Articles - 2013 Outlook: A year in global climate change

 Simon Webber and Giles Money, Portfolio Managers for the Global Climate Change strategy, Schroders

 "2012 was another year of extreme natural weather. However, international policy progress to limit climate change has been meagre at best and as a result we believe adaptation is a rising theme. Energy efficiency will also continue to be a huge growth area as, although the global economy will continue to normalise, economic conditions will remain tough. In the meantime, business confidence to invest in climate change solutions – both for mitigation and adaptation – will gather pace.

 "In the US presidential election campaign, climate change was, frustratingly, only notable by its absence. Yet, ironically, Hurricane Sandy – likely to rank among the eight costliest US storms – struck the East coast just days ahead of the election, and immediately led to a much higher level of debate about the risks of leaving climate change unabated.

 "In 2012 as with the previous year, climate change took a back seat to the global economy in terms of media coverage as the European sovereign debt crisis grabbed the headlines. There was no pause, though, in the evidence for climate change:
 • The number of weather-related disasters has quintupled over the last three decades: Munich Re identified global warming as one of the main reasons
 • A NASA study highlighted that extreme heat waves had increased in frequency by more than 50 times in the last 30 years. Again, climate change was cited as the only plausible explanation
 • Average Arctic temperatures in 2011 were over 2.2oC above average temperatures during 1951-1980. This is the warmest 12 months on record in the Arctic and scientists believe the region is moving closer to climatic tipping points that could fundamentally alter its ecological state.

 "These are just a very small number of examples. Ultimately, the average planetary global temperature has increased by 0.8oC since pre-industrial temperatures and the models all indicate that this will continue to rise. At the same time, evidence linking climate change and extreme weather is getting stronger. As the global economy starts to normalise in 2013 and the effects of climate change become ever more evident, we expect attention to turn again to climate change."

 From mitigation to adaptation

 "2012 saw a marked change in expectations. With international progress on global emission reductions falling so woefully short, it is increasingly accepted that the opportunity to limit warming to +2oC (an increase that climate scientists label as dangerous) by the end of this century is rapidly disappearing. We therefore expect planning for adaptation to climate change to be a growing theme in the next 2-3 years for both governments and companies. You only have to look at the Thai floods and their impact on very tight supply chains (in this case hard disk drives) to see why this is becoming such a focus area. Governments feel the same about food supply and other key necessities."

 "As such the preparedness and resilience of individual businesses will become an important component of profitability and equity valuation in the future. Resilience is hard to value in a financial model, yet it clearly has value. Companies with the best understanding of the implications of climate change on their business will become synonymous with quality."

 Outlook for our five climate change themes

 "With the above in mind the outlooks for our five climate change themes are below:

 Energy efficiency

 "As we forecast in 2011, energy efficiency was a strong and constant theme in 2012, and we foresee more of the same in 2013. Structural growth in energy efficiency is being driven by the tough macro conditions and deleveraging governments. This environment favours energy efficiency investments because they offer fast pay-back times and do not require subsidy. With austerity measures in much of the developed world this year, this is likely to continue. 

 "For example, we expect energy efficiency housing to perform well in 2013. Consumer awareness has moved to the point where it is possible to price in to the value of the home the investment to achieve low energy and integrated renewable generation, as well as driving brand and product awareness. The savings to consumers are significant and some of the leading housing builders are taking market share. As the US housing sector starts to normalise in 2013, this theme should pick up further.

 "A whole range of related construction retrofit / renovation efficiency related products, including insulation, heat pumps, lighting and high efficiency glazing are also set to support the home improvement sector growth profile globally. In particular, 2013 could well be the year that LED lighting goes mainstream in the commercial and residential lighting industries. An $8bn LED market today compares to a global lighting market of $119bn. In ten years time we estimate LEDs should represent over half the entire lighting market.

 Sustainable Transport

 "In 2011, we forecast that emissions regulations would push the sustainable transport industry forward. This indeed was the case and we expect tighter regulation to continue to drive this theme forward in 2013.

 "One area we expect to grow as a result of regulation is turbocharging which is the most cost efficient way to lower your carbon footprint today. In 2011, 9.5% of US vehicles were equipped with turbochargers – which make the engine more efficient – up from only 2% in 2008. By 2017 it should be almost a quarter."

 Clean energy

 "In the last five years the world has installed more wind and solar power than the entire generation capacity of Germany. As global energy prices continue to gradually rise, the affordability and competitiveness of renewable energy is consistently improving.

 "However, a proliferation of companies in the sector has lead to over-supply, falling margins, and low returns on capital for most. Consequently share price returns over the last two years have been awful for both industries.

 "We could, though, be close to an inflection point. Modest end-market growth, industry consolidation and rock bottom valuations represent the ingredients for a new cycle of investment returns for patient investors, as capital leaves the sector to chase higher returns elsewhere. This is one area we expect to be increasing our exposure over the next 1-2 years, from very low levels today."

 Environmental resources

 "The global population this year exceeded seven billion. As the world continues to grow in number, and rising income in emerging markets prompt more resource-intensive dietary habits, demand for agricultural produce will continue to increase. Added to which, more volatile weather patterns will cause supply disruptions, putting even more pressure on the world’s resources."

 "This summer’s drought in the US – the worst since the 1950s – will only serve to increase the debate about food and energy and how they are impacted by climate change. The drought sent corn and soybean prices soaring. While prices have now stabilised, they remain elevated highlighting the extent to which global food chains can be endangered by climate change-related natural events."

 "We expect demand for agricultural productivity solutions to see structural growth, with machinery, precision technology solutions, seeds technologies and fertilisers to see particularly strong demand."

 Low-carbon fossil fuels

 "Natural gas is a crucial component of the transition to a low-carbon environment. Since 2009, however, North American gas prices relative to global LNG prices (which are usually priced off crude oil) have widened and widened to extraordinary levels. We believe, however, that US gas markets are now entering a new phase of structural growth as very low US gas prices lead to industrial demand and investment to correct the dislocation."

 "In fact with the recent LNG impact report from the US department of energy making it clear that significant volumes of gas could be exported and simultaneously create positive economic growth this further highlights that 2012 is likely to be the 10 year low in US natural gas prices."

 "Recent M&A activity has demonstrated that the intrinsic long-term value of these types of gas assets is considerably above the current market value. We are hopeful that – absent another record warm winter – US gas prices can continue the normalisation process towards a new $4-6 range supported by strong demand growth, and capped by plentiful economic supply."