New Solar ETF Shines
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Solar is the prodigal son of alternative energy. Solar technology companies were shunned in previous decades for losing millions in an impossible attempt to compete with fossil fuels. With fossil fuel prices sky high, investors now welcome back solar with open arms.
Claymore/MAC Global Solar Energy Index ETF (NYSEArca: TAN) has introduced the first pure solar energy play. TAN fills an important niche with a well-thought out ETF. It arrives a bit late to the party, because valuations are lofty, but its time will come.
'These are real companies,' said Christian Magoon, President of Claymore Securities, Inc. 'Of the 25 companies in the index, 20 of them were profitable in 2007.' Profitability is not uniform because most of the companies are in fairly early stage growth mode. Annual revenue growth of 50% is common.
It is easy to see what makes solar so attractive. It generates no greenhouse gas emissions, benefits from chipmaking advances, can serve tiny off-the-grid as well huge utilities applications, and has substantial political backing.
Still, solar remains one of the most expensive ways to generate electricity. Advances in solar cell output have been relatively slow. Solar produces less than .1% of electricity worldwide, many times less than nuclear and hydro and significantly less than geothermal and wind. And wind is growing much faster.
'The big dilemma in solar is getting over the big capital outlay,' says Magoon. 'Innovation is going to be a major growth factor for the solar industry.' A breakthrough product could strike paydirt, but the pressure is really on because other alternative energy sources are benefitting from economies of scale.
'Solar power may not need to achieve grid parity given its minimal environmental impact,' notes Magoon. 'What helps and will continue to help is government subsidies.' But these statements are equally true of some other low-impact energy sources.
The most promising solar strategy is little-known but decades old thermal solar technology, which uses arrays of mirrors to heat molten salt to power generators. In March FPL Energy, the largest operator of solar power in the U.S., said it plans to build and operate a 250-megawatt solar plant in California's Mojave Desert. Cost of electricity from thermal solar is estimated at 16 to 20 cents per killowatt hour, compared to under 10 cents for most fossil fuel plants. The more plants are built, the faster that gap is expected to close.
The World Bank summarized solar thermal's benefits in a 2006 report on the nascent industry:
'Solar thermal, based on a hot fluid, can integrate well with conventional thermodynamic cycles and power generation equipment, as well as with advanced, emerging technology. It offers dispatchable power when integrated with thermal storage, and thus good load matching between solar insolation (exposure to sunlight) and the strong growth (in many countries) in electrical demand during summer. The collector technology itself is constructed of predominantly conventional materials, glass, steel, and concrete, and no fundamental scientific breakthroughs are required for the cost to continue to drop.'
Better known than thermal but trailing in the cost race are photovoltaic cells, which generate electrical current when the sun strikes them. PV has the unique ability to be placed in small batches where it is needed, on or off the grid. Southern California Edison this March announced plans for a 250 Megawatt PV installation distributed on warehouse rooftops in the Los Angeles basin. Producers are ramping up to meet such demand. US-based Fluor is in the midst of building the world's largest new polysilicon facility in China at a cost of $1 billion.
Magoon notes that 'solar power may not need to achieve grid parity given its minimal environmental impact. Environmentally conscious US states like California and countries like Germany are mandating a minimum of alternative energy usage despite far higher costs.
'We have seen people who want their money to match their morals,' said Magoon. TAN is an obvious candidate for Green investors. But Green investors need to be aware that alternative energy stocks and solar in particular are volatile. 'It's a wild ride. Solar stocks, and thus the index, have and will experience volatility.'
The high valuations and growth rates of TAN's stocks attracts speculators. On its second day TAN saw 1 million shares trade, which is impressive for a niche ETF but also a sign of potential volatility. Such volume helps pay operational costs and provide liquidity which benefits all investors.
We cannot say much more about TAN's volatility because its undelryling index, MAC Global Solar Energy Index, is brand new. This is unfortunate, because most investors find historical price charts essential for getting a feel for volatility of an ETF.
TAN's index, however, is to be congratulated for avoiding a common mistake among alternative energy and other niche ETFs: inclusion of giant multinationals just because their involvement in solar is significant.The solar divisions of these behemoths are larger than many pure play firms but still are only a fraction of the parent company's overall business. Investors are exposing themselves mostly to non-solar activity in owning a giant multinational. TAN sensibly excludes any firm which generates less than one third of its revenues from solar.
Experienced traders may plunge into TAN immediately. Long-term investors, however, are best to watch TAN's gyrations for at least several months to get a better picture of its considerable volatility. Because its component stock companies are growing so fast, unusually high valuations are likely to remain the norm. If fossil fuels remain expensive, which appears almost certain, then over the very long-term solar cannot help but prosper.