524 Billion Euros. That is APG’s total invested assets worldwide (as of October 2022). The goal: a decent and sustainable return for the funds’ participants. The portfolio is obviously broad. From investments in wind farms in Zeeland to shares in international hotel chains. And from safe bonds to the somewhat more fluctuating trade in gold or soy. Who are the people behind these investments? What drives them? What choices do they make? And why?
In this episode: Martijn Olthof, Manager of DMEF (Developed Markets Equities Fundamental) Industry & Energy.
Listed investments in utilities, renewable energy, oil and natural gas. That is what Olthof focuses on, with his interest as an equity investor currently focused primarily on utilities. For a long time, those were somewhat boring, predictable stocks. Now that they will be playing an important role in the energy transition, that has changed. For the longer term, then, that transition is an important theme in Olthof’s work, and when it comes to the question of how that will play out, you cannot avoid talking about the European energy crisis.
Is the energy crisis a blessing in disguise for the energy transition?
Olthof: “The energy crisis might have a positive effect on the energy transition, because we have been made even more acutely aware of our dependence on fossil fuels from countries like Russia. But the high energy prices could also slow down our ability to make our energy supply more sustainable, because there is less money left to invest in that sustainability.”
How can Europe get away from this dependence on Russian natural gas?
“We wouldn’t be able to simply replace all the natural gas from Russia with renewable energy in any case. To cope with the energy crisis in Europe, it is not enough just to generate more renewable energy. We also need to ensure that the demand for energy decreases, for example by using more insulation and through more conscious use. But even then, we cannot avoid looking for alternative fossil energy sources. And then you do run into an area of tension. Some are against natural gas from Qatar from a human rights perspective, while others oppose getting shale gas from the US because of the environmental impact of fracking. Also, not everyone wants drilling for natural gas to be going on in the North Sea. But ultimately you have to get the energy from somewhere.”
No one knows when the war will end, what the balance of power will be then and how that will affect Russian natural gas supplies. As an investor, how do you deal with all this uncertainty?
“One of my main investment principles is that you only take a large investment position if you are convinced about something that has not yet been priced by the market. When it comes to geopolitics, I often have no better insights than the market. It is quite difficult to predict geopolitical developments and, as an investor, to have a conviction that something is going in a certain direction. Even geopolitical experts you talk to don’t see everything coming. So I often choose to set up the investment portfolio in such a way that our investments are not hit harder than the benchmark if a certain geopolitical development doesn’t happen, or if it does. Then it’s better to focus on the things you do think you can beat the market with.”
Can you give us an example of when you had such a conviction?
“A few years ago there was a lot of political turbulence in Guyana. The oil company Hess drills for oil there, and it was believed that this turbulence could possibly lead to the revocation of Hess’ drilling license, or to higher taxes. The share price fell dramatically at that time. Conversations with people from the U.S. Embassy in Guyana then gave us a better picture of the political relations and situation in the country, after which we drew the conclusion that Hess could probably continue its operations. So that price correction was an overreaction of the market and we bought shares accordingly. Later it turned out that politically it did indeed end with a hiss, which worked well in our investment portfolio.”
You could also have been wrong, after all, the market is usually right. Don’t you doubt your decision at a time like that?
“To do this work, you have to be humble in the sense that you should not be too quick to think you can beat the market. Capital markets can be ruthless; you never know everything. So it’s important that you have a huge curiosity, about how something works in a technical sense but also about how market sentiment comes about. In this case, we were pretty convinced that the market reaction was exaggerated. You have to have a certain level of stress resistance. It’s important to feel the pressure, but you have to know when to intervene and when not to.”
Why are you currently looking for investments primarily in the utility sector and not, for example, in oil producing companies?
“The pension funds APG works for are increasingly scaling back their investments in fossil fuels like oil and natural gas. And the utilities sector is attractive because, like the oil and natural gas sector, these companies have an important role to play in the energy transition. Not only by building wind turbines and solar farms, but also because of the huge investments needed in the power grid - so that the grid can handle the increasing supply of wind and solar energy. But also to cope with the demand, which will continue to rise in the coming years - just through increased use of electric cars and heat pumps. The shift that utilities are going to have to make for the energy transition makes the sector attractive to investors not only in Europe, but also in the U.S.”
In the Netherlands, consumers wonder why the variable price for electricity or natural gas varies so much from one supplier to another. How can that be explained?
“Some of these companies are strictly traders, buying all their energy on the exchange and then reselling it. They do this on a short-term basis, so once the term of a fixed contract is over, they have no choice but to fully pass the price increases on to the customer. But if power companies have nuclear or hydroelectric plants of their own, their costs hardly rise at all. Those companies may not simply pass on those high market prices to the end user, so their customers’ rates rise less in comparison.
But there are other factors at play. For example, an energy company that had many contracts with Russia’s Gazprom and supplies energy to consumers at a fixed price will go bankrupt the moment natural gas supplies from Russia are completely cut off - at least if the government does not come to the rescue. Other energy suppliers, while also purchasing natural gas from Gazprom, had customer contracts stating that they charge market prices. So when the gas supply from Russia stopped they had to buy gas on the market at a higher price, but were able to pass that cost on to the end user.”
Say the war in Ukraine ends tomorrow. How would that affect the energy prices?
“Energy prices were already rising as the economy was recovering from the Covid pandemic. They were high, but still within certain ranges. When the war started, they really exploded. If the war in Ukraine were over tomorrow, prices would probably move to a level not as low as during the pandemic, but much lower than now.”
And if we look further into the future?
“The realization is sinking in that natural gas is not infinitely available, as it was in the years before covid. There was actually a surplus of cheap natural gas on the world market at that time. This was due to the large amount of natural gas released as a byproduct from oil production in the U.S., as well as natural gas extracted there through fracking. Such a surplus is - I think - no longer expected in the longer term, so I don’t expect us to go back to those extremely low prices. But looking even further ahead: eventually we will have to get away from fossil fuels. At some point demand has to start decreasing towards zero, making fossil fuel prices extremely low and eventually irrelevant. But looking at current fossil energy consumption and emissions, I don’t see it going that way for the time being.”
A world in which fossil energy is completely replaced by renewable forms of energy: what does the road to that look like?
“The first step is to make the process of generating power green, and this is already underway. In some countries, of course, power from solar and wind is easier to generate than in others. But in some places, sustainably generated power is already taking over the role of fossil power. Norway, for example, has been running entirely on power obtained from hydroelectric plants for decades. Nevertheless, greening our power generation is a huge job, requiring not only a lot of manpower and materials, but also permits. If you want to build a high-voltage pylon, it will take 6-8 years before you can get started. The challenge is also that we need much more electricity for the next step: the electrification of other parts of the economy, such as transport, heavy industry and aviation. This requires research and preparation now, but the bulk of the transition itself will have to take place in the 30-40s.”
What kind of contribution can investors make to the energy transition?
“For investments to be profitable, including in renewable energy, requires the right conditions. You create those in an interaction between government and business, in which you as an investor or business are also active. But ultimately you do need a government that provides those conditions, by making fossil energy more expensive and green energy cheaper. It is still very difficult to invest on a large scale in making heavy industry and transport sustainable, because those conditions are not there yet.
What would also help is a much higher carbon price. If that were a few hundred euros per ton of emissions and applied throughout the world, it would be a lot easier for a company like Tata steel, for example, to say: we are switching to hydrogen.”
What makes the energy sector so interesting to you?
“I never planned for the energy sector to become my specialty, but in my first job as a corporate finance consultant at McKinsey, I was paired with someone who had been there a little longer and had utilities as his focus sector. He thought that was just an annoying sector and was actually happy to pass it on to a junior. From then on, I’ve been focused on these companies and found it super interesting. It’s political, it’s financial, it’s technical. Later, I also added the oil and natural gas sector to that focus. In 2004-2005, climate change didn’t play such an important role for utilities and fossil fuel companies. That was added later, which has only made these sectors more fascinating - including with respect to my work at APG. These are interesting times for the energy sector. This is when you can see how certain companies are cracking or flourishing.”