Gold and Energy Advisor: Gold, Oil & Energy Markets Investment Research
James DiGeorgia, Mr. Macro
- Chief Editor -
Mr. Macro
Geoff Garbacz, Mr. Micro
- Chief Strategist -
Mr. Micro
Dan Hassey, Mr. Retirement
- Senior Stock Analyst -
Mr. Retirement

Gold and Energy Advisor's Real Wealth

Real Wealth #178  05/21/2008

Tax Break For Aletrantive Energy Companies = Big Gains For Several Energy Stocks


Dear Subscribers,

I just returned from the Money Show in Las Vegas, Nevada and the most often asked question posed to me was...

"Do you think we’ll ever see the day that our energy dependence on oil will be broken?"

The answer, of course, is yes; but not for another quarter century, although our dependence will steadily reduce incrementally as time passes. It’ll be a gradual reduction, but the days of oil’s dominance will come to an end as alternative energy sources become more efficient and cheaper to employ as the economies of scale push emerging technologies to economic viability.

To this end, it should be noted that alternative energy research received a big boost this past week when legislation that would renew billions of dollars in tax breaks for solar, wind, biomass, Geothermal and other renewable and sustaining energy sources and a proposed new tax credit for ethanol fuels not produced from corn advanced in the U.S. House of Representatives this past Thursday.

The bill, approved by the Ways and Means Committee by a vote of 25-12, would extend about $54 billion in expiring tax breaks for renewable energy sources, education and a number of business expenses including research and development.

It would also extend federal tax deductions for state and local sales taxes.

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Tax breaks for investment in coal gasification projects would also be expanded under the legislation, which comes as oil hit a record just hit of $130 a barrel.

Ways and Means Committee Chairman Charles Rangel, a New York Democrat, said in a statement, "This is a strong, timely and fiscally responsible tax relief package," adding that "...these new and extended tax breaks would reduce U.S. dependence on foreign oil."

The legislation would also give an extra three years for a $1.01 per gallon tax credit for ethanol produced from grass and waste materials, which was included in a $289 billion farm bill approved by Congress on Thursday. The Ways and Means legislation would provide for the tax credit through 2015, while the farm bill allows for the new tax credit through 2012.

While President Bush opposes the farm bill, the legislation passed Congress by enough votes to overturn a veto. Given the spiraling high price of gasoline and electricity and the upcoming national election, it’s very likely many Republicans will vote to overturn a Bush veto, so it appears this legislation will soon become law.

These record gasoline prices have encouraged the use of corn based ethanol, which enjoys generous tax breaks. About one-third of this year's corn crop will go to ethanol producers, prompting livestock feeders and food makers to blame the ethanol boom for driving up their costs.

Closing hedge fund tax loophole intended to fund these $54 billion in tax breaks for alternative energy

To help pay for the cost of extending those and other tax breaks, the bill would close a tax loophole that allows hedge fund managers to defer taxes on their pay by sheltering it in offshore tax havens. The bill also would raise money by delaying proposed rules affecting the way multinational corporations account for interest expenses for 10 years.

The legislation now goes to the House, which could take it up as early as THIS week.

The bill also provides $2 billion in bonds to help governments and power companies to finance clean renewable energy projects.

The bill also would renew through the end of this year a program allowing state and local governments to issue $400 million in bonds for updating public school facilities. A political morsel dropped into this legislation to make overriding a Presidential veto -- a shoe-in.

Making it even easier to pass the proposed legislation also extends tax breaks aimed at both helping rebuild areas devastated by Hurricane Katrina in 2005 and give New York City some tax credits for transportation spending in the area destroyed by the 9/11 attacks.

Geothermal energy as an alternative energy source and the companies that may profit from this relatively limitless energy source.

These tax breaks are going to really help develop some very viable alternative energy sources including one of the most viable -- geothermal.

The fact is that tens of billions of dollars has already poured into geothermal energy projects around the world and this sector of the energy industry is no longer a marginal business and genuinely merits a serious look by investors looking to invest in alternative energy stocks with significant -- upside potential.

While there are a dozen geothermal companies combined in Canada, Australia, the UK and New Zealand, the fact is there are just two pure-plays trading on US exchanges - Ormat Technologies (NYSE:ORA - News) and US Geothermal (AMEX:HTM - News),

According to Mark Taylor, an analyst covering this sector for New Energy Finance, a clean energy financial research firm, "The industry is on the cusp of what could be an extraordinary growth period."

Smart money appears to have noticed. In 2007, private equity firms invested more than $400 million in geothermal energy, which is derived from hot water under the Earth's surface and can be used for space heating or generating electricity.

Warren Buffett's Berkshire Hathaway (Berlin Stock Exchange: BRKA) as well as leading investment houses such as Goldman Sachs (NYSE:GS - News) and Morgan Stanley (NYSE:MS - News) have also invested in the sector.

Chevron, arguably the sector’s largest player, has been active since the 1970s and invested over $100 million last year to expand existing operations in Indonesia.

United Technologies’ (NYSE:UTX - News) subsidiary, UTC Power has also jumped in to meet surging demand for turbines.

Last year, $3 billion was invested in disclosed deals in the sector; an increase of 183 percent from 2006, according to New Energy Finance.

Geothermal Energy will become a major part of the energy industry and you’re being given a ground floor opportunity as an investor.

The strong growth in geothermal research and projects is being driven by a number of factors. Broad climate change concerns are clearly a key. More specifically, though, is the trend of US states requiring that utilities derive more energy from green sources, says Karl Gawell, the executive director of the Geothermal Energy Association.

The main investment driver, he says, is the recently-introduced US production tax credit, which at 2 cents per kilowatt hour for the first ten years, can account for a third of the cost of a project. Congress extended this renewable energy credit to the geothermal category for the first time in the 2005 energy bill.

The tax break makes geothermal comparable in price, and thus competitive, to wind energy, and is critical for the sector's sustained success, say experts.

"I am very bullish on the sector so long as the tax credit gets extended – then it should be smooth sailing for these guys," says Alex Harbin, an analyst with Toll Cross Securities, referring to the five geothermal stocks listed on the Toronto exchange that he follows.

He is most bullish on US Geothermal – which has a partnership with Goldman Sachs - because it is the only one with an operational plant, even though at 15 megawatts it is a pygmy.

He also likes Nevada Geothermal (CDNX:NGP.V - News), which has drilled impressive production wells but has yet to build its $76 million, 50 megawatt plant, which it is doing in a partnership with Morgan Stanley. (Harbin owns stock in U.S. Geothermal and Nevada Geothermal and his firm has done investment banking business with US Geothermal within the last 12 months.)

Buffett’s involvement in the sector is through MidAmerican Energy Holdings, which has a 50 percent stake in CalEnergy, a utility operating ten generating plants run in Southern California's Imperial Valley

The Potential

CalEnergy is a large player in a fragmented market, according to analysis by Glitnir, a Nordic bank with a geothermal global niche focus, which also forecast "considerable consolidation" in the coming years as cash-poor smaller players get absorbed.

That consolidation could be accompanied by significant growth, as investors and users become increasingly comfortable with the technology in a country with sizable resources.

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Most of that is located in Oregon, Idaho, California and Nevada, where geothermal could account for 60 percent of the state’s electricity needs. Geothermal could satisfy 30 percent of Hawaii’s electricity needs.

The US Geological Survey estimates the US could generate 150,000 megawatts; technological advances could double this.

With 3,000 megawatts, the US already has roughly a third of the total global capacity. That's equivalent to just six standard-sized conventional power plants, but enough to generate $1.8 billion in electricity sales.

Projects under development would double capacity, requiring $9.6 billion of additional investment, according to Glitnir. Another $22 billion would be needed to develop currently identified resources in the next ten years, which could increase electricity sales six-fold to $11 billion a year.

Harbin cautions that the "low-hanging fruit" of the most prospective property – much of it on public lands in the West – has already been snapped up by the first movers, making good finds harder to come by and more expensive to develop.

What stocks to invest in and at what price?

I like both Ormat Technologies (NYSE:ORA - News) and US Geothermal (AMEX:HTM - News) but I would go slow and accumulate these shares with a long term (3-5 year) time horizon. Remember, I think we’re coming into this at nearly the ground floor stage.

US Geothermal trades on the AMEX and is trading at $2.40 a share. Buy no more than a 1,000 shares to start and please don’t chase the stock if it starts to run. It’s thinly traded and any substantial volume will cause the stock to jump. Pay no more than $2.95 a share.

Ormat Technologies trades on the NYSE and actually has options available, which gives us a great opportunity to buy the shares via writing a June $50 put which will drop $180 in your account for every 100 shares you commit to buying. I recommend adding no more than 400 shares at this time. If by the third Friday Ormat is trading for $50 or more, you’ll wind up keeping the cash and not getting the stock sold to you. If the shares close for $49.99 or less, you’ll pay $50 a share and keep the $180 per 100 shares, lowering your cost for the shares sold to you. Long time subscribers know how much I love put writing.

Finally, these and other alternative energy recommendations will not be included in our conservative Model Portfolio. My intention is to group these kinds of recommendations in a Gold & Energy Advisor Alternative Energy Portfolio.

Best Wishes,

James DiGeorgia, Editor


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