I had a bit of an epiphany over the weekend because of two unrelated events. First my younger brother announced that he was installing 5.2 kW of solar panels on his house in Arizona. After that a potential client from Dallas described his new line of low-cost high-performance insulation products as "regular guy stuff." In combination, these events clarified and crystallized my thoughts on a fundamental theme that investors may want to use as a touchstone when analyzing alternative energy investments: the difference between regular guy stuff that can solve energy storage problems today and science fair projects that may be economic someday.
For several weeks I've been trying to think of a way to work an excerpt from Merle Haggard's 1981 classic Rainbow Stew into a Seeking Alpha article. The song is all about a regular guy's somewhat jaded view of science fair projects, government promises and the human condition in general. But it speaks the truth in a way that only country music can:
"There's a big, brown cloud in the city and the countryside's a sin;
the price of life is too high to give up its gotta come down again;
when the world wide war is over and done and the dream of peace comes true;
we'll all be drinkin' that free bubble-up and eatin' that rainbow stew.
When they find out how to burn water and the gasoline car is gone;
when an airplane flies without any fuel and the sunlight heats our home;
one of these days when the air clears up and the sun comes shinin' through,
we'll all be drinkin' that free bubble-up and eatin' that rainbow stew."
In the 27 years since Rainbow Stew was released, we've seen immense progress on air pollution; wind energy has become cost competitive; and if my younger brother is a reliable indicator, solar panels have become regular guy stuff. Today the imagination of the rainbow stew crowd is focused on greenhouse gasses, battery powered electric vehicles and the holy grail of hydrogen fuel cells. While there is universal hope that the daunting technological barriers will be attacked and leveled, there is no consensus on which class of technology will win the prize; how long the development path will be; or when the science fair projects will be cheap enough to qualify as regular guy stuff. Until then, regular guys will do what they have always done, start the journey with a single step and build on that progress by putting one foot in front of the other.
Rechargeable batteries are a ubiquitous but largely invisible part of modern life. For the last 100 years they have been the epitome of boring regular guy stuff; growth in the storage sector has been slow; and the companies that make rechargeable batteries have carried rust belt valuations. But nothing stays the same forever and in the rapidly evolving world of alternative energy, rechargeable batteries have become a critical enabling technology to keep the power flowing when the sun doesn't shine and the wind doesn't blow. If my brother can't use all the power produced by his solar panels, his choices will be to (a) waste the excess capacity, (b) sell the excess to his local utility, or (c) store the excess for use after dark. The only thing I know for sure at this point is that he will make his choice based on a careful analysis of the costs and benefits of each option, as will every other regular guy who faces the same decision. My brother's decision, and the individual decisions of millions of other regular guys will be the ultimate drivers of growth in the energy storage sector. To paraphrase Ben Franklin, we have entered an era where a kilowatt saved is two kilowatts dear. Energy storage has already made the transition from a philosophical ideal to an economic necessity for regular guys.
In a May 2008 report on the energy storage sector, Merriman Curhan Ford (OTCQX:MERR) estimated the global market for rechargeable batteries at $20 billion annually with roughly 70% of global sales coming from lead-acid batteries and the remaining 30% coming from other chemistries. The report then stated that catalysts are already in place that could drive demand to $100 billion or more over the next several years. While some of the market catalysts identified by MCF will depend on the development of exotic batteries for electric vehicles, the bulk of the forecast growth will come from regular guy applications that can be adequately served by lead-acid technology; boring stuff like a storage system for my brother's 5.2 kW of solar panels.
Lead-acid is the cheapest rechargeable battery technology in existence and has been the king of energy storage for over 100 years. Lead-acid batteries have a remarkable safety record and with recycling rates approaching 99% environmental issues are almost non-existent. While low energy densities and short cycle lives have historically limited the economic benefit of using lead-acid batteries for large-scale storage, several recent technical developments promise big improvements in performance at a very modest cost. Because of their size and weight, lead-acid batteries are not likely to be the first choice for electric vehicles. But when you put it all together, rumors of the king's illness or impending death have been greatly exaggerated.
Over the last several years, the rainbow stew crowd has aggressively promoted lithium ion as the battery technology of the future for almost every conceivable application. They point to the size, weight and energy density advantages of Li-ion batteries and dismiss critical issues like cost, raw materials availability and a deplorable safety record. They also ignore the fact that every major improvement in Li-ion safety has come at the cost of reduced battery performance. Portable electronic devices have improved remarkably over the last decade, but the bulk of the gains have come from improved device designs, not improved Li-ion batteries. My willingness to speak the truth may be unpopular, but the fact is Li-ion is a mature technology that is simply too expensive for the large-scale energy storage jobs the rainbow stew crowd wants it to do.
I believe the biggest challenge facing energy storage investors is separating rainbow stew hype from economic reality. There is universal agreement that electric vehicles would be good for a host of environmental and economic reasons. The problem is that lead-acid batteries are too heavy for the job and Li-ion batteries are too expensive for the job; which leaves us with a gaping chasm between what idealists want and what battery technology can deliver. The rainbow stew approach is to hope that the newest wrinkle in an aging face will slash the cost of Li-ion batteries and make EVs more than an outrageously expensive status symbol. The regular guy approach is the Pickens Plan: start the journey with a reasonable first step and build on that progress by putting one foot in front of the other. I remain hopeful that we will one day solve the EV battery dilemma, but I see nothing on the horizon that tells me a solution is even close.
If you look at the universe of energy storage companies I've been tracking since mid August, the established manufacturers with the lowest market valuation ratios are Exide (XIDE) and Enersys (NYSE:ENS), lead-acid leaders that have fallen dramatically in price over the last couple of months but are certain to be the first big winners when regular guys buy energy storage solutions. The same pattern holds in the transition manufacturers class where Axion Power International (NASDAQ:AXPW) carries a low market valuation despite the fact that its PbC technology will bring advanced battery cycle-lives and recharge rates to the lead-acid world. In the mid-range you find solid companies like Advanced Battery Technology (OTCPK:ABAT), China BAK (NASDAQ:CBAK) and Hong Kong Highpower (NASDAQ:HPJ) that manufacture advanced batteries for portable devices. At the nosebleed extreme of the valuation spectrum, you find companies like Altair Nanotechnologies (NASDAQ:ALTI) and Ener1 (NASDAQ:HEV) that have not yet manufactured or sold commercial products and are betting their future that a substantial segment of the new car market will pay an immense premium for sub-par performance. I think betting against regular guys in favor of rainbow stew is a sucker's game.
As the energy storage sector grows from $20 billion to $100 billion in annual revenue, there's no question that rainbow stew solutions will grab the bulk of the headlines. But unless and until the fundamental economics of battery manufacturing change, the lead-acid manufacturers who produce cost-effective energy storage solutions for regular guys will make the bulk of the money. As an investor, I believe cash flow trumps rainbow stew every time.
Disclosure: Author holds a long position in AXPW.OB and is a former director of that company.