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Where to invest for green profits

FEATURE: Graeme Davies points investors in the right direction as to what could turn out to be one of the investment opportunities of the next decade
December 4, 2009

This is the crux with alternative energy investment – where to get the best exposure. And investors in UK companies will find pure-play investment opportunities rather thin on the ground. On a global view, the largest alternative energy companies are European, American and Asian, and best reached through an investment fund with a global mandate. As Guinness Asset Management fund manager Ed Guinness says: "The UK quoted sector is not representative of the global situation. Investors should look internationally."

In the UK, until recently operators were either small research-led parts of a much larger corporate machine or research and development houses with little commercial ethos. This is changing as technologies have been spun out and listed to seek further development funds. The credit crunch slowed this process down and cleared out some of the deadwood.

But those who survive remain a somewhat disparate bunch in terms of the quoted companies in the sector. At the generation stage, most of the capacity is likely to be found within the major utilities, but an investment here is an investment in a portfolio of generating assets including fossil fuels. In the UK, there are smaller generators of wind power but the choice is limited.

In the supply chain, the investment choice improves. The London markets, both the main list and the Alternative Investment Market (Aim), are home to a wide variety of supply chain companies in wind, solar and other alternative energy technologies.

The energy efficiency opportunity

Significant early gains in emissions reductions can be won through simple improvements in energy efficiency. This means using less energy intensive lighting, heating, appliances, motor cars, installing better insulation and through a better understanding of the supply and demand of power grids.

There are myriad technologies that either use less power, use alternative sources of power to fossil fuels, or simply make our consumption of power more efficient. Building materials companies and construction businesses are now often at the forefront, driven by government targets for 'carbon neutral homes'.

On a longer-term view, efficient boiler developers such as fuel-cell companies Ceres, Ceramic Fuel Cells and Energetix, which use more conventional engineering, have potential, although they are still some way short of commercialisation. Otherwise, the Aim market is home to several energy efficiency technology companies such as Bglobal, a supplier of smart meters, and Vphase, a supplier of voltage stabilisation devices which can instantly limit energy consumption by a home or business simply by stabilising the voltage delivered at the optimum level required for appliances. There are also several lighting technology companies such as Dialight, LED International, Nanoco and Eruma who, through lower energy LED technology, can slash energy use in commercial buildings.

Other technologies that could have huge energy efficiency implications in the future include Zenergy Power’s high-temperature superconductor technology. Zenergy has developed a high-temperature superconductor that outperforms the incumbent material, copper, and has applications across many industries including power generation. It has already been included in a hydro-electric power project in Europe and could also allow for wind turbines to be lighter and more efficient in future, changing the cost dynamics of the industry.

But all these companies are relatively early stage, and several are disruptive technologies targeting established markets, which adds to risk. An investment in these companies is high risk but the rewards could be significant.

Slow burners

The UK's major utilities are all active in the renewable power generation sphere but some, such as Scottish & Southern Energy, are more active than others.

But there are ways of gaining exposure to the longer-term dynamics of the wind and solar industries through their supply chains. UK investors can already access the wind turbine supply chain through companies such as Hansen Transmissions, which supplies gear boxes, or Clipper Windpower, which is trying to gain a foothold in the turbine manufacture business. We prefer Hansen at the moment as Clipper is facing significant challenges within its own business.

In solar power, London boasts a raft of supply chain companies such as Chinese wafer and module makers Renesola and Jetion, and British wafer maker PV Crystalox Solar.

The solar market has been hit by a glut in raw material supply which has driven down prices just as demand has eased due to the credit crunch. This has hit margins but the longer-term potential of this industry remains significant.

The Aim market is also home to smaller alternative power generation developers such as Novera Energy, Renewable Energy Generation and Renewable Energy Holdings, all of whom are building wind farms onshore in the UK and Europe. Helius Energy is a developer of biomass-fired power stations. These companies lack the balance-sheet strength of the major utilities, but they’re building out assets which could catch the eye of larger players looking to hoover up generation capacity.

The carbon option

The other major option for investment in this field is in one of the number of carbon credit originators that operate around the globe. These companies invest in and facilitate projects in the developing world that either displace carbon or create clean energy, thereby earning credits that can be sold into polluters in the developing world.

This carbon trading system is one of the key planks of United Nations policy on climate change and is already well established in the European Union, with hope rising that the US could adopt a mandatory carbon trading system in the near future. UK-traded carbon originator EcoSecurities was recently taken over by a division of JPMorgan, illustrating the potential value in such companies. Trading Emissions is discussing a potential merger with Leaf Clean Energy which would give it a more rounded exposure to projects in the developing world and in the US.

Finally, there is a proxy investment on the whole carbon trading market in the form of Climate Exchange, the operator of carbon trading exchanges in Europe and the US. It has already grabbed the biggest market share of the European Emissions Trading System and is well positioned should the US adopt a cap-and-trade system. It has also formed ventures in China and India with a view to future developments there. Carbon trading is a market already punching through $100bn in annual value and, in the years to come, this could expand significantly with Climate Exchange chief executive Neil Eckert forecasting that the US market could be three times the size of the EU market. If Copenhagen and its follow-up agreements truly enshrine a desire to reduce emissions in a new global treaty, then a company such as Climate Exchange could just find itself in the right place for the long term.

Funds

The Aim market is also home to a handful of alternative energy investment funds that often invest, private-equity style, in both early-stage technologies and revenue earning alternative energy companies. Options include the Ludgate Environmental fund and Low Carbon Accelerator. There are also an increasing number of unit trusts, investment trusts and exchange-traded funds that invest in the alternative energy sector (see fund profiles on pages 70-71).