In a month that saw rising US coronavirus cases reported and increased geopolitical tension with China, US equities continued their rally, buoyed by increasing optimism around vaccine outcomes and an ongoing expectation that the Fed will “do whatever it takes”. Additionally, it could be argued that the US reporting season was more sanguine than expected, especially in the tech sector.
Quarterly reporting by some of the largest companies contributed to gains after Amazon, Facebook, Alphabet and Apple all recorded significant beats compared to analyst expectations. Unsurprisingly, companies that reported disappointing results were those with more direct exposure to the consumer economy including Boeing, McDonalds, and Harley Davidson.
The Shanghai SE Composite was the strongest bourse gaining +11.9%, while the S&P 500 returned +5.6%. New Zealand’s S&P/NZ50G, while off the pace relative to global indices, was still a solid performer at +2.4%. However, the S&P/ASX 200 index lagged at +0.6% after being tempered by a strong surge in Victorian coronavirus case numbers that threaten to slow the nation’s economic recovery.
In vaccine news, the FDA provided Pfizer and BioNtech a “fast track” for their respective vaccine campaigns. Early in the month Pfizer reported that its vaccine trial had been successful in producing antibodies in trial patients. Whilst in the therapeutics space, Gilead Sciences, who have been in the headlines with their treatment drug Remdesivir, reported new data suggesting the drug reduced mortality risk by up to 62%. These two developments in part helped allay investor concerns about the ongoing rapid increase in daily new cases.
The US Federal Reserve maintained their stimulatory stance with commentary coming late in the month from Jerome Powell that on top of the more than US$6 trillion liquidity already in place, they remain committed to stimulus for as long as it takes to provide relief and stability. Meanwhile the Republicans and Democrats negotiated over an extension to the $600 per week enhanced unemployment benefit which was set to expire at the end of July. The Democrats are currently arguing for a full extension of the relief costing upwards of US$3 trillion, while the Republicans are arguing for a reduced package of $200 per week reducing the stimulus injection to US$1 trillion. Not to be left out, the European Union came to the stimulus party unveiling a €750 billion programme targeted at rescuing economies within the Eurozone.
In our local market, a key talking point was the news delivered by Rio Tinto that after completing a strategic review of their New Zealand Aluminium Smelter (NZAS) they would look to cease production by August 2021. While this had been a known risk and potential outcome of the review, the market was caught off guard and reacted by sending the sector’s respective share prices tumbling on an intra-day basis. The smelter currently represents approximately 13% of total New Zealand electricity demand, with the majority of the supply coming from the purpose built dam at Lake Manapouri, Fiordland.
Assuming that the decision to close down the plant remains in place, there are many moving parts which will determine what happens next in the sector. We simplify this down to three identifiable stages which can correspond as the short, medium and long term.
The first stage is the requirement for Transpower to complete a transmission upgrade in the lower South Island. The completion of these works will allow Meridian and Contact Energy’s deep South Island hydro generation to flow to the north of the South Island and reduce the amount of water spilled at times when supply overwhelms demand. These works are expected to be completed by May 2022. Until these works are completed wholesale South Island electricity prices are likely to be depressed, which in turn will have a negative impact on Meridian and Contact Energys’ earnings. During this stage North Island power prices will be relatively less impacted which will create price separation between the two islands.
The second stage involves the laying of an additional transmission cable along the bottom of Cook Strait which would allow for surplus South Island electricity to be delivered into Wellington and the lower North Island. It is expected these works, again undertaken by Transpower, would cost approximately $150m and take up to 8 years to complete.
The third and final stage, would see transmission upgrades made in the North Island which would have the ultimate impact of allowing low cost renewable electricity generated by Meridian and Contact Energy to be delivered into the highly attractive demand catchment of the Greater Auckland region. This is likely to be disruptive to Mercury’s valuable Waikato hydro scheme.
In summary, the near-term beneficiaries are those companies that have North Island renewable generation as they will benefit from the relatively higher power prices achievable in the North Island. However in the long run, South Island hydro will compete in the North Island and likely earn a higher return than the electricity that was once sold to Rio Tinto. Additionally, the country’s demand for higher cost thermal fuel generation will decline meaningfully, boosting the proportion of renewable energy in New Zealand into the high 90%’s.