IT’S DIFFICULT TO BE neutral on the subject of global warming. There are political agendas, religious agendas, and financial agendas on both sides of the equation and often these agendas are even merged with one another.
You can decide where you stand along the spectrum from confirmed believer that manmade warming is occurring to dedicated denier, but, in the end, where you stand doesn’t really matter. More than any other apocalyptic event we discuss in this book, global warming illustrates one of our central tenets: what you believe isn’t important, it’s what everyone else believes. And in this case many government leaders and the vast majority of climate scientists around the globe believe that global warming is real, that it’s being caused in large measure by human economic activity, and that its consequences will be catastrophic on a global scale if the trend is not reversed.
Nevertheless, the debate continues with one side blaming human activity, the other arguing that warming may just be the result of the natural cycles of the Earth. But it is precisely this confusion and obsession about the environment and about climate change that creates opportunity for the investor. Money is going to be spent. Many governments have already begun to mandate all sorts of measures to reduce carbon emissions, and those mandates will expand exponentially as political pressure increases.
Whether you consider manmade global warming a legitimate concern or a mass delusion, it’s critical at this point to protect your portfolio accordingly to take advantage of the popular direction that governments are going on this. Governments themselves and the companies that reside within their jurisdictions will spend many hundreds of billions of dollars over the next twenty years to reduce emissions and attempt to counter the effects of carbon already in the atmosphere. New technologies will emerge, as will new financial markets for things like “cap and trade,” one of the more likely mechanisms for providing incentives and punishments for carbon emitters.
The Roots of the Global Warming Crisis
For all of the fraught arguments back and forth about global warming, the science that underlies it is pretty simple. It begins with the sun radiating massive amounts of energy into space. A tiny portion of that energy comes through the Earth’s atmosphere and is absorbed by the ground and surface water. Those “hot” surfaces then reradiate heat into the atmosphere at different wavelengths than sunlight. If Earth did not have an atmosphere, virtually all of that reradiated energy would be lost into space (and we wouldn’t be here to argue about warming, since there would be no oxygen and the Earth would be a much colder place). But our atmosphere, composed mostly of nitrogen and life-giving oxygen with traces of other gases and water vapor, acts as a blanket, absorbing some of the reradiated energy and warming enough to provide us with a relatively large comfort zone between the two poles.
It is the content of the atmosphere—how much of the various gases it contains—that becomes the issue at hand. While the main components of the atmosphere do not absorb much of the reradiated energy from the Earth’s surface, other gases do. Their capacity to absorb this heat gives them their collective name: greenhouse gases. Some of them occur naturally, some are the combined product of nature and human activity, and some are solely created by human beings. The principle greenhouse gases are carbon dioxide, methane, and nitrous oxide. Other significant greenhouse gases produced almost exclusively by industrial sources are hydrofluorocarbons, perfluorocarbons, and sulfur hexafluoride. Put simply, all other things being equal, the more greenhouse gases in the atmosphere, the warmer the atmosphere becomes. And there is no doubt that the amount of greenhouse gases in the atmosphere is increasing and has been for more than a century. Worse, the rate of increase is increasing.
Going Green
The fear of global climate change is at least somewhat related to the problem of oil, which, as we explained in the previous chapter, is becoming increasingly difficult to find and extract. In this chapter, we’ll look at two strategies that are being employed to help solve the problems caused by the burning of fossil fuels—strategies that tie closely to the investment opportunities surrounding global warming.
Strategy One: Develop alternative energy technologies to replace coal and oil.
Most of us are familiar with the two most popularly discussed alternative energy sources right now, namely wind and solar. Big windmills and solar panels are the products that capture “free” energy from the sun and the wind and most large utilities in the United States are using those methods to produce at least a small portion of their power output. But there are also old standbys. Hydropower from dams is one, albeit one that is falling out of favor given the growing problems attached to fresh water supplies. Nuclear power is another. Following the tragic meltdown of the Chernobyl power plant in 1986, however, nuclear power has been growing only slowly, and it certainly isn’t something the green movement endorses. Nonetheless, it is one of the few sources of power that could conceivably produce enough power to eliminate most coal and oil-fired power plants. Finally, while there are many other potential sources of energy, we are only beginning to understand their potential. Some of these options include geothermal power, power generated by tides and ocean currents, and power derived from the methane produced by rotting garbage.
Strategy Two: Increase energy efficiency to reduce oil consumption.
Many people believe that alternative methods of generating power are a crucial first step toward avoiding global warming related catastrophes, but they are only part of the solution. The other part is becoming more efficient, that is, consuming less power. If we can slow the growth of power demand we can build fewer power plants and burn less fossil fuel in the future. And the opportunities to do that are remarkable, beginning with the popularity of automobiles like Toyota’s innovative Prius hybrid. Other similar cars, including all-electric vehicles that plug into an outlet to recharge their batteries, are coming to market. Appliances are becoming more efficient and many of us will be reading from the light generated by highly efficient light emitting diodes in the next few years.
Much more can also be done with energy infrastructure. The big high-tension wires that carry power from generating plants to communities and factories far away could be much more efficient, for example. Wires formed of new materials could prevent much of the “leakage” that now occurs in long-distance transmission, in effect increasing the capacity of a generating plant without burning more fuel. Computerized controls, both on the electrical grid itself and inside our homes, will be able to monitor power demand and better coordinate supply. We’ll be recharging our electric cars at night when overall demand for electricity is lower, thus getting more efficient utilization of capital-intensive power stations. And during the day, when electrical demand surges, the power company will be able to tap the batteries of hundreds of thousands of electric vehicles to prevent brownouts and blackouts.
Both of these strategies offer significant opportunites for companies that create products or services that help to reduce greenhouse gas emissions. Let’s take a closer look at the myriad investment implications of global warming.
Investing Implications of Global Warming
In terms of global warming, the fear is ongoing. There is no fade the fear. Either the Earth is warming because of human activity, or it isn’t. What matters is that people are obsessed with “climate change” and they always will be, and, because of our global prosperity over the past century, we have the luxury to explore other technologies and alternative fuels to help power our society. So let’s look at some of the safest and most effective ways at creating alternative energy. In this case it makes more sense to explore the options by their general categories.
Alternative Energy Plays
Given the human propensity to always find something to worry about, global warming tends to come to the fore mostly when everything else is going well, the economy is booming, and people are feeling good about their lives. So what if we have our two cars and our nice house, our kids are healthy, and our neighbors are friendly? Evidence of this tendency can be found in Google Trends, which tracks how many instances of a particular search phrase are occurring over time. Typing in the phrase “global warming” shows how often people are searching for that phrase on Google. It’s a barometer of our fear of climate change.
The chart shows queries—proxies for fear or concern—about “global warming” peaking in early 2007 just as the economy and the stock market were peaking, too. In other words, when everything else was going well in our lives, we were worried about climate change. And when did worries about “global warming” hit a multi-year low? The market crash in 2008 coincides very closely to a huge drop in queries about “global warming” and they fell even farther as unemployment rose. When we had a real here-and-now problem to worry about, global climate change took a back seat.
One of the people we most respect for sheer intellectual firepower is a professor at a major university. He posed to us this question: we don’t know if global warming is true or not, but what if there is just a 1% chance that it is true and not only that, but that the effects are exponential, that once global warming begins to create real problems they begin to cascade swiftly and cataclysmically? Shouldn’t we err on the side of defending against its effects rather than simply ignoring it, even if there’s only a one-in-a-hundred chance it could happen?
What does this mean for investors?
First, panicked attempts to find alternative energies that require government subsidies to make them succeed are long-term losers. Take the solar industry. As noble as it is to find a source of power that draws its energy from the ultimate source of power, solar power simply isn’t workable right now. The only way in which it is currently cost-effective to power your home, or any other building for that matter, with solar energy is if there is no cap to the amount of government subsidies a country provides.
Spain tried to do a no-cap subsidy for solar and it failed. Costs were simply too great. Solar revenues dropped 80% the year after it removed the no-cap subsidy. Germany, which generates lots of revenues for solar companies, is also considering dropping its no-cap subsidy. Once the subsidies go away, the industry will go away.
The second alternative power source that generates a lot of attention (and some government subsidies) is the wind, which is an indirect form of solar energy (the sun’s energy generates atmospheric temperature and pressure discrepancies that in turn generate wind). Interest in wind power waxes and wanes, gaining a lot of media attention when well-known investors get involved. Back in 2007 T. Boone Pickens was on CNBC and in The Wall Street Journal and the New York Times, trashing America’s dependence on foreign oil and touting the benefits of wind power. As we mentioned in the last chapter, the Department of Energy estimates that wind power is going to go from generating 3% of our energy needs to about 30% by the year 2030. If that is correct—and we don’t trust any forecast that looks that far into the future—then wind power stocks should get a big lift. And if it’s wrong, it doesn’t matter. By taking the back-door approach to investing in wind energy, we can find companies whose primary businesses are doing so well that their small investments in wind energy basically give us a free play on wind. Here are two back-door plays: the same two plays mentioned earlier, AeroVironment (AVAV) and Otter Tail (OTTR), work as excellent back-door plays here. What we like about them is that they are both under the radar, not broadly followed by Wall Street (despite one of the richest men in the world, Bill Gates, being the largest investor in Otter Tail), and will grow quickly with interest in wind power. Of the major alternative energy sources, the one that holds the most promise is nuclear power. We know this, in part, because it is already in use around the world. We also already all know the problems with nuclear energy: it is relatively expensive to build nuclear power plants; if things go wrong they can go disastrously wrong; and we don’t know the solution to disposing of nuclear waste. But those concerns begin to pale when we consider the benefits of nuclear power:
- Zero emissions.
- Cheaper than solar, wind, oil, even natural gas.
- The technology has become significantly safer as operating experience accumulates in places like France, which produces more than 80% of its energy through nuclear power generation.
So nuclear power certainly takes the lead among alternative power sources and that gives investors a potential path to profits with stocks like these:
Cameco (CCJ) is a clear front-door play on nuclear power because it is the world’s largest uranium producer, accounting for around 19% of world production. The company has a joint venture with GE in which CCJ supplies uranium that GE will enrich for power use. And it doesn’t hurt that Cameco also mines gold.
American Ecology (ECOL) is the back-door play into nuclear energy. Forget about all the politics involving whether or not we should build new nuclear reactors. This company is the perfect play on cleaning up the waste that’s generated by the reactors we currently have. It has virtually no competition and probably won’t because of the huge costs and technological expertise to start a company that cleans up nuclear waste at power plants. It’s also in the business of recycling oil waste, making it a potential play on increasing oil prices. It’s eco-friendly, solves a major problem, and you can be a total global warming agnostic or atheist and still make money.
Emissions Plays
Regardless of the debate about whether human emissions are driving global warming, it is worth having at least some stocks that are focused on reducing emissions. These stocks should rise over time not just because of concerns about global warming, but also because pollution control is something that has been remarkably successful and much favored by populations in the industrialized or industrializing countries of the world. Emissions reduction has been so successful, in fact, that according to the Environmental Protection Agency (EPA), emissions caused by cars are one-fourth of what they were in 1970, the year the agency was founded. If we concentrate on automotive emissions technology, we come up with three plays.
Borg-Warner (BWA) makes automotive systems. Up to 70% of company sales are derived from technologies and applications that increase fuel efficiency and/or reduce emissions. Magna International (MGA) also makes complete automotive systems that it then sells to the major car companies. The company’s hydroforming business is a key technology in creating lighter and stronger cars. Finally, OM Group (OMG) owns thirteen thousand tons of cobalt, a crucial element for manufacturing batteries to power the coming generation of hybrid automobiles. All three companies have strong traditional businesses that will continue to generate cash flows regardless of our worries on global warming. And yet an ever increasing part of that cash flow will be driven by the need to make lighter, more fuel-efficient vehicles with cleaner emissions.
Efficiency Plays
The problem with energy consumption, pollution, emissions, and global warming isn’t always the companies, though. Sometimes it’s the customers. We consume oil, we consume gas, we use and waste energy on a daily basis. During the oil spill in the Gulf people were eager to boycott BP service stations. Few were saying “let’s turn the air conditioning down at night so we use energy more efficiently and hence have less need for oil and gas.” Instead we just kept driving and turning on the air conditioning to stay comfortable.
But there are technologies to enable us to use energy more efficiently. One is called the “smart grid,” a method and technology by which energy is distributed through the utility system according to who needs the energy the most. Most electric grids right now are dumb; electricity is sent out and anyone who wants can tap into it. However, by using sophisticated routing technology we can determine the biggest consumers of electricity and make sure that more electricity is sent to those consumers than to those who are not the biggest users. As usual, there are front-door ways and back-door ways to play smart grid technology.
Cisco (CSCO) is a back-door opportunity known for its Internet routing technologies. They make sure the bits and bytes that go through the Internet end up at the right locations in the fastest amount of time. When a single byte leaves your computer on its way to another one around the world, Cisco routers are usually involved in making sure those bytes get there safely and quickly. Cisco has $40 billon cash in the bank and is obviously unlikely to go out of business with over $10 billion a year in earnings before interest and taxes.
With its experience routing through networks like the Internet, it’s no surprise that Cisco is tiptoeing into the (potentially) multi-hundred-billion-dollar smart grid market with the recent purchase of GridNet, a San Francisco–based company.
Another back-door play is Intel. With the entire electric utility grid going to smart technologies, chips will be needed, and Intel is the biggest chip maker in the world. With $16 billion cash in the bank and cash flow of $14 billion as we write this book, Intel can scale up quickly with the smart grid industry.
The front-door companies are companies that are already profitable, already have the bulk of their revenues in the space, and are growing with the sector. They include Echelon Corporation (ELON), Itron (ITRI), and Comverge (COMV).
All three companies provide the parts, components, and services to build out the smart grid infrastructure. All three companies have 100% of their revenues devoted to the sector, are growing, and have cash in the bank.
Of course the problem that contributes to many of the issues of this book—peak oil, global warming, carbon emissions—is the fact that we all drive cars all the time. You can’t really get people to stop driving cars and consuming oil, and, certainly, there have been advances that take that reality into account. For example, according to Matt Ridley, author of The Rational Optimist, a parked car in the United States in 1970 actually had more carbon emissions than a car today driving on the highway due to the leaks and other inefficiencies in cars forty years ago.
However, the real solution is the electric car. The problem, though, with making the electric car more practical and affordable has always been the battery. Think of your laptop. You charge it all night. Then you take it on an airplane to watch a movie, and two hours into the movie the battery dies. How many batteries like that would it take to drive a car sixty miles an hour for ten hours?
The back door on the electric car companies is, of course, the major car companies. Ford, Toyota, and Honda are all involved in some form of electric car production, but it is only a small part of their business. Tesla (TSLA), a car company that focuses exclusively on electric cars, is developing an electric car for Toyota.
A better approach is to look at the battery companies. A123 Systems (AONE) makes rechargeable lithium-ion batteries and battery systems, both for both hybrid and pure electric passenger vehicles. China BAK Battery (CBAK) makes lithium-ion rechargeable batteries intended for use in light electric vehicles and other hybrids. Ener1 (HEV) also makes rechargeable lithium-ion batteries and battery systems. Its batteries are being used in hybrid, plug-in hybrid, and electric vehicles, busses, and trucks.
Between nuclear energy, anti-emissions technology, wind power, rechargeable batteries, and smart grid stocks, we feel this is a portfolio that counteracts the fears of global warming, while having the added side benefit of helping the world.