As investors become increasingly risk averse amid market turmoil, credit markets remain unstable, and oil and natural gas prices retreat, the alternative energy sector is facing yet another challenge.

Many of the smaller start ups that were working their way towards profitability cannot get the financing they need just to stay in business. As a result, share prices of alternative energy companies are dropping increasingly faster than most other sectors.

On top of that, the world’s political leaders have shifted their focus to the economy and questionable green subsidies might even get slashed as well. In Canada, the recent re-election of Prime Minister Stephen Harper’s minority government pretty much sealed the deal on the elimination of the opposition party’s $13 billion carbon tax-based program.

Senators Obama and McCain both have promised to support the sector in hopes of increased energy independence and a greener planet. But when faced with the current economic crisis, the market is forced to wonder if the U.S. government will be willing to extend their commitments to the green industries for the long-term? More importantly, if the economy doesn’t get turned around, will anyone even care?

Clifford Krauss at the New York Times reports in a recent article Alternative Energy Suddenly Faces Headwinds.

But after years of rapid growth, the sudden headwinds facing renewables point to slowing momentum and greater dependence on government subsidies, mandates and research financing, at a time when Washington is overloaded with economic problems.

John Woolard, chief executive officer of BrightSource Energy, a solar company, said he believed the long-term future for renewables remained promising, though “right now we are looking at tumultuous and unpredictable capital markets.”

Venture capital financing for some advanced solar projects and for experimental biofuels, like ethanol made from plant wastes, is drying up, according to analysts who track investment flows.

At least two wind energy companies have had to delay projects in recent days because of trouble raising capital. Several corn ethanol projects have been delayed for lack of financing in Iowa and Oklahoma since last month, and one plant operator in Ohio filed for bankruptcy protection last week.

Tesla Motors, the maker of battery-powered cars, recently announced it had been forced to delay production of its all-electric Model S sedan, close two offices and lay off workers.

Investment analysts say initial and secondary stock offerings by clean energy companies across global markets have slowed to a crawl since the spring, and for the full year could total less than half of the record $25.4 billion for 2007.

Worldwide project financings for new construction of wind, solar, biofuels and other alternative energy projects this year fell to $17.8 billion in the third quarter, from $23.2 billion in the second quarter, according to New Energy Finance, a research firm in London. The slide is expected to be sharper in the fourth quarter and next year.

In the United States, financing for new projects and venture capital and private equity investments in renewable energy this year might still top last year’s results because so much money was in the pipeline at the beginning of the year, but the pace has slowed sharply in the last month.

If credit continues to stay tight and energy prices don’t rebound we should expect to see further declines in this sector.

There will be some demand for solar, wind, and other alternative energy projects, but without economic efficiency as the driving force behind investment in the sector, there could be a long time before any rebounds come.

We’ve been speaking quite a bit about the potential impact of a deflationary environment. We’re already starting to see the impact of it in the way mining companies run their businesses. Some mines are shutting down, others are “temporarily” closed for care and maintenance (which is never an issue when commodity prices are high), and new projects getting shelved half-way through their development.

Renewable energy companies aren’t much different than mining companies. They too have long lead times and projects that take years of development before they even get their first dollar in revenue.

The alternative energy sector has taken a drubbing. Early investors in many ethanol projects have learned their lesson. The Financial Times states the six largest ethanol producers in the United States have shed more than $8.7 billion since their highs in 2006.

As a result, most institutional investors just aren’t willing to cut a check for a few hundred million dollars right now. Uncertainty is high and almost no one is willing to take the plunge on a business which might not even be economically viable in another six months.

The money is only going to three places right now. It’s either going to the sidelines, companies that we know will survive a recession and come out even stronger, and stocks with moderate to high (and sustainable!) yields.