Energy, carbon, hedgehogs and foxes

Whether it is the recent protests in London, arguments over carbon fibre yachts or the UK’s commitment to net zero carbon emissions by 2050, concerns over the climate have undoubtedly risen towards the top of the political agenda. Ed Hezlet explains the investment implications.

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Oct 30, 2019
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Even the most reluctant follower of current affairs couldn’t have failed to miss the rise in popular and political concern over environmental issues, and global warming in particular. Whether it is the recent protests in London, arguments over carbon fibre yachts or the UK’s commitment to net zero carbon emissions by 2050, concerns over the climate have undoubtedly risen towards the top of the political agenda.

It would seem improbable that the investment world is going to be insulated from these concerns. However, I would argue that at present, it is fiendishly difficult for investors to pick the winners. Let’s take the government’s flagship 2050 net zero carbon emissions objective as an example. Achieving this target not only looks like a difficult and nuanced problem to solve, but it also raises four major issues for investors to consider.

1. Historical precedents may not be useful

Past energy revolutions have tended to be slow and additive rather than overnight transitions. Global consumption of energy from coal continued to grow right up until 2013, when coal represented 30% of the world’s total power consumption, despite the significant rise in oil and gas as an energy source from the early twentieth century.1

Comparisons with past energy transitions may be anomalous, however. This is the first time that we are trying to engineer a change in the global energy system due to concerns over the climate, rather than being motivated by an immediate economic payoff. The combustion engine and the automobile are likely to have been a significant “pull” for the growth in demand for oil, rather than the current push to reduce the carbon intensity of our energy consumption.

1Taken from https://ourworldindata.org/energy-production-and-changing-energy-sources (Ultimate source is Vaclav Smil (2017) and BP Statistical Review of World Energy)

2. Can democratic constraints be overcome?

Cheap and plentiful energy has been extraordinarily beneficial to humankind, helping to reduce both the time burden and financial costs associated with heating, lighting, transportation and consumer goods to name just a few benefits. As a result, taking actions to curb energy use or increase its cost to the end consumer places politicians on a tightrope and risks punishment at the ballot box. Ultimately, seemingly noble and far-sighted actions to reduce carbon emissions can end up meaning little if the politician who championed the legislation is replaced by a competitor who promises the opposite.

The protests of the “gilets jaunes” in France (initially triggered by rising fuel prices) and even recent events in Canning Town, illustrate that political leaders are facing a tricky balancing act when it comes to gauging the electorate’s reaction to climate policies. The best hope for politicians is for technological advances to provide a “win-win” situation, where abundant sources of clean, low cost energy help reduce carbon emissions while also benefiting the economic status of the population.

3. The vagaries of the UK weather may not be helpful

With the nights drawing in, you can’t help but notice that the UK is often a dark and cloudy place. According to the late Sir David MacKay, Edinburgh receives an average of 94 watts per m² of solar power, whereas Cairo receives c. 2.5x this amount.The problem becomes even more acute when you consider seasonality. Mackay also calculated that the average sunshine intensity in the UK is about 9 times lower in winter than it is during the summer months.

Unfortunately, the UK’s longitudinal position appears to be particularly poorly suited to benefit from solar power, which is one of the most promising renewable technologies. UK electricity generation needs to peak in the winter months to meet demand (see the elevated blue line in the chart showing how electricity demand rises in January and February), which is exactly the time when solar power generation is at its lowest!

2https://royalsocietypublishing.org/doi/pdf/10.1098/rsta.2011.0431 (MacKay David J. C. Solar energy in the context of energy use, energy transportation and energy storage. Vol. 371 - Philosophical Transactions of the Royal Society A: Mathematical, Physical and Engineering Sciences) is the full reference

4. Different electricity generation systems don’t always play nicely together

Wind power, where the UK is a world leader, is inherently intermittent, even on a national scale. Data from Gridwatch shows the average daily power generation of the UK wind fleet over the year to July, in orange on the chart. Overlaying the power generated from combined cycle gas turbines (CCGT) in blue, the data clearly shows that gas is being used as the flexible power source to balance the intermittence of the UK’s wind power generation.

For example, average daily output of gas plants peaked at nearly 25 GW on 24 January, when wind power generation was minimal. However, from 2 March to 17 March, power generation from gas averaged just 10.4 GW as wind output rose. In this instance, the technologies appear symbiotic, but it can also be argued that the intermittency of wind power is causing gas plants to operate at lower average capacity utilisation, making their unit production costs higher than they would otherwise be. As a result, variable power generation can create very real costs to the wider power generation system.

https://gridwatch.co.uk/downloads

Furthermore, unless brilliant advances are made to storage technology, carbon capture or our ability to derive utility from bouts of excess power, the mixture of gas and renewables above doesn’t get you to an end goal where you are able to completely decarbonise a power grid. Given a 2050 net-zero objective, it might be logical to shift focus towards technologies that promise complete decarbonisation of UK electricity generation—for example, increasing the share of nuclear power.

The implications for investors? Think like a fox…

Philip Tetlock, the author of “Superforecasting: The Art and Science of Prediction” draws a distinction between thinkers—those who rely on a single big idea to make sense of the world (referred to as hedgehogs)—and those who are sceptical about overarching theories and instead rely on varied ideas, which they are happy to adjust based on new events (the foxes).3

In such a complex domain, where the interaction of politics, technology and physics is likely to shape the evolution of the world’s energy system, I think it is best to act like a fox. We will be watching developments closely and hope to see the scientific and entrepreneurial talent of the UK continue to bring new technologies and companies to UK markets.

Ed Hezlet is an assistant portfolio manager in the J.P. Morgan Asset Management International Equity Group – Behavioural Finance Team. Read more about our UK capabilities >

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3 Philip Tetlock: The art and science of prediction

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Go to the profile of Ed Hezlet

Ed Hezlet

Investment Assistant, UK Equity Group, J.P. Morgan Asset Management

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