Nathan Lim

Australia Headlines

• Western Australia’s energy market is broken – wholesale electricity prices ($180 per megawatt hour) cost more than unsubsidised solar and wind, more than double rates in Eastern Australia
• Renewable Energy Target review delivers on preconceived conclusion – local renewable energy industry in peril

AEI Assessment

The Renewable Energy Target review lead by climate skeptic Dick Warburton has recommended changes that would effectively arrest renewable energy development in Australia. While the grandfathering option in the recommendation should provide some security for existing investments (assuming it is adopted), there is nothing to support further large scale developments. We are disappointed that the government seems to be deliberately ignoring the global trend whereby nations are reducing their emission intensity from power generation to address climate change. Support for this trend also comes from the added benefit that it also improves local air quality.

North America Headlines

• California oil refiners take in record oil-by-rail from Utah
• Colorado activists drop fracking opposition in return for new task force to address concerns regarding hydraulic fracturing
• Consolidated Edison sees nearly 100% growth in solar rooftop installation in 2013 – solar cheaper than residential electricity rate
• Democrats increasingly backing oil and gas industry
• Energy Information Administration (EIA) says imported oil to meet 22% of US demand, the lowest level since 1970
• Reinstatement of the Production Tax Credit by Congress before year end remains highly uncertain
• California, under Assembly Bill No.327, starts rulemaking process to integrate cost-effective distributed energy resources into the grid
• Department of Energy, 2013 Wind Technologies Market Report – Wind Power Purchase Agreements at record low of US$25 per megawatt hour
• California passes bill to streamline residential solar applications and installations
• Gina McCarthy, Environmental Protection Agency (EPA) head, says renewable fuel standard ruling out shortly and could be higher because of increased gasoline usage
• EPA to decide this year whether to regulate methane emission from drilling (fugitive emissions)
• FutureGen 2.0 (experimental near-zero emission coal plant) gets EPA approval for CO₂ injection wells
• EPA must rule by December 1 on Ozone standard. Tightening to 60-70 parts per billions will impact power generators through additional nitrogen oxides and volatile organic compound abatement equipment

AEI Assessment

The policy debate around shale oil and gas continues to swing towards the moderates and away from the critics. The growing realisation of its transformational impact on the economy has broadened its appeal as it seems to hold the promise of jobs, prosperity and energy security. As a result we have raised our assessment for oil to Positive.

Renewable energy support policy continues to slide but the cost of solar and wind has fallen so dramatically that financial supports are becoming decreasingly important. As noted above rooftop solar and large scale wind are now competitive in conventional energy markets. Even after deducting the benefits of various subsidies, the economics are not so drastically affected as to completely negate renewable energy’s competitive position. Scale in both technologies and sensible policy support (like California’s decision to make rooftop solar installations less bureaucratic), continues to drive cost down making renewables so close to being strongly competitive against conventional energy on an unsubsidised basis.

The EPA is signalling its strong desire to continue to improve air quality by all means possible with FutureGen now able to proceed to construction and the department’s finding that ozone levels still too high.

Europe Headlines

• UK Department of Energy and Climate Change, less than one-quarter of UK public support shale gas development
• German electricity price go negative again from high wind production
• Italy passes changes to Feed-in-Tariffs for solar, effectively a 20% retroactive cut
• European Commission expected to confirm 40% carbon emission target by 2030 in October, efficiency and renewable targets to be considered
• Ukraine and Russia moving towards a permanent ceasefire

AEI Assessment

The next major policy development for the EU is their 2030 targets. Preliminary discussions continue to suggest efficiency and renewable targets will only be binding at the EU level and not at the country level. Given the ongoing divergence in energy policy amongst member states (Poland versus everyone else essentially), this seems to be a reasonable compromise as it recognises that some countries are more willing than others to migrate to higher levels of renewable energy and take responsibility for their contribution to climate change. Countries have exceeded EU targets in the past so an aggregate target does make sense as long as there are not too many other countries looking to get a free ride. Making the efficiency target non-binding is disappointing though as these are easily the most direct and least difficult technologically to reduce a nation’s energy intensity.

A political resolution in the Ukraine, at the time of publication, appears to be in the making which will substantially reduce the political risk in this region.

China Headlines

• Beijing cuts coal consumption 7% in first six months of 2014
• Smaller cities steer away from GDP as primary performance metrics, focus on raising living standards for poor, reducing poverty and environmental protection
• 70% of Chinese coal companies losing money as coal price at seven year low
• China appeals mixed World Trade Organisation ruling on US duties levied on solar panels, wind towers
• National Development and Reform Commission says China will start national carbon trading by 2016

AEI Assessment

It is becoming abundantly clear that China has recognised that business-as-usual will further aggravate the economic, societal and environmental imbalances in the country. Bringing forward its national carbon trading market and the move away from solely using GDP as a measure of success is tacit recognition by the government that externalities cannot be ignored forever. This will continue to put downward pressure on energy intensive, high emission industries.

Japan Headlines

• Japan has added 9,770 megawatts of clean energy since July 2012 – 98% is solar
• Minister of Environment, Japan should target 30% renewables by 2030
• Abe appoints new cabinet with the popular Yuko Obuchi tasked to push through the unpopular nuclear re-start agenda

AEI Assessment

Japan’s version of President Obama’s “all of the above” energy policy is best demonstrated by the expansion of solar power over the past two years. Over this time, Japan has approved an astonishing 65 gigawatts of new solar projects which actually exceeds Australia’s entire installed base of all forms of generation. The comment made by the Minister of Environment hardly seems necessary but is an important recognition by the government of the role of renewable energy in the energy mix. Yuko Obuchi appointment as the first female Trade and Industry Minister is hoped to appeal to the broader electorate as a recent Nikkei newspaper poll found 65% of female respondents opposed restarting Japan’s nuclear fleet.

Global Headlines

• India is considering adopting a Feed-in-Tariff regime for solar
• India proposing 10,000 megawatts of wind per year
• Brazil energy auction attracts offers of 26 gigawatts of wind, solar
• Africa to install more renewable power in 2014 than in previous 14 years
• 2,200 cellphone towers in India to be powered exclusively with solar
• India does not impose solar dumping duties
• Global solar installations on track for record for 2014, 52 gigawatts
• India’s Prime Minister Modi says good governance and clean energy are top priority

AEI Assessment

Momentum is building for an energy transformation in India and Africa. The deployment of solar cellphone towers in India is significant because it was needed to address the lack of dependable power in the area. This is a reflection of the larger problem facing the developing world where a centralised grid strategy has failed to lift nations out of energy poverty. Building a distributed energy grid around where energy is consumed instead of where resources are located is expected to be a fundamental principle in grid deployment in the developing world.

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Australian Ethical holds positions on 3 recycling companies.

Would you withdraw money from an ATM and then bin it? Have you bought batteries from the shops and then immediately throw them away? As absurd as this sounds, we as a nation do this every day.

According to the Australian Bureau of Statistics, we send 46% or 24.9 million tonnes of waste to landfills every year. When compared to Sweden which only sends 1% of its waste to landfill (and in fact imports garbage as a profitable industry), we are literally burying money every day.

Urban mining is a popular term used to describe the stripping and reusing of valuable metals, mostly from electronic waste. At its core is the basic principle of recycling and acknowledges that it is cheaper and more efficient to re-use materials than to produce them from virgin sources. As the US Environmental Protection Agency (EPA) has calculated, recycling one ton of paper saves 4,100 kilowatt hours of energy which is enough to power the average American home for six months.

When considered in the context of global markets, recycling in all its forms is a responsible and clearly a more sustainable way to invest in commodities. Many recycled metals like aluminum, gold and zinc are chemically indistinguishable from commodities produced from virgin materials and are an important resource for many major industries. For example, approximately 30% of global aluminum production now comes from the recycling of old scrap.

Australian Ethical holds positions in three companies involved in urban mining and commodity recycling at an industrial scale.

1. Horsehead Holdings Corp (market capitalisation US$1 billion)

The current growing global shortage in zinc as a result of mine depletion has been identified as the principle driver behind the 27% rise in the zinc price over the past 12 months.  Horsehead is the world’s largest producer of zinc from recycled sources. The company collects electric arc furnace (EAF) dust which contains zinc. EAF dust is listed as hazardous waste and is generated by North American steel mini-mills. By collecting and processing EAF dust, Horsehead is amongst the world’s lowest cost producers of zinc and has been in the zinc production business since the mid-1800s. It has recently completed the relocation to its new, state-of-the-art facility in North Carolina which will benefit from lower energy usage, higher labour productivity and reduced maintenance costs. Zinc produced by Horsehead is used in the manufacturing of brass and hot dip galvinising, which is the process of adding rust protection to steel.

2. Covanta Holding Corp (market capitalisation US$2.8 billion)

Covanta is one of the world’s largest owners of Energy-from-Waste (EfW) facilities. The company meets solid waste disposal needs by using waste to generate renewable energy. This is the same methodology the Swedes have utilised to reduce landfill waste by 99%. The EPA has estimated that for every tonne of municipal solid waste processed at an EfW facility, the release of approximately one tonne of carbon dioxide equivalent emissions into the atmosphere is prevented due to the avoidance of methane generation at landfills. In total, Covanta’s net greenhouse gas emissions are a negative 20 million tons annually as they actually reduce the amount of emissions that would otherwise have escaped into the atmosphere.

Assuming we used EfW in Australia on our 24.9 million tonnes of landfill waste, we could cut our aggregate emissions by nearly 25 million tonnes or, said differently, reduce our national emissions by 4.6%. Furthermore, since EfW can provide baseload power, if that energy displaced our dirtiest coal-fired generators, we would further reduce our emissions and accelerate our dependence off coal.

Covanta is in a very strong financial position having just raised its quarterly dividend by 39% to provide an annual yield of 4.8%. It also confirmed its 2014 operating profit guidance of between US$470-500 million.

3. Darling Ingredients (market capitalisation US$3.2 billion)

After a series of large acquisitions, Darling has emerged as a world leader in bio-nutrient transformation. Essentially, Darling collects the inedible and waste products from abattoirs, bakeries and restaurants and converts them into food, feed and fuel. One of Darling’s most notable achievements is its Diamond Green Diesel facility that converts animal fats and used cooking oils oil into renewable diesel. The facility can produce 137 million gallons of diesel a year and is profitable without subsidies.  Output from this one facility equates to about 4% of Australia’s total demand for diesel. Darling also operates facilities in the Netherlands that safely disposes of inedible waste products which are converted into enough renewable energy to power 40,000 Dutch households each year. It also operates another facility in the Netherlands that converts animal fat and manure into renewable energy for its own self consumption and feeds power back onto the grid during off-peak hours. Darling has consistently generated robust cash flows giving it a strong financial core.

Urban mining is almost an inexhaustible source of raw materials. It closes the loop in terms of production, consumption and disposal because the end just leads back to the beginning. In a world where natural resource grades are falling and becoming more challenging to extract, it just makes sense to make better use of what we have than to further deplete our limited resources.

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We highlight nine reasons for this imbalance and suggest some of these factors are secular as opposed to normal cyclicality.

Charts 1 (left)  and 2 

Reason number 1.

Global production is not coming off-line fast enough. As is the case in Australia where approximately 40% of all seaborne coal is unprofitable, producers are forced to keep selling at a loss in order to fulfil previous shipping commitments. This is an unfortunate position for producers but will ultimately correct itself once they run out of money or demand picks up

Reason number 2.

Japan has ramped up consumption (which is actually supportive of prices) but this is only transitional demand until it restarts more nuclear power plants and builds out the 65 terawatts of solar they have approved over the past two years – incidentally this is greater than Australia’s total installed capacity of all types of power.

Reason number 3.

Ending a multi-generational trend, electricity consumption in the developed world has either stopped growing or is in outright decline. The weak global economy has undoubtedly reduced power consumption but some of the demand destruction is also the result of increased energy efficiency, increased distributed generation and behavioural changes.

Reason number 4.

Domestic coal is not so welcome at home anymore. This is best seen in the US where in the past 10 years, they have gone from exporting approximately 20 million tonnes to about 55 million tonnes at the end of 2013. Tightening legislation required existing power plants to upgrade their emission equipment with some owners simply electing to close the facility as the upgrade was too expensive. With the latest US Environmental Protection Agency (EPA) rules on mercury becoming enforceable on March 2015, the next major round of closures will further destroy coal demand.  This coal is finding its way into the international coal markets further expanding the gap between supply and demand.

Reason number 5.

The EPA has also just released legislation targeting the reduction of carbon emissions from existing power stations. Featuring heavily in its “building block” compliance approach is coal to natural gas switching. With domestic natural gas prices so low, it is expected this will result in another round of accelerated closures of non-compliant coal-fired power plants. The legislation is also expected to essentially prevent the construction of any new coal-fired plants in the US. This should push even more coal into the international markets.

Reason number 6.

For its next decadal goal, the EU has targeted a 40% reduction in greenhouse gas emissions from 1990 levels by 2030. A cut of this size will naturally force out the highest emitters or at the minimum prevent their growth. Amongst the highest emitting fossil fuels, coal will continue to be friendless in Europe.

Reason number 7.

A more punitive price on carbon will make the EU’s goal more easily achievable. At this time, carbon prices have been distorted by unintended policy decisions but in time it is expected the “right” structure will be found. When this happens, we expect the cost of coal pollution will dramatically increase the cost of coal-fired electricity and allow other, low emission technologies to better compete.

Reason number 8.

India’s new Prime Minister Narendra Modi is very much pro-solar having strongly supported renewable energy when he was Chief Minister of Gujarat. Calling for solar power to bring electricity to 400 million people is ambitious without equal. This goal tacitly recognises that India has failed to bring its people out of energy poverty using conventional methods. Building a new grid that has distributed generation at its core is a unique opportunity for this country as they should be able to avoid some of the of legacy issues faced by the developed world as they incorporate greater amounts of renewable energy.

Reason number 9.

China announced that it would ban coal-fired power from Beijing by 2020. While some market commentators have highlighted that coal consumption in China is so strong that this amounts to a token gesture, we suggest that China has a long history of experimentation before making up its mind. It is more instructive that China is taking such extraordinary steps to deal with air pollution that high emitters should heed the warnings coming from the government. Ordinary Chinese citizens are fed up with the pollution and coal is an obvious target for their frustrations. Given that China is also experimenting with carbon pricing, are the world’s biggest producers of solar power (and a close second or third in wind) and have made pollution abatement a priority, we might be seeing the beginnings of a major structural shift in China’s generation mix.

Coal faces many secular challenges as end markets are fundamentally changing the way they regulate and consume coal. Its position as the cheapest form of power generation is insufficient to offset the growing acceptance that price is not the only deciding factor. Coal prices will continue to face downward pressure because clean air today and a more sustainable tomorrow are worth more than all the coal from Newcastle.

By Nathan Lim CFA, Australian Ethical Investment 

The post Why coal is struggling (and will continue to do so) appeared first on AdviserVoice.

“I am delighted to move Mason up to full control of the Larger Companies Trust. He has become an invaluable team member at Australian Ethical over his 2+ years with us and is well regarded as an analyst. I have no doubt he has the necessary skills required to manage the Trust. His dedication and passion for investing is obvious for all to see,” said David Macri, CIO, Australian Ethical.

Prior to joining Australian Ethical Mason spent three years at ING Investment Management as a senior equity analyst. His career has also included time at ABN Amro and AMP Capital Investors. He is a CFA charter holder.

Mason replaces CIO David Macri as PM of the Trust to allow David more time to focus on strategic development of the current business and its offerings, as well as concentrating on managing the team and the overall investment process for managed funds and Australian Ethical’s superannuation fund.

The post Australian Ethical appoints Mason Willoughby-Thomas CFA as portfolio manager for the $277mn Australian Ethical Larger Companies Trust appeared first on AdviserVoice.

Nathan Lim

“Four cities, five days, 14 companies: we made the most of our trip to China and it confirmed our concerns and reaffirmed our decision to downgrade our economic assessment for the country.

“We also picked up several key insights into China’s development,” said Nathan Lim who runs the international equities fund.

China has settled into a lower gear

We were able to conclude that the slowdown in China has already happened and it appears the economy has settled into a lower gear.  Amongst the weakest sectors right now are steel, coal and chemical refining. The strongest include automobile manufacturing, shipyards and the logistics sector. In a broader sense, the weaker companies are those with a mix of customers leaning more towards the government or construction. There is a general view that the second half of 2014 will be roughly flat or only modestly higher than the first half as there does not seem to be another major stimulus program on the horizon. A near term risk we see are reports of broad inventory destocking. Running warehouses so thinly can have a chilling effect on sentiment as it represents a lack of confidence. We worry that excessive pessimism could be a self-fulfilling prophecy.

Monolithic stimulus programs are a thing of the past

The Chinese government has recognised that its previous rounds of stimulus were excessive and lead to massive misallocations of capital that has resulted in excess capacity in numerous industries. As one local manager put it “China is no longer building ghost cities”. The lessons learned from these prior experiments means stimulus will be far more directed and, at this time, is going into rail, offshore drilling, renewable energy and anything to do with pollution abatement.

China is redefining its economic playbook to be less dependent on fixed asset investment. It is trying to transition to an economy that is more balanced between investments and domestic consumption while simultaneously dealing with the legacy of unproductive capacity and their attached loans. Balancing the need for short term growth while allowing the excesses to wash out of the system will take time and constant vigilance, but at this time the authorities seem to be doing a good job.

Lean manufacturing has arrived in China

In those meetings where we had a chance to visit the factory floor, it was insightful to see lean manufacturing being rolled out. China may have lost its low wage advantage but its move into advanced manufacturing will be a wake-up call for all European and US manufacturers and their workers. In some factories it was reported that the products being made in China exceeded the quality standards overseas and were amongst the most efficient factories anywhere (a US multinational with 100 manufacturing facilities globally said of the five that had achieved silver certification, three were in China!). The move to lean manufacturing is seeing a dramatic impact on productivity as Chinese divisions of multinationals are making the investment into advanced equipment and bringing even their most sophisticated components and products into the country. Granted that implementation had clearly achieved varying levels of success, it demonstrates yet again the competitive forces emerging from this country.

The corruption crackdown is real

The corruption crackdown is real and will have a long lasting impact on doing business in China. Everything from the way government tenders are awarded to ensuring pollution regulations are enforced has taken a massive step forward since the appointment of Premier Li Keqiang. In the short term, this has had a chilling impact on the economy as government related economic activity slowed down due to arrests and officials taking excessive care; however, as tendering activity has resumed we heard from two companies who won tenders despite not being the cheapest bid for the first time ever because their solution better matched the requirements. Merit based competition will favour foreign multinationals as they have a generational lead on salesmanship. The typical local competitor competes almost exclusively on price and when faced with annual national wage inflation of between 5-10%, they will struggle to maintain margins.

People are fed up with the pollution

It is no exaggeration that the pollution in China is bad. The air, soil and water is under such stress that we could finally be at that point the US and UK found themselves following the Cuyahoga River fires and London ‘pea soup’ disaster in the 1950s that a generation finally takes responsibility for the environment.

While pollution it is being addressed, a concern we have is the rate of improvement is insufficient to offset public unrest as even ‘clear’ days with PM readings in the low triple digits is still well above the World Health Organization’s recommended level of 25. Enforcement of industrial discharge standards and waste disposal is an area we hope will benefit from the government’s crackdown on corruption.

Conclusion – China looking more closely at itself and its peoples’ need

“Reflecting back on our trip, China continues to grow as an economic force but its new found focus on human capital.

Looking to its people’s needs/abilities will surely be its most powerful move yet because just imagine what its populous will achieve when they do not have to fight through choking smog and corrupt officials to earn a living,” said Mr Lim.

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Australian Ethical outlines its latest investment strategy.

Australian Ethical’s Smaller Companies Trust has participated in the frenzy of recent IPO activity on the ASX.

While AE fund manager, Andy Gracey, sees some quality he is also wary of ‘opportunistic’ IPO’s as investment bankers and vendors look to take advantage of the healthy current investor appetite.

“Individual investors need to assess some of the assumptions included in any forward looking forecasts and carefully compare these against listed peers.

It is also worth considering the motives behind the IPO.

“We prefer companies that are listing for strategic and growth considerations and are wary of venders listing for pure financial considerations. We have ignored many IPOs because the future earnings projections appear overly ambitious.

“We are looking to cornerstone drug development company Innate Immunotherapeutics,” said Andy Gracey, portfolio manager, Australian Ethical.  The company (Innate) is mid-stage in clinical development of a multiple sclerosis therapy which has already shown promising early stage results in secondary progressive MS patients.

“We have also invested in Sealink Travel Group which is a tourism and ferry business, operating under the brands of Captain Cook Cruises and Sealink.

“The fund participated in the renewable energy IPO of Meridian Energy IPO, while buying hydro and geothermal generator and energy retailer Mighty River soon after it listed, said Mr Gracey”.

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Commenting on the result, Phil Vernon, Managing Director of Australian Ethical said, “We have been working hard over the past few years to get the business on a sound commercial footing by improving our products, making our fees more competitive and reducing our costs. The business is now well placed to benefit from any uplift in equity markets.”

Revenues have been positively impacted by improvements in equity markets but have also absorbed numerous fee reductions. Expenses were positively impacted by a reduction in fixed staff costs although these were partly offset by increased variable outsourced provider costs.

“Our operational efficiency has increased significantly over the past few years. Investments in new systems and improvements in processes have allowed us to reduce our staff numbers from 46 to 34. We are also experiencing near record funds under management despite equity markets still being significantly lower than their peak” said Vernon.

“Greater brand awareness and further improvement in client acquisition and conversion processes have also led to record new clients taken on in January and February this year which is a positive sign for the future.”

The post Australian Ethical announces profit increase appeared first on AdviserVoice.