Energy, Climate & Investment

The 2020 ECI Report January 2008 #1

Peninsula Capital Management PO Box 941 Mt Eliza TEL 03 97 877 455

The Heat is On
Welcome to the first edition of the 2020 ECI Report. We hope it becomes a recognized guide to Sustainable
Investing both for clients of Peninsula Capital Management and a wider community of interested analysts,
activists and investors.

The first draft was prepared on the hottest day of 2007 which one of the hottest years on record which in turn
was part of the hottest decade on record. Writing and research continued through three weeks of erratic
weather: heat followed by unseasonal cold days and nights, strong winds and flooding rains to the north. In
Queensland one area received more than its typical annual rainfall in three days. This was a small taste of real
world climate change with its skewed patterns and greater “amplitude”. Under rising greenhouse conditions
more and more energy is trapped by carbon gases which intensifies and disturbs oceanic and atmospheric
systems.

Hardened skeptics need proceed no further, but we are persuaded by the weight of evidence and the quality
of convergent data sources. The UK Royal Society, the US Navy, NASA, the CSIRO and leading science research
agencies, many of the world’s biggest corporations such as GE, oil companies like Shell, numerous large banks
and insurers and of course the UN’s IPCC.

Atmospheric CO2 -- from the

combustion of fossil fuels in major
part -- increased from around 280
parts per million in the 19thC to 380
parts per million today.
About 35% of carbon dioxide
emissions are absorbed by oceans,
which causes rising problems for
marine organisms.
Dissolved in ocean water, CO2 forms
carbonic acid by stripping out
carbonate ions, and less is available
for their shells, skeletons and
exoskeletons. This is having a major
impact on the life expectation of
many fish and marine species

Rising Alarm

Rising alarm on the emission of nearly 30 Billion tons per year of CO2 from fossil fuel burning - the world’s
volcanoes and tectonic change only emit about 300 Million tons per year - has been condensed by the IPCC
into a simple message we can summarize, below:

The global rise of average temperatures parallels the increase in atmospheric carbon released by industrial
processes over the last 150 years. one of us are exempt from this trend. Our goods, food, daily travel, heating,
cooling, cooking and holidays all leave a carbon trail or ‘footprint’ behind. Globally we consume about 31
billion barrels of oil, 17 billion barrels equivalent of natural gas, and 6 billion tons of coal a year. It is simply
very unlikely that the injection into the atmosphere of this amount of carbon, previously stored over hundreds of
millions of years, would have zero effect when released in such a compressed period of time.

The worst case scenario for runaway climate change is unimaginably bad. It includes the accelerated and sure
destruction of thousands of coastal towns and cities as sea levels rise, and the extinction of huge numbers of
animal, fish and plant species, with dramatic droughts and floods inland, possible new and miniature ‘ice ages’
in some regions of the planet, social stress and ultimately, perhaps, war and chaos as food and water supplies
dramatically shrink. We can hope this end game scenario does not come about, but the best outcome will
need a radical and historically rapid change of our entire energy systems, ways of using resources, and our
overall economy. Rising alarm simply mirrors the present implacable growth of carbon emissions, and the
effects this can have within at most 25 or 35 years.

We will need a great shift in corporate, political and community thinking to prevent a further 2 degreeC rise in
the Earth’s average temperature by 2040 or 2050. Fortunately a an Increasing numbers of world leaders do
grasp the science such as Angela Merkel, a physicist by training. Her government is mooting a 60% cut in fossil
fuel burning by about 2055.

The investment and capital mobilization

ALARM CALL FROM THE IEA
The OECD’s energy watchdog agency the IEA
reported in November 2007 that under its ‘trends
continued’ or Reference Scenario world energy
consumption would increase 55% by 2030, driven
by Chinese and Indian demand growth and
continued high per capita demand in the OECD
countries, including Australia.
This big increase in fossil fuel burning would raise
world average temperatures by 3 degC, according
to the IEA. The agency also set out an Alternative
Policy Scenario under which urgent energy saving
and renewable/alternate energy development
measures were put in place. Under this Scenario,
growth in fossil fuel emissions would only be 27%
above current, holding the increase of world
average temperatures to 2 degC
coal-fired generating plants per month. Indonesia, a major coal exporter is now contemplating a similar
renewables, nuclear-and-coal future.
needed to achieve this momentous change
will of course be enormous. It will dwarf all
current spending in the energy sector, already
running hard to stand still because of
depletion, and racking up spending in 2006 to
more than 450 Bn dollars (400 billion USD)
per year simply for Exploration and
Production (E&P) in oil and gas.
The scale of the infrastructure required can
be grasped by the following. The British
Government has been obliged to set plans
for raising the level of the Thames barrage,
Holland is raising its dykes and projecting
huge scale floating cities, Japan has installed
massive pumps to protect Tokyo; France is
placing dykes around all low lying nuclear
power plants to prevent flooding. Climate
change fear has prompted Sweden to plan for
a complete Zero Oil economy by 2025; China
is massively building nuclear power plants
and windfarms – as well as 1000 MW of new

Food, Water and Energy merge

Food and water can be thought of as ‘embodied energy’, which is simple to understand for water because of
its high weight and need to be pumped, stored, transported, desalinated, purified and recycled.
When produced through desalination, even by the most efficient processes, around 7 – 45 kWh of energy is
needed per cubic metre, enough for about 2.5 or 3 days per capita consumption in Australia. With
biofuels we have an open convergence of food, water and energy in a completely new paradigm: what were
previously thought of as food crops, or supplies of fibre and non energy raw materials are now potential or
real sources, or ‘feedstocks’, for biofuels production.
 Holland is preparing for
Climate Change through
developing ‘floating cities’
made up of floating houses

Many of the biofuels, as the World Bank and IMF openly admit, are intensely dependent on irrigation and
almost zero ‘net energy yielders’, meaning they need as much input energy, mostly fossil, to be produced as
they yield as fuel in the tank of your car, but worse still food is being diverted to fuel. The USA’s RFS
(renewable fuel scheme) announced by G W Bush in his State of the Union address, January 2007, set massive
and impossible targets for maize ethanol production, and handed down large subsidies for the many
companies that rushed into this sector. Since then, some have simply gone into liquidation, and the low
credibility of the Bush RFS is now regularly pinpointed by financial commentators and even by the Wall Street
Journal, in particular their huge water needs and intense impact on food prices.

The convergence of rising food crop demand as feedstock for fuel, increasing greenhouse gas levels in the
atmosphere, a still expanding world population, and now admitted depletion of world oil, natural gas and coal
reserves can in fact only drive food prices higher and faster. The period in which the Ags & Softs, or agro-
commodities lagged behind the Energies and Metals, in the commodities sphere, is now over. Nevertheless,
we can be rather sure that biofuels will continue to be developed, in part because the other main route for
substituting oil for cars – batteries for storing renewable source electricity – remain costly and complex, and
the focus of intense, high-cost R&D. Selecting the biofuels that yield the most energy, and demand the least
water, will very surely be a winning investor strategy.

Oil prices are up about 450% since 2002, and since 2006 world grain and oilseed prices have begun to move
towards the same trajectory. Record highs, sometimes in absolute terms, have been attained in recent weeks
for some grains, and the best correlated agro-commodity with petroleum – sugar – is beginning to move
ahead. One clear reason for this is energy costs for intensive farming, especially irrigation farming, but another
is simply the massive quantities of previously food-only crops used for oil substituting fuels production. In
2006-2007 about 25% of the US maize crop was used for fuel ethanol production, and over 50% of the EU-27
rapeseed crop was turned into biodiesel fuel – enough to cover about 2% of car diesel fuel used on Europe’s
roads.

An Australian drought is surely no surprise, but when Ukraine’s wheat yields were dramatically low, due to
crop losses from huge excesses of rainfall that occurred from May 2007 onward, the market took note. Since
that time, wheat prices have been climbing back near an all-time record 10 USD per bushel and the oilseeds,
led by palm oil, rapeseed oil and soybean oil have followed, triggering an ‘upstream’ rise in soybean prices,
now attaining a record 13 USD per bushel.
Energy Transition

Very soon in fact, we will hear talk of a world energy transition plan, probably linked to whatever supercedes
the present Kyoto Treaty after the current 2008-2012 phase. Under almost any scenario we will see wider
carbon-limiting measures with a direct impact on the economy and investing, due to an accelerating need to
move away from the fossil fuel. The Garnaut Commission will provide the Australian blue-print for our own
response which may be prove more radical than the European concept of “20 20” - ie 20% renewables in each
country’s 2020 electrical generation energy mix.

This will be just the first stage before “40 40” which will require an even more massive investment in
renewable, carbon capture and changed public behavior. One thing is clear: outside wartime there has never
been an economic, financial and business trend which will have such longevity and economy-wide influence,
depth and power.

Winning the Carbon Game

That may be the broad picture but investors still need income need growth. How will this be achieved in a
carbon constrained economy? One local company offers some insights. CO2 had made a series of
announcements during 2006 and 2007 as AGL, Origin and Qantas bought carbon permits based on the
company’s ability to lock up carbon via the almost indestructible mallee gum. This business was all voluntary
and few noticed. Matters changed when Woodside was required to offset carbon before it could proceed with
a key project, the development of the Pluto gas field. Suddenly CO2 was an essential part of the Woodside
business as the EPA said its large Pluto gas field depended on off-setting at least part of the project’s carbon
emissions over an extended period. The deal involved 50 years of sequestration at a total price of $100m.

Minemaker was another obscure company until investors noticed in mid January that it held a large rock
phosphate lease near Tennant Creek. On a day when the rest of the market was falling it rose 30%. The reason
was simple. Investors had discovered that world phosphate prices had tripled. Not only were fertilizers in hot
demand as US farmers planted more grain for fuel supply, reserves were depleting rapidly. Major deposits like
Nauru and Christmas Island were exhausted leaving the market sensitive to even small increases in demand.

Like those above Eden Energy may play a small part in the investment mix, but it points the way. In January it
won a tender for the first hydrogen fuel dispensing depot in India. Eden’s hydrogen production and fuel
blending could play an important part in India’s long term response to both climate and energy policy. The
plan is to use a blend of gas and hydrogen (“hythane”) to fuel India’s public transport fleet. This will require
infrastructure and much co-ordinated effort but the rewards may be ultimately huge.

Eden is not the only hydrogen player. Rio has teamed up with BP to provide the world’s first hydrogen
powered electricity plant. Hydrogen will be stripped from the Abu Dhabi’s gas and the CO2 sequestered. This
may be more about PR than physics, but it will be widely noted that two of the world’s largest energy
companies are combing to provide a greener fuel for the emirate.

Minerals also will be part of the response. Suppliers of rare metals which provide better batteries, lighter
aircraft, faster communications etc are being targeted by metal processors. Lithium will be in strong demand
now that all the large auto companies are switching their focus to hybrid vehicles or fully electric models. If
even one tenth of US vehicles used lithium ion batteries, supply would be difficult. GM says that 50% of its
models will be “alternative” by 2010. Galaxy Resources is one of the few able to offer exposure to lithium, a
critical metal of coming decades.

More conventional ways to de-carbon portfolios are available. Energy farms managed by Babcock & Brown
Wind, Viridis Clean Energy, Transfield Infrastructure and others offer regulated and mandated income mixed.
Viridis combines wind and land-fill methane while Transfield manages conventional gas fired power stations
and wind farms, but they each offer relatively high and low risk yields.
Transfield’s low gearing and paired relationship with Transfield Services has particular appeal.

Many are also aware of the Silex Systems story. As GE prepares the Silex developed uranium enrichment
process for world markets, this Australian based company can conserve its cash to focus on high performance
solar cells. These “multi-junction” cells are a departure from conventional photovoltaic and capture the full
spectrum of the sun’s energy. The aim is double current solar efficiencies. Demonstration cells will soon be
available. Equally interesting is the twist on this technology which uses the same silicon technology to convert
heat to electricity. If successful much wasted heat from boilers, power stations trucks and cars could be
captured as surplus energy. Revenues could eventually equal income from uranium enrichment, ultra efficient
solar cells and its other major project, super fast optic silicon chips.

High technology will only form part of the carbon response. Much of the transition will be based on simpler
technologies, improved systems, faster communication and relatively inexpensive conservation measures.
Specialty funds will appear and offer highly focused plays in the emerging carbon finance market, as well as its
offshoots and derivatives. This may include fixed income securities twinned with municipal or State bonds and
based on physical resources linked to, or produced from alternate energy production and water saving
activities.

Investors will still have to be wary because of the scale, novelty and innovativeness of these massive but
entirely new investment and economic development shifts. And yet the shift is inevitable. This is non-
discretionary investment in the fullest sense.

In short we see our role as two-fold: researching and selecting the better carbon solutions while avoiding the
at-risk carbon heavy industries. In the middle a large group of carbon neutral activities which need to be
assessed on their merits.

Disclaimer: The above report has been prepared as general advice and is not to be relied upon in the absence of specific advice related
to each individual’s risk profile and investment objectives. While every effort has been made to ensure the accuracy of the above
information, no warranties, express or implied are entered into.
Prepared by Richard Campbell with the assistance of Andrew McMKillop

Peninsula Capital Management is a an authorized representative of RM Capital (AFSL221938)

PO Box 941 Mt Eliza, Vic 3930 03 97877455 Fax 0397877655