Green Energy Prospecting: Eye on Ocean Power Technologies 10 comments
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Before we take a look at Ocean Power Technologies (OPTT), let's take a brief glance at the energy market. As of this writing, oil has been hitting its all-time highs - the price of oil has been increasing seamlessly for well over a year. Until recently, gas prices have managed to stay relatively low due to a record supply, but with the traveling season upon us, the increased demand for fuel has started to drive gasoline prices upwards as well. The increase in the price of oil and gas would imply that alternative energy producers would be more competitive, but that has not been the case.
Sunoco (SUN), which started selling Verasun (VSE) branded E85 in Rockville, MD, has its flex fuel priced at around $2.70/gallon. Regular gas, at the same station, is selling at $3.40/gallon. Considering ethanol boasts ~80% of the efficiency of regular gasoline, the price parity is an illusion - you're really paying the same price for the amount of energy you get. Nevertheless, increased gas prices have allowed Verasun to increase the price of ethanol as well, but Verasun's stock is still trading at 52 week lows, as are other ethanol producers - like Pacific Ethanol (PEIX). If ethanol was a cheaper substitute to oil, then we should be seeing a completely different picture. But with the rise in the prices of corn and transportation, Verasun and other ethanol producers have struggled with their costs to remain in operation, a testament their stock performance can vouch for.
Indeed, current ethanol pricing is staying on par with increases in the prices of oil, but ethanol producers cannot gain the margins needed to be profitable, even with government subsidies. If oil continues to escalate in price, ethanol producers will be able to increase their margins towards profitability.
For potential investors in alternative energies, this scenario elucidates that alternative energy has to be cost-effective. That is, more money has to be made from the sale of the energy than the cost put into its production, while being competitively priced with the competition. With this in mind, we take a look at Ocean Power Technologies .
The Industry
Transportation fuels like gasoline and jet fuel, petro-chemicals like plastics and many pharmaceutical ingredients are derived from oil. But the energy that we turn into electricity is primarily derived from completely different sources. Of the four major sources of electricity generation in America, ~50% of the electrical power comes from coal, ~20% from nuclear power, ~20% from natural gas and ~7% is hydro-electrical.
Current costs (in cents) per kilowatt/hour fall within the following ranges:
- Natural Gas: 3.9-4.4 Cents/kW-h
- Coal: 4.8-5.5
- Nuclear: 11.1 – 14.5 (elevated inefficiency is mainly a result of political pressures)
- Wind: 4-6
- Geothermal: 4.5 - 30
- Hydro Electric (Dams): 5.1 – 11.3
- Solar: 15-30
The Company
Unlike hydro-electric power, which typically functions by storing and releasing water from reservoirs via dams, ocean power (the process) uses a buoy system that generates energy from the movement of waves.
Ocean Power Technologies has already developed a functional 40kW buoy generator and is on the verge of releasing the 150kW buoy. The upgrade path starts with 40kW and moves through 150kW, 250kW and 500kW. Ocean Power’s time line puts the 500kW buoy in the year 2010.
Their current means of cash flow from operations is from petty government contracts (both national and international) to the tune of $1-$2 million. In the 9 months ending January 31, 2008, operating losses of over $12 million outstripped revenues by almost 400%. On April 30, 2007, Ocean Power completed their initial public offering in the United States, which produced net proceeds of $89.9 million, and as of January 31, 2008 they had about $106 million in cash and cash equivalents. To date, however, the company has never been profitable. Since inception, it has burned through ~$47 million. Management reported in the 10-K that to be profitable without any government subsidies, they must annually sell at least 300 of their currently non-existent 500kW generators.
Aside from the vague statement, management gave very little information about those estimates or the likelihood of meeting these expectations. We will try to fill in the gap and see if these estimates are feasible.
Business Outlook
In order for management’s claims to have any weight, we will have to assume that the cost per kW/hour will be competitive with coal which, depending on the grade, costs between $0.048-$0.055 kW/hour. Therefore, we will assume the end-user cost of electricity produced by the 500kW buoy system to be $0.05 kW/h. Management estimates the life of each buoy at 30 years, but actual buoys that were made were not tested for more than 18 months. Therefore, we will assume a 25-year lifespan, that 8% of revenue will go toward cost of repair and maintenance over the useful life of the buoy, and that there will be 85% runtime (buoy system is shut down during rough seas and stormy weather). Under those assumptions, after 25 years, one buoy would generate almost $4.3 million in revenue. We further assume that whoever buys this buoy would reasonably expect at least a 7% annualized return on that investment. This would put the purchase price of one buoy from Ocean Power at $789,000. Based on these assumptions, $789,000 is the highest price Ocean Power can sell their 500kW buoy. If they plan to sell 300 of them per year, this would put annual revenues at $236.7 million.
The question then becomes what kind of annual costs would Ocean Power need to incur to generate this revenue?
The costs become much harder to estimate. Barely fitting on a truck bed, the current 40kW buoy is 12 feet wide and 52 feet long. Because of the shear size, all consecutive buoy systems will have to be put together on site, which may increase costs beyond current operational norms. Furthermore, the 500kW buoy is expected to be 62 feet wide and 128 feet long -- four times the dimensions of the current 40kW buoy. This translates into more physical parts and resources required toward manufacturing the larger buoy. To accommodate for the increase in production requirements, Ocean Power plans to add approximately 90,000 square feet of leased space by the end of 2010. The costs and location of such a space are as of yet unknown. Head-count is also expected to increase from the current count of 40 to 160. This would likely balloon Selling General & Administrative costs from about $4 million to around $20 million annually.
Furthermore, Ocean Power had net operating loss-carry-forwards for federal income tax purposes of approximately $24.2 million, which begin to expire in 2009. These two obvious expenses would eat away a large chunk of $106 million in cash the company has. With $66 million remaining for operations, it is hard to imagine that this would be enough to manufacture 300 of the 500kW buoys. Ocean Power’s estimate was to get at least 300 of those buoys sold annually, so margins are likely small and require economy-of-scale to allow for profitability. If the highest sale price is $789,000, and we assume very liberally that one buoy will cost $400,000 to make, it will still be an annual cost of $120 million, which their current cash reserves cannot accommodate.
Realistically, the margins will be much smaller than that, and we think it’s reasonable to expect that Ocean Power will seek more funding through the dilution of their stock, debt instruments, or both.
While this is a very promising company, there is too much uncertainty regarding their costs and general operational efficacy. Endurance of their buoys has not been fully tested, which makes energy output and productivity hard to estimate, especially when some of their customers have subsidized costs of maintenance and repair. Also, the competitive market is large, with roughly 30 other companies in their field -- companies like Blue Energy, which promises costs as low as $0.02 per kW/h. Ocean Power’s current market capitalization is trading on par with book value, which is mostly comprised of cash. Due to the small size of the company, it seems very likely that the increased spending on the horizon, and the likely need for more financing, will put more pressure on the stock, which is already trading at half the price of its initial public offering.
No doubt, wave technology is interesting and promising, but whether Ocean Power can deliver return on equity at current valuations seems questionable. In short, it is too early in their production timeline to be confident in Ocean Power’s ability to both increase its operations dramatically and be able to incur the costs of those operational requirements. Until we can see progress in Ocean Power’s ability to effectively scale production, this stock should simply be kept on the radar screen.
Disclosure: none
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This article has 10 comments:
I applaud you for tackling the analysis of Ocean Power Technologies (OPTT). It is difficult to gauge the prospects of a company still under development and by its own admission, still two years from profitability.
I have spent a significant amount of time analyzing this company and others in the alternative energy sector. Let me offer a few points:
1. You begin your analysis with the following assertion: "In order for management’s claims to have any weight, we will have to assume that the cost per kW/hour will be competitive with coal which, depending on the grade, costs between $0.048-$0.055 kW/hour."
You may want to reconsider this line of reasoning in future analyses. While I understand the logic, it misses some very significant points.
First, to an increasing degree, U.S. states are coming under mandates called Renewable Portfolio Standards, which require the utilities to increase their generation of electricity from renewable sources. In spite of the coal industry's efforts to modify its emissions, coal is not clean. Unless I am mistaken, in California, coal is not even an option. Utilities in California are barred from contracting for more power from coal. More states are following California’s lead. Just in case you think resistance to coal is only in California, search for a recent story on the Kansas governor who is blocking construction of new coal plants.
Therefore, using coal as a benchmark and asserting that OPTT's power generation must meet coal's generation costs to compete is an incorrect assumption.
To understand the new paradigm, search for a recent contract by which electric utility Southern California Edison will place 250 megawatts of solar power on distribution centers and warehouse roofs. I can assure you that the solar panels are not generating power at 5 cents per kwh. It is the mandate that the California utilities must generate power from a minimum of 20% renewables that is driving the solar investment.
Second, there is a growing momentum to recognize that the repeated quotation of electricity generation costs from coal at the current “$0.048-$0.055 kW/hour” understates the environmental damage. Add in carbon taxes. Add in carbon sequestration costs. Is generation still at 5 cents? I don’t think so.
2. You base your sales price for an OPTT buoy working backwards from this coal generation cost per kwh. I’ll leave that aside for a moment, to clarify a more important point. I believe you are mistaken that the company can achieve profitability only with production of the PB500 at a production rate of 300 per year. What the company was communicating was that at that rate of production, electricity generation is at 5 cents per kwh, including all costs and profits to OPTT. The company is showing that with the continued scaling of its buoys, it can achieve really low electricity generation costs without assuming an overly aggressive level of production. (Draw a parallel to the wind industry. Do you think the first wind turbines generated power at the current 6 cents per kwh?)
In fact, the company may be able to get to profitability building the earlier generation PB150. At 400 buoys per year, the company estimates an electricity generation cost of 15 cents per kwh. This is without subsidies, incentives, or the investment tax credits and includes a return to OPTT. I am willing to bet that Southern California Edison’s recent solar deal is at 15 cents per kwh or higher. Also understand that the PB150 is already in production.
3. Also understand that the company outsources production of the buoys with the exception of the control system. This is its standard operating model and therefore, the outsourcing costs are built into the cost assumptions. You made it sound as if the company needed to expand dramatically in order to increase production significantly. You may be overstating the expense required.
4. Finally, consider that the equity market capitalization is currently less than the total net cash on the balance sheet. This means that the company’s enterprise value is less than zero. In other words, you’re buying the business for nothing, nada, zip. I can assure you that of all the alternative energy plays I have reviewed, this is rare indeed.
If this company is able to follow the development model of the wind industry, i.e. start with a small model then scale the basic technology to larger and larger versions of the initial model, Ocean Power Technologies will reward its investors handsomely.
Another issue to consider is the transmission costs associated with offshore, these of course should be balanced with the RPS (renewable portfolio standards) and the fact that the market for this is global. Ocean based power is an interesting opportunity and worthy of debate and further analysis as it is where wind was 15 years ago, but moving fast.
Good to see someone noticing OPT. I can't quite praise your article as strongly as others have - frankly I think you need some help with your editing/proofreading process - but it inspired a response from "Alt Energy Analyst" that was outstanding in its accuracy and scope, IMHO. Also, NickGogerty's response led me to his blog, which is the first place I've seen a decent comparison of true costs of energy generation. We constantly hear "wind costs 6 cents/kwh, coal costs 4 cents", etc. - and this sort of information, while it is constantly repeated in the mass media, is a great example of lying by omission. Without a stated payback period, a given energy generation cost is utterly meaningless. For example, in the second year of operation, a coal plant's operating cost is almost entirely fuel cost. By that standard, wind, solar, geothermal, and ocean wave cost absolutely nothing. It is only by specifying a period over which construction costs are amortized, that a cost per kilowatt hour can be calculated.
So, thank you Stan for taking a first shot at analyzing OPT, and AltEnergyAnalyst and NickGogerty for extremely valuable responses.
Stan,
In regards to the response on your site, it's nice to see that you crunched some numbers using another 'ocean power' company. You should've adressed it in your article initially, I think it gives a better perspective about energy production companies like Ocean Power Tech. Overall it was an interesting read, good job.
I just hope that management will come out with some numbers to justify their own estimates and expectations.
Again, this is a layman's observation - I'm neither an expert in the energy field nor an analyst. But I'd think under those circumstances the customer in question would be willing to pay a little more per kwh for their power. The question of competition in my mind relates more to other forms of passive green power -- solar, wind, etc. And there, again, we're talking about very specific regional issues: is there adequate sunlight to get the most out of solar? same for wind? and so on. Either way it seems like we're really talking about a niche power product whose application may be pretty limited compared to traditional power.
Adding to Stratton's comments, I feel that one of the attractive aspect of ocean power is its diminishing cost structure over the years it is producing energy. The up front cost may be large, but once the buoys are up, keeping it going requires minimal maintenance/management cost. Perhaps someone would care to do a multi-year cost study to determine the break even time frame.
I have been to OPTT's web site and looks like they have projects going on in both the east and west cost of US and Spain. They are also considering Australia, Japan and other developed economies. No doubt, they are going global. If they truly succeed in going global, I can see large volume in buoy production going to China, further reducing their cost structure.
Thinking outside the box, some cities may also want to harness ocean energy, but may not be at or near the coast (maybe 50 to 100 miles in land). In this case, I think superconductor will benefit from this growth. Besides considering producers of superconductor, silver may not be a bad future play on this sector since it is the raw material in which superconductor is made.