A waste of the world’s energy
Talking shops such as COP28 will do nothing to cut emissions, says Max King. Unleash the private sector
We all predicted the outcome of the COP28 summit in Dubai: the semblance of a deal papering over deep differences. This, after all, was the result of previous COP summits. Carole Nakhle, founder and CEO of Crystol Energy, a global energy research group, argues that “countries have not delivered on the promises they made at COP27”. There is also a difference of perspective between the developing and the developed world. “There is a lack of consistency... from rich countries preaching on the need for a switch to renewables, yet asking for more hydrocarbon production”, especially when 45% of people worldwide do not have access to reliable electricity.
In addition, “the subsidies for green energy in rich countries is negative for developing countries that cannot afford them and thereby suffer from a competitive disadvantage in costs.” Lucian Pugliaresi, president of the Energy Policy Research Foundation, points out that despite more than $6trn of subsidies for wind and solar energy over 20 years, they still only account for 2.3% of energy consumption, while fossil fuels comprise 80%.
Nuclear energy makes a comeback
Most of the energy transition, says Nakhle, has not been fossil-fuel reducing but has come from natural gas crowding out coal and oil and renewables replacing nuclear. Now, nuclear is back in favour but “energy transition is hard and slow”, says Pugliaresi.
To achieve the International Energy Agency’s target of “net zero” by 2050, he estimates, will involve reducing the share of fossil fuels in the energy mix from 80% to 16%. By 2030, world oil consumption, currently 102.3 million barrels per day (mb/d), is targeted to fall to 77mb/d while oil exporters’ cartel Opec estimates it will be 112mb/d. “Thinking you can take 30mb/d out of demand is ludicrous,” he says.
What if new investment is halted? “There will be a rapid decline in oil and gas production as you have to keep investing to avoid depletion,” he forecasts. The result would be a huge spike in prices to a multiple of current levels and Opec’s share of output would rise from 35% to 82%, increasing their pricing power.
Governments think alternative energy will flow into the market so fast that fossil fuels won’t be required, he says. Yet that would require not only massive investment in production but also in transmission infrastructure, to overcome intermittency. With global electricity generating capacity multiplying fourfold by 2050 to achieve net zero, solar output alone would need to generate more than twice as much electricity as current total global generating capacity. “Just because the supply of wind and solar is inexhaustible does not make it inexpensive.”
The good news is that energy demand per capita in developed countries is falling; the bad news is that it is rising in developing countries where it is just a fraction of the OECD figure. “Non-OECD countries have a desperate need for economic growth and they want cheap power,” says Pugliaresi. Hence while OECD countries have cut coal-plant capacity, developing countries, notably China, have added to it; overall capacity has risen by 350GW since 2015. Most of this extra capacity, especially in China, is back-up plant for the intermittency problem of renewables, so it won’t be used intensively. Still, “economic development needs energy and the world will need more power by 2050. If the OECD achieved net zero by 2050, it would only reduce the carbon dioxide emissions of the whole world by 10%.” Even in the OECD, netzero commitment is weak. Only 15 countries have enshrined it in law. For others it is just a target, as it is in all but one developing country.
What makes the net-zero drive harder, says Pugliaresi, is that the pillars of modern civilisation rely on iron and steel, cement, fertiliser and plastics, for which there is no alternative but to use fossil fuels. Nakhle thinks that these industries will still need 1520 mb/d of oil or oil equivalent in 2050.
However, she points to substantial progress in energy efficiency. Thirty years ago, if the Middle East sneezed, the world caught a cold; but conflicts in the Ukraine, Israel and elsewhere show that is no longer the case. The invasion of Ukraine will provide further impetus to energy security, not just to guard against supply shocks but also to lessen the corrupting flow of wealth into the hands of violent, dysfunctional and autocratic governments around the world.
In this respect, the advent of fracking has been a godsend, turning the US from the world’s largest importer of hydrocarbons to the largest exporter. Between 2010 and 2020, the US supplied 84% of the incremental global demand for hydrocarbon liquids. But reduced dependence on Opec creates another energy-security problem: the supply of metals and minerals needed for renewables depends on politically unstable countries for extraction and processing.
Still, Pugliaresi argues that “we shouldn’t give up on reducing carbon emissions, but we need to get serious with people about the challenges. Climate policy is made by well-meaning academics who haven’t spent ten minutes with engineers. We will get to net-zero but it will take longer than 30 years.” As for COP summits, Gareth Ramsay, an economist at BP, says that “up till now, COP summits have all been about governments, now it will switch to companies.” This
“Reaching net-zero means reducing fossil fuels’ share in the energy mix from 80% to 16%”
implies returns on capital for investment that make it attractive, which creates opportunities for investors. “Tackling demand is the only way to reduce fossil-fuel consumption, not stopping supply. Electricity consumption will probably double in the next 30 years but the world needs to double spending on infrastructure.”
With states heavily indebted, the cost of borrowing higher than for 15 years and real interest rates positive, the capacity of governments to invest or subsidise is increasingly constrained. There are growing doubts about the sustainability of America’s “inflation reduction act”; it is probably too late to curtail it but it won’t be extended or increased without an additional source of finance and “there is no possibility of a carbon tax in the US any time soon”, says Ramsay.
The magic of innovation
The problem is that the energy transition was sold to electorates as a cost-free project that would generate higher living standards without curtailing individual freedom. People now realise they have been misled; hence the backlash against the energy transition.
The optimists, led by Bill Gates, think sacrifices are unnecessary. His Breakthrough Energy fund has invested $2bn in 100 companies to reduce carbon dioxide emissions and is raising another $1bn. His focus is on technology-led solutions that allow companies and consumers to continue to operate as they do now while reducing carbon dioxide emissions.
He does not expect consumers to have to pay more to buy products that are environmentally friendly, nor to buy less or travel less. Customers will buy an electric vehicle not as a status symbol but because it’s cheaper and comparable in performance to one with an internal combustion engine. “The one thing that’s magic in this world is innovation,” he says.
The scale of innovation is massive and the usefulness of each avenue of research in making a difference is impossible to judge. Hydrogen, battery storage, nuclear fusion, and carbon capture and storage all have fervent advocates. But improving and expanding existing technologies also continues apace.
If only governments would create a stable long-term framework to encourage long-term investment and then stand back, tear up their targets and timetables and stop bullying their citizens, the transition to renewable energy will be relentless. At present, governments, egged on by the-end-of-the-world-isnigh pessimists are the problem, not the solution.
“There is no possibility of a carbon tax being introduced in the US any time soon”
Small-cap stocks have struggled this year. None of the four stocks I chose at this stage last year finished in the black, despite some big gains during 2023. Brave Bison (Aim: BBSN), a media, marketing and technology play skewed towards social media, is currently down by 10%. This surprises me. It was cheap when I included it, and the brother directors (Oliver and Theo Green), who managed to expand their previous firm, Tangent, bought five million shares in November. I see no reason to abandon this position.
Altitude (Aim: ALT), a promotional products company that owns a platform connecting buyers, distributors and manufacturers, is unchanged; investors may be loath to buy because the stock isn’t cheap, but profits are growing quickly. Once earnings catch up and bring the valuation down, the stock could bounce. If anything, the business case has become even stronger.
Australia’s Harvest Minerals, which produces the fertiliser KP Fertil in Brazil, has been a dreadful performer, slumping from 8.4p to 0.71p as fertiliser prices have slumped. If the business case recovers then the stock is a multi-bagger – but investors face the very real risk of a discounted placing or even a delisting. I would now avoid the stock until much of the uncertainty is removed. I’m happy to admit I got this one wrong.
Finally, XP Factory’s shares have slipped from 21.5p to 16p, but the company appears to be trading strongly. Escape rooms and experiential leisure are proving popular, and the Boom Battle Bar has been a solid acquisition. It offers a range of games including axe throwing, and is popular with parties. All the right metrics are pointing north. Cash is not a concern; the group should be able to keep funding its expansion.
This year’s selection comprises a mix of profitable small caps and two high-risk special situations that are unprofitable yet have plenty of upside. As always, consider them as suggestions for you to do your own research. I have done my best to highlight both the positives and negatives.
Renold (Aim: RNO), 34p
Renold is a manufacturer of industrial conveyer chains, bicycle and motorcycle chains, and machine components. It’s a thoroughly unexciting business, and yet the stock price has more than held its own in the past two years as the company has repeatedly put out good news.
After the last update, house broker Cavendish produced an adjusted earnings-per-share (EPS) target of 6p for 2024, with £19.2m of adjusted profit forecast. At the current price of 34p, that means the stock is trading on a price/earnings (p/e) ratio of less than six.
There has been no dilution of shareholders since 2018. The business is self-funding small, bolt-on acquisitions and so there doesn’t appear to be a need to come to the market for more cash. There is, however, a large pension deficit sucking capital from the business. Net cash flow (after tax) was £11.7m in the six months to 30 September, but there was a £6m outflow for pension contributions. Still, £2.6m of this was accelerated and originally planned for the second
“People can choose to smoke, drink, gamble and vape. Nobody chooses to get bombed”
half of Renold’s financial year. The deficit will become smaller over time, so I don’t believe this is anything to worry about.
I am quietly confident that in the coming bull market Renold could double from this level. That won’t happen overnight, unless someone bids for the entire company. But it is a resilient business on the front foot. Given the earnings growth, the market may eventually want to rerate the stock from six times earnings to a higher value.
Supreme (Aim: SUP), 112.5p
Supreme is Europe’s leading provider of wholesale batteries, lighting, vaping and nutritional products. It has established close ties with Duracell and Panasonic, but it’s the vaping side of the business that attracts attention. Many say this is because it is a nicotine product and thus triggers a similar reaction to alcohol, tobacco and gambling companies. But while all of these can be addictive and ruinous, I am confused as to why defence companies are often left out of discussions about ethical investments. People can choose to smoke, drink, gamble, and vape. Nobody chooses to be bombed.
In any case, everyone is entitled to their own opinion. It has been suggested that this company may not achieve the valuation it would otherwise deserve because of objections to vaping. I don’t believe that, as the numbers are compelling.
This is a fantastically profitable business, and house broker Shore Capital expects EPS of 17p this year, giving the company a price/earnings (p/e) ratio of seven at the current price of 120p. On the cash front, there was an outflow of £2.7m overall in the half-year to 30 September, but this was due to a £16.4m investment of working capital to support ElfBar: Supreme had
been selected as a master distributor for the online vape store brands ElfBar and Lost Mary. Excluding this investment, operating cash flow was £17m.
The company has £5m of net debt but also an unused £35m debt facility to make more acquisitions.
This sounds good so far, but there may be trouble ahead. We are awaiting the results of the consultation on possible new UK e-cigarette regulations that ended on 6 December. The company has made moves to pre-empt this by changing packaging to make it less appealing to children, but will it be enough? Under a Labour government, vapes may only be available under prescription, following Australia’s move in 2021.
My feeling is that removing a less harmful way of getting a nicotine hit and a way for smokers to reduce their cigarette consumption – some people use vapes to help them give up smoking altogether – makes no sense. But it’s clearly a big risk. Supreme has also seen plenty of growth, although this has largely come from ElfBar, which it doesn’t actually own. I believe the balance between potential risk and reward is priced attractively on a p/e of seven.
Afentra (Aim: AET) 31.5p
Oil and gas explorer Afentra, short for “African energy transition”, changed its board in May 2021. Paul McDade, former CEO of Tullow Oil, now runs the firm. He plans to buy assets and use his knowledge and connections to improve them.
The company finally completed its Sonangol acquisition in Angola on 8 December. This is a deal that gives the company non-operating interests in two areas in offshore Angola. The deal is scheduled for completion on 1 December next year. Afentra should be able to generate $49m in adjusted Ebitda in 2024, compared with a current market value of £70m. Profit before tax is forecast to reach £23.8m, meaning the company will trade on a single digit p/e, assuming everything goes to plan.
The Sonangol acquisition will provide free cash flow for the company to buy existing assets as well as provide lending facilities with which to go after more targets. A bet on Afentra is a bet on CEO Paul McDade. He has certainly bet on himself, scooping up £199,550 of shares in August 2022.
BSF Enterprise (LSE: BSFA)
BSF Enterprise is a biotechnology company that acquired cell-based tissue engineering company 3D Bio-Tissues in 2022. A share placing allowed it to raise £1.75m at 7.37p to finance the takeover, and it mustered another £2.9m at 17p in an oversubscribed placing in April 2023.
The company aims to replace animal meat tissue with lab-grown, scaffold-free bio-equivalents. The scaffold is the structure that holds the meat together, and it is often synthetic or plant-based in lab-grown meat products, altering the texture of the meat. Tests showed that BSF’s cultivated meat was very similar in appearance to conventional meat in the raw state, and when cooked it was also consistent in terms of appearance, aroma, and tendency to sear or crisp.
If we assume that operational cash-flow costs remain the same, then the company is likely to have enough capital for well over 12 months, allowing it time to make further progress with its products and build commercial relationships. The stock is unprofitable and so it must be regarded as speculative. But with the company also producing lab-grown animal skin for the tanners of a luxury-leather-goods manufacturer to test, and having sent its patented City-Mix (a supplement that boost cell production) to several customers to test, there is ample upside if BSF can monetise its assets effectively.
PCI-Pal (Aim: PCIP), 50p
This company provides payment services for cardholder -not-present (CNP) transactions. It has been the subject of a lawsuit from competitor Sycurio, while a profit warning has also contributed to the recent share-price decline. Broker Cavendish has trimmed the company’s sales growth forecast for the year to 30 June 2024 to £19.1m from the previously expected £20m. But given the £14.9m achieved in the previous year, the company is still growing quickly and has reiterated that it expects its first full-year adjusted profit this year.
Management believes the lawsuit was designed to put a spanner in the company’s growth, and on 25 September PCI-Pal announced it had won the case in the UK High Court. The company showed not only that Sycurio’s patent was invalid, but also that even if it had been valid, PCI-Pal’s Agent Assist solution would not have infringed it.
The company is seeking a full recovery of costs in the UK, but it is not out of the woods yet, as the US lawsuit is still ongoing. Therefore, I have to regard this company as speculative and highly risky due to the lawsuit. The group is also still in the red, although this is expected to be the first full year of adjusted profit.
Should the lawsuit go the wrong way in the US, then the share price could go much lower. However, given the current share price is only slightly above the price before the news of PCI-Pal’s total victory, I believe this risk is more than priced in.
“A bet on oil and gas group Afentra is a bet on CEO Paul McDade. He has certainly bet on himself, buying shares worth £200,000”