EcoAlpha Asset Management

Oil's Third Bear Trap?  An Opportunity for Sustainable Investment January 6, 2015 As we last identified in late 2012, we strongly believe now is an opportune time to allocate to investments in sustainable and efficiency solutions. For reference, in January 2013 we (as AWJ Capital Partners) allocated 4% of our strategy that we were executing in a prior fund (AWJ GSF Fund) specifically to solar companies. We had observed accelerating fundamental demand within the solar sector, yet most stocks were down -75% as declining module and silicon prices brought down the entire industry. We used the broader weakness as a buying opportunity for those companies with the strongest long-term fundamentals. This 4% solar allocation appreciated +115% over the next 12 months and through the end of Q3 2014, has yielded +41% annualized returns. In mid-2014, we formed EcoAlpha Asset Management LLC ("EcoAlpha") to further capitalize on the opportunity for growth within the sustainable solutions investment areas. Three investment managers from the seven investment firms to which AWJ GSF was allocating became partners in EcoAlpha, acting as domain experts in water, agriculture and energy efficiency. EcoAlpha offers long-only and hedged strategies to leverage the interconnectedness of each investment area while removing the double layer of fees associated with the fund of funds model. In our opinion, this optimized structure coupled with accelerating fundamental growth in efficiency solutions adoption and a massive pullback in oil prices and prices of efficiency solutions companies (especially energy efficiency solutions), has created one of the greatest investment opportunities we have seen in our careers. What's happening? In the last six months, oil prices have gone from $110 to $60 per barrel and many currencies have moved in favor of the dollar, globally. Investors have sold securities related to oil, energy, power generation and energy efficiency. It feels to us like the proverbial, "throwing out of the baby with the bathwater." We believe this selling pressure has created significant opportunities to purchase great efficiency solutions companies at historically low prices and, where appropriate, sell short those companies that will continue to be challenged in this difficult environment. Through our energy efficiency lens, we have identified many varied opportunities in power generation and transportation. Power Generation In our view, falling oil prices should not negatively impact renewable energy solution companies-specifically solar and wind companies. Within power generation, base load energy prices rarely define comparative price levels when evaluating against alternatives. It is generally the variable load that defines comparative price. Coal and nuclear are base load feedstocks, as variable load is typically fed by natural gas. In the U.S., oil and natural gas prices parted ways years ago. High oil prices did nothing to sustain natural gas prices and the decline in oil has not driven a decline in natural gas pricing. As such, it should have very little impact on demand for alternative energy. With the dramatic declines in the cost of solar and wind generation, price has ceased to become the sole driver for demand. The largest power markets in the developed world-China, U.S., E.U. and Japan-each have distinct policy and market-based drivers behind the deployment of renewables. China in particular is moving to solar and wind to solve for environmental and health problems. In the U.S., the EIA estimates that dirtier, less efficient and less stable sources have started seeing declines-nuclear and coal power are becoming less important for different concerns-nuclear regarding safety and upfront capital investment and coal regarding pollution. Coal is projected to move from 37% of electricity generated today to 32% or less by 2040, while nuclear is moving from 19% today to just 16% in 2040. The accelerating retiring of coal-fired plants is exacerbating this decline. Oil is expected to remain at 1% between now and 2040. Meanwhile, renewable energy is expected to see the largest increase in generation, jumping from 12% today to 16%+ by 2040. Furthermore, with regard to natural gas power generation, we believe there is also mispricing in the market for efficiency solutions companies. Combined Cycle Gas Generation is a key bridge technology in power generation to make up the gap between the necessary decline in coal-fired generation and a more renewables-centric future. Given the challenges perceived with nuclear energy, natural gas power with its lower emissions profile and relative cheap LCoE will become the workhorse technology for the medium term. We believe that demand for natural gas efficiency solutions will increase dramatically to make power generation cleaner and cheaper. For the above reasons, we believe that the 30%+ decline in solar stocks (as evidence by the TAN ETF) and the 30-50% decline in companies involved in natural gas efficiencies each precipitated by oil's 50% decline is unwarranted. Transportation Oil price does have a potential impact on demand for efficiency within the transportation sector as lower oil prices generally mean lower gasoline and diesel prices. This extends payback times for alternative fuels and hybrid electric vehicles. In this space, we expect the impact will be largely absorbed by the natural gas powered vehicle space as the value proposition of natural gas diminishes as mostly a replacement for diesel. The impact on the broader efficiency trends in light-duty transportation (the vast majority of the market) may turn out to be different and unexpected. Café standards (and other such regulations in the E.U., China and Japan) drive the efficiency trend and not fuel prices. Here we expect lower fuel prices to drive more new car sales-more sales of more efficient cars since OEMs are committed to upgrading efficiency of their fleets by roughly 4% per year. This will have the effect of the turning over the worldwide fleet at a slightly accelerated rate. In short, automakers have three options to drive required efficiency gains: hybridization, internal combustion efficiency and light-weighting. With less incentive for hybridization due to lower gas prices, investors should expect to see spending growth in light-weighting and engine efficiencies. Notwithstanding the fact that light-weighting and engine efficiency should experience increased demand, stocks of these solutions providers have seen declines of 15-30% over the past several weeks. Meanwhile, engine efficiency solutions like turbo chargers are on track to see +85% fundamental growth through 2019 and recently posted an acceleration of growth in Q3 2014. Finally, although falling oil prices may have some impact on demand for transportation efficiency, the concurrent weakening in some currencies vs. the Dollar reduces the impact. This will likely have two effects. Producing countries can experience massive disruption to their oil production, economyand budgets as revenues drop. This can lead to a decrease in oil supply from high cost producers, unconventional drillers and deep water drilling techniques. Additionally, countries such as the U.S. and those that have seen stable currencies, will benefit from an almost $1.7 trillion reallocation of capital from producers to consumers with this ~$50 drop in oil prices. For context, $1.7 trillion is approximately 2.2% of total global GDP in 2014! ($78 trillion global estimate).  The Opportunity In the near term, markets will do what markets will do. In times of major volatility we tend to see the "fire, ready, aim" mentality. We believe this creates opportunity as the massive disruption in oil prices globally has pressured companies small and large, related or unrelated. A drop in oil prices can ignite global growth as consumers spend massive amounts of reallocated capital. It can eliminate high-cost marginal producers or debt-laden organizations. It can also ignite turmoil and conflict between countries. Active managers cannot change the action of the markets but can capitalize on cheaper prices and entry points for public securities that maintain uninterrupted or accelerating fundamental growth. We don't know when or by how much oil prices will recover, but we do believe opportunities exist in both Power Generation and Transportation regardless of oil price.   If history is any indication of what can be borne of sharp drops in oil price, then asset owners needs to allocate to sustainable solutions seeing accelerating fundamental growth and prepare for a potential, drastic rebound in oil prices. Nobody wants to get caught in a bear trap  To learn more, please visit our website: http://www.ecoalphaassetmanagement.comor contact us at: info@eallc.com