Last week we mentioned the scientific principle that when the scale of things increases, new and unexpected phenomena emerge. And we pointed out that this will have profound implications for investors in the resource sector.
Coincidentally, the November issue of Scientific American came out last week bearing the cover story, “A Plan for a Sustainable Future,” that unfortunately misses this point. Nonetheless, the article is an important read because it speaks to some exciting opportunities in companies developing alternative energy. And, even more important, despite its faults, the article does give us hope that our children may be able to live a good life on this planet. And, who knows, it may not be too late for us as well.
Let us explain...
WIND ENERGY: WILL IT STAY CHEAP FOR LONG?
The lead writer of the Scientific American article is Mark Z. Jacobson. If you've read any of my last several books, you should be familiar with this name. Jacobson is a professor of civil and environmental engineering at Stanford. I know him personally; we've sometimes lectured at the same conferences. He also has been interviewed twice for TCI.
Our interest in his work arose some eight years ago when he published an article in one of the world’s leading peer reviewed general science journals, Science, in which he argued persuasively that wind energy was a cheaper way of generating electricity than either coal or natural gas. He followed this up with another article suggesting that wind energy could be used (via electrolysis) to generate hydrogen fuel for trucks and automobiles that would be less expensive than gasoline.
Recently, wind has started to get more attention from governments around the world, since it is a proven alternative energy technology. We also think much can be said in favor of wind. It is certainly plentiful, clean, renewable, and apparently cost-effective (at present). However, because of the scale at which the world's energy supplies must be expanded, there's a lot more involved in wind power development than many of its proponents realize.
Jacobson's latest article proposes that 100% of the world's energy needs can be met with a combination of renewable energy sources. The biggest source would be wind, but solar, geothermal, and tidal energy would also play a role. While it may be theoretically possible for such a plan to work, we must consider that, in science, the answer to every problem always gives rise to further questions. Answers are always changing as knowledge expands and new problems emerge.
It may be true, for instance, that a small number of wind turbines built today might produce electricity cheaper than a coal-fired plant. But Jacobson's plan calls for 3.8 million wind turbines spread across the planet, each one large enough to produce 5 megawatts of power. It's hard to imagine a construction project on that scale that would not suffer from resource constraints.
For instance, let's take the most readily available commodity that would be used in making wind turbines: iron ore. Iron is one of the most common minerals in the earth's crust. Combined with nickel and other metals, iron is the major component of steel. Among all the major raw materials on the planet, iron is putatively the one the world is least likely to run short of.
But let's look a little closer.
Today, there are three major steel-exporting nations: India, Australia, and Brazil. Together they provide 70% of the world's exports of iron. Not surprisingly, China is the world's largest iron consumer and importer.
Apart from these three, most countries that produce iron ore use it entirely to satisfy domestic demand. They have no excess available to export. In fact, India has been hinting recently that it may need to stop exporting iron because its own consumption has been rising faster than production. That would leave us with just two iron exporters in the fairly near future.
Despite the economic recession, the iron market is expected to grow by 4 percent to 5 percent annually to support the construction taking place in the developing world and elsewhere. We think there is real question as to whether Australia and Brazil will be able to keep up under current conditions, never mind the proposed 20 percent or more additional demand for iron ore that Jacobson’s proposal would imply.
For one thing, though Brazil’s and Australia’s reserve base is a small fraction of the world's total iron ore reserves, it is particularly rich in iron and has a massive infrastructure that allows the iron to be transported to its desired markets. If we conservatively assume their currently stated reserves are accurate, and apply standard geological analysis, their iron production from existing reserves will likely peak within the decade – and perhaps within seven years or so if additional demand for turbines comes to the fore.
In order to continue to produce iron, they would have to develop reserves that are uneconomical today. At the very least, this means the price of iron ore must rise to new heights. This would add considerably to the cost of building wind turbines. The price of iron ore has, incidentally, been rising faster than the price of oil over the past decade.
However, there's no guarantee that enough new deposits could be developed fast enough to prevent wind turbines from becoming cost prohibitive. With India out of the picture, the world would have to turn to places like Russia and the Ukraine.
Frankly, we doubt these countries could deliver enough iron to meet the world's demand. For one thing, they would have to spend massive amounts of energy and resources (including steel) building the infrastructure to produce iron ore. Delivery would also be a problem. Building just one 5mw turbine takes over 1,000 tones of steel. Multiply that by 3.8 million turbines and you get some idea why nearly preternatural infrastructure and transportation costs are associated with the development of iron ore deposits.
So, while Jacobson gives us hope that the world could achieve a sustainable energy supply, the actual details will be fraught with snags. It will be a tremendous exercise in research and planning. After all, if even the most abundant raw materials could suffer from supply shortages, what about those essential resources that are considerably rarer?
Jacobson's plan (including its vision of renewable energy sources other than wind) would be limited by supplies of other minerals such as silver and rare earth minerals (which are called “rare” for a very good reason). Copper, too, would be required for all energy supply growth. Yet copper prices have also risen much faster than oil over the past 10 years.
Clearly, while all this spells a great challenge for the world, it is also creating some exciting opportunities for investors...
3 STOCKS THAT WILL RIDE THE WIND BOOM
Companies that produce iron ore should provide strong profits over the next few years as a result of the developing world's growing need. If nations start building windmills on the scale Jacobson proposes, the profits should be even higher. Currently, the top 2 iron miners are Vale (NYSE:VALE) and BHP Billiton (NYSE:BHP).
As for wind energy firms, we continue to like the largest wind company in the U.S., FPL-OLD. FPL has a lot of downside protection because of its utility business.
Naturally, many other companies will benefit as the world seeks greater energy supplies, but these three are an excellent place for investors to start.