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Client Update - 11th June 2021

In its recently published report – Net Zero by 2050 – the International Energy Agency (IEA) sets out a roadmap of how the world might achieve a zero carbon economy in order to meet the Paris Agreement target of limiting the rise in global temperature to less than two degrees. There were a number of points that struck us in reading the report. One is the IEA suggestion that commitments on global emissions reduction made to date have fallen short of what is required. A second is that technology currently exists to deliver most of the planned reductions in CO2 by 2030. However, almost half of the additional reductions necessary between then and 2050 will come from technologies that are currently at the demonstration or prototype phase. For both existing and developing (and new) technologies, there is a huge amount of investment to be done over coming years.

The other point is that to achieve the new zero ambition, there has to be a broad range of contributions. These come from technology, increased energy efficiency, changes in behaviour, additional and urgent policy changes and actions that are put in place to combat the negative social and economic consequences of the energy transition. None of this is new but the report sets out a comprehensive roadmap of what needs to happen and, importantly, stresses the urgency of accelerating measures on all fronts. The timing of the report is crucial too, just a few months before COP26 (UN Climate Change Conference). One of the priority actions identified by the IEA and included in the Summary for Policy Makers, is the need to increase spending on research and development in areas such as electrification, hydrogen, biofuels and carbon capture. There is a lot of private sector activity in these areas but a ramp up in official financial support will accelerate progress.

The need for acceleration is clear and part of this is the shift away from the use of fossil fuels. There were two very interesting developments last week that illustrated how that shift can be achieved as well as demonstrating the importance and influence of “ESG” (Environmental, Social and Governance) investing. The first example was a European oil company being subject to a court ruling in The Netherlands which will force it to accelerate its emissions reduction plans relative to those already in place. The second example comes from the US and involves another oil major. This firm was subject to investor activism that forced board-level changes in favour of new directors supportive of an acceleration in the diversification away from oil. The European case is an example of how ESG risks can materialise, the US case an example of how investors can drive corporate change. I expect we will see more of this.

If the IEA’s outlook is a credible roadmap to net zero, it is clear that oil companies have to quicken their shift away from their traditional hydrocarbons business and accelerate investment, research and deployment of their intellectual and physical capital into more and more renewable energy sources. Some of the areas where there is great potential is in the development of alternative fuels, such as Sustainable Aviation Fuel (SAF), other synthetic alternatives to oil based fuels, and the use of hydrogen as a source of energy for hard-to-abate industrial processes. Many of these are examples of technologies being at the prototype phase.

Sustainable aviation fuel development is seeking to replace oil with other “feedstuffs” to reduce life-cycle emissions and contribute to the circular economy. The use of household waste is one potential alternative input into the production of SAF. Elsewhere, projects are underway to use hydrogen to develop e-fuels that could be used in energy-intense processes like steel making and long-distance transportation. Chile has just announced a project in the Magallanes region in the south of the country that will involve the production of “green” hydrogen using wind-powered electricity and carbon-dioxide capture from the atmosphere to produce e-methanol which could have wide ranging applications as a carbon-neutral fuel. The science is fascinating, even if I do not understand it. The encouraging thing is that things are happening. There is a push from regulators, from shareholders and creditors and a pull from the opportunity of developing game-changing technologies that could lead to long-term profitable growth for those technology leaders.

Closer to home, the housing market is running hot, driven higher by the temporary stamp duty holiday but also as the working population has more cash in their pockets. The shift to working-from-home has meant people are looking for bigger homes with garden space outside of cities, and instead are looking in rural areas. With more people living in villages and towns, this will be supportive for local commerce and will inject money into parts of the UK which have fallen behind in recent times, as people flocked to city centres for employment. One risk with this rise in demand, though, is that banks may have been relaxing lending constraints, further adding to demand and potentially fueling a bubble.

We tend to avoid investing in physical property, as we believe there is a liquidity mismatch between the underlying asset class and the structure of many bricks-and-mortar property funds – you cannot sell a door or a window to fund a redemption after all. Most open-ended property funds gated in March 2020 and while many have reopened since, it has caused huge disruption for underlying investors. This is not a risk we like to take any more with our Model Portfolios, especially as this can cause some complications on platforms. Until platforms and bricks and mortar property funds change the way they operate, we will continue to prefer to achieve access to steady revenue streams and capital growth via infrastructure assets, which have explicit inflation-linking embedded into the contracts and pricing.

We await further information from the Government on the final phase of the re-opening of the economy, currently scheduled for the 21st June and when I write next week, I expect we will know more. Until that time, take care and have a lovely weekend.

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