The world is undergoing a colossal change in the way it thinks about sourcing, producing, and delivering energy as it attempts to reduce carbon emissions and transition to a ‘net-zero’ economy. When we look around us, there is no doubt that the energy transition is under way, but this is a multi-decade journey of which we are still in the very early stages.
Several geo-political, macro-economic, and environmental events over the past few years have affected the global energy system in multiple ways, both positively and negatively. And the choices that we make in the coming years are no doubt going to have profound consequences on the future of the climate and, indeed, the planet.
In this month’s edition of Core Offerings, we provide an update on global investment trends in the energy transition to date, some inconvenient truths, and where we see the opportunities in the coming years.
Eighteen months on from Russia’s invasion of Ukraine, the global energy landscape has changed. The war destabilised global energy supplies, which increased price volatility and shone a spotlight on energy security. One key question to arise from this is: did the energy crisis lead to accelerated investment in the energy transition, or has it prompted renewed investment in fossil fuels?
The International Energy Agency’s (IEA) 2023 Energy Investment Report shows that the war accelerated investment into a range of clean energy technologies, but also led to a short-term scramble for oil and gas supply (not necessarily new investment). There is no doubt that the war highlighted the world’s dependence on fossil fuel consumption—but it also revealed the lack of reliability that offshoring energy provides.
Previously, fossil fuels and energy security came as a package. Both were seen as reliable and affordable, and it was renewables that came at a premium. Not anymore. Clean energy, in many parts of the world, is now the more affordable option, and energy security comes with the higher price tag (for a range of reasons, including geo-political as well as reduced capex). The benefits of clean energy are that it can now support energy security, and the quest for greater energy security is ultimately leading to a faster transition.
Did the energy crisis lead to accelerated investment in the energy transition, or has it prompted renewed investment in fossil fuels?
According to BloombergNEF, global investment in renewable energy skyrocketed to USD 358 billion in the first six months of 2023, a 22% rise compared to the start of last year and an all-time high for any previous six-month period. Most of this investment was related to small-scale solar, but renewable energy venture capital commitments were also up 25%. According to the IEA, for every USD 1 spent on fossil fuels, USD 1.70 is now spent on clean energy. Five years ago, that ratio was 1:1.
A multitude of factors has driven the momentum in clean energy investment. Policy support, including the US Inflation Reduction Act (IRA), the REPowerEU plan in Europe, and the GX (Green Transformation) programme in Japan are just a few examples of how some global policymakers have taken bold action to support investment in renewables. Adding to that, high fossil fuel prices (aided by lower investment) and a strong alignment of climate and energy security goals are fuelling capital into this space.
Consumers too are investing in more electrified end uses—demand for electric vehicles (EVs) is up, and global sales are expected to break through 2022’s record of 10 million to reach 13 million in total sales in 2023. In Australia, Tesla sales recently reached sixth place in the monthly sales leader board, its best ever performance. The momentum is being led by renewable power and EVs, but with strong contributions from batteries, heat pumps and nuclear power.
“Thermal coal exports, worth A$60bn last year (2022), will be reduced to 1% of that in 40 years if the world limits global warming to 1.5 degrees above pre-industrial levels.”
“The levelized cost of renewable energy continues to fall with onshore wind falling 6.3% in 2022, offshore wind falling 10.2% and fixed axis PV falling 1.7%. Electric vehicle sales are continuing to increase, and are expected to hit 13 million in 2023, up from 10 million in 2022.”
China’s clean energy investment hit USD 546 billion in 2021, just under half of the world’s total. For H1 2023, China was again the largest contributor with USD 177 billion of new investment. The accelerated investment forms part of the Chinese government’s strategy to cut its energy intensity and reach peak emissions in a “well-planned and phased out approach” with the aim of being carbon neutral by 2060, according to President of China, Xi Jinping. In 2020, Xi pledged to achieve peak CO2 emissions before 2030 and carbon neutrality by 2060.
Indeed, China has already invested heavily in solar, and represents around 40% of the world’s solar industry. According to the Global Energy Monitor, China is set to double its production of wind and solar to produce 1,200 gigawatts of energy by 2025, five years ahead of reaching its goal by 2030.
China is not only at the forefront of renewable energy investment, but it also dominates global critical mineral supply chains, accounting for around 60% of worldwide production and 85% of processing. Many critical minerals have no viable substitutes and are indispensable for the energy transition, as they are required in almost every piece of renewable energy infrastructure, including EVs, solar and wind turbines. You can read more about our views on critical minerals in Australia’s next mining boom? The role of critical minerals in renewable energy.
Even as global energy supplies tightened during 2022, the development of China’s renewable energy investment continued unabated.
Whilst it is the world’s largest investor in renewables, China remains the largest consumer of coal and, as a result, is the world’s largest CO2 emitter. Its economy still remains heavily dependent on coal to meet its electricity needs, and it is responsible for around 30% of global emissions—more than the US and Europe combined.
However, environmental pollution costs China significant sums every year, and many believe that China is nearing peak fossil fuel generation. According to the China Electricity Council, forecasted consumption for fossil fuels is expected to rise for another three years, but renewables are expected to account for half of new capacity additions.
Further, it is viewed that China’s supply chains for critical minerals are rife with forced labour, and many western countries have released policies that aim to reduce the reliance on China for critical minerals. Policies like the IRA have clear directives to reduce reliance on ‘dirty’ supply chains, which in theory cuts China out of the energy transition in the US. But it’s incredibly difficult to completely decouple from China. Many inputs into renewables are sourced from China but traded on global markets with no trace of Chinese origin.
What’s clear is the energy transition won’t be without its trade-offs. Countries and policymakers will need to weigh up the costs and benefits for each and every stage of the transition. China’s investment in renewable energy is creating healthy competition between the East and West, as all global economies focus on reducing carbon emissions.
The IRA includes approximately USD 390 billion of spending/tax credits over the next 10 years related to energy and climate change. The goal is to put the US on track towards 40% emissions reductions by 2030.
The IRA has, no doubt, been the most comprehensive and ambitious climate legislation ever passed in the US, or globally for that matter. The economics are extremely attractive, offering generous credits and tax subsidies for both commercial and residential consumers across multiple renewable energy technologies.
A year on from the legislation being signed into law, it is making significant progress toward shifting the US to 80% clean electricity and cutting emissions by 40% by 2030. To date, there has been USD 278 billion in private clean energy investments, and around USD 70 billion has become available in grants, rebates, and subsidies for the end user. To date, around 272 new clean energy projects have been announced, including EV manufacturing facilities, battery manufacturing sites, and wind and solar construction. Sales of EVs are expected to reach over 1.5 million in 2023, fuelled by the generous incentives of the IRA.
What is becoming clear is that the US, China, and the rest of the world are now in explicit competition for jobs, economic value, technological leadership, and supply chain dominance across multiple clean energy markets. The reasons for this are based on both economics and security. It is possible that the healthy competition between leading nations could spark a ‘green war’ of sorts, which will be beneficial to the long-term health and stability of the planet but could ultimately result in increased cost pressures and supply chain disruption.
Decarbonisation is a major threat to revenue, given Australia has relied extensively for decades on the taxes gleaned from exports of commodities like coal and gas.
Australia is targeting a 43% fall in emissions by 2030 and the achievement of net-zero emissions by 2050. It is widely known that these targets will require an enormous collaborative effort from government, the private sector, and individuals alike.
Minister for Climate Change and Energy, Chris Bowen, has highlighted the mammoth task ahead. He says that in order for Australia to reach net-zero emissions, Australia must install 22,000 500-watt solar panels every day for eight years, along with 40 7MW turbines every month—backed by at least 10,000kms of additional transmission lines.
Several key governmental policy reforms will support these targets, including the Safeguard Mechanism, Rewiring the Nation program, National Electric Vehicle Strategy, and the National Reconstruction Fund. But a key risk for Australia is that it lacks progressive policy action, or in other words, a clear policy runway to encourage private sector action.
Whilst the IRA is, no doubt, beneficial for global decarbonisation, it encourages capital towards the US that may otherwise have stayed in Australia. Bowen recently said, “The task of the Australian Government is to ensure that the IRA does not distort activity that would have otherwise would have happened in Australia”. Australia needs the policy support to keep invested capital local, otherwise it runs the risk of seriously locking itself out of the next decade of climate opportunities.
Further, the recent Intergenerational Report from the Australian Government has made the bold prediction that Australia’s multi-billion-dollar thermal coal export industry will be all but wiped out in 40 years if the world continues on its path towards net-zero emissions by 2050. Australia needs to be developing strategies now in order to ensure that gaps left by the coal, oil and gas industry are filled with the unprecedented opportunities that are likely coming from critical minerals.
The good news is that Australia is in the prime position to capture value in the clean energy transition, from critical minerals extraction to the onshoring of refining. But we need pragmatic leadership at the helm (both across public and private sectors) to ensure that Australians can see the advantages, and ensure costs are not going to blow out.
Decarbonisation can drive economic growth, create jobs, and bring substantial benefits to the environment and public health. But it must be done purposefully and strategically. It cannot be forgotten that the correlation between cheap energy and prosperity, defined by GDP growth, go hand-in-hand. Few believe the transition to clean energy is ‘costless’.
If the world is to achieve net zero emissions by 2050, global demand for critical minerals is going to have to increase by 350% by 2040.
2022 was an extraordinary year for many fossil fuel companies, as high energy prices resulted in high revenues. Oil prices peaked at approximately USD 128 per barrel (bbl) in March 2022, two weeks after the Russian invasion of Ukraine. Since that peak, oil prices have fallen by around 35% to USD 83 bbl. At its lowest (in June), the pullback was 44%. However, despite this fall in oil prices, the MSCI World Energy sector (the companies engaged in this sector) has seen a positive total return over the same period—around 9%—significantly outperforming the underlying commodity price.
Part of the explanation for this divergence lies with the transition to net zero and sustainability factors that now govern corporate decision making. Uncertainty over the pace, cost and means of the energy transition is being reflected in the capital allocation framework of company boards. The major constraint on near-term investment levels has shifted from capital availability to capital allocation, returns, and the cost of bringing new supply to market in a higher interest rate environment.
Oil and gas companies are experiencing record profits—however, they are prioritising returns to shareholders via dividends, share buybacks, and debt repayment.
According to the IEA, less than half the oil and gas industry’s unprecedented cash flow is going back into traditional supply. Between 2010 and 2019, three quarters of cash outflows were typically invested into new supply. This is now less than half, with the majority going to dividends and share buybacks (39%) and debt repayment (13%).
“There is only one way to get the world off oil and gas, and that is not to expect the companies that benefit from that industry most to lead the way. These companies are set up to maximise shareholder returns and they are doing exactly that.”
For any long-term investor, considering the implications of climate change will play a crucial role in portfolio risk mitigation over the coming decades.
For any long-term investor, considering the implications of climate change will play a crucial role in portfolio risk mitigation over the coming decades. Changes in long-term structural trends will weigh heavily on fossil fuel demand and portfolios need to pivot in such a way that they are resilient and positioned for success in a net-zero world.
Investors are likely to continue to be challenged by a heightened level of uncertainty surrounding the pace and path of the energy transition. Notwithstanding a lack of clarity, and questions surrounding the precise characteristics of the future, we believe there are still investments and sectors that will play a durable role in mitigating portfolio risk.
Net-zero infrastructure – Infrastructure investments are, by nature, in it for the long haul. To reach net zero, significant infrastructure will be needed for decarbonisation, especially mature sustainable technologies like wind and solar.
Critical minerals – With demand expected to increase exponentially for many critical minerals (lithium, copper, rare earths), we favour exposure to this thematic through specific stock selection, thematic exchange-traded funds (ETFs) and direct commodity ETF exposure.
Companies in transition – Companies which have clearly defined transition pathways and that have developed a holistic understanding of the risks and opportunities associated with the move to a low carbon future.
Enablers of the transition – Efficiency and optimisation, on both the supply and demand side, need to be augmented with digital technology for energy system balancing and control. We like companies which consider adopting artificial intelligence technology, data management, connectivity, and security.
Survival of the adapters – Traditional fossil fuel companies face diminishing marginal demand that threatens revenues and could make assets worthless in the future. To remain relevant in an ever-changing world, companies need to adapt to the clean energy future.
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