Watt – No charge?

With 17 new wind farm projects planned for Scotland adding an additional 25GW generating capacity, the UK’s offshore wind power capacity is projected to more than double. In 2022, the government set an ambitious target to increase the UK’s offshore wind capacity to 50GW by 2030, so the planned wind farms are a major boost.

This forms part of the UK’s path to net zero by 2050 and while there are many pathways to achieving this goal with nuclear and hydrogen likely to play a part, at the end of the day, to deliver net zero will require a marked shift to electrification in the UK.

Tomorrow’s electricity system will be significantly bigger than today’s, to cope with the growth of electric vehicles (EVs) and heat pumps. However, the supply side will be dominated by intermittent renewables, principally wind and solar. Flexibility in the system will become even more important. Already, the Demand Flexibility Service has been developed when national energy demand is at its highest-during peak winter days where some customers are incentivised for voluntarily flexing the time when they use their electricity.

The Government’s Energy Digitisation Task Force estimates that by 2035 there could be over 27million EVs in the UK, equivalent to three nuclear power stations. The grid is likely to need 20 to 30 gigawatts of flexibility by then, so could electricity be sent back into the network when demand is high? In order to do so, a major overhaul of Britain’s electricity network will be required with the development of regional grid plans, greater data sharing and a joined-up way for households to help supply energy back into the grid from their new smart devices.

As we have highlighted previously, one of the challenges for the grid is electricity storage.  However, it also now appears a lack of power cables between Scottish wind farms and the rest of the UK is also to blame for power wastage on the windiest days. Only one major undersea cable and two main junctions connect the UK grid to offshore power generation. As a result, on the windiest days power bottlenecks can arise which require some turbines to be turned off to prevent damage!

Energy storage looks set to be a large part of the UK’s electrification flexibility space. It is also becoming a more significant asset class for investors particularly those with an ESG (Environmental, Social and Governance) stance.  Interestingly, in last week’s Budget Chancellor Jeremy Hunt confirmed that nuclear energy will now be classed as ‘environmentally sustainable’ for tax purposes to encourage investment. Given the size of investment required and lengthy-time scale such as Hinkley C, will that be enough to attract new investors?  At least the Government has recognised the promise of small modular reactors, such as those being developed by Rolls Royce.

 

What have we been watching?

On Wednesday last week the UK market had its worst daily performance since the Covid-19 pandemic as fears of a fresh banking crisis swept through global markets. There were also large falls in commodities with Brent oil dropping to $70. Markets were already jittery due to the collapse of two US banks but the catalyst for Wednesday’s crash was concerns about European investment bank Credit Suisse as its biggest shareholder, Saudi National Bank said it could not provide any further financial support prompting a 30% fall in the shares. A measure of calm was restored when Credit Suisse subsequently announced it would borrow $54bn from the Swiss central bank to shore up its finances. Over the weekend, the Swiss central bank brokered a deal where UBS is to take over Credit Suisse for $3.2bn which will include government guarantees. While the action by the Swiss authorities was welcomed, there was a ‘sting in the tail’ which has led to continued weakness in markets this morning. The rescue deal will lead to a $17bn write-down in the value of Credit Suisse AT1 bonds, so a cause of angst for some fixed income investors. Meanwhile, central banks have moved globally to keep credit flowing. The US, Canada, UK, Swiss, European and Japan central banks are to boost the flow of US dollars through the financial system.

When there is an earthquake there is usually a series of after-shocks and the same is probably true of the global banking sector, where investors will no doubt wait for the dust to settle with a fear of a run on some smaller US regional or distressed banks. Central banks have a real task on their hands now – tackling inflation and avoiding contagion risk within the banking sector. The banking sector does feel like a game of ‘whack-a-mole’ at the moment!

The US saw the second and third largest bank failures since the financial crash within three days of one another. Signature Bank became the latest US bank to be closed by regulators.  The US Treasury Department and banking authorities took swift action to prevent a risk of a run on other smaller regional US banks but their bigger US counterparts are reported to be seeing a rush of depositors fearful the crisis will spread. Analysts estimate that the percentage of deposits that are insured has fallen to about 50% in recent years. At Signature just 10% of deposits were insured. Not surprising therefore that those depositors without insurance protection are moving their cash to bigger US banks. There are reports that federal home loan banks which serve as a funding backstop for regional US banks are looking to raise money as they are seeing higher-than -usual demand for funds. Markets remain wary of other potential unrealised losses at other regional US banks. SVB’s failure appears largely specific to the funding crisis facing its niche tech client base and the foolishness of management’s treatment of available-for-sale (AFS) securities. However, at the end of last week, some of the largest American banks banded together to deposit $30bn into First Republic in attempt to bolster its finances.  

The problems in the US banking system also led markets to re-assess the likely pace of future interest rate hikes by the Federal Reserve (Fed), with some even expecting it to pause for breath at its next meeting. This led to the biggest two-day fall in US two-year bond yields since 1987. Previous big moves down in US bond yields have occurred during periods of historic financial market and economic distress. SVB is not the first seismic shock from higher bond yields and lower money supply (LDI pension problem in the UK arguably was), but markets are still concerned that it may not be the last.

Beyond the banking crisis, US and Russian relations sank to a new low as the two nations became embroiled in a fresh row after an American drone was downed over the Black Sea, near Snake Island. Given authorisation is believed to have come from the Kremlin, is this a provocative action to convince NATO and the US that Russia is prepared for a protracted war in Ukraine?

Not surprisingly, the UK Budget was completely overshadowed by the global banking crisis. Chancellor Jeremy Hunt’s tenure last Autumn began with a die-hard attempt to stabilise the public finances and with them, UK financial markets which were in panic mode thanks to Kwasi Kwarteng/Liz Truss. Last week’s Budget was an attempt to deliver long-term sustainable economic growth via supply-side measures including new investment allowances, more assistance with childcare costs and scrapping tax-free limits on personal pension pots to discourage early retirement, the latter aimed at doctors. The £2,500 Energy Price Guarantee has been extended for a further three-months. However, the tax burden will climb to a new record high since the Second World War and nearly 6million people will be dragged into higher tax bands by stealth. Given the scale of industrial action in the UK, the other key points in the Budget were that inflation is expected to plummet from over 10% to under 3% with recession avoided.

The European Central Bank (ECB) stuck to its guns with a 0.5% interest rate hike to 3.5% and sees inflation as ‘too high for too long.’ The ECB is not offering guidance on interest rate policy but suggests future moves will be ‘data dependent.’

US inflation was 6% over the twelve months to February, down from 6.4% the previous month and in line with expectations.

Read our latest Chinese investment insights from Alpha PM

 

China’s retail sales re-bounded in January and February with growth of 3.5% as the country abandoned its zero-Covid policy.

Read our latest investment insights from Alpha PM

 

Bank sector woes and implications for the global economy fed into the oil market with Brent oil falling to $70. What will OPEC+ do? Presumably, the oil cartel will wait and see how central banks respond to the banking crisis.

Finally, talking of the UK’s shift to electric vehicles, another law of unintended consequences? Caravan parks in the South West have warned the government they will not be able to cope with the rising number of holidaymakers with electric cars. One site near Weston-Super-Mare has a thousand caravans but only three electric charging points and the owner has been told the National Grid can only support a few more. Holiday parks tend to be in remote coastal locations where a massive upgrade to infrastructure would be required. Electric car drivers unable to re-charge their vehicle could in the future end up on a true stay-cation!

 

Read Last Week’s Alpha Bites – When the balloon goes up

 

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