Sustainability

Trends Summer 10 Sustainability

A Credit Suisse Megatrend

Daniel Kurz, Thematic Strategist, CIO Office

Sustainability refers to the capacity Historically, notwithstanding the most dangerous words in invest- to endure. This publication’s look at nearly seven-fold increase in the ment? Has our large initial endow- sustainability will focus solely on one world’s human population over the ment of various resources, especially theme of this multifaceted mega- past 200 years, cyclically rising re- fossil fuels, made technological ad- trend, namely on the resources from source prices inevitably revisited vances possible, or was it technology which people derive the energy and their centuries’ old secular down- that unleashed a resource bounty? food to carry forward our way of life. ward trajectory. As expected, high There are increasingly prevalent Population explosion-based demand prices triggered heightened resource signs, like diminishing energy returns growth coupled with rising resource exploitation investments while tech- on energy invested (EROEI) and pro- prices have, once again, raised re- nological advances allowed for pro- found groundwater depletion issues, source depletion issues. Yet this ductivity enhancements. Falling real that we are indeed exploiting key re- same siren song has been sung nu- commodity prices followed. sources such as oil, water aquifers, merous times before by so-called and soil at unsustainable rates (see “Malthusians,” who have warned of Going forward, dare we assume that chart 1 concerning oil). This implies resource shortages owing to geo- “this time is different,” verbiage that that technology has primarily allowed metric population increases accom- Sir John Templeton called the four us to exploit resources more quickly panied by only arithmetic increases in the food supply (http://www.esp. Chart 1: Energy consumption growth exceeding population growth org/books/malthus/population/mal- +600% thus.pdf). since 1950

Oil Oil Oil

Oil Oil Oil Oil

Oil Coal Pop.: Pressure on Resources 6.8 bn Pop.: Pop.: Pop.: 2.5 bn +172% Population: 980 m 310 m since 1950 200 m

1 AD 1000 AD 1800 1950 2008 Population Growth Increased consumption and demand Thomas Malthus, 1766-1834 Source: World Urbanization Prospects, 2007 Revision

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rather than provided us with more Chart 2: Global coal energy production in million tons of oil equivalents resources. In a nutshell, that is our M toe resource sustainability dilemma. It is 5000 also our “call to arms” for expanded energy infrastructure investment and WEO 2006: Reference scenario greater resource usage efficiency. 4000

Energy dependency WEO 2006: Alternative scenario As clearly depicted in chart 1, especially East Asia 3000 since 1950, there has been an asym- lignite Africa FSU metrical increase in energy consumption lignite lignite subbituminous relative to population growth as deter- subbituminous bituminous mined by oil used (oil was 34.0% of the 2000 China world’s primary energy in 2007). This also bituminous bituminous holds true for coal consumption (coal was South Asia 26.5% of the world’s primary energy in 1000 OECD Pacific lignite lignite 2007), as can readily be inferred from bituminous bituminous OECD Europe chart 2. OECD North America subbituminous bituminous lignite 0 Meanwhile, fossil fuels still comprised 1950 2000 2050 2100 81.4% of the world’s primary energy (see Year chart 3) as of 2007, down from 86.6% World Economic Outlook (WEO) Reference Scenario: the projected trajectory of global coal energy consumption 34 years earlier, with nuclear power filling Source: Energy Watch Group (EWG), www.bgr.bund.de/ most of the resulting fossil fuel share re- duction gap.

Why are sufficient energy and expand- Chart 3: World’s primary energy consumption and breakdown in Mtoe ing energy supplies so vital to sustaining 1973 2007 our global economy and to underpinning Combustible waste is nothing more than a per capita global GDP growth? Because 6 115 Mtoe byproduct of fossil fuels; 12 029 Mtoe lasting economic growth can only occur run out of fossil fuels, run with the energy leverage derived by shift- out of waste to burn ing from manual labor to machinery and equipment.

The linkage between sustainable GDP growth – which requires productiv- ity growth – and energy consumption growth is quite intuitive. It boils down to the fact that large amounts of dense en- Other* 0.1% Coal/peat 24.5% Other* 0.7% Coal/peat 26.5% ergy (much energy per unit volume), gen- Oil 46.1% Gas 16.0% Oil 34.0% Gas 20.9% erally fossil fuel in nature, are required Nuclear 0.9% Hydro 1.8% Nuclear 5.9% Hydro 2.2% for virtually every aspect of modern, in- Combustible renewables & waste 10.6% Combustible renewables & waste 9.8% creasingly information-based economies * Other includes geothermal, solar, wind, heat, etc. Mtoe = million of tons of oil equivalent including: Source: IEA, Key World Energy Statistics, 2009

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 Construction and maintenance of infrastructure that allows for oil exploitation, mining, electricity generation, water availability, IT, transportation, and manufacturing  Mechanized agriculture  Transportation  Generation of services and production of all goods  “Leveraged output”

To gain additional perspective into both leveraged output and energy dependency, consider that farming without tractors and fossil fuel-based fertilizers would be the equivalent of a huge crop yield contrac- energy consumption. For perspective, plex to replace aging pipelines, rigs, and tion. Construction without excavators contemplate that replacing the 250m platforms. It is telling that in nearly each and backhoes would result in hugely in- strong US vehicle fleet would require ap- of the past 45 years, we’ve found only a creased labor requirements, as occurred proximately 10.5bn barrels of oil, or one- small fraction of the 48bn barrels of oil in India in the summer 2008 when oil third of annual global oil consumption. that were found in peak year 1964. Over became unavailable and thousands of Or, consider that in 2009 the OECD the same time period, annual oil con- shovel-wielding workers stepped in only projected USD18trn in worldwide en- sumption has risen by more than 150%, to accomplish a fraction of the mecha- ergy infrastructure investments over the from 12bn barrels to over 31bn barrels nized work. Manufacturing assembly lines next 20 years. Notably, others have pre- today. Therefore, it is clear that plenty without electricity would result in a col- dicted that an (energy-intensive) multi- of energy sector capital spending will be lapse in output and efficiency. ple of that dollar amount will need to be called for (Charles T. Maxwell, Weeden spent just for the oil infrastructure com- & Co; IEA). To really drive this point home, let us reflect for a moment on the energy equivalent of 3.79 liters/1 US gallon of gaso- Chart 4: Current per capita energy consumption line: Kilograms of oil equivalent (KGOE)

1 US gallon of gasoline = 451 hours or eleven weeks of human work output! The 7,928.5 math: 1 gallon = 114K BTUs or 33.4 3,612.3 kWh of energy. Human agricultural work 890.1 1,487.1 1,265.4 output: 1/10 of a horsepower, or .074 1,088.8 KW. 33.4 kWh/.074 KW = 451 hours Asia of work (http://www.nafa.org/Template. Ex-Japan

cfm?Section=Energy_Equivalents and Asia is home to

IEA) Europe 59% of the

Carribean world’s North Africa

Middle East / population North America Interestingly, just maintenance-based South America

replacement of the global stock of ma- Central America / chinery requires significantly increased Source: World Resources Institute Earthtrends database

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As we continue to gather more informa- to pump water from some wells that are will need to spend more than USD50bn tion, our energy needs grow apace. Ac- more than 1,000m deep. India, in turn, is to construct desalination plants over the cording to Harvard University physics pumping water from wells that are 400m next 10 years. Long-time oil industry an- professor Alex Wissner-Gross, a Google deep on average, while well depth in- alyst Matt Simmons has calculated that search generates roughly 7 grams of CO2 creases up to 30m a year in some re- making up for this natural water short- because it is routed through various data gions (NASA and the German Aerospace fall will reduce Middle East oil exports centers, which require energy to keep Center). by 28% over the next 20 years as more running; boiling a pot of water generates energy gets diverted into desalination. If roughly 15 grams of CO2. Separately, it In the interim, the call grows louder for one “layers” this on top of 10 years of took 13 years of analysis by the world’s desalination plants in Middle East coun- BP World Energy Statistics data show- most powerful computers to map the hu- tries with very low renewable water re- ing that 100% of the Middle East’s extra man DNA. Perhaps it should come as no sources and burgeoning populations – production has been consumed domes- surprise that the IT industry’s CO2 output the UN projects 34.7% growth in the tically over the same time period, then has reached the equivalent of the airline Middle East population over the next 20 the Middle East’s oil exports may even industry’s (Peter W. Huber, PhD, Man- years. For instance, in km3 terms, the an- fall nominally over the next 10 years, fur- hattan Institute). nual water consumption to availability is ther tightening the remaining world’s en- 44% in Iraq, 53% in Iran, 121% in Is- ergy supply. Addressing the growing per capita wa- rael, 722% in Saudi Arabia, 1,150% in ter consumption associated with emerg- the UAE, and 2,200% in Kuwait; the re- Finally, continued outsized emerging mar- ing market development will also make gion as a whole currently consumes 85% ket economic growth, underpinned by increasing demands on energy, espe- of renewable water resources (http:// better EM region balance sheets as well cially given the need to drill progressively www.worldwater.org/data.html). Demo- as “the law of small (consumption) num- deeper wells in sections of China and In- graphics will force a shift to energy-in- bers,” points to substantial energy us- dia. Beijing, which gets about two-thirds tensive desalination. According to a Janu- age growth ahead for the majority of the of its water from aquifers, is now having ary 2010 Bloomberg article, Saudi Arabia world’s population (see chart 4).

In summary, the “symbiotic” relationship Chart 5: Long-term energy supply/consumption growth in Mtoe between real global GDP growth, which in Mtoe averaged 3.7% p.a. between 1971 and 2007 (IMF), and energy consumption 14 000 Energy supply CAGR over 36 years: 2.1% growth is readily apparent (see chart 5). 12 000 (supply growth reflective of demand growth)

10 000 Declining energy density challenges Extracting substantially more net energy 8 000 from the bulwarks of global energy supply, 6 000 oil and coal, may prove difficult. The global 4 000 oilfield depletion rate is at 6.5% p.a.; without capital spending, it would be 9.1% 2 000 (IEA). Simultaneously, the remaining ac- 0 cessible coal grades are less energy-en- 1971 1975 1979 1983 1987 1991 1995 1999 2003 2007 dowed, challenging coal-based electricity generation expansion options. For exam- Coal/peat Oil Gas Nuclear Hydro ple, in the US, the nation with the world’s Combustible renewables & waste Other* biggest coal energy reserves by far at 120 Mtoe = millions of tons of oil equivalent Source: IEA, Key World Energy Statistics, 2009 billions of tons of oil equivalent (Btoe), pro-

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duction volume continues to rise but en-  Low-density wind: only 1% of the sun’s mill generates only 2-3 megawatts; ergy extraction peaked in 1998 at 598 energy is converted to wind (wind ac- meeting New York City’s energy needs Mtoe. The discrepancy is attributed to a counts for less than 0.7% of global would require 13,000 units spinning at mix shift to lower energy “sub-bituminous” energy production) and wind turbines top speed or 50,000 turbines across coal grades (see chart 2). Meanwhile, operate on average at only 27% of in- New York State to assure adequate China, the nation that contributed the vast stalled capacity. One 50-story wind- wind exposure. majority of primary energy growth over the last two decades on the back of sharply Chart 6: Projected land-use intensity per terawatt-hour increased coal mining, has become a net Biodiesel from soy 894.0 coal importer. Is it any wonder that War- Electricity from biomass 543.4 ren Buffett’s Berkshire Hathaway bought Ethanol from cellulose 455.9 Ethanol from corn 347.1 a leading US railroad last year? Ethanol from sugarcane 285.6 Wind 72.1 In addition, oil exploration efforts are be- Hydropower 54.0 Petroleum 44.7 coming more energy intensive. Specifi- Solar Photovoltaic 36.9 cally, the energy returned on energy in- Natural Gas 18.6 vested (EROEI) for oil will continue to fall Solar Thermal 15.3 Coal 9.7 from 100 barrels of oil extracted for every Geothermal 7.5 1 barrel of oil energy used to 20:1 (cur- Nuclear Power 2.4 rently) to 5:1 – from walking into oil in Si- Efficiency gains (electricity) -18.2 Efficiency gains (liquids) -63.4 berian and Texan pastures a century ago to deep well exploitation energy return -200 0 200 400 600 800 1000 1200 2 economics dead ahead. Land-use intensity in 2030 (km /TW-hr/yr) Source: http://www.plosone.org/article/info:doi/10.1371/journal.pone.0006802. Please note: values shown are Lower EROEIs are not only limited to oil for 2030, as measured in km2 of impacted area in 2030 per terawatt-hour produced/conserved in that year. Numbers and coal, they are integral to low-den- provided are the midpoint between the high and low estimates for different techniques. For liquid fuels, energy loss from internal combustion engines is not included in this calculation. sity alternative energy or renewable energy sources that society has chosen to embrace and scale-up to material global Chart 7: Energy returned on energy invested (EROEI) energy supply contributors from a minis- 100% cule 0.7% share in 2007 and 0.1% in 90% 1973 (see chart 3). Building renewable 80% energy platforms calls for huge amounts 70% of energy. This is reflected in electricity 60% costs per kWh of 10-15 US cents for 50% wind and 20-30 cents for solar. By com- 40% parison, coal-fired electricity costs about Most renewable 30% 3 cents, natural gas 4 cents, and nuclear energy sources operate at 20% 5 cents. Clearly, expansion of affordable EROEIs between 2 and 8 coal-fired based electricity generation 10% 0% will remain an economic necessity for 50 48 46 44 42 40 38 36 34 32 30 28 26 24 22 20 18 16 14 12 10 8 6 4 2 emerging market advancement – some EROEI 80% of the world’s population. A few of Used for energy production Available to society the reasons why renewable energy re- Source: Euan Mearns, Resource Insights, 2008: http://resourceinsights.blogspot.com/2008/09/ mains so expensive: net-energy-cliff.html

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 Low-density solar: manufacturing of sil- Broader resource sustainability place 25 millimeters of topsoil lost to ero- icon-based solar cells is extremely en- challenges and the tie-in to energy sion, productive soil is for all intents and ergy intensive (mining-based, heating consumption purposes a nonrenewable resource (In- to 2000 C, etc.). Even if solar cells Not only are we using the world’s energy ternational Soil Reference and Informa- were free, solar power would remain sources unsustainably, but per capita wa- tion Centre). In aggregate, then, signifi- costly given the huge structures and ter availability has been declining, we are cant headwinds for sustained food supply support systems required to extract degrading our soil, and per capita ara- increases that an expanding and richer large amounts of energy from a source ble land continues to be pinched by the global population will call for. so weak it takes hours to get a sun- spreading global human population foot- tan (Peter Huber, PhD, Senior Fellow, print (see charts 8, 9, and 10). Given that The tie-in to energy consumption and Manhattan Institute). it takes approximately 500 years to re- broader resource sustainability chal-  When conventional energy is replaced with renewable energy, everything gets bigger, not smaller – and bigger costs Chart 8: Per capita water availability compared with 1950 more (see chart 6). 100 80 The flip side of declining energy density and EROEI metrics is expanded energy 60 40 investments and a larger share of GDP Indexed devoted to assuring adequate energy 20 supplies. Said differently, if the EROEI 0 of oil declines from 20:1 today to 5:1, 1950 1960 1970 1980 1990 2000 2010 2020 2030 then the oil-related outlays will need to Developed countries Developing countries – arid rise from roughly 4-5% of global GDP Developing countries – humid to 16-20% for us to sustain our oil out- Source: World Bank put. Similar math applies for coal and a shift to low-density energy sources. All Chart 9: Soil degradation and principal causes of soil degradation told, sustaining energy production could 1% 66% 45% 26% 9% 27% 24% 8% 28% result in a pronounced reallocation (or a 29% 80% revisiting of past realities) of global GDP 28% 26% 49% 35% (see chart 7). 23% 15% 5% 6% 7% Declining EROEIs/falling energy inten- 41% 38% 40% 30% 18% sity will not only call for more energy 13% 4% investments. Energy conservation and 22% 14% 12% 30% efficiency improvements such as re- Asia World duced electricity transmission losses, Africa Europe more effective grid management, more Oceania S. America N. America efficient engines, better insulation, etc. C. America Stable soil (Deviations from 100% attributions due to will become more important than ever Degraded soil rounding) as de facto energy sources. This will ig- Very degraded soil Deforestation nite and sustain an energy-technology Areas without vegetation Over-exploitation for fuelwood investment boom driven by the same Overgrazing Agricultural practices Industrialization underlying energy economics funda- mentals. Sources: World Summit on Sustainable Development 2002, International Soil Reference and Information Centre

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lenges are perhaps best highlighted via the pronounced transformations of developed country economies and the associated radically changed farming strategies. Most significantly, farmers adopted techniques that provide high returns per hour of labor. Large monocultures, which rely heavily on technical inputs, resulted. For example, in the US, the amount of corn produced per hour of labor is over 350 times higher than the Cherokees could raise with their traditional farming.

The enormous leap in farmer productiv- ity would not have been possible without large injections of fossil energy and machine power. In fact, the flow of energy input into modern US agriculture is 50 times higher than in traditional agriculture. However, modern, high-income farming has a price: high-technology agricultural techniques depend on non-renewable stocks of oil and have negative environmental impacts, which lower the sustainability of the agro-ecosystem. The impacts include soil erosion, reduced bio- diversity, chemical contamination of the environment by fertilizers and pesticides, and mining of groundwater. Hence, intensive agriculture based on heavy technological subsidies of fossil energy is eco- Chart 10: Per capita world arable land logically unsustainable (David Pimentel, (ha/person) PhD, Cornell University and Dr. Bernd 0.5 Schanzenbächer, Director of EBG Capi- 0.50 tal AG). 0.4 0.45 0.40 0.3 The US, the world’s largest food producer 0.30 and exporter, by no means stands alone 0.28 0.2 0.25 0.23 in its resource-intense farming. China, 0.20 for instance, eclipsed the US in terms of 0.1 millions of tons of fertilizer deployed by 0.0 the mid 1980s. As of 2006, its annual 1950 1960 1970 1980 1990 2000 2010 2020 consumption at 40m tons was double Sources: FAOSTAT, UN, Enviromental Health Perspectives that of the US. Yet average Chinese rice (Data are rough estimates and can vary depending on assumptions – data shows relative trend) yields per hectare remain approximately

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81% of America’s amidst growing soil nology, consuming resource endowments and broad-based environmental degra- unsustainably even as we are increasingly dation issues (IFA, FAO, IRRI World Rice degrading our environment. It is, there- Statistics 2006). fore, incumbent upon us to shift our technological focus to improved overall energy Implications for asset allocations efficiency, especially in view of falling en- How should investors position themselves ergy returned on energy invested dynam- to assure adequate diversification and to ics; to massively increase R&D into viable maximize returns given increasing en- alternative energy generation, including ergy and resource supply challenges and commercialized fusion, a potentially end- the necessity for enlarged sustainabil- less source of clean energy; and to be ity-based capital spending? By allocating better stewards of the planet’s oceans, portfolio funds to appropriately-diversi- aquifers, and remaining arable land sur- fied, well-managed multi asset class so- faces. The marketplace will ultimately lutions that invest in: reward those investors with the foresight and insight to capitalize (finance) the very  Energy assets with constructive supply/ industries and companies that will help demand dynamics put our population and the planet itself  Energy infrastructure and technology on a more sustainable path. The same assets strategic investor trajectory will call for  Water infrastructure assets, such as investments prior to a “cheery market the Credit Suisse Water Index and its consensus” being reached or sometimes constructive multi-year track record amidst emotionally driven market correc-  Farmland assets tions, because those are the junctures  Agricultural infrastructure assets during which the best long-term return odds beckon. As always, investors will need to consider their portfolio tolerance for illiquid assets, as some of the aforesaid multi asset class solutions will not be liquid in nature. That said, strategic investors’ capacity to com- mit select funds to less liquid assets can be advantageous to achieving favorable long-term returns. This is especially apt during periods of outsized liquidity bias and the resulting constructive relative val- uations typically on offer in less liquid asset classes.

Conclusion Clearly the explosion in the human population as underpinned by an even steeper ramp in overall energy and food (water) consumption brings with it large challenges. In short, we are, thanks to tech-

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