Realities of the energy transition

“A multi-decade re-engineering of the entire global economy” – Julian Bishop, co-lead portfolio manager of Brunner debates the realities of the energy transition with host Joe Lynam. He argues that the production of nearly everything in the world relies on fossil fuels to some degree, something that will inevitably take time to change. The duo also examine the tie in with global population size and growth, look at whether energy in general and renewable energy in particular contains opportunities for investors, and draw their conclusions on the ultimate realities of the energy transition.

This is a marketing communication. Please refer to the key information document or KID before making any final investment decisions. Investing involves risk. The value of an investment and the income from it may fall as well as rise and investors might not get back the full amount invested. Past performance does not predict future returns. The mention of any particular security or strategy should not be considered as a recommendation. For further information on the Brunner Trust please go to www.brunner.co.uk.

JL: Hello and welcome to the 20th and latest instalment of Connected Investor. The podcast from the Brunner Investment Trust. I am Joe Lynam, the BBC World Service presenter and Newstalk business editor. And in this podcast, we're going to touch on the tortuous journey that is the energy transition and how that might play out over the next few years and what it means, of course, for investors in the Brunner Fund. I'm joined by the co-lead of the Brunner Investment Trust, Julian Bishop. Hello Julian. 

JB: Hello, Joe.

JL: You've been a busy boy over the last few months. You've kind of gone on the record with your thoughts about the energy transition. Can you set out for us what the key challenges are as you see them?

JB: Yeah, the sentence that I've used is that it's a multi-decade reengineering of the entire global economy.

JL: No pressure.

JB: No pressure! So, it's a big deal. It's trillions of dollars of investment that are required. I think most people underestimate just how reliant the world is on fossil fuels, across the board. There are some obvious ways in which fossil fuels are used. You know, when we're flying or driving our cars and really the production of everything requires oil and gas or electricity generated using coal, and that's the case whether you're sending a text message or eating a loaf of bread or heating your home or moving from A to B. Basically every economic act today involves stored energy from fossil fuels with very few exceptions. So, the entire economy today could not really exist without the widespread use of oil and gas. We couldn't feed 8 billion people on the planet without oil and gas, and therefore the challenge is extremely, extremely difficult.

JL: Now you have spoken about the link between fossil fuel usage and our carbon footprint and population growth. I mean, is it a good thing in energy transition terms that populations have started to stagnate in Europe and in China?

JB: Yeah. I mean, this is where the sort of ethics get complex, right? Because you don't want to say you don't want to have more people, but every person has a carbon footprint, and as people get wealthier their carbon footprints increase. Probably fair to say that the net carbon footprints of Europe or somewhere like China would decline in tandem with population, you know, as and when it shrinks. Very long term, actually, there's an interesting point, you know if you look at birth rates in places like Southern Europe and places like Korea, the birth rates are well below replacement now. So…

JL: I think it’s Korea. It's like 0.8 per woman,

JB: Yeah. So, it's crazy low. There's a guy called William MacAskill. He's a philosopher who talked about very long-term forecasts about population, called What We Owe the Future, and I think he makes the point that if you extrapolate the birth rate in those countries, which are increasingly common around the world, for 500 years, the global population will be 100 million people compared to 8 billion today. So, over a long-term time frame it is possible that we see depopulation, which obviously will be very helpful for meeting those objectives of net zero. We are ‘long term’ as investors, but we're not quite that long term.

JL: Even I won't be back in a few 100 years to discuss it with you anyway. In terms of the return in investing in renewable sources of energy. How is that played out over the most recent few years?

JB: Not great to be frank. So, a lot of capital being deployed into renewable energy, and the generation of electricity itself has never been a particularly profitable activity. But recently we've seen a lot of money going to wind farms, solar farms, and they come with certain problems. You make assumptions about the life of a wind turbine, for example, the productivity of a wind turbine and some of those have been quite disappointing, frankly and some of the deflation that was anticipated in the cost of wind turbines, for example, has also meant that returns have not been as good as you might have hoped for. So, I saw something recently, actually. If you look over the last three years, for example, compare to stock prices of companies operating renewable energy farms, compare them to oil and gas investments, and they've been far less successful actually, from a short-term perspective. So, hopefully that's correcting now. There is a big problem with renewable electricity, and which hasn't really been solved. That's intermittency.

JL: Aha! So, the sun doesn't always shine.

JB: Apparently not, no. Nor does the wind always blow. So, there’s still this problem of having to pair renewables with another form of electricity and normally it’s with gas. Gas turbines that can be switched on and off relatively easily, but that makes it a little bit more expensive. So, on a stand-alone basis, wind is very cheap. It's very, very cheap form of electricity, but you have this problem of intermittency and how to store surplus electricity for use at another time. One of our investments as a company, SSE, it's a utility company, and they have what's called a ‘pump storage project’ underway. So, this is in Scotland and literally the best way to store energy today is to pump water up a hill with the electricity when you have surplus energy, and then let it back down again, in a sort of artificial hydroelectric cycle, when the wind isn't blowing or when the sun isn't shining. And that's an interesting way. But it's amazing, this era of extraordinary technologies

JL: That seems very 19th century almost, isn't it?

JB: It is very 19th century, exactly. But that's an amazing project in Scotland, I think is capable of storing 30 Gigawatts of energy, which like half a million, you know, EV batteries.

JL: And talking of batteries, are giant batteries not some sort of solution for the intermittency problem with renewable energy, or is that still a pipe dream?

JB: I think it's still a pipe dream. It's very, very costly, that's the problem. You know there's some talk about, you know, people using their EV batteries. So, use electric vehicles to sort of store energy, you know, surplus energy that's generated by wind, for example, overnight and then sort of releasing that back into the home during the day. But large battery instalments are still a bit too costly to be economic. You know, hopefully the costs will come down, and that's one of the ways in which we can get to net zero. But again, this is going to take decades. This is this is going take an awful long time and this requires a large capital investment in itself. You know, we could talk about copper, perhaps, but all these projects require electricity, so the way to decarbonise means more electricity at the expense of fossil fuels burns in situ and electricity requires copper. Pretty much all copper is used in the generation or transmission of electricity or in motors and we need a lot of copper, and the world doesn't have that much of it. So, there's a bit of a choke point there, too.

JL: And of course, the commodities overall have become much more expensive, not just copper. But a lot of commodities have become a lot more expensive. What about nuclear energy? Julian? The French have a huge amount of their energy requirement in nuclear, but it's a very expensive business. And some countries, including Germany don't want nuclear anymore because of the huge risk, potentially.

JB: Yes, I mean, I think a lot of pragmatic environmentalists are supportive of nuclear in principle, it's reliable, It's low carbon. The trouble is, it's never really been scaled. So, every reactor is unique. That has meant that it's very costly. So really, what you would need to do is standardise the production of those reactors. Scale of production and then costs will probably fall reasonably quickly. But there's a huge political aversion to it. And the German example is pretty stark in that regard, So, you know, the German green movement is pretty powerful and following the Fukushima disaster in Japan, the decision was made basically to turn off all their nuclear power. But they've replaced that with coal. So, they're burning lignite, which is halfway between coal and peat. It's an incredibly carbon intensive form of energy, and I think a lot of people would say that's been a huge environmental own goal. In France, where they standardise reactor types, a lot of electricity is generated via nuclear. So, you know if you get the TGV in France on holiday, you know, the likelihood is that it's powered by nuclear energy. So that's true low carbon transportation. But it does seem as though the sort of political wind is against nuclear. But I do sense that that's changing at the margin, and there are some companies that are coming up with much smaller, modular forms of reactor that can be maybe used, you know, in more local sites. So, for example, artificial intelligence data centres, they consume fast amounts of electricity. So, there's companies like Rolls Royce who are experimenting with small nuclear reactors of the type that would be used in nuclear submarines, for example, in an industrial setting. So, it would be quite interesting to see if that ever takes off.

JL: Any other sectors and any other types of companies that the fund is looking at, given this transitional requirement?

JB: So, we have a variety of investments in the portfolio, that we think provide intelligent exposure to the energy transition. We have positions in a couple of utilities that are responsible for generating electricity and investing a great deal in wind, in solar, reasonable economics we think, and in pump storage solutions like the one I mentioned in Scotland. We have a position in a resources company called Rio Tinto. So, they have iron ore, but they also have growing exposure to copper, which is the metal of electrification, they own part of Escondida, which is the biggest copper mine in the world in Chile and a mine called Oyu Tolgoi in Mongolia. And then we have a series of industrial investments. So, there’s a company, for example, called Schneider Electric, which is listed in France, that makes a lot of the components that's, for example, you would use to operate their grid and their network and that's a really terrific business, which is growing a lot faster, so there’s this theme that electrification has really taken off. It’s worth mentioning, by the way - the raw statistics. But you know, less than 20% of the world's energy consumption comes from electricity. That number needs to increase materially. So that's the solution to the energy crisis. We need to electrify everything, as seen most obviously today in EVs taking off. But we need to do that across the board. We need to generate hydrogen. Hydrogen uses electricity to produce basically a portable fuel that can be used in other applications, such as shipping, for example, So, there are lots of areas where investment is needed. It will take a very long time. But I’m optimistic over that time frame that it is possible. I just think anyone who's sounding the death knell for oil and gas in the next few years is sort of missing the fact of how difficult this will be.

JL: Yeah, so rumours of the death of the fossil fuel industry have been greatly exaggerated, as Mark Twain would say. And that's a pretty good place to stop I think, Julian. Thank you very much. That is Julian Bishop, the portfolio co-manager of the Brunner Investment Trust. That's all the time we have for this episode of the Connected investor. Make sure that you're subscribed to it wherever you get your podcast so that you don't have to go hunting for it next time and thank you for listening. We value your views, and we are keen to know what you think. So, get in touch through the website brunner.co.uk. That's B R U N N E R dot co dot uk. If you could also leave a review on Apple Podcasts and give us a rating so that we can learn for the next time, that would be great. So, from Julian Bishop and from me, Joe Lynam, ta ta for now.