The energy transition will require major investment and concerted political will to deliver on net-zero targets.

However, the imperative for action is rising as the cost of inaction increases. Fortunately, the costs of solutions are proving increasingly economical. With major spending in the sector accelerating there is value to be realised for companies that provide the means to tackle climate change and those that provide solutions to mitigate its impact.

Key messages

  • The energy transition is complex and diverse but is having an increasingly important influence on equities.
  • Climate change is set to impact value assets both positively and negatively with some equities well placed and others set to suffer.

The challenge

To reach the net-zero goals of 2050 (or later), will require major investment which energy data analysis provider BloombergNEF (BNEF) estimates at USD 92–173 trillion over the next three decades, of which USD 33–57 tn is expected to be invested in power-generation assets and batteries according to its various scenario outlooks. BNEF calculates that an average of 3.2x more solar and 5.2x more wind installations will be required in each year through to 2030 vs 2020 deployments. This will require investment to accelerate from around USD 300 bn over the last few years to between USD 760 bn and USD 1.8 tn annually.

The core technologies for decarbonising comprise solar, wind and energy storage solutions e.g. batteries. These are now at sufficient scale to be increasingly economically attractive and are generally cheaper than conventional thermal fuels (gas, coal, etc.). However, solar and wind today make up less than 4% of global final energy consumption.

The path to tackling the challenge

We can consider responses to climate change simplistically via two pathways: reactive and proactive. Over time we will see a mix of the two but their respective ratios will be subject to governments’, citizens’ and corporates’ willpower:

  • Proactive – Taking action today to prevent further climate change through the reduction of emissions. This implies effectively rebuilding a decarbonised energy system across transport, heating, industry and power.
  • Reactive – Responding to the consequences of climate change (e.g. higher temperatures, rising sea levels) as they arise.

A proactive strategy means higher expenses today, but would reduce the long-term cost which could rise exponentially. Action is accelerating and there is cause for optimism as renewables are increasingly competitive and offering new business opportunities.

A reactive approach is cheaper today and because of the Covid crisis many nations will struggle to justify expenditures on a proactive strategy. Ultimately, however, the cost of inaction will be higher in the long term, becoming apparent through increased extreme weather events causing infrastructure damage, crop failures, migration, insurance costs, and stranded assets (including property).

Evidencing these rising costs, SwissRe has estimated USD 250 bn worth of damage from extreme weather in 2021. This is the sixth time costs have exceeded USD 100 bn since 2011. The insurer also recently stated that 2021 was the fourth-highest year on record for insured catastrophe losses (excluding non-insured) at USD 120 bn.

Companies that offer solutions in both proactive and reactive strategies will be able to generate value as they will have strong growth pathways ahead. Companies geared to proactive strategies are relatively easy to identify: renewables operators, clean tech, etc. Those that can provide reactive solutions will likely be more diverse across sectors, e.g. infrastructure companies building flood protection, key equipment manufacturers, etc.

Where we are in terms of progress

Energy transitions have long underpinned the development of society and typically take decades. Over time we have tried to access more carbon-based energy with less effort, first burning wood, then coal, then oil and gas. Now we need to develop energy systems without carbon. We have the technologies today, but we are just at the start of this latest transition: just 3–4% of primary energy is from solar and wind today.

In contrast to the past, the imperative is now to avert or minimise major environmental changes, hence the net-zero targets aimed at preventing a point of irreversible change to the environment. In order to progress towards those net-zero targets, it will be critical for government policy to remain supportive to ensure proactive investments are made. The policies will typically take two forms: either incentives such as grants or tax breaks, or legal obligations such as premiums for high emissions (carbon pricing mechanisms).

Governments are already deploying major stimulus in energy infrastructure with the Green New Deal in the EU and the recently passed USD 550 bn infrastructure package in the US. We also note that much of Western energy infrastructure is ageing and in need of reinvestment. US grids are on average 40 years old so major investment is required irrespective of decarbonisation agendas to maintain reliable energy supplies. China is also taking aggressive action, as attested by the Ministry of Industry and IT’s recently issued five-year plan to better manage energy-intensive industries and facilitate decarbonisation goals. Other major economies such as Japan and Korea have also been accelerating their policy action.

The energy crisis a catalyst for change

The current energy crisis appears to be prompting a positive long-term response in terms of decarbonisation, arguably in a reactive manner but supporting proactive measures. Energy-hungry companies that have found themselves exposed to both power shortages and merchant pricing (unhedged) are securing independent energy supplies from renewable resources to reduce their carbon costs and the risk from government-imposed energy curbs (e.g. BASF signing a 25-year renewable power purchase agreement with Ørsted). This is an area where major tech companies have long been active, but now other companies are following suit.

What this means for equity markets

The energy transition is complex, with consequences and actions across a broad range of sectors. Companies need to clearly gear themselves towards the trend in order to ensure they do not end up having “stranded assets”. Furthermore, they are under growing pressure to make net-zero commitments driven by investor demand, government pressure and a growing emphasis on ESG. At the recent COP26 summit, an alliance championed by the Bank of England’s former governor, Mark Carney, comprising banks and asset managers representing 40% of the world’s financial assets (USD 130 tn) pledged to meet the climate goals set out in the Paris Agreement.

Capital availability will also be influenced by decarbonisation agendas. Green bonds are becoming a major source of finance benefitting from strong demand. Polluting industries are also finding it increasingly challenging to raise financing, both on equity and debt markets, which will further benefit cleaner actors. Polluters will also face rising costs as government policy moves increasingly towards penalising them, thereby putting pressure on the value of companies that are not evolving.