KEY POINTS:
Stockmarkets hate uncertainty and richly reward the few investors who correctly see the future of an industry, an idea or a technology.
One of the biggest question marks facing the global economy today is how we can increase energy supplies by the additional 50 per cent forecast to be needed in the next 25 years and at the same time drastically lower our dependency on hydrocarbons, which currently provide 80 per cent of the world's energy needs.
This sort of talk, which reached a climax last year with the oil price hitting US$78.15 ($105.74) a barrel and petrol prices rising every second day, prompted one of my clients to threaten to sell his Westfield shares because "people would not be able to afford to drive to the supermarket".
Tim Bond, global asset allocation strategist of Barclays Capital, writing in Barclays 2007 Equity Gilt Study, reckons that to reconcile the increased energy needs of the developing world with the need to reduce CO2 emissions associated with climate change requires nothing short of an energy revolution.
Where Bond differs from our gloomy Westfield shareholder, however, is that he sees the change as being "highly stimulatory for the global economy".
But first, some background: since 1998 real oil prices have tripled. At the same time the scientific case that global warming is down to humanity has hardened. In a nutshell, the world has realised that the current supply of energy will not match demand and, worse still, the type of energy we do have is incompatible with our survival.
Things look bad, but do we sell or buy?
Bond starts by reciting the case for change: 65 per cent of CO2 emissions come from energy use and therefore that climate change policies restricting emissions are a certainty. Policy will price dirtier hydrocarbon fuels out of the market while pricing alternative clean sources in.
But the question for Mum and Dad, retired in Rotorua, is which horse to back and, equally importantly, how might high energy prices affect other asset classes?
The outlook is for very high and volatile energy prices, the very same situation which existed in the 1970s.
Bond points out that in that 10-year period most asset classes with the exception of oil and commodities produced very poor real returns: - 3.6 per cent a year for US bonds and 1.4 per cent a year for stocks. Average returns at these levels are daunting even for a "fund manager of the year".
In the 1970s high inflation caused by energy scarcity hurt returns from bonds as nominal interest rates rose to compensate for higher inflation, thus bond prices fell. But there was no respite in the stockmarket - at the same time shareprices fared badly too as price-earnings ratios ended the decade at half the level they started at.
Bond says we are in an interim stage where the framework for climatic change policies is still to be hammered out. Once that is done the price of clean energy producers will rise and that of hydrocarbon producers will fall.
"The 1970s was not a decade that rewarded extensive diversification. To judge from the distribution of returns across assets, energy scarcity was the dominant theme. In a market system, high returns are typically part of the signalling mechanism that diverts and prioritises capital flows into the areas that most require investment."
According to the International Energy Association, to meet forecast demand and maintain the existing infrastructure some $20 trillion of new funds is needed for energy investment between now and 2030, with the usage of coal growing the most in percentage terms.
These are huge numbers but Bond sees this as an opportunity rather than a threat and cites the 1990s when vast sums were raised to build the information technology economy.
Much of these funds were wasted on bad investments yet, five years after one of the biggest misallocations of capital in history, the global economy enjoyed its fastest pace of growth for 30 years.
So where is the $30 trillion going to come from?
Bond suggests that with a suitable policy framework, investment in alternative energy supply may become highly attractive to the large pools of pension-fund assets looking for stable, long-term, inflation-linked payouts.
Alternative energy like building a hydroelectric station in Scotland or a wind turbine in Southland is a lot less risky than a drilling rig in Iraq. Furthermore, much of the risk of alternative energy derives from the fact that everything is priced relative to oil which, due to unfortunate geology and geography, is highly volatile.
All of the world's historical changes in energy supply - from dung to wood to coal to oil - were followed by stronger economic growth.
So what does all this mean for Mum and Dad saving for retirement?
Bond concludes that the outlook for the next few years will be dominated by the twin energy themes, high levels of risk and, if you get it right, high returns. To mobilise and attract funds the alternative energy sector will need to offer high returns.
Bond recommends overweighting energy stocks in portfolios and finishes with the cheerful observation that if the energy revolution doesn't happen then nothing else will.
* Brent Sheather is a Whakatane-based investment advisor.
