EROI; The Metric Energy Investors Need to Understand

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Energy returned on energy invested (EROI) is slowly starting to make its way into main stream discussion, but it is not commonly heard on the lips of investors. Long term investors who want to understand the evolution of the world's energy system and profit from it will find EROI as a critical tool. The solar industry has a positive long term outlook given simple physics, its EROI, and the today's geological reality. 

The Economics

The energy returned on energy invested simply states the "ratio of the energy delivered by a process to the energy used directly and indirectly in that process." The connection between monetary profits and return on investment is quite logical. Higher energy inputs relative to outputs will mean more costs and all other items held constant, fewer profits. The growth of harder to find oil and decreasing coal mining yields can be seen in the slow decrease in the overall EROI for these fuels.  

8020 Vision has a nice chart that explains this idea. The below chart is a tad optimistic as other studies have found that solar's current EROI is in the same range as traditional fossil fuels. The important point remains that as the world edges closer to 2100, geological constraints and the positive EROI of solar will make it more profitable.

Possible Investments

First Solar (NASDAQ: FSLR) is one of the stronger players within the solar space. Their thin film technology is not as efficient as some of their competitors, but the firm makes up for it with cost decreases. Unlike their Chinese cousins, First solar is not walking around with a giant debt load. Their total debt to equity ratio of 0.15 is healthy. A quick look at their gross margin of 32.8% shows that it is one of the stronger players in the space. Strong margins are a necessary ingredient of a secure company and First Solar's numbers are encouraging. 

First Solar's shares have slowly come back to life over the past year, and there appears to be more space to grow. Their estimated earnings in 2013 are $4.07 per share. Based on a current share price around $35 it has a forward P/E of 8.6. Relative to the broad market this is cheap as a P/E of 15 is the long term average. First Solar's lower efficiency technology is a long term risk, but for the current time period it is a promising investment.  

SUNPOWER CORP COM USD0.001 CLASS'B' (NASDAQ: SPWR) uses high efficiency technologies and a vertically integrated approach to sell entire systems. Higher efficiency panels help to reduce total costs by reduce the number of parts and real estate necessary. In North America it operates a popular leasing program that decreases the investment costs for the end users and helps to drive volume. Their partnership with the French oil giant Total helps to put SunPower on very strong footing for the future. The growth of mainstream solar will require support from many sectors, and the fact that big oil has decided to back this company is a major vote of confidence. 

SunPower's balance sheet is not as clean as First Solar's, but it is not horrendous. Its total debt to equity ratio of 0.74 is not nearly as high as Canadian Solar's. SunPower 's gross margin of 15.6% is not as strong as First Solar's, but SunPower has a positive long term outlook. Their unique high efficiency technology, backing by Total, and experience selling to a variety of customers should pave the way for long term success. At a price to book ratio of 1.29 SunPower is not especially cheap, but investors with long term horizons should not ignore this firm. 

Canadian Solar (NASDAQ: CSIQ) is a different story. A poor balance sheet can easily give a company the flu and leave it so venerable that any hiccup can drive it into bankruptcy. The solar industry is very competitive and driven by cost decreases and technological development. Without capital to invest and grow a solar manufacture will quickly fall behind. 

This company has a short term debt load of $891 million and a long term debt load of $225 million. With a total debt to equity ratio of 2.85, Canadian Solar is not in a good place. In addition to these factors the company has a low gross margin of 7.9% that leaves it at a disadvantage. Over the coming years it will need capital to upgrade its capital equipment. Its balance sheet is already constrained and this is a bad omen. 

Conclusion

In the name of technological growth and conservation we have tried many new technologies like ethanol. A quick look at ethanol's EROI would have made it obvious that the fuel has serious shortcomings. Solar's EROI continues to improve; showing that solar is a truly promising fuel. SunPower is one of the best solar investments and First Solar is another worthy of consideration. 


MrCanadian1 has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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