From the June 2010 issue of Research Magazine • Subscribe!

Will Clean Energy Thrive?

It wasn't that long ago that crude oil was over $150 per barrel and the world was clamoring for alternative energy sources. Politicians and the public were angry and motivated. Clean energy stocks were soaring and the moon was the next stop. But shortly thereafter, oil prices dramatically fell and the financial crisis took center stage. What happened? And is clean energy investing still a good investment theme?

Like most emerging industries, alternative energy is volatile and littered with risks. Most companies within the sector have yet to turn a profit. It's very similar to the good old days in the late 1990s when many Internet startups were all promise and no profits. Some succeeded, but most failed.

Robert Wilder CEO and founder of Wildershares describes today's clean energy market as a "mixed bag." And in 2010, clean energy stocks have lagged conventional energy stocks along with underperforming broader stock indexes.

Does this spell trouble for alternative energy sector?

Alternative energy typically uses renewable resources like sunlight, wind, rain, tides and geothermal heat to produce energy. Unstable oil prices, concerns about global climate change and the U.S. government's growing support of renewable energy through legislation have driven the push to commercialize alternative energy sources.

Still, alternative energy faces many obstacles.

Tight credit markets along with falling natural gas prices have eliminated or stalled many alternative energy projects. Even without these obstacles, new methods for producing energy can take many years before becoming accepted standards. Furthermore, for alternative energy to really succeed, people's behavioral patterns must shift away from old ways of thinking to new ones.

Many companies within the alternative energy sector are funded by venture capitalists and not yet publicly traded. The vast majority of investors will never get the opportunity to invest in venture funded start-ups and even if they could, most probably couldn't stomach the risk.

The next best option may be alternative energy ETFs. Let's analyze them.

Nuclear Option

The construction of nuclear plants has two primary barriers: financing and time. The last completed nuclear reactor, Watts Bar-1, went online in 1996 but it took 24 years to complete. The estimated cost of a new nuclear plant in the U.S. is $6-10 billion. As a result, it's usually more economical to stretch out the life of existing plants by installing additional reactor blocks.

The Market Vectors Nuclear Energy ETF (NLR) follows the performance of nuclear stocks inside the DAXglobal Nuclear Energy Index. NLR currently owns 24 different nuclear stocks and has a small year-to-date loss of 0.13 percent. NLR's annual expense ratio is 0.61 percent.

Solar Potential

Solar energy uses photovoltaic panels to capture energy from the sun which is then converted into electricity. In 2009 around 2,000 megawatts of solar capacity were generated. Still, solar energy accounts for less than 1 percent of U.S. electricity production.

After recording large gains over the past five years, solar stocks have recently stalled. "The sector is now seeing pricing pressure as cheap China panels flood the market and margins collapse," observes Wilder. "In time increased global capacity to make panels may lead to some select stock winners, but now is not that time."

Solar ETFs like the Claymore/MAC Global Solar Energy Index ETF (TAN) and Market Vectors Solar Energy ETF (KWT) have lagged the broader stock market by posting double digit year-to-date losses. Put another way, solar stocks have become a contrarian investor's delight.

Wind Rising

Using wind to generate electricity has become a fast growing segment within the alternative energy sector. It's plentiful and it produces no greenhouse gas emissions.

Wind turbines make electricity, wind mills are used for mechanical power and wind pumps are used for pumping and draining water. Particularly in the western U.S., wind farms, which are groups of massive wind turbines, can be seen along various highways. The farms are plugged into the electric power transmission network to feed power to substations located near population centers. Historically, these substations have used natural gas and coal-fired power sources, but wind is now fulfilling more and more power demand. The U.S. Energy Department recently projected that wind could potentially meet 20 percent of U.S. electricity demand by 2030.

Recently, a long delayed offshore wind farm in Massachusetts received approval after a protracted political fight involving whether the project would disturb local scenery and recreation.

The First Trust ISE Global Wind Energy Index Fund (FAN) and the PowerShares Global Wind Energy Portfolio (PWND) each follow the emerging wind sector.

Transportation Plays

Those who believe the clean transportation movement is a head fake might want to reconsider. Warren Buffett has placed his bets on China BYD, which plans to unveil a compact electric car to be sold in China later this year. Venture capital juggernaut Kleiner Perkins Caufield & Byers is backing Fisker Automotive, a maker of environmentally friendly sports cars.

Some of the most advanced electric powered automobiles ever to be manufactured are making their way onto the road. GM's Chevrolet Volt is a hatchback that rides four people and is due later this year. Nissan is manufacturing an electric 5-passenger car called Leaf. Tesla Motors is a privately held Silicon Valley-based company that produces an electric powered sports car called the Roadster. Most of these automobiles are designed to travel at least 100 miles on a single charge.

Despite technological progress, the sale of electric vehicles is still hampered by price and practicality. For instance, Tesla's Roadster has double the energy efficiency of the Toyota Prius, but as a sports car it lacks mass appeal to the broader consumer market. Even after factoring in the $7,500 federal tax credit, the Roadster still has a steep base price of $101,500.

Because the clean transportation movement is still tiny and fragmented, getting direct market exposure to public companies within this emerging space via a mutual fund or an ETF isn't yet feasible. Nevertheless, limited opportunities exist.

Quantum Technologies (QTWW) is a publicly traded company that provides technology to Fisker Automotive. And Tesla Motors filed a preliminary prospectus with the SEC in January indicating its plan to go public.

Broader View

For a broader industry sector approach, see the Market Vectors Global Alternative Energy ETF (GEX), PowerShares WilderHill Clean Energy Portfolio Fund (PBW) or the PowerShares WilderHill Progressive Energy Portfolio Fund (PUW).

Each of these funds cover a range of emerging technologies like biofuels, wind power, hydroelectricity, geothermal power and solar energy. Instead of betting on single technology, a diversified approach allows you to capture the power of many. Annual fund expenses for diversified clean energy ETFs run between 0.60 and 0.62 percent.

Despite poor performance by clean energy ETFs, a reversal is never off the table. Wilder notes, "Oil is volatile and another spike over $100 could mean back to the races for clean energy." However, with alternatives more costly than conventional energy, they could flounder for a while longer.

One more thing: Before you conclude that traditional energy stocks will go the way of the dinosaur, just know that many companies have already embarked on alternative energy projects in order to stay competitive. Unlike their upstart competitors, they have deep pockets and experienced management.

To that end, investing in the Select Sector Energy SPDR (XLE) is another way to get exposure, albeit indirect exposure, to the wild world of alternative energy. XLE contains 40 energy stocks that inside the S&P 500. Top holdings include Exxon Mobil, Chevron, and Schlumberger. XLE has gained around 9 percent on the year.

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