We’re often told that we’re living through an era of disruptive innovation and this disruption is both a threat to existing business models and an opportunity for economic growth. Funding the leading edge of innovation is a vital component to that growth, but are today’s investment opportunities commensurate in scale and potential returns to, say, the railways boom of the 1840s, the spread of electrification in the early decades of the 20th century, or the expansion of financial services following the abolition of capital controls in 1979?
The diffusion of ideas
Some economic commentators believe that we’ll struggle to match the welter of new technologies, ideas and industries that drove economic growth through the last century, but others are rather more bullish on our prospects despite lazy assumptions in the financial press over so-called ‘secular stagnation’. A paper published in 2015 by the Stanford Graduate School of Business on the ‘Facts of Economic Growth’ suggests that we could be on the cusp of another growth surge in the global economy, one based on innovation and the expansion of the knowledge economy, particularly in emerging markets.
The paper, produced by Charles Jones, an economist noted for his research on long-run economic growth, points out that in the 1970s China produced an insignificant number of PhDs in science and engineering, but by 2010 the People’s Republic was producing 26 per cent more than the US. This, alone, could have a profound effect on growth in the future. But the paper also highlights how lag periods to the adoption of new technologies have narrowed sharply. The diffusion of ideas, the speed at which a technology is adopted following its invention, is a key determinant of growth rates, so we should be confident on that score, too.
A technology that has failed to keep pace
Conversely, a relatively slow rollout of ideas and technologies, in some cases quite deliberate, represents a major barrier to the growth of nascent industries. For 30 years or more, investors have been aware of the potential on offer through the expansion of the renewable energy network, including the development of a large-scale electric vehicle industry, but we’re only just reaching the point at which these technologies are perceived as economically viable.
Leaving aside the relative cost advantages of fossil fuels, the issue of subsidies and the political clout wielded by global energy corporations, what has proved to be the major impediment to the rollout of electrical vehicles and the cost-effective harnessing of renewable energy sources? From a technological perspective, one would have to say our inability to provide a range of batteries that adequately fulfils end-user requirements.
Demands of a changing marketplace
In broad terms, these end markets can be divided into three categories: high-volume consumables such as smartphones; residential and commercial energy storage; and large-scale industrial applications, covering electricity networks and non-grid generation and distribution. The last category also includes cell-powered transportation, electric cars, buses and trains.
Changes in the way that we utilise battery technology – specifically a greater onus on mobility and increased individual power demands – dictate that battery technology needs to advance to ensure longer run-times and to facilitate high-current and variable load requirements. This is already giving rise to increased product innovation, enhanced efficiency and cost-effectiveness, although the battery industry is still struggling to overcome major technological hurdles.
Samsung feels the heat
Last year, for instance, South Korea's Samsung Electronics (OTC: SSNLF) was forced to recall its Galaxy Note 7 smartphone, not once, but twice, following numerous reports of the battery units catching fire. The smartphone was hyped as the main contender to Apple's (NASDAQ:AAPL) iPhone 7 Plus, but Samsung had no clear answer as to why the battery malfunctioned, and eventually had to curtail production, leading to an estimated $5.2bn (£4.2bn) one-off provision. Samsung’s problems echoed those of Dell Inc a decade earlier, when it had to recall 4.1m laptops after problems with the batteries, made by Japanese electronics giant Sony (TYO: 6758), rendered them a fire hazard.
Limitations in battery technology, and attendant issues linked to supporting infrastructure, have constricted the rollout of electrical vehicles. Their relative cost has proved a deterrent for motorists, with batteries one of the most expensive components. About a quarter of the cost of electric vehicles such as the Nissan Leaf or Tesla Model S are linked to their power storage systems. And there are inherent problems linked to the lithium-ion technology at the heart of most car battery systems. This has often translated into relatively limited range compared with standard internal combustion vehicles and the batteries can also take an age to recharge, although there has been slow, incremental improvement in the ability to manufacture lithium-ion batteries that can pack more power in the same space. Most industry-watchers believe that 2017 could mark an inflection point as manufacturing costs decline and storage capacities expand appreciably.
Lithium-ion technology set to expand
And it’s not as though this represents cutting-edge science, at least in terms of the timeline. The earliest variants of lithium-ion rechargeable batteries, which have become commonplace through the rise of personal computing and mobile telephony, were originally developed in the early 1970s as a power source for implanted medical devices. The first substantial commercial rollout of lithium-ion batteries had to wait until 1991 through the involvement of Sony, although the technology has subsequently achieved pre-eminence in the global market.
Although numerous alternative technologies are either in development or have already moved into the commercial sphere, this corner of the market is predicted to keep on growing strongly due to the continued expansion of the consumer electronics industry, with demand strengthening for portable electronics, including smartphones, LCD displays, tablets and wearable devices. US-based consultancy Transparency Market Research predicts that the global lithium-ion battery market is poised to rise in value from $29.7bn in 2015 to $77.4bn in 2024, registering an annualised growth rate of 11.6 per cent over the period. The primary and secondary (rechargeable) battery market is currently worth around $120bn, with the latter category the primary driver of growth.
The global market in lithium-ion batteries has been subject to intense consolidation, with a handful of manufacturers accounting for the lion's share of global supply. These include Panasonic Corp (TYO: 6752), Samsung, GS Yuasa (TYO: 6674), LG Chem Power Inc (OTC: LGCLF) and the aptly named Automotive Energy Supply Corp (a joint venture between Nissan (TYO:7201, NEC (TYO:6701) and NEC TOKIN).
High barriers to entry
Market forces dictate that the low cost of fuel sources such as petroleum and thermal coal has acted as a deterrent to innovation in energy markets. And although smaller technology companies have been able to prosper by leveraging their intellectual property, costs linked to the manufacturing process remain prohibitive. High barriers to entry are typified by the competitive advantage the established players have in terms of easy access to rare raw materials. This presents a challenge for prospective start-ups, or at least those companies unable to bring economies of scale to bear. Short of developing a novel technological offering, entry into the market can be a daunting proposition for smaller players.
We’ve certainly seen deal activity further up the food chain; in 2014, Panasonic teamed up with Tesla Motors (US:TSLA) to set up a new lithium-ion battery manufacturing facility in North America – the much-vaunted Gigafactory. Tesla expects the Nevada-based facility to reduce the production cost of its electric vehicle batteries and power-packs by around a third, while capacity upon completion should allow Tesla to produce enough batteries to power 1.5m cars per year.
Intensifying commercial incentives
Regardless of the ascent of lithium-ion technology, it seems curious that commercial battery technology has evolved at a snail’s pace compared to the devices they power. After all, the lead-acid battery invented by French physicist Gaston Planté can still be found under the bonnets of most cars powered by internal combustion engines; a 157-year old technology that commands a 65 per cent share of a 21st century market.
However, there’s reason to believe that commercial incentives to develop a new range of energy storage systems are intensifying, driven, at least in part, by tightening environmental legislation, but also by rapidly falling generation costs for alternative energy. The consensus view among policymakers and industrialists is that battery technology will need to improve markedly if we’re to realise a large-scale consumer take-up of affordable electric vehicles – and there are certainly hopeful signs on that score.
The falling cost of electric motoring
Back in 2014, the cost of Tesla's battery packs was estimated at $240 per kilowatt hour (kWh). This has subsequently dropped to $190/kWh; a figure in line with an existing supply contract that LG Chem has with General Motors (NYSE: GM). Industry analysts believe that EV battery costs will be well below $120/kWh by 2030.
This has a direct feed-through into the cost of buying and running electric vehicles. research by Bloomberg New Energy Finance suggests that ongoing reductions in battery prices will bring the total cost of ownership of electric vehicles below that for conventional vehicles by 2025, even with low oil prices. The research goes on to say that by 2040, electric vehicles will account for 35 per cent of new light-duty vehicle sales. Even if those figures were to overshoot by 50 per cent, it would still represent a sea change in the private transportation market. If accurate, it would be equivalent to the displacement of 13m barrels of oil per day, or 11 per cent of global electricity demand. It’s easy to see why Elon Musk and Panasonic are pouring billions into expanding capacity to meet the expected growth in this area.
Batteries for renewable sources - and critical mass
Improved energy storage is also critical if we’re intent on generating cheaper and more widely available electricity through renewable sources, particularly given the vagaries of solar- and wind-powered generation. Efficient grid and non-grid storage batteries are required to collect surplus energy during periods of high activity and bridge the gap when the input is low or when user demand is heavy.
The imperative for development is becoming more urgent as the underlying renewable power sources edge closer to ‘critical mass’ – the point at which they’re largely cost-competitive with fossil fuels in many markets. The “relative cost advantages of fossil fuels” mentioned at the beginning of the article are fast evaporating. So even though crude oil prices went into freefall midway through 2014, renewable energy operations attracted a record $329bn in investment during the following year – nearly six times the total in 2004.
Responding to the price falls
There are some forms of renewable energy, namely geothermal, hydropower and modern biomass, that have been price competitive with fossil fuels and nuclear energy for some time. However, solar photovoltaics (PV) and onshore wind energy have now emerged as cost-competitive options – something that might have seemed almost fanciful at the beginning of the decade.
Solar module prices have dropped by three-quarters since 2010, and the more we build the less expensive they become; with every doubling of cumulative installed capacity, prices fall by around a fifth due to economies of scale and incremental improvements. Many would already argue that we’ve reached the tipping point at which environmental and social consideration give way to the economic rationale. Government subsidies have helped wind and solar get a foothold in global power markets, but economies of scale are the true driver of falling prices.
Energy companies are committing unprecedented levels of capital into batteries and other power storage systems in a bid to match the growth in renewable energy capacity. The ‘Renewables 2016 Global Status Report’ by energy policy network REN21 highlighted the largest annual increase in generating capacity ever, with an estimated 147 gigawatts (GW) added in 2015. The bottom line, however, is that the fast-maturing renewables sector must overcome significant storage limitations; infrastructure is still geared towards the use of fossil fuels.
Alternatives to lithium-ion in train
Despite this, there are hundreds of energy-storage and management start-ups working on the problem of getting renewable energy to homes and businesses when they require it. Although lithium-based batteries should remain the default option for energy storage in the years ahead, alternatives are emerging. The use of lithium-sulphur is a promising option that offers potential cost benefits and higher energy density compared with lithium-ion batteries. Sony is said to be developing lithium-sulphur batteries with a view to commercialisation by 2020, while a potential overreliance on lithium has fostered research into sodium-ion and potassium batteries.
Eventually, however, graphene, a revolutionary material developed at the University of Manchester could hold the key to making batteries light, durable and suitable for high-capacity energy storage from renewable generation. The material, a one-atom-thick carbon lattice, is a great conductor, extremely lightweight and chemically inert. Graphene-based supercapacitors are also in development to complement batteries as part of an integrated storage solution. The material offers so little resistance to electrical current that it’s thought that if you replaced the standard lithium-ion battery in your mobile phone with a graphene unit it would be able to power the device simply from the kinetic energy generated by walking along with the phone in your pocket. This might seem like science fiction, but the physics suggest otherwise. The practical problem relates to the large-scale production of low-cost graphene, although the increased utilisation of 3D printing technology could change all that – economies of scale again.
IC VIEW:
Our dependence on fossils fuels won’t disappear overnight, but our switch in favour of renewable energy sources is accelerating towards the point at which the utilisation of alternative energy will become a mainstream option – perhaps the mainstream option.
The signs are already there. Consistent with an earlier pledge that all Toyota (TYO:7203) vehicles will be emissions-free by 2050, the world’s biggest automaker is now preparing to move forward with full-sized all-electric vehicles. Shell (RDSB), Europe's largest oil company, has established a separate division, New Energies, to invest in renewable and low-carbon power. Not to be outdone, France's Total SA (FP:PAR) has agreed to buy French battery maker Saft Groupe SA in a €950m (£830m) deal, cranking up investment in clean energy. Meanwhile, China’s National Development and Reform Commission, the country’s economic planner, said that China intends to plough 2.5 trillion yuan (£296bn) into renewable power generation by 2020, as the world’s largest energy market continues to shift away from coal power towards cleaner fuels.
If oil and gas majors and the world’s biggest automakers are buying into a clean energy future, retail investors need to sit up and take notice. One theory suggests that alternative power sources will increasingly dominate the energy landscape, as they’re dependent on technological advances, rather than the cost of an underlying fuel stock. As such, efficiencies increase and prices fall as time goes on – there’s no shortage of evidence to support this proposition. But intrinsic to the continued rollout of green technologies is the parallel development of effective batteries and power-storage systems – they’re intertwined. It’s one of the few genuine industrial growth stories out there. We’ve outlined a few options currently available to retail investors, but the industry and the technology that underpins it is evolving rapidly, so opportunities are only going to expand.
A narrow investment landscape
If you accept the proposition that the markets for both electric vehicles and renewable energy are heading towards price parity with the established technologies in these areas, then you might want to consider ways of tapping into the growth of these markets. That could mean a direct investment in those automakers that have committed serious capital to developing a range of practical electric and/or hybrid vehicles - and there are few large-scale manufacturers that aren't developing a co-ordinated strategy in this area. You might also consider gaining exposure to dedicated generators of alternative energy, or those power companies that are transitioning away from conventional generation feedstocks in favour of renewable sources.
As ever, we at the IC tend to plump for the 'picks and shovels' investment theme: a strategy whereby investments are made in providers of necessary kit for an industry, rather than in the industry's end product. On that basis, we think there is a compelling case to be made for the battery industry, as it is, at once both well-established through the likes of Panasonic and LG Chem Power, and moving rapidly into untapped areas of the market through 'blue-sky' technologies. The latter point needs to be taken on board with the usual caveat that it's very difficult to predict who the eventual winners will be in a new technology space, together with the reality that many of the innovative start-ups in this area are not publicly traded.
Best in show - or is it?
Tesla Motors, named in honour of the great Serbian electrical engineer Nikola Tesla, has certainly been the most hyped and heavily backed corporate entity in this space. The boldness and ambition of its Canadian founder, Elon Musk, has drawn comparisons with industrial innovators such as Alexander Graham Bell and you could argue that Musk, almost single-handedly, is taking electric cars mainstream, although he does attract his fair share of criticism.
Tesla will roll out its highly anticipated Tesla Model 3 later this year, but isn't solely focused on motoring. In 2015, the group began making large batteries, dubbed Tesla Powerwalls, rechargeable lithium-ion energy-storage units intended for home and off-grid use, which can power an average two-bedroom home for a full day. Elon Musk recently said that he expects to sell more Powerwalls than cars; so much attention will focus on initial sales of the Powerwall 2 unit, which has only just come to market.
Tesla is pursuing an integrated model through the development of its Gigafactory in Nevada, complemented by a recent controversial takeover bid for SolarCity (NASDAQ: SCTY), a retailer of solar panels and energy, of which Musk is chairman. If the bid is successful, Tesla and Panasonic will build solar panels in SolarCity’s Buffalo, New York facility; Panasonic will cover capital costs, with Tesla making a long-term purchase commitment. So far, so good, but some analysts, most notably Mark Spiegel of Stanphyl Capital, liken the proposed tie-up to a bailout; a way of Elon Musk salvaging some value out of an existing stake in SolarCity before it was forced to file for bankruptcy.
Critical voices, however, tend to be in the minority, or are simply drowned out by the excitement about the brand, and its enigmatic figurehead. The 2010 Tesla initial public offering took the automaker public at a price of $17 a share; now shares are around the $237 mark. The projected earnings multiples, like those of Apple Inc, defy gravity. But unlike Apple, it generates negative cash flow. And although Tesla can access capital cheaply through strong institutional support, its ability to fundraise presents a major downside in its potential dilutive effect for existing shareholders. Some, like US mutual fund manager Ron Baron, believe the stock could multiply in value by 20 times over the next couple of decades, but the danger exists that other minority interests could be forced to pay for the chief executive’s missionary zeal.
Investing at source
Some integrated thinking on investment matters never goes astray. Our natural resources specialist, Alex Newman, has long recognised that the continued development of the electric car industry would rapidly drive demand for graphite and lithium – key inputs in battery technology. Indeed, consumption is forecast to grow by 10 per cent a year between 2011 and 2025.
In September 2015, Alex outlined the investment case for Aim-traded Bacanora Minerals (BCN), a miner of high-grade lithium and borate in Sonora, northern Mexico. The miner has signed a landmark agreement with Tesla Motors, as one of only a handful of lithium hydroxide suppliers to the automaker’s Gigafactory in neighbouring Nevada.
It’s still early days for the miner, which rebuffed an indicative reverse takeover offer from fellow Aim constituent Rare Earth Minerals (REM) towards the end of last year. And near-term focus is on an ongoing feasibility study designed to set out how best to optimise the production of battery-grade lithium carbonate, but given Bacanora’s proximity to the Gigafactory, combined with existing offtake agreements, it’s a junior miner worthy of closer inspection.
Offshore options and start-ups
There are dozens of smaller start-ups working at the fringes of battery technology, although most remain privately backed. One such example, Aquion Energy, a US tech start-up partially funded by Bill Gates, is developing saltwater battery technology. The company says its Aqueous Hybrid Ion battery will cost no more than the cheapest batteries on the market, but last twice as long. There are listed options in the US, smaller companies that stand to grow at an accelerated rate due to the expansion of demand for battery technology. We like the look of Arotech Corp (NASDAQ: ARTX), a Michigan-based tech company that operates two business divisions: electric fuel batteries, which is involved in the development and manufacture of zinc-air batteries for military and homeland security applications and developing electric vehicle batteries for zero-emission public transportation; and Arotech Defence, comprising IES Interactive, a provider of high-tech multimedia training systems for law enforcement and paramilitary organisations. You would find it difficult to identify end markets with greater growth potential.
There are other overseas options open to investors, too. Furukawa Battery Co (TYO:6937), which trades on the Tokyo Stock Exchange, has been specialising in battery manufacturing for 100 years. Although the company has been primarily engaged in the production of conventional systems, it is expanding its technical offering. It is the only publicly traded manufacturer of water-activated batteries. The company’s Mg Box is a magnesium-air box battery, which when filled with two litres of liquid, provides enough electricity to charge a cell phone for up to 30 days, or power digital devices and LED lights for up to five days.
Closer to home, and following on from a deal to acquire Satki3, a US manufacturer of solid-state lithium-ion batteries, Dyson Ltd, a UK manufacturer synonymous with design innovation, plans to spend over £1bn on battery development by the end of the decade as it increases its efforts to expand into new sectors. Dyson’s efforts to develop batteries with greater storage capabilities will be aided by a government grant from a regional development fund – as if he needed the money.
Going off-grid for profits
The UK government is committed to supporting technologies that will underpin the expansion of renewable energy sources as a proportion of our overall energy mix, which brings us to our preferred, albeit speculative, investment option. Novel battery and newer types of storage systems are still in their infancy, but are set to grow rapidly in the next few years as unit costs come down. Emerging battery storage systems can assist with renewables by smoothing the effect of variable energy output – typical for wind and solar power – and by providing enough capacity that renewable power generation could replicate a constant conventional energy source.
One UK manufacturer that meets this requirement has not only attracted the IC's attention, but continues to generate a large volume of comment on trading forums. RedT Energy (RED) is a producer of stationary energy-storage systems (giant industrial batteries) that address the inherent mismatch between availability and demand in renewable energy generation. The company's technology can also be used to provide local grid services in remote or isolated areas without access to power infrastructure. When we reviewed the investment case at the end of last year, we pointed to analysis from Cenkos Securities that the company's Vanadium Redox Flow Battery system is "substantially cheaper" than anything on offer from rivals, including Germany's Gildemeister Energy Solutions GmbH - the market leader. RedT has already gained commercial traction through deals to supply its power-storage systems to an African telecommunications company, together with an isolated community on the Scottish Isle of Gigha, but we envisage a growing number of opportunities down the line.
