Friday, May 30, 2008

Piggie Goes to Market

In the post “Corn at $6.00” on May 27, 2008, there was a promise made for one more tip in selecting strong alternative energy plays. The issue is distribution. This topic has been covered in previous posts on ethanol and other biofuel, but its importance justifies repetition. How is the proposed new fuel source to be delivered to the consumer, whether a business, industry or an individual? Through existing channels or is new infrastructure required?

The U.S. is an economy linked across wide geographies that challenge producers of everything from food to capital goods. The question of where to locate production - near input supplies or near distribution points to customers - is the quintessential economic question facing alternative energy developers.

Transport innovations have been the foundation of the country’s early economic success - wagon trains and ferries across rivers, the cross-continental railways, the interstate highway system, canals and locks linking water ways, a national or at least regional electric grid.

The fact that the U.S. economy is currently in precarious condition means the question of distribution efficiency is growing in importance. In my view, the weakened U.S. economy may have reduced the amount of capital now available to invest in new distribution infrastructure. Producer will need to make do as far as possible with the installed electric grid, pipelines, and storage capacity. This means the relative wisdom of promoting one alternative energy technology over others is shifting and could lead to changes in public policy and fiscal support as well as a reallocation of capital.

Investors need to reconsider the distribution issue vis-à-vis current and new positions. Following are some examples, including a name covered in Small Cap SEARCH newsletter.

Ethanol producers are the biggest loser from a distribution standpoint. Ethanol cannot be sent down existing gas pipelines and must be sent to blenders via truck or rail. By the time a gallon of ethanol arrives at a gas station for use in vehicles (the most likely use of ethanol), considerable fossil fuel inputs have been expended through fertilizer, production fuel, and distribution fuel. These high-costs render questionable further investment in distribution infrastructure. A non-starter in my view…

Hydrogen is a favorite because of the widespread availability of inputs, but distribution is also an issue. However, the favorable production scenario could leave room for investment in distribution infrastructure. Another important note is that hydrogen has been distributed on a limited basis for various industrial purposes. This gives producers of hydrogen some basis for further investment to bridge that distance from production sites to distribution points at gas stations for vehicle use.

Dynetek Industries, Ltd. (DNK: TSX) produces power distribution systems. Dynetek is near breakeven at the operating level and is producing positive cash flows. You can also play the distribution angle with Air Products & Chemicals (ADP: NYSE). Air Products is providing distribution and storage infrastructure in both the U.S. and the U.K. It is highly profitable and trades at 19.7 times earnings. However, as a highly diversified chemical company, it is not a hydrogen pure play. Among the hydrogen fuel cell producers FuelCell Energy (FCEL: Nasdaq) focuses on stationary fuel cells for power generation. This makes FCEL appealing since this application does not require a build out of infrastructure as would be necessary for automotive use. FuelCell is not yet profitable, but appears to be headed in the right direction with growing sales and a declining cash burn in the January 2008 quarter.

The big winners from a distribution standpoint are those that generate electricity and can connect to existing electrical power infrastructure - solar, wind and wave generators. Wind and wave projects are still at an early stage, so investors in these technologies are also making a bet on management’s ability to execute as well as the economic sustainability of the technology. GreenHunter Energy, Inc. (GRH: AMEX) was recently profiled in the April 8, 2008 post “The New Black Gold.” Two points in favor of this development stage company: 1) management includes skilled and successful entrepreneurs who cut their teeth in the oil and gas industry and 2) the business model is based on a portfolio of wind, solar, geothermal and biomass.

Biofuels have been the focus for investors interested in the vehicle fuel challenge. Efforts continue on electric powered vehicles, but distribution is also a factor. Electric powered cars are fine as long as the driver never ventures very far from home. Imagine the challenges in making the annual family vacation adventure to Yosemite. The U.S. Department of Energy provides a handy map of charging station locations on the Internet if you need to find a charging station fast. There are no electric charging stations anywhere near Old Faithful! There are eleven in the metropolitan area of Phoenix, Arizona but a tourist still cannot get to the Grand Canyon and back.

Enter battery developers like Altair Nanotechnologies, Inc. (ALTI: Nasdaq). Altair is using nanomaterials to produce lithium batteries that hold more power supply and charge quickly, say in the same amount of time that it would take to fill a tank with gas. Altair has struggled to penetrate the vehicle manufacturer market, but has found a customer in Phoenix Motorcars. California’s public utility PG&E has signed up for the first 500 of the Phoenix Motorcar all-electric fleet pick-up truck that features Altair’s lithium ion nano-battery.

If these examples demonstrate nothing else, investors should take away the message that in the alternative energy industry some little piggies will go to market and others will stay home. The question for investors is which ones are which.

Neither the author of the Small Cap Copy web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. ALTI was profiled in the November 2006 issue of the newsletter Small Cap SEARCH with generally favorable commentary and remains a one of the stocks in the SEARCH group.

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