Picking Renewable Energy Stocks With John McIlveen

The Energy Report:

In your last interview, your primary concern in making investment decisions was safety. I know you focus primarily on Canadian companies, but has all the "fiscal cliff" talk influenced your approach to renewable energy investments?

John McIlveen: With the fiscal cliff, I could see how renewables might get pushed to the back burner in the process of cutting a budget deal. Some renewable incentive policies might even be used as a bargaining chip to get other budget items through, such as higher taxes or spending cuts.

TER: How have the oil and gas market dynamics in 2012 affected the outlook for companies in the renewables industry?

JM: Renewables are very competitive with oil-fired power, but not with gas or natural gas-burning plants. Gas sets the marginal price for power and affects the prices for a new project that developers are trying to build. This doesn't affect existing projects because these are all under long-term contracts with fixed prices that generally include an escalation clause. But for bidding a new contract, a low gas price pinches the budget for developers.

TER: How much do current prices affect the timing of any new investment decisions in the renewables field?

JM: In those states that don't have a renewable portfolio standard -- and about two-thirds of the states do have one -- there isn't going to be much incentive for renewable power, period. States that do have renewable portfolio standards, such as California, have to consider how they will achieve the percentage of renewable power objectives that they have. If they really want to hit their portfolio standards, they're probably going to have to pay up in terms of the power price they're willing to contract for. There's still incentive on the state level to proceed with renewable energy. But on the federal level, not so much. Most of the incentive programs, such as investment tax credit grants and/or biodiesel tax credits, for example, are all expiring.

TER: Are the dynamics different in Canada than in the U.S.?

JM: Each province has its own way of going about things. Some have incentive programs. Some do not. Some have a high tariff structure. Some do not. In the U.S., if natural gas is going to affect the local market in terms of new project prices and power prices, then developers may just put a project on the back burner. They would perhaps look to areas outside the U.S. that may be getting power supplied by oil-fired generation, such as much of the Caribbean and more remote mining sites in South America. When you're replacing the cost of oil, which in some jurisdictions is as much as $250/hour, renewables at as much as $100/hour look pretty good.

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TER: Where do you see the best growth opportunities in renewable energy?

JM: Within the U.S. it's more case-by-case or more like state-by-state, depending on how much they want renewable power. Probably the best growth opportunities lie more in the Caribbean and Central and South America where they don't have a natural gas supply and import oil to generate electricity. Using renewable power and cutting oil imports is great for their balance of payments and at the same time their consumers are getting a lower price for the power.

TER: Getting to specific companies you cover, I see that you've raised your target price for Ram Power Corp. (SPZ:TSX ) all have lower yields as well, given that they have a good payout ratio. So they're 75% or lower in terms of dividend to free cash flow.

TER: Given what you currently see on the horizon, how should investors interested in alternative energy stocks play this market in the coming year?

JM: I'm still emphasizing safety for the majority of your holdings in this space. You might also want to pick up a few of the juniors that you think could become takeover targets or already are, such as Western Wind. We'll have to see what happens after the fiscal cliff is hopefully avoided and whether the federal government turns some attention back to renewables.

TER: We'll know much more about that relatively quickly. Meanwhile, we appreciate your input.

JM: My pleasure.

Jacob Securities Senior Vice President for Research John McIlveen has been with the firm five years and has a total of 26 years' experience in special-situations research and merchant banking. In 2004, he became Canada's first sell-side analyst to focus solely on renewable energy research and consistently has been ranked a top performer by Bloomberg on accuracy of estimates and returns. He is currently treasurer of the Canadian Geothermal Energy Association and a published academic with 15 papers, including his and coauthor Alan Rugman's 1985 best Canadian book-nominated "Megafirms: Strategies for Canada's Multinationals."

DISCLOSURE:
1) Zig Lambo of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: None. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) John McIlveen: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview.