Market Musings 270822: Energy crisis forces radical behaviour change
Market Musings 270822:
Energy crisis forces radical behaviour change
Is the current energy crisis Europe’s “Lehman moment”?
Europe in the grip of an energy crisis
As everyone returns from their summer holidays (me included), news headlines are dominated by the relentless march higher in European natural gas and electricity prices. The sources of this energy price surge are well-known in the form of heavily reduced Russian natural gas exports towards Europe on the one hand, and the effects of the current heatwave on the other.
With benchmark Dutch natural gas prices today around 15 times higher than the average for the first half of 2021, European gas demand is naturally starting to fall as companies cut back energy-intensive production and services.
European natural gas, electricity prices hit record highs
Source: Bloomberg
Global energy demand just keeps rising…
While this price development is clearly very unwelcome for both companies and households, it will inevitably drive a radical change in behaviour as we all learn to adapt to this new energy environment. Efforts to reduce the carbon intensity of the global economy up to now have been insufficient to arrest rising temperatures around the world. Put bluntly, we still consume far too much energy and too many goods, which then result in a carbon footprint which the world simply cannot sustain over the longer term. Indeed, according to BP, the world saw its largest ever increase in primary energy demand in 2021, driven largely by non-OECD countries like China and India..
These record energy prices are a huge drag on the European (and global) economy, with Europe paying a huge energy “tax” to oil and natural gas exporters after years of benefiting from relatively cheap energy. Both businesses and households will continue to adapt to this new environment by trying simply to consume less energy, one way or another.
Renewable energy on the bounce
On the energy supply side, we can expect to see accelerated investment in low- and zero-carbon energy production through renewable energy sources (principally solar and wind as well as geothermal) and nuclear power (for baseload electricity generation).
Solar energy stocks have outperformed since May
Source: Bloomberg
Secondly, in order to reduce the volatility of energy supply as the world transitions to using more renewable energy sources, we need to see heavy investment in electricity storage via hydroelectric dams, industrial-scale batteries and gravity-focused energy storage solutions. To this end, renewable energy storage funds remain an excellent infrastructure investment, offering solid rates of return, long-term growth in demand and relatively high income yields.
Strong, steady performance of renewable infrastructure funds
Source: The AIC
Energy efficiency/conservation now in focus
However, we must all focus much more on energy conservation and efficiency than previously, as it is much more productive to save energy than it is to generate it. This can take many forms, including:
- heat pumps to partially or fully replace gas central heating, LED lighting,
- smart light controls and smart meters to reduce electricity consumption, and
- better window, roof and wall insulation of homes and office buildings in order to reduce heat loss.
There are also simple energy-saving measures to take: Reduce speed limits on highways; ask consumers to turn down their thermostats a touch; encourage the use of public transportation by reducing the cost of tickets, or letting people ride on weekends for free. The International Energy Agency has been preparing for an energy crisis like this for 40-plus years and has a 78-page handbook, “Saving Oil in a Hurry,” ready for use.
I think the following chart shows how households in Europe need to wake up to this looming energy cost tsunami now - these are forecasts for the UK energy tariff price cap going into next year…
UK households about to see a huge surge in energy fuel bills
Source: ft.com
Investing conclusions
My first observation would be that consumer spending is NOT an area which is going to do well in general over the next year or so, given the huge squeeze on discretionary spending to come from this surge in energy cost.
Secondly, I would invest in energy efficiency and circular economy funds and stocks, as these themes should benefit from the intense focus on investment in energy generation and in energy conservation.
But I would be wary of being too pessimistic on the outlook for the global economy, as the situation can change relatively quickly. Liquefied natural gas (LNG) supply from Qatar and the US to Europe should continue to increase over the next few months. Bear in mind that the natural gas price in Europe is more than 5 times higher than in the US at present, with greater LNG exporting capacity being built in the US.
The worst-case scenario of Russia completely cutting off natural gas pipeline exports to Europe may very well not come to pass, allowing Europe to get through winter without suffering widespread gas and electricity rationing.
Thirdly, companies and households will continue to adapt to this record energy price environment by economising and reducing demand wherever possible, particularly by curtailing heavy energy consumption production of aluminium and nitrogen fertilisers.
Ultimately, record-high energy prices focus minds and should drive accelerated investment in transition to a low-carbon energy future, which would be good for us all in the long run, even if we suffer today.
Have a great week ahead,
Edmund
Disclaimer
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15 comments
The problem is one of payback period. Sure, loft insulation reduces energy consumption, but if the payback period is 20 years, is it really economic?
Similar arguments can be made about wind turbines. How much do they cost, how much do they generate, and how long will they last? As far as I'm aware it's a very uneconomic way of generating electricity. Economic considerations are important. No-one can just had-wave them away, as well end up making bad capital allocations.
Fission seems, as far I can understand, a proven economic source of power. The same applies with hydro. Fusion is just a pipe dream at this stage.
there's significant political pressure to change the nature of energy pricing. For example it doesn't seem right that a solar/wind farm is paid at the marginal price when none of their input costs have risen, in contrast with fossil fuel derived electricity. There is huge demand destruction going on worldwide, from individuals adopting energy saving measures to companies changing their practices ( or going bust). I don't expect this profit bonanza for energy companies to last for years on end, especially with a recession on the way.
Welcome back Edmund
Is there a risk that the next pricing schemes for renewable power might be less generous than the existing schemes, and this might affect the future valuations of some of these renewable trusts, at least their future growth rates? To really grow wind, solar power generation etc, doesn't the price they receive be disconnected from the natural gas prices, to assist national industrial competitiveness. I own a number of these trusts, but it strikes me the risk of political and regulatory changes to their businesses might have grown in the last few months
Hi mteller
I am by no means an expert on these pricing schemes, but in my research I have gained some insights which have given me some degree of confidence about future prices and thus revenues into the solar and battery farms held by these trusts.
From what I understand (from viewing the most recent results video from NextEnergy Solar Fund (LON:NESF) ) energy supply contracts are negotiated at regular intervals and prices set at these points. Contracts run for several years. I noted that in the case of NextEnergy Solar Fund (LON:NESF) they had established contracts quite recently and at good rates. This gave me some confidence with respect to NextEnergy Solar Fund (LON:NESF) . I also think the other trusts will be operating in a similar fashion.
Clearly these things cannot be taken as a certainty, but assessed as a level of risk.
But with regard to share price, in addition to possibility of stable revenues, I place quite a lot of weight on the high and growing dividends on offer, the fact revenues are inflation linked, that the trusts are expanding in UK and outside of the UK, that the operations through innovation are likely to become more efficient, that the trusts are increasingly trading their energy in the open market in addition to the pre-set revenues, and that ESG motives are pulling increasingly growing investments into this space.
Obviously only my opinion which could so easily be wrong. So, I note the risk to the generous pricing schemes but feel other factors will offer additional opportunities which will support a growth to share prices.
Regards
Howard
Excellent post as always Edmund. I have a significant holding in £DORE. Mainly because of the variety of assets it holds. It has a leaning a distinct towards hydroelectric power but also holds solar and wind assets and is looking to purchase infrastructure assets. Electricity distribution in the Nordics is cited as a likely target.
Regarding the gas price, the current price is in my view unsustainable in the medium term and nothing goes up ad infinitum. As your narrative states people will adapt to using less energy and as demand lessens prices will fall. As to when?
It strikes me that Russia has likely shot itself in the foot.
Hi
I posted this on the SCVR the other day, seems appropriate to re-post it given the topic of this thread.
For anyone looking for strong dividends plus stocks with a reasonable share price growth, then a couple of RNS's 22/8/22 might catch your attention.
Nothing spectacular, but what I think are useful portfolio holdings as they offer:
Growth, quite low volatility, large and growing dividends (paid quarterly), global and national political tailwinds, inflation linked revenues for parts of their revenues, government subsidies (for parts of their revenues), additional revenues from trading in energy markets, green credentials to attract ESG investors and institutions, growth from innovation in the technologies they operate (innovations will improve efficiencies, effectiveness and thus profitability), buy and build expansions in the UK and non-UK regions.
First RNS was from NextEnergy Solar Fund (LON:NESF) the RNS is here
https://www.investegate.co.uk/...
Second RNS is from Bluefield Solar Income Fund (LON:BSIF) the RNS is here
https://www.investegate.co.uk/...
As you will see they are both Investment Trusts investing in solar farms. Usefully, they are now also co-locating battery storage alongside the solar farms to capture and help with trading the solar energy.
Below the YTD share price (chart captured 22/8) of NextEnergy Solar Fund (LON:NESF) and Bluefield Solar Income Fund (LON:BSIF) I have also added in NextEnergy Solar Fund (LON:NESF) and Gresham House Energy Storage Fund (LON:GRID) two other examples.
In addition to these share price rises, if you are interested look at the sizes of the dividends (range from 4% to 6% approx).
Disclosure I hold NextEnergy Solar Fund (LON:NESF) Foresight Solar Fund (LON:FSFL) Gresham House Energy Storage Fund (LON:GRID) but not Bluefield Solar Income Fund (LON:BSIF) . I also hold JLEN Environmental Assets (LON:JLEN) which is similar but stretches beyond solar into wind and Biofuel sourced energy. I also hold Greencoat UK Wind (LON:UKW) which is an IT focused on wind farms (but going into solar now). For further diversification I also hold Drax (LON:DRX)
Clearly these might not interest many - SCVR holders do not necessarily favour ITs, nor favour energy stocks (which I avoided) - but after digging into this sector quite extensively I came to a conclusion that in these volatile times there seemed quite a bit to commend this 'green energy' sector.
I thought some people might like to take a look.
Regards
Howard
I hold Gresham House Energy Storage Fund (LON:GRID) (and Vestas). The problem I have with a lot of these alternative energy funds is that their NAVs seem to be synthetic - they can't mark to market, so it's a bit difficult to really figure out the value. So when investors get excited about their futures then the valuations can easily disconnect from reality.
None of which is to disagree with Edmund's analysis. The challenge is to figure out the second order effects - we know prices will rise and therefore demand will drop (and, somehow) supply will be increased, but that only takes us so far. The long-term fixes - more development of alternative energy sources, more nuclear, changes to building regulations - take time to develop, while the short-term fixes - keep coal fired power stations burning, import more LNG - are deployable relatively quickly.
Way beyond my pay grade, although in the longer term I can't see how energy storage solutions can fail to be a winner regardless of how power is generated.
timarr
I share your view on your opacity of valuations amongst the various trusts. Ultimately it undermines their shared eponymous attribute, “trust”.
There are plenty of companies in the renewables space whose fundamentals can be ascertained by traditional securities analysis. After a good run-up on Biden’s recent legislative win, US solar names are pricey today from a value perspective. But they are exceptionally volatile and better entries are regularly on offer. It’s worth keeping an eye out for opportunity. European utilities however look good value and, in particular, ENEL - one of the biggest renewables generators globally - is completely detached from fundamentals owing to weakness in the Italian bourse (European recession, government crisis), where it is a big portion of the index.
In the associated circular economy category, the same contrast goes for Tomra, whose volatility can be exploited for a good entry, and Veolia, which is looking very good value indeed today.
But I can see the appeal of the various energy storage trusts as a lock away and forget investment.
Hi
An EDISON note out today about £FSFL might interest some.
This is a portion of the note ....
'FSFL has recently secured further exclusive positions in ready-to-build battery storage projects totalling c 60MW targeted for completion in the coming months. FSFL expects these to be accretive to the portfolio NAV and target yields.'
This is the RNS ...
https://www.investegate.co.uk/...
In the RNS there are links to EDISON site where they have detailed reports on Foresight Solar Fund (LON:FSFL) as well as comparisons reports of Foresight Solar Fund (LON:FSFL) vs Bluefield Solar Income Fund (LON:BSIF) vs NextEnergy Solar Fund (LON:NESF) thus placing Foresight Solar Fund (LON:FSFL) in the wider context of the other Investment Trusts operating in the solar space in the UK.
The EDISON site is a bit clunky but offers quite a lot of resources.
I hold Foresight Solar Fund (LON:FSFL) & NextEnergy Solar Fund (LON:NESF) but not £BSIF
Regards
Howard
Edmund. Thanks for this. I've tried to think it through on several occasions, but I just find there are so many moving parts.
Energy production and storage businesses are clear near-term winners; but most have longish lead times (think Planning Approvals) and require big front end investments. All those flat roofs on modern shops and business parks seem ideal for solar panels; but which companies own them and will/can install them?
Company cost structures are changing dramatically. Low direct and indirect energy users will have a relative benefit; but it is not just energy. Labour costs, raw material prices, distribution charges have all changed significantly. There will be many winners and losers in every industry/ activity, but how do I identify them? Quality management, quick on its feet will be key.
And, dare I think it? The Russia/ Ukraine conflict will not continue for ever. Russia may then be eager to restart energy exports, and Continental Europe anxious to return to some normality. Climate change will still be a factor, but how much of energy saving and generation investment started in the current crisis, will find itself marooned, uneconomic?
Good, quick-witted management is required. But that's not new. Finding my way through all this, confounds me.
I hold Renewables Infrastructure (LON:TRIG) and looking into solar funds (solar panel prices have fallen so much that they seem to make sense, even at 2020 power prices).
Do heat pumps actually save energy? Some say they don't generate enough heat especially when its very cold. One person I know hates his, talks about ripping it out, too complicated, goes wrong and problems with servicing.
The other issue is we are replacing gas/oil with electric but around 40% of electric is produced by gas and its not very efficient apparently.
Smart metres, I have one but don't see how it saves anything. But I agree people can cut down. I hardly use my computer anymore but I'm struggling to find any more ways to cut down consumption. Heating can't go much lower.
Insulation I agree, houses in the UK could be much better but very few grants now and many companies are only doing grant work.
How about solar panels then houses would generate their own electric, what they don't use is either stored in batteries or exported.
I do hold Gresham House Energy Storage Fund (LON:GRID) and a few others, Renewables Infrastructure (LON:TRIG), £RENG and Gore Street Energy Storage Fund (LON:GSF)
I will look into Foresight Solar Fund (LON:FSFL)
RB, heat pumps are a joke. I know 2 people who installed them and turned them off ( even before the current elecy prices!) as the pumps running the loop are like having a +2 Kw kettle on a rolling boil all day.
Smart meters are only there so in further they can implement variable charging based on time of day.
heat pumps are a joke
It depends whether you are a government committed to reducing carbon emissions or a consumer on a budget.
Under the current price cap the ratio of the cost of a unit of electricity to gas is 4:1 and after 1 Oct it will be 3.5:1. Field trials suggest older retrofit heat pump installations have a COP (coefficient of performance - ratio of heat output to electrical input) of around 2 - 2.5 and later better quality installations closer to 3. Since the electricity / gas price ratio exceeds the COP by a significant margin, it is inevitable that a heat pump will cost more to run than a gas heating system of similar capacity. However, over the last 10 years the CO2 emissions per unit of electricity compared to gas have fallen from about 2.5 : 1 to roughly the same due to the elimination of coal and the increase in wind and solar. A heat pump will cause emissions of about 1/2 to 1/3 that of gas for the same heat output. If your priority is to save the planet, a heat pump is the way to go. If you want to be warm and minimise your costs, then stick to gas for the foreseeable future.
Great to see you back posting on Stocko Edmund.