IT DIDN'T TAKE

President Bush's declaration during last month's State of the Union address that America has an "addiction" to foreign oil to convince Tim Woodward of the value of alternative energy. The managing director of Nth Power, an energy venture-capital firm based in San Francisco, has long been a fan of developing alternate sources of fuel. And for the past eight years he's put his clients' money where his mouth is.

Alternative-energy investors have weathered many booms and busts. Solar power was eclipsed by wind, which in turn was blown aside by fuel cells. Ethanol derived from corn has hung around for years, thanks in large part to generous government funding, without coming close to supplanting gasoline. Now there's switchgrass.

Despite past failure and unfulfilled promises, it's undeniable that soaring crude prices have renewed interest in the sector once gain. Nth Power estimates that of the money that flowed into venture funds last year, slightly more than $800 million was earmarked for "clean technology" start-ups. That's up from around $700 million in 2004. The amount has grown every year for the last four years.

Spikes at the gas pump and soaring home-heating bills have garnered the attention of consumers too, but Americans have been down this road before. During the oil shock of the 1970s, high prices prompted many to bet big on alternative-energy technologies. When oil and gas prices eventually retreated, most of those investments floundered as alternative energy faded into the background. But this time around, says Woodward, it's different.

"There's a real push toward energy independence and a cleaner source of energy as people start to take global warming seriously and realize the true costs we have in this country of supplying our oil habit," says Woodward, whose firm invests in a range alternative-energy start-ups. "People are willing to pay a premium as a way to do their part, as a way to help solve that problem."

A sticking point has always been cost. Renewables are notoriously expensive, so their inability to compete with traditional energy sources has held them back. But as technologies are refined, Woodward predicts companies like the ones that Nth Power invests in will become more cost-effective.

"A lot of these technologies that are viewed as questionable because of economic considerations are more viable today and will be more so five years from now," he says.

SmartMoney.com spoke with Woodward about the specific start-ups that Nth Power is pouring money into, and why alternative energy must be the wave of the future.

SmartMoney.com: What areas of energy are you focusing on?

Tim Woodward: We're an energy venture-capital firm. We broadly define the energy market space. That market has evolved from a focus on the power industry, which is really the electricity industry, and has become much broader to include all of energy. From oil exploration, processing, natural-gas exploration, refining, to all of the technology that touches on consuming energy, including batteries in laptops, and anything related to uninterruptible power supplies, where 24/7 electricity is critical, like data centers and hospitals. And then it carries over to the customer side how the homeowner can manage their energy consumption in more intelligent manners. Whether that's buildings, heating and cooling systems, to homeowners who want to put solar on their roofs, or want to use a different type of fuel in their cars.

SM: What kinds of companies does Nth Power invest in?

TW: We invest in private companies. We're at the early round, at a point in time when the company is about to launch a product. So we're pretty far upstream in [the venture process] and we continue to invest in the businesses prior to their public offering.

One of the companies we invest in, and I'm on the board of, is AllConnect. We provide a service for [residential customers in the process of moving]. We allow you to sign up for all your home services through a single transaction. It could be DSL, phone, cell service, electricity, gas, water. We do that through your electric utility. For example, you could call ConEd and you'd be transferred to our facility, where in about half an hour you could have all your other services signed up. It enhances [ConEd's] brand in relationship with the customer. We get in front of a moving customer when they make critical decisions so companies like Verizon and Comcast want access to that customer.

It's related to the evolving energy market. Electric utilities are in a more competitive marketplace. Electric utilities view themselves as having a pipeline into a home that can bring services into the home, similar to the TV company, cable company or phone company. So the utility company is beginning to broaden the services it's bringing to the customer.

I'm on the board of a company in New Jersey that provides "peak load management." At times in Manhattan, or in southern New Jersey, when everyone turns on their air conditioners, the power grid is pushed to capacity.... We offer a cost-effective way for the utility to wirelessly communicate with a home and cycle the air conditioner to reduce the amount of power used. It can save a significant amount of energy....We build the equivalent of a power plant around load-management devices. It's the ultimate in renewable energy.

SM: How do you decide which companies and technologies to invest in? Why did these look promising?

TW: These are the most promising areas [of alternative energy to us]. These are the areas that fit in with our venture investment approach. It's important to have the amount of capital to get a company launched, and get it through a liquidity event like an IPO. Building a large power plant is not a venture type of play. We look at what areas of energy are suitable for the amount of money we can deploy.

One of the drivers that's creating interest in the alternative energy sector is reliability power. More of the world is dependent on electricity. As we move from a manufacturing and industrial process...more and more people expect everything to work all the time. The need for that reliable power grows every year. At the same time the system providing that power grows more vulnerable. People are more aware of blackouts becoming a common occurrence, and trends like that. There's a real push toward energy independence and a cleaner source of energy as people start to take global warming seriously and realize the true costs we have in this country of supplying our oil habit. People are willing to pay a premium as a way to do their part, as a way to help solve that problem....I think consumer trends are favoring renewable sources.

SM: Alternative energy seems to be very popular right now partly because with oil so high it becomes economical to pursue. How viable are the business plans on a long-term basis if oil prices retreat?

TW: Historically we have had energy crises in this country and on a global basis. People experience high prices only to return back to normal and back to old habits. It hasn't changed consumer behavior. It happened several times and had ramifications in the market. We're not alone in looking at the market and seeing that there are systemic changes in the system now. It's not a temporal thing. Oil prices may fall from $60 to $40 a barrel. But the days of $40 oil or $50 oil are in the past. People would say we've established a new floor. People are looking at a world where energy prices are more likely to increase than decrease. They're starting to respond that investing in some of these alternatives may make sense with today's prices and will make a lot more sense in the future.

People are feeling vulnerable.... When the next Katrina happens, you are going to take action to do something to hedge that risk. That action is going to be investing in some technology, something different than what you were doing before. In the last year you've seen a boom in advanced technology. The consumer has finally woken up to say the world is changing. The problem with energy is that it's so critical with what happens every single day. People can't take it for granted.

SM: Which category of renewable energy does Wall Street seem most enthusiastic about now?

TW: The solar market that industry alone has continued to grow 40% to 50% a year for the past five years. It's mostly driven by government subsidy programs in Europe, as well as here. What that really allowed for is a fundamental technology at a lower price point, to a level that in the next five to seven years, I'm convinced that the cost to deliver to homes will be competitive to rates you purchase electricity at today. When that happens, you'll see a massive change in attitude toward solar products.... We can see four to five years on the horizon, and a lot of these technologies that are viewed as questionable because of economic considerations are more viable today and will be more so five years from now. And the consumer is much more aware of the need.

SM: Given how popular alternative energy is becoming, how outrageous have the valuations gotten on the businesses you're looking at investing in? Is any of it overhyped?

TW: It sort of depends on your perspective. Some would say solar companies are priced at a level where they absolutely have to execute on their plans perfectly in order to meet the expectations of the share price imparted on them. I think there's some truth to that, but also some upside left. In the private sector we don't see as much volatility in pricing. It's a more sophisticated investor that's a little more controlled in their enthusiasm. Once companies get to the public market, there are situations where individuals shareholders can certainly get excited by a trend and drive it up to a valuation that doesn't make sense. I think over the long run, they're fairly valued. But I could easily see in the next year or two some of these companies can get ahead of themselves.

SM: Are you investing in companies that are earning money already or still losing money? Do you think these companies can make profits in a free market, or do they need the help of legislation and government subsidies?

TW: Some of them have broken through to making profits. Others are still not there. Part of it is that we're investing in an early phase, when companies are building their businesses. At a point in time when they go public, investment banks and Wall Street look to them to be profitable. Our portfolio is biased toward companies not yet profitable. Solar is probably the most developed market with the greatest number of companies. It's really launching a commercial business. Those [solar companies] are at the cusp of being profitable now or in a 12-month time frame. The one area that is clearly still struggling is fuel cells, and we're careful to invest in it. It's a bit of a bet on tomorrow. The question is when is that tomorrow? There will ultimately be a market for fuel cells. But today the cost to manufacture fuel cells still doesn't make them very economical in most cases.