Solar Energy Going Parabolic, But The Investment Opportunity Is Not There

Includes: KWT, TAN
by: Simit Patel

Gregor MacDonald recently shared a very interesting chart showing that solar usage is going parabolic.

So, this should be a great investment opportunity, right?

Perhaps not so much, if one considers how solar stocks have fared. Two ETFs that follow the solar energy space are Market Vectors Solar Energy (NYSEARCA:KWT) and the Claymore/MAC Global Solar Index (NYSEARCA:TAN). They are down 26.12% and 23.2% respectively year-to-date.

The situation is similar in ways to what is going on with natural gas, in that falling costs have contributed to much greater usage of the energy source in question, but have deteriorated profit margins of many of the businesses in the sector. In such scenarios, it is not so much that there is no opportunity, but rather making sure you are positioned in the right value chain surrounding that opportunity.

For solar, here is my take on how the value network will evolve:

1. I do not share the viewpoint that solar will be the dominant source of energy powering the world, nor do I believe that peak cheap oil, which I regard as very real, is the same as "peak energy." As I've stated many times in articles on energy investing (see this example) I believe nuclear is keystone of the energy mixup of the future. Accordingly, I believe solar energy systems that are designed to be complementary to nuclear power systems will be where we find the most viable and lucrative opportunities for investing in solar.

2. Operating from the viewpoint that solar is ancillary to nuclear, we first need to see the nuclear infrastructure emerge - which I think is already underway. Namely, I believe the grid of the future is rooted in modular nuclear reactors. Although companies like Babcock Wilcox (BWC) are working on modular reactors in the US, I think it will be far more beneficial to see how such reactors develop in China and Africa. That is where I believe we will see the union of modular reactors coupled with solar power to deal with peak hour activity. Africa in particular attracts enough sun to be a more significant user of solar power.

As for why solar needs to be complementary to nuclear, the answer boils down to one word - a word you will almost never hear from the staunch advocates of solar or other renewable energies: density. Solar is not a dense form of energy; fossil fuels and nuclear power are far, far, far more dense. This ultimately means that solar will be expensive and difficult to scale. As Paul Hockenos notes, the IEA estimates that 3/4 of global energy needs will still be met by fossil fuels by 2035. Hockenos also notes that China, while they are investing aggressively in solar and other forms of renewable energy, are planning an energy composite that still relies on fossil fuels and nuclear power.

Because of government subsidies and the marketing appeal of renewables, far too much of what we currently see from solar participants focuses on creating big solar farms or attempts at generating large amounts of solar energy. I view such efforts as doomed to failure. Businesses that focus on creating solar power that serves as a complement to fossil fuels or nuclear reactors - the latter of which I regard as the true future as the price of all fossil fuels begins to rise - will be the ones that find the business model that unlocks returns for their shareholders.

So what's this mean for prospective investors who want to get in on the energy sector? Well, given the view that I've outlined here, it should come as no surprise that my focus on energy is almost 100% nuclear-oriented, with a particularly strong focus on uranium as a fuel for nuclear power plants. One caveat to this view is if there really is so much natural gas in the world that natural gas prices stay low an inordinate amount of time - at which point it may be a good enough source of energy (still has sufficiently high density and lower emissions than other fossil fuels) to justify usage over nuclear. If we keep seeing stories like this one, telling us that countries like Tanzania have seen their natural gas reserves triple, we may come to learn that the world is awash with natural gas and that natural gas is the centerpiece of the energy supply of the future. Then, solar will need to be designed to be complementary to natural gas rather than nuclear.

Still, though, I favor nuclear based on a simple supply demand analysis (see my previous article). Once we see modular reactors becoming more and more commonplace, and we start to see solar companies modify their strategy so that they are complementary to this an environment, then a viable strategy for investing in solar will become clearer. Until then, I think, public market investors who are passionate about solar are better off patiently waiting.

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