Thematic Investing

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Postmodern Populism – The 2008 election and the impact of the likely trends towards “Big Government.”

Climatic Consequences – Investment implications of the behavioral, regulatory, and physical impact of climate change.

Water Worries – Precipitation patterns changing, drought increasing, snow cover decreasing, and pollution rising.

Build & Rebuild – Infrastructure development creates opportunities for builders, owners, and operators of infrastructure assets.

The Big Fix – The experiences of the US in the 1830s and 1930s, and Japan in the 1990s, reveal 3 separate steps necessary for recovery.

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Thematic Investing

  1. 1. See Appendix A-1 for Strategist Certification and Important Disclosures Thematic Investing November 2008 Edward M. Kerschner, CFA Chief Investment Strategist Citi Global Wealth Management +1.212.559.2323 edward.kerschner@citi.com The Global Wealth Management division at Citi comprises two of the most respected brands in wealth management: The Citi Private Bank and Citi Smith Barney. Citi Investment Research is a division of Citigroup Global Markets Inc. (the quot;Firmquot;), which does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Non-US research analysts who have prepared this report are not registered/qualified as research analysts with the NYSE and/or NASD. Such research analysts may not be associated persons of the member organization and therefore may not be subject to the NYSE Rule 472 and NASD Rule 2711 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account. Customers of the Firm in the United States can receive independent third-party research on the company or companies covered in this report, at no cost to them, where such research is available. Customers can access this independent research at http://www.smithbarney.com (for retail clients) or http://www.citigroupgeo.com (for institutional clients) or can call (866) 836-9542 to request a copy of this research. Clients of Citi Private Bank in the U.S. and LATAM must contact their Citi Private Bank branch Financial Advisor for information regarding the securities mentioned herein. Note: Our “thematic” analysis does not consider stock-specific metrics such as valuation, EPS, and P/E, or balance sheets, market capitalization, liquidity, etc. Accordingly, when making investment decisions, investors should view thematic analysis as only one input to their investment decision. Since thematic analysis employs a longer-term methodology, its results may differ from the conclusion of fundamental analysis. For example, in some thematic reports, we may mention specific stocks as being well positioned, but our fundamental analysts may currently rate some of those stocks Sell owing to valuation. Published 11/06/08
  2. 2. Table of Contents Page Postmodern Populism – The 2008 election and the impact of the likely 3 trend towards “Big Government.” Climatic Consequences – Investment implications of the behavioral, 12 regulatory, and physical impact of climate change. Water Worries – Precipitation patterns changing, drought increasing, 18 snow cover decreasing, and pollution rising. Build & Rebuild – Infrastructure development creates opportunities for 24 builders, owners, and operators of infrastructure assets. The Big Fix – The experiences of the US in the 1830s and 1930s, and 27 Japan in the 1990s, reveal 3 separate steps necessary for recovery. 2
  3. 3. And the Winner is… The Obama Edge • Quantitative models developed by well-regarded presidential historians suggested that Obama had a high likelihood of achieving a victory. The Republican Party was dealing with the dreaded “triple whammy” in 2008: an unpopular president, a weak economy and a second term election. Professor Allan Lichtman’s “Thirteen Keys to the Presidency” Key 1 (Party Mandate): After the midterm elections, the incumbent party holds more seats in the US House of Representatives than it did after the prev ious midterm elections. FALSE Key 2 (Contest): There is no serious contest for the incumbent party nomination. TRUE Key 3 (Incumbency): The incumbent party candidate is the sitting president. FALSE Key 4 (Third Party): There is no significant third-party or independent campaign. TRUE Key 5 (Short-Term Economy): The economy is not in recession during the election campaign. UNCERTAIN Key 6 (Long-Term Economy): Real per-capita economic growth during the term equals or exceeds mean growth during the previous two terms. FALSE Key 7 (Policy Change): The incumbent administration effects major changes in national policy. FALSE Key 8 (Social Unrest): There is no sustained social unrest during the term. TRUE Key 9 (Scandal): The incumbent administration is untainted by major scandal. TRUE Key 10 (Foreign/Military Failure): The incumbent administration suffers no major failure in foreign or military affairs. FALSE Key 11 (Foreign/Military Success): The incumbent administration achieves a major success in foreign or military affairs. FALSE Key 12 (Incumbent Charisma): The incumbent-party candidate is charismatic or a national hero. FALSE Key 13 (Challenger Charisma): The challenging-party candidate is not charismatic or a national hero. UNCERTAIN Electoral Barometer* and Popular Vote Margin 30% Incumbent Party Won 25% 1972 1964 20% 1984 Popular Vote Margin 1956 15% 10% 1996 1988 5% 1948 2004 1960 2000 0% 1968 1976 -5% 1992 2008 (Reagan Landslide) * Abramowitz Electoral Barometer = 1980 -10% President’s net approval rating in Gallup 1952 Poll + ( 5 x Real GDP growth) - 25 (Eisenhower trounces Stevenson) -15% Incumbent Party Lost -20% -100 -80 -60 -40 -20 0 20 40 60 80 100 Barometer Reading Source: Professor Allan Lichtman, American University; Professor Alan Abramowitz, Emory University; Citi Investment Research 3
  4. 4. Election ‘08: Back to the Future? The Record • On average, neither Democrats nor Republicans have been “bad” for the stock market; likewise following turnover of Democratic and Republican administrations. • The combination of a Democrat president and Republican-controlled Congress has proved most favorable for stocks, while an “all blue” combination of a Democrat president and a Democrat-controlled congress (i.e., the Obama scenario) has been least favorable. Average Change by Presidential Political Party Since 1829 3.0 3.0% 50% Interest Rates (10 Yr Bond) Inflation (CPI) Stock Market (DJIA) 2.0 2.0% 40% 1.0 1.0% 29% 0.34 30% 0% 24% 0.0 0.0% -0.33 20% -1.0 -1.0% -1% 10% -2.0 -2.0% -3.0 0% -3.0% Democrat Republican Democrat Republican Democrat Republican Average Change when Incumbent Political Party Changes Since 1829 3.0% 3.0 60% Inflation (CPI) Interest Rates (10 Yr Bond) Stock Market (DJIA) 2.0% 2.0 1% 42% 41% 1.0% 1.0 0.53 40% 0% 0.0 0.0% -0.23 -1.0% -1.0 20% -2.0% -2.0 -3.0 -3.0% 0% Democrat Republican Democrat Republican Democrat Republican Average Change by Political Party in Executive and Legislative Branches Since 1829 30% 3.0% 3.0 Interest Rates (10 Yr Bond) Inflation (CPI) Stock Market (DJIA) 2.0% 2.0 1% 20% 1.0% 0% 1% 1.0 17% 0.30 0.07 13% 0.0% 0.0 12% -0.11 -0.12 8% -1.0% -1.0 10% -2.0% -2.0 - -3.0% -3.0 0% -7% Dem. Pres Rep. Pres Rep. Pres Dem. Pres Dem. Pres Rep. Pres Rep. Pres Dem. Pres Dem. Pres Rep. Pres Rep. Pres Dem. Pres Rep. Congress Rep. Congress Dem. Congress Dem. Congress Rep. Congress Rep. Congress Dem. Congress Dem. Congress Rep. Congress Rep. Congress Dem. Congress Dem. Congress Source: Citi Investment Research 4
  5. 5. Big Government A Secular Shift in Opinion • The downsizing of the Federal Government may be ending. • In 2008 the candidates were tapping into a secular shift in opinion about the desired level of government involvement in the economy. In recent years, there has been a trend towards an increase in the percentage of Americans saying “government should do more.” • About half of the US economy could be at risk of government oversight and regulation. Federal Government Expenditures Value Added by Industry Desired Level of (% of GDP) (2007 – % of GDP) Government in the Economy 20% 47% 80% Government should do more Government is doing too many things Agriculture Construction Linear (Government is doing too many things) 0% Government 4% 13% Linear (Government should do more) Information 5% 60% Manufacturing 15% 12% Finance, Insurance, Real Estate 40% 21% Wholesale & Retail Trade 10% 12% 20% Healthcare 7% Transportation Services 3% Utilities 19% Mining 2% 2% 5% 0% 1950 1960 1970 1980 1990 2000 2010 Dec- Dec- Jan- Mar- Sep- Jul- Sep- Oct- 1995 1997 2002 2007 2007 2008 2008 2008 Source: The Wall Street Journal / NBC News Poll; Bureau of Economic Analysis 5
  6. 6. Populist Record • pop•u•list § Pronunciation: 'pä-py&-list Function: noun Etymology: Latin populus the people § A member of a political party claiming to represent the common people. • Early American Populism Teddy Roosevelt’s “Trust-Busting” Andrew Jackson Kills the Bank of the US The Great Merger Wave of 1898–1903 was brought to Jackson effectively destroyed the bank by vetoing its an end by effective federal intervention, most notably 1832 re-charter by Congress, halting the deposit of President Theodore Roosevelt’ s celebrated trust- U.S. funds in 1833, and letting it slowly decline until the busting, which began with a 1904 Supreme Court case. expiration of its charter in 1836. In addition to the end of the merger wave, a recession Jackson’s actions effectively ended all monetary that lasted throughout 1903 and until the third quarter of restraint in the U.S. The resulting “Panic of 1837” 1904 also took its toll on stocks. Public commentary at caused a collapse of the banking system, a multi-year the time blamed Roosevelt’ s ‘trust- busting’ for the depression, and a prolonged bear market. Panic of 1907. Dow Jones Industrial Average: Dow Jones Industrial Average: 1895-1910 1830-1850 25 80 “Panic of 1837” 20 60 15 40 10 “Panic of 1907” 5 20 1830 1835 1840 1845 1850 1895 1900 1905 1910 Source: Merriam-Webster; Historical Statistics of the United States 6
  7. 7. Populist Record • Modern American Populism Carter’s Stagflation LBJ’s Nixon: JFK The “Misery Index” “Great Society” The Silent Populist vs. Big Steel (Inflation + Unemployment) America was in a “golden age” of “Great Society ” promised to stamp Nixon was preoccupied with foreign 25% low inflation and rapid growth, with out poverty in both rural and urban affairs. Nixon was often quoted as few excesses in the financial settings. LBJ pursued Medicare, saying: “You don’t really need a 20% system, which was still heavily Medicaid, aid to education, and a President for domestic policy.” regulated. major “War on Poverty.” 15% But domestically, it was a very But, JFK’s victory over Big Steel Unfortunately, the decision to fight active regulatory period: EPA, 10% undercut business confidence, both the War on Poverty and the Consumer Product Safety provoking fears that the President War in Vietnam led to inflation, Commission, OSHA and for a time, intended to initiate de facto controls rising interest rates and the end of wage and price controls. 5% on prices and profits. a bull market. 0% 1950 1960 1970 1980 1990 2000 2010 Dow Jones Industrial Average:1960-1980 1200 DJIA Real DJIA 1000 800 Adjusted for inflation, 600 DJIA falls 47% 400 200 1960 1965 1970 1975 1980 Source: Bureau of Labor Statistics; Historical Statistics of the United States; Citi Investment Research 7
  8. 8. Populist Pause • The 28 year pause began with the “Reagan Revolution.” President Clinton’s Tenure Top Marginal Income Tax Rate Populist Pause 1980-2008 100% Clinton signed into law welfare reform, so people 1981 – Ronald Reagan had to look for a job before being eligible for welfare; ended the “retirement test” for Social 80% Security benefits; pushed NAFTA; signed the 1989 – George H.W. Bush largest capital gains tax cut ever and reduced government spending as a share of GDP by 3 60% 1993 – Bill Clinton percentage points. By reacting to the political environment and posing 2001 – George W. Bush 40% as “a New Democrat, an Old Democrat, and ultimately, in effect, a moderate Republican,” (as The Economist pointed out), Clinton created a 20% very favorable environment for investors 1950 1960 1970 1980 1990 2000 2010 Dow Jones Industrial Average:1980-2008 16,000 DJIA Real DJIA 12,000 Adjusted for 8,000 inflation, DJIA gains 340% 4,000 0 1980 1985 1990 1995 2000 2005 2010 Source: Tax Policy Center; Citi Investment Research; The Economist, Which Bill Clinton?, August 24, 1996; FactSet 8
  9. 9. Populist Platforms Taxes • On the last three occasions when there has been incumbent party change, in the post-election year Congress has passed a major fiscal package that has included significant changes to tax rates. • Obama offers large tax breaks to low- and middle-income taxpayers. • A number of key tax provisions expire in 2010, and revert to their previous levels. Election Year Post-Election Year Winning Party Winning President Fiscal Reform 1976 Democrat Carter 1980 Republican Reagan 1981 Economic Recovery Tax Act of 1981 1984 Republican Reagan 1988 Republican G.H.W. Bush 1992 Democrat Clinton 1993 Omnibus Budget Reconciliation Act of 1993 1996 Democrat Clinton 2000 Republican Bush 2001 Economic Growth and Tax Relief Reconciliation Act of 2001 2004 Republican Bush 2008 Democrat Obama 2009 ????? Top Federal Tax Rate: Select Tax Rates: Today and Under Obama Plan Currently and Post 2010 60% Currently Post-2010 Itemized Deduction Phaseout Top Federal Tax Rate Income Tax Brackets 35.0% 39.6% 48.65% 50% Social Security Payroll Tax (High to Low) 33.0% 36.0% Medicare Payroll Tax 28.0% 31.0% 40% 36.45% 25.0% 28.0% 15.0% 15.0% 30% 10.0% 15.0% 20% Stock Dividends: Taxed as 15.0% ordinary Rate for taxpayers 10% income above the 15% bracket Capital Gains: 0% 15.0% 20.0% Rate for taxpayers Today Obama? above the 15% bracket Source: Citi Investment Research; Tax Policy Center 9
  10. 10. Postmodern Populism • President-elect Obama’s electoral platform suggests that more sectors are at risk than stand to benefit. At Risk Sector Sub-Sector Comment Energy Big Oil Companies Obama has proposed windfall profit taxes when a barrel of oil is over $80 Coal Miners A carbon cap and trade regime would favor natural gas and nuclear power Finance Alternative Investments Obama supports taxing carried interest as regular income Brokers & Asset Managers A higher tax on capital gains would be a negative Credit Card Companies Obama has proposed to ban universal defaults, and interest on fees Multi-line Insurance Companies Obama has proposed preventing insurers from overcharging for malpractice insurance Tax Preparation Companies Obama has proposed simplifying tax filings for middle class Americans Healthcare Biotech “Biogenerics” (i.e., generic biotech drugs) a negative Managed Care Government intervention poses risks Pharmaceuticals Greater government role in Medicare drug prices Retail Upscale Retailers Higher taxes on upper-income groups would be a negative for luxury goods Utilities Coal-burning Utilities Potentially at risk from a carbon cap and trade regime High Payout Utilities A higher tax on dividends would be a negative for high payout stocks Relatively Well-Positioned Sector Sub-Sector Comment Energy Ethanol Producers Obama supports subsidies and tariffs for ethanol Nuclear-powered Utilities Well-positioned under a carbon cap and trade regime Solar Industry Obama favors renewable power sources Wind Power Industry Obama favors renewable power sources Healthcare Drugstores What they lose from brand name pricing pressure, they make up on movement to generics Generic Drug Makers Generics would help the government save money under a universal healthcare system Retail Low -end Retailers Obama’s tax cuts would primarily benefit those with very low incomes Source: Citi Investment Research 10
  11. 11. Postmodern Populism • Party does not dictate stock market direction. Fundamentals, such as growth and inflation, have much more significance. The DJIA rallied in the period following the election victories of populist Democrats Carter, LBJ, and JFK, and then performed poorly following Carter’s inauguration (reflecting stagflation), but continued to do well early during the administrations of LBJ and JFK (reflecting economic stimulus). • But the record of modern populism (1960 – 1980) was a stock market that zigged and zagged, and rose modestly in nominal terms, but declined 47% in real terms. • Will Obama emulate Clinton, who “posed as a New Democrat, an Old Democrat, and ultimately, in effect, a moderate Republican,” or modern populists JFK and LBJ, big government social activists? DJIA Performance following the Election of First Term Populists Inauguration thru 1 st Year Election thru Inauguration Inauguration thru First 100 Days Inauguration thru First Term Average of Populist Presidents 3% -1% -2% 12% J. Carter (1976) 4% -8% -17% -4% R. Nixon (1968) -2% 2% -14% 10% L. Johnson (1964) 2% 3% 8% 5% J. Kennedy (1960) 6% 7% 15% 18% T. Roosevelt (1901) - -9% -9% 0% A. Jackson (1828) 2% 0% 6% 42% DJIA Performance DJIA Performance DJIA Performance (Avg. 1 st Term Presidents since 1829) (Avg. when Dem. replaces Rep. since 1829) (Avg. Select Populists since 1829) 80% 80% 80% 69% 60% 60% 60% 33% 40% 40% 40% 20% 20% 20% 12% 11% 7% 2% 3% 2% 1% 0% 0% 0% -1% -2% -2% -20% -20% -20% Election thru Inauguration Inauguration Inauguration Election thru Inauguration Inauguration Inauguration Election thru Inauguration Inauguration Inauguration Inauguration thru first 100 thru first year thru first term Inauguration thru first 100 thru first year thru first term Inauguration thru first 100 thru first year thru first term days days days Source: Citi Investment Research 11
  12. 12. Climatic Consequences • For investors, the issue is not whether climate change is occurring. Governments, regulators, corporations, and individuals are reacting to the perceived threat of climate change. • In the past 420,000 years, there have been four transitions from glacial to warm periods. All of the four transitions were accompanied by increases in atmospheric carbon dioxide. • GHG abatement is not necessarily “Green.” • Climate change initiatives are part of a much broader agenda Variation with Time of Temperature “Mammoth with the Eye” and Carbon Dioxide (CO2) Levels (18,000-13,500 B.C.) 390 15 CO2 levels today are 25% Carbon Dioxide (LHS) Degrees Variation (RHS) 360 above prior peak levels Carbon Dioxide (PPMV) 10 330 5 300 270 0 240 -5 210 180 -10 400,000 350,000 300,000 250,000 200,000 150,000 100,000 50,000 0 Years Before Present Multiple Agendas Climate Friendly vs. Green $100 oil Environmental Economic CLIMATE FRIENDLY “GREEN” Climate Change Energy Efficiency Nuclear Power Plants Radioactive Waste Coal Gasification Noxious CO2 Hydroelectric Power Environmental Damage Wind Farms Deaths of Birds & Bats Finland Developing Nuclear Power vs Diesel Fueled Cars Air Pollutants Markets Energy Security “Fuel Poverty ” Russian Gas Source Biofuel Production Threat to Rare Species Political Social Source: J.R. Petit, et al., Climate and atmospheric history of the past 420,000 years from the Vostok ice core, Antarctica, Nature 399 (1999); Grotte de Rouffignac, France; Citi Investment Research 12
  13. 13. Climate: Regulatory Response • Two tracks of negotiations will continue: (i) Kyoto-track (excludes US); (ii) Bali track (includes US), and which are expected to converge in Copenhagen in December 2009. • 44-76% of global GDP has committed to reducing GHG emissions under Kyoto. • Despite the US not signing Kyoto, 26 states (59% of GSP) will curb GHG emissions by 2012. Kyoto Timeline The United Nations Framework Convention on Climate Change (UNFCCC) began to negotiate a global treaty to reduce the emissions ofsix GHGs. 1992 Kyoto Protocol was adopted at the Convention’s third meeting in Kyoto, Japan. 1997 Industrialized and transition economies assumed binding emission caps to be achieved during the five-year period from 2008 to 2012. 2008 § Kyoto-Track: Kyoto parties; Finalize second round of targets. § Bali-Track: All Countries; Develop initial commitments for many developing nations and US. 15th Conference of the Parties in Copenhagen 2009 GHG Emissions by Country (2002) Percentage of Global GDP US Gross State Product (E.U. 25, 16%) Accounted for by Kyoto “Annex 1 ” Countries likely Covered by GHG Emissions Schemes by 2012 Other - Non- US 100% RGGI - Total 23% Annex 1 10 States, 76% 25% 80% 19% 60% Other, 41% 47% 46% 44% 40% Other - WCI - Total 7 Annex 1 China States, 20% 20% 11% 15% France 2% Italy 0% Russia Total Ex. US and Ex. US, Ex. US and 6% 2% U.K. India MGGA - Total Australia Australia and Canada Separate 6 States, 13% Canada 2% 4% Japan Canada Initiatives, 8% Germany 5% 2% RGGI: CT, DE, MA, ME, MD, NH, NJ, NY, RI, VT 3% WCI: AZ, CA, MT, NM, OR, UT, WA MGGA: IL, IA, KS, MI, MN, WI Source: United Nations Framework Convention on Climate Change (UNFCC); Citi Investment Research Separate Initiatives: CO, FL, HI, 13
  14. 14. Climate: Regulatory Implications Power Generation • Nuclear power plants are completely carbon-free sources of electricity, but the electricity generated by a nuclear power plant costs more than electricity generated by fossil fuels. • Nuclear power is increasing, mainly in China, India and Russia, as a response to strong power demand, greenhouse gas emission concerns, and energy security fears; a 65% increase in capacity by 2015. • Coal is the most abundant hydrocarbon. Clean, climate-friendly coal will need to be big part of solution. Carbon Content of Fuels US Electricity Generation Costs (Tons of carbon/terajoule of energy) (Cents/kWh) 30 8 6.7 6 20 3.8 - 5.6 4.2 4 10 2 0 0 0 Coal Oil Gas Nuclear Nuclear Natural Gas Oil* Coal Global Nuclear Electricity Generation Carbon Capture Technologies Cost (Gigawatts) (Cents/kWh) 800 10 Operating/Building Planned Proposed 7.7 8 7.0 600 6.5 6 4.8 400 4 200 2 0 0 No Capture Gasification Oxy Post Source: World Resources Institute; Citi Investment Research; World Nuclear Organization; US Consulting; Bloomberg 14 Combustion Combustion
  15. 15. Climate: Regulatory Implications Renewable Energy Technologies Mature Hydroelectric, Geothermal, Landfill Gas, Onshore Wind § Maturing Offshore Wind § Viable Photovoltaic Solar § Global Renewable Energy Wind Turbine Wind Capacity Installed New Wind Capacity Installed Existing Capacity Cum. Installed Capacity (gW) (by Country) (2007 – Megawatts) 200 (2006 - excl. Hydro) Rest of Canada, Rest of World World, 1723 386 Rest of World, Ocean Asia Solar PV 14% (tidal) UK, 427 Americas Geo- 160 6% Portugal, Germany, 23% 0% U.S., 5244 Europe thermal 434 Portugal, 2% 8% Italy, 603 UK, 3% 120 10 yr CAGR = 25% France, 3% France, 888 Italy, 3% Germany, 80 Denmark, 3% 1667 Wind China, 6% Biomass U.S., 18% 54% and 40 India, 1730 Spain, 3522 Waste India, 9% 33% China, 3449 0 Spain, 16% 2000 2002 2004 2006 2008E 2010E Global Polysilicon Supply-Demand Levelized Cost by Source US Wind Power Classification (Metric Tons) in Global Electricity Supply (US$/kWh) 200 $0.50 Polysilicon Demand Polysilicon Supply $0.40 150 $0.30 100 $0.20 Texas $0.10 50 $0.00 0 Solar Hydro Geo Wind (1- Nuclear Coal Gas (~1%) (20%) (<1%) 2%) (25%) (40%) (15%) 2006 2007 2008 2009 2010 Renewable Traditional Source: Renewable Energy Policy Network for the 21 st Century; Global Wind Energy Council; US Department of Energy; Citi Investment Research 15
  16. 16. Climate: Regulatory Implications Transportation • Increased Fuel Efficiency • Alternative Fuels § Corn ethanol can only ever be a fuel additive; there’s just not enough corn to replace motor fuels. § Cellulosic technology may offer a way for ethanol to become a major source of motor fuel. • The Climate Backlash: “Food versus Fuel” CO2 Emissions Relative to Conventional Engine Automobile (“Well-to-Wheel” carbon emissions) GHG Emission Reduction Technologies Advanced Gasoline Engine Conventional engine Advanced Diesel Engine BorgWarner BorgWarner Honda, Peugeot, Tenneco Advanced gasoline engine Biofuels Advanced diesel Honda, Peugeot, Tenneco Hybrid Technology Fuel cell (gasoline) Toyota Motor Gasoline hybrid Toyota Motor Fuel cell (Hydrogen from nat gas) Diesel hybrid Fuel Cell (Hydrogen from renewables) 0 Vehicle Load Reduction 0% 20% 40% 60% 80% 100% Magna International US Corn Yields (Bushels/Acre) US Corn Prices (Cents/Bushel) § Increased biofuels production accounts for only 2-3% 900 165 of overall increase in global food prices. Despite a 20% increase § The “food versus fuel” debate ignores the inevitability . . . prices have been rising in corn yields . . . 700 155 of technological progress, and echoes Malthus’s argument in 1798 that the starvation of Great Britain 500 145 was inevitable and imminent. § Converting forest and grassland to crop, corn-based 300 135 ethanol nearly doubles greenhouse emissions over 30 years and increases greenhouse gases for 167 years. 100 § Corn ethanol requires 3-4x more water than 125 1996 1998 2000 2002 2004 2006 2008 1996 1998 2000 2002 2004 2006 2008 conventional crude refining. Source: World Resources Institute, US Department of Agriculture; Citi Investment Research; Global Financial Data 16
  17. 17. Climate: Physical Implications • In recent years there have been a number of climatic trends: § Temperature — a warming of the global climate, but not every year, everywhere. § Wind — an increase in the frequency of intense hurricanes. § Water Worries — climate change is having a significant impact. Global Annual Temperature Anomalies 1.0 0.6 0.2 -0.2 -0.6 1850 1875 1900 1925 1950 1975 2000 2025 Factors in the Water Supply-Demand Balance Category 4 and 5 Hurricanes (% of total) (41%) Supply Demand West Pacific (25%) (34%) Precipitation South Indian (18%) Patterns Changing (35%) East Pacific Drought Emerging market (25%) (25%) North Atlantic Increasing consumer sector (20%) (28%) Southwest Pacific Snow Cover Developed economy (12%) Decreasing industrial sector (25%) 1975-1989 1990-2004 North Indian (8%) Pollution Rising 0 20 40 60 80 100 120 140 Source: University of East Anglia, Norwich, UK; Changes in Tropical Cyclone Number, Duration, and Intensity in a Warming Environment, PJ Webster, et. Al, Science, September 2005; Citi Investment Research 17
  18. 18. Water Worries: Precipitation Precipitation Patterns Changing Heavier § Briefer § Less Frequent § Changing locations § • Australia has had wetter conditions in the past 30 years, but the distribution of rainfall has changed. • Spain’s severe drought continues; in late 2007, water levels in reservoirs resumed downward trend. Percentage of Total Global Land Area in Very Dry Conditions Trend in Australian Annual Rainfall (Land areas within 600S – 750N) (1970-2007, Millimeters) 40% Global very dry areas have more than doubled since the 1970s 30% 20% 10% 0% 1960 1970 1980 1990 2000 2010 Rainfall Distribution Water Levels of Spanish Reservoirs Over India (Percent of Capacity – 12 mo. MA) During 2007 80% Monsoon Season In India 50% of Atlantic Mediterranean annual precipitation 60% takes place in 15 days 40% 20% 2005 2006 2007 2008 2009 2010 Source: IPCC; Australian Bureau of Meteorology; Indian Ministry of Power; Ministerio de Ambiento 18
  19. 19. Water Worries: Droughts/Snow Cover Snow Cover Decreasing • From the South American Andes to the Asian Indus River basin the area covered by glaciers is shrinking. • In southwest US a reduction in water availability below current consumption is projected within 20 years. Drought Increasing • Drought increases, as precipitation over land has marginally decreased while evaporation has increased. Anomaly of Northern Hemisphere Snow Cover Extent 3 1 -1 -3 1960 1970 1980 1990 2000 2010 Palmer Drought Severity Index Colorado River: Flow at Lees Ferry (U.S.) Cumulative deficit relative to local mean in surface land moisture minus 108 Yr Avg. (Million Acre Feet) 2 12 8 1 4 0 0 -4 -8 -1 -12 1960 1970 1980 1990 2000 2010 1900 1920 1940 1960 1980 2000 Source: National Center for Atmospheric Research; Rutgers University Global Snow Lab; Upper Colorado River Commission 19
  20. 20. Water Worries: Desalination • Desalination has become a viable option. • Globally there are currently over 200 desalination plants in planning or up for consideration. Global Water Desalination Capacity Current Desalination Projects (Millions of Cubic Meters/Day) (by Country - % of Global Total) Spain 120 Others 18% 29% 80 U.S. 13% 40 India UAE 5% 9% Libya 5% China 0 Saudi 6% Australia Arabia 1988 1992 1996 2000 2004 2008 2012 2016 7% 8% Cost of Water Proposed Desalination Plants in California (US$/m 3) France Germany UK Australia US Japan US (Tampa Bay) Algeria Israel Russia Africa Groundwater China Desalination India $0.00 $1.00 $2.00 $3.00 $4.00 Source: Global Water Intelligence; United Nations Educational Scientific and Cultural Organization; Citi Investment Research; Pacific Institute 20

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