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Alternative Energy Storage and Cheap Oil

Oil prices have fallen off a cliff recently and everybody’s breathing a sigh of relief as prices tumble at the gas pump. Late last week I read on Bloomberg that Francisco Blanch, a commodity strategist at Merrill Lynch, is forecasting a market bottom in the $25 range and a 2009 average price in the $50 range. The relief is welcome but I have enough experience in the oil business to know that we’re merely experiencing that pleasant calm that comes when the eye of a hurricane passes overhead. This is no time to go out and buy a gas-guzzler!

The following chart from the Energy Information Administration tracks the spot price of West Texas Intermediate Crude Oil from January 1986 through November 2008.

click to enlarge

What I find most fascinating is how the long-term trend was essentially flat from ’86 until it reached an inflection point in the late ‘90s, a time that roughly coincides with recovery from the ‘97 Asian financial crisis and increased sales of motor scooters and personal cars in developing economies. Those changes permanently altered the global oil consumption landscape and since the late ‘90s oil prices have followed a steady upward trend. I don’t want to join the peak oil debate, but I think the long-term price chart presents compelling evidence that the world passed a “peak cheap oil” inflection point about 10 years ago.

We are currently seeing a sharp correction in the oil market that’s been amplified by financial market restructuring and a global recession, but if my analysis is correct oil prices will revert to their new trend line over the next 12 to 18 months and then resume their relentless upward march until another inflection point is reached. By the time the global economy emerges from the current recession, it looks like $70 to $80 oil is a virtual certainty.

So the real question is how will a temporary decline in oil prices impact the energy storage sector over the next couple of years?

Many observers have suggested that a precipitous decline in the oil markets will have a disastrous impact on alternative energy investments. I disagree because I believe reversion to the established trend line in the oil markets can only take us back to the $70 to $80 level and many alternative energy technologies remain cost effective at that price point. Moreover, electricity prices are not likely to experience the same violent swings as oil. So the fundamental market drivers that favor the use of wind and solar power are different. Sales may decline for a time, but they will almost certainly recover with the overall economy.

I’ve consistently argued that plug-in electric vehicles cannot be cost effective in North America where consumers demand a vehicle that will travel 50 to 150 miles at highway speed and a battery pack to provide the necessary range will add $10,000 to $30,000 to the purchase price of a car. Before the oil price crash, I believed the overwhelming majority of US consumers would reject plug-in electric vehicles for simple budgetary reasons. Low oil prices and a deep recession can only exacerbate that problem by encouraging potential purchasers to defer purchase decisions until the economic picture becomes clearer. New car sales have already fallen by roughly 40%. Simply put, this is a terrible time to be offering scared consumers a new power train alternative that is more expensive on the showroom floor and promises uncertain operating and maintenance cost savings on the road. As I noted in an earlier Seeking Alpha article, “the green in our personal philosophies always takes a back seat to the green in our wallets.” The triumph of economics over philosophy will be even more pronounced during a major recession.

Under conditions that are likely to prevail for the next 12 to 18 months, I believe companies like Ener1 (NASDAQ:HEV) and Altair Nanotechnologies (NASDAQ:ALTI) that have made big bets on the rapid adoption of plug-in electric vehicles are almost certain to be major disappointments. Altair had about $30 million in working capital at September 30, 2008, which translates to roughly 12 months of operating costs. Ener1, in comparison, only had $16 million in working capital, which translates to roughly 6 months of operating costs. Both companies will need substantial additional capital before the economy turns the corner. While Altair is in a better position than Ener1 when it comes to both liquidity and capital requirements, I question whether either company will have enough liquidity or be able to generate enough revenue to weather a 12 to 18 month recession.

Last week I characterized American style EVs as the epitome of wasteful arrogance. However the situation is very different in Asia where adding small amounts of electric boost to bicycles and motor scooters can provide huge life style benefits and operating cost savings. Since they operate in a different environment, I believe that companies like Advanced Battery Technology (OTCPK:ABAT), China BAK (NASDAQ:CBAK) and Hong Kong Highpower (NASDAQ:HPJ) that are focused on reasonably priced batteries for mass market applications like bicycles and hybrid scooters are likely to encounter significant end-user demand despite low oil prices. Their revenue from other consumer products may suffer because of the recession, but the long-term potential of personal transportation applications in developing markets is nothing short of spectacular.

Predicting the likely impact of low oil prices on grid-based storage systems is difficult because the market is so new. Historically, the bulk of the batteries used in grid-based applications were lead acid batteries for switch and control systems. All of the recent efforts to use flywheels and Li-ion batteries for frequency regulation, and use sodium-sulphur, lead-carbon and flow batteries for bulk storage, are essentially demonstration projects where the utilities are trying to collect enough hard data from hands-on experience to make a thoroughly studied decision about whether those solutions will be cost-effective in the long-term. The grid-based projects that have been installed to date and are scheduled to be installed over the next couple of years are only the beginning of a process that will ultimately result in rate applications to Federal, state and local utility regulators. So even if all of the current projects are successful, we won’t see utilities making decisions to buy storage systems on a large-scale basis for 3 to 5 years.

I expect the level of utility testing for grid-connected storage systems to grow rapidly over the next couple of years in spite of the recession. These demonstration projects will likely generate something north of a hundred million in revenue for a handful of companies including Beacon Power (BCON), Altair, Axion Power (NASDAQ:AXPW), ZBB Energy (NYSEMKT:ZBB) and A123 Systems (IPO pending). While that number is objectively large, I would be surprised if any company received enough revenue from utility demonstration projects to pay their corporate overhead and generate an operating profit. Companies like Axion, ZBB and A123 that can rely on product sales in non-utility markets have a good opportunity to minimize their losses while continuing the development of grid-based storage solutions. The outlook is far less optimistic for companies like Altair and Beacon that have no real revenue prospects from sources other than electric vehicles and rapid commercial rollout of grid-based storage solutions.

In closing I’d like to draw readers’ attention to an article in the current issue of IEEE Spectrum Online that provides a good summary of the battery-supercapacitor hybrids developed by Australia’s Commonwealth Scientific and Industrial Research Organization (CSIRO) and Axion Power International. I’ve been on the receiving end of a lot of hostile comment over the past few months for having the temerity to suggest that a cheaper lead-carbon alternative might be able to reduce the price of an HEV without hurting performance. I’m delighted to see that well-respected thought leaders in the electrical and electronic engineering fields are starting to take notice.

Disclosure: Author holds a large long position in Axion Power International, has recently bought small long positions in Exide and Enersys and may make additional storage sector investments in the future.

Source: How Will Temporary Decline in Oil Prices Impact Energy Sector?