The Clean Tech Primer 2017

In New York, Raymond James released its Clean Tech Primer 2017, arguably the most cogent and concise summary of activity and prospects across the gamut from solar power through to water technology, including all biofuels, biopower and bioindustrials. The report’s lead author, Pavel Molchanov, will be on stage at ABLC 2017 this March for an in-person update on the clean tech power, fuels and materials spectrum — but today, we present a digested version of the report, which you can download in its entirety here.

Overview

Clean tech is not an industry but a theme: a multi-decade, multi-pronged growth story – mostly, but not exclusively, within the energy complex – that we believe investors should be aware of, even if they do not have direct exposure to any of the underlying verticals. The complexity of investing in clean tech is the wide range of distinct markets: some very well-known and others more “below-the-radar”.

What Are the Key Risks?

Here is the single biggest thing we’ve learned (sometimes the hard way) over the past decade: growth is easy to find in clean tech, but that is not enough. All of the verticals we’ve outlined are growth industries in that they are gaining market share relative to more mature, established technologies. But all this needs to be seen in the context of inherently high risks in young, rapidly evolving industries, and a market mood that can swing rapidly from risk aversion to risk appetite, and vice-versa.  Technology change is relentless, particular vis-à-vis coming down the cost curve.

For example, the market price of PV modules is barely one-tenth of what it was in 2006-2008, spurring massive growth in global installations, but many manufacturers are less profitable than they were then. Competition from  conventional energy is naturally relevant for the direct hydrocarbon substitutes, as has been visible during the oil price down cycle since 2014.  Policy risk matters a great deal for some verticals (e.g., solar feed-in tariffs) but not others (e.g., electric vehicle sales are more sensitive to consumer preferences).

How Should Investors Pick Stocks?

One thing that has  not changed since 2006 is the fact that clean tech remains a textbook example of stock picker’s market. This sector simply does not lend itself to making broad calls. Within each subsector – even the narrow ones, with a handful of public players – we still have to focus on each individual company’s positioning (product mix, margin structure, industry partners, geographic footprint, etc.)

Putting everything together, our current  Strong Buy-rated stocks are 8point3 Energy Partners (solar), EnerNOC (smart grid), Green Plains Partners (bioindustrials), and Silver Spring Networks (smart grid). Our current  Outperform-rated stocks are AquaVenture Holdings (water tech), Enviva Partners (biopower), SunPower (solar), and TPI Composites (wind).

Key Takeaways

Solar power: China becomes ever more dominant while Europe’s importance shrinks, and commoditization across the PV value chain remains relentless.

Wind power: Less fragmented and with less volatility in the value chain than solar, as higher penetration in the global electricity mix translates into a fairly mature industry.

Biopower: Historically a Europe-centric market, wood pellets are starting to see adoption in other geographies with decarbonization policies.

Bioindustrials: Renewable fuels are one of the few issues that both sides in Washington can agree on – and we should not overlook the opportunities beyond fuels in high-margin specialty materials.

Natural gas fuels: Despite the slow adoption by fleets in North America, case studies in South America and Asia illustrate the appeal of this petroleum substitute.

Electric vehicles: Some of the media hype is excessive, but EV sales are finally reaching critical mass, and development of charging infrastructure is following suit.

Fuel cells: Still a fledgling niche market in vehicles, while use in distributed generation is limited but making headway in early-adopter markets such as Korea.

Power storage: Grid-scale storage solutions represent an early-stage but important enabling technology for mainstreaming intermittent renewables.

Smart grid: This particularly diverse space is vital not just for preventing blackouts but also improving the grid’s reliability, efficiency and customer responsiveness.

Water technology: While not energy-sensitive, this space fits into the broader paradigm of resource scarcity, as illustrated by the growing need for desalination outside the Middle East.

Key Theme in Biopower: Will Asia Become a Major Market for Utility-Grade Wood Pellets?

Over 80% of the world’s demand for utility-grade wood pellets is in Europe, specifically northern Europe, with the U.K. being by far the largest pellet market globally. That is not a law of nature but rather the direct result of the European Union’s strict carbon reduction requirements for power generators. A year ago, we wrote about the prospect that the U.S. could similarly spur pellet demand with the pending Clean Power Plan, the first-ever federal decarbonization mandate for the power sector. That, however, is no longer in the cards, because the incoming Trump administration has made it clear that it will not implement the Clean Power Plan.

Thus, in states with highly coal-reliant power markets (e.g., West Virginia and Indiana) there will be little if any regulatory push to switch out of coal. On the other hand, a few of the Asian economies are ramping up moves towards co-fired plants (using a blend of coal and pellets), with South Korea leading the way, and to a lesser extent Japan. These are early-stage initiatives, and Europe is set to remain the predominant market for pellets through at least 2020, but insofar as there is optionality for near-term adoption, Asia looks more promising than North America.

Key Theme in Bioindustrials: Will the Trump Administration or the U.S. Congress Modify the Renewable Fuels Standard?

Unlike most of the themes on our list, this is fundamentally a political issue – but not a party-line one. Let’s recall that the Renewable Fuels Standard was first enacted in 2005 by a Republican-controlled House and Senate, and signed into law by President Bush. It was then upsized in 2007 by a Democratic-controlled House and Senate, and again signed by President Bush. Every year, the EPA sets the blending targets for corn ethanol, cellulosic biofuels and other advanced biofuels, and it has the authority to deviate (downwards) from the statutory figures in the RFS law.

Under both presidents Bush and Obama, the EPA’s blending targets have generally increased. Needless to say, the biofuel industry tends to be unhappy when the EPA requires lower volumes than what’s written in the statute – while, conversely, some of the petroleum fuel companies would prefer the RFS to go away altogether.

In all likelihood, little if anything will change in 2017 – and not just because the EPA has already issued the 2017 targets. At the legislative level, the powerful farm lobby’s backing for biofuels gives both parties a political incentive to keep the RFS in place. Thus, we think it would be very unlikely for Congress to vote to repeal or fundamentally transform the RFS. A more plausible scenario would be regulatory tweaks by the EPA to how the RFS is implemented, particularly the Renewable Identification Numbers (RINs).