Outlook Snapshot

Cyan Investment Management

July-August 2022

Outlook
 
As illustrated by the extreme share price movements, the market is still grappling with how to treat the global and domestic macro issues of Central Banks handling of inflationary threat and the resulting economic landscape (not to mention ongoing geopolitical risks). These are the macro influences that are almost impossible to accurately forecast. For that reason, we focus more at the micro, or company, level. Obviously, the macro environment causes associated issues at the company level, including costs pressures, supply chain, business confidence, consumer confidence and discretionary spending levels. These challenges will abate over time, but need to considered and respected in the short-term.
 
What we can say is, the companies in which we are invested are, generally speaking, delivering to our expectation, emerging from the current challenges and are well positioned for the next 12 months.
 
We still see a gap between price and value in many of our holdings. However, with sentiment feeling more positive, and with reporting season approaching, we hope that some of that inherent value will be released in the short to medium term as the market re-focuses on quality, growing companies and fundamental research. Hopefully sentiment remains positive for a period of time.
 
We welcome the upcoming reporting season and expect some key themes to emerge. It is likely that management will be non-committal in regard to forward-looking statements, so we have positioned the portfolio towards well capitalised businesses with a growth ambition. In the short-term there is likely to be a focus on cost-control with a medium-term view to growth. Consumer-facing business will be closely watched.

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Nuclear energy is a promising solution for climate change

Magellan Asset Management

August 2022

Fukushima, on the northeast of Japan's largest island, is vulnerable to earthquakes and tsunamis. From 1971, the area hosted the Daiichi nuclear plant. Based on global appraisals of tsunamis, the facility was built 10 metres above sea level. The commercial plant and others ensured nuclear energy supplied 30% of Japan's power needs.[1]

That is until an earthquake of magnitude 9.0 on the Richter scale struck in 2011. An ocean surge, which peaked offshore at 23 metres, was still 15 metres high when it swamped three reactors at the Daiichi plant. Radioactive material escaped for six days. More than 2,300 people died and over 100,000 were evacuated.[2] Japan was paralysed by what the chairman of a parliamentary inquiry described as "a profoundly man-made disaster".[3]

Tokyo reacted to the alarm of a public who watched on TV as the tsunami smashed into land. Within a year, only one of Japan's 54 nuclear reactors was operating.

Enthusiasm for nuclear power, which reached a peak of 17% of global energy production in 1996,[4] dimmed around the world.[5] Germany immediately decided to phase out its 17 nuclear plants by 2022. Only three remain but it looks like Europe's energy crisis could delay their closure. In the rest of Europe, the drive to nuclear power stalled such that Italy, Lithuania and nearby Kazakhstan have ditched nuclear while Finland in March opened the continent's first new nuclear plant in 15 years. The US has opened only one reactor (in 2016) since 1996.

Reduce one risk but still face another. That danger is climate change. The UN-overseen Intergovernmental Panel on Climate Change warned in April the world is "at a crossroads" in its quest to halve emissions by 2030 to limit the rise in the earth's temperature.[6] The obstacles? Voters oppose carbon taxes. Renewable energy is struggling to match fossil fuels as a source of 'baseload' power on reliability and cost. Declining investment in fossil fuels has boosted hydrocarbon prices. Russia's invasion of Ukraine in February further bolstered oil and gas prices while exposing Europe's reliance on Russian energy as a liability. 'Energy security' has gained renewed political significance.

What to do? A large part of the answer could be nuclear energy, which is generated in a process known as fission - when uranium or plutonium atoms are split to release heat that makes steam to spin turbines.[7] Even though radioactive waste is produced during fission that can last forever,[8] policymakers are talking of adding to the 439 reactors in operation across 32 countries (while another 54 reactors are being built) that still supply about 10% of the world's energy needs.[9]

The talk is generating action. The US in April announced a US$6 billion effort to prevent more closures among the country's 94 reactors sprinkled across 56 plants that make the US the world's largest generator of nuclear power. Since 2013, 12 US reactors have closed 'early' and another 11 reactors are scheduled to shut by 2025.[10] Nuclear power, first tapped in the US in 1958, has supplied about 20% of US electricity generation since 1990.[11]

Europe too is reemphasising nuclear. The UK in April said it would build as many as eight new nuclear plants by 2030.[12] In February before Ukraine was invaded, French President Emmanuel Macron said the world's second-most nuclear-powered country (56 reactors that supply 70% of the country's electricity) needed 14 new reactors by 2050.[13] Earlier the same month, the European Commission added nuclear energy to a list of sustainable energy sources that are valid replacements for fossil fuels.[14] In July, the European Parliament backed the EC decision.[15] Asia hosted all the world's new nuclear capacity in 2021 and more is coming.[16]

It's easy to see why leaders are attracted to nuclear energy. As long as countries can source uranium or plutonium, the nuclear option offers energy self-sufficiency and is the lowest-cost greenhouse-gas-free energy - one that is cheaper than all but the lowest-cost fossil fuels. OECD analysis, which assumes long-lasting nuclear plants will spread fixed costs and adds a carbon price of US$30 per tonne of CO₂ onto the cost of fossil fuels, estimates nuclear energy could cost as little as US$30 a megawatt hour compared with US$45 for gas and US$75 for coal.[17]

Two promising developments could make nuclear more appealing. The first is the coming of commercial mini-nuclear reactors.[18] These mini-reactors would produce between 300 megawatts (small) and 700 megawatts (medium) of power compared with at least 1,000 MW electrical (MWe) produced by standard-sized reactors.

The advantages of mini-reactors are lower initial capital costs, less-complex design and that they take only four years to build rather than the decade needed for standard facilities. Mini-reactors can be built and shipped, thus are a better option for remote areas. They are safer because they require no manpower or electricity to shut down.[19] They produce less waste. They are cheaper to decommission. The International Atomic Energy Agency says there are about 50 designs for mini-reactors and four are close to being finished in Argentina, China and Russia.[20] Rolls-Royce says it can have 470 MWe mini-reactors connected to the UK grid by 2029.[21]

The second development is nuclear fusion. Whereas in nuclear fission an atom is split, fusion is combining atoms (using special hydrogen, deuterium and tritium as fuel). When fusion occurs, the difference in mass between nuclei and the newly formed heavier-but-lower-mass atom is released as energy. It takes special machines (tokamaks) or lasers to generate the intense heat and powerful magnetic forces required to produce an energy so powerful that one litre of fusion fuel matches 55,000 barrels of oil for energy.[22]

Breakthroughs are occurring in mimicking the energy source of the Sun and stars. In the UK in February, a fusion reactor produced a world record of 59 megajoules of heat energy over five seconds, more than double the previous record of 22 megajoules set in 1997.[23] In the US last September, a superconducting magnet needed in fusion broke magnetic field strength records during trials.[24] A month earlier in the US, laser light created enough heat to generate a record yield of laser fusion; 10 quadrillion watts of fusion power for 100 trillionths of a second.[25]

Aside from producing greenhouse-gas-free energy, fusion comes with two other notable advantages. One is that fusion eradicates the risk of a nuclear meltdown because, if disturbed, the process stops. The other is that no radioactive waste is produced. Fusion research is expensive, however, and advances whereby fusion reactors offer the world affordable power seem far off and might never happen.

That's the best hope too for the devastation that nuclear energy risks. Accidents that include Three Mile Island in the US in 1979, Chernobyl in the former Soviet Union in 1986 and Fukushima are blamed on human error. A possible calamity occurred in March when Russian shelling started a fire at the Zaporizhzhia nuclear plant in Ukraine, which with six reactors is Europe's largest. The incident highlighted the vulnerability of nuclear facilities to war, terrorism, suicidal rage or rogue states turning a nuclear plant into a military base, as Russia has now done with Zaporizhzhia.[26] Many say ageing nuclear facilities pose a threat. Nearby Germans have long had concerns about the state of the Tihange nuclear plant in Belgium. The regional German government has called for the plant to be closed.[27]

Nuclear energy's risk tied to the internet age is cybersecurity. The US and Israel in 2010 used Stuxnet malware to interfere with Iran's Natanz plant while a nuclear plant in Germany was reported to have suffered a "disruptive" cyberattack about a decade ago.[28] While the threat might be exaggerated by opponents of nuclear energy, it adds to political challenges of gaining public support for the nuclear option.[29]

Even with all the risks, nuclear energy is an established source of power that will gain traction as an answer for climate change, especially if more technological leaps are made. Nuclear energy might be most notable for how its adoption will vary across countries as communities judge their tolerance for the risks surrounding the most-promising energy solution to mitigate global warming.

To be sure, nuclear is not touted as the sole solution for climate change. Leaps in renewable technology or its economics could undermine the need for nuclear. But the reverse could apply too. The shift to more nuclear could take too long to contain the rise in the earth's temperature to 2 degrees Celsius. Nuclear energy, with its huge initial investment, might never match the lowest-cost fossil fuels, especially if plants are excessively regulated to soothe public concerns about safety. Some countries such as Australia and Germany are against nuclear though the energy crisis could change that.[30] Russia exports nuclear technology so its isolation might slow the industry's development. Any nuclear-building spree comes with risks and no doubt cost overruns (a problem too when upgrading ageing facilities). Against this, only three notable accidents in more than six decades is a fair safety record for any industry.

Energy security is what gives nuclear energy fresh appeal. Expect more policymakers to push for nuclear. It's just that the next nuclear mishap - and human error, even malevolence, almost guarantees one - might, Fukushima-style, set back the best option to mitigate climate change on every measure but safety.

Heavier but less mass

Tokamak is a Russian acronym that stands for the 'toroidal chamber with magnetic coils' that was developed in the Soviet Union in the late 1960s. The machine contains a large doughnut-shaped vacuum chamber where a few grams of hydrogen fuel are heated to 150 million degrees Celsius to form a substance known as plasma. This substance allows electrons to roam between different nuclei so they can collide and fuse. The challenges include having sufficient plasma particle density to increase the likelihood that collisions occur and enough confinement time to hold the plasma, which has a propensity to expand, within a defined volume. Within the tokamak, magnetic fields are used to confine and control the plasma.[31]

The process is seeking to capitalise on the insights of UK physicist Arthur Eddington (1882-1944).[32] Eddington observed that four hydrogen atoms weigh more than one helium atom. He surmised that if four hydrogen nuclei were fused then some mass must be lost in the process. According to Einstein's famous equation E=MC², that lost mass must become energy that amounts to the mass lost multiplied by the speed of light. Eddington's brilliance, as revealed in his book Internal constitution of the stars in 1925, was he deduced that hydrogen crashing into hydrogen to form helium under immense gravitational forces is how the Sun and stars produce energy (shine).[33]

The hope of many scientists nowadays is that nuclear fusion is the solution to climate change, even the world's energy needs. Many have tried since the explosion of a hydrogen bomb in 1952 to crack nuclear fusion as a source of power.

The world's biggest experiment underway to achieve nuclear fusion is the International Thermonuclear Experimental Reactor, or ITER, Project that groups China, the EU, India, Japan, Korea, Russia and the US.

ITER's first plasma experiment is scheduled for 2025, 15 years after building the facilities began on a site in the south of France. With 10 times the plasma volume of the largest machine operating now, the ITER tokamak is designed to move on from small-scale fusion experiments.

The key quest is to get fusion to reach the point where the energy output from the fusion reaction matches the energy needed to create the conditions that sustain the fusion reaction. A later goal of ITER is to attain 10 times the energy output, which would mean that 50 megawatts of heating power could become 500 megawatts of fusion power.^[34]

If scientists at ITER or elsewhere achieve these and other feats, nuclear fusion could well power the world. No breakthroughs away from ITER appear imminent while the ITER results won't be known for decades and might prove fruitless. In the meantime, nuclear fission conducted in mini-reactors might be the best option for those countries willing to risk using nuclear power to combat climate change.

Number of nuclear reactors by country

Author: Michael Collins, Investment Specialist

Funds operated by this manager:

Magellan Global Fund (Hedged), Magellan Global Fund (Open Class Units) ASX:MGOC, Magellan High Conviction Fund, Magellan Infrastructure Fund, Magellan Infrastructure Fund (Unhedged), MFG Core Infrastructure Fund

[1] World Nuclear Association. 'Fukushima Daiichi disaster.' Updated April 2021. world-nuclear.org/information-library/safety-and-security/safety-of-plants/fukushima-daiichi-accident.aspx

[2] The earthquake and tsunami are estimated to have killed nearly 20,000 people.

[3] The National Diet of Japan. 'Official report of the Fukushima Nuclear Accident Independent Investigation Commission.' 2012. Chairman Kiyoshi Kurokawa. Page 9. web.archive.org/web/20120710075620/http://naiic.go.jp/wp-content/uploads/2012/07/NAIIC_report_lo_res.pdf

[4] Britannica. 'Nuclear power.' britannica.com/technology/nuclear-power. See also International Atomic Energy Agency. 'Nuclear power status in 1996.' 24 April 1997. iaea.org/newscenter/pressreleases/nuclear-power-status-1996

[5] See Bulletin of Atomic Scientists. 'Nuclear power and the public.' 3 August 2011. thebulletin.org/2011/08/nuclear-power-and-the-public/ t

[6] Intergovernmental Panel on Climate Change. Sixth assessment report. Media release. 'The evidence is clear: The time for action is now. We can halve emissions by 2030.' 4 April 2022. ipcc.ch/report/ar6/wg3/resources/press/press-release/

[7] See 'Nuclear 101: How does a nuclear reactor work?' US Department of Energy. 29 March 2021. energy.gov/ne/articles/nuclear-101-how-does-nuclear-reactor-work

[8] Plutonium-239 has a half-life of 24,000 years while strontium-90 and cesium-137 have half-lives of about 30 years (half the radioactivity will decay in 30 years). See US Nuclear Regulatory Commission. Last reviewed 23 July 2019. nrc.gov/reading-rm/doc-collections/fact-sheets/radwaste.html

[9] IAEA. 'The database on nuclear power reactors.' World statistics. These reactors amount to 393,818 megawatt electrical total net installed capacity, while those being built promise 53,744 MW_e more capacity. In Asia, countries building reactors are China (16 under construction), India (six), Japan (two to add to 33 operational reactors), and Korea (four). Two more countries are poised to host nuclear power when the plants under construction are built. Last updated 18 July 2022. pris.iaea.org/pris/

[10] US Department of Energy. 'DOE seeks applications, bids of $6 billion civil nuclear credit program.' 19 April 2022. energy.gov/articles/doe-seeks-applications-bids-6-billion-civil-nuclear-credit-program

[11] US Energy Information Administration. 'Nuclear explained. US nuclear industry.' Last updated 21 April 2021. Figures are for the end of 2020. eia.gov/energyexplained/nuclear/us-nuclear-industry.php

[12] BBC. 'Energy strategy: UK plans eight new nuclear reactors to boost production.' 7 April 2022. bbc.com/news/business-61010605. See UK government. 'Nuclear energy: What you need to know.' 6 April 2022. gov.uk/government/news/nuclear-energy-what-you-need-to-know

[13] France 24 news services hosting article by Agence France-Presse. 'Macron calls for 14 new reactors in nuclear 'renaissance'. 10 February 2022. france24.com/en/live-news/20220210-macron-calls-for-14-new-reactors-in-nuclear-renaissance

[14] European Commission. 'EU Taxonomy: Commission presents Complementary Climate Delegated Act to accelerate decarbonisation.' 2 February 2022. ec.europa.eu/commission/presscorner/detail/en/ip_22_711

[15] European Parliament. 'Taxonomy: MEPs do not object to inclusion of gas and nuclear activities.' 6 July 2022. europarl.europa.eu/news/en/press-room/20220701IPR34365/taxonomy-meps-do-not-object-to-inclusion-of-gas-and-nuclear-activities

[16] IAEA. 'Nuclear power reactors in the world.' 2022 edition. pub.iaea.org/MTCD/Publications/PDF/RDS-2-42_web.pdf. Page 2.

[17] Organisation of Economic Cooperation and Development with the International Energy Agency and the Nuclear Energy Agency. 'Projected costs of generating electricity 2020 edition.' Page 14. oecd-nea.org/upload/docs/application/pdf/2020-12/egc-2020_2020-12-09_18-26-46_781.pdf. See World Nuclear Org. 'Economics of nuclear power.' Updated September 2021. world-nuclear.org/information-library/economic-aspects/economics-of-nuclear-power.aspx

[18] The US military first used smaller reactors in 1962. World-nuclear.org. 'Small nuclear power reactors.' Updated December 2022. world-nuclear.org/information-library/nuclear-fuel-cycle/nuclear-power-reactors/small-nuclear-power-reactors.aspx

[19] TIME. 'As Putin threatens nuclear disaster, Europe learns to embrace nuclear energy again.' 22 April 2022. time.com/6169164/ukraine-nuclear-energy-europe/. See 'Table 1. Safety enhancement and cost reduction benefit-challenges analysis.' Page 16. International Atomic Energy Agency TECDOC series. 'Benefits and challenges of small modular fast reactors.' 2021. pub.iaea.org/MTCD/Publications/PDF/TE-1972web.pdf

[20] International Atomic Energy Agency. 'Small modular reactors.' iaea.org/topics/small-modular-reactors

[21] 'Green light for mini-nuclear reactors by 2024, says Rolls-Royce.' The Telegraph of the UK. 19

April 2021. telegraph.co.uk/business/2022/04/19/green-light-mini-nuclear-reactors-2024-says-rolls-royce/

[22] Bloomberg News. 'Nuclear fusion could rescue the plant from climate catastrophe.' 29 September 2019. bloomberg.com/news/features/2019-09-28/startups-take-aim-at-nuclear-fusion-energy-s-biggest-challenge. For the same mass of material, fusion produces four times more energy than fission. International Thermonuclear Experimental Reactor, or ITER, Project. 'Advantages of fusion.' Undated. iter.org/sci/Fusion

[23] ITER Newsline. JET makes history, again.' 14 February 2022. org/newsline/-/3722

[24] Massachusetts Institute of Technology. 'MIT-designed project achieves major advance towards fusion energy.' 8 September 2021. news.mit.edu/2021/MIT-CFS-major-advance-toward-fusion-energy-0908

[25] National Ignition Facility. 'National Ignition Facility experiment puts researchers at threshold of fusion ignition.' 18 August 2021. llnl.gov/news/national-ignition-facility-experiment-puts-researchers-threshold-fusion-ignition

[26] 'Russia's army turns Ukraine's largest nuclear plant into a military base.' The Wall Street Journal. 5 July 2022. wsj.com/articles/russian-army-turns-ukraines-largest-nuclear-plant-into-a-military-base-11657035694

[27] John Kampfner. 'Why Germans do it better.' Atlantic Books. Paperback edition 2021. Pages 252 to 253.

[28] Infosec. 'Cyberattacks against nuclear plants: A disconcerting threat.' 14 October 2016. resources.infosecinstitute.com/topic/cyber-attacks-against-nuclear-plants-a-disconcerting-threat/

[29] Public opposition to waste solutions is always a hurdle. See 'The nuclear power dilemma: Where to put the lethal waste.' The big read. The Financial Times. 6 February 2022. ft.com/content/246dad82-c107-4886-9be2-e3b3c4c4f315

[30] See 'Why Germany is resisting calls to ease energy crunch by restarting nuclear power.' 20 April 2022. Germany along with Austria, Denmark, Luxemburg and Portugal even opposed the EU adding nuclear to the taxonomy. ft.com/content/229c21c7-991c-4b44-a2f9-20991670a4ba

[31] ITER Project. 'What is fusion?' and 'What is a tokamak?' sections. iter.org/proj/inafewlines#3

[32] Britannica. 'Arthur Eddington, British scientist.' britannica.com/biography/Arthur-Eddington

[33] Rivka Galchen. 'Can nuclear fusion put the brakes on climate change?' The New Yorker. 4 October 2021. newyorker.com/magazine/2021/10/11/can-nuclear-fusion-put-the-brakes-on-climate-change

[34] Daniel Andruczuyk, associate research professor, nuclear, plasma and radiological engineering at the University of Illinois Urbana-Champaign. 'Will nuclear fusion ever power the world?' 28 December 2021. gizmodo.com/will-nuclear-fusion-ever-power-the-world-1848149991.

Important Information: This material has been delivered to you by Magellan Asset Management Limited ABN 31 120 593 946 AFS Licence No. 304 301 ('Magellan') and has been prepared for general information purposes only and must not be construed as investment advice or as an investment recommendation.  This material does not take into account your investment objectives, financial situation or particular needs. This material does not constitute an offer or inducement to engage in an investment activity nor does it form part of any offer documentation, offer or invitation to purchase, sell or subscribe for interests in any type of investment product or service. You should read and consider any relevant offer documentation applicable to any investment product or service and consider obtaining professional investment advice tailored to your specific circumstances before making any investment decision. A copy of the relevant PDS relating to a Magellan financial product or service may be obtained by calling +61 2 9235 4888 or by visiting www.magellangroup.com.au.

Past performance is not necessarily indicative of future results and no person guarantees the future performance of any strategy, the amount or timing of any return from it, that asset allocations will be met, that it will be able to be implemented and its investment strategy or that its investment objectives will be achieved. This material may contain 'forward-looking statements'. Actual events or results or the actual performance of a Magellan financial product or service may differ materially from those reflected or contemplated in such forward-looking statements.

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Hedge Clippings | Friday, 26 August 2022

Newly minted Treasurer Dr. Jim Chalmers set the proverbial cat amongst the superfund pigeons this week by proposing that an (unspecified) portion of all super balances should be invested in "national priorities" - areas like "housing and energy". To ensure his point was made, he was supported by Paul Keating, the self styled grandfather and co-creator of Australia's compulsory superannuation system.

Hedge Clippings can see some merit and logic in this - in fact we have previously proposed that given super's long-term investment timeframe of up to 45 years or more, and the long-term investment needs and nature of infrastructure, the $3.4 trillion in super (forecast to grow to over $9 trillion by 2040, and $34 trillion by 2061) makes an ideal source of capital. Added to that, infrastructure as an asset has the attractive investment characteristics of steady long term income and growth, and in Australia at least, a stable political environment. Whilst slightly out of date (actually we couldn't find any date on the report, except at that stage the total in super was a mere $1.7 trillion) this report by the Financial Services Council and EY considered the issue in detail.  

However, the difficulty, as pointed out by a number of super funds and their trustees, is that they're responsible for returns, not national priorities such as housing and energy. This argument falls down of course when one considers the emphasis on the ESG credentials of many funds, and the fact that they're the beneficiaries of a government legislated stream of fees akin to Norman Lindsay's Magic Pudding. Chalmers will argue, with some justification, that given the government's role in supplying the pudding's recipe, plus its generous (but complex and changeable) tax concessions ingredients, that they're entitled to stipulate how and where it is invested.

Up to a point Lord Copper, as Mr. Salter would say. The danger of giving politicians of the day the power to direct which "national priorities" are important is obvious. One would imagine Scomo's priorities for instance might be somewhat different to someone (probably anyone) else's.

Moving on.  

Last week we noted that a strategy paper delivered at the Portfolio Construction Forum (PCF) by Marko Papic put forward the view that President Xi would not invade Taiwan as it would cause China itself too much damage - political, military, economic and social. One alert reader of Hedge Clippings (thank you!) pointed out that the same Marko Papic had apparently prepared a similar presentation for the February PCF, espousing the view that Putin would not invade Ukraine as it would cause Russia itself too much damage - political, military, economic and social. Needless to say, as the Russians invaded Ukraine on 24th February, and the PCF was held on the 25th, we understand there was some deft adjustment to the agenda. This time around we hope his thesis is correct, but hope, as they say, is not a reliable strategy.

Which brings us to anniversaries: As above, his week the war in Ukraine passed the six month mark, when most - but particularly Putin - thought his "military exercise" would be over in weeks. Sadly, next week also brings up the 25th anniversary of the death of Diane, Princess of Wales. But on a happier note, (for those old enough to remember) August 24th was the 50th anniversary of one of the greatest rock concerts of all time - Neil Diamond's "Hot August Night" held at the Greek Theatre in Los Angeles. The resulting live recording was made into a double album running over an hour and a half. Here's a link to Crunchy Granola for old time's sake.

It must be the cry of generations: Oh! for the days when music was music!

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Could the US Supreme Court's decision against the EPA derail decarbonisation efforts?

4D Infrastructure

August 2022

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The content contained in this article represents the opinions of the authors. The authors may hold either long or short positions in securities of various companies discussed in the article. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely as an avenue for the authors to express their personal views on investing and for the entertainment of the reader.