Green And Coal Energy Company Hedging Costs

by: David Pinsen

Green versus coal energy companies

First Solar, Inc. (FSLR) rose 6.7% on Wednesday, on news of its CEO's ouster, but the company is still down 65% year to date. It's been a tough year for First Solar investors, and the recent failure of Solyndra has cast a broader pall over the solar industry, which has so far failed to live up to the promises of some of its advocates.

Despite years of government subsides, as of July, 2011, wind and solar comprised such a small percentage of electric power generation in the US that the Energy Information Energy didn't break them out separately, and instead bundled them together with biomass and geothermal in this report. The pie chart from that report (a screen capture of which appears below) shows how little electricity is generated from these green sources in America (5.1%) versus from coal (43.3%).

(Click charts to expand)

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A look at the hedging costs of green energy versus coal companies

For the table below I looked at the costs of hedging First Solar, Inc. and four other leading green energy companies, along with 5 leading coal producing companies against greater-than-20% declines over the next several months, using optimal puts. As the data in the table show, these stocks turned out to be expensive to hedge, with three of the green energy stocks too expensive to hedge using a 20% decline threshold. First, a reminder about what optimal puts are, and why I've used 20% as a decline threshold; then, a screen capture showing the current optimal puts to hedge one of the coal stocks, Peabody Energy (BTU).

About Optimal Puts

Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. Portfolio Armor uses an algorithm developed by a finance Ph.D. to sort through and analyze all of the available puts for your position, scanning for the optimal ones.

Decline Thresholds

In this context, "threshold" refers to the maximum decline you are willing to risk in the value of your position in a security. You can enter any percentage you like for a decline threshold when scanning for optimal puts (the higher the percentage though, the greater the chance you will find optimal puts for your position). I have used 20% thresholds for each of the securities below. Essentially, 20% is a large enough threshold that it reduces the cost of hedging, but not so large that it precludes a recovery.

The Optimal Puts For BTU

Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of BTU against a greater-than-20% drop between now and March 16, 2012. A note about these optimal put options and their cost: to be conservative, Portfolio Armor calculated the cost based on the ask price of the optimal puts. In practice an investor can often purchase puts for a lower price, i.e., some price between the bid and the ask.

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Why there were no optimal contracts for 3 of these stocks

In some cases, the cost of protection may be greater than the loss you are looking to hedge against. That was the case with 3 of the green energy companies below. On Wednesday, the cost of protecting against greater-than-20% declines in those stocks over the next several months was itself greater than 20%. Because of that, Portfolio Armor indicated that no optimal contracts were found for them.

Hedging Costs As Of Wednesday's Close

The green energy stocks below are listed in descending order by market capitalization; the coal stocks that follow are listed in that order as well.



Cost of Protection (as % of position value)

Green Energy Companies
(FSLR) First Solar, Inc. No Optimal Contracts
(CVA) Covanta Holding Corporation 8.97%*
(GTAT) GT Advanced Technologies No Optimal Contracts
(ORA) Ormat Technologies, Inc. 9.62%*
(AMRS) Amyris, Inc. No Optimal Contracts
Coal Energy Companies
(SSL) Sasol Limited 14.0%*
(BTU) Peabody Energy 7.93%*
(CNX) CONSOL Energy, Inc. 10.1%**
(ANR) Alpha Natural Resources, Inc. 15.7%*
(NYSE:WLT) Walter Energy, Inc. 16.3%*
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*Based on optimal puts expiring in March 2012.

**Based on optimal puts expiring in April 2012.

***Based on optimal puts expiring in May 2012.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.