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Central banks and climate change: all hot air

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Sovereign wealth funds, state investment vehicles that collectively have over $8tn in assets under management, appear obvious candidates to spearhead investment into climate-friendly assets. Most have long-term investment horizons, and all work in the interests of nation states that would need to spend big to mitigate the impact of global warming.

Some recognise this. Norges Bank Investment Management, or NBIM, which somewhat ironically derives its wealth from Norway’s vast oil supplies and which is touted as the world’s largest sovereign wealth fund, has made ESG goals a core part of its investment strategy. Increasingly it pays to go green. Global SWF, a data platform that tracks over 400 sovereign wealth funds and public pension funds, notes in a report out earlier this year that Australia’s Future Fund has “along with a sound investment strategy, historically yielded excellent results” and made money “in both rising and falling markets”.

It may not always be the case that going green makes short term gains —— a lot of the assets in certain parts of the ESG sphere may now be overvalued. But, combine the dangers of being stuck with stranded assets with the reasons we’ve listed for the official sector going green, and what strikes us as odd is that the stance of NBIM and the Future Fund is not replicated across the board. When broadened out to include all of the top 100 funds, Global SWF finds just 35 of them have an ESG report:

For those who follow the world of official sector asset management, this might not come as much of a surprise. Despite their capacity to set the agenda, the official sector has often been too conservative to do so and tended to follow the herd —— even when such decisions have run counter to the interests of the state they represent. During the global financial crisis, for instance, reserve managers pulled $500bn-worth of dollar liquidity at a time when their counterparts in central banks were struggling to cope with a lack of greenback funding.

Central bank reserve managers, which are responsible for north of $12tn in reserves, have traditionally had a different set of responsibilities to sovereign wealth funds. Traditionally tasked with stabilising volatile movements in their domestic currencies, which can spook investors and exporters, they hold assets that are liquid enough to sell quickly so that, in the event of turmoil, they can intervene in FX markets. They are primed for preventing crisis and therefore not so focused on the longer-term.

Some within the field are calling on reserve managers in central banks to change their tune.

At the start of this week Gary Smith of Sovereign Focus and John Nugée of Laburnum Consulting issued a joint paper that argues reserve managers ought to consider climate change enough of an emergency to make investments in technologies that will lower carbon emissions a priority:

The Paris agreement includes commitments to both cut climate-altering emissions, and continually revisit and strengthen those commitments. It is an ongoing promise. Whilst the long-term arguments for a renewable energy transition are indisputable, there will be near-term financial costs associated with the transition. The capital investment required in the rollout of solar and wind energy projects and in re-equipping households to enable the switch to green energy will require large scale funds, and will require them now.

This is the argument for mobilising all sources of national wealth to finance a green transition. Martin Luther King in his seminal 1963 speech addressed what he termed “the Urgency of Now”, and it is a phrase being used with increased frequency and vigour in the climate change debate. Now is the time to act as every year without action makes the task of restoring global climate equilibrium more difficult.

Sovereign Wealth Funds are a clear source of funding for this task, and according to the financial think-tank OMFIF, have assets under management of around $8.5 trillion. However in the current twin crises it is our view that FX reserves should also be considered as part of the solution: and at around $14 trillion take the total firepower available in national wealth accounts to a number that equates to almost 20 per cent of global GDP. This is a sizeable war chest that should not be idle at this critical moment.

Is this set to happen? The optimist in us would note that central banks have stepped up the rhetoric on fighting climate change. Even the Fed, a laggard in this area, signed up to the Network for Greening the Financial System.

Yet, so far, this has been mostly talk. And, as mentioned earlier, the official sector is not known for leading the charge. We hope we’re wrong, but we fear we may be waiting a while long for them to put their money where its mouth is.



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Oil price jumps above $70 after attacks aimed at Saudi oil facilities

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Oil prices jumped above $70 a barrel for the first time in 14 months after Saudi Arabia, the world’s top oil exporter, said its energy facilities had been attacked on Sunday, targeting “the security and stability” of global supplies.

A drone attack from the sea on a petroleum storage tank at Ras Tanura, one of the largest oil shipping ports in the world, took place on Sunday morning, the kingdom said.

In the evening, shrapnel from a ballistic missile fell in Dhahran, where state oil company Saudi Aramco has its headquarters and near where thousands of employees and their families live.

While Saudi Arabia’s ministry of energy said the attacks “did not result in any injury or loss of life or property”, and a person familiar with the matter said no production had been affected, the attacks have still unsettled oil markets that have rebounded strongly in recent months.

Brent crude, the international benchmark, rose 2 per cent to a high of $71.16 a barrel while West Texas Intermediate, the US benchmark, rose by a similar amount to a high of $67.86 a barrel.

Yemen’s Iran-allied Houthi fighters claimed responsibility for the attacks and said they had also focused on military targets in the Saudi cities of Dammam, Asir and Jazan.

A Houthi military spokesperson said the group had fired 14 bomb-laden drones and eight ballistic missiles in a “wide operation in the heart of Saudi Arabia”.

Amrita Sen at Energy Aspects emphasised that while a direct hit on oil supplies appeared to have been avoided, the threat to the market would still be taken seriously by oil traders.

“The oil price was already on a strong footing after Saudi Arabia and Opec’s decision last week to keep restricting production,” she said.

Brent crude, the international oil benchmark, has risen close to $70 a barrel since the cartel and allies outside the group, including Russia, decided not to unleash a flood of crude on to the market.

Amid uncertainty about the oil market outlook as the coronavirus crisis continues to have an impact on crude demand, the group decided against raising production by 1.5m barrels a day from April.

Given the supply curbs, while the kingdom has the extra production capacity to tap into, “geopolitical threats to supply will add a premium to the price”, Sen added.

The kingdom’s state media outlet said earlier in the day that the Saudi-led military coalition confronting the Houthis had intercepted missiles and drones aimed at “civilian targets” without indicating their location.

The Eastern Province, where Dhahran is located, is where much of Saudi Aramco’s oil facilities are located. The attack is the most severe since September 2019.

At that time the kingdom was rocked by missile and drone fire that hit an important processing facility and two oilfields, temporarily shutting off more than half of the country’s crude output.

The Houthis have ramped up assaults on Saudi Arabia through airborne attacks and explosive-laden boats and mines in the Red Sea, laying bare the vulnerability of the country’s energy infrastructure despite the kingdom’s production prowess and its hold over the oil market.

“The frequency of these attacks is rising, even if the impact on energy infrastructure appears limited,” said Bill Farren-Price, a director at research company Enverus. “We know the capacity to cause serious damage exists, so this will boost the risk premium for oil.”



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Rio Tinto set to start negotiations over Mongolian mine

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Rio Tinto is set to start face-to-face negotiations with the government of Mongolia as its seeks to complete the $6.75bn expansion of a huge copper project in the Gobi desert. 

The Anglo-Australian group is sending a team of senior executives to the capital Ulaanbaatar to try and hammer out a new financing agreement so that the development timeline can be maintained and underground caving operations can start later this year.

The discussions will focus on a number of issues including tax, a new power agreement and benefit sharing, according to people with knowledge of the situation.

Some government officials want Rio to pay more than $300m of withholding taxes on income it has received from Oyu Tolgoi LLC, the Mongolian holding company that owns the mine. 

Rio receives a management service fee for running Oyu Tolgoi’s existing open pit and the underground project as well as interest on money it has lent the government to fund its share of the development costs.

However, the officials say it is “very difficult, if not impossible” to engage constructively on the issue because the payments are the subject of arbitration in London.

For its part, Rio believes the issue of withholding taxes is dealt with in the separate investment and shareholder agreements that cover its operations in the country.

The underground expansion of Oyu Tolgoi ranks as Rio’s most important growth project. At peak production it will be one of the world’s biggest copper mines, producing almost 500,000 tonnes a year.

Although Rio runs the existing operations and is in charge of the underground expansion project it does not have a direct stake in the mine.

It’s exposure comes through a 51 per cent stake in Turquoise Hill Resources, a Toronto-listed company. TRQ in turns owns 66 per cent of Oyu Tolgoi LLC, with the rest controlled by the government of Mongolia. 

The project has been beset by difficulties and is already two years late and $1.5bn over budget. The government said earlier this year that if the expansion is not economically beneficial to the country it would be necessary to “review and evaluate” whether it can proceed.

To that end the ruling Mongolian People’s party and its new prime minister Luvsannamsrain Oyun-Erdene are trying to replace the Underground Development Plan with an improved agreement.

Signed in 2015, this sets out the fees that Rio receives for managing the project as well as the interest rates on the cash Mongolia has borrowed to finance its share of construction costs.

However, it was never approved by Mongolia’s parliament and has become a focal point for critics who say the country should receive a greater share of the financial benefits.

Rio, which recently appointed a new chief executive, has told the government it is prepared to “explore” a reduction of its project management fees and loan interest rates as well as discuss tax.

However, analysts are sceptical that the two sides will be able to put a new agreement in place by June when a decision on whether to start caving operations must be taken if Oyu Tolgoi is to meet a new target for first production in October 2022.

Rio is also at loggerheads with TRQ on how to fund the cost overruns at Oyu Tolgoi. Last week, TRQ’s chief executive resigned after Rio said it planned to vote against his re-election at its annual shareholders’ meeting.

In a statement, Rio said it was committed to working with TRQ and the government of Mongolia to enable the successful delivery of the Oyu Tolgoi Project

“Aligning and co-ordinating our joint efforts to resolve the concerns of the Government . . . going forward is of the highest priority,” it said.



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Value investor John Rogers sees an end to Big Tech’s stock market dominance

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The veteran value investor John Rogers predicted the US is headed for a repeat of the “roaring twenties” a century ago that will finally encourage investors to dump tech stocks in favour of companies more sensitive to the economy.

The founder of Ariel Investments told the Financial Times in an interview that value investing “dinosaurs” like him stood to win as higher economic growth and rising interest rates took the air out of some of the hottest stocks of recent years.

Rogers, who has spent a near four-decade career focused on buying under-appreciated stocks, said the frenzied buying of special purpose acquisition companies, or Spacs, signalled frothiness in parts of the market, even while a coming economic boom underpinned other share prices.

“This will be a sustainable recovery. I think there’s going to be kind of a roaring twenties again,” Rogers said, adding that the strength of the economic recovery would surprise people and challenge the Federal Reserve’s ultra-dovish monetary policy.

The US central bank is “overly optimistic that they can keep inflation under control”, he said, and higher bond market interest rates would reduce the value of future earnings for highly popular growth stocks such as tech companies and for the kinds of speculative companies coming to market in initial public offerings or via deals with Spacs.

“Spacs are a sign that growth stocks are topping. A signal that the market is frothy,” said Rogers, a self-styled contrarian and famed for his Patient Investor newsletter for clients that debuted in 1983.

Value investing is based on identifying cheap companies that are trading below their true worth, an approach long espoused by Warren Buffett. Value stocks and those sensitive to the economic cycle boomed after the internet bubble burst in 2000, but the investment strategy has been well beaten over the past decade by fast-growing stocks, led by US tech giants. 

“We’ve been looking like the dinosaurs for so long,” said Rogers. “We’ve been waiting for that booming economic recovery since 2009.”

Proponents of value investing believe that the combination of expensive growth stock valuations and a robust recovery from the pandemic will cause a significant switch between the two investing approaches.

Higher bond market interest rates reduce the relative appeal of owning growth stocks based on their future earnings power.

When 10-year bond yields rise, “growth stocks look way, way too expensive versus value,” said Rogers. “Value stocks are going to come out of the recovery very strong, they’re going to have a tailwind from an earnings perspective. Their earnings are going to be here and now, not 20, 30 years down the road.”

The Russell 1000 Value index outperformed the equivalent growth index by 6 percentage points in February, rising 5.8 per cent versus a drop of 0.1 per cent for the growth index. That was the biggest outperformance for value since March 2001, according to analysts at Bank of America.

“Although rising rates triggered the rotation, we see a host of other reasons to prefer value over growth,” the analysts wrote last week, “including the profit cycle, valuation, and positioning that can drive further outperformance.”

Rogers said he expected higher overall stock market volatility from rising interest rates this year but value should reward investors as it did “20 years ago once the internet bubble burst”. Ariel is bullish on “fee generating financials” and Rogers said preferred names included KKR, Lazard and Janus Henderson, while it was also bullish on traditional media, including CBS Viacom and Nielsen.

Chicago-based Ariel is one of the few large black-owned investment companies in the US, with $15bn of assets under management. It manages the oldest US mid-cap value fund, dating from 1986. 



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