214. Why infrastructure is crucial in the transition to net zero

TRANSCRIPT: EPISODE 214
30 September 2022 (pre-recorded 26 September 2022)

Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.

[INTRODUCTION]

Sam Slator (SS):

I’m Sam Slator from FundCalibre, and today I’ve been joined by Rebecca Myatt who’s a portfolio manager on the Elite Rated [First Sentier] Global Listed Infrastructure fund, but also lead manager of the [First Sentier] Responsible Listed Infrastructure fund. Hi Rebecca, thanks for joining us this morning.

Rebecca Myatt (RM):

Thanks for having me.

(SS):

So, perhaps we could start on why investors should consider responsible listed infrastructure. Why does sustainability matter in this area?

(RM):

Yeah, so, responsible listed infrastructure is the marriage between listed infrastructure and socially responsible investing. It appeals to a broad group of investors who want a commitment towards environmental or social goals, as well as a financial risk-adjusted return.

Infrastructure assets are often characterised by their large, environmental footprints and social license to operate; this gives them scope to have significant impact, both on the planet and the people within it, and makes them ideal candidates for this type of investing.

(SS):

And you’ve chosen the UN sustainable development goals as a metric for this fund. Why did you choose those and not something else?

(RM):

Yes, so we like the UN Sustainable Development Goals because they acknowledge that achieving a sustainable future is a journey, and that every company has a role to play in getting us to that destination.

As well as environmental criteria, the SDGs also target social criteria. And these are particularly relevant for infrastructure assets, given that they provide essential services to a large number of people. We’ve definitely preferred this, than targeting a single metric. So, for example, a number of people seem to target a carbon number, but if you ask an infrastructure portfolio manager to lower the carbon, then they just wouldn’t invest in utilities and could have more oil pipelines in the portfolio, for example, but that’s probably not what you want from trying to lower the carbon, because clearly you’re trying to push for that energy transition.

Now, by focusing on Sustainable Development Goal no.7, which is affordable clean energy, and Sustainable Development Goal no.13, climate action, there’s a natural bias to owning utilities that can accelerate the build-out of renewables at the expense of things like coal generation. And we believe that this approach is much more relevant, because it delivers meaningful change.

(SS):

And you’ve mentioned carbon a bit there, how does net Zero fit into all of this?

(RM):

Well, net Zero will really only be achieved by a substantial investment in infrastructure assets. You know, if you think about the 2020s, we think we’re going to see a continued decarbonisation of the power generation sector. That’s been happening for the last decade. So, that’s going to be an acceleration in renewables, and further closure of coal plants.

When we get into that late 2020s, early 2030s, we’re going to be talking about electrification of the transportation sector. And really when we’re talking about that, you know, around 75% of the investment is actually in the transmission and distribution networks behind the charging station. So, if we are going to electrify transportation, then it’s really investing in the utilities that will get us there.

And then when we get to the late 2030s, early 2040s, we see technologies such as hydrogen, which will help us to decarbonise industry. So, when we’re talking about industry, we’re talking about how we think about gas. We’re talking about aviation and shipping and space heating. And really, it’s the utilities that are investing today, that will enable that hydrogen to be cost competitive in the 2040s, and to be used to decarbonise that industrial sector, which is by far the hardest to do. So, you can see from all of that, that in the pathway to get to net zero, it just requires significant investment in infrastructure, which leads to structural earnings growth drivers for these stocks.

(SS):

And what’s your view on engagement versus divestment? How do you think investors can actually help enforce positive change?

(RM):

Well, I think divestment just doesn’t work. You know, as equity analysts, we’re really trying to think forward. We’re trying to think about, how can a company change? And how can we be part of helping that company change and be on that journey? You know, just by saying, ‘Oh, this company is bad and we’re not going to invest in it,’ those shares just get traded in the market and someone else buys them, but there’s no ton of carbon that actually gets reduced through doing that divestment. So, you know, we think that by engaging with companies and by helping them to push forward in terms of their investments, we can really lead to positive change in the future.

(SS):

And there’s obviously a lot of disruption and volatility in the energy sector at the moment. How is that impacting some of the companies that you’re invested in?

(RM):

Yeah, so with the halting of Russian gas supplies to Europe, we’ve seen electricity prices increase tenfold to what is now an energy crisis. Customers are clearly struggling to pay their bills. We’ve seen a number of politicians intervene to find short-term solutions to ease prices. But really, there’s a lot more that needs to happen for us to become independent of Russian gas.

So, in the short term, we’ve seen politicians try to cap the gas price, cap the electricity price, find ways to reduce consumption, and then just doing outright windfall taxes. You know, we’ve seen a number of countries do their own things. So, there’s been no consistency between the countries either.

When we’re thinking about integrated utilities in Europe, we actually think that, in the short- term, the only way to solve this crisis is going to be by trying to get multiple different sources of gas from different countries, and also for everyone to be consuming less.

When we think longer-term, the majority of the way that we’re going to get there and get off Russian gas, is going to be by further investment in renewables, and in the networks behind the renewables. And also in LNG infrastructure, because we’re now going to be importing gas from places like the US.

So, I think we’re going to go through a time where it’s still going to be a lot of uncertainty, a lot of political intervention, and, from a portfolio perspective, we’re definitely tilting more towards the US utilities, where we see significant investment opportunities on a number of fronts.

You know, if you think in the US, around 28% of their energy is coming from renewable sources versus Europe at 38%. So, first of all, we’ve got this catch-up trade and then we’ve got an acceleration towards net Zero. And the inflation reduction act that was enacted not so long ago, is clearly supportive for the continued investment in both renewables, and also in energy storage and hydrogen.

(SS):

And obviously one of the knock-on consequences of this energy crisis has been, it’s been helping to push up inflation. How does listed infrastructure behave in a really high inflationary environment?

(RM):

Yeah, so we think around 70% of the investment universe has some form of inflation protection. Now, that can come in a few different ways. So, it can come in an explicit link to inflation through regulation or a concession agreement or contract. And that’s really where, say, a utility will earn a real return, and inflation will be a direct path through to the consumer with a lag.

The other way that we can pass through inflation is through pricing power. So, take the US freight railways, for example. They’ve been able to increase their prices because they’re in this duopolistic market structure, and they can basically pass through their operating costs, as well as protecting and enhancing their return.

So, you know, clearly when we’re in a really high inflation environment like today, this social license to operate really comes into play, and we’ve seen a number of customers trying to find innovative ways to smooth the effects of this high, inflationary environment to consumers, whilst remaining NPV neutral.

And that could be the extension of a concession for having a lower price impact today, or that could be a smoothing out of how they take inflation over a number of years. So, I think having that social license to operate is really important, when consumers are clearly struggling for the affordability of their energy bills.

(SS):

That was really interesting. Thank you very much.

(RM):

Thanks so much for having me.

(SS):

And if you’d like to find out more about the First Sentier Global Listed Infrastructure fund, please go to fundcalibre.com.

Please remember, we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at the time of listening. Elite Ratings are based on FundCalibre’s research methodology and are the opinion of FundCalibre’s research team only.