Alternative Energy May Be Down, but It's Not Out

Industry drivers are "stronger than they've ever been," says Guinness.

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Alternative-energy investing isn't an off-the-grid idea anymore. Today, retail investors can choose from a growing lineup of mutual funds and exchange-traded funds focused on providers of renewable energy. Among the best known of the bunch is the Guinness Atkinson Alternative Energy fund, run by a London firm that also invests in conventional energy.

The Alternative Energy fund, led by Tim Guinness along with son Edward Guinness and co-manager Matthew Page, has had a bumpy ride since its March 2006 inception. After soaring 43 percent in 2007, the fund is down 14 percent since the beginning of this year. In all, it's gained an annualized 5 percent from its launch through the beginning of April.

U.S. News spoke with Edward Guinness about the most promising alternative-energy stocks and the next generation of biofuels and how the industry could emerge from this downturn as one of the best places for investors to put their money. Excerpts:

Where are we in the growth cycle of alternative energy?

In general, the drivers of this industry are very, very strong—stronger than they've ever been. As energy prices rise, the various technologies are either becoming competitive economically or have the potential to become competitive within five to 10 years. Behind that are the twin blocks of energy security and environmental concerns supporting both legislative change and market change. What is the outlook for each sector?

The subsectors of alternative energy are all at very different stages. For example, we've had hydro for more than 100 years, so it's clearly a very mature technology, and it has very low operating costs. From an investor's point of view, there will be attractive returns from hydro companies as electricity prices rise. Wind is reaching the point where it can compete with coal- and gas-fired electricity. The industry is going through a major growth spurt at the moment, and turbine manufacturers are growing as fast as they can. The industry is growing at 20 percent to 30 percent a year, and that's probably the maximum speed it can grow.

Solar is probably at the most exciting point in its growth curve. At the moment, it's still more expensive than traditional electricity without subsidies. In five to seven years' time, we'd expect solar to cost half what it does today.

If you look at wind and solar: Wind is generating 1 percent of the world's electricity today and could reach 10 percent by 2023. Solar is generating just 0.1 percent of world electricity today, and even if it grew at 35 percent a year—which it has been for 10 years—solar would still only make up 5 percent of world generation by 2023.

The geothermal industry technology is actually quite old, but it hasn't yet fed into large-scale adoption of geothermal projects. In my mind, it's the most exciting because it can be achieved without environmental impact. From a cost point of view, it's competitive today—it's just about permitting and developing sites.

What is your take on biofuels?

Biofuels are a hot topic, but we're not heavily invested in them. Clearly, there's potential growth in the amount of biofuel produced over the next 10 years, but it's going to be challenging to get there because high feedstock prices mean that ethanol refiners are not able to produce profitably. The number of new plants being built has almost ground to a halt. There's an extended effect on the rest of the supply chain, and also higher food prices are a much bigger problem than higher energy prices. That needs to be addressed for biofuels to make a meaningful dent in consumption of gasoline and diesel. What biofuel solutions wouldn't significantly affect food crops?

Examples of second-generation biofuels solutions are cellulosic ethanol and even possibly algae. Cellulosic is produced by refining the whole plant rather than just the starch from corn kernels, which leads to much higher yields. Longer term, algae could yield hundreds of times more biofuels, but the technology to enable this is still in its infancy. From an investor's point of view, we're looking at only vertically integrated opportunities at the moment, where the refiner also owns its feedstock source and is therefore not negatively impacted by increasing feedstock prices.