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……


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

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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

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.

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More than one everyday…

That’s the astonishing rate at which offshore wind turbines went up around the UK last year1. In fact, the UK installed 60% of European new offshore wind capacity in 2017.

On average, offshore wind currently contributes just over 6% of the nation’s electricity demand, but the existing 1,762 wind turbines dotted offshore are anticipated to increase by 50% within the next five years. The sector’s ambition is for a greater than 4x increase in operating capacity by the 2030s, making it (in aggregate) among the UK’s largest infrastructure developments.

Assets are coming on line much sooner than in the past. As with many other renewable energy technologies the cost of offshore wind is falling rapidly as the technology develops, through economies of scale and as construction and operational experience evolves. 2017 saw the first operational 8MW turbines (think 80m blades!) becoming operational and the world’s first floating wind-farm off the coast of Aberdeen.

Evolution of wind turbine heights and output

Until recently it seemed almost impossible for the UK to transition to being powered mainly by renewable sources in an affordable and secure way. But as the recently published, National Infrastructure Assessment Report2 states, “It is now possible to conceive of a low-cost electricity system that is principally powered by renewable energy sources”. (The National Infrastructure Commission was established in 2015 to provide five-yearly assessments of the UK’s infrastructure needs). The Commission goes on to recommend that at least 50%, and up to 65%, of the UK’s electricity in 2030 should come from renewables. It suggests this could be achieved with costs comparable to what consumers pay today for their energy (in real terms).

When it comes to offshore wind, the UK is leading the world.

Across the Kames ethical fund range we hold the following:

John Laing Plc – Infrastructure developer – over a quarter of its portfolio is renewables (wind and solar).

Orsted A/S – Built the world’s first offshore wind-farm in 1991 and has just completed the world’s largest offshore windfarm at Walney, off the coast of Cumbria and able to power 600,000 homes.

Greater Gabbard & Wods Transmission OFTO’s – ‘Offshore Transmission Owners’ – OFTO’s assets broadly comprise offshore and onshore substations and cabling connecting the wind-farm to the mainland.

SSE – 1,420 MW of offshore wind – third largest UK offshore wind owner and part owner of the Greater Gabbard offshore wind-farm.

1 Crown Estates – Offshore wind operational report, 2017
2 National Infrastructure Commission – National Infrastructure Assessment 2018

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Tramspotting. Choose to unlock economic growth

Choose to unlock economic growth, choose a clean city to work in, choose quicker commute times, choose well connected and frequent public transport, choose the bus, choose to walk, choose to cycle, and choose to keep building that wonderful tramline …. I feel like this could be an unpopular soapbox with my colleagues in Edinburgh. Bear with me a minute.

Transport networks are reaching capacity in the UK. When we talk of change in the automotive industry we immediately think of electric vehicles, which is a change we unreservedly support. But if we all owned an EV tomorrow, our commute time wouldn’t change. Ryan highlighted the rapidly decreasing commuting speeds a few weeks back.

This is a problem.

The National Infrastructure Assessment (NIA), released earlier this year, highlighted that productivity is too low in too many UK cities and a lack of transport infrastructure is a key contributor.

This is a problem that will get worse.

In 1970 around 77% of the UK’s population lived in urban areas. That figure has increased to 83% today and is predicted to hit 92% by 2030 according to the World Resources Institute. What’s more, the UK’s highest value jobs are found in London and it is projected to grow faster than anywhere else in the country.

It’s all about capacity.

In order to unlock growth within our ever growing cities we will need to increase the flow of people in, out and around them. The NIA measured how our city roads cope during peak hour traffic compared to off-peak traffic. As the size of an urban area increases, the capacity of our roads during rush hour quickly depreciates. Manchester’s reduction in capacity during peak hour? -56%. Greater London? A whopping -76%.

So we need to increase capacity, but how best to do it? Invest in high capacity public transport modes of course!

We have pulled together some data from the Norwegian Centre for Transport Research that gives a clear picture on how to increase travel capacity throughout highly populated areas. Walking and train/ tram come out as clear winners.

Source: Norwegian Centre for Transport Research

The good news is there are organisations out there that are currently involved in high capacity UK infrastructure projects. For instance, Transport for London recently completed Cycle Superhighways 3 and 6, each carrying between 7,000 and 8,000 cyclists during peak hours. The Crossrail 2 project, which would add 10% to London rail capacity and bring an extra 270,000 people into London during peak hours, is due to start work in 2020. NetworkRail are investing to increase the speed and the capacity of the Edinburgh to Glasgow rail line and are also adding 42km of new tunnel in London as part of the Elizabeth line – another significant capacity increase.

So yes, let’s keep choosing to build and invest in higher capacity transport modes to keep our cities moving.

More tram disruption anyone?

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 4 years’ industry experience (as at 30 June).

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Climate change: Five key investor questions… answered

  1. When will renewables be cheaper than fossil fuels?

According to the annual Lazard LCOE (levelised cost of energy) study, renewables are already cheaper without any subsidies than fossil fuels in most parts of the world. Indeed, in some areas, the most expensive form of solar energy is cheaper than the cheapest form of conventional energy on an LCOE basis. In addition, fuel-price inflation or volatility is less of a risk for renewables because wind and sunshine is relatively predictable compared to fossil fuel prices, making it easier to lock in long-term prices. Finally, renewables projects are much simpler to undertake from an engineering perspective. As such, the projected cost at the start of a renewables project is much more likely to be accurate than a conventional energy project. According to the Union of Concerned Scientists, the average nuclear power station project runs over budget by approximately +107%, whilst wind and solar project costs overrun by less than 10% and less than 1% respectively.

The average cost of energy (unsubsidised)

Source: Lazard estimates.

2. Will we be able to entirely replace fossil fuels with renewable energy? 

Yes. We believe this is not a question of if but when. The reality is that it will take decades to completely wean ourselves off fossil fuels, even if we invest heavily now. But renewables should continue to get cheaper due to relative technological immaturity and scaling up of the industry. In the future, the areas with the best wind and sunshine will probably export renewable energy, much like they do fossil fuels today. Below is a thought experiment from Quora which was referenced by Forbes:

If we cover 43,000 square miles of the Earth with solar panels, even with moderate efficiencies achievable easily today, it will provide more than 17.4 TW power. The Great Saharan Desert in Africa is 3.6 million square miles and is prime for solar power (more than twelve hours per day). That means 1.2% of the Sahara desert is sufficient to cover all of the energy needs of the world from solar energy. The cost of the project would be about five trillion USD, a one-time cost at today’s prices without assuming any economy of scale savings.1

If $5 trillion is anywhere near correct, it is very cheap indeed. A recent estimate (see chart below) estimates $2.1 trillion of capex on renewables by 2050. We view this as a conservative estimate. For context:

  • Estimated $7.9 trillion capex has been spent on the oil and gas sector since 1998.
  • Estimated $1.5 trillion has been spent on the recent US tax cut
  • World GDP is about $50 trillion annually.
  • The equivalent estimated cost 17.4 TW of nuclear power would be $52 trillion cost (pre cost overrun)

The IMF estimates that we are actually subsidising fossil fuels indirectly to the tune of 300bn euros per year if environmental damage is taken into account. According to Munich Re, losses from natural disasters are on the rise; they estimate that the cost in 2017 alone was $330 billion. Like I said, a $5 trillion one time cost is cheap.


Annual Global Renewable Energy Capex (billions of 2015 USD)

Source: DNV GL as of 30/09/17. Data from 2015-2050 is estimated or forecast

3. When will electric vehicles with decent range be cheaper than the equivalent oil burner?

If you can afford to (and want to) spend over £50k on a car, then you can get an electric vehicle today that is equivalent to, or cheaper on a three-year cost of ownership basis, than the equivalent oil burner (i.e. the Tesla Model S is cheaper than the BMW 7 Series). In 2019, with the release of the Tesla Model 3 in the UK, drivers will be able to get an electric vehicle for under £40k that is equivalent to a BMW 3 series. Whilst this serves a broader portion of the economy, and is a potential game changer for the electric vehicle adoption, it will probably take a further 2-3 years before affordable cars become available for mass adoption at the sub £20k price range. However, there are multiple car manufacturers launching such cars in the near future. Remember, the largest proportion of and EV cost is the battery, which continues to decline in cost every year.

Lithium-ion Battery Pack Prices – Price ($/kWh)

Source: Bloomberg New Energy Finance

4. Will we have the resources and energy grid to cope with electric vehicle demand?

The disruptive adoption of a new technology requires innovation. The prevailing assumption that the electricity grid of today will not adapt to renewables is flawed in our view. Utility-scale storage is becoming economical for storing excess supply and it can be fed into the grid during peak demand. New ways to offer on-street charging, like lamppost charging points, combined with bi-directional charging (i.e. using consumer’s electric vehicles as a battery which absorbs excess power and then returns it to the grid during peak demand) are examples of innovations that enable charging and disrupt the traditional utility model.

Interestingly, peak demand for electric vehicle charging will be at night, when demand for other electricity is at its lowest. Morgan Stanley has estimated $1.7 trillion capital expenditure is required on electric vehicle infrastructure by 2040. As referenced earlier, this is just 20% of the $7.9 trillion spent on oil & gas capex since 1998. The resources required to support the building of batteries and renewables are generally abundant and, as the industry scales, the vast majority of materials used will become recyclable and reusable.

5. What companies should we invest in to benefit from these disruptive trends?

The companies most easily linked to a particular trend are rarely the best companies to invest in. Disruptive companies tend to come from the ‘left field’ and offer something new and innovative that the incumbents either haven’t thought of, have found too difficult or have tried to prevent due to the threat it poses to their existing business. Mature incumbents are therefore the last place we look for investment ideas to play disruptive trends.

Furthermore, companies that become synonymous with a particular trend (i.e. electric vehicles = Tesla) might be good investments but suffer from two main issues:
1) They are very well known and intensely analysed by market participants, and
2) Tend to quickly attract elevated valuations which can be very difficult to live up to.

So where do we look? We have three key preferences when investing in disruptive trends:
1) We prefer innovative and disruptive, typically not mega-cap, companies that are in growth mode.
2) We prefer companies that are unheard of by the wider public and have little sell-side coverage.
3) We demand that they have a powerful enough position in the value chain to consistently capture a return above their cost of capital as they grow.

The last point is important because too often investors make the mistake of chasing a trend and investing in commoditised products and services which are temporarily benefiting from a trend but which have no discernible competitive advantage.

More questions? Perhaps we’ve already answered them in previous soapbox articles:

Just one thing (most common questions about electric vehicles) here
Joined up thinking (Cross sector inefficiencies when investing in disruptive trends) here
Statistically significantly wrong (difficultly forecasting disruptive trends)  here
America’s new pollution king (cars now emit more CO2 than coal) here.

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