In this latest podcast the team look at the factors to consider when investing around the theme of decarbonisation and how companies with strong decarbonisation credentials, able to drive the energy transition, are considered within the investment universe. What shapes the pathway to net zero and what will be required to get there? Which companies could be well placed to capitalise and therefore provide good investment returns for investors? Electricity generation, energy storage and transportability all come under the spotlight.
Joe Lynam: Hello and welcome to the latest instalment of Connected Investor from the Brunner Investment Trust.
I am Joe Lynam, the BBC presenter and Newstalk business editor, and in this podcast we're going to pick up on a theme of increasing relevance for investors – decarbonisation - what electrification means for markets and of course, the Brunner Fund
I'm joined by the co-leads of the Brunner Investment Trust, Christian Schneider, who you will know, but also by new boy, Julian Bishop, co lead of the Brunner portfolio. Good evening to both of you.
Christian Schneider: Hi.
JL: Julian, as the new kid on the block, what's Brunner's position when it comes to backing companies with strong decarbonization credentials?
Julian Bishop: Thanks. It's a very good question. We see decarbonization as one of the most significant themes in coming decades; we are talking about effectively a complete re-engineering of the global economy. Fossil fuel usage is deeply embedded into almost every economic activity there is, so huge industrial investment will be needed, which will drive growth for a lot of businesses providing relevant products and services.
At Brunner, we like to serve with all of our investments. We balance quality, value and growth. I think it's clear that the growth is there; whether the quality and value is, is another question.
For quality, we need barriers to entry, sustainable competitive advantages, high returns on invested capital, things like that; for value, we look at free cash flow generation.
Whether we back a company with strong decarbonization credentials depends on the balance of those three factors.
The more you read about the journey to net zero, the more that you realize that it just requires electrifying everything; electric cars are a good example, but we need to do that across all segments of the economy.
The International Energy Agency suggests only 18% of today's usage comes from electricity; the rest is primarily fossil fuels, burnt in situ - an engine, boiler or furnace. That ratio will have to increase whilst the total amount of energy consumed increases because of economic growth, particularly in emerging markets.
So huge, huge capital investment, and lots more electricity required if we are to hit net zero by 2050. I think that as we find ways to move it around and store it, there'll be lots of opportunities for Brunner in our investments.
JL: Christian, quite a few big, energy intensive companies, whether in chemicals, mining or the production of oil and gas, have stated goals to reach net zero, by 2050 or whenever, but getting there is tough, because oil and gas is so profitable still.
Connected Investor Takeaway - What do you think will key in terms of decarbonisation and the road to net zero?
CS: Absolutely. As Julian alluded to, the decarbonization we're facing here, will be a companion factor for the next decade or two.
It will create all sorts of fault lines in the economy; fault lines for companies that have to decarbonize, fault lines for companies that create business, or have businesses that help decarbonize -luckily, those that that do not have to worry too much about it. You're right, it's a cheap source of energy right now, and the infrastructure is in place. To decarbonize means the economy has to shift completely in terms of supplying energy to companies that use it and have consumers that use the energy out there.
So where we're filling up the car with diesel or gasoline currently, electricity needs to be distributed going forward. There will be a plug in power station that will be refuelling the vehicle at home, potentially, but that puts a lot of attention on the grid. At the same time, we're shifting away from carbon and fossil fuel driven electricity generation, to more sustainable providers.
Unfortunately, this creates more volatile power, and the grid needs to accustom itself to that. So, a lot of fault lines out there, but this creates opportunities for companies shifting the infrastructure forward. It will create opportunities for companies that win the race to decarbonize and separate themselves from its peers.
Last but not least, we are also focusing on companies that don't need to worry at all, because for them it's not a big issue; so there are various aspects to think about as an investor.
JL: Julian, are we close to some sort of critical mass whereby companies producing the right type of decarbonized or electrified product are profitable? At the moment the returns aren't good enough; even if the goal is there and the technology is there, it doesn't have quite the critical mass yet for takeoff.
JB: I think the production of renewable electricity delivers reasonable returns, but there's very little in terms of barriers to entry to prevent somebody from generating electricity; it's not a high value add activity. We invest in a couple of utilities that produce electricity and get a regulated return; it's not very high, but it is decent.
In terms of the cost competitiveness of renewable, it's there; solar and wind today is very competitive with gas, coal, etc. as prices have come down a great deal. But, as Christian alluded to, the issue of the intermittency of renewable power generation remains; it's very hard to store or transport energy.
A couple of things interest us; despite all the talk of batteries and so on, the easiest way to store electricity on an industrial scale today, is actually just to pump water up a hill and then get it back down when you need it – ‘pumped storage’.
JL: Not very avant garde.
JB: It's not, but it's what you need to do; to store electricity on a massive scale, you let it back down - a sort of small scale hydroelectricity plant. That's pretty much the most sophisticated way of storing energy today and you get 75/80% of your energy back. The need for storage really complicates the economics of electricity, and is one of the most significant problems to overcome.
So electricity generation makes profit and is cost competitive; we now need to solve the issue of storage and transportability.
One of the opportunities I think will be out there, and will solve a lot of problems in the future, is hydrogen. Green hydrogen - hydrogen produced from renewable sources - can be stored and transported, which will be a major breakthrough. I think when that happens, the pathway to net zero, will accelerate a great deal.
It's very interesting Christian - you've got multiple colored hydrogen, don't you? Blue hydrogen and, of course, now green hydrogen, which is the goal. Germany is looking very seriously at hydrogen with talk of hydrogen powered cars, yet other bits of Europe are less keen.
CS: Kind of, German carmakers have experimented with hydrogen cars as long as I'm in this business, actually; I started in 1996, when a large number of companies were already looking into the technology to see whether it can be done economically. Yet they struggle to do so; the technology is there to create hydrogen, but to do it mass efficiently is currently, and for the last 25 years, has been a challenge.
For the time being, electrification of cars looks the more viable way forward, although as Julian alluded to, once produced at scale and cost efficiently, green hydrogen is a great way of storing energy. Because as you know, a solar power plant will create power when daylight is there. Not at night, of course. But we will watch the Champions League on TV...
JL: Or Eurovision.
CS: Or Eurovision. Again, making the last place there as Germans as usual. Same is true for wind power plans. Actually they have one time nature and so we need this storage capacity to buffer these things out basically.
JL: Julian, in terms of storage, are companies coming along? You've mentioned batteries and you're talking about hydrogen, are there companies the fund is looking at which could make a big leap in this area?
JB: No. Nothing we have specifically addresses that we don't have any investments in hydrogen, which are of significance today. We invest in the utility I mentioned, which is involved in pumped storage.
But there's nothing I would point to in storage where we have an investment; again, we try to balance sort of quality value and growth. I think today a lot of investments in storage are reasonably speculative, so that's sort of better suited, I think, to angel investors; people who are more willing...
JL: To take a huge risk.
JB: Take a huge risk; a bit of a punt with the expectation of either losing all your money or making a huge return - and that's not what we do. In cricketing terms, we're all about hitting one and two, not swinging for sixes.
JL: Finally, are there companies you'd like to invest in but they're based in countries that there is an ESG risk?
CS: Good point. Clearly, around the world, a lot of investment in decarbonization is in countries with a democratic background and others that are less so focused on democracy and the rule of law basically. We take a careful look at both, and countries that do have a lower ESG rating are not ruled out - we are not primarily an ESG driven fund. Yet we take those risks kind of carefully in mind when we make our assessment about the quality of investment that's out there. So a company that is headquartered, residing and doing most of the business in a country where the rule of law is not applying, you want an extra haircut in order to make it interesting.
So two companies, same price, same valuation doesn't make sense if there is this extra added risk to that. So that's the approach we're taking here at this point.
JL: Thank you very much. I think we'll call it a day there. Make sure you're subscribed to Connected Investor wherever you get your podcasts, so you don't have to go hunting for it next time. Thank you all for listening, and if you want to get in touch, go to our website, www.brunner.co.uk From Christian from Julian and from me Joe Lynam. Ta-ta for now.
Investing involves risk. The value of an investment and the income from it may fall as well as rise and investors might not get back the full amount invested. Past performance does not predict future returns. For further information contact the issuer at the address indicated below. This is a marketing communication issued by Allianz Global Investors UK Limited, an investment company, incorporated in the United Kingdom, with its registered office at 199 Bishopsgate, London, EC2M 3TY, www.allianzglobalinvestors.co.uk. Allianz Global Investors UK Limited company number 11516839 is authorised and regulated by the Financial Conduct Authority. Details about the extent of our regulation are available from us on request and on the Financial Conduct Authority's website (www.fca.org.uk). The duplication, publication, or transmission of the contents, irrespective of the form, is not permitted; except for the case of explicit permission by Allianz Global Investors UK Limited. The Brunner Investment Trust PLC is incorporated in England and Wales. (Company registration no. 226323). Registered Office: 199 Bishopsgate, London, EC2M 3TY.
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