Investing in Alternative Energy Penny Stocks

Interest in alternative energy has grown for many years, though the specific level of interest tends to ebb and flow based on the price of existing energy sources—oil first and foremost among them.

This tight linkage to other energy sources is based on three major factors: the profitability of alternative energy versus existing sources (which improves as oil gets more expensive), the level of consumer interest in adopting alternative energy (which increases when oil is high but quickly fades as prices drop), and the existence of government subsidies (which vary with political priorities and the level of sustained anger over energy costs in the electorate).

The first thing to understand about alternative energy companies, then, is the likelihood, extent, and speed of adoption of whatever technology they are selling. Oil is the 900-pound gorilla of the energy sector because it is so widely used: to produce gasoline for vehicles, to generate electricity, and even to produce plastics and a wide range of other goods.

Oil prices have been driven in part by the increasing difficulty of tapping new reserves (which tend to be in less-accessible locations like deep water, harder to extract, or harder to refine) and growing demand in developing markets like China and India, though some of the price is also tied to speculation (exactly how much is a hotly-debated topic) and the value of the U.S. dollar. (Since the oil trade is denominated in the dollar, a weak dollar sends prices higher for U.S. buyers.)

Alternatives to oil are being explored in all three arenas. Hybrid and all-electric vehicles are coming to market, electrical generation is shifting to alternatives like natural gas, and even plastic production has options like increased recycling and the use of plant-based materials.

Natural gas reserves have exploded—particularly in the U.S. but in other locales around the world as well—thanks to new technologies, primarily hydraulic fracturing. For that reason, most new electric power stations are being built to burn natural gas, and liquid natural gas (LNG) terminals are being built around the world to facilitate global natural gas trade. This should reduce demand for oil for both electrical generation and heating over the long term.

&nbspOn the other hand, nuclear power—which was once seen as the best alternative for electricity in many regions—suffered a tremendous blow as a result of the tsunami-induced Fukushima disaster in Japan. Many countries, particularly in Europe, that had embraced nuclear power have not only stopped future expansion plans but are now looking at eliminating existing plants.

The two primary alternatives—focused predominantly on electrical generation—are wind and solar. Wind installations are limited by available locations—obviously there must be sufficient wind consistently enough to be economically viable—and the simple fact that they will not generate power 100% of the time. Nevertheless, in some areas massive wind farms are becoming a common sight.

Solar power is much more consistent (during daylight hours, of course); its primary limitation has been cost. Solar arrays are expensive to install in the first place and have a lifespan of no more than 20 years in most cases. The market is currently dominated by Chinese firms and their less-expensive products, as evidenced by the much-ballyhooed failure of U.S. firm Solyndra.

The fortunes of wind and solar companies—along with those that produce any of the various forms of biofuels—will be tied closely to oil prices. At this point they are unlikely to see explosive growth given the vast natural gas reserves currently under development (note that natural gas prices are at historical lows), so potential rewards are low.

The exception to this case would be a significant geopolitical event—most likely military action against Iran (whether by the U.S. or, as is more likely, Israel) that would threaten the global oil trade. The U.S. and its allies would move quickly to reopen the Strait of Hormuz in such a case, but in the meantime alternative energy companies would be likely to see a price spike.

Alternative energy technologies beyond wind, solar, and biofuels are little more than experimental at this point, so investments in any such companies would be highly speculative. A technology that is unproven has a long path to market and ultimately may not work or be accepted by consumers.

Bear in mind that all penny stocks are high-risk investments by their very nature. Low liquidity can make the sale of such shares very difficult, and little reliable information is available about these companies. Penny stock investments—even if made to exploit a short-term condition like an oil market shock—should be made cautiously and only with risk capital.