Energy 3.0 – “At the Cusp or on the Brink” Part 1

Introduction to Energy 3.0

I am introducing a new series of posts that are a distillation of my views on the energy market. I recently spent two years working in the energy efficiency industry and formed my perspectives during this time. My understanding of this sector is nascent, dynamic and subject to change. Two years is an incomplete introduction to one of the world’s largest industries and there is much to learn.

Having worked previously in technology, investment research and venture capital, I approach markets with a world view that is a combination of these lenses which are very different than the typical energy industry perspective. At the time I began working in energy I was mildly curious. However, as I learned more about this critical sector, I found my interest growing. As a student of changes and trends from humankind’s interaction with technology, it’s impossible to ignore energy. An examination of the energy industry, its role in our world and economic impact suggest its past and future history is inextricably intertwined with that humankind’s growth and development. Join me in this series and I invite your comments and challenges to my views– I am a data driven analyst and welcome skeptics as friends that ultimately serve to hone my views.

Energy is as Old as Humankind

Energy = Civilization = Population Growth = Economic Growth = Life. While this is a large statement, I believe it is a logical conclusion upon examining the data. It seems hard to ignore that our progress as a species has marched hand in hand with our energy consumption and economic output. Which led? I am not sure, but the data appear reasonably correlated and so I will recognize the relationship and the co-dependency of population, economic growth, technological progress, quality (and quantity) of life and our ability to harness and use energy. Regardless of which developed first, it’s true that our civilization at this time depends upon an abundance of inexpensive energy.

Table 1. The Evolution of Civilization

Source: Chris Montaño; Human Race

I have divided the history of energy into 3 distinct eras and called them Energy 1.0, Energy 2.0 and yes, Energy 3.0. Each era is defined by the energy sources available to humankind during that time. While none of these dates are crisp, they serve as markers where a trend in a new energy source was well established.

Our early history as a civilization was essentially driven by burning things- mostly wood and toward the end of the era, coal. Fire was our first source of energy and it brought us quite far by heating us, providing cooking and eventually leading to the steam engine. However, most work done during Energy 1.0 was performed by muscles- human or livestock. Once we understood hydrocarbons and leveraged them, we were into Energy 2.0 which saw the advent of industrial society, the modern city and work performed mostly by mechanical motors and engines. The ability to change the form factor by which work was delivered and tailor it to specific jobs gave rise to manufacturing and general availability of goods on an unprecedented scale. Motors also changed transportation and introduced autos and airplanes and ships driven by motors rather than wind. This era saw the global economy evolve into the trillions.

Table 1 illustrates the parallel development of energy and humankind. On virtually all measures of civilization’s advances, humankind’s economic growth and energy consumption and population growth have been in lockstep. It is also clear that progress and consumption have been non-linear and exponential. Population grew from ~800M to 2,400M from 1759 to 1944, a period of 185 years but required only another 77 years to reach add more than 4,500M people and reach a global population of 7,000M

Energy 3.0- “On the Cusp or on the Brink”

I am naming this series Energy 3.0 – “At the Cusp… or on the Brink.” As I have looked at energy demands and economic forecasts along with projected population growth through this century, it seems clear that the next era requires significant increases of energy supplies. In essence we are at the “Cusp” of a new wave of demand in energy based upon population, economic and technological growth. However, if we fail to identify significant new supplies or extend current ones, then perhaps we are “on the brink” of deeper, more unpleasant changes for our civilization.

Our growth as a species has been spectacular and I wonder how long it can continue at its current pace. The implication is that we are ultimately hurtling toward some envelope of sustainability in our planet’s ability to provide food, water, and energy for everyone and natural resources for the technology needed for continued growth. Given the exponential growth of all biological populations, I cannot help thinking about the asymptotic limits of what our planet can sustain. Realizing that we have faced similar questions of sustainability in the past yet managed to navigate our way to continued growth and progress as a civilization, I think it’s possible that we will yet again thread the needle. However, I cannot help having the feeling that somehow this time, it is different and the scale is greater than what we have ever faced and the rate of change is ever accelerating.

Driving this situation are a couple of billion people in the developing world that are headed toward middle class economics- and energy consumption in the next 50 years. The World Energy Outlook for 2011 forecasts a 1/3 increase in energy demand between 2010-2035 and 50% of that demand growth coming from India and China. As their consumption patterns match those of the developed nations, it seems reasonable that our resources and infrastructure to meet energy demands will be taxed severely. Economics 101 suggests that increased scarcity of a resource goes lockstep with increase in prices. Of chief concern is the fact that virtually all energy supplies are currently delivered by natural, non-renewable resources. While this is not necessarily a problem in itself, logically there is a limit on what we can expect to extract and use. It seems a prudent step begin developing renewable sources of energy and ensure what energy we do have is developed as economically efficiently as possible.

While renewables have been around since the first wind powered mill was built, modern society has been built upon the energy density of hydrocarbons. There is simply nothing that packs as much energy into a compact form, easily transportable and with an infrastructure that can rapidly translate hydrocarbons into usable energy. There exists no solar or wind powered motor that can drive a container ship across the globe or power an intercontinental flight. The fact remains that the primary drivers of our economy remain gas turbines and diesel motors. These motors power our jets, shipping trucks, container ships and most passenger and military vehicles around the globe.

Renewables electricity generation is at its beginning in being explored in earnest. In fact, in its current state of development it appears to me an economic experiment. It is borne from our reasonable concerns regarding projected energy demands coupled with resource constraints and the nagging worry that we may have already pushed past the tipping point of global climate balance. How this experiment unfolds and the data that it bears will have a profound impact upon our way of life.

The Audacity of Hope Part II

In my prior entry, The Audacity of Hope, I told the story of Vann Nath, one of the few survivors of the infamous S-21 death camp. While no one is certain, the latest figures that I read were that 14,000 went in, 7 came out. One of them was Mr. Vann Nath. He passed away a month ago on September 5th. The Economist printed an eloquent obituary that can be found at this link.

I wanted to remember Vann Nath and the brief role he played in my life. While I never met him, I did commission a painting that he did entitled, “Hope”. I detailed the entire story in my prior blog post. I encourage you to read it and reflect on this remarkable person and his passing.

Why is this important to me? I think because at my core, I am a hopeful person. And I am touched by those rare individuals that are thrust into seemingly hopeless circumstances and demonstrate the strength of spirit to bring forth hope amidst great darkness. There is no training or degree or education that prepares one to be a person of great soul. Mr. Vann Nath was such a person.

I am posting a picture of his painting, entitled, “Hope”. May his spirit of hope amidst insurmountable challenges strengthen us.

Rest well.

“Hope” by Vann Nath

The Future’s so Bright…

I was reviewing my old posts and found this one, R&D Spending a Tale of 2 Companies. In it I discuss the portion of spending on R&D of First Solar (FSLR) and Suntech Power (STP). I noted that the ratio of spending for STP was low relative to the amount spent by FSLR and that as a whole the cadre of solar companies were spending relatively low amounts on R&D. I made the implicit assertion that the innovators will win this market.

I wanted to see how the two stocks had fared since my post. In figure 1, I have plotted the relative performance of the two stocks since the day of that post.

Figure 1. Relative Performance of FLSR and STP


While FSLR has outperformed STP by almost 32%, it still lost more than 1/3 of its value in that time. During this same time the NASDAQ  increased by 23%. Classic case of fundamental analysis missing the stock price action. In short, I was “less wrong” – a far cry from being “right” on the stock action. However, if you are pairs trading or measuring relative performance between the two stocks, then not too bad.

On a fundamental basis, as I re-read my post, I was struck by my initial assumption that this business is about technology and innovation. In retrospect, it is about technology and yes innovation is important. However, all of these need to be focused on relentlessly driving down costs. And while I did mention the need for economic parity with current, carbon based generation technologies, cost is a 1st order driver- not technological innovation.

Why is this important? Because an analysis that merely takes into account costs is very different from an analysis that is driven by cost. This is akin to a small course error across a large distance. For example, a rocket ship that is traveling to Mars will miss the mark by a wide margin if it is off course by a small amount. Likewise, in a long term market such as electical generation and distribution, a small error in assumption will lead to a large missed opportunity in the long run.

And from all appearances, the long run of solar power looks very bright. This brief teaser of a statement by a researcher from the International Energy Agency tells the whole story. Solar energy is poised to be the dominant energy source for the world by 2060. What have I learned? That it will be low cost that will get us there, everything else will be ancillary.

History as Destiny

*Author’s note. I dusted off this piece of writing that was 7 years old. After the RSA confab, seemed like this still has some relevance. So unedited, here it is!

“What has been will be again, what has been done will be done again; there is nothing new under the sun.”

Ecclesiastes

It is old news that the Internet delivers global reach to large and small companies with a few keystokes. But there is another primary beneficiary of the Internet’s globalization effects- hackers. As the communications industry embraces packet switched networking we are witnessing the convergence between the domains of computing and communications. These once disparate realms are merging into a (seemingly) transparent, global network. Hackers are overjoyed that so much capital investment would be made in extending their reach and enabling grander exploits.

Hackers have gone upscale as well. The image of pierced and tattooed cypherpunks laboring in equipment-strewn rooms lit only by the glow of CRTs has been replaced. They are now highly recruited, highly paid, pierced and tattooed cypherpunks with well negotiated contracts from international corporations (and other organizations.) CRTs are out and flat screens are in.

Even more interesting is that, in spite of the spectacular success of the World Wide Web, the Internet continues to evolve. While capital investment has poured into the links of the Internet in the form of broadband networks using wires, optical fiber and radio waves, the Internet’s underlying protocols are not static. The anticipated emergence of the “Semantic Web” whereby computers interact with computers using “machine understandable” protocols (XML, RDF, OIL), promises to open up even more powerful services and efficiencies- for both commerce and hacking alike.

While the Internet really is a profound innovation in technology and commerce, the fundamental nature of its users remains essentially unchanged. Regardless of complex ontologies of Digital Content and Network Security (DCNSec), the fundamental goals of security remain quite simple:

keep the “bad guys” out from where they shouldn’t be

stop the “bad guys” from stealing what belongs to others

prevent “bad guys” from harming innocent people

ensure that honest people can do business

 

Whether we are talking about “meatspace” or “cyberspace”, security needs stem from basic human nature and our consequent behavior. This is not a technological issue but behavioral. Only now the capabilities require sophisticated skills in technology, finance and law. As long as innovation is applied to countering the threat of hacking, innovation will be applied to subverting those defenses- it is human nature. We believe it has always been so and we expect it will always be so.

 

 

Investment Theses

The question is, “What’s not digital?”– Virtually every communications network and information system including television & radio broadcast, movie distribution, financial records, medical records and database in the world is migrating to (or likely already exists in) a digital electronic format. Additionally, our physical infrastructure (e.g. water systems, power grids, etc…) is increasingly incorporating Internetworked control systems. With “digital data” forming the fabric of commerce, communications and ingrained into the infrastructure of our society- security is no longer an option.

Digital content and networks are inherently open platforms – The transformation to digital content and networks creates the need to develop a baseline measure of security. Packet switched networking was not designed with security needs in mind. Unlike some kinds of information transmission schemes (e.g. CDMA) in which the modulation technique delivers unintended, marginal security, there is no native embedded security in most digital content. DCNSec must be tailored and engineered as an overlay to an installed Internet. The rigorous work of incorporating security as a design factor is nascent at best and we question if the Internet as we know it can ever be “secure.”

The transition to IP networks is a forgone conclusion and now forms the underlying fabric of the communications network(s) – Packet switched networking has arguably been the most rapidly adapted communications protocol in the history of modern communications. Regardless of the transmission media (glass, air, wires), IP networking means that digital bitstreams form the unifying communications protocol going forward. It is our opinion that the digitization of communications networks and content has created significant and permanent opportunities in the digital/network security sector.

Security is fundamentally an economic risk management proposition not a technology challenge – The cost of security and the friction it introduces into a system must be weighed against the risks assumed by the level of security chosen. There is no single technology that can fully satisfy an organization’s security needs. Security is ultimately, like all risk management issues, an executive level decision. Unfortunately, there are no widely employed standards, methods, and metrics used to measure exactly what “security” is and the risks associated in the systems deployed (or lack thereof.) While the financial world has developed sophisticated risk management methodologies and metrics, there are no known methods to measure a company’s “information Value at Risk” (iVAR.) We anticipate that as the digital content and network security industry matures, quantitative standards of risk management will increasingly be applied as decision-making tools.

We do not believe that there will be an “endpoint” to the security challenge – While all markets eventually reach maturity, we believe that the challenge of securing digital content and networks has only begun. As long as individuals and organizations continue applying innovation to subvert DCNSec, there will be a need to apply innovation to the security problem. There are multiple threat models to consider spanning a spectrum of resources and sophistication. Security challenges stem from relatively harmless “cyberpunks” to malicious “blackhats”, to industrial espionage, cyberterrorism, organized crime and state-sponsored cyberwarfare and espionage. These multiple threats lead us to conclude that we have only seen the initial “leg up” in DCNSec and a long growth period is now underway.

Growing network diversity, application complexity and pervasive connectivity exacerbates the security challenge – From an end-to-end perspective, network complexity is increasing. New technologies and software from the physical to the application layer are increasing the challenge of defining and implementing security. Software complexity in device OSs at the ends of the network (as measured by lines of code) has increased by nearly an order of magnitude in the last decade. Wireless networking in particular is a security challenge. The proliferation of wireless networks in the home, public, and workplace (e.g. 2G, 3G, 802.1x, homeRF, Bluetooth, UltraWideband) is moving toward a “network mesh” whereby devices move across multiple networks and technologies providing an always-on network connection. Additional technologies such as embedded operating systems, expanded address space in IPv6, cheaper processing, cheap RFID chips and multiple wireless network connections are driving a pervasive network and computing environment with an explosion of the number of internetworked devices. There is no current system or standard to authentic devices roaming from network to network.

Cheer up, it’s going to get a lot worse – The next step in the Internet’s evolution is likely to make the current security challenges look simple. Most use of the Internet today revolves around the World Wide Web. The WWW is a collection of protocols that allows for the transmission and presentation of data from computers to users through web browsers. While servers can move and display information, processing is limited. However, the Worldwide Web Consortium (W3C) is in the midst of developing standards for the rollout of the “Semantic Web.” In the semantic web, computers will be able to process data from other computers. Essentially, it will make the content on the web “understandable” to the servers that manage and control the data and endpoint computers that access the web. We believe that the Semantic Web will enable new generations of software agents and web services along with unprecedented levels of data mining. The prospect of software agents that can traverse the Internet reading and collecting and processing vast amounts of data has profound security and privacy implications. Considering that the slammer worm inflicted most of its damage within 10 minutes, imagine the extent of the problem when a significant amount of information collection and processing is built into future “semantic malicious code.”

The geopolitical outlook suggests increasing priority on security efforts – The terrorist attacks of 9/11/01 have brought security issues to the forefront. While primary concern remains on physical security, clearly, digital content and networks remain vulnerable to attack and consequently, require comprehensive security solutions. We do not foresee this risk to diminish significantly in the near future. In fact, we see emerging threat scenarios as we understand the linkage between vital infrastructure and digital content and networks.

One thing leads to another

A great deal of work is being done on renewable energy sources. With very cool stats thrown around such as:

  • the amount of energy impacting the earth from the sun in one hour will supply the entire world’s consumption for a day
  • 1 square meter receives from the sun the equivalent of 1000 watts of energy

I could go on but the point is that energy is all around us. In fact, if we are to believe Einstein’s “signature equation” of E= mC2- then we ARE energy, albeit in a rather cool, slow and static format. There are untapped (and I am guessing unknown) realms of energy extraction from our surroundings that  we have yet to imagine and explore.

So while we wrangle and create endless spreadsheets on the economical viability of one renewable energy source versus another, keep this in mind- the great game of innovation has only begun. It can only get more interesting from here.

R&D Spending- A Tale of 2 Companies

In my last post regarding solar companies, I looked at the continuing revenue build out and the market share battle between First Solar (FSLR) and Suntech Power Holdings (STP.) We saw that First Solar’s thin film offering appeared to be taking market share from the phtovoltaic provider, STP. In this note, I will again revisit the revenue build of this nascent industry as well as look at what I consider to be a primary long term indicator of growth potential, research and development.

Revenue appears to be recovering from March Lows

In spite of stellar growth the previous 7 quarters, the 12 alternative energy companies that I track showed Q/Q declines in the December ’08 and March ’09 quarters. While the June ’09 quarter was a positive Q/Q result, it was still an almost 22% decline on a Y/Y basis. Perhaps the worst is over for solar technology’s revenue growth, however, I believe that fledgling industries such as this with blockbuster demand curves remain anybody’s market for some time. For example, the Internet investment opportunity was kicked off by Netscape, America Online and Yahoo. Today, only one of those companies is operational and Yahoo is fighting to remain a dominant player in light of the fairly late market entrant of Google. Likewise, in solar technology, I anticipate that there may be category defining companies that are private or not even yet formed.

Figure 1. Revenue Build Recovers from the March, 2009 Bottom

Alt Energy Companies 20090923

Source: Chris Montaño, CFA;  Gridstone Research

R&D -The Lifeblood of Technology Companies

In formative industries with great demand curves, I like to look at research and development. While there is no guarantee that spending money on R&D will result in winning products, it simply makes sense to me that companies investing in the future through research have the best chance to adapt to unpredictable market conditions and evolving technology. And even though the demand curve for solar power technology looks massive today, it remains an uncertain and difficult market in very early stages.

I also think that the key to solar technology’s long term viability as a renewable energy source is its economics- can we produce electricity from photovoltaics at the same cost as coal or gas? Without technologies that enable production of electricity at a price point equivalent to coal or gas powered generation, photovoltaic electric generation will remain a niche method. Efficiency of solar cells regardless whether they are thin film or silicon substrate is the cornerstone of economic viability. The company that can produce the highest efficiency photovoltaic device is in the best position to become  a major company through the world’s most ancient energy source and newest business- solar energy.

Figure 2. R&D in Absolute Dollars and as a Percentage of Net Revenue

Alt Energy RandD 20090925

Source: Chris Montaño, CFA;  Gridstone Research

As I look at the graph in figure 2, I am struck by a couple of things:

  1. Photvoltaics are still massively underinvested in view of the market opportunity. I was surprised at the modest quarterly spending in absolute dollars -$53M. Even on a trailing 4 quarter basis, this seems a bit on the small side. I think this means a couple of things- it could mean that there are simply not enough photovoltaic professionals to absorb more R&D dollars. Or it could also mean that the companies are still pouring all of their resources into a technology that is immature and requires so much engineering effort, that the industry itself could be considered “R&D.”
  2. 2.5% of industry revenue needs to climb for photovoltaice generation to achieve “grid parity.” It seems a stretch to think that 2.5% of industry revenue will achieve the products that will generate electricity as cheaply as utilities. The types of efficiencies that photovoltaics will need to attain economical generation without subsidies and tax benefits will likely require a lot more than $53M. And while the trailing 12 month number is a bit more encouraging on an absolute basis ($180M), it is still less than 2% of total industry trailing 12 month revenues.

In view of my previous post where I compared FSLR and STP revenue contribution, I thought it might be interesting to see how STP and FSLR fared in their respective R&D investments. Figure 3 makes an interesting graph depicting the divergent R&D priorities being invested by two companies. First Solar seems quit3 aggressive in its spend while Suntech Power appears to be tapering off.

Figure 3. A Tale of 2 R&D Budgets

STP and FSLR RandD

Source: Chris Montaño, CFA;  Gridstone Research

While it certainly takes a lot more than R&D to make a great company, one thing I am personally convinced of- without world class R&D, it is very difficult to attain and maintain a leading role in the technology industry.