By GRAHAM FROST 24/11/2006
Alternative energy is big news these days. Barely a day passes without global warming hitting the headlines and governments are under increasing pressure to push energy consumers towards cleaner alternatives to fossil fuels. Even China, the world’s second biggest emitter of greenhouse gas (after the US), this week announced that it will build the world’s largest solar power station.
However, although alternative energy will undoubtedly grow in popularity (even some of our wealthy neighbours in Mayfair are swapping their Bentleys for greener ‘G-Whiz’ electric cars), does it make a sensible investment?
| "The key point to remember is that alternative energy companies are very dependent on the oil price." |
The key point to remember is that alternative energy companies are very dependent on the oil price. High oil prices increase the attraction of alternative fuels; one of the primary reasons the sector has boomed in recent years. If the oil price is low then there’s little incentive to use alternative sources of energy without juicy tax advantages or being compelled to do so by legislation. The chart below, which compares an alternative energy investment trust to the energy sector and main stockmarket clearly illustrates this point:
Nonetheless, the longer term prospects are arguably very compelling. One way or another, demand for alternative energy will soar and the successful companies in this sector stand to make a mint. There’s also bound to be increasing Government subsidy in this area, another reason to be bullish. The biggest immediate challenge is identifying the winners from the losers, both in terms of alternative energy types and the companies developing the new technologies and processes. Doing so is a high risk game, as highlighted by ITM Power (an AiM listed company that is developing hydrogen fuel cells). The shares catapulted from 166.5p to 335p on 19 April this year following encouraging news from recent fuel cell tests, but have since fallen back to around 160p. The company originally floated on AiM in June 2004 at 50p a share. The share price then doubled within eight months, moved by more than 25% in both directions over the next six months, before starting a meteoric climb to its peak in mid April and fall since then.
Even using investment funds does little to mitigate volatility, in part due to high correlation with energy prices. For example, the Merrill Lynch New Energy Investment Trust has turned £100 into £201 over the last three years. However, in the 12 months to April 2003 the trust shrunk £100 into £31. It has also fallen by 20% over the last six months. Despite such volatility investor appetite appears healthy, perhaps due to strong three year performance; the trust is currently trading at a 2% premium to net asset value whereas most investment trusts are trading at a discount. Such funds also tend to have a high US exposure, so currency movements can further increase volatility.
A potentially safer way to access this sector is via funds which supply renewable energy, such as wind power, to large power companies. This reduces risk as the funds usually have long term contracts in place, so as long as they can supply the renewable energy then income should flow into the fund. Two Venture Capital Trusts, Keydata Income and Ventus have proved popular in this area. While neither is raising money at present, they may look attractive on the secondary market in years to come.
| "You may already have high exposure to the oil price through your existing portfolio..." |
While the long term prospects are exciting, we believe that alternative energy funds are still too high risk for most investors. You may already have high exposure to the oil price through your existing portfolio, so adding an alternative energy fund could be a step too far. If you do invest you might hit the jackpot shorter-term, but plan to invest for at least 10-15 years in case you don’t!
Risk Warning
Venture Capital Trusts (VCTs) and AiM shares should be regarded as higher risk investments. Past performance should not be seen as an indication of future performance and the value of investments and the income from them can rise and fall. Levels and bases of taxation can change and the availability of tax reliefs will depend upon individual circumstances. It can be difficult to sell VCT and AiM shares at times owing to lack of liquidity in the market. Forced sales in an unwilling market can lead to prices considerably lower than the standard price quote. The rules applied by the London Stock Exchange to companies whose shares are traded on AiM are less onerous than for the Official List. You should not invest in AiM shares unless you can afford to lose your entire investment and both VCTs and AiM shares should only represent a small part of an overall portfolio.