BKR - ESG Wars 2: NET Power's Carbon Capture Vs. TAN Solar And FAN Wind Power ETFs

2023-09-25 13:37:56 ET

Summary

• NET Power, a carbon-capture startup, uses innovative technology to achieve net zero natural gas power. The challenge for NPWR will be scaling the technology.
• The nascent offshore wind industry in the US is struggling due to cost overruns and politics.
• Due to political dysfunction, decentralized technologies such as solar and carbon capture are likely to be more successful in the U.S. renewable energy market than big infrastructure projects.

With renewable energy becoming an increasing priority for governments around the world, carbon capture, wind power, and solar power have all caught the attention of investors. I recently got a reader request to take a look at carbon-capture startup NET Power ( NPWR ). A buzz has been building around the company and the billionaire family behind it, which came public via SPAC in June with major shareholders including Occidental Petroleum ( OXY ) and Baker Hughes ( BKR ). Environmentalists are skeptical of carbon capture projects, but NET Power employs a novel technology to burn natural gas in pure oxygen for net zero natural gas power. There are technological hurdles to overcome, but there's big money behind the technology. The founders have a track record in energy tech, having successfully scaled a biogas business that they sold to BP ( BP ). I feel strongly that renewable energy is where the most money in the market will be made in the next 30 years. So should investors place their bets on carbon capture plays like Occidental and NET Power, on the wind energy industry ( FAN ), or on the solar industry ( TAN )?

I also got a request for coverage on the wind industry. The nascent offshore wind industry is struggling amidst cost overruns and political wrangling at the federal, state and local levels. The industry has been crippled by "Build America" mandates and political demands to turn it into a union jobs program. The unions exist, but the equipment and manufacturing capability don't. Operators are dropping out, and the industry is begging the Biden Administration for support , and so far to no avail. Most of the expertise in the wind industry is European, and Europeans can't contribute to American lawmakers' reelection campaigns, so absent some very altruistic choices by the administration to ease tariffs and regulation, the projects are likely to see tens of billions of taxpayer dollars down the drain with few or no working offshore wind farms to show for them. As such, wind stocks have been crushed.

My basic thesis about investing in green energy in America relates to the kind of society that we are. Let's face it - America is a highly individualistic society. We excel when political and economic power is decentralized and people are free to make choices that benefit them. Over time, this has pros and cons. The biggest pro is that the US is a top 5 place in the world to make money. The biggest con of an individualistic society is that we're often bad at collective action and collective projects. Infrastructure (highways, airports, etc.) is generally worse in the US than in countries with far lower levels of income, and social problems like homelessness, pollution, and crime are generally higher. A few Europeans over the years have told me that they've been shocked after seeing the Hollywood version of America and then being "welcomed" at the old Newark or LAX airports. The Hollywood version of the US does indeed exist, but you still often have to dodge potholes in your Ferrari.

As this relates to green energy, I believe that decentralized technology will probably win more often than not in the US over big, federally-funded infrastructure projects. This means solar is likely a better bet than wind in the renewable space, and that carbon capture projects are potentially worth investing in. While it's possible for visionary infrastructure projects like high-speed rail and offshore wind farms to succeed, it can't happen without changes to the current dysfunctional political framework. The recent infrastructure bill and green energy bills are meant to change the state of infrastructure in America, but change often comes slowly, and they're already fumbling the ball.

Solar stocks are down big too, but looking at recent earnings estimates and following the industry I feel that they're likely to quickly recover - a lot of what's driving down these stocks is interest rates. Because these industries are so capital intensive, interest rates going from 0% to nearly 6% has a huge impact on how quickly investments in capital expenditures pay off for businesses and households.

Again, I'm not an engineer, but the sun is nature's favorite energy source. Being able to put some solar panels on your roof doesn't require D.C. to function properly, and you don't need anyone's permission to do it. Utilities also are figuring this out, and if battery storage improves I think we could see another upswing in solar like the nearly 4x price return in 2020-2021. This month, I saw solar panels on run-down shacks in the desert in Spain - a clear indicator that the technology is starting to become cost-effective everywhere.

Avoiding Pitfalls In Green Energy Investing

Green energy is a hot investment area and is likely to continue to be so for the coming years and decades. Investing trends like cannabis, sports betting, and electric cars tend to bring out wannabe operators who will raise money and burn it. Meanwhile, most of the big money is made privately.

1. Capital structures are one thing to be aware of and something I see over and over again. A typical SPAC deal gives 20% of the company to early investors for free via warrants , so if the stock is successful, they get a free roll on the public shareholders. For example, NPWR is a SPAC, and that means that the founders will make much more money if the deal is successful than they would by running a typical public company. Some argue that this encourages talented operators to take their concepts public, while others note that most operators are not talented and just pocket investors' money. Individually, the former is true, but collectively the latter is true. There are ways to mitigate this, either by joining the institutional side on SPACs and IPOs and buying before stuff goes to market, or dramatically tightening your willingness to invest when facing unfavorable capital stacks. NPWR also doesn't have a ton of trading volume, so betting small is the way to go.
2. Looking at operator track records helps. The last SPAC the NPWR guys did was a success - a relative rarity in the energy-tech SPAC space.
3. Unless you have specific expertise in the space, you're generally going to have to rely on secondhand knowledge of tech. Some investors only invest in what they know best, but then 99.9% of us would have missed huge 2010s profits in trends like cloud computing and semiconductors. Seeking Alpha author Stephen Tobin has done deeper dives into the tech side of NPWR for those interested.
4. Finally, it is important to pay attention to valuation. All else being equal, the higher the valuation you're paying, the riskier the investment you're making is. Alternately, you can buy trashy stocks with no earnings on momentum, as long as you know to get out when the market turns. Solar seems to fall firmly in value territory. TAN's biggest holding, First Solar ( FSLR ), is trading for 12x its 2024 earnings estimates , while the second-largest holding Enphase Energy (ENPH) is 18x its 2024 estimates . If you believe the composite analyst estimates about the underlying business (and I do), you're looking at returns in the 20-30% annualized range, potentially for 10-plus years. During the 2021 bubble, investors were paying far higher prices for the same stream of earnings. Wind stocks are cheaper still, but one wonders whether they're value traps due to inferior technology. One didn't have to be a smartphone expert to see that the iPhone was beating the BlackBerry 14 years ago.

Bottom Line

2023 is set to be the hottest year in recorded history , and renewable energy is an increasingly urgent priority for governments worldwide. Taking a quick look at some green energy plays, I'm attracted to the low valuations and huge growth potential of solar stocks. I don't like offshore wind stocks due to the political and engineering challenges they have. I'm also intrigued by the carbon capture startup NET Power, with backing from Occidental Petroleum and others. Here I think you can buy some TAN for a long-term investment and some NPWR for a more speculative play with upside. FAN looks to be a good candidate to cut your losses in if you own it.

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