Wellian Weekly 11.10.2021

The Energy Crisis and Portfolio Construction

One of the reasons why energy prices are rising is due to the “lack of wind” over the last couple of months. As the country transitions from the reliance on fossil fuels to renewable energy sources, now is an apt time to think of the primary, secondary and tertiary implications of the energy complex. It isn’t all down to the lack of wind though that is causing incredible price spikes that we are witnessing at the moment. Other contributing factors to the rising prices are the supply of gas from Russia has been curtailed, the cold winter last year reduced inventories and a sharply rising oil price (which has very little to do with the petrol shortages we have been witnessing of late). You could argue it has been a perfect storm for consumers of energy with such a series of headwinds, but the principle of having multiple input sources makes logical sense.

In many parts of the world it is now cheaper to generate electricity using wind power and solar farms than it costs to burn coal, but economics is only one part (albeit a major factor) of the policy programme that decides how a national grid and energy complex is put together for a nation. The rapidly growing renewables space which is predominantly driven by solar, wind and wave have their own characteristics, strengths and weaknesses and these need to be taken into consideration with regard to how much of each is used if any at all. Solar power for instance doesn’t work too well at night – for obvious reasons!

Excluding the Net Zero initiatives and the objectives to meet the climate targets of the Paris Agreement, the present national grid contains power generated by coal, oil, gas, nuclear, and renewable sources, but over the next three decades the shift to renewables HAS to take centre stage.  The energy grid then will have to be primarily driven by renewables, but you can guarantee there will not be only one source of renewable energy because simply put it just doesn’t make either logical, economic or political sense. The size of the problem is massive. To get to 1.5 degrees the amount needed to invest in these renewable sources to replace traditional energy generation also demands at the very least diversity.  What if there were supply chain issues relating to the creation of photovoltaic cells, or wind turbines which halted production for an extended period? What if there were not enough engineers to service them for instance? On top of that, the grid needs to change and adapt. As previously mentioned, solar power doesn’t work at night, so the need for power cells (i.e. massive batteries) will have to be incorporated into the grid so that steady form power is delivered twenty four hours a day.

Therefore, when considering how to create a balanced uninterrupted grid, it makes sense to have numerous sources to rely on. Putting all your eggs in one basket is not good – a bit like constructing a portfolio. Admittedly there are a number of factors contributing to rapidly rising energy prices at the moment, and there are times when even the majority of assets in a broadly balanced portfolio rise and fall – and sometimes in lockstep– even if you are invested in different asset classes, but this doesn’t mean you’ve constructed a poor portfolio, or energy grid for that matter.

The events of the last couple of months have really highlighted the need to create balance and diversity in the real world (from an energy perspective among others), but equally it has highlighted the need to do something similar with your investment portfolio.  There will be times when everything is going great, and times when your diversified portfolio behaves “irrationally”, and this is to be expected – especially in such a complex dynamic system such as the financial markets.  Having a long-term horizon allows you to look through the short-term noise. It should help you sleep better at night and have confidence for the future. Humankind is innovative and there will always be a solution.

 

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