There were some interesting ideas about probable long-term investment returns in the presentations accompanying the annual Barclays Capital Equity Gilt Study published this week. The "short and dirty" conclusion is that historical relationships all point to the continued likely outperformance of equities against bonds in the medium to longer term.
This is in spite of two of the biggest players in the global financial markets, namely pension funds and dollar-flush governments, both for different reasons currently pouring huge amounts of money into bonds rather than equities. Neither group is made up of value investors, and their behaviour has driven down longer term bond yields to levels where, even after recent price movements, the probability of making positive real returns is very low.
The most topical aspect of the study this year however concerns an issue that is of huge importance to everyone, as well having implications for investors. This is the challenge that the world faces in seeking to meet two potentially conflicting imperatives: how to fill a serious impending shortage in world energy supplies while simultaneously reducing carbon emissions, of which energy supply is or course the primary component.
On current trends, according to the International Energy Agency, global energy demand is projected to rise by more than 50 per cent over the next 25 years. With no dramatic change in government energy policies, more than half of this increased demand will have to come from the traditional sources of oil, gas and coal. The investment required to meet this new demand, as well as replace ageing existing sources of supply, will be in the order of $20 trillion, equivalent to something like 15 per cent of total global capital investment over the period.
The complication, of course, is that coal, oil and gas are the principal sources of CO2 emissions. Around two-thirds of total greenhouse emissions come from energy use. To avoid global temperatures rising to the extreme danger levels highlighted in various recent official reports, policy changes in favour of alternative energy sources and nuclear power are inevitable if global growth is to be sustained.
While the political climate is clearly moving towards acceptance of new policies to counter climate change, even in the US, the dilemma is that the more action that is taken to reduce carbon emissions, the greater the share of the energy supply gap that will have to be filled from other sources. That in turn will almost certainly increase still further the massive capital that will be needed to finance the investment needed to secure the twin objectives of increased energy supplies and reduced carbon emissions.
At the moment, argues Tim Bond, the head of asset allocation at Barclays Capital, the world is still in a painful no-man's land. Despite the big rises in energy prices over the last three years, forward prices continue to point to further price rises in the dirty fuels such as coal and oil, but not in other types of energy. He says: "We can deduce that as yet the markets do not believe that policy changes will successfully reduce global demand for the dirtier fuels in favour of cleaner energy courses."
On the other hand, the continued uncertainty about what policies might be introduced is helping to restrain capital investment in new projects. The energy industry is starting to respond to the signals given by higher energy prices, and investing in new capacity, but has not so far done more than make a small dent in the problem.
The costs faced by energy producers are soaring, as BP's results this week made clear. There are not enough drilling rigs, ships to transport coal, and so on, to meet demand. While global spending on upstream oil investment in nominal terms doubled in the five years to 2005, Bond notes, because of the higher costs facing producers, the real inflation-adjusted increase in spending has been less than 20 per cent.
Left to their own devices, the markets will eventually solve the problem of the mismatch in future energy supply and demand through the pricing mechanism, but the lead times in energy supply are long, beset with environmental and strategic issues, and the process may be painfully disruptive. Other things being equal, the results will be high and volatile energy prices for many years, with the ever present danger of severe economic disruption, as there was in the 1970s.
The good news is that, in principle, financing the huge amount of capital expenditure that will be required to fix the energy and climate change problems should not be a problem. As every current market indicator suggests, the world is awash with capital that is looking for a home that offers high-yielding returns.
Yet the climate change imperatives are a complication. It is hard to see how governments can make new policy initiatives on carbon emissions without interference in the market. Some degree of Government controls over pricing seem sure to be part of the mix. What implication will that have for energy prices and investment in the freely traded market?
Investors have a keen interest in how these issues play out. During the 1970s, the last time energy prices were high and rising, notes Bond, oil and commodities were just about the only mainstream assets that produced positive real returns. In the stock market, apart from banks, oil and gas and energy suppliers were the only sectors that produced decent returns.
The same phenomenon has been evident in the world equity markets since the start of 2003.
Could a rerun of that scenario happen again? We don't know for certain. Bond's view appears to be that it might, although he also argues that the massive programme of capital investment required to fill the energy gap will be positive for world economic growth, even if it produces a speculative bubble in the process. A good chunk of the extra energy needed will be feeding the fast-growing economies of China, India and others.