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Client Update - 12th February 2021

I will try and steer away from COVID this week, as we all now know as much as each other about the end of lockdown – we all have no idea! I will therefore move to a theme that continues to gather momentum, investing with an eye on Environmental, Social and Governance issues (ESG). I have written about ESG in previous letters and I have mentioned how popular it has become. There remain concerns that it could be just another fad of investing, but we do not think so. For a long time, fossil fuels have been the predominant source of energy. Today, that is changing. According to the International Energy Agency, renewable primary energy is the second most important fuel in global electricity generation, ahead of oil and natural gas (but still behind coal). For OECD countries, coal’s contribution to electricity generation has been falling since 2007 while renewable energy is just behind natural gas as the dominant fuel. Renewables will become the main fuel source in the coming years. At the same time, electricity will replace carbon as the major fuel source in a number of sectors – transport and buildings for example. More of the electricity will come from renewable sources and more economic activity will be driven by electricity rather than the “burning” of fossil fuel. A good example can be seen on the popular island of Mallorca. Even though we are not able to holiday there, it is grabbing headlines for different reasons. It will now produce green hydrogen using solar energy which will then be used to fuel the island’s bus and rail network and rental vehicles, provide power to commercial and public buildings and allow an auxiliary power reserve to be maintained. It will transform the island’s economy, create jobs and help reduce the smog that engulfs Palma on a hot August day.


Spain has historically been a net importer of energy. It has no oil and gas reserves to speak of. What it does have is lots of land and lots of sun. Solar and wind power are thus potential drivers of economic growth in the future. This is an important point. Fossil fuel reserves are not uniformly distributed around the world. The easiest to access are concentrated in a few geographical locations. That has allowed economic rent to be exploited by sovereign states that control the reserves and selected companies that can exploit them. There are all sorts of geopolitical and ethical issues associated with the history of fossil fuel excavation and trade. However, the sun shines in lots of places (even in the UK occasionally). Wind blows everywhere. Countries that have historically been fossil fuel poor can possibly look forward to a future of being renewables rich. The shift has the potential to change national economic fortunes, structurally improving long-term growth and productivity, impact on trade balances (for good and for worse) and significantly change the geopolitical balance of power.


The recent article in the Financial Times magazine (How the race for renewable energy is reshaping global politics) maps where solar and wind power potential is greatest. These areas are diverse. Solar intensity can be found in the Arabian gulf (lucking out again as a major source of energy), the south-west of the USA and Mexico, the Pacific coast of south America, much of Africa and, of course, Australia. Areas of high wind speed, and thus potential locations for wind farms, include many coastal areas in the deep south of Argentina, New Zealand, the British Isles and continental mountainous regions like the Rockies and to the north of the Himalayas. These are just the areas where wind and solar potential is greatest but other areas can also unlock the potential – the south of Europe is not that different to the northern coast of Africa in terms of sunshine resources.


The reduced reliance on oil and the handful of large suppliers that control the market (OPEC and others) will also have other economic consequences. Energy prices should be lower in the longer term and less volatile as there will be reduced “political” influence on energy supplies. The Middle East has been a geopolitical battleground for decades and part of the reason for that has been the West’s need to secure oil supplies. When the politics has turned bad, oil prices have gone up. When that has happened it hurt consumers, raised inflation and, on occasion, triggered recessions. Politics can interfere in the supply of the technology and capital needed to exploit renewable energy, but nobody can control the sun and the wind.


I have written at length during COVID on the dominance of technology as an investment. It is the development of technology that has attracted a lot of investment capital in recent years in clean energy, and this has indeed been a source of strong returns in our ESG portfolios over the last 12 months. One of the companies involved in the Mallorca project referenced above has delivered a 46.4% increase in its share price since the end of October. While there continues to be lots of focus on the usual tech names of Facebook, Amazon, Netflix, Google etc, the clean energy sector is gaining significant momentum and we suspect that this will continue. The intensification of ESG policies amongst the investment community will ultimately reward companies involved in delivering a zero-carbon future relative to those that are still emitting greenhouse gases. We are very pleased to offer ESG portfolios to our clients and we have a brochure dedicated to this style of investing if it is of interest.


Finally, a word on the UK. Vaccinations have now reached over 13 million and infection rates are steadily falling. The British government is being cautious about re-opening the economy, especially given the concerns about the danger of importing new strains of the virus. However, it is likely that the UK should be able to open its economy – domestically at least – before many others in Europe. The Bank of England was reasonably optimistic about growth in the second half of the year and the gilt curve has steepened in response. Just like elsewhere there is a lot of pent-up demand waiting to be unleashed. We have raised exposure to UK equities in this environment and would expect sterling to at least hold on to recent gains against both the dollar and the euro. As always, we are looking for investment opportunities for our clients, as not only do we enjoy the challenge, there is not really a lot else to do for now!


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