years.
So a good bet for anyone thinking of investing is Kaydon Corporation (NYSE:KDN). The firm has a strong track record in providing specialist equipment for high technology engineering applications. Only 10% of its current sales come from the nascent wind-energy industry, but this is expected to quadruple over the next three years.
At $47, the shares are up around 20% on last year and trade on a p/e of 20 times 2008 forecast earnings – but with firms such as Shell complaining that a “two- to three-year delay in delivery of windmill systems” is holding up its plans to build more wind farms, the market for Kaydon’s products looks safe.
Solar power
The relatively high cost and environmental challenges of finding sites large enough for solar farms means this renewable is likely to supplement, rather than replace, other energy sources, such as nuclear. Rockefeller University’s Professor Ausubel cautions that 12,000 square kilometres (an area roughly the size of Connecticut) of photovoltaic cells would be needed to power New York.
However, the technology is constantly improving – the silicon panels that are vital to the process of converting sunlight to electricity are becoming more efficient, while cost per kilowatt hour is steadily falling, bringing it closer to alternatives such as wind.
And given the increasing levels of government subsidy available to develop solar solutions in places like Beijing – China hopes that solar will play a major part in its aims to meet 15% of the country’s energy needs from renewable sources by 2010, and wants to rival global solar leaders Germany and Japan – investors should look hard at the opportunities available.
One of the most interesting is silicon. Although unrefined silicon is the world’s second most abundant element, the refined version is much harder to source, largely because it’s difficult and expensive to produce. Given that a wall of money is heading into a solar energy industry that already gobbles up around half of the refined silicon available, the scene is set for a boom.
One way to get exposure is via a polysilicon supplier such as MEMC Electronic Materials (NYSE:WFR), the leading US supplier of silicon wafers. The shares have already enjoyed a strong rise this year, but investment bank UBS reckons they have further to go with a p/e of 23 and a modest price/earnings to growth ratio (PEG) of 0.8.
Hydro power
Humans have used water energy for centuries in the form of the waterwheel. And unlike solar and wind power, the advantage of hydro power is that you can predict when the power will arrive and how long it will last. This makes it a perfect source of energy, but only if it can be captured and converted.
The trouble is, that’s expensive – Professor Ausubel describes it as “the least efficient way of using land to produce power”, with an output of just 0.1 watts per square metre, compared with wind power at 1.2.
This partly explains why France went nuclear rather than replicate the La Rance tidal power plant built in 1966. In addition, there are only limited numbers of sites worldwide either with sufficient “drop” or tidal range to be of much use.
And then there’s the potential environmental impact of altering either river or tidal flows. The world’s largest hydro dam, the Three Gorges on the Yangtze river in China, has been at the centre of a string of controversies, including the relocation of a million people when it was built, and more recently massive landslides.
Yet interest is picking up all over the world – in the UK, plans are being developed to create a hydropower barrier across the Severn River that could generate up to 10% of the UK’s electricity. In 2004, power generator Scottish & Southern Electricity switched on its first new hydropower station in Scotland since the 1960s and is committed to refurbishing a further 50 sites in a ten-year rolling programme.
However, one of the best opportunities could lie in Turkey, where demand for electricity is expected to double in under eight years. As a result, RBC Capital Markets counts US firm AES Corporation (NYSE:AES) as a “top pick” – the company stands to profit from a joint venture with local firm IS Ictas to build a number of hydropower plants by 2011. The p/e is 20, but RBC expects the share price to rise 40%.
Geothermal power
In certain parts of Iceland and New Zealand you can fry an egg on the rocks at your feet – the heat is consistent, delivered free 24 hours a day and needs no infrastructure to access other than a frying pan. Sure, larger projects require all kinds of equipment, including drill wells and turbines, but that’s not a problem as the technology already exists.
It’s just that geothermal power lost out to fossil fuels as the energy source of choice as the Western world industrialised. As such, it’s still a marginal energy source today, but growing interest in renewables has seen groups such as US-based Pacific Gas & Electric sponsoring large-scale research and development projects.
One stock to watch is Ormat Technologies (NYSE:ORA), which designs, owns and runs geothermal plants around the world. On a p/e of more than 60, it looks very expensive, but Outstanding Investment’s Byron King reckons that as the only major stock offering a pure play on geothermal energy, investors should buy if the share price falls below $40 (from around $49 just now).
Could algae be the fuel of the future?
According to the New York Times, renewable energy could be derived from an unlikely source – algae. Researchers at the University of Minnesota claim that certain strains of algae are up to 50% oil, which, once extracted, could be turned into biodiesel or jet fuel.
To prove the point, a New Zealand company recently demonstrated a Range Rover powered by an algae biodiesel blend. The main drawback is cost – at around $20 a gallon, it’s currently around ten times too expensive – not to mention the lack of algae filling stations.
On the flipside, yields are potentially massive – an acre of corn produces about 20 gallons of oil per year, compared to 15,000 for the same area of algae. It can also be grown almost anywhere and happily absorbs pollutants from sewage and power plants. While commercial production is “still years away”, and it’s not directly playable for your average investor, the US is taking research seriously and funding is now “pouring in” from sources including the Pentagon, big oil companies, utilities and venture-capital firms.
Nuclear – the most realistic alternative
On the back of disasters such as Russia’s Chernobyl and Three Mile Island in the US, the future of nuclear reactors is still a topic that divides Western countries in particular. The French rely on them, but German legislation effectively outlawed new reactors in 2002.
Meanwhile, in the UK, which, like the US, obtains around 20% of its electricity from nuclear, up to five more will be built as our current plants run down, according to Gordon Brown in a recent speech to the Confederation of British Industry.
But in spite of persistent resistance and public scepticism over reactor safety and the disposal of nuclear waste, nuclear power undoubtedly compares favourably with other alternative energy rivals, such as wind and solar power, on several counts.
Firstly, despite high initial build costs and long lead times for new plant, nuclear energy is still the only economically scaleable alternative to fossil fuels, capable of powering a whole nation without peppering the landscape with huge windmills or fields of large solar panels.
Secondly, the bang for your buck – known as “cost per kilowatt hour” – easily beats offshore wind farms and, as Professor Brian Eyre of the Royal Society points out, the supply of power to a national grid is consistent and can be easily controlled, unlike the stop-start nature of most other renewable sources. A domestic nuclear power plant also enjoys good “energy security”, as it doesn’t rely on oil or gas pipelines situated in politically sensitive areas, such as the Gulf or Russia.
But the truth is it doesn’t matter what the West thinks. Emerging markets are embracing nuclear – Capital Research estimates that the number of nuclear reactors proposed worldwide has risen by 67% to 256 in the past 12 months. China’s nuclear plans are particularly aggressive, with Beijing planning to build 30 nuclear plants over the next 12 years, en route to becoming the world’s largest energy consumer in 2010, according to the US Department of Energy. In short, nuclear power is here for the long haul.
There are several investment options available, one of which is uranium, the power that fuels nuclear plants. The price of this “white hot metal” has risen roughly 14 times in six years, though recent volatility saw the price peak in June at $138 a pound, sink to $75 by mid-October, and then recover to $93.
The closest product to an exchange-traded fund is the Uranium Participation Corp (TSX:U), a Canadian fund that buys uranium oxide and uranium hexafluoride. As long as you are prepared for volatility, there are some interesting mining stocks in the sector – UBS tips Uranium One (TSX:UUU), whose annual production of uranium is due to soar from two million pounds last year to 20 million by 2013 via acquisitions. UBS sees upside of 30% next year.
A better bet might be Cameco (TSX:CCO), which accounts for around 20% of uranium production and is on a p/e of 22. Problems with flooding at its vast Cigar Lake mine and a volatile uranium price have seen the share price fall to $39 from a high of $59 in June, but this makes this dominant player an even better long-term buy.
The indiscriminate mark-down of shares amid the credit crunch has also thrown up value elsewhere. A year ago we recommended niche engineering firm group Redhall Group (LSE:RHL), which runs a successful division making containers for nuclear waste. It’s still a good company, but no longer good value, having risen by around 80% since the original tip, to trade on a p/e of 34. But as an alternative you might want to look at Costain (LSE:COST), a firm heavily involved in power station decommissioning, and currently trading on a p/e of just seven.