Sub-Prime Lending for Alternative Energy
2008 was a watershed year when global markets taught the Masters of the Universe that loans are more than slick packaging, sophisticated forecasting models and favorable rating agency reports. Unfortunately, we’ve all suffered grave collateral damage from politically popular programs to loan money to people who can’t afford to pay it back. I can only hope that the staff at the DOE has been paying close attention because they’re the ones who’ll have to decide the fate of dozens of applications that have already been filed in connection with the auto industry bailout. If the publicly announced Stone Soup loan requests I’ve seen from companies that want to manufacture electric vehicles and EV battery systems are any indication, it will be a difficult and politically charged process. Four of the more audacious if not downright piggish loan requests include:
The Energy Independence and Security Act of 2007, which is affectionately referred to as the auto industry bailout in the common tongue, authorizes $25 billion in DOE grants and low interest loans for projects that reequip, expand or establish domestic facilities to manufacture qualified advanced technology vehicles and components. The program generally requires the applicant to pay 20% of the project costs and allows DOE funds to cover the balance. A total of $2.5 billion has been set-aside for companies with fewer than 500 employees. Before making a loan, the DOE is required by law to determine whether the applicant is “financially viable without the receipt of additional Federal funding associated with the proposed project.”
In a recently released Interim Final Rule, the DOE said it interpreted the viability standard to mean that
the applicant must demonstrate a reasonable prospect that [it] will be able to make payments of principal and interest on the loan as and when such payments become due under the terms of the loan documents, and that [it] has a net present value which is positive, taking all costs, existing and future, into account.
In making decisions, the DOE said it plans to consider the applicant’s:
- Debt-to-equity ratio as of the date of the loan application;
- Historical earnings before interest, taxes, depreciation, and amortization (EBITDA);
- Debt to EBITDA ratio as of the date of the loan application;
- Historical interest coverage ratio (EBITDA ÷ interest expenses);
- Historical fixed charge coverage ratio (EBITDA + fixed charges ÷ fixed charges + interest expense);
- Liquidity as of the date of the loan application;
- Statements from lenders that it is current with all payments due under loans made by those lenders; and
- Financial projections demonstrating its solvency through the term of the loan.
It doesn’t take much time with Google (NASDAQ:GOOG) and an Internet connection to ascertain that none of these companies has:
- Historical product sales that represent more than about 5% of the requested loan amount;
- An earnings history that would make EBITDA calculations possible or comparisons meaningful;
- Enough liquidity to finance their substantial recurring losses during the construction period;
- Enough liquidity to finance inventory and start up expenses on their proposed plants; or
- The 20% down payment required by statute.
While I’m sure they’ve all provided letters from investment bankers that say, “If you approve the loan we’re highly confident we can raise the equity;” the DOE is not Hollywood and even if the applicants get Federal money to build their dream facilities, there can be no confidence that “if you build it they will come” because the proposed products are simply too expensive for anyone other than the emotionally entangled or the mathematically challenged.
I’ve carefully studied a May 2004 EPRI Report that concluded HEVs, PHEVs and EVs would attain cost parity with internal combustion engines if Ni-MH battery prices fell to $350 to $400 per kWh at medium volume production of 100,000 units per year. The same report speculated that Li-ion batteries might be an even better solution if cycle-life and safety improved significantly and economies of scale slashed battery costs to the $350 to $400 per kWh range. While we have seen impressive growth in HEV sales from 84,000 units in 2004 to 296,000 units in the first eleven months of 2008, none of the assumed battery cost savings have materialized. Ni-MH battery prices have not fallen in response to increased demand. Moreover, all of the enhanced performance Li-ion technologies are more expensive than their predecessors. Since I see no reason to believe that Ni-MH and Li-ion battery prices will plummet anytime soon, I think it’s high time that we revise outdated economic assumptions to reflect unpleasant current realities.
I’ve used a battery cost table prepared by Sandia National Laboratories in a couple of recent articles. The Sandia report shows that Li-ion batteries are roughly 2/3 more expensive than comparable Ni-MH batteries. It also shows that Ni-MH batteries are roughly 2/3 more expensive than a new asymmetric lead-carbon capacitor that has already been successfully demonstrated in a 100,000-mile HEV road test. While one commenter has called me a captain buzz-kill for having the temerity to discuss real-world economics, I can’t justify using Federal funds to subsidize a “best available technology” that’s almost three times more expensive than a “best affordable technology.”
A couple days before Christmas, I published a Seeking Alpha article that put pencil to paper in an effort to calculate whether the PHEV and EV proposals that are the current darlings of scientists, economists, politicians and reporters make sense at current battery prices. Since I failed to include maintenance cost savings in my original tables and was reasonably criticized for the oversight, I’ve re-run the numbers. They’re still ugly!
The average American drives 40 miles a day, or about 12,000 miles per year. Assuming an average fuel efficiency of 25 mpg, the average driver will use about 480 gallons of gas per year. A comparably sized plug-in electric vehicle would need about 10 kWh of battery storage to get a 40-mile range. The following table calculates the 10-year costs of a pure EV based on the principal battery chemistries that could be used in transportation. The table assumes a 40-mile range and a 40-mile average daily use, straight-line depreciation of 10% per year, imputed interest of 6% per year on the unamortized battery cost, an average electricity price of $0.06 per kWh and annual maintenance savings of $180. It then divides the total cost of ownership by 4,800 to determine a breakeven gasoline price.
Valve regulated lead acid batteries cannot offer a 10-year useful life, but I’ve included them in the table to serve as a baseline for end-user cost comparisons. I’ve also included asymmetric lead-carbon capacitors, which are still too bulky for subcompact EVs. Once you eliminate these two technologies from the mix, it becomes painfully clear that a pure EV using Ni-MH and Zebra batteries can’t break even until average gas prices exceed $2.22 per gallon and a pure EV using Li-ion batteries can’t break even until average gas prices exceed $3.69 per gallon
While the price performance figures for a pure EV with a 40-mile range are disappointing, they deteriorate rapidly when you try to manufacture a pure EV with a 100-mile range. To illustrate the point, the next table goes through the same calculations using a 100-mile potential range and a 40-mile average daily use.
These two tables starkly illustrate an inconvenient truth about prevailing PHEV and EV proposals:
- Pure EVs cannot pay for themselves unless you buy the cheapest batteries possible;
- Pure EVs cannot pay for themselves unless you consistently use the maximum range; and
- HEVs and PHEVs will be less cost-effective than pure EVs because of additional maintenance costs.
Senator Robert Kennedy is fondly remembered for saying, “There are those that look at things the way they are, and ask why? I dream things that never were, and ask why not?” The sentiment is stirring, full of hope and incredibly inspirational. It also meshes well with my personal conviction that in America, we get up in the morning, we go to work and we solve our problems. But no problem can be solved until we accept the facts as they are with all of their inherent complexity.
Scientists, economists, politicians and reporters are supposed to make assumptions; it’s part of their job description. Companies, on the other hand, are expected to deliver tangible results in mass quantities at a reasonable price. Investors do not prosper unless their companies can make a product that meets or exceeds market expectations.
Over the last five years, Ni-MH and Li-ion battery manufacturers have achieved remarkable product performance gains but failed miserably when it comes to controlling costs. Unless they can find a way to slash manufacturing costs, HEVs PHEVs and EVs cannot compete with internal combustion engines until oil prices stabilize over $100 per barrel. Until Ni-MH and Li-ion battery manufacturers can show a concrete and achievable short-term plan to slash battery costs through specific actions, spending billions of dollars building new factories makes no more sense than giving a $200,000 adjustable rate mortgage to a busboy.
The time for optimistic battery price assumptions and happy talk about future economies of scale is past and we all have to play the cards we’ve been dealt. Under current economic conditions, the only battery technology that has a reasonable shot at being cheap enough to do the job is advanced lead-acid; and even that won’t be certain until asymmetric lead-carbon capacitor technology advances from pre-commercial prototype to finished product.
A journey of a thousand miles may begin with a single step, but I’ve never seen a successful plan that didn’t involve taking every step along the path. There simply are no short cuts.
Disclosure: Author holds a large long position in Axion Power International (NASDAQ:AXPW), a leading domestic developer of asymmetric lead-carbon capacitors. He also holds small long positions in Exide (XIDE) and Enersys (NYSE:ENS) and may make other energy storage investments in the future.