Energy industries will outperform in the longer term.
The escalation of Fukushima has meant a gloomy reassessment of the overall damage it has caused. Future prospects in the nuclear power market look grim. At the same time, disturbances continue across North Africa and the Middle East.
The immediate outcomes are negative. Global GDP will be impacted by spiralling energy prices, and a downbeat Japanese economy. That means higher inflation (already pretty high) and lower GDP growth.
The cost-effectiveness of nuclear power changes. If new nuclear plants are built, they’ll have to incorporate new designs for higher safety; face opposition from citizens; spikes in disaster insurance premium and so on.
In the short term, this may mean bearish or sluggish equity markets for quite a while. Eventually, businesses will adapt and the systematic long-term investor who can wait for returns will get them. A portfolio focussed on energy industries should outperform a broader diversified portfolio.
In the longer term, much more money will be thrown into clean renewables. The growth potential there is huge. The global energy market is not fast-growth – the long-term CAGR is about 1.5 per cent. But the share of renewable energy is very low.
According to the Renewable Energy Policy Network for the 21st century (REN21), fossils account for 78 per cent of global energy consumption and nuclear power accounts for 3 per cent. Traditional biomass, (wood and waste), contributes 13 per cent while hydro services three per cent.
Taken together, wind, solar, geothermal, modern biomass and biofuels account for just under three per cent. That market share must climb rapidly if renewables are to become a meaningful alternative. Regardless, the world will remain heavily dependent on fossil fuels for decades. If there’s a massive scaling up of renewables, there’s going to be turmoil across multiple value chains. While we lump them together for convenience, “renewables” represents many totally different industries, with roughly the same end-goal.
Each has different technologies. They are all at different points of maturity. Each has its own advantages and also its own problems. None are technologically stable. Some can only be deployed for specific tasks, or in specific places.
Most are both more expensive and less convenient than fossils. Solar costs for instance, would have to reduce by upto 80 per cent to make it comparable to coal. Wind is more cost-competitive than solar but even more difficult to deploy onto grids, due to intermittency and locational factors.
Scaling up usually reduces costs. But other problems may arise. Biofuels for instance, run into a barrier, if scaled up to the point where land currently used for food, or other cash-crops, is diverted. In 2007 and 2008, North American maize prices skyrocketed due to diversions to biofuels.
Many technological breakthroughs will be required to address these problems. A lot of money will go into research and development. Downstream technologies must also be reworked to fit large-scale renewable deployments. Transport may increasingly be driven by engines working off electrical batteries. That means a re-look at transport value chains. There will be shakeups in commodity markets as new materials are developed during this process.
It would be a brave man who tried to predict all details because there will be so many changes, and they will occur in unpredictable bursts in so many areas. Business in these new areas will die quickly when they bet on the wrong things and grow exponentially if they bet on the right ones.
The next big bubble could be in renewables, and it could dwarf what happened with the Internet in terms of both size and duration. In such circumstances, valuations are a risky game. We will see a renewal of interest in the private equity/ venture capital (VC) industries because the risk:reward equations are typical for such investors.
VCs rely on a shotgun approach. They back say, 10 businesses under the assumption that say, 8 will die, and two offer multiple returns that over-compensate. They mitigate risks by assessing quality of management, building multiple scenarios and doing extensive financial modelling. It’s still very hit-and-miss.
VCs do act as a first-filter. If they’ve backed a business and brought it to an IPO, the chances are, the business will yield quick capital gains in bubbly conditions. (It’s entirely possible that it will later collapse, a la so many Internet “winners”.)
That gives us some sort of blueprint for the investing future. If you want decent, long-term returns, invest systematically and broadly and wait for the global economy to adjust to higher energy costs . If you want excess returns, focus on energy. If you want to gamble with high risk: very high return bets, track renewables.
