The Energy Report: JinMing, the first half of October was a bloodbath on Wall Street, and resulted in the stock market's worst performance of 2014. How did the selloff affect the companies you cover?
JinMing Liu: Renewable energy, or cleantech stocks, have very high beta, so what happened in the past weeks had an even bigger impact on them. On the general market level, this correction could be very healthy. We need to wait to see how the cleantech and renewable markets develop, because they could go quickly either way. I suggest investors be patient.
TER: So investors should sit tight to let the market settle down some?
JL: They should have patience, because cleantech stocks, in general, have a higher risk profile. Cleantech and renewable energy companies are a newer industry, and the risks associated with them are higher than with more mature, bigger companies.
TER: Is that true of the waste-handling stocks as well?
JL: That is a different space. The waste-handling industry has different subsectors. Municipal solid waste is relatively mature. There are also industrial waste and food-processing waste subsectors, which have different risk profiles.
In the municipal solid waste market, companies like Covanta Holding Corp. (CVA:NYSE; CVGYQ:OTCBB) have relatively mature operating models and, generally, very high cash flow. On the other side, industrial waste handling and food-processing waste handling have two different sets of factors affecting them. For food-processing waste, the final products are sensitive to commodity prices, which can affect the stocks of companies like Darling Ingredients Inc. (DAR:NYSE), which I cover. Because of what happened recently with the uncertainty surrounding the Renewable Fuel Standard compliance requirement and sanctions against Russia, expectations for the global consumption of agricultural products have been adjusted. As a result, prices for Darling's products are under pressure. That led to some pressure on the stock.
"Strategic Environmental & Energy Resources Inc. uses pyrolysis and plasma technology to reduce the volume of the waste from different industries."
The industrial waste segment is very fragmented. Many smaller companies are trying to get in, but the competition is relatively high.
We are also looking at technological improvements in the waste industry. Some technologies are relatively mature, such as landfill operations, traditional waste-to-energy solutions, burning trash to generate electricity, or the rendering process for agricultural waste. These are mature technologies. Companies either bury, burn or cook food waste to make the final products. But given the increases in different commodity prices, including crude oil, and in landfill prices because of finite space available for landfills, different types of technologies are called for.
For example, some companies are trying to use municipal solid waste to produce biofuels. Another crossover company, called Strategic Environmental & Energy Resources Inc. (SENR:OTCMKTS), is using a combination of pyrolysis and plasma technology to reduce the volume of the waste from different industries, including oil refineries and medical waste. These are the areas in which we expect to see potential significant progress in the near future.
The U.S. generates a lot of waste each year. The waste disposal industry is worth about $50–60 billion per year in the U.S. The traditional waste-handling companies like Covanta have relatively stable business models. Their growth will come from incremental market growth. We may see better opportunities in the future in technologies that help us improve waste-handling and processing.
TER: The waste industry is driven, in many respects, by regulations. What environmental regulations are generating the greatest business opportunities today?
JL: The most promising opportunity right now is in energy efficiency through reduced waste. There are quite a few mandates out there. In 2012, the Obama administration put out an executive order requiring energy efficiency at industrial facilities. On the state level, last year California put out a mandate for utilities to install 1.3 gigawatts (1.3 GW) of grid-connected energy storage capacity by the end of 2020. Those areas are driven by regulation, and we'll see a lot of very good business opportunities.
TER: Has any other state done anything as specific as California?
JL: Many grid storage projects are ongoing. The U.S. Department of Energy has an active database documenting these, whether they're under construction, in operation or just proposed energy storage facilities. These projects are happening across the country. Whether other states have mandates, I'm not sure.
"The risk associated with cleantech and renewable energy is higher than with more mature, bigger companies."
One of the important reasons utilities install energy storage capacity is to push off big investments in infrastructure. As you know, this country has very old power infrastructure. That's why I believe new technologies in alternative distributed power generation and energy efficiency and storage will help us work with the aging power infrastructure and move to more sustainable development.
TER: President Obama has implemented several regulations regarding environmental improvements. Do you think his executive action, bypassing Congress to implement the regulations, will survive the political opposition?
JL: Yes. First of all, I don't foresee any problem in executive orders being carried out, because I don't think they are that politically sensitive. For example, the Obama mandate for improvement in the Corporate Average Fuel Economy standards for vehicles got support from all the major automakers. Second, the government should have the determination to carry out a specific executive order, meaning putting in place effective measures of enforcement. We think there is a good chance that the U.S. Environmental Protection Agency will reduce CO2 emissions from power plants, for example. On this end, we don't expect significant impact on waste-to-energy facilities, since they mostly use renewable municipal waste.
TER: Renewable fuels must compete with well-established fuels, so the question of grid parity, or renewables' ability to compete, comes up. Municipal solid waste as energy, for example, has struggled in this country. How effectively can renewable fuel compete today?
JL: This question has to be answered for the different types of fuels. Ethanol currently competes very efficiently against traditional fossil fuels like gasoline, because we as a country have built a large production capacity for ethanol and our farming/agriculture sector can support such a huge capacity.
On the other hand, for a similar biofuel, biodiesel, it is very hard to compete without state volume mandates and subsidies.
Municipal solid waste is a tricky fuel. You can burn it to generate electricity, but municipal solid waste, as a fuel, depends on the tipping fee—the fee charged to municipalities by waste-processing facilities to break even. Revenue from sales of electricity generated is the upside for profitability.
TER: Does Covanta use any special combustion technologies?
JL: Covanta uses more traditional technology; its technology is at least 20 years old. There are other emerging technologies for waste-to-energy, like plasma. Air Products & Chemicals Inc. (APD:NYSE), a large company, is building facilities using plasma technology in the United Kingdom. Strategic Environmental, as I mentioned earlier, uses plasma technology in combination with pyrolysis technology to reduce volume or to get rid of some specialty waste.
"Lithium batteries have the most promising growth profile, for the very simple reason that lithium batteries offer very high energy density."
Processing waste with plasma is an interesting approach. If members of the public hear that a waste-to-energy facility will be built, they most likely will not support it. But if they hear that a plasma gasification power-generation facility is planned for their neighborhood, they may support it. That is how powerful newer technology might be for the waste-to-energy sector.
TER: What other companies do you cover in waste management?
JL: Darling Ingredients, which recently changed its name from Darling International, handles agricultural and food waste. Darling has grown very big through acquisitions. Its stock recently was under a lot of pressure simply because, as a food-waste processing company, its final products are sensitive to agriculture commodity prices. When the corn price is at $3–$4/bushel and the soybean price around $9/bushel, pressure is on Darling's stock. But in the long term, I believe that Darling is a good stock.
TER: How are you rating your waste-handling companies these days?
JL: Right now I have a Hold rating on most of my waste-handling companies because the valuations of most of these companies were very high and I expect some correction. I don't want to use the word "bubble," but the valuations stopped me from being positive on these stocks. As I've said, the stock market was due for a correction because the valuations of most stocks are very high, and many of the environmental waste-handling companies are trading even higher because they have higher beta.
TER: Energy storage also encompasses a wide variety of technologies and applications. Which applications and technologies offer investors the greatest returns and growth?
JL: In the long term, there will be many competing energy-storage technologies, like the ultracapacitor from Maxwell Technologies Inc. (MXWL:NASDAQ) and lithium batteries from many companies.
When we talk about energy storage, it can be discussed in terms of two applications—power applications versus energy applications. Power applications refer to a high power output for a relatively short period of time. Energy applications refer to discharge of electricity for longer periods of time near the system's nominal power rating. Ultracapacitors are very good for the first type of application. They can offer a burst of energy to propel a large bus to a certain speed. Other energy-storage applications need longer output periods with more stable energy flow.
"In this kind of environment, it's smart to invest in companies that are less volatile—in more defensive stocks."
A lot of competing technologies will be on the market in the near future, but among them, lithium batteries have the most promising growth profile for the very simple reason that lithium batteries offer very high energy density. For many applications, we need small but powerful energy sources.
Lithium batteries are also available in different shapes, which are important for the development of applications. For example, in a cellphone we want a battery that's as compact as possible but has a lot of power, whereas in home energy storage devices, many large format lithium batteries can be used, in a cabinet of the size of a refrigerator. Form factor is another important benefit of lithium batteries.
In the next five to 10 years, we'll see very strong demand-driven growth from electric vehicles, smartphones, tablets, power tools and gadgets we can't imagine. That's why I prefer the technology.
TER: Do companies providing energy storage options, such as Highpower International Inc. (HPJ: NASDAQ), Maxwell and Polypore International Inc. (PPO:NYSE), work throughout the range of applications, from cellphones to megawatt-size grid energy storage, or do they focus on specific sectors?
JL: Maxwell Technologies offers the ultracapacitor, which is for specific vehicular and renewable energy applications. Highpower International is a lithium battery company. Its batteries range from units that can be used in very tiny gadgets, such as a smart watch, to grid-connected energy storage devices. Polypore International is an important supplier for the manufacturing of lithium batteries. It offers a specialty product called the separator—basically a piece of membrane to separate positive and negative electrodes inside a battery. That membrane is very important for the performance and safety of lithium batteries. As you may have heard, lithium batteries may explode if things go wrong.
TER: The Tesla Motors Inc. (TSLA:NASDAQ) gigafactory won't be online for several more years, but when it comes online, what effect do you expect it to have on battery prices?
JL: Lithium battery price has been on a downward path for a long time, and I believe the lithium battery price will continue to decrease regardless of when the Tesla gigafactory comes online.
In the past few years, the demand for lithium batteries has been growing at an annual rate of about 26%. Tesla's gigafactory wants to build about 30 gigawatt-hours of batteries, which is almost identical to 2013's global lithium battery production capacity. If this industry continues to grow at 26% each year, in less than three years, we'll see lithium production, in terms of volume, double. Within five years, that number could triple or quadruple. I don't believe Tesla's gigafactory will have an impact on the pricing. The expansion of other companies' production capacity would satisfy the demand for other areas and applications. Tesla's gigafactory most likely will satisfy its own electric vehicle production.
TER: Finally, the International Monetary Fund has cut its forecast for global growth. It says the Eurozone could slip into recession, and the stock valuations may be "frothy." How should investors conduct their business in this climate for the next six months?
JL: I agree with the notion that we are looking at a bubble. In this kind of environment, it's smart to invest in companies that are less volatile—in more defensive stocks. For example, Covanta Holdings pays dividends and generates stable cash flow each year. That's a defensive stock I can suggest.
TER: Thank you, JinMing. I appreciate your time.
JinMing Liu is senior vice president and director of research with Ardour Capital Investments LLC, which focuses on energy technology, alternative energy and power, and clean and renewable technologies. He has been with Ardour Capital for seven years.
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