The Organisation of Arab Petroleum Exporting Countries – a regional cousin of oil cartel Opec – discovered its tremendous pricing power in oil markets after the Yom Kippur War in 1973. That realisation, among other factors, helped usher in the stagflation of the 1970s and a lost decade for investors. In the latter half of 2021, we became concerned that Vladimir Putin had reached the same conclusion regarding natural gas in Europe. Prior to the invasion of Ukraine, Russia supplied 40% of Europe’s gas, and a higher gas price would mean higher European electricity prices and higher inflation.
A dearth of oil and natural gas exploration in recent years has exacerbated the issue. Similarly, the transition to a low carbon economy will be inflationary as productive energy capacity is taken offline and replaced with new renewable energy sources. The tragic events unfolding in Ukraine have reinforced these trends. These considerations helped inform our portfolio positioning as we came into 2022.
Let there be light
We hold a basket of renewable energy infrastructure funds, including NextEnergy Solar Fund (LSE: NESF), which look set to benefit from the current macroeconomic backdrop in two ways. First, around half of NESF’s revenues are derived from the sale of electricity. Electricity prices have increased fourfold over the past 12 months, and many renewable energy funds are beginning to lock in these prices via longer-term agreements. Its other source of revenue is government subsidies which, in the UK, are linked to the retail price index. The fund stands to profit from high inflation and any increase in long-term inflation forecasts will flow through to its net asset value (NAV).
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A tried and tested inflationary hedge
SPDR MSCI Europe Energy ETF (LSE: ENGY) is an exchange-traded fund (ETF) comprising the major European oil producers, including Shell, BP and Total. The European oil sector trades at seven times earnings, assuming a longer-term oil price of $80 per barrel. This level seems sustainable given rising annual demand and low levels of exploration. During the stagflationary period of the 1970s, the top performing stockmarket sectors were energy and materials. Technology and consumer staples – the stockmarket darlings of the recent past – lagged badly. This ETF could provide a hedge to such an environment.
Falling back on the basics
Taylor Maritime Investments (LSE: TMI) holds a portfolio of 30 modern dry-bulk carriers, which typically carry agricultural and industrial commodities. The market is under-supplied with these vessels and, unlike container ships, that shortage looks set to persist since few new deliveries are scheduled in coming years. This shortage translates to high charter rates: TMI’s portfolio is delivering average cash yields of 25% per annum, before depreciation. It has low leverage and trades at around a 10% discount to NAV.
Historically speaking, shipping has done well during periods of war, as war disrupts trade patterns, increasing shipping miles and therefore fleet utilisation. Dry-bulk carriers are also relatively insensitive to economic fluctuations since they transport staples such as grain, soybeans and iron ore. The fund targets a dividend of over 5% but has signalled that, due to elevated levels of cash generation, it may pay special dividends in the coming months.
Chris Clothier is co-manager of the Capital Gearing Trust.
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