Opportunities emerging from rising

demand for AI computing power

Alphinity Investment Management 

May 2024

The AI boom is likely to drive a surge in energy consumption after decades of sluggish demand. Powering energy-hungry data centres has become a significant bottleneck within the AI capex cycle.  We take a closer look at the implications for global energy and gas markets, but also highlight various potential beneficiaries across different industries.

• The proliferation of Generative AI is likely to cause electricity consumption to inflect higher and begin grow once again.
• Chronic underinvestment in power generation creates a bottleneck, making gas a practical short-term solution amid costly and highly intermittent renewables.
• Analysis suggests this could drive incremental growth in US gas demand of ~1-2 bcf/d or 1% - 1.8% of current demand. That is on top of the ~1% of demand from LNG export projects that have already reached FID.
• Alphinity have multiple avenues of exposure to this thematic. ConocoPhillips benefits as a leading global gas producer and trader, along with tech giants Nvidia, Microsoft, Google, ASML, and Cadence Design who supply essential technology to enable AI. Trane Technologies, Ferguson, and Prologis facilitate the physical construction of data centres. Additionally, in the Sustainable fund, we own Schneider Electric and Quanta.

Source: Intel, Nvidia, Morgan Stanley, Company Reports, Alphinity

How much energy do data centres consume today and may consume in the future?

Generative AI and large language models have sparked strong rallies in some stocks, particularly those directly exposed to data centres. These centres, vital for AI processing, are reigniting electricity demand, challenging the adequacy of power supplies and infrastructure. The energy demand from data centres, already high, is predicted to grow, prompting significant investments in energy infrastructure, including natural gas and power distribution systems.

Currently, data centres consume about 2.5% of global electricity, a figure Boston Consulting Group expect to rise to 4% by 2027 and as high as 7.5% by 2030, increasing the U.S. electricity demand at twice the rate of the previous decade. If correct, that will be equivalent to powering ~20% of all homes in the US. This surge underscores the urgent need for expanded power generation to prevent potential blackouts and is driving a meaningful uplift in capital expenditures by utility companies. With the U.S. leading the global data centre market, approximately 40% of global capacity, this trend is likely to be mirrored worldwide, affecting energy consumption and infrastructure development on an international scale.

Did you know?

• Data Centres could consume the same amount of electricity as ~20% of total US homes by 2030
• GenAI consumes 4-5x the power of traditional data centres. By 2027, global demand for GenAI alone could drive the same power consumption as the entirety of Spain.
• Virginia is home to around 35% of the world's hyperscale data centres.
• Within the space of 24mths, PJM, the Eastern Interconnection regional transmission organization (RTO), has revised its 10-year average annual peak load growth forecast from 0.5% to 5.5% per year. Unprecedented in recent history.

Estimating how this increased demand translates into actual electricity demand

Bottom-up analysis: GenAI to add 1% of incremental electricity demand growth per annum

Power consumption in data centres is calculated by adding server and storage power use, multiplied by power usage effectiveness (PUE) and operating hours. By estimating GPU growth, chip utilization and power efficiency, one can project potential power needs. AI racks can need up to five times more power than traditional ones. AI data centres using GPU clusters, consume 30-100kW per rack. Taking this fact further, mature LLMs such as ChatGPT in inference mode, consume 400-1300 kWh daily, requiring significantly more power as user queries escalate post-training.

Source: Boston Consulting Group

Assuming total GPU volumes rise from ~1.8m in 2023 to ~4m in 2026, custom silicon & GPU utilization rates range between 70-90% and data centre PUEs (a measure of a data centres energy efficiency) decline from 1.5 to 1.3,  Morgan Stanley predicts incremental global data centre power usage will rise to 326-460 TWh by 2027, a significant increase from the current 360 TWh, with GenAI contributing about one-third of this demand. Schneider Electric estimates AI will account for a slightly lower 15-20% of the growth. This equates to a 105% compound annual growth rate for GenAI and 20% for overall data centre power, making GenAI's 2027 power demand comparable to Spain's and adding 1ppt of growth to overall electricity demand growth rates.

Top-down analysis: AI energy demands to double in 3yrs

The number of data centres are increasing rapidly, exemplified by Microsoft's plan to build up to one new data centre every three days, at the same time as the power intensity increases significantly. As such, BCG predicts U.S. data centre capacity will rise from 2.5% to up to 7.5% of total energy demand by 2030, increasing electricity demand by 260 TWh. McKinsey comes up with similar estimates, foreseeing power needs for U.S. data centres to double from 17GW to 35GW, equivalent to the current combined global capacity of the big 5 tech giants. Globally, institutions like the IEA foresee data centre, AI, and cryptocurrency electricity consumption doubling in the next three years to 1000 TWh, matching Japan's total power use. This surge suggests electricity demand growth could shift from stagnant for the past two decades, to 0.5-2% annually by 2030, raising questions about future supply sources.

What source of energy is most likely to meet this demand?

Owners of data centres, most of whom have committed to net-zero targets, face a dilemma with surging electricity needs. Renewable energy sources offer intermittent supply with 25-40% capacity factors and when paired with energy storage, higher costs. With the rapid growth in AI demand necessitating immediate and reliable power, gas generation emerges as a logical short-term solution, providing consistent electricity around the clock. Renewables will still grow in importance, especially as the cost of energy storage falls. Nuclear energy & small modular reactors are potential alternatives (see Amazon's DC acquisition), but challenged due to the long lead times to deploy and cost challenges.

Recent discussions among CEOs and experts highlight the shifting demand landscape and gas's role in meeting these urgent energy needs.

"The energy needs over the course of the next couple of decades (driven by AI) is going to be enormous and over the next 5-10yrs, the amount of gas fired power generation that will be required to deliver that electricity, to fire all the data warehouses, that are going to be required is going to be enormous" - Ryan Lance, CEO of ConocoPhillips

"Electricity demand is experiencing three times faster growth per year this decade than what we've seen in previous decades, driven by the increase in electric vehicles and emergence of new, large-load data centres..... This is a major shift for our country, and it's a major shift for the natural gas market to be able to keep up with this" - Alan Armstrong, CEO of Williams Company

This could drive an incremental 1% to 1.7% pa of unexpected demand for natural gas

Bernstein projects that with ~25% of the U.S. incremental demand met by gas-fired generation, an additional ~230 TWh would necessitate ~15GW new gas capacity, increasing gas demand by ~1.1 bcf/d or 1% of the total market. Under Morgan Stanley's scenario--70% renewables and 30% fossil fuels with 70% server utilization--gas demand would rise by ~13GW over 5 years. Jefferies, accounting for upcoming renewable installations and existing energy plans, forecasts an annual increase of 1.6-1.8 bcf/d in gas demand. Consequently, AI could boost U.S. gas demand by 1-1.7% annually in the late 2020s, potentially significant against an already planned 10 Bcf/d of incremental LNG exports (or ~1%).

Additionally, this growth in data centre energy use could induce market volatility and regional imbalances. You are already seeing examples of crypto miners building server farms in the Permian where they can take advantage of cheap associate gas. Companies that can take advantage of the volatility through globally balanced gas portfolios and/or large trading capabilities will likely benefit.

Addressing one key assumption - advancements in chip power efficiency gains

This analysis contains multiple complex variables, such as diminishing chip power efficiency, the shifting power requirements as AI models transition from training to inference, and regulatory influences on renewable energy development and new gas infrastructure permitting.

A critical factor in this context is compute intensity. Notably, while advancements in chip technology, exemplified by Nvidia's B200 Blackwell, yield substantial efficiency improvements per compute unit, the absolute power consumption continues to escalate, with the Blackwell chip (announced a fortnight ago) experiencing a 43% increase in maximum theoretical load compared to its predecessor, the H100.

Source: Schneider Electric White Paper: Challenges and Guidance for Data Centre Design

Conclusion

The tech sector's rapid evolution often outpaces slower-moving industries and governments, potentially causing bottlenecks. While technological advancements may offer some relief, they may not suffice to meet the surging demand for power. Consequently, this growing need is expected to spark a renewed interest in gas-fired generation. Companies such as ConocoPhillips are well positioned to benefit from fulfilling this demand and capitalizing on the ensuing market volatility.

Additionally, Alphinity has significant positions in the technology companies that are crucial to the rapid growth of AI, as well as exposure to the "picks and shovels" companies further up the value chain. These businesses are actively addressing emerging challenges, including managing heat generation, enhancing, and securing the electrical grid, and overcoming the scarcity of strategically located land.

These include technology companies like Nvidia, Cadence Designs, Alphabet and Microsoft, alongside companies such as Trane Technologies, who are the leaders in data centre cooling solutions. Prologis, who are spending ~US$7-8bn over the next 5yrs to build 20 new DCs. ASML who manufacture advanced AI chip equipment, and Ferguson who supply infrastructure essentials such as pipes and fire suppression for DCs. Furthermore, our sustainable strategy owns Schneider Electric with 20% of sales to DCs and Quanta, the top U.S. grid EPC.

Author: Chris Willcocks, Portfolio Manager

Funds operated by this manager:

Alphinity Australian Share Fund, Alphinity Concentrated Australian Share Fund, Alphinity Global Equity Fund, Alphinity Global Sustainable Equity Fund, Alphinity Sustainable Share Fund

Tax Loss Selling

Marcus Today

May 2024

We are approaching June, and it's a good time to start talking about tax loss selling in stocks.

It is something that we should all think about in May rather than June. It works like this:Assuming you pay capital gains tax - many of you don't - on June 30th the tax man will freeze your portfolio, add up all the capital gains you've made this year, all the capital losses, offset the losses against the gains, and come after you for CGT on any net profit.If your accountant hasn't reminded you, then this is a reminder that you can minimise ('defer' really) your capital gains tax (CGT) liability this year by realising some losses as well as gains before the year-end, rather than just holding on. Basically, if you have a net capital gain from stocks sold, or any other capital gain, you should now be looking through your collection of current holdings for any stocks with losses attached (that you could sell now), and in so doing crystallise a loss that can be used to offset any gains made during the year. In so doing you can minimise your need to pay tax this year. Ultimately, it is not about how much tax you pay, that will not change. It is about when you pay it. It's obvious stuff.

Capital losses can offset capital gains.

• Stocks that have not performed well over the year, stocks in which a lot of shareholders are holding at a loss coming into the financial year end, tend to get sold down again towards the end of June. Thanks to tax loss selling, bad performers perform badly in June.
• Small illiquid stocks, ones that have not performed well where again, a lot of shareholders are likely holding at a loss, can get absolutely massacred by tax loss selling in June because the selling is forced through when the liquidity is not there. Net result, if you hold an illiquid stock that is running at a loss, take the loss early, because if you wait until the end of June when every other dodo wakes up to it, you'll be selling into a last-minute frenzy.

If you do want to take a loss before the end of June but want to continue holding the stock long-term, it is a good idea to take the loss early (now for instance), and not buy it back immediately, but wait until the other tax loss sellers destroy it. If all goes well, you can buy it back lower down as the liquidity issue bites the share price closer to the financial year-end.Even if you don't have tax issues, thanks to tax loss selling, trading opportunities can arise, especially in the small illiquid stocks that get massacred. Once the tax loss selling fades away, sold-down stocks can bounce significantly as small buy orders rebound the prices. So traders should be looking for the lows in small illiquid sell-offs over June, hoping for a rally into July. But another word to the wise, whilst you might think you should wait until July 1st to buy, experience suggests that many of the stocks impacted by tax loss selling tend to bounce before the year-end, a week or so before. So for a trader, the game is to identify the stocks getting destroyed and watch for the first rally, rather than July 1st, to get stuck in. The rebounds can be just as sharp as the last-minute drops. Hesitate and you'll miss it.

Which Stocks Do You Sell for Tax Reasons?

Legal Note: ATO Wash Sales Provisions

Taking Advantage of the Selling

Hints for Taking a Loss

• If a stock is going down, it is far more likely to continue going down than it is to turn on a sixpence to suit you.
• An early loss is the smallest loss - The further a stock falls, the more intense the selling becomes as higher losses cause more selling decisions, so sell early.
• The odds are in your favour - If you sell 10 falling stocks, it will be the right thing to do in nine cases, but you will only remember the other one.
• Clear the mind - If you sell now, you are no longer exposed, and all you have to do is come to terms with the loss.
• You can buy it back - If you sell now, you can always buy it back - you might even buy it back lower than you sold it, and in the meantime, you have a period of clarity.
• The eye of the hurricane - If you sell now, you enter the eye of the storm and all becomes calm. You have a moment to think and can watch from a distance. You can always choose to enter the storm again, and you will be thinking more clearly and be armed with a plan if you do.
• Would you buy this stock now? - If you are making a loss on a stock, think to yourself... "If I had cash, would I buy the stock now at this price?" If the answer is 'no', why are you holding it? Sell it. Most people begin to 'hate' the stocks they lose money in... so this argument always works.
• Your state of mind has a value - What would your spouse pay (or you pay) to have you carefree at the weekend, instead of ripping the heads off the kids? Look after yourself. There are not that many weekends in the year (or your life). Don't ruin too many of them by keeping risky loss-making positions until Monday because you didn't have the guts to sell them on Friday.
• Averaging down is a mug's game - If you have money to invest, you should be putting it in the best investment in the whole world. Do you really think that will be the very same stock you have already bought at a higher price and that is falling at the moment? Very unlikely. You already have an exposure... why do you need more of something that has already proved itself to be a dog?
• There is no logic in being emotional about losses - Do what most brokers do with their own shareholdings. They have an Excel spreadsheet linked to live prices monitoring all their holdings and what they are worth. At the bottom of the page is a total of what all the holdings are worth now. That clicks over every second, all day. Up $500, down $500. This figure is the only truth. This is what the shares are worth.
• The price you paid is irrelevant - If it's gone down, it's gone down. XYZ stock doesn't 'owe you'... what you paid for it is irrelevant to where it goes next.
• Opportunity cost - Not selling a dog ties up capital that could be employed somewhere more gainfully than in a dog stock.
• If in doubt, sell it - It crystallises a capital loss for this tax year. Why wait until the end of the year to take your losses? Taking losses today could set you up for making and taking gains this year. You can always buy it back once you've made the sale.

Hopefully, you hold good long-term stocks and won't have to take a loss, but when you do, read this again and see if you can get to the bottom of the list before you put the sell order on.

Author: Marcus Padley

Funds operated by this manager:

Marcus Today Equity Income SMA, Marcus Today Growth SMA

The Rate Debate -

Navigating Australia's Economic Crossroads

JCB Jamieson Coote Bonds

May 2024

Funds operated by this manager:

CC Jamieson Coote Bonds Active Bond Fund (Class A), CC Jamieson Coote Bonds Dynamic Alpha Fund, CC Jamieson Coote Bonds Global Bond Fund (Class A - Hedged)

Looking beyond the noise at this year's Budget

Pendal

May 2024

WHEN you've watched enough federal Budgets (this was my 35th in markets), you start to see familiar patterns across commentaries.

Every vested interest or ideological bent comes out bleating about the Budget being irresponsible or reckless, that there's too much spending or not enough major reform.

What worries me more is when people view the government as no more than a large corporation and when they speak of the budget like a profit and loss statement.

Looking through the noise and self-interest is what really matters for bond markets in the year ahead.

I have narrowed it down to three impacts.

Inflation

There are a number of direct measures that reduce inflation, one of which is electricity subsidies.

Every household gets $300 off their electricity bill, by way of quarterly $75 payments directly off the bill. Businesses receive $325.

The average household bill is $2,000 a year, so that's 15% off.

Electricity is 2.4% of the CPI basket, so this equates to 0.36% off inflation in direct impact. The government is quoting 0.5% overall impact.

Queensland has already announced a $1,000 subsidy while Western Australia has announced a $400 subsidy, again not means tested.

It will be interesting to see what upcoming state budgets keep rolling existing subsidies (no impact to inflation), let them roll off (inflationary) or, like Queensland, increase them (deflationary).

If we assume modest subsidies coming up from other states, then the electricity impact on lower CPI could be 0.8% or even higher.

Other measures in rental assistance and cheaper medicines are slightly deflationary.

Overall, federal Treasury is forecasting inflation of 2.75% in 2024/25, which is below the current Reserve Bank (RBA) forecast of 3.2%.

We expect an upcoming downward revision of the RBA forecast of 3.8% CPI for 2024, which looked too high anyway. This could also see its 2024/25 forecast moderated lower, though still near 3%.

Tax cuts and spending

Against the direct impact of the Budget on lower inflation, markets ask the question of whether the extra money in people's pockets may cause higher inflation if and when it is spent.

There is around $20 billion of new spending measures (the Stage 3 tax cuts have been locked in since 2019) in this Budget, with the majority in the next two years.

The Budget will return to deficit, with a forecast of $28.3 billion for 2024/25 and $42.8 billion in 2025/26.

While still low by international standards, the main question is whether or not deficits are appropriate at this point of the cycle.
It must also be noted that it also is based on the usual conservative commodity price forecasts.

For example, an iron ore price of US$60 is assumed, despite a current price nearer US$110 and a five-year average of US$120.

This opens up potential upside surprises as we have seen in the past few years.

This has really excited Budget hawks and has some calling for higher rates as all this money is supposedly spent, stoking inflation.

The question I would ask is whether or not this money is being injected into an economy at full capacity.

On this, my view is that we are sufficiently past the pandemic that supply chains can handle the modest rise in consumer spending without stoking inflation.

Consumers will be spending more in the year ahead. Tax cuts, subsidies and lower inflation should finally see some growth in real incomes - however, this is from a base of real incomes having for the past few years.

Bond issuance

We will see an update on the 2024/25 program from the AOFM shortly.

Given high refinancing (two benchmark maturities totalling $83 billion) the borrowing task is expected to be around $90 billion, as the RBA has borrowed much more than needed this year.

It is important to remember that when determining yields, bond demand and supply dynamics are largely outweighed by economics.

As a bond manager, I only view supply and demand as a short-term impact around supply events.

Ignore the booming debt rhetoric from some commentators and self-styled bond vigilantes - Australian debt will remain AAA for at least the medium term, and with the RBA moving to an "ample liquidity" framework, demand for bonds will remain robust.

So, what does this mean for bonds?

Well, the market always votes straight away, and has already made a half-hearted attempt to run with the higher spending higher inflation narrative.

However, as the dust settles (to quote the cliché), yields are "sharply unchanged".

I think the RBA will see the Budget for what it is - a mixed bag of measures that will leave it hopeful of further inflation relief but wary of whether the 2%-3% band can be achieved and then sustained.

I would also make the observation that the "Future Made in Australia" spending is an overdue response to the global game-changing US Inflation Reduction Act.

By comparison, our government's measures are modest for now, but can be expected to increase in the future.

We are in a very different world to the last decade and governments must respond.

For now, a more detailed breakdown of the domestic economy is below.

Author: Tim Hext, Pendal portfolio manager and head of government bond strategies

Funds operated by this manager:

This information has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and is current as at December 8, 2021. PFSL is the responsible entity and issuer of units in the Pendal Multi-Asset Target Return Fund (Fund) ARSN: 623 987 968. A product disclosure statement (PDS) is available for the Fund and can be obtained by calling 1300 346 821 or visiting www.pendalgroup.com. The Target Market Determination (TMD) for the Fund is available at www.pendalgroup.com/ddo. You should obtain and consider the PDS and the TMD before deciding whether to acquire, continue to hold or dispose of units in the Fund. An investment in the Fund or any of the funds referred to in this web page is subject to investment risk, including possible delays in repayment of withdrawal proceeds and loss of income and principal invested. This information is for general purposes only, should not be considered as a comprehensive statement on any matter and should not be relied upon as such. It has been prepared without taking into account any recipient's personal objectives, financial situation or needs. Because of this, recipients should, before acting on this information, consider its appropriateness having regard to their individual objectives, financial situation and needs. This information is not to be regarded as a securities recommendation. The information may contain material provided by third parties, is given in good faith and has been derived from sources believed to be accurate as at its issue date. While such material is published with necessary permission, and while all reasonable care has been taken to ensure that the information is complete and correct, to the maximum extent permitted by law neither PFSL nor any company in the Pendal group accepts any responsibility or liability for the accuracy or completeness of this information. Performance figures are calculated in accordance with the Financial Services Council (FSC) standards. Performance data (post-fee) assumes reinvestment of distributions and is calculated using exit prices, net of management costs. Performance data (pre-fee) is calculated by adding back management costs to the post-fee performance. Past performance is not a reliable indicator of future performance. Any projections are predictive only and should not be relied upon when making an investment decision or recommendation. Whilst we have used every effort to ensure that the assumptions on which the projections are based are reasonable, the projections may be based on incorrect assumptions or may not take into account known or unknown risks and uncertainties. The actual results may differ materially from these projections. For more information, please call Customer Relations on 1300 346 821 8am to 6pm (Sydney time) or visit our website www.pendalgroup.com

Market Commentary - April

Glenmore Asset Management

May 2024

Funds operated by this manager:

Glenmore Australian Equities Fund

Quarterly consumer price index update

Montgomery Investment Management

May 2024

The long-awaited quarterly consumer price index (CPI) figure was reported this week. Over the March quarter, CPI rose by 1.0 per cent, which follows the previous 0.6 per cent December quarter increase. Over the 12 months to March 2024, CPI rose by 3.6 per cent. Whilst the annual rate of inflation is trending downwards, the quarterly figure increased by 0.4 per cent and poses ongoing challenges.
The leading drivers behind the quarterly increase:

Education fees rose by 5.9 per cent. This uplift was the strongest quarterly rise reported since 2012.
Housing rose by 0.7 per cent. The rental market is incredibly tight, with a 2.1 per cent increase due to an ongoing mismatch between supply and demand. Property prices also rose by 1.1 per cent. This was an improvement from the 1.5 per cent read in the December quarter. High material and labour costs continue to contribute to the housing pricing pressure.
Food and non-alcoholic beverage increased by 0.9 per cent.
The most recent quarterly results have presented a slight blip in the data, however, on an annualised basis the inflation figure is heading in the right direction, approaching the Reserve Bank of Australia's (RBA's) 2-3 per cent target range. Despite this, markets are now concerned that these latest figures have potentially pushed out the RBA's timeline, and there is not enough data to warrant an RBA rate cut in the coming months. The latest read is stoking fears that inflation is sticky and there is an ongoing battle in achieving a consistent path to their inflationary target range, within the expected timeframe.

Similarly, the U.S. faces ongoing inflationary challenges. The annual inflation rate rose by 3.5 per cent in March, a 0.4 per cent increase from the 3.2 per cent reported in February. The market anticipated 3.4 per cent. Both central banks require confidence that inflation is steadily slowing back within their respective target ranges. Widely speaking, it is evident that there is economic turbulence with ongoing geopolitical uncertainty having widespread global economic affects. Back home, other factors to consider are the strong labour market and upcoming tax cuts. The labour market remains relatively tight with the unemployment rate at 3.8 per cent in March. This coupled with the incoming stage three tax cuts, provides more turbulence and adjustment in the RBA's economic outlook and monetary policy decisions.

Author: Natalie Kolenda

Funds operated by this manager:

Montgomery (Private) Fund, Montgomery Small Companies Fund, The Montgomery Fund

JH Explorer in Charleston: Power cabling the energy transition

Janus Henderson Investors

April 2024

Funds operated by this manager:

Janus Henderson Australian Fixed Interest Fund, Janus Henderson Australian Fixed Interest Fund - Institutional, Janus Henderson Cash Fund - Institutional, Janus Henderson Conservative Fixed Interest Fund, Janus Henderson Conservative Fixed Interest Fund - Institutional, Janus Henderson Diversified Credit Fund, Janus Henderson Global Equity Income Fund, Janus Henderson Global Multi-Strategy Fund, Janus Henderson Global Natural Resources Fund, Janus Henderson Tactical Income Fund

This information is issued by Janus Henderson Investors (Australia) Institutional Funds Management Limited (AFSL 444266, ABN 16 165 119 531). The information herein shall not in any way constitute advice or an invitation to invest. It is solely for information purposes and subject to change without notice. This information does not purport to be a comprehensive statement or description of any markets or securities referred to within. Any references to individual securities do not constitute a securities recommendation. Past performance is not indicative of future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

Whilst Janus Henderson Investors (Australia) Institutional Funds Management Limited believe that the information is correct at the date of this document, no warranty or representation is given to this effect and no responsibility can be accepted by Janus Henderson Investors (Australia) Institutional Funds Management Limited to any end users for any action taken on the basis of this information. All opinions and estimates in this information are subject to change without notice and are the views of the author at the time of publication. Janus Henderson Investors (Australia) Institutional Funds Management Limited is not under any obligation to update this information to the extent that it is or becomes out of date or incorrect.