CNL Cleco Corp.

Historically, the growth outlook of alternative energy companies has been inversely related to the prices of petroleum products and directly related to the fortunes of the economy. In the near term, however, the fortunes of the alternative energy players are undergoing a radical transformation.

On one hand, the continuing European debt crisis has led to the U.S. Federal Reserve reducing its growth forecast, raised projections for unemployment and leaning on buying more mortgage debt to tide over a troubled economy.

The U.S. economy was not able to completely shake off the negative momentum that plagued it in 2010. In the first nine months of 2011, the economy was affected by unseasonal and harsh weather, heightened uncertainty spawned by the crisis in the Eurozone, a drop in federal defense purchases, and the supply-chain disruptions associated with the Japan quake and ensuing crisis.

As a result the U.S. jobless rate rose to 9.0% in October 2011. Going forward, Zacks expects unemployment rate for fiscal 2012 and 2013 at 8.9% and 8.4%, respectively. U.S. Federal Reserve also raised its projections for unemployment. This has led to implementation of Operation Twist (sterilized large-scale asset purchases) by Fed to lower rates.

As the Fed sells shorter-dated assets and uses the proceeds to buy longer-dated securities, effectively removing duration from the market, longer-dated yields will be kept lower than would otherwise be the case. As a result, we now expect the 10-year Treasury note yield to hover around 2.8% in fiscal 2012, reflecting both persistent flight-to-quality effects and the impact of Operation Twist.

We expect the Euro-area crisis to continue to cast a spell over financial markets. The heightened uncertainty may contribute to sharply lower equity prices and wider risk spreads. This we invariably feel will lead to slow consumer spending and the general pull-back from risk may yet manifest itself in hiring and capital expenditure decisions.

This would not be a welcome environment for alternative energy players who in recent times have been reeling under weak demand owing to the supply glut. Faced with struggling economies, regulators in Europe and U.S. may opt to be tight-fisted over spending on alternative energy projects.

On the other hand, steadily rising oil prices and China’s new solar power tariff regime is a clear pointer for investors to look beyond the near-term earnings horizon for healthier performance. The U.S. Energy Department in its monthly Short-Term Energy Outlook for November increased its crude-oil price forecast for 2011 by 1.6%. The agency now expects that the West Texas Intermediate oil will average $93.80 a barrel in fiscal 2011, up from the October projection of $92.36.

As a result, we believe that the oil price upside will only boost the emerging positive alternative energy narrative.

According to the European Photovoltaic Industry Association (EPIA), the world industry association for solar photovoltaic electricity market, based on a study looking at five major solar markets -- Germany, Italy, France, Spain and Britain -- power generated from solar modules in Europe could be competitive in relation to conventional forms of energy by the end of the current decade.

A number of traditional utility companies have growing alternative energy operations. But the fortunes of some of these companies, particularly those with significant fossil-fuel exposures, are less attractive than their peers.

In the utilities space, we are less optimistic about the prospects of Atlantic Power Corporation (AT), DPL Inc. (DPL), Dynegy Inc. (DYN) and UniSource Energy Corporation (UNS).

Conversely, favorable rate cases and stable sales growth in the respective service areas make companies like CPFL Energia S.A. (CPL), The AES Corporation (AES), Cleco Corporation (CNL) and Duke Energy Corporation (DUK) attractive.

Like everyone else, the Alternative Energy industry was hit hard by the Great Recession and essentially remains in recovery mode. And while the economy is in recovery mode, so is our hope for the industry.

A major growth area in this space is Solar Energy. The U.S. has a lot of catching up to do, despite enormous potential, to get anywhere close to the global leaders. According to the Solar Energy Industries Association (SEIA), the U.S. trade association of approximately 1,000 companies in the solar energy industry, in fiscal 2010 the U.S. solar energy industry grew 67% year over year (compared to overall GDP growth of just 3%) with installations valued at $6 billion. That trend continues in 2011 with new photovoltaic (PV) installations in 2Q11 up 69% year over year.

The agency also strongly believes that solar is already the fastest growing energy sector in the U.S. and by 2014 it will likely be the largest source of new electric capacity in U.S.

According to the European Photovoltaic Industry Association (EPIA), the world industry association for solar photovoltaic electricity market, the cumulative global installed PV capacity stood at almost 16.5 GW at the end of 2010, compared to only 9 GW at the end of 2007. Per EPIA estimates in 2010, Germany ranked first followed by Italy and Spain in terms of cumulative installed solar electric power capacity, as of year-end 2010.

Here we take a look at the Solar Energy space and attempt to identify this nascent industry’s strengths and weaknesses.

OPPORTUNITIES

Environmental advantage: Solar power is one of the most benign electricity resources. Solar cells generate electricity without air or water emissions, noise, vibration, habitat impact or waste generation. Over time, rapid population growth, depletion of non-renewable conventional sources, escalating pollution levels will help shape a much more pronounced global focus on renewable projects.

The long-term bullishness is shared even by oil goliaths like Royal Dutch Shell plc (RDS.A) and BP plc (BP) who expect that by fiscal 2050, one-third of the global energy needs will come from renewable sources.

Fuel risk advantage: Unlike fossil and nuclear fuels, solar energy has no risk of fuel price volatility or delivery risk. Although there is variability in the amount and timing of sunlight in the day, season and year, a properly sized and configured system can be designed to insure high reliability while providing a long-term, fixed-price electricity supply.

In light of the Fukushima Daichi episode in Japan, the global focus has tilted towards solar in a big way. German plans to phase out nuclear power plants by 2022 will definitely boost solar fortunes in one of its largest global markets.

Location advantage: Unlike other renewable resources such as hydroelectricity and wind power, solar power is generally located at a customer’s site due to the universal availability of sunlight. As a result, solar power limits the expense and losses associated with the transmission and distribution from large-scale electric plants to the end-users. For most residential consumers seeking an environment-friendly power alternative, solar power is currently the only viable choice.

Environmental legislations: Alternative energy companies are increasingly benefiting from new legislation in the U.S. stipulating installation of renewable sources of electricity generation as mandated by Renewal Energy Standards (RES). At the federal level, Congress has extended the 30% federal investment tax credit (ITC) to both residential and commercial solar installations until December 31, 2016. Also, under the American Reinvestment and Recovery Act (ARRA), the U.S. Treasury Department implemented a program to issue cash grants in lieu of investment tax credit for renewable energy projects.

Subsidy programs: Governments, most notably in China, Japan, Canada, U.K., Australia, India and the Middle East, have increased their financial support for solar projects. China is aiming at increasing its installed solar power capacity to 10 GW by 2015 from 878 MW at the end of 2010.

In Europe, the European Union's goal of a 20% share of renewable sources in the energy basket by 2020 will keep the flow of new projects going. Specific solar energy stocks under our coverage that stand to benefit from this environment with a Zacks #1 Rank (short-term Strong Buy rating) include Westinghouse Solar Inc. (WEST).

WEAKNESSES

Excess capacity: In the near-term, the solar industry is facing the problem of excess solar cell and module capacity. Going by the trend of solar companies citing sluggish demand and high inventory levels, affecting margins, virtually the whole industry is in a pause. The earlier rush in vertical integration by individual players for self-reliance in their solar wafer/cell needs, has thrown up a lot of unutilized capacity for the industry.

Looking forward to the near-term, the industry, facing a supply glut owing to higher production in 3Q2011, will reflect on the aftershocks of inflated inventory and underutilization of capacity leading to lower Average Selling Prices. Solar players like STR Holdings Inc. (STRI), JinkoSolar Holding Co. Ltd. (JKS) and Real Goods Solar Inc. (RSOL) are in for a turbulent future in the near term.

Recent start-ups: A large number of these companies are recent start-ups with limited resources. As such, quite a few depend on their customers’ ability to finance solar projects and remain exposed to continuing near-term losses due to start-up costs. Companies such as Trina Solar Limited (TSL) and Yingli Green Energy Holding Co. Ltd. (YGE) would fall in this category.

Subsidy roll-back: Budgetary constraints have caused prime global solar markets like Germany, Italy, Australia, U.K. and Taiwan to roll back a portion of their grants. Earlier, sales of solar players from the above countries witnessed a sharp rise mainly fueled by the rush to complete projects ahead of subsidy roll-backs. Going forward we expect to see a paradigm shift from a market hoisted by growing governmental/institutional support to one of stable growth. This may affect companies such as First Solar Inc. (FSLR) and SunPower Corporation (SPWRA), which generate a substantial portion of sales from markets like Germany.

Fortunes tied to crude: Alternative energy stock prices generally rise and fall in direct proportion to the price of crude oil. While in times of high oil prices this may present an opportunity, it also increases volatility in the sector.

As per the latest release by the Energy Information Administration (EIA), which provides energy statistics of the U.S. Government, global crude oil and liquid fuels consumption will grow from its record-high level of 87.1 million barrels per day (BPD) in 2010 to 88.2 million BPD in 2011, and will reach 89.6 million BPD in 2012. In its monthly Short-Term Energy Outlook, the agency said the world fuel consumption growth through 2012 will be largely driven by the increased demand from emerging economies.

New emerging technologies: The alternative energy industry remains an emerging sector with a consistent focus on the lowest-cost technology and cost-competitiveness using traditional means of electricity generation. This may prove disastrous for existing companies ruling the solar roost should a cheaper alternative emerge.
 
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