Low and Dry

2018 brought a bumper summer for Europe – almost wall-to-wall sunshine, toasty temperatures and barely any rain. Great for relaxing in a beer garden and watching the World Cup and, you would think, for those choosing to holiday close to home (more on that later). However, while you were sipping those G&Ts and topping up your tan (or, if you are Scottish like me, cowering in the shade until the evening when it was safe to come out) there were less obvious (and less positive) consequences of the heatwave.

Take, for example, the Rhineland – Germany’s industrial heartland and home to many of Europe’s largest industrial producers. The river Rhine is the lifeblood of the area and a major logistical artery, underlined by the fact that over half of the containers that travel inland from the giant hubs at Rotterdam and Antwerp do so by barge.

However, this all depends on there being enough water in the river, which by the end of one of the driest summers recorded in Germany, there wasn’t. Water levels fell below those needed to run barges at full capacity and by late November, the situation had reached critical levels where even empty barges were unable to travel on some sections.

To put things into perspective, a standard sized barge has the capacity of about 160 lorries, so with water transport drastically reduced, is all of this supposed to be carried by road and rail? Supply chains simply don’t have that much slack and as a result, many major companies with production facilities in the area suffered.

BASF’s Ludwigshafen site, located on the Rhine, is the world’s largest integrated chemicals complex. Around a third of its material transport needs are met by barges, and as a result of low water levels, it had to reduce production to 60% of capacity. What’s more, facilities like this can’t just be ramped back to normal at the drop of a hat – it takes weeks! Add to this the increased costs of finding alternative sources of transport and the cost quickly mounts up – estimates are for an impact of around EUR200 million for BASF.

BASF is not alone, the likes of Covestro and Solvay announced significant impacts on their ability to receive shipments of raw materials. But it’s not just big chemicals companies… Commuters faced challenges topping up their tanks as supplies of petrol couldn’t get through to garages.

Even holidaymakers weren’t safe from the good weather! Buses had to replace boats on several stages of popular river cruise routes along the Rhine and the Danube, leaving tourists unimpressed as their leisurely cruise with a luxury cabin quickly turned into a cramped and bumpy coach ride.    

So there we have it, as a result of human actions, weather is getting more extreme and climate change continues to impact the way we live and the way companies operate. This may be a minor concern when you’re enjoying the summer sun and I suspect it previously wasn’t much of a worry for large industrial companies either. But when the impact starts becoming more tangible and can be measured in millions of pounds of lost profits, then I’m sure companies will very quickly start to care and take action. Until they do, they will be left high and dry by taking natural resources for granted and assuming they will always be able to use them on the same terms as before. 

About the author

Iain Snedden is an investment specialist in the equities team. He has responsibility for representing the firm’s equity capabilities both within and out with the firm, with a particular focus on our suite of global equity products. This involves ensuring colleagues and clients are kept up to date on developments within the funds and the wider market. Iain joined us in 2015 to work in the Client Management team with responsibility for a portfolio of UK-based institutional clients. Prior to that, he worked at Baillie Gifford and held roles within the client accounting and business risk functions. Iain graduated from University of Edinburgh with a first class honours degree in Accounting and Business Studies. He has 8 years’ industry experience (as at 30 November 2018).

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Tick tock goes the Klöck

Climate change and general concern for the environment, they’re an ever-increasingly important issue for society, so why would it be any different for investors? It isn’t. This is something we’ve been watching for a long time; our ethical franchise will have been running for 30 years next year, so it’s something deeply engrained in our processes.

Lately, plastics and the pollution they cause have faced increasing scrutiny and regulation. This backlash has a fundamental impact on companies in the high yield universe. Take the metal can specialist, Crown Holdings. They suggest that the aluminium can is the world’s most recycled beverage container… and actually it is estimated that 75% of all aluminium ever produced is still in use today. Crown believe that a 1% shift from plastic bottles to metal cans for soft drinks alone could increase demand by billions of cans. This could be an impressive tailwind for positions that produce metal cans – companies like Ball Corp, Crown and Ardagh.

But for every winner, there’s a loser. Klöckner Pentaplast is one of the world’s largest producers of plastic films. This company makes the rigid plastics that cover your food, wraps around batteries, surround gift cards and the packs that your painkillers come in. As such, Klöckner is highly exposed to plastic packaging regulation (and backlash). While regulation isn’t the only problem that this company faces, it certainly hasn’t helped. Operating performance has been deteriorating, with limited revenue growth, falling earnings and negative free cash flow. To its credit, Klöckner has been trying to use more sustainable raw materials, focusing on recycled plastic. But so has everyone else, and the cost of recycled PET has been rising in response – compounding the problem.

Something else that’s interesting about Klöckner Pentaplast is how it has structured its debt. The company has issued a type of bond known as a Toggle PIK. These allow the company to pay interest in cash (like normal) or to elect to ‘pay in kind’ (this means adding more debt to its existing debt!). This toggle option means the company isn’t forced to pay cash away when it can’t afford to. But this extra debt means that the company is becoming increasingly indebted – even as it struggles to pay its existing obligations! This risk means that PIK bonds often come with large coupons, and can be an excellent investment when the business is doing well. This is where stock selection is so important.

We decided not to participate in the Klöckner bond when it was first issued at par (i.e. 100) this time last year. I reviewed the company when the bond was trading in the 50s last month, having lost almost half of its value. We chose to pass again, as the firm’s fundamentals had continued to deteriorate. This week, Klöckner announced it would elect to pay its interest in PIK. Today, the bonds are priced at 35. I can hear the Klöck ticking…

Meanwhile, our can makers in the portfolio continue to hold in very well amidst the recent market volatility. These are fundamentally strong businesses that may also benefit from a helpful regulatory tailwind.

About the author

David McFadyen is an investment analyst in the Fixed Income team, focusing on high yield bonds. David joined us from BlackRock in 2015 and held various roles across distribution including investment writing and client management before joining the Fixed Income team in 2018. He has an honours degree in Business Management from the University of Glasgow. He is a CFA charterholder and has 4 years’ industry experience (as at 30 November 2018).

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Transition transmissions

Christmas; a time of festive good cheer and occasional natural gassy excesses. Fortunately, this brussel sprout-fuelled bonanza tends to pass by mid-way through whichever repeat you happen to be watching on Christmas day.

Contrast that with the US – which is increasingly gassy all year round!

I know what you’re thinking- what am I talking about? Am I just being rude? No, I’m referring, of course, to the US’s natural gas production. Which is at record levels, as is gas power electricity generation. In fact, the US became a net exporter for the first time in 2017 (liquid natural gas (LNG) exports rose 58% in the first half of 2018, compared with the same period in 2017).

Which is good, because globally gas (as a cleaner burning fuel) is benefitting from coal’s demise. Hence its ‘transition fuel’ status.

Source: BP Statistical Review of World Energy.

The problem is, that assumption only holds true if you don’t let methane (the main component of natural gas) leak out everywhere during its production or transport! If this happens, the arguments around ‘transition fuel’ begin to break down since methane is a far more potent greenhouse gas than CO2, (think 80x more potent). If that happens US gas’ export potential also becomes potentially diminished.

That’s why both Kames and Aegon Asset Management recently supported a collaborative letter from investors to 29 oil and gas companies urging their support (publicly and privately) for sensible methane regulations by the US Environmental Protection Agency’s (EPA). Specifically, our concerns relate to the EPA’s proposed roll-back of standards regulating oil and gas methane emissions and the risk that further proposals will eliminate direct regulation of methane emissions from US oil & gas drilling sites completely.

Minimising methane leakage is important, not least because recent scientific studies* (based on analysis of 30% of sites in the US) suggest that methane leakage from the oil and gas industry are 60% greater than official estimates. We expect the highest ESG standards and we also want a level playing field for the companies that we invest in**; for the oil & gas majors (who argue that they hold themselves to the highest international standards) and the rest. Involuntary natural gas leakage of any sort is never a good thing……

*https://www.nature.com

**Kames Global Sustainable Equity Fund doesn’t invest in the oil and gas majors (or minors).

About the author

Ryan Smith is Head of ESG Research. He joined Kames Capital in October 2000 as an SRI analyst and was appointed to his current position in September 2002. He has 18 years’ industry experience*. His role involves managing the team that conducts the ESG screening process for our Responsible Investing funds. Ryan’s team also provides corporate governance screening and research for all equity investments, and conducts research into environmental and social issues. Before joining us, he worked as an environmental chemist for Severn Trent Water. Ryan has an MSc in Environmental Chemistry from Nottingham Trent University and is a CFA charterholder.

*As at 30 November 2018.

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The collapse of civilisation and the natural world is on the horizon

Last week’s Change Summit in Poland came to an end and it was the stark warning from Wildlife Broadcaster, David Attenborough that left a resounding mark in everyone’s minds. At the summit he warned that today’s generation is essential if we are to prevent catastrophic global warming.

In response to this, Kames Capital’s, Craig Bonthron gives his view on the importance of public figures taking a stance…

“The gravitas of Sir David Attenborough is always welcome. He is a globally recognised figure who combines a vast knowledge of the natural world with a gift for communicating that is quite frankly unequalled. In a world of constant news and noise it is very easy to place non-immediate issues to the back of our mind and for most of us the UN climate change summit is probably one of those things. But some issues are too important.  Climate change is the gravest threat multiplier that the human race and the natural world we inhabit has ever faced and having Sir Attenborough speaking directly to world leaders about it was no mere PR stunt, it was very important. His words were stark and impactful. I believe that the human race has the technology and capital to meet the challenge but we need to move fast. We need both the carrot and the stick of global governments to us force the down paths that Sir David has urged us to take.  The UK is bidding to host the 2020 UN climate change summit, let’s hope that world leaders listened to him last week and we have made meaningful progress by then.”

About the author

Craig Bonthron is an investment manager in the Equities team, responsible for co-managing global equities portfolios. He joined us in 2014 from SWIP, where he was investment director in global equities. In addition Craig also had analysis responsibilities for the tech, energy and utility sectors. Prior to SWIP, he was a portfolio manager at Kleinwort Benson Investors, a member of the global environmental equity team. Craig has a 1st Class honours degree in Building Surveying, an MSc with Distinction in Business Information Technology Systems from Strathclyde Business School. He has 17 years’ industry experience*.

*As at 30 November 2018.

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Meat the Agricultural Disruptors

Plant based burgers that bleed?! Could companies like Beyond Meat and Impossible Foods be the future of our food needs?

Tech giants, venture capitalists and famous names such as Bill Gates and Leonardo DiCaprio are backing a burgeoning industry that hopes to disrupt traditional agriculture. Beyond Meat recently filed for an IPO and it’s the first public listing from a slew of companies offering vegetarian meat products that taste, smell and cook like the real thing. Yes really.

The ethical debate and health concerns of factory food production have done nothing to quell our hunger for meat. But more recently, the effects of global warming have shone a light on the industry- will this be the start of meat’s ‘Tesla moment’?

Agriculture has a huge environmental impact, generating around 24% of global greenhouse gas emissions (according to the US Environmental Protection Agency[1]). To add context around that, the global transportation industry accounts for just 14%.

And with meat consumption predicted to rise, forecasts from climate change scientists warn that “unabated, the livestock sector could take between 37% and 49% of the GHG budget allowable under the 2°C and 1.5°C (Paris agreement GHG) targets, respectively, by 2030.”[2]

It is also a drain on resources. It is estimated that livestock occupy 30% of the planet’s land surface and account for 78% of all agricultural land use. 1,799 gallons of water are needed to produce a single pound of beef[3].

Animal meat is just a molecular structure of water, protein, fat and carbohydrates and we are very quickly discovering they can be replicated – but by using entirely plant based ingredients. As Jessica Appelgren of Impossible Foods describes it; “We are at the molecular level figuring out what makes meat meat and reconstituting that from the animal kingdom.”[4]

And they are just a bit more sustainable…

Source: Beyond Meat

It’s proved challenging but we are beginning to move beyond fossil fuels. So, who’s to say we can’t transition to less meat in our diets? The reason Tesla has been such a successful disruptor of the auto industry is because they offer a similar product, but without the nasty side effects of a traditional combustion engine.

Cars and burgers. Modern society loves them both. But if disruption of the latter is possible, it needs a viable alternative….and maybe another eccentric CEO!! Companies like Beyond Meat and Impossible Foods could provide the solution.

1 https://www.epa.gov/ghgemissions/global-greenhouse-gas-emissions-data
2 Harwatt, H. (2018): Including animal to plant protein shifts in climate change mitigation policy: a proposed three-step strategy, Climate Policy
3 Livestock’s Long Shadow: Environmental Issues and Options, FAO (2006)
4 National Geographic, November 2018, p86.

About the author

Euan Ker is a sustainable investment analyst. He is responsible for analysing and monitoring environmental, social and governance factors within the Global Sustainable Equity Strategy. Euan joined us in 2014 as an investment implementation analyst with responsibility for implementing macro investment decisions across a number of fund-of-fund mandates, totaling some £13 billion under management. Prior to moving to the ESG Research team in 2018 his responsibilities also included asset class, regional and currency hedging overlays through derivatives. Euan has a 1st Class Honours degree in Management with Economics from Robert Gordon University. He has the IMC professional qualification and has 5 years’ industry experience.*

*As at 30 November 2018.

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‘The Generation Game’

Much like the gameshow format, the 100 year model of utilities producing electricity and selling it to customers is beginning to look obsolete. Historically, when it came to energy, size was everything; think big energy, big networks and mega-mega-watts. But technology is allowing customers to break away from these traditional models and technology companies themselves are encroaching on the utility-customer relationship.

The future is 4D. Decarbonised, Decentralised, Digitised, Democratised. Or 5D, if you add demand destruction (6D?!). Let’s quickly look at these in turn.

Decarbonisation – Happening right now and policy, economics and consumer attitudes are increasingly supportive. Solar generation continues to set new records (check out Project Sunroof if the idea of a rooftop solar array appeals) and we have written about the UK’s strength in offshore wind
here
.

Decentralisation – Driven by decarbonisation. Across multiple geographies the expectation is for  smaller scale generation to increase significantly, providing capacity which is not connected directly to the grid. Data exchange (see digitalisation) also enables this. One development on this front will be that increasingly, our cars will also be electricity network storage tools.

Decentralization ratio

Source – Bloomberg New Energy Finance

Digitalisation – Diversification makes integration critical. Fortunately, big data, analytics, sensors and the ‘Internet of Things’ are making managing the supply and demand balance easier. In other parts of the electricity value chain, digitalisation offers opportunities to improve asset productivity (e.g. predictive maintenance and drones for line maintenance), through to better service and insights into customer behaviour (e.g. e-billing and chatbots).  Did you know that the UK has a ‘virtual’ power station? It does; and it comprises solar panels on customers’ homes with domestic storage batteries, remotely controlled by the utility (UK Power Networks in this instance).

Democratisation – Consumers are no longer mere users of electricity, they are more informed and can be electricity producers. Want a mobile app that will reward you for switching off your appliances during times of peak demand? No problem. And when you use it, points literally mean (actual cash) prizes. During a trial of its GenGame (!) with 2,000 customers, Northern PowerGrid found that the average household reduced its electricity consumption by 11% or 305 watts, during peak times. Some saved as much as 4.9kW by turning off hot tubs and tropical fish tanks.

Our energy landscape is being transformed; as investors we need to be careful we don’t underestimate the pace of change in this world of new energy.

About the author

Ryan Smith is Head of ESG Research. He joined Kames Capital in October 2000 as an SRI analyst and was appointed to his current position in September 2002. He has 18 years’ industry experience (as at 30 November 2018). His role involves managing the team that conducts the ESG screening process for our Responsible Investing funds. Ryan’s team also provides corporate governance screening and research for all equity investments, and conducts research into environmental and social issues. Before joining us, he worked as an environmental chemist for Severn Trent Water. Ryan has an MSc in Environmental Chemistry from Nottingham Trent University and is a CFA charterholder.

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