Energy Industry

• The Company: Clean Energy Fuels, the largest provider of compressed and liquefied natural gas for alternative-fuel vehicles in North America.
• The Filing: DEF 14-A filed with the SEC on April 15, 2008.
• The Finding: It’s an addiction that threatens our economy, our environment and our national security — oil. In a four-minute video and legends of commercials on television, Boone Pickens, the legendary oil tycoon, says the U.S. can reduce dependence on foreign crude by harnessing domestic energy alternatives, such as wind and natural gas.

The Upshot: The Pickens Plan alleges that by building new wind generation facilities and tapping huge stores of domestic natural gas, the country can replace more than one-third of our foreign oil imports in 10 years.

“Independence” rhetoric aside, what troubles me in the energy debate is Picken’s lack of transparency. In addition to sinking millions of his own money on a 4,000-megawatt wind farm in Texas, he owns about 61 percent of the common stock of Clean Energy Fuels, the largest provider of natural gas in North America for transportation (which I positively commented about in this blog back on June 23).

The Question: Is the Pickens Plan motivated by self-interest or a sincere effort to both make money and do well by the country. What do you think?

• The Company: Quest Resource Corp, a producer of natural gas.
• The Filing: Form 8-K filed with the SEC on August 25, 2008.
• The Finding: The Chairman and CEO of Quest Resource Corp, Jerry Cash, resigned Monday after the Oklahoma Department of Securities launched an investigation into alleged fund transfers from the natural gas exploration company to an entity controlled by Cash. Initial indications are that the questionable transfers could involve about $10 million.

The Upshot: Quest Resource was nonspecific, but I suspect that the undisclosed entity is dedicated to exploration and production of coal bed methane gas in the Cherokee Basin area in southeast Kansas and northeast Oklahoma, an area where Cash first put roots down in the 1980s.

Quest Resources paid Cash about $2.6 million in salary, cash bonus, and stock grants in 2007, according to the 2008 proxy statement filed with the SEC on May 20, 2008.

In addition, the company rewarded him an estimated $4.3 million in stock last year in connection with his new employment agreement.

Cash stands to lose almost $5.5 million in compensation due to him (salary, unvested equity, and cash bonus) if the Board determines he left-or was terminated-for reason(s) of theft or dishonest acts that materially enriched him at the expense of shareholders.

The company has wiped clean any fingerprint of Cash from its officers/biography homepage.

The Question: Could the fallout — and uncertainty — from Cash’s alleged activities delay pending exploration and development in the emerging Marcellus Shale play located in southwest Pennsylvania?

• The Company: Gushan Environmental Energy, China’s largest producer of biodiesel as measured by annual production capacity.
• The Filing: Form 6-K filed with the SEC on August 15, 2008.
• The Finding: Jianqiu Yu, Chairman and Principal Executive Officer, said Gushan Environmental plans to raise its annual biodiesel production capacity from 290,000 tons to 400,000 tons by the end of 2008 and 600,000 tons by the end of 2009. Despite a continuing shortage of diesel supply in China, however, operating profitability at the company could come under pressure in coming quarters.

The Upshot: Gross profit margin for the second-quarter of 2008 ended June 30 fell 250 basis points year-over-year to 41.3 percent. Respective increases in sales volume of biodiesel of 21.8% (to 59,921 tons) and average selling price per ton of 33.5% (to $865.00) were more than offset by a decline in sales of higher margin, chemical by-products, such as erucic acid and erucic amide (sold directly to foundry, pharmaceutical, and food customers).

In addition, the overall average unit costs for the primary feedstocks, vegetable oil offal and used cooking oil, escalated 31.2% year-on-year to $348.40 per ton in the second-quarter of 2008, a result of Gushan’s suppliers passing on their own running cost increases.

As Gushan expands operations to new locations in China, management expects the usage ratio of used cooking oil to increase because used cooking oil is more readily available in these expansion areas, according to the company’s 2007 annual report filed on June 30 with the SEC.

Unlike vegetable oil offal, used cooking oil produces comparatively lower quantities of by-products. By utilizing a greater percentage of used cooking oil as a portion of raw materials, management expects the percentage of revenues contributed by by-products to decrease, which could adversely impact profitability.

Direct users (including marine vessel operators and factories), petroleum wholesalers, and individual retail gas stations represented 47.6 percent, 34.2 percent, and 18.2 percent, respectively of 2007 biodiesel revenue.

The government of the People’s Republic of China controls the retail price of biodiesel through ‘guidance pricing.’ As such, Gushan is looking to expand sales to chemical customers (at higher average selling prices than it receives from other direct users). These customers use biodiesel to produce a variety of products, including elasticizers, surfactants, leather greasing agents, and anticoagulants

The Question: Can Gushan shift more production to higher-margin chemical markets to offset potential volume losses of profitable by-products?

• The Company: Suntech Power, a Chinese solar energy company.
• The Filing: Form 6-K filed with the SEC on August 20, 2008.
• The Finding: Suntech Power said its gross margin rose to 24.1 percent in the second-quarter ended June 30, from 20.3 percent a year ago. The gross improvement was mainly due to stronger pricing driven by strong product demand and appreciation in the euro versus the U.S. dollar — less to do with an expected drop in polisilicon pricing.

The Upshot: Contrary to anticipation, Suntech Power said in a conference call with analysts that 45 percent of its polysilicon, which accounts for about 70 percent of Suntech’s costs of goods sold, still came from the spot market in the second-quarter, and that ratio should remain the same for the rest of 2008.

The current-shortage of solar-grade silicon supply, however, may finally be comingy to an end as suppliers and new entrants ramp up output in coming years. At Greentech Media’s PV Annual 2008, Travis Bradford, president of the Prometheus Institute, said he expects the amount of silicon for the solar industry to quadruple from 30,070 tons in 2007 to 125,302 tons in 2012.

Suntech is on track to reach installed capacity of one giga-watt in output by the end of 2008 and 1.4 giga-watts by year-end 2009. The company has procured 900 mega-watts of competitively priced silicon for 2009. One megawatt, or 1 million watts, is enough energy to power about 800 homes.

In addition, raw material costs as a percentage of total costs of goods sold are expected to decline at least 20 percent the coming year, according to Chairman and Chief Executive Dr. Zhengrong Shi.

“Take nothing on its looks; take everything on evidence,” wrote Charles Dickens in is semi-autobiographical classic, Great Expectations. “There’s no better rule.”

Equity investments in silicon suppliers, such as Shunda Holdings and Glory Silicon, should ensure stability in its supply chain, lower fixed-cost pricing going forward, reduce dependence on the spot market, and ensure enough feedstock and silicon wafers to hit targeted manufacturing output of 2.0 giga-watts in 2010, lowering dependence on the higher-priced priced spot market silicon.

A next-generation PV process, called Pluto, is expected to allow conversion efficiency rates in the range of 18 percent to 19 percent on PV cells manufactured with mono-crystalline silicon wafers, up from a current 16.4 percent.

The Question: Could lower silicon prices and improving technologies lead to the achievement of grid parity with fossil fuel electric power generation sooner than the now expected 2015?

• The Company: AeroVironment, a provider of small, unmanned aircraft systems to the U.S. military.
• The Filing: Form 10-K filed with the SEC on June 26, 2008.
• The Finding: AeroVironment, best known for its hand-launched, remote-controlled surveillance and reconnaissance aircrafts, is quietly gaining altitude in the wind power industry.

The Upshot: Sole supplier to all U.S. Department of Defense programs for unmanned aircraft systems (UAS), small planes — with names like Raven, Dragon Eye, and WASP — contributed 86 percent of total sales for fiscal 2008 ended April 30. The company derives about 14 percent of its revenue from sales of its patented PosiCharge fast charge system, which can quickly recharge industrial vehicle batteries, such as forklifts and airport ground support equipment, with a high electric current while they remain in the vehicles during scheduled breaks.

In addition to developing non-military markets for its small UAS, such as border and petrochemical infrastructure monitoring, the company is pursuing clean energy applications for its proprietary aerospace design technology.

Leveraging its competence in high-efficiency electric powertrain and lightweight, low-speed propeller designs, the company has introduced a small, modular wind turbine solution, called the Architectural Wind system, designed for installation on building rooftops in urban areas, combining functional with architectural aesthetics.

One early adopter of the Architectural Wind system is Massport, operator of Logan International airport, located in Boston, Massachusetts. On July 22, AeroVironment announced the successful installation of the project at the airport, which comprises 20 five-blade wind turbines. Each turbine is expected to generate about 60,000 kilowatt-hours of electricity each year.

The company says that Architectural Wind systems have been installed on buildings throughout the country, including the new Kettle Foods potato chip factory in Beloit, Wisconsin; Laughlin Air Force Base near Del Rio, Texas; and, the St. Louis County Government Service Center.

Clean energy advocates should not hastily dismiss AeroVironment as just another newcomer. Unlike many companies that herald their innovations — without proof of concept — AeroVironment has a 35-year history of converting ideas into results, including the Gossamer Condor, the first human powered airplane capable of controlled and sustained flight; the Solar Challenger, which set records for solar-powered manned flight in July 1981; and, the Global Observer, successfully completing the world’s first liquid hydrogen powered, unmanned test flight in 2005.

The Question: What do you the reader think — can AeroVironment successfully deliver on its promising wind-turbine payload?

• The Company: National Oilwell Varco, a global provider of equipment and components used in oil and gas drilling.
• The Filing: Form 10-Q filed with the SEC on August 8, 2008.
• The Finding: National Oilwell Varco benefited from higher rig construction volumes in the second-quarter ended June 30, with its Rig Technology segment reporting a 49 percent year-on-year increase in operating profit of $506.4 million. Going forward, however, higher material costs, such as steel for piping, could offset improved manufacturing efficiencies.

The Upshot: Rig Technology revenue in the second-quarter increased 36 percent to $1.9 billion, as higher oil and gas prices spurred growing demand for new rigs as well as the equipment, consumables and services needed to reactivate and/or refurbish many older rigs.

Price inflation for steel products — used in oil and gas wells — is running about 45 percent this year, fueled by a run-up in prices of its major raw material inputs, coking coal and iron ore. Metallurgical coal is up about 13 percent in price year-on-year to about $104 per metric ton and the price of iron ore scrap has doubled in three years to more than $200 per ton, according to the Energy Information Administration.

The company has generally been successful in mitigating the financial impact of price escalations in all grades of steel by applying surcharges to and adjusting prices on the products it sells. In fact, profit margin grew 230 basis points, as a favorable product mix (higher margin, more-complex directional and extended reach pipe drilling) and higher production volumes offset rising raw material and employee costs.

Efficiency initiatives, such as quick response manufacturing and broader outsourcing, however, will be of little benefit should an expected shortage in supplies of steel piping itself materialize.

The supply of steel pipe is the lowest he’s ever seen, said Tudor, Pickering, Holt analyst Jeff Tillery in an interview with The Dallas Morning News. Distributors are keeping less than four months’ supply today, compared with six months in 2006.

The Question: Could newer oil and gas plays, such as the Haynesville Shale in Louisiana or the Iara region (off the Brazilian coast), witness drilling delays in 2009?

This is a guest post submitted by BNET member Stephen Rassenfoss. To submit your own post, please visit submit.bnet.com.

Lately, the natural-gas exploration sector has taken a nasty hit — spot prices for natural gas have dropped roughly 40 percent since early summer, and stock prices of many exploration companies have followed suit. Although gas prices are still relatively high by historic standards, the recent decline raises some serious questions for gas-exploration companies, especially those with ambitious plans to exploit huge reserves trapped in shale formations that extend from New York to West Texas.

Managers in the exploration business live with the uncomfortable reality that while drilling is a long-term investment — shale produces slowly and requires a lot of wells — gas prices rise and fall from minute to minute. So it’s especially difficult to estimate how profitable such investments might be.

Some exploration execs might be tempted to take heart in a pep talk delivered a few weeks back by executives of National Oilwell Varco, a major provider of oil and gas drilling equipment. Because the company sells to just about anyone who’s anyone in the business, National Oilwell is sort of a canary in the coal mine — or at least a pack mule in the shaft. Although the company makes most of its sales outside the U.S., its customer network puts it in close contact with every big and small name in the oilwell service business.

At its second-quarter conference call at the end of July, National Oilwell executives repeatedly described an “explosion” of U.S. drilling demand aimed at exploiting gas shale reserves. Their optimism was based on the company’s sales to those drilling and completing those wells, and is especially notable because drilling horizontal wells and then knocking out the gas from these hard-to-produce formations tends to require the kind of high-performance equipment in which National Oilwell specializes.

“There is cash out there today” for rigs “designed specifically for these shale plays,” National Oilwell CEO Pete Miller said at the time. “Look at some of the drilling contractors that are best in new technology, they’re winning the game… Even if you saw a decrease in the price of natural gas, you’re still going to see the shale plays being drilled, and you’re still going to see the demand for these new rigs.”

Among other things, Miller predicted that gas drilling will benefit from federal energy-policy changes that will encourage U.S. demand for natural gas. He suggested that the U.S. land-rig count could rise to somewhere between 2,200 and 2,300 next year — up from a bit more than 1,900 now.

There will be losers as well. Miller and others noted that old rigs unable to go after unconventional formations will be replaced by newer, more efficient equipment. Higher demand in other markets has also allowed service companies to pass on some stiff price increases. The combination of higher priced services and lower gas prices isn’t good news for companies drilling hundreds of wells to develop gas in the next hot plays.

Of course, National Oilwell can afford to look on the bright side. After all, if there’s a gold rush on, the best way to profit is to sell shovels. So — is Miller’s optimism about the prospects for U.S. gas exploration well-founded, or just self-serving?

Stephen Rassenfoss is a business writer in Houston and a former assistant business editor at the Houston Chronicle.

• The Company: Green Plains Renewable Energy, a fuel-grade ethanol producer.
• The Filing: Form 10-K filed with the SEC on February 13, 2008.
• The Finding: Green Plains is celebrating commenced production of ethanol at its new 55 million gallon per year facility in Superior, Iowa. If a bill introduced by Senator Kay Bailey Hutchison (R-TEX), and co-sponsored by eleven other Republican Senators-including John McCain – that calls for freezing the corn ethanol mandate at 2007 levels of 4.7 billion gallons – becomes law this fall, the ethanol producer’s celebration could be short-lived.

The Upshot: Green Plains, like many of its ethanol peers, is struggling under a mountain of debt. The estimated cost to construct the 55 million gallons of ethanol per year Superior plant was approximately $107.4 million.

The company has a second ethanol facility operating in Shenandoah, Iowa, with nameplate capacity of 55 million gallons of ethanol per year, too, which cost an estimated $83 million to build.

Critics contend Midwest corn going to produce fuel-grade ethanol is responsible for food inflation, and wastes valuable resources, such as water. One bushel of corn, which weighs about 56 pounds, produces about 2.7 gallons of ethanol (using the dry mill process). And, it is estimated that one gallon of ethanol requires about 1,700 gallons of water.

In addition, ethanol production contributes to greenhouse gas emissions. For example, each nameplate 55 million gallon per year plant emits approximately 148,000 tons of carbon dioxide annually, according to Green Plain documents filed with the SEC.

Green Plains is a small player in an industry with an estimated U.S. ethanol production of approximately 13.4 gallons by the end of 2009, according to the Renewable Fuel Association. Management’s appetite for growth, however, exceeds its wallet. Limited financial flexibility — total debt exceeds stockholder equity — combined with contractual obligations of approximately $301 million due in one -to- three years, could prove to be burdensome should Congress mandate production cutbacks in current Renewable Fuel Standard mandates.

The Question: Could even talk of repealing Renewable Fuel Standards dry up financing required by ethanol producers, leading to either insolvencies of small producers like Green Plains — or facilitate merger acquisitions in the ethanol space?

• The Company: Anadarko Petroleum, an oil and natural gas company with operations in Algeria and the United States.
• The Filing: Form 10-Q filed with the SEC on August 6, 2008.
• The Finding: Despite record energy prices in the second-quarter, Anadarko said its net income for the three-months ended June 30 fell 98 percent to $23 million, due to $1.6 billion in derivative losses.

The Upshot: Volatile energy prices coupled with $1.2 billion in capital expenditures in the second-quarter, primarily for drilling and development opportunities, dictated the need for predictable cash flow. Through the use of derivative instruments, such as swaps and options, the company sought “to lock-in” prices for forward delivery, ensuring sufficient cash flow.

The company received prices (excluding derivatives), on average, of $9.88 per thousand cubic feet for natural gas and $117.63 per barrel of crude for delivery in the United States, up almost 61 percent and 64 percent in price, respectively, year-on-year.

Unfortunately, by hedging against falling prices, Anadarko traded away, on average, $0.58 per thousand feet of cubic feet and $85.80 per barrel in potential gains for natural gas and oil, respectively, in the second-quarter of 2008.

Fortunately, the losses were recorded as “unrealized losses,” for no monies actually changed hands — as the contracts were for forward delivery (GAAP accounting rules). This explains why discretionary cash flow from continuing operations in the second quarter was $438 million.

Anadarko was not alone in making the wrong bet in the price direction of oil and gas. Natural gas producer Chesapeake Energy and Noble Energy – among others — recently posted losses of $1.6 billion and $716 million, respectively , in (unrealized) hedge trades.

The Question: If oil and gas companies control the prices of fuel commodities — as their critics allege — how come they cannot correctly predict price directions?

• The Company: Cheniere Energy, a Houston-based liquefied natural gas (LNG) project developer
• The Filing: Form 10-Q filed with the SEC on August 11, 2008
• The Finding: After approximately three years of construction — and subject to the completion of routine punch list items — Cheniere Energy completed construction of an initial 2.6 billion cubic feet per day (Bcf/d) of send-out capacity of LNG and 10.1 Bcf/d of storage capacity at its Sabine Pass receiving terminal in Cameron Parish, Louisiana. The development approach Cheniere adopted for the terminal — direct operational control — almost bankrupted the company, due in large part to significant cost overruns.

The Upshot: Total construction, commissioning, and operating cost budget (through the achievement of full operability) will run almost $500 million more than the initial 2004 estimated $1 billion price tag.

Although the U.S. has limited LNG infrastructure, Cheniere still bet all of its chips on rising domestic demand for LNG. No hedging here — the company opted to shoulder the entire financial risk, looking to capture extra profit as sole operator/owner.

Domestic storage capacity has neither stimulated local demand or diverted supply. This paradigm shift, where LNG becomes an attractive alternative to crude or natural gas, has yet to happen, for abundant supplies of locally sourced, low-cost, piped natural gas has effectively restricted LNG shipment flows to traditional trade routes — European and Asian markets.

An additional 1.4 Bcf/d of send-out capacity is expected to be complete by the fall of 2008, and as operations are ramped up, the Sabine Pass LNG terminal could handle up to 240 cargoes per year come 2009, according to management. The Company is also sinking millions more in developing two other onshore LNG receiving terminals and related natural gas pipelines along the U.S. Gulf Coast.

As of the six months ended June 30, Cheniere has accumulated a deficit and long-term debt of $611.2 million and $2.82 billion, respectively. Nonetheless, Chairman and CEO Charif Souki remains confident in the strategy: “build it, and they will come.” To date, however, only three commercial cargoes had been confirmed and unloaded.

On August 11, Souki told analysts that the company accepted a commitment for $250 million of convertible security financing, which should provide liquidity sufficient for three years of operations — assuming even limited use of its Sabine Pass terminal.

The Question: Although the financing is good news, if sellers can contract higher LNG prices in Europe and Asia, where will the company find suppliers willing to ship LNG to its U.S. terminals?