Market Report February 2021
What Investors should know about Hydrogen
The potential of hydrogen as an energy source is gaining increasing interest. The potential may not be reached for another 20 years or so. However, the repercussions are likely to be felt within most long-term investors’ planning horizons, which is a solid reason to start thinking about the investment implications now.
This isn’t a brand-new technology. The most basic method of producing hydrogen is to create energy by running a direct electrical current through water, which liberates hydrogen and oxygen. Water electrolysis dates back to 1800. Zénobe Gramme, a Belgian electrical engineer, designed the Gramme machine in 1869 for the low-cost manufacture of hydrogen.
The conversion of renewable energy to hydrogen began in the 1930s, when Norsk Hydro used hydroelectric power at its Rjukan facility in Tinn, Norway, to produce hydrogen for the production of fertilizer ammonia. Renewable energy conversion to ammonia will be one of the next steps in “greening” global industrials in this century, with the potential to replace 175 million tonnes of ammonia per year.
On the periodic table, hydrogen is the lightest atom. This makes it an excellent transportation fuel because a kilogram of hydrogen has nearly three times the energy of a liter of diesel. It also contains more than 100 times than it is in Tesla’s present batteries. Because of this weight advantage, Airbus has announced that its future carbon-neutral fleet will be primarily powered by hydrogen. On the ground, a mix of hydrogen fuel cells (for range) and batteries could be the next big thing in auto and truck fleets (for power). It makes sense to utilize rocket fuel if drivers desire the range and power of a rocket.
Renewable hydrogen is currently uneconomic. While we feel green hydrogen has a promising future, the economics are currently unfavorable. Hydrogen is two to four times more expensive than the most competitive energy storage and transportation technologies when competing directly in transportation applications. Green hydrogen is not competitive with its carbon-intensive precursor, “gray” hydrogen, which is often produced by steam-reforming natural gas in existing industrial processes that employ hydrogen as a feedstock.
Green hydrogen’s economics will be aided by four aspects. First, as the industry grows, plants will grow in size, resulting in lower unit costs due to economies of scale. Second, by constructing additional plants, more technological expertise will be developed. The use of polymer electrolyte membranes in electrolyzer construction has previously shown to save money.
Third, because renewable energy is intermittent, it has a natural niche in the market. As wind and solar power have grown more integrated into the electrical grid, several countries have seen an increase in the number of instances of zero or even negative spot electricity rates during periods of oversupply, when weather conditions are favorable for renewable generating. Such excess can be converted to hydrogen. Because electricity is hydrogen’s most variable cost, the short-term break-even point is drastically reduced.
Finally, governments are more receptive to assistance. Funding for hydrogen from “green banks” is expanding, which is helping to cover capital expenses and expedite the three elements mentioned above. Carbon pricing will also help to close the cost gap between hydrogen and its fossil-fuel competitors in some sectors.
The ramifications of hydrogen, in our opinion, are wide-ranging and are likely to affect a wide range of businesses around the world. While we don’t yet know which companies will benefit the most, we can outline the characteristics that they will most likely require to capitalize on the opportunity. Arranging these characteristics along a hydrogen industry value chain can serve as a roadmap for how companies along the chain might benefit.
Chart: Looking for the opportunities in the hydrogen value chain
A few words about diversification in the environment of QE programs and bull markets
Systematic risk has a few distinguishing characteristics: it is on average higher than idiosyncratic risk, it is volatile and most crucially, it tends to rise when idiosyncratic risk rises, i.e. when volatility rises. To put it another way, systematic risk is far from being a minor or insignificant source of risk. Another thing worth analyzing is the interaction through time between idiosyncratic risk and systematic risk of a portfolio. The intensity of this relationship is meassured by the slope of linear regression of systematic risk on idiosyncratic risk. Another area of research may be the predictability of their relationship over the same multi-year period moving window, as determined by their correlation coefficient.
Another approach to visualize this phenomena is to look at the tails of any pair of asset classes’ combined distributions. For example, there was a 68 percent likelihood of finding the MCI EMU in a comparable position from 1994 to September 2008, when the S&P 500 returned in the lowest decile (the 10% lowest returns). From September 2008 until the present, this probability has increased to 90%. There was a 40% chance of finding the MSCI EMU in the same decile as the 10th decile (the 10% greatest return), this probability has climbed to 55 percent since September 2008.
Two probable sources of asset price co-movements have been identified in academic literature. First, correlated news processes linked to monetary and fiscal policy and second, correlated trading and positions in reaction to order flow. The first factor is that the same news can be relevant to multiple, if not all, asset classes at the same time. The second one refers to the fact that the order flow converts private data into publicly available data.
Central banks have expanded the range of eligible assets throughout time, from sovereign bonds to corporate bonds (including fallen angels in the US), asset-backed securities, and even equity (in Japan). None of this proves that QE has “killed” diversification, but it does make it a reasonable possibility. The sharp accelerations in QE that started in 2008 and 2020 have coincided with jumps in the sensitivity of systematic risk to idiosyncratic risk (i.e. a decline in diversification opportunities). In contrast, the reduction in QE from mid-2017 to the end of 2019 had the opposite effect. The effects of quantitative easing are likely to be both direct and indirect.
Directly, because central banks have stepped up their presence in a number of market segments. Indirectly, since their words and actions have encouraged private agents to engage in a high level of hazard and risk-taking in a variety of assets, both listed and unlisted. Other variables, such as passive investment, might, nevertheless, have contributed to the rise in systemic risk.
What Investors should know about the present US inflation
During the summer, base effects should heat up inflation. Shutdowns induced by pandemics resulted in unusually high monthly inflation figures. Core consumer price inflation (CPI) remained unchanged in March 2020, but then decreased by 0.4 percent in April and 0.1 percent in May, marking the only back-to-back monthly decline in the last 40 years. In June, the core CPI leveled off before increasing 0.5 percent in July and 0.3 percent in August. As such statistics exit the monthly data series, the year-over-year core CPI calculation will be erratic, even if underlying inflation remains stable. Even moderate monthly inflation of 0.15 percent until the end of the year would boost year-over-year core CPI to over 2.4 percent in the summer. This is not a forecast. Rather, it illustrates the volatility of core CPI in the absence of a rise in underlying dynamics.
Once COVID-19 has passed, the Fed’s monetary reaction to increasing inflation will be the primary variable driving asset prices. We anticipate the Fed to stay the course, maintaining full-throttle accommodation throughout the year, even if GDP is solid and inflation is increasing. The Fed is more concerned about tightening too soon than too late, and is willing to risk, if not encourage, an inflation overshoot in order to support stronger growth.
Even if year-over-year estimates begin to decrease in late summer, the demand side of the economy is expected to recover faster than the supply side, pushing month-to-month and quarter-to-quarter inflation higher in the second half of the year. With fiscal assistance focused directly at consumers’ pockets, we doubt companies will be able to keep up with a months-long spending spree once the economy recovers.
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The views expressed in this document do not constitute research, are not investment or commercial advice, and do not necessarily reflect the views of all management teams. They change over time.