Letters

 

June 3rd, 2021

Good Afternoon,

We recently completed our second quarter of investing (Conduit launched during Q4 2020). The portfolio returned +4%, compared to the index of +6%. At quarter end, our returns since inception are +24% and YTD +18% (unaudited). This compares favourably to the MSCI World Index (AUD) of +17% & +9.3% respectively.  Over this period we have held approximately 60% cash, and remain disciplined until opportunities arise. All investors can view their holdings in real time and have daily liquidity. Out of respect to investors, we will not detail specific investments.

Hug it Out

The tree hugging university student and the climate change sceptic do not see eye to eye. Like any great tussle, the debate between the catastrophists and the science sceptics is thriving as many “expert” commentators weigh in. Despite this, the outcome may be unclear for decades, or more. We have a greater degree of certainty around the trajectory of Government, corporate and consumer activity. This is our focus. Let the games begin!

Our analysis suggests that the green revolution is a $50 trillion opportunity over the next 15-20 years.  For context, this is 3x larger than the expansion of central bank balance sheets since 2008 from the US, EU, Japan & the UK. We have been told “don’t fight the Fed” – is this a case of “don’t fight the planet” ? The range of probabilities and scenarios are vast, with environmental, geopolitical, strategic and economic implications.

I’m gunna do this and I’m gunna do that:

Countries representing 65% of GDP and 55% of the population have a net zero emission target, or similar, that has been announced or legislated. A target is one thing, but execution is what matters. Will the current group of leaders implement change and set regions on a sustainable path? Or will future leaders unwind the momentum?

  • The US, China and the EU are aligned on climate for the first time. The key points:
    • Accelerate and incentivise investment in green projects & technologies
    • Increase the cost emitters of carbon have to pay
    • Potentially assess imports and exports on carbon footprint and tax accordingly
  • Whilst Europe is a champion advocating climate change, the execution of policy has been underwhelming. The majority of “funds committed” paint a rosier picture than what has and will eventuate. The devil is in the detail and the European Court of Auditors has criticised the EU for its lack of implementation.
  • The EU will announce key legislative proposals related to the EU green deal in July:
    • For example, it will be considered that all imports be subject to the same carbon requirements as products made within the EU. This may be a stroke of political genius and unleash FDI in Europe, or catalyse an exodus of industry akin to what we witnessed when China entered the WTO in 2003 and became the manufacturing hub of the world. Sectors of focus include cement, chemicals and steel
    • Might a European steel business become the most cost competitive in the coming years, as a carbon tax turns to a tailwind?
  • Green issues will be a significant part of the German and French elections in September 21’ and April 22’
    • Economic incentive – estimated 0.8 correlation with each euro spent on renewables and GDP growth
    • The Greens are leading the polls in Germany and a coalition is probable. The agenda will be to push the movement, as well as invest in technology and innovation. They have captured the younger voter.
    • The political balance is tight and depending on who wins what (Ministry of Finance & Economy are key), the approach to fiscal spending may result in a substantial contraction of GDP in 2022 and fail to offset a green stimulus.
  • Biden’s proposed green investment, focuses on renewable energy and catapulting certain industries. Despite the popularity from the electorate, the legislative process appears to be stalling
    • Republicans and select Democrats are suggesting plans should be scaled back. Executive orders are possible, but there is more work to do (despite crushing the election)
  • From a funding perspective, the US has ample room to tax corporates and climate may be the catalyst. 55% of companies have a tax rate <21% in the US, this is 3-5x higher than Germany, France and Japan
  • China accounts for 30% of emissions and 65% of growth over the past 20 years. China has made climate progress that is noteworthy and world leading
  • In all Chinese provinces except one, solar and wind prices are below or equal to coal, with associated tariffs.  Wind and solar prices have fallen 70% & 90% respectively since 2010. Is it any surprise given China builds two wind turbines every hour?
  • China plans to launch an emissions trading scheme this month

Corporate Leadership

Companies accounting for $14trn of sales have a net zero commitment. Oxford University found that 20% of the largest corporates are focused on reducing their impact.  Across industries, there are phenomenal opportunities

  • Corporates with green projects are at a material advantage when it comes to sourcing capital. There is a greater availability, at a lower cost (can lead to 15-20% margin improvement)
  • The European Banking Association is exploring a “Green Asset Ratio” for banks – which if enacted will translate to increased availability of credit for carbon friendly businesses
  • Demand for green bonds is growing at a multiple to non-green in Europe
  • Chinese banks are accelerating green loans. In some areas, the extra credit accounts for 6% of provincial GDP
  • Upgrades of buildings can reduce emissions by 50%. Next generation construction is a $300 billion opportunity in Europe alone
  • Job creation in green related sectors will outpace the oil & gas industry by 6x
  • 15 major US utilities have endorsed a national green energy approach in the past six weeks.
  • Companies that have adopted green strategies are typically being rewarded with higher valuation multiples by investors as a wave of money bets on the future

Industry example that will result in a green response:  

    • Bitcoin mining currently emits 40 million tonnes of carbon (on par with New Zealand’s footprint)
    • China is responsible for 70% of crypto mining and 5% of China’s emissions can be linked to bitcoin mining
    • Annualised revenues from “mining”  are approximately $5bln (driven by the cost of energy and GPU speed)
    • The gross profit margins in mining are “the highest cash on cash returns I have seen in my three decades in business”, an industry figure told us Yet, the second order effects are much greater and underappreciated
    • There is no carbon tax. A carbon tax of $50 (20% cheaper than Europe), on China production, would equate to $1.5bln in taxes, or 30% of revenues. This is 20x all carbon taxes collected today
    • Green Angle: Miners are looking outside of China to establish operations (currently China, Iran, Russia and Kazahkstan account for 90% of mining):
      • It is attractive to develop a renewable energy facility, that can be integrated with the grid and based on variable demand, also mine Bitcoin. The operator may also be eligible for carbon credits. This is no different from a traditional mining operation, such as a copper mine, with gold as a by-product, operating in a region with better infrastructure
    • As capital and industry moves to arbitrage across jurisdictions, what initially may have been an inflationary impulse flips to deflationary, as excess capacity for renewables, crypto mining and other supplies (such as semiconductors) takes off.

Separately, I am delighted to report that Conduit has recently appointed a dedicated blockchain and crypto analyst. We reported our concerns to investors ahead of the 40% capitulation on May 19th and are exploring both opportunities and risks that may materialise.

The Consumer of Tomorrow:

I launched Conduit Capital because Millennials & Gen-Z, who will represent 70% of the world’s population by 2030 and be the largest beneficiaries of an intergenerational wealth transfer, act differently to their parents, thus creating investment opportunities.

  • The green movement accelerated when Greta Thunberg became a phenomenon. Her followers (young and old) worship her and she shook up Davos. School curriculums are being changed so kids learn about recycling. In contrast, research suggests 70% of people over the age of 65 do not believe climate change is caused by humans
  • The Tik-Tok generation gains more “likes” on social media from doing the right thing and being sustainable, than what was occurring 15 years ago
  • Unilever’s sustainable brands are surging 20% faster than other products
  • Plant based products are the fastest growing in supermarkets. 25% of products launched in 2019 UK supermarkets were plant based
  • Ikea is redesigning 9,000 products to reduce emissions by 15%

Our ESG policy is aligned with this and we do not invest in fossil fuels, tobacco, gaming, defence or factory farming.

How do we monetise this?

  • The political fragmentation in Europe and the US, combined with market valuations representing a historical 95th percentile, has meant we have observed much of the aforementioned from the side-line, since we launched
  • However due to recent market volatility, I have increased our exposure to business models that are enablers and beneficiaries of the green revolution. For example, those that are long carbon credits and avoided those that are short. The carbon market is <1% of global GDP – this seems unsustainably low
  • Markets are implying no growth for select businesses in a few years. We have the counter view and argue this may be one of the fastest growing areas
  • Irrespective of political gyrations, the economics of being green are more compelling than not. The cost and availability of funding is much more advantageous and critically, consumers vote with their wallets

We are in a sound position to capitalise and unless the facts change, we won’t be fighting the planet.

What an exciting time to be alive!

Jack Dwyer

Founder

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