Each of the last three decades has been consecutively warmer than the previous: this was the conclusion of the Intergovernmental Panel on Climate Change’s fifth assessment report in September. What’s more, it said that the period 1983 to 2012 was probably the warmest in 1400 years. Whilst catastrophe levels were lower in 2013, which we should all be thankful for, the evidence is overwhelming that anthropogenic climate change is happening.
In 2013, as with the last couple of years, climate change took a back seat to the global economy in the public and political domain. This did not, though, stop many climate change-related investment themes strongly outperforming global markets.
We continue to find evidence that 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 for their business will become synonymous with quality.
With this backdrop in mind, we review the outlook for our five climate change themes.
We have consistently argued that technologies with the fastest payback would have the strongest chance in the tough economic backdrop experienced over the last few years. The challenge for investors as the environment improves will be to strike the appropriate balance between up-and-coming technologies that are hurtling down the cost curve and those that are already competitive.
We expect LED general lighting to grow significantly in 2014. Industry experts have the growth figure as high as 80% and we expect a compound annual growth rate in excess of 30% over the next few years. We believe that LED companies with strong management, attractive valuations and solid business models can expect considerable performance next year. In ten years’ time we estimate LEDs should represent over half the entire lighting market.
We also feel much more positive about the construction sector globally, but particularly in developed markets. This opens up opportunities for a whole range of efficiency-related products in construction retrofit and renovation, including insulation, heat pumps, lighting and high efficiency glazing.
Another major theme within energy efficiency is e-commerce. Whilst the relevance to climate change may not be immediately clear, we have proven that the significantly-lower carbon footprint of online retailers allows them far better pricing disruption. This will lead to significant and continuing share gains against traditional bricks-and-mortar retailers. We expect both significant growth and market share gains in 2014.
2013 was a year of significant growth in auto production. In the US and Japan, demand is back to pre-crisis levels and China now leads the world in terms of sales in a single region. Europe, however, is languishing significantly below its pre-crisis level and we would expect a modest recovery there next year.
One aspect that has been consistent is the improvement in fuel efficiency of vehicle sales. We have said for some time that emissions regulations would push the sustainable transport industry forward and this has indeed been the case. We expect tighter regulation to continue to drive this theme forward in 2014 and beyond.
One area we expect to grow in 2014 is the electric vehicle (EV) market (see figure 1). At the Guangzhou auto show in December there were 18 pure EVs on show from 12 vendors. In the EU alone there are plans for 9 million such cars on the roads by 2020. The equivalent estimate for 2013 was for under 100,000 cars for the US and Europe combined which highlights the growth potential.
Figure 1: Number of EV launches since 1997
Source: JPMorgan estimates
With modest end-market growth, industry consolidation and attractive valuations we believe this will be an interesting sector to watch this year, especially for companies with the strongest business models and managements.
Soft commodity prices suffered significant backwardation in 2013 as the US and Brazil produced big crops on the back of the 2012 drought that inflated prices to levels where more marginal land came into production. We continue to believe that productivity tools and technology will dominate farmer spend and that there is structural growth in capital investment in agriculture. However, as we suspected, 2013 was a normalising year for inventories and in the face of a strong rally elsewhere in the market, gains in this theme were harder to come by.
In last year’s outlook we forecast that 2012 would mark a ten-year low in US natural gas prices and that prices could normalise above $4 per thousand cubic feet (Mcf). Prices went on to rise over 15% on average in 2013 (with the post-winter seasonal trough over 60% higher) and the commodity traded as high as $4.50/Mcf in December 2013.A combination of factors were at play: a slow-down in drilling activity as a result of the previously weak prices; improved infrastructure takeaway in the key producing region of the Marcellus in the north-eastern US; and a cold winter, which has finally led to a draw-down of gas inventories to below the five-year average, after many months of excessive storage levels (see figure 2).
Figure 2: Working gas in underground storage compared with the five year maximum and minimum
Source: US Energy Information Administration
Consensus forecasts are for US natural gas to average between $3.50 and $4.50/mcf in 2014. We agree, although we suspect prices will reside at the upper end of this range.
On the positive side, new pipeline capacity continues to come on-stream for the Marcellus (the heartland of production growth) meaning that incremental gas will be able to reach South Louisiana, the Gulf Coast and the Midwest. Ongoing bottlenecks in Gulf Coast oil refining and continental pipeline capacity are leading to a steadying of onshore oil production levels and lower volumes of associated gas (which accounts for nearly one third of total supply). Both trends are supportive of gas pricing.
In the longer term, we expect the marginal driver of pricing strength to be US export capacity, which enables US operators to benefit from higher international prices. Four US export licences for Liquefied Natural Gas (LNG) have now been approved, and with more to come the US is expected to be a net exporter of gas by 2020. This international LNG market remains very attractive – it has been the fastest growing fossil fuel over the past decade, growing at 7% per annum since 2000. The market continues to be underpinned by growing Asian economies that are increasingly short of domestic supply.