Sidekick Money · Market Pulse - 20th Feb 2023

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Welcome to this week’s Market Pulse. In this week’s edition we have:

Make America Green (Again)
Price squeezed London renters giving up on the city.
Energy Security vs Climate Change. Big oil wins

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It’s important to note that the content of this Market Pulse (including the answers to any questions) is based on current public information which we consider to be reliable and accurate. It represents Sidekick’s view only and does not represent investment advice - investors should not take decisions to trade based on this information.

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1) Make America Green (Again)

The US has been in a few races in its time. We had the space race and the nuclear arms race. Now, they’re in another race. The race to net-zero.

Less than 3 years ago President Donald Trump started aggressively rolling back the Obama administration's climate policies. Under his watch, the US ditched the historic 2015 Paris climate agreement. But a lot has changed since then. 6 months ago, President Joe Biden signed into law 3 new bills, including the Inflation Reduction Act. These could be the most important laws passed in the US in decades. With the three new laws, President Biden is hoping that by tying the much needed transition to a green economy to national security and American reindustrialisation he will get Republican support.

The new laws were designed to reshore American manufacturing, boost American jobs, and clean up the American energy supply. These laws will make $2trn in spending available over the next 10 years[1]. According to Credit Suisse the uncapped nature of tax credits and all related private investment could add an additional $1trn[2]. This equates to a spending boost of more than 10% of US GDP over the next decade.

To put the sheer scale of the planned spending into some perspective, between 1957, when the Russians launched Sputnik, till 1969, when the Americans finally landed on the moon, the federal government spent around $30bn on the space race, or about 4% of 1965 GDP[3][4]. The expected investment into green tech, American infrastructure and manufacturing is expected to be more than twice that.

Not everyone is happy that the US government is opening its wallet however. European politicians have expressed concern that they can’t compete with the sheer scale of the US subsidies [5]. They fear European efforts to build out green technology supply chains will suffer as a result. Their fears are not unfounded. European companies are already rushing across the Atlantic to get in on the action.

But the US won’t be able to go at it alone. At least not initially. China is currently the global leader in the manufacturing of solar panels, off-shore wind blades and batteries. They also process the majority of key raw materials needed for a clean energy transition, like lithium and copper. These are all things the US will need to wean itself off fossil fuels.

The Biden administration wants to cut 2030 US emissions by 50% compared to 2005 levels[6]. Climate models suggest that they could achieve a 40% reduction but they face some hurdles[7]. One of the biggest challenges is getting construction permits. To get renewable electricity from windy or sunny states to where it is needed you need transmission lines. Getting permits for lines that cross multiple states are difficult and can take more than 10 years[8]. Paradoxically, environmentalists are now potentially obstructing a transition to net-zero. If the US doesn't make getting construction permits faster and easier, the Inflation Reduction Act might not achieve the hoped for reduction in emissions.

Currently the US gets roughly 20% of its power from renewables, compared to 30% in China and more than 40% in the UK. If the Biden administration gets its way, the US will set the pace in the transition to net-zero over the coming decade. This is a race well worth winning.

2) Price squeezed London renters giving up on the City

Average house prices in London increased 6.7% during 2022 but, thanks to a lack of supply for rental properties and rising external demand, rents are rising even faster[9]. This has the potential to fundamentally change the mix and shape of the city.

During 2022, the average monthly rent paid in London increased by 9.1% to £2,100, outpacing the gains in house prices[10]. This is almost double what the rest of Britain has to pay on rent[11]. Median full-time earnings in London, at just under £42,000, is nowhere near double the UK median of £33,000. London is simply becoming unaffordable[12].

Covid prompted a shift in homeowners leaving the city as they sought more space. Now, it’s renters that are leaving. According to a report from Hamptons International, of all the people that decided to move house in London during 2022, 40% decided to leave the city. This is the largest exodus of London renters in a decade. [13]

A rental market supply and demand mismatch is simply pricing many out of the market.

According to Rightmove, the supply of two-bedroom properties in London is down 35%[14]. Landlords usually have interest only mortgages on their properties. This makes them very sensitive to rising interest rates. When your fixed mortgage rate rises above the rental yield you start losing money fast. Fixed mortgage rates for buy-to-let landlords have jumped from 3% to more than 6% thanks to rate hikes by the Bank of England[15]. Add to this the removal of some tax perks landlords enjoyed in previous years and higher stamp duty, then it's no wonder they collectively sold 35,000 more properties than they bought in 2022[16].

Compounding the demand supply mismatch is strong external demand for London rental properties (+59% compared to 2019) [17]. Demand is driven by a few factors including ‘regretful’ returners missing the bright city lights and house buyers being priced out of the market and moving into the rental sector.

There is little evidence that the situation is improving. As long as high interest rates put house prices at risk, the supply of rental properties will likely remain under pressure as landlords sell more buy-to-let properties. Living in London is becoming increasingly unaffordable for many people who might be forced to turn to commuter towns for something more affordable.

3) Energy Security vs Climate Change. Big oil wins

The Oil Big 5 (ExxonMobil, Chevron, Shell, BP and TotalEnergies) are raking in cash thanks to the war in Ukraine. 2022 has been one of their most profitable years ever. And 2023 could be just as good[18].

While oil companies are swimming in cash, many citizens are facing energy poverty. This has led to calls for windfall taxes on oil companies. When the EU announced new legislation for a windfall tax, ExxonMobil sued in response. President Joe Biden remarked that “Oil companies’ record profits today are not because they are doing something new or innovative. Their profits are a windfall of war”[19].

Ok, so oil companies are making a lot of money. But, on its own, that’s not necessarily a problem - it’s about what they intend to do with it…. So far they are increasing dividends and buying back their own shares. There has been some backlash against this but we feel it’s potentially distracting attention from a more important issue.

Instead of using the windfall profits to speed up their transition to net zero they are also increasing spending on developing new oil and gas fields. ExxonMobil announced a $10bn investment in an off-shore project in Guyana that will produce more than 250,000 barrels of oil per day[20]. BP announced they are scaling back their climate targets, now aiming to cut carbon emissions by 20-30% by 2030. Their previous target was 35%-40%[21]. New oil and gas projects and less ambitious emissions targets won’t make reaching Paris Agreement climate targets any easier.

According to McKinsey, the oil and gas industry is directly and indirectly responsible for more than 40% of global emissions[22]. They have a big role to play if we want to stand any realistic chance of mitigating the worst outcomes of climate change. The International Energy Agency warned back in 2021 that there can be no new oil & gas projects if we want to limit global warming to 1.5% by 2050[23]. The IPCC put out another stark climate warning in April 2022[24]. Since then, at least 7 new oil & gas projects have been announced[25].

But it is not that simple. Europe faces a serious problem. They have to increase the supply of fossil fuels in the short term to ensure energy security. They can no longer rely on Russia. But this means they are potentially putting longer-term global climate goals at risk. Proverbially stuck between a cold and warm place.

Once new oil and gas fields are developed it seems unlikely they won’t be pumped dry. This is the insidious thing about climate change. The climate doesn’t care where you pump it out of the ground or where you burn it. While developed nations might switch to renewable energy and reach net-zero by 2050, regions like Africa will need a lot of cheap energy to ensure a good standard of living for their rapidly rising populations. They will buy all the cheap energy they can.

We all need Big Oil in the short term but we also need them to carefully balance our short-term needs with humanity’s longer term climate goals. Large investments into new oil and gas projects is a climate bell not easily unrung.