I've been blogging about the energy storage sector since last July because batteries, single purpose devices that most of us take for granted unless they need to be recharged or replaced, are an essential enabling technology for cleantech, the sixth industrial revolution. With this week's impressive launch of A123 Systems (AONE), the tsunami of investor interest I've been predicting since last fall has finally arrived. Since the A123 Systems IPO has introduced an entirely new class of investors to the energy storage sector, this seems like a particularly good time to go back to square one and explain how energy storage is different from other technology classes. Since I've already written extensively on most of these issues, this article is full of hyperlinks to earlier blogs.
Energy storage is a diverse industrial sector that encompasses a variety of mechanical, electrochemical and electrostatic devices and eighteen pure play public companies that range from well known to unknown. Since some of my earlier blogs came across as fairly harsh, I'd like to make it clear from the outset that I believe there is tremendous long-term potential in every energy storage technology. While I've turned some readers off through my outspoken criticism of wasteful planned uses for extraordinary storage devices and my general disdain for companies that let their stories outrun their business fundamentals, reader comments on my blogs are usually extensive and a well-informed group of regular commenters adds a balance and perspective that I could never achieve on my own. So if you have questions please ask. If I don't know the answer there's a good chance one of my readers will.
Over the last year, I've spent uncounted hours blogging, responding to reader comments and trying to debunk some of the more common misconceptions about energy storage. Those efforts ultimately lead me to a four-sided analytical framework that I believe every energy storage investor needs to understand. The four sides of the framework are:
- Batteries rely on chemistry, rather than physics, so the rapid rates of change we've come to expect from information technology and electronics will be rare in the battery industry. Moore's Law simply does not apply. It's perfectly reasonable to assume that battery technologies will continue to improve at single digit annual rates, but expecting disruptive changes that result in huge cost reductions or performance gains is unreasonable.
- The battery business is hard-core manufacturing and revenue growth will be tied to the construction of new factories, a process that requires substantial amounts of time and money. Accordingly, the time lag between a new product announcement and the receipt of substantial revenue from product sales will typically be measured in months or years, rather than weeks. Moreover, revenues will tend to stair-step as new factories come on line instead of following a smooth upward trend.
- Battery manufacturing requires huge amounts of raw materials that typically account for 70% to 80% of total production costs. So while material constraints have not been major issues in many new industries, they can be important issues for batteries that are based on scarce or expensive raw materials.
- The cleantech revolution will be unlike anything that's gone before. For the first time in human history we live in a world where six billion people know about the lifestyle that 600 million of us take for granted. Since they know there is more to life than bare subsistence, each of them is working very hard to earn a small piece of the dream. The only way to accommodate six billion new consumers without catastrophic conflict or horrendous environmental damage is to find relevant scale solutions to chronic shortages of food, water, energy and every commodity you can imagine. The first, and perhaps the most important, step down that path is the minimization of waste in all its pernicious forms.
Investors who learn these framework principles and rigorously adhere to sound discipline can prosper in the energy storage sector. Investors who ignore the framework principles and go off chasing rainbows do so at their peril.
Last fall I wrote an article titled "Alternative Energy Storage: Lithium, Lead or Both?" It remains a personal favorite because it explains a number of important energy storage concepts in simple terms, discusses the history of the battery industry, explains the economic and technical drivers that brought the industry to where it is today, and explains why I believe that:
- Commercial and industrial energy storage decisions will always be based on detailed studies that carefully weigh the fully loaded cost of storage against the value of the stored energy;
- Consumer energy storage decisions will be very sensitive to both front-end costs and back-end energy savings;
- There is no silver bullet technical solution to the energy storage problem and our clean energy future will require the use of several different storage technologies; and
- The prize will ultimately be shared by dozens of companies instead of being concentrated in one or two.
Like many commenters, I'm not excited about PHEVs and EVs, but the reasons for my cynicism go beyond the commonly cited issues of high-cost, uncertain reliability, and unknown consumer demand. I'm an unrepentant critic of cars with plugs because they waste battery capacity; an expensive resource that I believe will become increasingly precious over the next three to five years. The popular Prius from Toyota (TM) uses 1.5 kWh of battery capacity to slash fuel consumption by roughly 40%. The planned GM Volt will use its much larger battery capacity far less efficiently. If the goal is to reduce dependence on imported oil, we're far better off using our available battery production to build large numbers of Prius class HEVs that cost $22,000 each than we would be using the same battery production to build a small number of Volt class PHEVs that cost $40,000 each. If the goal is to reduce C02 emissions, the contrast is even bleaker because most of the electricity to power Volt class PHEVs will come from coal and natural gas fired power plants for the foreseeable future.
According to Frost & Sullivan, the global lithium-ion battery market was roughly $7 billion in 2008, including $5.5 billion for consumer products, $1.5 billion for industrial products and $28 million for transportation. While a number of new lithium-ion battery plants are planned, some of them won't be built and those that are built won't go into production for another couple of years. Since the NiMH batteries that are currently used in most HEVs are seriously resource constrained and demand for all classes of HEVs is expected to skyrocket over the next five years in response to aggressive European CO2 emission standards and accelerated U.S. CAFE standards, I have no doubt that every lithium-ion battery developer with an operating factory and a quality product will have more customer demand than it can possibly satisfy. I also expect the emergence of more robust lithium-ion batteries to create entirely new classes of demand that we don't even recognize today.
On balance my sense is that A123 is probably trading at or near a reasonable value given its financial condition and short- to medium-term revenue prospects. I'm not as sanguine about the valuations of some of the other domestic lithium-ion battery developers because their financial condition is far weaker than A123’s and they've let their stories and stock prices get ahead of business fundamentals. As a result, I don't see a tremendous amount of short-term upside potential in the lithium-ion subgroup.
Notwithstanding my neutral outlook for the lithium-ion subgroup, I continue to believe that the lead-acid subgroup including Enersys (ENS), Exide Technologies (XIDE), C&D Technologies (CHP) and Axion Power International (AXPW) have significant short-term upside potential because lead-acid batteries have been unfairly criticized by lithium-ion battery developers for years and the companies that make them have been largely ignored by a market that's obsessed with searching for the next big thing. Over the next few years, revenue growth in the lead-acid subgroup should outpace revenue growth in the lithium-ion subgroup by a wide margin. Moreover, the companies in the lead-acid subgroup all trade at substantial discounts to their flashier cousins. When I was much younger, a wise old stockbroker taught me that the secret to successful investing was to buy undervalued stocks, hold fairly valued stocks and sell overvalued stocks. Based on everything I know about the battery industry, I believe that cheap will continue to outperform cool over the next year the same way it has since last November.Disclosure: Author served for four years as a director of Axion Power International (AXPW) and holds a large long position in its stock. He also holds small long positions in Enersys (ENS) and Exide Technologies (XIDE).