The most promising alternative energy plays

One perhaps unexpected casualty of the credit crunch has been the alternative energy sector.

Shares in the world’s biggest producer of wind turbines, Copenhagen-listed Vestas Wind Systems, lost about a fifth of their value yesterday.

The group reported a €119m loss for the three months to the end of June. It’s the second quarter in a row that the company has lost money. And it warned that profits for the year would be lower than previously forecast. Tighter bank lending and governments desperate to cut back on spending have both taken their toll.

But could this be a buying opportunity?

The dangers of investing in government-backed sectors

As the FT’s Lex column points out, “renewable energy has taken a battering during the global downturn.” The S&P Global Clean Energy Index “has fallen almost three-quarters from its 2007 high.”

The trouble with wind energy and solar power is that both rely on government support to prop them up. And at the moment, governments across the world are cutting back where they can. For example, new wind power installation in the US was down by more than two-thirds year-on-year in the first half, while the Spanish government is slashing subsidies to the renewables industry in general.

Hence yesterday’s poor results from wind turbine manufacturer Vestas. Orders from both Europe and the US have been delayed. On top of that, banks have been far more wary of lending to the wind park developers who buy turbines from Vestas and other manufacturers.

It’s another valuable lesson in the dangers of investing in a sector which is so heavily dependent on government backing. Politicians can promise the world when they feel flush with cash. But now that sovereign debt is the focus of investor angst, they are looking for ways to shore up their budgets.

To be fair, it’s not as though no one is buying turbines any more. In fact, as Lex notes, future orders for Vestas look pretty solid. “The most recent weakness is largely the delayed result of last year’s 50% slump in orders.” The group “still expects to lock in at least one-quarter more orders this year than in 2008, its record year.” And as Bloomberg reports, Vestas “has signed at least eight orders in the past month, including its biggest ever in the US and its largest in Australia.”

The need for alternative energy sources is here to stay

And the drive to wean the world off its reliance on fossil fuels isn’t going to go away. Even putting concerns about climate change aside, with oil prices stuck stubbornly in the $70-$80 a barrel range, there’s plenty of incentive to explore alternatives.

But a further problem for Vestas and other turbine manufacturers in general is that competition in the sector is hotting up, particularly from China. As Eoin Treacy points out on Fullermoney, “China has a key advantage in production due to its monopoly of the rare earth elements market.” Rare earth metals are vital to produce the components for wind turbines.

Sure, if you’re feeling brave, then now might be the time to take a punt. Prices across the sector have been hit by Vestas’ profit warning. MoneyWeek’s resident share tipster Paul Hill picks his favourite play in the wind sector in this week’s issue of MoneyWeek magazine, out on Friday.

But I’d be reluctant to make any big bets on the industry. Given its dependence on subsidies, there’s just too much uncertainty for my liking. And it’s very unlikely that wind power will ever provide more than a small proportion of our future energy needs.

Where should you put your money?

So what might be a better option? At our most recent MoneyWeek Roundtable, we invited a group of energy experts in to discuss which sources of energy were best-placed to help wean us off fossil fuels. Nuclear power was a clear favourite. But perhaps a more interesting option – if not strictly renewable – is natural gas. With recent breakthroughs in extracting gas from ‘gas shale’, the US is sitting on massive reserves.

For our experts’ views on the best way to play natural gas, you can read the article online here: The future of energy – eight stocks to buy now. If you’re not already a subscriber, subscribe to MoneyWeek magazine.

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