Are There Benefits From Buying Alternative Energy Technology?

Meanwhile, farther down the West Coast, those rolling blackouts are already in play: Deregulation, among other factors, has contributed to a full-fledged power crisis in California, and Pacific Gas & Electric, a major utility, has declared bankruptcy. Yet despite those blackouts, environmentalists fight to prevent new power lines, new power plants, and new nuclear and coal power options. The problem is clear: The US, Europe, and the world in general need new forms of energy technology.

WHO'S GOING TO BENEFIT?

Companies that provide alternative energy technologies stand to gain the most from the present energy crisis -- if the technologies are adopted. If you own stocks in any of these companies, you too will be poised for reward. Does this mean you can expect something similar to the technology runup of the 1990s?

It is a truism that when oil prices rise, all energy stocks advance. (For more information on oil price dynamics, see "Why Not Oil Stocks?" at Working-Money.com.) But keep in mind that the earnings potential of alternative energy stocks is low. In 1978, when oil prices were high and poised to go higher, I bought stock in a small solar-energy company at $2.30 per share. I held onto the stock and saw the price rise to about $2.50 per share before it started falling. By about 1983, even with oil prices still high, the shares had fallen to $0.50. I finally sold my stock, forfeiting 80% of my share value. After 1985, when oil prices came back down, many solar-energy companies went out of business altogether.

In retrospect, after having studied energy stocks, I now understand that the loss in value was caused by more than just a badly managed firm. The decline was also caused by the poor profit potential of alternative energy systems and the lack of demand for those systems. People like the idea of alternative energy; they just don't want to use it in real life.

When energy prices go up, it's only natural to seek out energy technology stocks, but investors often act on their belief that those stocks will be more profitable than they end up being. They soon realize the hard truth when energy technology stock prices plummet. The problem is, the fundamentals of energy physics make new energy technology much less promising than, say, computer technology.

Energy, just like any technology, can be explained by physics. However, the physics of energy have proved much more of a barrier to technological improvements than the physics of electronics have. In any 10-year period, electronic equipment has improved and costs have declined. However, energy technology just plods along, with advances made in the smallest of increments. For example, in the mid-1970s handheld calculators and solar-energy systems were both just entering the market. A decade later, a handheld calculator that sold for $1,000 in 1975 could be had for just $1. In comparison, a solar-energy system that also cost $1,000 in 1975 would still have cost about $800 in 1985. So why is it that energy technology hasn't followed the same path as electronics technology?

PROBLEMS WITH ALTERNATIVE ENERGY

Look at some of the statistics surrounding energy. We have known about fuel cells for more than 100 years, and yet with all our advances in materials science, computing, and physics, fuel cells are still not viable for everyday technology. Our utilization of solar energy also is limited. The amount of energy that an acre of solar radiation can produce is about five million British thermal units (BTUs) per hour at optimal conditions. That is far less than the 500 million BTUs per hour that a modern coal mine on one acre of land can produce -- but then, a coal mine cannot be renewed.

But what about renewables? A forest has at most five billion BTUs of energy per acre, and it takes at least 15 years to create it. A cornfield has less than a tenth of a billion BTUs of energy per acre and takes one year to produce. In contrast, an oil field has 500 billion BTUs of energy per acre or more -- but again, it cannot be renewed. Energy technology based on forests, corn crops, or other biomass would take up more than the surface of the entire Earth just to fulfill our current energy consumption needs, and the time required to renew those biomasses would be unfeasible.

Synthetic liquid fuels from coal, oil shale, or heavy oil have always been more costly than oil. Part of the reason is that coal, oil shale, and even heavy oil are more like solids than liquids and converting a solid energy resource into a usable liquid energy resource is a capital- and labor-intensive process, and therefore expensive. Every time oil prices go up, the cost of these processes goes up by about the same amount.

As you may be able to surmise, there are many factors that must be considered in energy technology. Energy technology investing is risky, but nonetheless, you'll find investors tempted by energy technology stocks. The thinking is that somehow, somewhere, someone is going to make it all work. Don't get carried away by that hope.

WHERE TO INVEST

Instead of investing in high-risk alternative energy technology stocks, why not stick to solid-performing energy and energy-related sector stocks? After all, not only are they considered safer, but they'll also protect you from inflation. Here are some options that will keep your money safe and growing in a turbulent energy environment:

Invest in oil and gas companies. They have made solid profits for more than 100 years and will continue to do so as oil and natural gas prices go even higher. This sector includes companies such as Exxon-Mobil (XOM), Texaco, Inc. (TX), and Chevron Corp. (CHV).

Invest in natural gas pipeline companies, oil and gas service companies, and oil and gas capital-equipment companies. Natural gas is a good substitute for oil and should stay valuable. The demand for it is rising, which should in turn trigger an increase in the stock prices of natural gas companies. Examples in this sector include Calpine Corp. (CPN), Dynegy, Inc. (DYN), and Williams Companies, Inc. (WMB). All industries related to oil and gas should also do well, since they are linked to the price of oil. As prices go up, their revenues go up as well.

Invest in downtown real estate. As the cost of oil increases, people will want to live closer to the city center in order to conserve gasoline. Demand for downtown real estate will go up, and so will its value. Buy into residential or business property, or a real estate fund.

Invest in railroads. Railroads are more energy efficient than trucking or airlines and should do better when oil and natural gas prices go up. Further, trains have a certain amount of flexibility, in that they can use newer coal or electric locomotives. Examples of railroad companies include Omaha-based Union Pacific (UNP), Canadian National Railway (CNI), and Norfolk Southern (NSC).
Be wary of utilities; they are experiencing contradictory regulations. Utilities in California and elsewhere face increasing unregulated costs, but can only sell to customers at regulated prices. This situation causes massive debt and lower stock values. Utilities may be a better investment when regulations become more consistent. If oil and gas prices go up, as they probably will, it may cause an economic downturn, which can reduce demand for electrical power just when utilities are catching up with their capacity shortfall. As a result, they may end up with too much capacity in five or 10 years, which would mean more losses and lower stock prices.

Not only that, political uncertainties abound in the energy sector. When oil and gas prices go up, politicians want to limit those prices. Thus, you may get a lower return on your investments.

CONCLUSION

After all your research, you may come to the conclusion that the only way to make money with alternative energy technology stocks is to buy the stocks, wait for energy prices to go up, and then be on the alert for a buying frenzy that pushes the stock prices higher. Then there are those investors who buy and sell a stock before the general public realizes that the company cannot make a profit. This sends the stock price into a fast decline. Such a strategy of buying low and selling high purely on speculation - the art of timing emotion - is risky. Instead, stick to the solidly performing stocks of oil and gas companies, natural gas companies, and oil and gas service companies. They are safer, and you are much more likely to end up with good returns.

Energy is an integral part of our economy, and it's an important sector to invest in. Nothing in our economy is produced or built without energy. As the economy grows, so should the energy sector. However, we have never had a robust, growing economy based on alternative energy systems, and it is highly unlikely that we will do so in the near future. Thus, proven energy sources such as oil and gas will continue to be extremely important to our economy and therefore a good investment.

Douglas Reynolds is a professor of economics at the University of Alaska Fairbanks. His models of oil production have been published in several academic journals.

Current and past articles from Working Money, The Investors' Magazine, can be found at Working-Money.com.

SUGGESTED READING

Reynolds, Douglas B. [2001]. "Why Not Oil Stocks?" Working Money, Volume 2: May.

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