Welcome to Pathways, a Macquarie Asset Management podcast where we provide fresh perspectives and insights for institutional investors and consultants about real assets, private markets, and macroeconomics.
Daniel McCormack:
Hi and welcome to the Pathways podcast. I’m Daniel McCormack, MAM’s Head of Research. Today we’re going to dive into what’s happening in the Middle East and what we think that means for investors, and particularly what it means for infrastructure investors. To help me unpack that, I’m joined by Liam Auer, a Managing Director in our utilities investment team. Liam, welcome to the podcast.
Liam Auer:
Thanks, Dan.
Daniel McCormack:
So today we’re going to cover three sections. First, we’ll talk about what’s happening from a big‑picture perspective. Then we’ll dive into the sectors in particular to drill down into the implications. And lastly, we’ll pull it all together with what this means for you, the investor.
But first, Liam, I think we should acknowledge the human tragedy of this event. Our hearts and thoughts go out to all of those who have been affected by it.
Let’s turn to the investment implications. You’re an active investor on behalf of MAM in the utilities space. As an investor, what are the questions you’re getting asked regarding the current conflict and what it means?
Liam Auer:
Thanks, Dan. We absolutely hope this conflict reaches a resolution, given the immense human impact.
The first question we’re getting asked—both by investors and around the board table with our management teams—is: is this 2022 again? At this stage, I think not yet, but it is a useful comparison given the obvious similarities.
We’ve had a major supply shock in energy, and as a result, energy prices are spiking. Europe in particular is more exposed, given it is a net importer of energy. TTF has jumped by about 60%. Brent crude has bounced around depending on the day and how governments are reacting.
However, we haven’t seen the energy price spikes we saw in 2022. To put some numbers around that, TTF is roughly €50 today, whereas in August 2022 it peaked above €300. So, we are still a long way from those extremes following the invasion of Ukraine and Europe shutting off access to Russian piped gas.
The reason is that Europe has diversified its supply away from Russia, which has added resilience. That said, it has also created some unique exposure to this current crisis, given Europe’s reliance on LNG.
This crisis probably affects oil more than gas. The Strait carries about 20% of global oil and about 20% of global LNG. But 20% of global LNG is only around 3% of global gas supply, so the overall impact on gas prices should be smaller, though uneven. Qatar, for example, is a particularly important LNG supplier.
There are also alleviating factors. Gas is a heating fuel in Europe but also fuels power stations. Wind and solar generation in Europe are growing by about 830 terawatt hours a year, while the LNG access Europe has lost equates to roughly 600 terawatt hours of electricity generation. Increased renewables deployment should therefore alleviate some of the power‑price impact from gas disruptions.
So, there are similarities to 2022, but also some fundamental differences that are more alleviating this time around.
Daniel McCormack:
That makes sense, particularly your point about oil being a truly global market, whereas gas is much more regional. Perhaps we could double‑click on Europe, where you’re based. What do you see as the main implications for the European market?
Liam Auer:
There are short‑term and long‑term implications. In the short term, we will see price impacts. Gas is the marginal fuel for a lot of power generation, and that is already feeding through to higher power prices in Europe.
Europe has also walked into this crisis more vulnerable than it should have, with gas storage at its lowest levels since 2021—around 40% full versus much higher mandated targets. The UK is even worse, with very little gas storage, leaving it particularly exposed to swings in LNG markets.
The implication is that Europe should continue to maximise renewables and indigenous gas production. This is particularly relevant for the UK, which still has access to North Sea production. There’s also been a change in tone around the acceptability of extracting indigenous gas supply while gas is still needed.
From an investor perspective, the duration of the conflict is critical. The economic impact varies significantly depending on whether this lasts one month or four months…
Daniel McCormack:
Well, I think you’ve hit the nail on the head with that point — it really does depend on the duration of the conflict. That will be a big variable in determining the size of the economic impact.
If we take inflation first, and assume the oil price roughly stays where it is — so it doesn’t move sharply higher, but also doesn’t fall away precipitously — you’ll probably see headline inflation rates around the world increase by about 100 basis points, maybe up to 150 basis points depending on the region. For core inflation, though, there probably won’t be much impact.
I did some modelling looking at core PCE for the US. Using the Fed’s flow‑through rates, core inflation moves from around 3% — where it is now — to almost 3.5%. That’s not nothing, but it’s a relatively small move and fairly manageable.
If oil were to go to, say, $150 a barrel — which is being talked about — I think we would need quite a lot to go wrong to get there, but just for argument’s sake, headline inflation would go north of 6% in most developed economies and could push towards 7%. Core rates would probably go north of 4% to 4.5%. That’s double central bank targets and presents a real challenge from a monetary policy perspective.
Turning to GDP, oil has a pretty formidable reputation as a growth killer, particularly in academic circles. I actually think that reputation is somewhat overrated. If you look at a chart of US recessions and overlay it with the oil price, you do see oil prices rising sharply before many recessions. But I would argue that’s often correlation, not causation.
For example, the financial crisis in 2008–09 was not caused by oil. The tech wreck in 2001 was not caused by oil. Even the 1990s recession — oil may have played a role, but the primary cause was the savings and loan crisis.
There are also many instances where oil price rises did not result in recessions. And finally, we’ve become much less dependent on oil economically. The amount of energy required to generate a unit of GDP has been steadily declining for decades, and within the energy mix, oil’s share has fallen. In the 1970s, oil accounted for about 40% of total energy supply; today it’s closer to 30%.
That said, oil is still a headwind to growth. It eats into real disposable incomes. A good rule of thumb is that a 10% increase in the oil price shaves about 0.1 percentage points off growth. So if oil prices stay where they currently are, you might see growth fall by about 0.3 to 0.4 percentage points — not a huge growth shock.
If oil were to go to $150 a barrel, however, growth could be downgraded by 100 to 120 basis points. For Europe and the UK, that would almost wipe out growth for the year. For the US, it might take growth from just over 2% to under 1%, which would be pretty sluggish by US standards.
So in short, there’s a big difference between oil prices holding at current levels — which I think is a manageable economic shock — and oil prices moving to $150 and staying there. In that scenario, we’d see much higher inflation and a noticeable hit to growth, which would be much more challenging from an economic perspective.
I also don’t think either Iran or the US could politically withstand that kind of environment for months. Rising gasoline prices in the US put tremendous pressure on President Trump, who doesn’t like high energy prices, to resolve the crisis. As the US heads into the summer driving season — when oil and gasoline consumption is typically higher — that political pressure will only intensify, especially with the midterms approaching.
Liam, let’s go into some specific sectors now, if that’s OK. You seem cautiously optimistic about the future here, even with oil and gas prices where they are. Can you run through some of the sectors that might benefit from this situation?
Liam Auer:
Yeah, of course. From a utilities and energy infrastructure perspective, I think this is a short‑term disruption. There will probably be a bit of pain, but it doesn’t necessarily derail the core thematics and the direction we’ve been positioning for across our investments.
There are probably three main sub‑sectors within the European utilities market where we see different exposures and different impacts.
First, merchant generators. To the extent that they have gas in their generation fleet, they’re probably OK for the next 12 months, given that they usually hedge their power or their fuel costs about a year in advance. Around 80% of European electricity volumes for this year were hedged at 2025 prices. That provides a degree of insulation to generators themselves, as well as to consumers, depending on how much of that cost gets passed through.
If this is a short‑term disruption, it largely washes through. If the disruption lasts longer, in a more downside scenario, you would expect some of that financial pain to start showing up in margins for those generators in 2027.
Renewable operators are fundamentally in a better position. Every megawatt hour of wind or solar being dispatched right now is displacing relatively expensive gas generation. As coal comes back on through gas‑to‑coal switching, their low marginal‑cost production is displacing higher‑cost generation. As a result, capture prices should theoretically be much better.
The financial benefit will really depend on how much of their fleet is contracted — whether under PPAs or CFDs — versus pure merchant exposure. Those with more merchant exposure will capture more of the upside. There may be a rebasing effect, where you see a bit of a sugar hit. Where generation is under PPAs or CFDs, those revenue models do what they’re meant to do, which is provide long‑term pricing insulation, and it’s ultimately the end consumer who benefits from that insulation.
Broadly, renewables should be OK in a shorter‑duration disruption, but it really depends on fleet mix and contract structure.
Grid and network operators are probably the most insulated. Regulated utilities have regulated returns, and those returns often include a degree of pass‑through exposure to macro variables. If interest rates rise, there can be a lag, but they are generally protected. More importantly in the short term, they have inflation‑linked revenues and capex programmes that automatically inflate.
That means the total value of their capex programmes should increase alongside revenues as inflation rises. Within that group, UK and Italian regulated networks are particularly well positioned. Not only are revenues indexed to inflation, but the regulated asset base itself is also indexed. There’s a high degree of protection for investors in those assets, which is a feature, not a bug, of those regulatory frameworks. They’re designed to provide steady, real returns and an important hedge within an infrastructure portfolio.
I would add a couple of caveats. First, you always need to work through the detail because every regulatory framework has its own specifics around how costs are passed through and when. Second, there’s a political economy risk. The longer and harder this hits consumers, the more inclined regulators or politicians may be to intervene to protect them. That can have unintended consequences for utility assets and power markets more broadly, so it’s something we watch closely.
There’s a final category, I think, which is, um, the value of flexibility will go up in this market. That’s across renewable flexibility or batteries, but also what we would call flexible gas infrastructure — infrastructure enabling that flexibility.
The impact of gas prices onto power markets generally, um, belies the central position and critical position that these infrastructure assets have. And I think they’ve been underpriced for, for a number of years.
Those assets — or perhaps their, their inherent value — will become a bit more recognised as this kicks off another round of debates, I suspect, as to how do electricity markets price, how do we remove or decouple gas prices from electricity prices, and those sorts of things.
But fundamentally, as we sit back, um, we do need flexibility and firm power. Gas is probably the primary source of that at the moment, and therefore it’ll be a question of how does that get paid and, and remunerated.
Daniel McCormack:
Yeah, you already touched on something there that I think is a real fundamental positive of investing in infrastructure generally, and that is its inflation hedge attribute. Compared to other asset classes, infrastructure’s ability to deliver good relative returns in high‑inflation environments is really strong.
And, you know, for investors worried about higher inflation, having an exposure to infrastructure can be a nice way to mitigate or hedge that risk.
Liam Auer:
We’ve obviously done a bit of a deep dive on the utility space. What do you think the outlook is for some of the other sectors in the economy?
Daniel McCormack:
First, I think any sector that uses oil as a significant input is, is going to be affected. Airlines and shippers and ports kind of come immediately to mind.
If I think about ports, for example — because that’s the infrastructure side of it — you know, the risk is that shippers put up their pricing, you see lower volumes as a result, and that backs, backs up into ports’ operational performance.
The thing is though, shipping costs are about 3 to 5% of end‑consumer prices, broadly speaking. So even when you have a significant increase in shipping costs, it doesn’t translate into a huge increase in the price that actual consumers face for the good in question.
So you’re not likely to see a big impact on volumes as a result. We actually think that shipping volumes should hold up, like, relatively well through all of this, and the port sector should hold up relatively well.
Now that said, there will of course be some disruption to certain routes, just courtesy of the direct impacts of the conflict, and those need to be assessed on a port‑by‑port basis. But generally speaking, we think volumes will hold up well.
Liam Auer:
And what about airlines?
Daniel McCormack:
For airlines, oil is a much bigger proportion of the end‑consumer cost — or the end‑consumer price — there. So, for example, oil is roughly a third of total costs, give or take.
So it’s going to translate into almost that for end ticket pricing. So the increase in oil prices that we’ve seen, we could see an increase in airfares.
The question then is, is that likely to translate into lower travel volumes and therefore an impact on airports? It could, and certainly I think some routes will be affected.
But a few years ago we did a real deep dive on the air travel sector and looked at its drivers. And, you know, really what we found was that at the aggregated level, right, the overwhelming driver was GDP growth.
We ran a bunch of regressions, and pricing was just not significant quite often. In some cases it even had the wrong sign — as in it had a positive coefficient rather than a negative one, which is what you would ex ante expect.
So in short, we came away with the conclusion that inflation and pricing doesn’t have a huge impact on air travel volumes over the medium term.
Now again, you know, there could be some, some short‑term disruption and certain airlines will be affected and certain routes could be affected. But we suspect that airline volumes, for the year as a whole or over the medium term, should actually hold up relatively well to this.
So, you know, more broadly, of course, any sector that uses oil prices significantly as an input and doesn’t have pricing power is going to face margin pressure. And then where energy prices are a significant proportion of the end‑consumer price, you could see, you know, an impact on volumes, even if the company can push that cost onto consumers.
Manufacturing is a space, I think, you need to watch. It’s hyper‑competitive and often has narrowing margins in this kind of environment, so that space could be affected. But, yeah, mostly I think the infrastructure sector should hold up relatively well.
Liam Auer:
OK, that’s an interesting one about airline travel. I guess people have, they’re committed to their holidays, and so long as, um, the broader economy is OK, there’s a commitment to that.
Daniel McCormack:
I mean, there could be an impact on GDP growth as we talked about before, right, particularly if oil goes to circa $150 a barrel. And I think that’s something to watch for. If we got to those kind of levels, you potentially see a larger impact on air travel volumes and therefore airports themselves. But we’re not there yet, and I think it would take quite a bit to get to those levels.
Liam Auer:
What are the implications for interest rates? Because that was obviously, um, the second‑wave impact from 2022, so I’d be keen to hear what you think about that.
Daniel McCormack:
I think it’s a fascinating time from a monetary policy perspective because, you know, depending upon the economy you’re talking about, inflation was too high before this crisis happened.
So if you look at the US, for example, inflation was too high there. UK inflation was too high there as well. And then you’ve got what looks like an inflationary crisis hitting.
Look, in theory, a central bank should not respond with policy to something like this. I say that because a move up in the oil price is a one‑off price shift. It’s a shift in relative prices, in economic speak. Sustained underlying inflation comes from too much demand and too little supply, or too much money chasing too few goods. This is not that.
And so the textbook response is to make sure that second‑round effects don’t happen from the initial increase in the oil price — that is, we don’t see inflation expectations move up, we don’t see an intensification of wage demand. So you jawbone it, you talk hawkishly to make sure that you don’t get those second‑round effects, but you don’t actually take policy action. That’s what the textbook says.
But, um, I think we will certainly get hawkish rhetoric from central bankers everywhere. I think the actual response may depend upon the economy’s starting point.
So, for example, the Reserve Bank of Australia has already tightened monetary policy following this crisis. Now, I don’t think it’s all as a result of the crisis. You know, demand was outpacing supply there already, inflation was too high there already, and this is really just the icing on the cake.
But if you look at Canada, for example, that’s a completely different story. That’s an economy that has plenty of spare capacity, and so it doesn’t really feel a need to respond.
And for the Fed — which is all‑important — where inflation was too high coming into this, but the labour market and the economy have just shown a bit of a wobble recently. We saw a decline in employment with the latest non‑farm payrolls, and, you know, consumer numbers have softened a little bit in recent months as well.
So I think what you’ll see from the Fed is probably the textbook response. You’ll see quite a bit of jawboning, quite a bit of hawkish commentary, but I think they will be reluctant to respond with a rate increase unless they saw significant pass‑through to core inflation or they saw those second‑round effects coming through.
So I think the response will vary depending upon the economy we’re talking about and the starting point for that economy. You know, this is the lesson from the 1970s, right — you can never afford to let inflation expectations rise, because getting them back down again is very costly, economically speaking.
Daniel McCormack:
Uh, Liam, let’s now move to our final topic, which is the implications for investors. We started with what investors are asking you about. Perhaps now we could turn to hearing from you what you think they should know at this point.
Liam Auer:
Yeah, thanks, Dan. So the first takeaway would be infrastructure investments — or a portfolio of infrastructure investments, particularly core — should be relatively resilient in the face of a short‑term disruption.
I think every investor and manager out there will be closely monitoring and be hyper‑vigilant, but at this stage there is a degree of resiliency out there, so it’s a cautious watching brief.
Then, moving into some more specific areas, I think particularly in Europe, the structural tailwind for renewables will continue. There’s obviously an anticipated increase in power demand structurally through the digital infrastructure or digital economy. This will probably accelerate that need for build‑out and desire to build‑out, as we saw after 2022, given Europe’s position as a net energy importer and a desire to move towards more energy independence.
So I think that is a thematic which should continue. There’ll be some short‑term disruptions to manage — supply chain, a bit of inflation — and then we’ll see what happens to interest rates. But fundamentally, I think the renewables acceleration and electrification of the economy will gain momentum or be reinforced by recent events.
I think a second impact, and one that goes hand in hand for the foreseeable future, is renewables and gas and flexibility. And the value of that flexibility is increasing. Therefore, there will be an opportunity for investors to play into those assets or play into those markets. And governments and policymakers and markets will probably look to build that firmness out and the flexibility that we need, coupled with a re‑examination of how those sorts of assets are paid for.
And there’s some interesting debates there as to whether it’s more regulated and decoupled and less price‑exposed. But fundamentally, as we move into that more intermittent renewable system, you do need more firm power capacity to act as that insurance policy to respond to weather‑driven shocks, which fundamentally are what happens to those renewable systems.
The third one is Europe probably needs to think a little bit around its position as an energy importer. They will have to run at decarbonisation probably harder than net producers of energy. They will have to think harder about their own indigenous sources and look to maximise that more than they have been, as well as look at more renewable alternatives such as biomethane, which also has secondary benefits for decarbonising other hard‑to‑abate industries such as agriculture.
There’s obviously been strong momentum there, and we’ve been playing into that. I suspect that will become even more prominent in the months and years ahead.
The final aspect of that is, after 2022, there was a big focus in the utilities sector on resilience and security of supply. That was both where are you getting your molecules and electrons, but also how exposed are they to physical exposure and security risks. That will, I think, only accelerate and that will require reinforcing of a lot of those critical national infrastructure assets.
It’s an operational challenge, but equally it’s a capex opportunity as grid operators and networks and power generators look to harden their assets and make them more resilient so that they can deliver when they’re getting called upon.
Stepping back for a broader question of asset allocation, how should investors be thinking about this and positioning their portfolios?
Daniel McCormack:
Look, I think infrastructure is genuinely very well placed in all of this. It’s defensive equity with an inflation hedge, so from a relative performance perspective, it is suited to negative supply shocks such as this. So good exposure to infrastructure should serve you well.
The response from bond markets to this crisis has been very, very clear. Bond yields across the developed world have risen. Bond markets view it as inflationary. So I think if the crisis continues or escalates, low‑risk bonds will probably struggle from a relative performance point of view.
In terms of listed equities, there’s a lot of concern at the moment about the risks there. Valuations are high, this is a disruptive shock for sure. I’ve actually spent a bit of time looking at the relationship between listed equities, their performance, and the types of events like this. What you come away with, actually, is that listed equities are surprisingly resilient.
You know, when you have geopolitical shocks like this, most of the time — over the last 40 years — equities have finished higher 100 days later, for example. And that holds even if you select the scenarios where interest rates subsequently rose. So that sort of bodes well for their performance.
It also holds even if you control for situations where the rise in the oil price was not demand‑driven but was supply‑driven. Actually, what you find is that equities tend to be resilient even in those types of scenarios — you know, one month or three months later, they’re higher by varying degrees.
I think equity investors need to be vigilant, they need to be nimble. And as I say, valuations are very, very high. But a detailed look at the historical record actually paints a picture that equity markets can be quite resilient to these types of events.
Um, the public credit space, I think, looks a little bit tricky because spreads there are very, very narrow. We’re facing a very disruptive event here, but we’re also facing a lot of disruption in terms of AI and just the more volatile macro and geopolitical environment generally. I think the public credit space looks a little bit concerning as well. I don’t think it’s accurately priced.
So in short, that would be my, my sort of tagline.
Liam Auer:
So it sounds like real assets with inflation protection is probably a good place to be.
Daniel McCormack:
Defensive equity with an inflation hedge, I think, looks and feels very good at the moment.
So that really brings us to time. Liam, thanks very much for joining us — some great insight there. What I heard from you was tailwinds for renewables continue, plenty of value placed on firm power and flexibility given we’ll have a greater need for that going forward.
You know, regulated assets you think are in a good spot here, although we want to be mindful of government intervention, particularly if the crisis goes on for a long time. And then security of supply was important, and will only be more important after this.
That’s a really nice summary of where we’re at. To you, our investors and listeners, thanks very much for tuning in. I hope you found that as interesting as I did. Until next time.
Liam Auer:
Thanks very much, Dan.