This week we would like to offer our thoughts on certain megathemes that are impacting investment markets. Firstly, credit where it is due, this is a topic inspired by an oped in the AFR by James Thomson who summarises what he sees the recent bid by Cannon-Brookes for AGL represents. He categorizes the bid as representing three broad megathemes: 1) Energy Transition; 2) Private Capital; and 3) The Billionaire Activist. While we broadly agree with this categorisation, we would like to give our take on them and add in a final component that we feel is missing: the politicisation of everything.
Context: On Saturday Mike Cannon-Brookes, co-founder/co-CEO of Atlassian and Australia’s third richest person, launched an $8bn bid with Canadian company Brookfield (who will pop up again later) to buy AGL (AGL.ASX). The plan would be to shut all remaining coal plants by 2030 and spend $20bn replacing them with renewable energy and batteries. AGL’s board has rejected the offer, representing a 4.7% premium to their Friday closing price, saying that the consortium would have to pay a significantly higher premium to gain control. This is to say nothing of the feasibility of the 2030 timeline; AGL’s board and Scott Morrison, amongst others, saying that it is wildly unrealistic while the other side is adamant that it is perfectly reasonable with the resources and right experience (Brookfield’s in particular) behind it.
Thomson's original article: 'Three megatrends collide in Cannon-Brookes, Brookfield’s AGL bid'
With that, on to our megathemes.
1) Energy Transition
Many of you may be aware of our thoughts in this sphere given some of our previous pieces, especially in relation to oil and nuclear energy. Mr Thomson posits that the pace is accelerating rapidly, a pace at which policy makers are increasingly caught by surprise. We, however, have a different angle which is that this may just be more intentional than previously thought. AGL had previously announced the closing down of her coal fired stations and, despite the rhetoric from the government around the implications for power prices and the noise made, we are cynical enough to think that this might be just that, rhetoric. After all, it was a Liberal government (under Turnbull at the time) that signed (granted, non-binding) the Paris Accords, committing to a target reduction in emissions of 26-28% on 2005 levels by 2030. This showcased at least a broad willingness to consider targeting net zero emissions. At the end of the day, the transition is happening. The issue is currently one of the timeline.
We find it hard to believe that there is such little financial literacy amongst policy makers to understand that this places immense risks on any new financing for traditional fossil fuels projects. It raises the question of stranded assets, front and centre. After all, what rational banker would underwrite large capex projects with decades-long payoffs if the risk is that there may not be a market at the end of that time horizon? This is why the yields on debt for coal or oil producers remains egregious. Newcastle Coal Infrastructure Group’s (NCIG) shorter-dated 2031, for example, comes through at a coupon of 12.50% p.a.; low interest rates anyone?
In fact, if it were not for the easy money policy from the Fed over the decade plus since the GFC, much of the shale boom that made the US the largest producer on the planet would not have been possible. Assuming that is about to change, the implications are tremendous for high cost producers and US production broadly. What we feel has been lagging is at best a lack of forward thinking and at worst a blatant disregard for the transition period. Economies dont transition overnight. Our base case is peak oil and upward energy costs either way, which makes the economics of renewables easier to swallow.
2) Private Capital
We have seen an increasing amount of capital flow towards the private side of the equation. And little wonder. With yields negative (and likely to stay there in real terms), institutions are forced to find bond proxies. This is why we see tremendous appetite for utilities and infrastructure from private players. For the more cynical, illiquidity is precisely what makes them so attractive. Much easier to massage the numbers and even out volatility using private markets than it is in public. We refer here to asset revaluations and, in a world of heightened volatility in equity markets, we will see this trend grow. Especially so given an aging demographic and surplus savings in the form of superannuation and pension schemes.
Sydney Airport and AusNet - a takeover offer from a consortium (including Sunsuper and three Canadian pension funds) led by the aforementioned Canadian outfit Brookfield being approved a few weeks ago - are the first of what should be many to come over the next few years. Looking globally, pension funds will have nominal targets of 7% on average in order to keep up with liabilities. With financial repression (i.e. official rates staying below CPI) very likely on the cards (closer than many may think), we see an even greater incentive for institutional players to show a preference for private markets.
Infrastructure and utilities might be worth a look.
3) The Billionaire Activist
Not since the Gilded Age have we seen income and wealth inequality reach present levels. It is precisely this confluence of factors that enables and emboldens a new class of billionaires to be increasingly active in their investments. Mr. Thomson points to Twiggy Forrest and Mike Cannon-Brookes as his examples, but think for a moment about the political front. The amount of time and money spent Stateside on fund raising for election cycles - via PACs (Political Action Committees) or otherwise - or the sheer ratio of Wall Street lobbyists to Congressmen and women; those within these financial services firms contributing US $2bn to campaigns/lobbying in the 2016 Presidential cycle, US $2.9bn for 2020 (that’s about $4m a day!). The Koch brothers of Koch Industries fame are another prime example, activism in public markets is only one aspect of this.
What we feel is oft forgotten is that, despite the pushback from the more traditional central banker, QE has potentially given this trend further impetus. Valuations of tech giants and eyewatering multiples has ended up creating and exacerbating income income inequality not seen across most of the Western world since the late 1800s. It has arguably never been more visible. The Covid-19 era fiscal and monetary policies, for example, has allowed Australian billionaires to almost double their wealth.
Why does this matter to the investor?
This new class of billionaires will continue to have a disproportionate impact (more so than historically) upon both the policy environment and the investment landscape. This newer generation of billionaires clearly has no issue using their wealth outside the political sphere to advocate and/or force change. The more cynical view is that it is less to do with climate activism and more to do with the fact that there might now be outsized returns available in the green energy industry over the short to medium term. That is to say, the green transition is happening, the global renewable energy market was already valued at $881.7bn in 2020 (Source: Allied Market Research), and we are near an inflection point in terms of both technology and large scale adoption. Is this particular bid centred on Cannon-Brookes getting in early on a lucrative investment or climate activism?
Our guess at the reality? Two birds with one stone for Mike (he does have form on the climate change issue, to be fair).
4) The Politicisation of Everything
The recent price action around the ongoing Russian debacle is rather telling. Unfortunately, we have grown up in a world where markets are supposed to be forward looking instruments and efficient. Despite the tremendous amounts of work done by father of the efficient-market hypothesis Eugene Fama, markets are made up of people. People aren’t always rational. Take the US’ stance on Russia preparing for an invasion of Ukraine despite very little evidence provided by the Biden administration. The volatility that we saw in the market digesting this is, we would argue, in no small part that of some traders (even on institutional desks) disbelieving an administration that does not align with their views while the other side does.
The debate on climate change and the energy transition is one we feel should be a purely economic question. But somehow it has ostensibly become a political debate between left and right, something we see as a megatheme the world over. The level of polarisation Stateside is at levels not seen since the Civil War. The debates across most of the developed world are similar, no doubt helped along by strongmen like Tsar Putin and Emperor Xi in their quest to dismantle a West they blame front and centre for their nations’ historic declines. Putin for the chaos after the fall of the wall (which arguably paved the way for his rise) and Xi restablishing Chinese “national pride” after the last 200-odd years of insults from the Opium Wars through to WWII and beyond.
But why does this matter to the investor? Simple, too often now we are seeing policy decisions made along broad partisan lines as opposed to being genuinely considered on the nuances/ economics of the matter. As the mainstream political spectrum has (seemingly) become wider and wider, compromise has become harder and harder. The Green Transition a perfect example; the further left you go on the spectrum, the more consideration given to immediacy and less consideration given to the economic impact (both the cost to consumers, how it will be achieved, and broader) while the further right you go it reverses. It is a variable that has become increasingly difficult to account for.
Markets & Commentary
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