Is this a setback for investment in new energy sources? Luckily not. There are a growing number of companies and industries which do not depend on artificial government subsidies and where the business models are robust and offer a solution with both better economics and a lower environmental (not just carbon) footprint. These businesses will prosper because they can provide cheaper energy. Everything else is a bonus.
We also subscribe to the thesis that China’s reluctance to agree to any measurement of its emissions has as much to do with ‘face’ as anything else. China’s leaders are acutely aware of the economic and social issues that polluting and resource inefficient industry engender. They are likely to continue to legislate for a more sensible and green industrial landscape. They just don’t want to be seen to be being pushed about by the West, which is correctly perceived to occupy no moral high ground as far as energy usage goes. And there are other grounds for optimism. In November, the US suggested the reductions from the Waxman-Markey bill (17% reduction by 2020, 83% by 2050) while China outlined a national plan targeting the reduction of emissions per unit of GDP by 40-45% over the period 2005-2020.
Whether one believes in climate change or not, however, the world needs energy. It is the life blood of economic growth providing the fuel for economies to industrialise, modernise and continue to grow. One of the great challenges over the next several decades will be in supplying energy to feed this growing appetite. Hence comments such as those made by sceptics who claim that there is no climate change, or if there is, it is not man made, misses the fundamental point. The point is, regardless of whether one believes in climate change, the global economy continues to industrialise. It is unstoppable. This is driving the need for greater supply of energy and materials while the supply of fossil fuels and natural resources is finite, which in turn will drive prices higher over time. Therefore what we are really talking about is security of supply issues as well as environmental and geo-political issues. This inexorable need for energy requires that it is sourced from a more diversified base, which includes harnessing other forms of natural energy, including the sun and wind.
As the negative mood over the global economy continues to recede, the world will begin to re-focus on possibly the largest and most daunting task to face mankind – climate change and meeting the need for more energy. The implications of unchecked carbon emissions read like a disaster movie. Few industries will escape the effects of climate change – manufacturing, transport, construction, financial services, healthcare and energy will all be heavily impacted.
From an investment perspective, the Wilderhill New Energy index (NEX) outperformed the MSCI World Equity index over the last one, three and five year periods. Investment in alternative energy is not just socially responsible but also profitable and has opened up a new investment horizon where the private sector has recognized a global need. The NEX’s high 35% annualised volatility over the past three years and wide discrepancies in valuations mean the sector is ideally suited to a long-short investment approach. For example, in lithium, which is essential for the manufacture of electric cars and portable electronics; we see much better value in Galaxy, a lithium carbonate producer than BYD, a Buffet favourite and lithium-ion battery manufacturer that trades at a price/earnings multiple over 70. With nearly all nations embracing the adoption of renewable and alternative energy, but at different speeds, the potential to make money from the growth that lies ahead in this industry is attractive.
One key figure stands out – $500 billion according to the Financial Times. This is the amount that will need to be invested each year to keep inside the limits that scientists say are needed to head off the threat of catastrophic global warming – on top of the $1.2 trillion required simply to meet growing energy demand in a “business-as-usual” scenario. While the benefits of averting climate cataclysm are incalculably large, the costs of doing so should not be enormous – as little as 1% of global output. In comparison, saving the banks has cost around 5% of global output. One could view ‘climate insurance’ much the same way one views home or auto insurance – a necessary and effective way of insuring against a catastrophic event.
The need to diversify our exposure to conventional energy solutions due to structural production challenges, environmental and energy security concerns will only become more acute with the passing of time. Underpinning the growth in demand for alternative energy on a global basis are three identifiable and powerful converging factors.
The first factor is the security of supply of conventional energy. When Gazprom, the Russian gas export monopoly, turned off the tap on supplies, customers across Europe found that they were cut off in the depths of winter. Security of supply is one of the important drivers behind the overall push into renewable energy. Governments of developed and large developing economies are faced with security of supply issues as geo-political risk has increased in regions where conventional energy is increasingly being exploited, adding to the cost of finding and developing new sources of supply.
The second factor is how the widening gap between the supply and demand of conventional energy will be met as industrialising economies like China, India and Brazil continue to increase consumption of conventional energy at a rate faster than global supply. While oil demand is impaired today due to the credit contagion, the crisis has sown the seeds of tight supply and higher prices in the future since capital has been constrained for projects necessary to develop supply to meet future demand.
The third factor is environmental concerns: governments world-wide (whether signed up to Kyoto or not) are legislating to lower emissions by forcing investment into alternative sources of energy as the level of emissions have now reached a level that is beginning to have consequences on climate and is supported by irrefutable scientific evidence. The EU directive where 20% of energy should come from renewable sources by 2020 stands out as a good example.
Alternative energy is inextricably linked to natural resources. Alternative energy is just another way to produce electricity cleaner, as a replacement for coal or natural gas. Ultimately, alternative energy has to compete on price with conventional energy because feed in tariffs and government subsidies will not remain in place indefinitely. Reaching grid parity through commoditisation will ensure that this nascent industry continues to grow 20-25% annually for the next decade.
It is now imperative that developing countries must by-pass the “dirty” phase of industrialisation by the rapid adoption of clean energy. The industrialisation of China over the last two decades has bought into sharp focus the impact a fast-growing, highly populated country has on the global economy. China’s appetite for natural resources is enormous and the country faces a growing oil supply gap (see Fig.1). It is the second largest consumer of energy behind the United States, and accounts for nearly 50% of global consumption of hard commodities. With the largest urbanised population in the world, it is also the largest polluter. A dark side to this rapid growth is the adverse impact on health, with an estimated 750,000 deaths annually from respiratory related illnesses due to pollution alone. Add India into the equation and the divergence in supply and demand of natural resources including conventional energy can only act to keep commodity prices high, especially in future periods of economic stability.
The growth in investment in the global renewable energy sector has remained more resilient than many commentators expected a year ago. Despite weaker economic conditions, major projects continue to be announced with China leading the way. For example, during a two month period last summer, Chinese provincial governments announced solar projects totalling 10 gigawatts (GW) versus an installed base of less than 1GW. One of the key routes China will have to follow in reducing its carbon emissions is reducing coal consumption. This explains China’s unprecedented thrust towards nuclear and renewable energy.
Wind should be the biggest beneficiary from any increase in target levels for alternative energy. Worldwide there are 121GW of wind turbines with the two largest markets, US and China, representing roughly a quarter of the total. Raising project finance has been difficult, but there are emerging signs of improvement that could see the sector revitalised in 2010. What is perhaps little appreciated by investors in Europe and the US is the speed with which China is addressing its voracious appetite for energy with renewable development. Recent statistics show China’s investment in wind energy exploded to nearly 24GW by mid-2009 compared to a generating capacity of around 12GW at the end of 2008. What is even more impressive is that this could increase fourfold to over 117GW by 2015.
Solar demand has improved in recent months and some producers have more demand than capacity. In addition, the deflationary decline in cell, module prices and margins appears to have ended. We favour the NYSE listed Chinese companies such as Yingli, Trina and Suntech, which have the advantage of lower production costs and European equipment producers and installers. In contrast, the outlook is less than auspicious for the European photovoltaic manufacturers, who have business models built on high silicon prices and now face declining/negative margins and lost contracts to Chinese manufacturers. We have shorted high cost producers like Sunpower, Q-Cells and REC due to high cost structures and stretched valuations within an industry undergoing rapid commodisation similar to TFT-LCD, Dram or printed circuit boards.
Most of us have heard of peak oil, but what about peak uranium? The world is running short of available mined uranium and nobody seems to have noticed, which could develop into a different type of nuclear crisis. The world is about to enter a period of unprecedented investment in nuclear power. There are 53 nuclear plants under construction worldwide, twice the level of five years ago. The combined threats of climate change, energy security and fears over the high prices and dwindling reserves of oil are forcing governments towards the nuclear option. Today, there is a growing gap between uranium supply and demand. At present, the world’s nuclear plants consume 170 million pounds of uranium each year. Of this, the mining industry supplies about 114 million pounds. The rest comes from secondary sources such as civilian and military stockpiles, reprocessed fuel and re-enriched uranium. That means there is a shortage of readily available uranium on the market, at a time when countries are stepping up construction of nuclear power plants (see Fig.2).
It is not clear how the shortfall can be made up since exploration and mine permitting are long and expensive processes. That means countries that rely on uranium imports will face uranium shortages, possibly as soon as 2013. Also, with financing tight for new projects, prices must go higher. That is good news for existing producers such as Cameco, Paladin and ERA. Taking only the new reactors being built or planned, the nuclear industry will have to source an extra 59 million pounds of uranium per year every year, which represents a staggering 50% increase in mine output from today’s levels. And looking at China’s plans for new reactors alone, this could even underestimate the growth in uranium demand. The world’s second-largest power market, China, had nuclear capacity of only 9GW between 11 reactors at the end of 2008. However, it plans to raise this to between 70GW and 86GW by 2020. Assuming 77GW of incremental Chinese reactor capacity (from today’s levels), this suggests an initial demand of 154 million pounds of uranium for reactor start-up, followed by ongoing needs of 39 million pounds per year. These figures represent a staggering 135% and 34% respectively, of 2008 global mine production of 114 million pounds.
How we respond to the threat of climate change could be one of the most important factors influencing society and financial markets in the 21st century. The Tiburon Terra Fund, a UCITS III compliant global long/short equity fund focused on alternative energy and natural resources, is focused on delivering returns to investors to benefit from these long-term trends. The fund launched at the end of October with seed capital of around $10 million.