The road to net zero

In this latest podcast the team look at the factors to consider when investing around the theme of decarbonisation and how companies with strong decarbonisation credentials, able to drive the energy transition, are considered within the investment universe. What elements shape the pathway to net zero and what will be required to get there? With that view in mind, which companies could be well placed to capitalise and therefore provide good investment returns for investors? Electricity generation, energy storage and transportability all come under the spotlight.

JL: Hello and welcome to the 16th and latest instalment of Connected Investor, a podcast from the Brunner Investment Trust. I am Joe Lynam, the BBC presenter and Newstalk business editor. And in this podcast we're going to pick up on a theme we discussed a little while ago, but one which has increased in relevance for investors and it's decarbonization and what electrification means for the markets and of course, the Brunner Fund.

I'm joined by the co-leads of the Brunner Investment Trust, Christian Schneider, who you will know, but also by the new boy, Julian Bishop, who has now also the co-lead of the Brunner Investment Trust portfolio. Good afternoon. Good morning. Good evening to both of you.

CS: Hi.

JL: Can I start with you, Julian, as the new kid on the block and ask you, what's Brunner's position when it comes to backing companies with strong decarbonization credentials?

JB: Thanks. It's a very good question. So I think I would start off by saying that we see decarbonization as one of the most significant themes of the coming decades and in the global economy, simply because we are talking about effectively a complete re-engineering of the global economy. So fossil fuel usage is deeply embedded into almost every economic activity there is. So it's a huge industrial investment that's going to be needed and it will drive growth for a lot of businesses who provide relevant products and services.

At Brunner, we like to serve with all of our investments. We like to balance quality, value and growth. So I think it's clear that the growth is there, whether the quality and the value is is another question. So far for quality, we need barriers to entry, sustainable competitive advantages, high returns on invested capital, things like that. And then for value, we look at free cash flow generation. 

So whether we back a company really with strong decarbonization credentials depends on the balance of those three factors. But I think what's clear is the more the more you read about decarbonization and the journey to net zero, the more that you realize that it just requires electrifying everything. And so electric cars are a good example of that. But we need to do that across all the segments of the economy. So the International Energy Agency, they suggest that only 18% of today's usage is actually coming from electricity. The rest is primarily fossil fuels, which are burnt in situ. So in an engine or a boiler or a furnace. And that ratio will have to increase whilst the amount of energy in total being consumed is increasing because of growth in the economy, particularly in emerging markets. 

So it's a huge, huge capital investment. And if we’re going to stand a chance of getting some net zero by 2050, we need to generate lots more electricity. We need to find ways of moving it around, storing it. I think as we do that, there'll be lots of opportunities for Brunner in our investments. 

JL: Christian, can I bring you in on this? Quite a few of the big energy intensive companies, whether they're in chemicals or mining or in the production of oil and gas, and they all have stated goals of reaching net zero, whether it's by 2050 or whatever year. But getting there is tough, because oil and gas is so profitable still. 

CS: Well, absolutely. I mean, as Julian kind of alluded to, the decarbonization where we're facing here, and that kind of will be a companion factor for the next decade or two for us.

It will create all sorts of fault lines in the economy, fault lines for those companies that have to decarbonize, fault lines for companies that kind of create business, or have businesses that help decarbonize -luckily, those that that do not have to worry too much about it. You're right. I mean, that's it's a cheap source of energy right now, and the infrastructure that's in place and to decarbonize simply means that the economy has to shift completely its course in terms of supplying energy to companies that use it and have consumers that use the energy out there.

So what we're going to filling station, kind of filling up the car with some diesel or gasoline currently, electricity needs to be distributed going forward. There will be kind of a plug in power station somewhere that will be kind of refuelling the vehicle at home, potentially. But that puts a lot of attention on the grid. At the same time, we're shifting away from carbon and fossil fuel driven electricity generation of power generation providers towards more sustainable providers.

Unfortunately, those creates more volatile power out there and kind of the grids needs to accustom itself to that. So as I said, a lot of fault lights out there, but those fault lines create opportunities for companies helping shifting the infrastructure forward. It will create opportunities for companies that win the race to decarbonize and separate themselves from its peers.

And also, last but not least, for us as investors and are focusing on companies that don't need to worry at all in the first place because for them it's not a big issue. So the various aspects in there as an investor to just think about decarbonization and the fault lines along it. 

JL: And Julian, would you say that we're close to some sort of critical mass whereby companies are producing the right type of decarbonized product or electrified product and that it will be profitable because at the moment the returns aren't near good enough yet, even if the goal is there, the technology is there, but it doesn't have quite the critical mass yet for mass take off.

JB: I think the production of electricity, of renewable electricity delivers reasonable returns. But as you know, there's very little in terms of barriers to entry to prevent somebody from from generating electricity. So it's not a high value add activity. So we invest in a couple of utilities, they produce electricity and they get a regulated return on their production. So it's not very high, but it is decent.

In terms of the cost competitiveness of renewables. It's there. I mean, solar and wind today is very cost competitive with gas, coal, etc. as prices have come down a great deal. But issue remains, and Christian just alluded to this, the issue remains the intermittency of renewable power generation. So it's very, very hard to store or transport energy. 

So there's a couple of things that we find interesting, despite all the talk of batteries and so on. The easiest way to store electricity on an industrial scale today is actually just to pump water up a hill and then get it back down again when you need, 

JL: which is not very avant garde.

JB: It's not very avant garde. No, no. But it's what you need to do. If you need to store electricity on a massive scale, you let it back down. You have a sort of minor, a small scale hydroelectricity plants. And in fact, so you get about 75, 80% of your energy back that way. But that's pretty much the most sophisticated way of storing energy today. And about need for storage really complicates the economics of electricity. So that's one of the most significant problems that needs to be overcome. 

So in terms of electricity generation, you know, it makes profit and it's cost competitive. What we need to now do is solve this issue of storage and transportability. So one of the issues that I want, one of the opportunities that I think will be out there in the future is hydrogen. I think that will solve a lot of problems. Once you have green hydrogen, that is hydrogen produced from renewable sources, and you can make a product that can then be stored and transported, that will be a major breakthrough. I think when that happens, that road to net zero, that pathway will accelerate a great deal. 

It's very interesting Christian. You've got multiple colored hydrogen, don't you? You've got blue hydrogen and of course you've got now green hydrogen, which is the goal. Germany is definitely looking very seriously at hydrogen. They talk about hydrogen powered cars and yet other bits of Europe are less keen on that. 

CS: Well, kind of the German carmakers have been experimenting with hydrogen cars as long as I'm in this business, actually. So I started in 1996, and back then there were a great deal of companies already looking into the technology and see whether it can be done economically. Yet they struggle to do so, it's kind of one thing to create hydrogen, so the technology is there, but to do it mass efficiently is currently, and for the last 25 years, has been a challenge.

So for the time being, it looks like electrification of cars is the more viable way forward. That being said, as Julian alluded to, green hydrogen once being able to be produce in scale and in a cost efficient way, is a great way of storing, storing energy. Because as you know, a solar power plant will create power when daylight is there. Not at night, of course, But we will watch TV on the Champions League, same with 

JL: or Eurovision.

CS: Or Eurovision. Again, making the last place there as Germans as usual. Same is true for wind power plans. Actually they have one time nature and so we need this storage capacity to buffer these things out which basically. 

JL: Julian, in terms of the storage idea, are there companies coming along? I mean, you've mentioned batteries and you're talking about hydrogen. Are there companies that the fund is looking at which could be about to make a big leap in this area? 

JB: The simple answer is no. There's nothing that we have that specifically addresses that we don't have any investments in hydrogen, which are of significance today. We invest in a utility I mentioned, and they're involved in what's called pumped storage, which is this idea of pumping electricity up, sorry, pumping water up a hill and then letting it back down again to generate electricity.

But there's nothing I, I would point to in and storage where we have an investment. So again, we try to balance sort of quality value and growth. I think today a lot of investments in storage are reasonably speculative. So that's sort of better suited, I think, to angel investors, people who are more willing 

JL: to take a huge risk.

JB: take a huge risk, take a bit of a punt with the expectation of either losing all your money or making a huge return on your investments. And that's not what we do. We're all about in cricketing terms talking about hitting one and two, not swinging for sixes. 

JL: Can I ask you the final question? And that is, are there companies that you'd like to invest in but they're based in countries that there is an ESG risk? 

CS: Well, good point. Clearly, around the world, a lot of investment in decarbonization efforts kind of this is in countries with a democratic background and others that are less so focused on democracy and the rule of law basically. We take a careful look at both, actually, as usual, countries that do have a lower ESG rating basically are not ruled out. We are not an ESG driven fund in the first place. Yet we take those risks kind of carefully in mind when we make our assessment about the quality of investment that's out there. So a company that is headquartered and is residing and doing most of the business in a country where the rule of law is not applying, you want to have an extra haircut on basically in order to make it interesting.

So two companies, same price, same valuation doesn't make sense if there is this extra added risk to that. So that's the approach we're taking here at this point. 

JL: Thank you very much. I think we'll call it a day there. That was Julian Bishop and Christian Schneider, the co-leads of the Brunner Investment Trust. And that's all the time we have for this particular podcast. Make sure you're subscribed to Connected Investor wherever you get your podcasts, so you don't have to go hunting for it next time. Thank you all for listening, and if you want to get in touch, go to our website, www.brunner.co.uk From Christian from Julian and from me Joe Lynam. Ta-ta for now.