HardAssetsInvestor

It’s In The Wind

Expensive oil vs. free wind. The world may finally be catching on, but how do you actually make any money on something that's free?

• The anticommodity
• Lessons from Altamont
• The challenge of pure-plays

Gently rustling the leaves of the trees, giving flight to a kite held by a child, violently tossing around everything in its way, wind is many things - including a green energy source.

What it isn't is a commodity. You can't bottle it, transport it, or trade it. In fact, it is essentially an anticommodity, a competitor to oil and natural gas, even a competitor, tangentially, to corn and soybeans.

Getting power from wind is hardly a new idea. Wind has been used to power grain mills and water pumps for centuries, and such mundane uses continue today. Electrical power generation by wind started way back in the 1880s and flourished in rural areas until the expanding electrical grid reached them. Times of high fossil fuel cost or low availability (such as after World War II in Europe) ensured that electrical power generation by wind was never fully abandoned.

In response to the fuel crisis in the 1970s, the first huge modern wind farms such as the one in the Altamont Pass in California were built to supplement electricity generation and lower electrical costs. As one of the oldest and largest wind farms in the U.S., the Altamont Pass installation has a long track record and continues to influence future wind farm development.

But the lessons learned from Altamont aren't necessarily rosy ones. Altamont is the object lesson in the need for extensive environmental impact studies before siting wind farms. The relatively small, fast design of the Altamont turbines and their close spacing proved deadly for birds in the area, something that is brought up every time a new farm is proposed. The industry counters that the current generation of wind turbines are much larger, with slower-moving blades which one industry expert categorized as the difference between a Cuisinart and a ceiling fan.

But the size of the turbines raises yet another issue - aesthetics. While many people think a large, gently spinning wind turbine is beautiful, the residents of coastal areas seem to disagree. In Cape Cod, a proposed offshore wind farm has faced significant hurdles because of the impact on the view as well as unknown fishing implications. Because the technologies are still relatively novel, it's nearly impossible to say with certainty what's real, and what's classic not-in-my-backyard syndrome.

Either way, in this era of rising energy costs and concern for the environment, wind power presents a zero-emission, low-cost way (3.5 to 5 cents per kilowatt hour) of producing much-needed electricity, and so the industry is growing.

Industry Growth

In 2007, just 1.3% of all electricity consumed worldwide was generated by wind power. The global wind energy industry is continuing to grow year by year. The World Wind Energy Association (WWEA) reports that 19.7 GW of capacity was installed in 2007 - an increase of 26.6%. This came on top of the record 2006 growth, up 25.6% over 2005.

Speaking of things green, Germany currently leads the world in established wind power capacity, with the United States, Spain, India and China rounding out the top five. Of those five, the U.S. saw the greatest increase in new capacity installed in 2007 (up 45% from 2006), but China gets the award for most improved with 127.5% more megawatts (MW) in 2007 than 2006. Who says China's nothin' but coal?

In the United States, 1% of electricity comes from wind power. Here are a few of the more-interesting propaganda bullets from the American Wind Energy Association:

• The new wind projects in 2007 accounted for about 30% of all new power-producing capacity added in the nation.
• Electricity generated by wind power reduces the amount of natural gas and other fuels used for electricity generation, thereby lowering price pressure on other fuels and saving money for consumers even if they live in regions with no wind farms or wind power generation.
• "To generate the same amount of electricity using the average U.S. power plant fuel mix would cause over 28 million tons of carbon dioxide (CO₂) to be emitted annually."

The point isn't that wind is all just roses and no thorns. Rather, this is an industry with serious legs underneath it, and the fundamental drivers - increased energy costs and increased environmental concerns - aren't going away.

Making The Play

Companies involved in wind power range from tiny pure-play wind power startups to major multinational mega companies, and everything in between. From turbine manufacturers to construction companies and project planners to utility companies, a wide range of goods and services are needed to plan, install, run and maintain wind farms.

As with many emerging technologies, the challenge is separating the pure-plays. Buying Siemens or GE for their exposure to wind power isn't particularly sound asset allocation. But there are a few pure-plays:

Vestas (CPH: VWS)

Vestas is a Danish company with a market cap of $105 billion- hardly a scrappy start-up. In 1945, Vestas started as a small appliance manufacturer. Through the years, its products changed until in 1979, it produced its first wind turbine. Since then is has become a leader in turbine technology, site planning, wind farm installation and ongoing maintenance. It works with both on- and offshore wind farms, and claims it has a 23% market share in the wind power industry.

Iberdrola (MCE: IBE)

Iberdrola is a Spanish electricity company with a market cap of around 46 billion euros. It is pretty diversified, though, as it uses gas, nuclear, fuel oil, coal and hydroelectric in addition to wind. It's worth a look only because it has 8% of its electricity is generated through wind and mini-hydroelectric facilities, and actively markets itself as "the World's Largest Wind Power Company by Installed Capacity." But, ultimately, it's a utility.

Clipper Windpower (LON: CWP)

Clipper Windpower is a British company with offices in England, the U.S., Mexico and Denmark. It is a pure-play wind power company, with a market cap of 640.6 million British pounds. It counts wind turbine design, manufacture and wind farm project planning among its main businesses. Not exactly a tiny company - unless you compare it with Vestas.

Comparing The Plays

These three companies give you three different ways to play the wind power paradigm. Here's how they have fared in the last year (May 11, 2007 to May 6, 2008).

The anchor for the chart is oil - because we would expect the fate of an alternative energy company to be intimately connected to oil. Just a reminder: Oil is up to almost 100% in the past 12 months.

Let's start with the dog of the bunch: Clipper Windpower. Prior to the arbitrary one-year mark, Clipper had been on an upward tear. Unfortunately, Clipper faced plain old operational problems in the last 12 months - production problems with its Liberty turbines and material sourcing problems caused embarrassing delays in filling orders and completing projects, and that's dragged the stock price down. It illustrates one of the problems of picking pure-play companies - sometimes it doesn't take much to throw a wrench into the stock price.

On the other hand, Iberdrola performs pretty much how you'd expect a utility company to perform - fairly good returns, no huge surprises, steady as she goes. The fact that the company has a high stake in renewables is admirable, but all the PR in the world doesn't change the fact that you make watts for a living.

Vestas is the clear winner of the three. As a wind pure-play, it is positioned to take advantage of the huge growth potential of wind, and it has a solid track record to boot. Vestas alone is most closely aligned with oil's rising cost. It's totally logical: As the price of oil goes up, alternative fuels become more economical. Investors know this, and they follow the money. Vestas just happens to be large enough and have been in business long enough that investors can actually get warm fuzzy stable public company feelings from it - years of filings, lots of boring board meetings, 17% gross margins. Most wind pure-plays are tiny, few are public and none have the size and stature of folks like Vestas.

TANSTAAFL

There ain't no such thing as a free lunch, even in wind.

Vestas, for its part, has been doing the right things, and making solid, investor-friendly press releases. But in February it announced its 2007 operating results. The numbers themselves were on the positive side of market expectations, but the company reported that its market share dropped by 5%. Vestas, having ruled the roost, found itself in the position where new entrants are coming quickly into the market, especially in China.

These new entrants are cashing in on the growing governmental push for green energy, and increased competition has led to a slip in Vestas' market share. The whipsaw effect as the market anticipated and processed all this was up 8% one day, down 8% the next. Those are the kind of roller coasters that keep investors up at night. You think investing in oil is a gut check? Oil's one-year volatility of 29% is nothing compared with Vestas' 45%.

Like all industries, wind power faces obstacles - new competitors, inconsistent regulation, grumpy neighbors and supply shortages for parts. But in the end, the inescapable fact that wind is a clean, unlimited power source means that this industry is around to stay, and poised for growth. It will be a long, long time before wind is such a dominant player on the world's energy stage that it can impact the price of oil. But there's no question they are related, and commodity players would be smart to pay attention to the fortunes of this clean little niche.