Company Delivers Electrifying Performance But Stock Gets Shocked.

Arthur Porcari style="font-style: italic;">


What’s that old Wall Street
saying. “No Good Deed Goes
Unpunished”?  Well, management and shareholders of US listed,
China based, always profitable uncontested leader in Electric Vehicle
(EV) manufacturing and “Quick Battery Exchange” (QBE) development,
Kandi
Technologies (NASDAQ-KNDI), know the feeling well. As of now,
five months after I published my href="http://www.altenergystocks.com/archives/2010/09/kandi1.html">
first article on KNDI, the stock,
which subsequently more than doubled on incredible volume, has now made
a full round trip and is back to where it started. This in spite of
significant business advances and a total absence of negative news.
Even more incredulous is the 20+% drop last week at a time when oil
prices surged above $100bbl, href="http://www.independent.co.uk/life-style/china-raises-petrol-diesel-prices-2221947.html">
PRC raised gas prices to a record of over $4.30 a gallon, and
Beijing had the following revelation:

“ href="http://www.edmontonjournal.com/health/Beijing+worse+than+hazardous/4345469/story.html#ixzz1EyGEA9kE">Beijing
air worse than ‘hazardous’

 Bloomberg News February 25, 2011 3:10 AM

Beijing’s air quality early this week was worse than “hazardous,” the
lowest rating on an index used by the U.S. Embassy in the Chinese
capital to measure conditions, and was classified as “Beyond Index.”
Heavy fog and the addition of almost 900,000 automobiles to Beijing’s
roads last year have contributed to the deteriorating air quality…”

If there every was a positive “Perfect Storm” brewing for a Company,
KNDI, now having begun sales in China of its line of three PRC approved
(two, full road speed and subsidies eligible) pure EV’s selling for
$6-10,000 before subsidy, should be in the “eye” of it.
Five months ago as a Wall Street unknown, KNDI stock was quietly
resting in the low 3’s.  At that time I published a multi-part
article which was quickly picked up by EV Internet news services and
blogs around the world introducing KNDI. As you can see from the chart
below, the effect was immediate and significant to the stock price.

Let me again make my position clear as I have on past articles. Though
since my first writing, I have personally visited the company and
management in Jinhua China, I do not have, nor do I care to have any
access to information not available to anyone who takes the time to do
good due diligence.  Aside from what I, along with four other
investors saw when we visited the Company last November, (which did not
include any restricted information), what I publish is made up of
public information in the form of past filings, press releases, active
use of Google’s on-line translation features scouring Chinese websites,
and of course my opinion.


Exceptional Company Execution

If you are new to KNDI, or need a refresher, I strongly suggest you
read my past Seeking Alpha articles on KNDI which can be accessed
through the links below. It now appears that my revenues and earnings
prognostication for 2010 year end stated in my September article will
apparently prove to be too high. This miss is primarily due to a few
months delay in State Grids’s (China’s dominant electric utility and
KNDI partner) completion of its Main Battery Charging Farm in
Jinhua.  This in turn delayed initial sales to only the last five
weeks of the year. I think you will find that most other speculations I
made have not only come to pass, but in many cases were far exceeded.

This chart shows a chronology of events that have taken place since my
first article. I have created a corresponding letter on the chart for
each published event to the headlines below. Several of the headlines
are from Seeking Alpha articles I wrote giving my “take” on prior
events. These articles are annotated by the ( style="font-weight: bold;">SA) after the date. Articles
annotated (AES) first appeared
on AltEnergyStocks.  My
point in listing these events is twofold; one to show there was no
negative event to cause the drop in the stock price and two to give the
reader quick reference to advances made.   

alt="Annotated KNDI chart" title="click for full size"
src="http://www.altenergystocks.com/archives/KNDI%20chart.png"
style="border: 0px solid ; width: 515px; height: 249px;">

• A- href="http://www.altenergystocks.com/archives/2010/09/kandi1.html">Examining
  Kandi
  Technologies: A China-Based EV and Quick Change
  Battery Company (Part I)   Sep 22, 2010  (SA,AES)
• B- href="http://seekingalpha.com/article/227416-buffetts-sweet-tooth-should-kandi-technologies-be-on-his-byd-dessert-menu">Buffett’s
  Sweet
  Tooth: Should Kandi Technologies Be on His BYD
  Dessert Menu? Sep 28, 2010 (SA)
• C- href="http://www.marketwire.com/press-release/Kandi-Announces-Joint-Venture-With-Leading-Domestic-Battery-Maker-Power-Company-Create-NASDAQ-KNDI-1329715.htm">Kandi
  Announces
  Joint Venture With Leading Domestic Battery Maker
  and Power Company to Create China’s First Battery Rental and
  Replacement Company; Expects EV Sales in Jinhua Will Begin in
  November   Oct 05, 2010
• D- href="http://seekingalpha.com/article/231289-kandi-technologies-still-charging-ahead">Kandi
  Technologies:
  Still Charging Ahead  Oct 21, 2010 (SA)
• E- href="http://www.marketwire.com/press-release/Kandi-Technologies-Names-Cathy-Cao-Executive-VP-of-Finance-NASDAQ-KNDI-1338900.htm">Kandi
  Technologies
  Names Cathy Cao Executive VP of Finance  Oct
  21, 2010
• F- href="http://www.marketwire.com/press-release/Kandi-Technologies-Corp-Reports-Third-Quarter-Adjusted-Net-Income-Grew-57-Anticipates-NASDAQ-KNDI-1353451.htm">Kandi
  Technologies,
  Corp. Reports Third Quarter Adjusted Net Income
  Grew 57% and Anticipates Full Year Sales Will Reach or Exceed $40
  Million  Nov 15, 2010
• G- href="http://www.marketwire.com/press-release/Kandi-Reports-First-Pure-Electric-Vehicle-Sales-Consumers-Jinhua-City-Conjunction-With-NASDAQ-KNDI-1361774.htm">
  Kandi Reports First Pure Electric Vehicle Sales to Consumers in
  Jinhua City in Conjunction With Opening of First “Battery Charging
  Farm” and “Express Change” Battery Station  Dec 01, 2010
• H- href="http://www.altenergystocks.com/archives/2010/12/kandi_technologies_an_intelligent_vehicle_electrification_plan_1.html">Kandi
  Technologies:
  An Intelligent Vehicle Electrification
  Pla href="http://www.altenergystocks.com/archives/2010/12/kandi_technologies_an_intelligent_vehicle_electrification_plan_1.html">n 
  Dec
  07, 2010
• (SA, AES by John Petersen)
• I- href="http://www.marketwire.com/press-release/Kandi-Talks-Expand-Consumer-Pure-EV-Sales-Neighboring-Provincial-Capital-City-Hangzhou-NASDAQ-KNDI-1367704.htm">Kandi
  in
  Talks to Expand Consumer Pure EV Sales to Neighboring
  Provincial Capital City of Hangzhou  Dec 13, 2010
• Hangzhou Government Planning for More Than 20,000 New Energy
  Vehicle
  Sales Before the End of 2012
• J- href="http://www.marketwire.com/press-release/New-Kandi-EV-Model-Approved-National-Subsidy-up-RMB-60000-per-Vehicle-All-EV-Pilot-Cities-NASDAQ-KNDI-1371066.htm">New
  Kandi
  EV Model Approved for National Subsidy of up to RMB 60,000
  per Vehicle in All EV “Pilot” Cities Throughout China  Dec 17,
  2010
• Kandi’s Newly Approved Lithium Ion Powered KD5011 Expected in
  Hangzhou
  Market in Coming Months
• K- href="http://www.marketwire.com/press-release/Kandi-Technologies-Announces-Registered-Direct-Placement-Approximately-166-Million-Common-NASDAQ-KNDI-1372203.htm">Kandi
  Technologies
  Announces Registered Direct Placement of
  Approximately $16.6 Million of Common Stock  Dec 21, 2010
• L- href="http://seekingalpha.com/article/243825-kandi-technologies-delivers-on-promise-in-less-than-a-year">Kandi
  Technologies
  Delivers on Promise – In Less Than a Year 
  Dec 28, 2010 (SA)
• M- href="http://www.marketwire.com/press-release/Kandi-Technologies-Approved-for-Trading-on-NASDAQ-Global-Market-NASDAQ-KNDI-1377600.htm">Kandi
  Technologies
  Approved for Trading on NASDAQ Global
  Market  Jan 10, 2011
• N- href="http://www.marketwire.com/press-release/Kandi-EVs-to-Be-Placed-on-the-Italian-Market-NASDAQ-KNDI-1386432.htm">Kandi
  EVs
  to Be Placed on the Italian Market  Jan 27, 2011
• O- href="http://www.marketwire.com/press-release/Kandi-Technologies-Retains-Lambert-Edwards-Associates-as-Investor-Relations-Advisor-NASDAQ-KNDI-1395525.htm">Kandi
  Technologies
  Retains Lambert, Edwards & Associates as
  Investor Relations Advisor  Feb 14, 2011

Why Electric Vehicles must succeed

Rapidly growing China with its 1.3 billion population may rank second
to the US in World Purchasing Power as seen from the table below, but
the following comparison of motor vehicles per capita shows a
disparity, which based on “Peak Oil” assumptions leaves little room to
even noticeably “close the gap” let alone allowing a catching up with
internal combustion (ICE) vehicles. With China’s massive coal and hydro
resources along with aggressive building of Nuclear Power Plants, there
is no reason they must rely on ICE’s.

alt="China vehicles" title="click to enlarge"
src="http://www.corstratinc.com/kndi/image/ch-mvper1000.gif"
style="border: 0px solid ; width: 515px; height: 220px;">
title="click to enlarge"
src="http://www.corstratinc.com/kndi/image/us-mvper1000.gif">
Source: href="http://www.tradingeconomics.com/united-states/motor-vehicles-per-1-000-people-wb-data.html">TradingEconomics-US

The tables above compare as of 2008 China to the US in per capita motor
vehicle ownership (cars, trucks, buses and freight but not 2-wheelers),
China on top with 32.2 motor vehicles per thousand population as
compared
to the table on the bottom for the US with 819.8. On this
basis, stunningly, href="http://www1.eere.energy.gov/vehiclesandfuels/facts/2010_fotw617.html">China
stands
in 2008 where the US stood in
1915.  Considering China’s current population exceeds the US
by
four fold, it should clearly be evident, even ignoring the rest of the
rapidly growing emerging economies, that alternative energy vehicles
will soon be mandatory in China, (for that matter, every country
irrespective of the price of oil). Thankfully China understands and has
made it quite clear it intends to be the world leader in vehicle
electrification. A realistic situation made easier for the country
since it has totalitarian control over its infrastructure for
“refueling solutions”, plenty of cash for initial subsidies and an
emerging middle class that can grow into EV’s, rather then be coaxed
away from gas powered vehicles.

US Stock Trading Comparisons

As of this writing, there are really only three relatively pure EV US
traded stocks for US investors to speculate on this rapidly emerging
potential trillion dollar pure EV space.   Listed on NASDAQ
is Tesla
Motors (TSLA) and href="http://www.altenergystocks.com/comm/content/kandi/">(KNDI),
and ZAP which trades on the OCTBB
(ZAAP).

The table below shows a general comparison I put together of some key
numbers of the three companies. TSLA’s numbers came from filings, press
releases and a href="http://blogs.edmunds.com/greencaradvisor/JPMorgan%20on%20Tesla%202010.pdf">
JP Morgan research report; ZAAP’s from recent press
releases and SEC filings; and KNDI from press releases and SEC filings.
Estimates for ZAAP and KNDI were derived by me based on information
gleaned from press releases.  

src="http://www.altenergystocks.com/archives/TSLA-ZAAP-KNDI.png">

US based TSLA’s current market
cap puts it at around 23 times JPM
research 2014 estimate of $1.07 a share. Now this report was put out
late last Summer, about the same time href="http://www.altenergystocks.com/comm/content/byd/">BYD (BYDDF.PK)
was sure it would
sell at least a few thousand of its e6 EV’s between China and the US by
the end of 2010. As it turns out, KNDI’s sales of 20 KD5010’s on the
first day of sales in China surpassed the total number of BYD e6’s sold
through the end of October. And, though some $10,000 cheaper then
TSLA’s $50,000 after tax subsidy Model S, BYD has now skipped a year
and doesn’t plan on bringing the e6 to the US until 2012. Thus,
bringing it more then a year behind schedule.

Lets call a spade a spade. TSLA is trading at its lofty levels for two
main reasons. It’s charismatic CEO, Elon Musk, knows how to spin a
story and there are a whole lot of “Green” funds that were formed after
President Obama took office and promised a plethora of Green companies
would soon be blanketing the country. This hasn’t happened, so those
Funds have to put their money somewhere. Though in an excellent space,
my bet is that TSLA is going to give a big shock to a lot of wallets in
the not distant future.  The fact that “money pit” TSLA has a
market cap twenty times always profitable KNDI is, IMO,
incredulous.   

California based ZAP (ZAAP) is
probably a company that most don’t
realize is now a possible “contender” in the EV space, both in the US
and China. But for those who do, I suspect they don’t truly realize how
expensive this entry was. I can’t imagine how this stock can currently
be trading with diluted market cap of $385 million. And this is well
down from the over half billion market cap it had in early January
right after it completed and announced a multi-part macro private share
placement at around $.24 a share with a lot of $.25 warrants totaling
some 200 million shares. The placement was used to raise $30 million to
buy 51% of a Jonway Automobile a Chinese gas powered carmaker who had
supposed revenues last year of around $77 million.

As stated in their href="http://finance.yahoo.com/news/ZAP-Completes-51-Acquisition-bw-3574494641.html?x=0&.v=1">Jan.
25
PR, “With ZAP’s electric vehicle (EV)
technology expertise and international experience, the combined company
intends to build the necessary production platform to address the
Chinese EV market,” they plan on taking their 16 years as a “ href="http://finance.yahoo.com/news/ZAP-Begins-Project-bw-3498858309.html?x=0&.v=1">pioneer
in
the
electric vehicle industry since 1994, engaging in the design,
development, commercialization and distribution of 100% pure electric
vehicles and power systems,..” and teach this Chinese company how
to
convert their gas powered cars to EV’s.  Who knows? After
generating some $4 million in revenues in 2010 and accumulating a
deficit of $143 million over the years developing their “expertise”,
maybe they have finally learned a secret or two to teach the Chinese
about EV’s.

OK, so back to KNDI. KNDI, like
all players in this new EV space
doesn’t have a heavy EV track record. But they have sold close to 4,000
mini-ev’s over the past couple of years. Know any other near pure play
company in the space that can make such a claim? As seen by his short
bio, KNDI’s  CEO, while not high profile, does have an impressive
EV background in China. Take this excerpt:

 “From October 2003 to April 2005, Mr. Hu was the Project Manager
(Chief Scientist) in WX Pure Electric Vehicle Development Important
Project of Electro-vehicle in State 863 Plan.”  

Incorporated in “State 863 Plan” was the genesis of China’s current
push to be the world leader in EV technology. The “WX” in the above
quote is Wanxiang, China’s largest diversified EV Company, the same
Wanxiang that caused Ener1 (HEV) stock to jump 65% on 21 million shares
on Jan. 18th on an announcement of a joint venture between the
two.  But enough on history, let’s look to the future.


A potential major win for KNDI

For those who have not been following KNDI, but clearly evident in
Company announcements going back to the January 2010, KNDI has been
leading a coalition of energy giants in China for a “Quick Battery
Exchange” (QBE) solution whereby style="text-decoration: underline;"> the consumer pays only for the
car,
and effectively “rents” the expensive battery.  The “rent”
is
effectively paid by a small surcharge each time the battery is
exchanged. This model was put into limited commercial operation by KNDI
through the href="http://www.marketwire.com/press-release/Kandi-Announces-Joint-Venture-With-Leading-Domestic-Battery-Maker-Power-Company-Create-NASDAQ-KNDI-1329715.htm">Joint
Venture
with State Grid in Jinhua in late November,
2010 as an experimental alternative to just plugging the car into a
charging post and waiting several hours for recharging. KNDI was at the
forefront of this potential paradigm shift due to its ownership of
several patents as can be seen by this href="http://translate.google.com/translate?hl=en&sl=zh-CN&u=http://www.zj.sgcc.com.cn/gsxw/201009/t20100929_7304.htm&ei=Nqv3TPyGIcX6lweahtWPAg&sa=X&oi=translate&ct=result&resnum=1&ved=0CBkQ7gEwAA&prev=/search%3Fq%3Dhttp://www.zj.sgcc.com.cn/gsxw/201009/t2010092">State
Grid
announcement on its
website.

In January of this year, through href="http://translate.google.com/translate?hl=en&langpair=zh-CN%7Cen&u=http://info.qipei.hc360.com/2011/01/100956321795.shtml&prev=/translate_s%3Fhl%3Den%26q%3Dstate%2Bgrid,replace%2Bthe%2Bbattery%26sl%3Den%26tl%3Dzh-CN">subtle
but
telling comments by PRC
owned State Grid, it now appears that QBE has been selected as a
major
“Standard” for re-electrification of China EV’s. To date KNDI has been
silent as to this potentially monumental Company event, in wait for a
more definitive announcement by the PRC. Currently it appears there are
two QBE models in operation. There is of course KNDI’s “side slide”
model as can be seen by this href="http://www.youtube.com/watch?v=BMocYfRbR84">video clip that
was taken with a cell
phone on my trip to the Company in November, and the second “rear
load”, that can be seen in this href="http://translate.google.com/translate?hl=en&sl=zh-CN&tl=en&u=http%3A%2F%2Fv.youku.com%2Fv_show%2Fid_XMjQyOTE2NTA4.html">video
clip. The significance to KNDI is
not that the Company expects their mode of QBE to be selected
exclusively; it is that the concept of QBE seems now to be a chosen
“standard” which in turn gives KNDI’s model already in operation with
State Grid a major advantage over future competitors.

Valuation

With its current $100 million market cap, the stock is currently
trading around replacement cost of just its land and buildings, plus
$25 million working capital excess which should soon be apparent with
the soon to be released 10k. The current market is giving no value for
its always profitable and growing legacy business, let alone value for
its China potential. Let’s look at that potential.

Non-China legacy business should reach $50 million in sales in 2011.
That should generate non-GAAP net of $.35-.40 a fully diluted share.
Each 5,000 cars they sell in China should add another $.30-35 per
share. Considering the cost to a consumer after subsidy will only be
around $3000, this should not be an unrealistic number and could just
as easily be a multiple with some government or fleet orders.

If and when they reach the 100,000 car per year level, which would
still make them a minuscule player in a 20 million car a year market,
per share earnings would be in the $8-9 a share level. Put whatever PE
you want on that type of growth.

Bottom Line

If the market has taught us anything over the last couple of years,
EVERY stock is a speculation, no matter how blue chip. Each investment
should be looked at from a risk/reward point of view. Based on its 9
year history (3.5 trading in the US) KNDI management has done an
exceptional job of growing the Company in spite of the stock
price.  The current “disconnect” between the current business and
China potential has, IMO, created an incredible upside with negligible
downside leaving me confident that KNDI will reward its shareholders
with a multi-billion dollar company irrespective of who the
shareholders are when that milestone occurs.  

DISCLOSURE: Long KNDI

It had been on my nightstand for awhile, but I finally got around to finishing Power Hungry: The Myths of ‘Green’ Energy and the Real Fuels of the Future by Robert Bryce. According to his own bio on the book jacket, “Bryce has been producing industrial-strength journalism for two decades” –whatever “industrial-strength” is supposed to [...]

Photo: J Henry Fair, with permission of Gerald Peters Gallery Crime and Punishment, Gulf of Mexico , 2010

A good documentary photographer takes us to places that we never could imagine and teaches us something at the same time. Some do it by shooting stark realism, like Canadian Ed Burtynsky, or South African Pieter Hugo, but J. Henry Fair’s work is more abstract.

His aerial photos look like a beautifully painted canvas tha…Read the full story on TreeHugger

“UV lamp from Radium, a Siemens company, treats 20 liters of water in about 15 minutes. Its powerful UV radiation destroys all pathogenic bacteria in the process.” Caption & image credit: Siemens.

Looking over comments on my recent post, Are Wisconsin Voters Willing To Take Their Chances At The Tap?, it dawned on me that the topic, proposed legislation to forb…Read the full story on TreeHugger

There's been too much blind faith within the cleantech venture sector on proprietary technology as the primary way for startups to create a competitive advantage.

Certainly, holding a defensible patent can help a startup with a cost or performance advantage to maintain that advantage over time.  Proprietary IP has been part of the success story of early cleantech "winners" such as First Solar, for example.

But the pursuit of such proprietary technology can be very expensive — in both direct and indirect ways.

First of all, it can be expensive to develop and commercialize products based upon truly differentiated core technology.  Thin-film solar is again another example of this.  From successes like First Solar to to-be-determined stories like Nanosolar, MiaSolé, Solyndra, etc., the pursuit of proprietary manufacturing techniques has meant having to invest hundreds of millions of dollars and years of effort in developing manufacturing equipment and techniques, all mostly from scratch.  

But indirectly, there's also a significant cost from trying to be secretive during the development process, out of fear that larger established competitors will be able to steal (or just borrow from) the tech sooner than the startup can get out to the market.  This is the not-often-discussed downside of a company remaining in "stealth" — it's tougher for the startup's technologists to get outside input on alternative approaches that might improve their tech, and for the startup's bizdev / senior management to know how best to position their product when it's ready for the market.  This can increase the chances that the startup develops a product that, by the time it's ready, has been leapfrogged, or that simply doesn't meet customer needs for other reasons.  When in the pursuit of proprietary tech, the startup remains insular for a few years — and this indirect cost can have significant impact.

Furthermore, none of the above fits very well with the current cleantech VC rhetoric about "capital-efficient" businesses.

But there are other ways to create a sustainable competitive advantage.  A startup can build a key set of channel or customer relationships that would be hard for a follower to wrest away.  A startup can build in a level of integration with customer processes or products that would be tough to un-do.  Brands can be built and utilized. There's even a form of "capital momentum" that we've seen where an early market leader uses their position to raise a lot more capital, including perhaps via an IPO, than their competition.  And then they'll be better-positioned to grow more quickly than those competitors. EnerNOC was an example of a firm using this kind of approach.

One key way of creating a defensible competitive advantage that I'm increasingly seeing deployed by cleantech entrepreneurs is market partnerships.  In many cleantech markets, the value chains have certain chokepoints where there's a high level concentration of component or product vendors.  And given the increasing interest in the corporate world around cleantech as a growth market, often these larger companies have aspirations (and sometimes even have launched their own products and services) to get into cleantech markets.  

Over the past couple of years, I've seen a lot of cleantech startups seek to develop sustainable competitive advantages in the marketplace by forming partnerships with these larger players.  

Most often, it's a partnership where the larger player is helping the smaller company to commercialize their proprietary technology. Forming a JV to build a first commercial production plant, for example. This can help with some of the challenges mentioned above in developing a proprietary technology.

But what I find more interesting are the partnerships I'm seeing where the startup works with entrenched upstream companies. Product manufacturers in traditional product lines (like, for instance, lighting products) who are developing new products based around emerging technologies (so to continue the lighting example, LEDs), but realize that their existing channels and sales models don't do a good job selling these new products. So a startup comes along with a system integration play, or a business model innovation, and is able to establish an exclusive relationship with the larger vendor.  

These and other examples are pretty interesting ways that cleantech startups with or without proprietary tech are creating competitive advantages not based on patents, but instead based on market dynamics.  For the startup, it's a lot more capital-efficient and speedy than developing a brand new technology from scratch.  And it also takes advantage of existing value chains, rather than attempting to disrupt existing value chains — and when these energy, etc., value chains are 100 years old or so, they have a tendency to resist disruption.

Now the question is, will cleantech VCs be open to such non-tech approaches to creating sustainable competitive advantage?  

Image credit Todd Eberle

After a visit to the Maison De Verre in Paris, I called it a green model for our times, being an urban, live/work, healthy redevelopment that was a demonstration of industrial materials and technologies. But it is also one of the most important and beautiful houses of the 20th century.

The owner, investor turned academic Robert Rubin, was away at the time of my visit, but Alastair Gordon, (author of Spaced Out) interviewed him about the Maison de Verre, …Read the full story on TreeHugger

Tom Konrad CFA

Electric utilities today look a lot
like newspapers in 2000: Too much debt in an industry primed for
disruption.

Speaking at the Economist’s Intelligent Infrastructure Conference, href="http://ideas.economist.com/speaker/brad-tirpak">Brad Tirpak,
Managing Partner at the private investment fund Locke Partners made the
case that electric utilities are as woefully unprepared for the coming
disruption of cheap, distributed solar power as newspapers were
unprepared for the disruption of the Internet in 2000. 

He outlined the following parallels:

1. Both had long been considered to be sure-fire businesses with
   dependable income.
2. Both took advantage of the seemingly dependable income to load up
   on debt.
3. Both face disruption from a disruptive technology (the Internet,
   and distributed generation and efficiency) with the potential to
   undermine their
   businesses.

What Happened to the Newspapers

Newspapers have not gone away, but as readers and advertising
increasingly migrated to the Internet, circulation numbers
dropped.  When a company is loaded with debt, a small drop in
revenues is magnified into a proportionately larger drop in
profits.  To stay solvent, newspapers had to raise
prices. 

Rising prices drove more readers away, starting the cycle all over
again, and eventually leading to bankruptcy for many of the
papers.  As you can see from the chart below, many of those papers
that survived without bankruptcy lost most of their stock market
capitalization as more and more of their income was needed to service
their debt. 
src="http://www.altenergystocks.com/archives/Newspapers.png">

The Price of PV

Mr. Tirpak expects a similar story to play out in utilities.  As
solar becomes cheaper and reaches grid parity, installations will grow
rapidly. 

Edward
Fenster, CEO of SunRun
made the case that we don’t even need further decreases in solar
photovoltaic (PV) panel prices to reach grid parity solar even without
the federal subsidies.  According to Fenster, solar panels
currently cost $1.65 per watt, but total installed cost is about $5.50
per watt.  While some of the extra cost is href="http://www.altenergystocks.com/archives/2010/12/structural_and_electrical_bos_components_for_solar_pv.html">Balance
of
System (wiring, inverter, mounting), the majority is labor and
permitting.  In Germany and Japan, permitting and installation are
only $1.50 per watt: Fenster believes we can get there too by doing
away with local permitting on standard installations ($0.50 per watt
reduction) and using greater scale and operating leverage ($1.50
per watt reduction.) 

Those reductions would lead to an installed cost of $3.50 per
watt.  According to my calculations, that would lead to a 30-year
internal rate of return of 4% (IRR) given a 20% capacity factor and a
$0.13 cost of electricity per kWh.  If we assume any electricity
price inflation at all, the IRR increases with it, and a $3.50 per watt
PV installation looks attractive at any interest rate below the
IRR.  We can also safely assume that there will be further
reductions in both panel prices and in other system component
prices. 

What Might Happen to Utilities

PV will probably reach grid parity in the next few years, through a
combination of rising utility prices, increasing returns to scale in
installation, and cheaper balance of system costs.  If this then
leads to rapidly growing PV installations, will it undermine utility
revenues, as the internet undermined revenues at newspapers? 

I think the analogy is based on a misunderstanding of both the
scalability of distributed PV and the utility regulatory environment.

First consider the regulatory environment.  Utility regulators are
charged both with ensuring that utility customers get service at a
reasonable cost, and also that utility investors will continue to be
willing to provide capital for necessary utility investments.  If
the rapid spread of PV were to threaten utility solvency, regulators
would take action to help the utility maintain solvency. 

Mr. Tirpak understood this, but made the assumption that the only
action regulators could take to protect utility solvency would be to
raise prices, which he assumed to mean the price per kWh of net energy
used.  If this were correct, then we would indeed see the vicious
cycle of increasing rates and declining volumes that has undermined the
solvency of newspapers over the last decade. 

It’s not all about cents per kWh

Regulators have other options.  First, they can allow the
utility to cut any PV subsidies intended to help the utility reach
solar energy targets.  If a utility were threatened by too much
solar power, such subsidies would clearly be unnecessary to achieve the
statutory PV penetration.  Subsidies are frequently cut in
response to unexpected growth in PV installations.  In fact,
declining subsidies in response to installation growth are often
designed directly into these programs.

Once subsidies are gone, the next step to protect utility solvency in
response to PV installation would be to change the structure of
electric rates.  Although we often think of energy (kWh) as the
only thing we buy from utilities, in truth we buy another valuable
service: electricity on demand.  href="http://www.altenergystocks.com/archives/2008/07/investment_ideas_from_the_onehouse_grid.html">Even
a
home with enough PV to produce all the electricity it needs on an
annual basis cannot disconnect from the grid: The power must be
kept on at night and on cloudy days, and excess electricity needs to go
somewhere when the sun is bright. 

Electricity storage could be used to take a home entirely off the grid,
but such storage would be prohibitively expensive.  If a home’s
average usage and generation is 24 kWh/day (requiring a 5 kW PV
installation), then enough battery storage would be needed to get the
house through a few cloudy days when generation is greatly
reduced.  Deep cycle lead-acid batteries typically cost $$200 per
kWh, so three days worth of storage would optimistically cost $14,400,
or $2.88 per kW of installed PV, making even $3.50/W PV
uneconomic. 

Since PV does not enable users to do without utility service,
regulators can increase the fixed cost of utility service without
increasing the variable (per kWh) cost.  This price rise will
improve utility profits without improving the economics of PV. 
Other options would be to switch to time of use pricing for
electricity, with low prices being charged when there is excess
electricity (which would be when PV is operating, since we are assuming
a PV glut) and higher prices when there is not enough (dusk on hot
summer days.)

In a private email, Tirpak responded to this argument by saying he
could not “quantify the support for solar.  People hate utilities
and love solar. Republicans and Democrats support it. At the end, the
[utility regulators] will listen to the public as well as
reliability.”  I certainly have met too many Republicans who hate
solar.  As for utility regulators (and I’ve testified before
electricity regulators several times), I simply can’t imagine them
intentionally adopting policies that would drive a utility into
bankruptcy.

I can’t quantify the public support for solar, either, but I can put an
upper bound on it. href="http://www.renewableenergyworld.com/rea/news/article/2010/06/are-residential-solar-leasing-funds-raising-capital">Residential
solar leasing companies like SunRun now can provide solar
electricity to customers in href="http://www.sunrunhome.com/solar-by-state">seven states for
less than the cost of grid electricity, without any upfront cost. 
They’re doing good business, and driving rapid market growth, but most
homes in those states still don’t have solar: SunRun uses innovative
strategies like partnering with >One Block Off the Grid (1BOG) to assure sufficient
volume.  If everyone truly loved solar, they could just hire a
call center in India to answer the deluge of telephone calls spend most
of their efforts installing panels.

Scalability

There are natural limits on how much PV can be installed by
customers.  Many people’s homes are shaded by trees or other
buildings.  Other customers are renters, and so do not have the
option of installing PV.  Industrial and commercial rooftops are
seldom big enough to produce enough power to meet relatively high
industrial and commercial electricity usage.

Utility scale installations could produce enough electricity, but such
installations need to sell their power directly to the utilities, at
much lower wholesale rates.  It will be quite some time before
solar PV is able to compete at wholesale rates in the absence of
subsidies.

Other Disruptors

Tirpak also lists other potential disruptors of the utility model: href="http://www.altenergystocks.com/comm/content/energy-efficiency-stocks/">
energy efficiency, href="http://www.altenergystocks.com/archives/2011/01/understanding_the_smart_grid.html">smart
grid, LEDs, href="http://www.altenergystocks.com/archives/2010/10/the_rodney_dangerfield_of_cleantech.html">ground
source heat pumps, and cheaper hydrogen.  He did not go into
detail on why he expects any of these to be significant, but my take is
that only cheap hydrogen has the potential to change the story I
outline above. 

Smart grid, by its nature, is being implemented by utilities at
regulators’ request: the smart grid will not allow us to do without the
grid, since it is the grid.  Perhaps Tirpak instead meant href="http://www.smartgridlibrary.com/2010/02/21/microgrids-%3F-fast-tracking-distributed-generation-in-the-smart-grid/">microgrids,
which are enabled by smart grid technology.  While microgrids have
the technical capability of cutting the cord to the larger utility,
they seldom have the legal authority.  A microgrid supplying power
to a small group unconnected to the utility would legally be a utility
itself, and subject to utility regulators.  For the reasons
outlined above, those regulators would not allow the formation of
microgrids to undermine the solvency of the utility.

Efficiency Technologies

The potential for LEDs to further reduce energy use is fairly
small.  In 2008, I made a weirdly similar (and similarly
overblown) argument that href="http://www.altenergystocks.com/archives/2008/11/is_there_life_after_the_bulb.html">utilities
might be undermined by the phase-out of the incandescent light bulb.  
My argument was not that this would reduce electricity sales (which it
will), but that it will undermine utility energy-efficiency
programs.  This will happen because the phase-out of traditional
incandescents would make the former stalwart of residential energy
efficiency programs, the compact fluorescent light bulb, (CFL) the new
baseline.  Current LED bulbs use almost as much energy as CFLs of
the same brightness, although the technology has the potential to use
only 40% as much.  But even assuming that LED technology reaches
this potential, where a CFL saved 75 watts replacing a 100 watt
incandescent, an LED only has the potential (at best) to save another
15 watts: One-fifth of the savings of the CFL when compared to an
incandescent.  Current technology saves only 2-5 watts over the
CFL, at a cost of $40.  If the now mature technology of CFLs did
not disrupt utilities, LEDs don’t have a chance.

Ground-source (aka geothermal) heat pumps (GHP) are already a mature
technology, and so are unlikely to see rapidly falling prices like
solar.  That said, they are already an enormously efficient way to
heat and cool a building, and their widespread adoption would do much
to reduce energy use. That is why I like href="http://www.altenergystocks.com/archives/2008/12/geothermal_heat_pump_stocks_1.html">GHP
stocks.  However, GHPs are more likely to be a boon to
electric utilities than a burden.   GHPs replace heating by
natural gas or fuel oil with electricity, adding to utility
sales.  Just as important, the timing of electricity used by GHPs
has the effect of improving utility grid utilization.  When
heating, GHPs run mostly in the href="http://www.altenergystocks.com/archives/2008/09/wind_and_heat_pumps_a_winning_combination_1.html">winter
and at night, which is just when utilities often have low demand and
high generation from wind.  When used for cooling, they reduce
summer peak loads by displacing less efficient air conditioners.

More broadly, energy efficiency technologies (which include LEDs and
GHPs) are unlikely to undermine utility revenues because of the href="http://www.altenergystocks.com/archives/2007/08/why_energy_efficiency_is_a_hard_sell_2.html">significant
barriers to adoption.  After all, energy efficiency is already
much cheaper than grid based electricity, costing only a few cents per
kWh saved.  With grid electricity costing five times as much as
efficiency already, it seems unlikely that a price shift that makes it
cost even ten times as much will make a radical difference in the rate
of adoption of efficiency technology.

Hydrogen

Of the technologies Tirpak listed, only cheaper hydrogen has a chance
of disrupting the electric utility model the way the Internet disrupted
newspapers.  Hydrogen might disrupt utilities by providing a cheap
way to store electricity, which in turn would allow individuals to go
off the grid.  Yet while hydrogen has the theoretical potential to
provide relatively inexpensive energy storage, cheap and efficient
electricity storage with hydrogen has not yet even been demonstrated in
the lab, at least to my knowledge.  That puts any such technology
at least a couple decades away from commercialization.  I’m not
holding my breath.

Conclusion

Given that utility customers are captive in a way that newspaper
customers never were, it seems unlikely to me that utility stocks in
the
coming decade will follow the performance of newspaper stocks in the
last decade.  Lower
prices for and increasing penetration of PV will change the way we pay
for utility service, but not free us from utilities all together. 
Only the advent of extremely cheap electricity storage would allow us
to truly cut the umbilical power line, and until we can cut that line,
regulators will find a way to charge us enough to keep utilities
solvent.

While regulated utilities should weather the coming solar storm,
independent power producers (IPPs) which sell their power into the spot
market, or whose power purchase agreements (PPAs) expire at the wrong
time, might be threatened.  This is especially true for IPPs with
inflexible generation that cannot easily ramp up and down to compensate
for fluctuating electricity supply from renewable sources. 

If you’re convinced that PV is on the cusp of grid parity and rapidly
expanding deployment, don’t short regulated utilities, as Mr. Tirpak
suggested.  Instead, look at IPPs with mostly coal-based
generation fleets and PPAs expiring in five years or so.

DISCLOSURE: None.

DISCLAIMER: The information and trades
provided here are for informational purposes only and are not a
solicitation to
buy or sell any of these securities. Investing involves substantial
risk and you
should evaluate your own risk levels before you make any investment.
Past
results are not an indication of future performance. Please take the
time to
read the full disclaimer href="http://www.altenergystocks.com/disclosures.html">here.

Image Credit: Consumerist

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