The Forgotten Renewable

The high-profile bankruptcy of solar equipment maker Solyndra LLC has put renewable energy economics squarely in the spotlight. Many now question if there are any renewable energy companies that could survive without government assistance.

As I said before, few sources of energy can compete with US natural gas from shale right now. And a spot gas price below $4 per million British thermal units is strong incentive to use it to generate electricity.

There is a renewable energy, however, that’s still cheaper to generate power with than natural gas. It’s also far cleaner and there’s immense untapped potential in North America, which will enrich any company that develops it.

I’m talking about hydroelectric power, the forgotten renewable energy. And the companies that build the next generation of capacity will enjoy locked-in returns, either with long-term sales contracts or by putting the facilities into rate base.

They’ll be generating from a source with costs that don’t change, giving them some of the most secure profit margins of any industry. And that adds up to rising profits, growing dividends and, ultimately, rising share prices. That’s in addition to unmatched safety.

An Untapped Source

America has generated power from dams since the Fox River plant began operating in Appleton, Wisconsin, back in 1882. Market share hit a peak of 25 percent in 1920.

Today many of the older structures are being dismantled. But technology has advanced rapidly, vastly increasing efficiency and limiting environmental impact. Hydro’s share of total US output is down to about 7 percent, much of it owned by giant cooperatives and public power authorities. But total installed capacity is more than three times what it was in the 1920s. And there’s potential in this country alone to develop an additional 60 gigawatts by 2025.

Ironically, hydro was hardly a footnote in the US Energy Information Administration’s 2011 Annual Energy Review, which focused almost entirely on “Non-Hydro Renewables” with little breakout for hydro alone. EIA forecasts annual output to rise at a slower rate than anything else but nuclear.

Hydro receives only half the tax credits available to developers of wind, solar and geothermal energy. And there are no incentives for pumped storage development, in which energy is used during off peak hours to push water uphill to be harvested as hydro power when demand peaks.

The silver lining is hydro is the only renewable energy that’s not dependent on federal largesse. That could prove critical in future years.

The Obama administration remains firmly committed to developing a range of electricity sources that don’t produce carbon dioxide (CO₂), from wind and solar to geothermal and nuclear. None of the prospective Republican candidates for president, however, even remotely share that zeal. As a result, if the president loses, renewable energy funding is likely to take a hit not unlike it did in the early 1980s, when a hostile Reagan administration replaced an enthusiastic Jimmy Carter in the White House.

For US power utilities, the upshot will be yet another disruptive shift in government energy policy of the sort that makes long-term planning exceedingly difficult. And their situation will be further complicated in most states by mandates requiring them to generate a percentage of energy from renewable energy.

Natural gas-fired plants emit less than half the CO₂ of coal power plants. And the expectation is abundant shale gaswill keep it cheap for years to come, even if companies like Dominion Resources (NYSE: D) and Sempra Energy (NYSE: SRE) do develop facilities to export liquefied natural gas (LNG).

Utility managements, however, have long memories and gas has a history of sometimes extreme price volatility. As a result few, if any, are going 100 percent gas, and most will be looking for sources with historically steadier costs.

Enter hydro. Hydroelectric resources are not evenly distributed across the country. The Northwest is most blessed with an estimated 34.4 gigawatts of additional capacity available for development, even by conservative assumptions for environmental concerns and technological feasibility. Even the Midwest (1.8 gigawatts), however, has opportunities. And the Southeast (12.8 gigawatts) is especially ripe, given pro-investment regulation and the lack of economic wind and solar potential.

The opportunity in hydro growth is hardly confined to the US. Canada is already the world’s third-largest producer of hydro power, ranking ahead of the US and behind only Brazil and China.

The country’s Conservative Party government has very aggressive targets for increasing use of renewable energy. And, unlike in the US, opposition parties are even more firmly committed to development. Some of that’s going into wind and solar. But the biggest effort is in hydro, which runs at a far greater percentage of capacity at a fraction of the cost.

Hydro is also the primary focus of development for energy in Brazil, which also has favorable regulations in place that lock in producers’ returns even if water flows fall short. As of 2008 hydro was 77 percent of the country’s total installed power capacity of 100.5 gigawatts, and it continues to grow, with a 41 percent jump in capacity expected by 2016. That’s according to Brazil’s Energy Research Office, the Empresa de Pesquisa Energetica (EPE).

EPE also estimates the country is using only about a third of its potential hydro capacity. Much of the new capacity is expected to come from a handful of major projects in the Amazon region. But there’s also an increased emphasis on small hydro–plants between 1 megawatt and 30 megawatts of capacity–with some 1,600 potential projects estimated capable of adding 15,000 megawatts to the country’s grid. Oil giant Petrobras (Brazil: PETR3, NYSE: PBR), for example, is currently bringing nearly 300 megawatts online.

Small hydro is a far lower impact source of power than large hydro. The largest of the latter is the contemplated Belo Monte Dam on the Xingu River, an 11 gigawatt project that’s been delayed by international protests precisely because of its potential impact on local ecology. The controversy has, however, arguably kept the spotlight off several other projects that continue to move forward.

Between them, Brazil, Canada and the US offer abundant opportunity for hydropower growth. Equally important, all three are generally favorable to investment and investors are not at risk to losing all to resource nationalism.

In the US, Idacorp Inc (NYSE: IDA) is the utility most weighted toward hydro production. Idaho regulators, however, have made it difficult for the company to profit from its low-cost output and the stock is high priced in the upper 30s.