Outlook 2014: Global climate change - Schroders Talking Point - Schroders
11-02-14 15:25
Outlook 2014: Global climate change
Giles Money, Portfolio Manager, Global Climate Change
27 Jan 2014
We look at some of the potential drivers of global climate change investing in 2014.
As we look back on 2013, we have on the one hand the misfortune of reporting yet another
year of record extremes in our climate, yet on the other, a lot of confidence that the climate
change theme is as relevant to investors as ever. 2013 was the seventh warmest year on
record and featured weather dislocations of the highest significance for decades; meanwhile, in Antarctica, the second lowest
temperature in history was recorded at a balmy -93 degrees Celsius. Giles Money looks back on 2013 and makes his predictions for
the year ahead.
2014: A year in global climate change
Each of the last three decades has been consecutively warmer than the previous: this was the conclusion of the Intergovernmental
Panel on Climate Change’s fifth assessment report in September. What’s more, it said that the period 1983 to 2012 was probably the
warmest in 1400 years. Whilst catastrophe levels were lower in 2013, which we should all be thankful for, the evidence is
overwhelming that anthropogenic climate change is happening.
In 2013, as with the last couple of years, climate change took a back seat to the global economy in the public and political domain.
This did not, though, stop many climate change-related investment themes strongly outperforming global markets.
We continue to find evidence that the preparedness and resilience of individual businesses will become an important component of
profitability and equity valuation in the future. Resilience is hard to value in a financial model, yet it clearly has value. Companies with
the best understanding of the implications of climate change for their business will become synonymous with quality.
With this backdrop in mind, we review the outlook for our five climate change themes.
Energy efficiency
Energy efficiency has been a powerful theme in 2013, and we foresee more of the same in 2014.
We have consistently argued that technologies with the fastest payback would have the strongest chance in the tough economic
backdrop experienced over the last few years. The challenge for investors as the environment improves will be to strike the
appropriate balance between up-and-coming technologies that are hurtling down the cost curve and those that are already
competitive.
We expect LED general lighting to grow significantly in 2014. Industry experts have the growth figure as high as 80% and we expect a
compound annual growth rate in excess of 30% over the next few years. We believe that LED companies with strong management,
attractive valuations and solid business models can expect considerable performance next year. In ten years’ time we estimate LEDs
should represent over half the entire lighting market.
We also feel much more positive about the construction sector globally, but particularly in developed markets. This opens up
opportunities for a whole range of efficiency-related products in construction retrofit and renovation, including insulation, heat pumps,
lighting and high efficiency glazing.
Another major theme within energy efficiency is e-commerce. Whilst the relevance to climate change may not be immediately clear,
we have proven that the significantly-lower carbon footprint of online retailers allows them far better pricing disruption. This will lead to
significant and continuing share gains against traditional bricks-and-mortar retailers. We expect both significant growth and market
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Outlook 2014: Global climate change - Schroders Talking Point - Schroders
11-02-14 15:25
share gains in 2014.
Sustainable transport
2013 was a year of significant growth in auto production. In the US and Japan, demand is back to pre-crisis levels and China now
leads the world in terms of sales in a single region. Europe, however, is languishing significantly below its pre-crisis level and we
would expect a modest recovery there next year.
One aspect that has been consistent is the improvement in fuel efficiency of vehicle sales. We have said for some time that emissions
regulations would push the sustainable transport industry forward and this has indeed been the case. We expect tighter regulation to
continue to drive this theme forward in 2014 and beyond.
One area we expect to grow in 2014 is the electric vehicle (EV) market (see figure 1). At the Guangzhou auto show in December
there were 18 pure EVs on show from 12 vendors. In the EU alone there are plans for 9 million such cars on the roads by 2020. The
equivalent estimate for 2013 was for under 100,000 cars for the US and Europe combined which highlights the growth potential.
Figure 1: Number of EV launches since 1997
Source: JPMorgan estimates
Clean energy
We feel vindicated in our 2013 outlook piece where we flagged up an inflection point in renewable energy. While by no means a
perfect representation, the Wilderhill New Energy Index – which tracks energy companies in the renewable sector – returned 53% in
2013. The over-supply, falling margins, and low returns on capital that plagued the sector are in the midst of a significant rebalance
from which we feel the strongest companies will emerge.
With modest end-market growth, industry consolidation and attractive valuations we believe this will be an interesting sector to watch
this year, especially for companies with the strongest business models and managements.
Environmental resources
Soft commodity prices suffered significant backwardation in 2013 as the US and Brazil produced big crops on the back of the 2012
drought that inflated prices to levels where more marginal land came into production. We continue to believe that productivity tools
and technology will dominate farmer spend and that there is structural growth in capital investment in agriculture. However, as we
suspected, 2013 was a normalising year for inventories and in the face of a strong rally elsewhere in the market, gains in this theme
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were harder to come by.
We do, though, feel quite positive that 2014 should see the worst of the slowdown. We think if the market continues to shun this
sector that it should be set up for a very attractive up-cycle in performance. Valuations currently look good in this sector, and investors
should look out for opportunities this year.
Low-carbon fossil fuels
In last year’s outlook we forecast that 2012 would mark a ten-year low in US natural gas prices and that prices could normalise above
$4 per thousand cubic feet (Mcf). Prices went on to rise over 15% on average in 2013 (with the post-winter seasonal trough over 60%
higher) and the commodity traded as high as $4.50/Mcf in December 2013.
A combination of factors were at play: a slow-down in drilling activity as a result of the previously weak prices; improved infrastructure
takeaway in the key producing region of the Marcellus in the north-eastern US; and a cold winter, which has finally led to a drawdown of gas inventories to below the five-year average, after many months of excessive storage levels (see figure 2).
Figure 2: Working gas in underground storage compared with the five year maximum and minimum
Source: US Energy Information Administration
Consensus forecasts are for US natural gas to average between $3.50 and $4.50/mcf in 2014. We agree, although we suspect
prices will reside at the upper end of this range.
On the positive side, new pipeline capacity continues to come on-stream for the Marcellus (the heartland of production growth)
meaning that incremental gas will be able to reach South Louisiana, the Gulf Coast and the Midwest. Ongoing bottlenecks in Gulf
Coast oil refining and continental pipeline capacity are leading to a steadying of onshore oil production levels and lower volumes of
associated gas (which accounts for nearly one third of total supply). Both trends are supportive of gas pricing.
In the longer term, we expect the marginal driver of pricing strength to be US export capacity, which enables US operators to benefit
from higher international prices. Four US export licences for Liquefied Natural Gas (LNG) have now been approved, and with more
to come the US is expected to be a net exporter of gas by 2020. This international LNG market remains very attractive – it has been
the fastest growing fossil fuel over the past decade, growing at 7% per annum since 2000. The market continues to be underpinned
by growing Asian economies that are increasingly short of domestic supply.
Related articles Outlooks 2014 Giles Money Global Equities
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