Alternative Energy Stocks Running on Fumes

It's been ugly out there for stocks of all types lately. From the oil services to agriculture sectors, stocks have been absolutely hammered over the past couple of weeks. In many cases, stocks are now down in 2010, a mildly depressing thought given that we are essentially halfway through the year.

Alternative energy stocks have been some of the hardest hit. Sure, some of the products these companies churn out, like windmills and solar panels, could provide power in perpetuity given the renewable energy sources like wind and solar - but the stocks themselves seem to be running on fumes.

For the record, wind is actually a form of solar energy (I don't want you energy gurus to call me out on this one). Wind is generated because the sun heats the Earth's surface differently depending upon the topography.

There is a great website maintained by the U.S. Energy Information Administration that explains wind energy basics, as well as other renewable energy sources like geothermal, biomass, and hydropower. And it's kid friendly, so if you have kids you should check it out with them. The website can be found by clicking here.

***But back to the subject at hand; why alternative energy stocks are stumbling like bar hoppers who have had too much to drink.

There are three reasons: the broader selloff in equities, the decline in oil prices, and the financial problems of many countries, most notably European countries.

I'll take a quick look at each of these reasons, and tomorrow I'll look at select stocks. Send in your favorites; so far I've had readers ask me to look at A123 Systems (Nasdaq: AONE), but I'd like more choices. My address is: editorial@smallcapinvestor.com

Reason #1: Market Sell-off: We need to look at a chart to put this in perspective.

The chart above shows the performance of the S&P 500 and the Russell 2000 over the last six months. You can clearly see that both big and little brother stocks have had a rough go, and that they are almost exactly where they started the year. Surprisingly the Russell has held up better in 2010 than the S&P 500, usually small caps take the brunt of the blow when markets deteriorate.

Many alternative energy stocks are small cap stocks, and while the broader Russell has been somewhat resilient, these little guys have rolled over. Looking at a selection of alternative energy ETFs this becomes pretty clear.

The chart above plots the Russell (in red) against PowerShare's Global Wind Energy ETF (Nasdaq: PWND) and Claymore/MAC's Global Solar Energy ETF (NYSE: TAN).

The ETFs show how badly stocks in these sectors are stumbling - I've looked at other alternative energy ETF's and they more or less exhibit this same pattern right now.

Reason #2: Oil Price Decline: There is no doubt that when oil and gasoline prices rise, people look to alternatives. Where is the price resistance? I'd say right around $4.00 a gallon gasoline. I'm not going to dig up the numbers to prove this, but I know I've read it in a number of places, and anecdotal evidence supports a price in that area.

Conversely, when oil (and gasoline) prices fall, so does interest in alternatives. Does that seem short sighted? Yes, but so be it. That's a discussion for another day.

The chart below compares the continuous contract for light crude (in brown) with the PWND (in green) and TAN (in purple). You can see that while the decline in oil prices has been more abrupt than that for the alternative energy ETFs, there is a distinct correlation.

It's going to be hard for alternative energy stocks to jump higher if oil prices continue to decline.

Reason #3: Sovereign Debt Concerns: This is the big one right now, and has contributed in no small way to the first two reasons for declines in alternative energy stocks.

As I said earlier, many alternative energy companies are small caps - i.e. fledgling companies that are still prone to swings in economic cycles. They also rely heavily on government subsidies.

Right now, governments aren't exactly flush with cash. It would take impressive political will for the powers that be to be pushing subsidies when they can't balance a budget without some sort of bailout.

***Of course the underlying problem is that many alternative energy solutions can't hold a candle to fossil fuel and coal solutions when it comes to basic economics. And that truth lies at the heart of the problem for these stocks. I recently saw a great comparison of power plant energy sources from Energy-Facts.org showing the relative power output of energy sources as compared to draft animals. While the carrier pigeon is cute, its power output is clearly not on par with any of its four legged competitors.

***But all is not lost for small cap alternative energy investors. Events like the BP (NYSE:BP) oil spill are an unpleasant reminder that there are in fact other factors that should be included in economic analysis of energy solutions. And these should include externalities.

So what does this mean for alternative energy stocks? It means that right now they are suffering the hangover effects of the three challenges I discussed above. But this will pass, and these stocks will recover to indulge again.

The stock market will recover, oil prices will rise, and the crisis in Europe will pass.

http://smallstocks.com/