Events
- The S&P returned -0.68% last week and has returned 4.01% year to date. The Clean Tech Index (CTIUS) returned -0.81% last week whereas the S&P Clean Energy Index fell over 6%[i]. Clean Tech did relatively well in large part due to agriculture stocks; the clean energy subsector plunged in line with news from Texas. The OMX Water Index was down 0.81% and has returned 5.06% year to date.
- Solar Edge Technologies reported earnings that were well received, on Monday, but later fell along with other clean energy names – see below.
Texas Sized Problems
A lot is being written this week about what happened in Texas and the failure of the grid, administered by ERCOT, leaving millions in the cold and dark. Moreover, water pipes have burst all over the state disrupting access to drinking water and wastewater treatment. It is a tragedy of untold proportion endangering millions of people, far more serious a topic than the musings of an investment manager, and occasional pundit.
The political class increasingly plays to their respective partisan bases instead of doing what they are elected to do: govern. As has been well documented by many news outlets; idle wind turbines were initially blamed for the crisis. This has proven to be false as 1) wind accounts for only a quarter of power at peak in Texas and outperformed ERCOT winter projections 2) wind turbines in Finland, Minnesota, Antarctica and Montana often operate at cold temperatures; it is a simple if not costless modification to the equipment and 3) Texas relies on baseload gas fired turbines (around 50%) that also lacked adequate insulation to withstand lower temperatures. The freeze in of oil and gas operation in the Permian and Eagleford also added a previously unforeseen dimension to the crisis.
The problems experienced by ERCOT remind us that our transmission system is fragile, underinvested, and performing tasks that it was not initially designed to do. This crisis will have legs, the market design of ERCOT enables spot prices to be passed directly to consumers. Reports are circulating that some people last week saw power bills as high as $17,000 after sitting in the cold and dark for days[ii]. The debate over the intermittency of renewables or the viability of hydrogen as a fuel is all very esoteric compared life threatening cold followed by life altering power bills thrust on unsuspecting consumers and voters.
Of far less importance in the scheme of things, many publicly listed clean energy concerns in solar, hydrogen and charging fell by 10 to 20% last week. However, the long term prospects of these companies did not decline, they improved as the utility of microgrids became more evident. This is not a comment on present valuation of these equities[iii]. Energy storage may well emerge as the winning theme in all of this though the viability of utility scale lithium remains an open question. Another winner will be infrastructure: 8% of the US population lost electrical power due to such a preventable scenario, the idea of rebuilding our asset base doubtless became more compelling regardless of deficit implications. You still need open businesses and live taxpayers to fund a deficit. There will undoubtedly continue to be arguments regarding the merits of renewables versus fossil fuels but I winterizing a number of turbines will prove to be more economic than building an entirely new fleet of gas plants.
The dangers of a good idea – and I am not going to even mention Gametop or Reddit.
There is an old Wall Street Credo: the only thing worse than a bad idea is a good idea. We have seen this time and again. Credit Default Swaps (CDS) as a hedging instrument or in some manageable quantity embodies the elegance and beauty of modern finance writ large, the ability to monetize and transfer risk brings out my inner finance geek. But we learned, or relearned, in 2008 that having a derivative ($55 trillion of outstanding credit default swaps) in some instances exceed the value of the notional was a bad idea.[iv] I did some convertible arbitrage in the late 90s. Convertible bonds for a long time before that were fairly vanilla instruments, junior debt with warrants. In the 1990s the Street realized that there was more to be juiced out of these things and more structures came into vogue: Liquid Yield Option Notes (LYONs), Preferred Income Equity Redeemable Securities (PIERS), and DECS, ELKS, PERCS and PRIDES. These structures all varied but one theme predominated: conversion had gone from a sleepy fixed ratio to a mechanism with collars and greater optionality. As these securities proliferated so too did funds arbitraging them against their underlying common stocks. It didn’t end well; converts can be an expensive form of financing and issuance eventually fell off. There was no systemic danger unlike CDS or other episodes because there wasn’t much leverage involved but this episode demonstrates the Gatsby like nature of the Street to reinvent itself and issue new types of securities.
And now we have Special Purpose Acquisition Companies – SPACS. On itself SPACS are a good idea and the risk of any party truly suffering a loss is comparatively low. SPAC investors put their money into escrow, SPAC managers issue a unit and most often a warrant within a given time frame and have an allocated time to find a target company to purchase and convert to a publicly listed company for benefit of the SPAC holders lest they receive their money back from escrow if all of this does not happen in the allotted time. There are other technicalities involving a vote on the target but it is all very simple.
Except now. In 2020 there were 248 SPAC IPOs that raised some $83 Billion as compared to 2016 numbers of 13 IPOS and 3.5 Billion[v]. Proceeds into the space grew by a 5 year CAGR of 88%. As Barton Biggs famously quipped: “There is no asset class that too much money cannot kill.” In all likelihood the escrow mechanisms will hold for each unit and investors will get their initial unit investment back except the volume of secondary trading usually dwarves the IPO issuance quickly so many investors come in above the escrow price. And there are now funds using leverage to invest in SPACS. I met a guy in a bar doing this years ago, at these rates he and his fund must have many peers by now.
I invest in clean technology for a living and love the idea making the world a greener place and, you know, possibly saving our planet. But how many EV companies, one common target of SPACS, will the market ultimately bear? There have been over 1900 car companies formed since 1895 and how many survived? Some got merged into other entities but most went the way of Delorean or Fisker the first time around. Moreover, the incumbents are just getting into the game now. GM, Ford, and VW have realized that not only are EVs increasingly popular; given the right scale and scope economies they are also cheaper to produce.
If someone proposes a SPAC of SPACS that will indicate the party is ending.
Opinions are expressed are solely my own. Any investments mentioned do not constitute a recommendation to buy or sell anything. If you do act on the opinions of errant writings without doing your own research you might consider talking to an investment advisor, a psychologist, foregoing that third drink or reexamining your decision-making process. I do cite sources and use end notes but amidst other responsibilities and foci I apologize for any plagiarism or regurgitation of other’s ideas though we all know there are not many original ideas. If you disagree with my content or opinion don’t read it.
[i] Bloomberg; Index returns include imputed dividends not just price return.
[ii] NBC News
[iii] Anyone who regularly reads my missives or knows me knows that, though I am not a value investor, I always remain valuation aware. I am not commenting on the present valuation of equities as a whole as I have noticed that while valuation eventually wins the argument dislocations can remain for a long time, even years. And, of course, valuation is an opinion subject to myriad assumptions. We all have our hits and misses.
[iv] Testimony Concerning Credit Default Swaps, SEC, October 15, 2008 before the House Committee on Agriculture.
[v] SPACINSIDER
