Clean Tech 2.0 – Megatrends In-Tact, Survivors Emerging

Survive first, and make money afterwards.
– George Soros

In managing the Essex Global Environmental Opportunities Strategy (GEOS) we remain strictly focused on environmental technology, with financial analysis an equally important component of our investment process.  During a very difficult period for clean tech investing, we have consistently executed our investment philosophy and process, ensuring GEOS is the nexus of environment and finance.  Since GEOS performance inception of June 2009, the Wilderhill Clean Energy Index (ECO) – a broad measure for clean tech – has returned nearly -55%, leaving investors to question the long-term viability of clean tech and new energy investing.

GEOS invests in companies that enable commercially-viable new energy and resource optimization technologies and services.  GEOS owns the survivors, with viable businesses that we strongly believe will execute and prosper in this period of recovery and differentiation.  The megatrends we have often described are not only in-tact, but we believe are growing stronger, enabling Clean Tech 2.0, where fundamentals take hold, adoption rates increase, and margins expand.  In the words of George Soros, it is time to make money.

The clean tech cycle since 2002 is not unlike other technology cycles, whether the dot-com boom or the telecommunications revolution.  In the early days of clean tech growth from the low in 2002 to the high in 2007, the ECO Index rose nearly +277%, driven by rapid non-OECD economic growth and related commodity price pressures which stoked fears of prohibitively expensive global energy.  Concerned governments, led by the EU, adopted generous incentive schemes to encourage development of alternative energy sources which led to a surge of capital investments in wind and solar energy, and smart grid technologies.  As with every boom, irrational exuberance led to unrealistic assumptions of clean tech adoption rates and related profitability.  Capital was cheap and poorly allocated, leading to huge excess capacity in the aftermath.  As just one example, the solar industry is still dealing with the fall-out of the massive build-out of poly silicon supply chains, causing great demand and supply imbalances and crashing profitability.  Over the past two years, clean tech stimulus has been reined-in, as government austerity plans have led to clean tech subsidy cutbacks, punishing companies with uneconomic business models and clean technologies having little commercial viability.  As the clean tech correction advanced, we have witnessed industry consolidation, and a landscape littered with companies that were rushed to the public IPO markets pre-maturely.

There are many parallels between the performance of clean tech shares these past few years, with that of the internet companies of the mid-1990s.  Post the dot-com bust, the internet industry has thrived, with the consideration of risk and prudent capital deployment leading to more sustainable and profitable industry growth.  As Amazon and eBay emerged from dot-com 1.0, those investors with the vision to commit capital following the dot-com crash have experienced Google, Facebook and continued strength in stalwarts such as Amazon.  This more constructive environment was structured due to considerations of business risk and disciplined capital allocations, leading to healthier and more sustainable industry growth.  The unique and highly profitable business models and fruitful innovations have led to well-financed companies and returns for investors.  Clean tech is at this transition point currently, and we believe clean tech 2.0 is unfolding.

As we have often posited, the need for new and clean energy technologies and resource optimization is increasing, with the multiple global secular trends placing great stresses on our natural resources and climate.  As the long-term catalysts for clean technology grow in importance, the near-term case is compelling, and building.  We conduct a few hundred company meetings each year, assessing our GEOS universe, to determine leading technologies positioned for natural resource optimization.  We are observing increasing action on the part of large multi-national companies, across economic sectors, to invest in clean technologies to limit business risks, increase competitive differentiation, and generate strong returns on capital.  The investments are happening now, driven by the commercial viability of clean tech to deliver energy-saving solutions for companies wishing to diversify and hedge continued strong commodity pricing pressures.  Many investments center on lessening the risks due to high oil prices, exhibited below in the 25-year chart below of Brent Crude prices.  The 200% increase of oil since the Great Recession of 2008 is an example of the non-OECD countries, primarily China, driving marginal demand.

Brent Crude Price, 25 years

Source:Bloomberg                                                                                                                                                                                                                

In many instances, we have reached the tipping point where the economics have finally caught up with previously lofty expectations.  Companies are investing in clean technologies because they make economic sense, not due to government subsidies.  With solar module prices plunging below $1/watt, solar energy makes economic sense, and adds to business flexibility given its distributed nature – the energy is owned, and the costs are sunk at currently attractive rates.  A major GEOS clean tech and efficiency theme is LED lighting, with its 75% energy cost savings versus traditional incandescent bulbs along with much longer lifetimes.  LED light bulbs and systems are starting to be widely adopted in general lighting applications following manufacturing advances and related cost decreases that enable lower price points versus incumbent lighting solutions.  Another example is natural gas engine technologies, which are now being adopted by mainstream trucking companies as an important means to hedge their diesel fuel risk while capitalizing on the significant cost differential between natural gas and diesel prices.  This cost and risk mitigation advantage is had while surpassing new Environmental Protection Agency (EPA) regulations regarding diesel particulate matter.

The reasons to embrace clean tech are many, from the longer-term secular trends such as non-OECD economic growth, to lessening inflationary pressures given soft and hard commodity price pressures.  We are in the midst of a major industry transition, and we remain fully committed to clean tech, as we believe clean tech 2.0 is emerging.  We are focused on investing in the survivors and new leaders that are emerging.