European investors are returning to green technology stocks after switching to safer investments earlier in the recession, and companies involved in energy efficiency and biofuel production show the most potential.

Interest in the clean technology sector is running high as governments set emissions targets and unveil subsidies for technologies to combat climate change, and as companies work on generating power from wind, waves and whisky leftovers.

What are the game changing possibilities? You're looking at wave, tidal, second-generation biofuels, said Bruce Jenkyn-Jones, Managing Director of listed equity funds at Impax, a specialist environmental investment company.

Just this week, U.S.-based Khosla Ventures raised more than $1 billion for renewable energy and clean technology funds, the largest clean-tech dedicated fundraising by a single venture capital firm since 2007.

Impax has also seen money start to come in again from the beginning of the second quarter, though this has not yet returned to the levels it was seeing in 2007.

Analyst Jean-Marc Bunce at Nomura Code says the trick is to determine which firms are on the verge of commercializing their technology and which will fall by the wayside as investors lose patience.

They will be increasingly polarized between the ones who are delivering in terms of commercial roll-out and in terms of revenue and cash generation, and those will be increasingly in favor. And then we will continue to see a fall out of those that have not delivered in terms of technology, he said.

Among fuel-cell makers, Bunce believes Ceres Power, which is developing combined heat and power units with Centrica's British Gas division, and Ceramic Fuel Cells will continue to flourish. Shares in both have already more than doubled this year.

Companies that help people easily improve the energy efficiency of homes and offices are also gaining steam, such as BGlobal, a provider of household smart meters giving data on energy use that has seen its shares double in value since the start of the year.

In this sector, broker Brewin Dolphin has a buy rating on Eaga and forecasts good growth in the firm's outsourcing and renewables activities.

I think that most of technology that will likely come to commercialization will be energy efficiency technology, rather than power generation technology, said David Cunningham, analyst at brokerage Arbuthnot.

MAKING WAVES

In terms of technologies that can really revolutionize the way power is generated, Impax's Jenkyn-Jones is cautiously optimistic about long-term prospects for wave and tidal power generation, pointing to privately held Pelamis, which produces power from a machine that looks like a floating snake.

Cunningham sees potential in a buoy device developed by Renewable Energy Holdings, but he feels the best bet for investors in this area are technologies that don't involve generating power offshore, such as hydroelectric.

Cunningham believes largescale commercialization of wave power, which has promised clean energy for decades, is unlikely for the next 10 years, given it has yet to show consistent, cost-effective performance under harsh offshore conditions.

Fund managers and investors should be investing in traditional businesses that have proven reliable sources of power generation, not in R&D shops that may never get out of the laboratory, he said.

BUGS & BINS

Next generation biofuels, which can use bugs and chemical reactions to turn plant material into fuel, are starting to deliver useable technology, however.

Jenkyn-Jones picked out Danish enzyme giant Novozymes, whose enzymes can be used to convert foodstuffs such as corn into bioethanol, and U.S. company Ensyn, which is converting wood waste into an oil-like product.

In Brazil, the largest producer and exporter of renewable sugar cane-based ethanol, the market has stalled in 2009 as a result of lower demand and recent over-investment, but biofuels investor Clean Energy Brazil says it remains promising.

Long-term, there's a lot of excitement, and it's really the most efficient fuel we can get, the firm's finance director John Koutras told Reuters.

Elsewhere, shares in Helius Energy have almost doubled this year on its plans to use waste products from Scottish whisky distilleries to generate power.

Generating power from household waste is another promising technology, with water company Pennon moving into this area via its Viridor unit. Jenkyn-Jones highlighted Covanta and Shanks as companies to watch in this area.

Waste is a much lower-cost source of energy than wind, says Viridor CEO Colin Drummond, highlighting that a plant fueled by waste can operate 80-90 percent of the time.

He believes that by 2020 waste could meet up to 6 percent of the UK's total energy needs, up from 1.5 percent currently.

What I find amazing is that the politicians seem to be ignoring it. I find that absolutely incredible.

(Editing by Paul Hoskins/Will Waterman)

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