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What’s the Global Energy Transition, and Why Does It Matter?

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  • Markets and Investing
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Raymond James Energy Analyst Pavel Molchanov discusses decarbonization and its investing implications.

To read the full article, see the Investment Strategy Quarterly publication linked below.

Key takeaways:

  • Energy transition is a megatrend not just for the next few years but toward the middle of the century.
  • A dozen of the top-tier oil and gas producers have committed to reorient their operations toward low-carbon energy over the next 20 to 30 years. They are doing it because they view it as good business.
  • Sustainable (ESG) investing – and, more specifically, climate investing – is raising the importance of energy transition for management teams, particularly at publicly-traded companies.

Energy transition, also commonly referred to as decarbonization, is one of the global megatrends of our time.

Here is the big picture: the global economy’s traditional reliance on fossil fuels (coal, petroleum, natural gas) is diminishing, as both technological/economic and political/regulatory factors drive the adoption of renewable energy sources and other low-carbon technologies.

For investors, it is essential to at least conceptually recognize the impact that this megatrend will have for the entire energy value chain, along with many non-energy areas (e.g., transportation, manufacturing, and agriculture). There will be winners and losers, but not always the ones you’d expect, and with a wide range of impacts in different geographies.

Renewable energy is good business

Technological change is creating economic incentives for self-motivated decarbonization. Case in point: more than 280 large companies around the world, encompassing nearly every industry, have committed to source 100% of their electricity from renewable sources — and many have already achieved this target. Even more impactful, a dozen of the top-tier oil and gas producers have committed to reorient their operations toward low-carbon energy over the next 20 to 30 years.

To clarify, these companies are doing it not because they are forced to by governments, but rather because they see it as good business. For example, the past decade’s massive reductions in wind turbine and solar hardware costs mean that in-house wind and solar farms routinely provide lower-cost electricity for data centers as compared to buying power from the grid – and, amid frequent headlines about weather-related power outages, integrating such assets with batteries can also provide 24/7 reliability. Bus and truck fleets converting to electric or fuel cell vehicles stand to achieve savings on fuel as well as maintenance, which offsets the higher upfront cost of these vehicles. Similarly, upgrading buildings with energy-efficient windows, LED lighting, and energy management software also pays for itself over time.

Milestones in sustainable policy, from the founding of the Social Investment Forum in 1984 to the 2050 E.U. target date for net zero C02 emissions.

Sustainable investing

Alongside the fundamental drivers mentioned above, sustainable (ESG) investing — and, more specifically, climate investing — is raising the importance of energy transition for management teams, particularly at publicly-traded companies.

Broadly speaking, there are two approaches to climate investing, and these are not mutually exclusive. First, investors can exclude those companies that are having a disproportionately negative effect on the climate. Second, they can favor those companies that are creating beneficial climate-oriented solutions.

Here are the key statistics vis-à-vis ESG: as of 2020, $16.6 trillion of professionally-managed assets (equity and debt combined) in the U.S. are covered by one or more ESG criteria, up 56% from 2018. Remarkably, this represents fully one-third of all managed assets. Within the $16.6 trillion pie, the largest single slice — climate funds — accounts for $4.2 trillion.

Meanwhile, the worldwide total of funds with a fossil fuel divestment policy is approaching $20 trillion, though the vast majority of the divestments pertain solely to coal, at least for now. Divestments are more common in Europe than elsewhere, and more common among universities and foundations than traditional asset management firms. Looking at debt specifically, green bonds are a popular way to raise capital for projects with a positive climate impact, including below-the-radar projects such as reforestation, public transit, or making the electric grid more resilient.

Energy transition has unlimited scope

Investing in energy transition does not need to be limited to high-beta, high-multiple stocks of solar, electric vehicle, or hydrogen companies (which is what tends to come to mind first). Certainly there are plenty of options in the clean tech sector – the aggregate market cap is approximately $1.5 trillion, the highest ever – but businesses in many other sectors are also playing a role.

For example, some banks and insurers are more active than others in boosting lending to renewable energy initiatives and/or cutting back on lending to fossil fuels. Alongside the well-known electric vehicle (EV) pure-plays, just about every major automaker has EV models available, and some have committed to becoming exclusively electric over the long run. Food, beverage, and other consumer goods companies are taking steps to reduce single-use plastics, which sometimes involves partnering with startups developing bio-based chemicals. REITs and homebuilders are deploying energy-efficient technologies across their asset base.

The bottom line is that investors ought to be creative, rather than only looking at the well-known high-flyers.

Investment Strategy Quarterly

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Investment Strategy Quarterly

Sustainable (ESG) Investing considers qualitative environmental, social and corporate governance criteria, which may be subjective in nature. There are additional risks involved, including limited diversification and the potential for increased volatility. There is no guarantee that these products or strategies will produce returns similar to traditional investments. Because criteria exclude certain securities/products for non-financial reasons, investors may forego some market opportunities available to those who do not use these criteria. Investment Strategy Quarterly is intended to communicate current economic and capital market information along with the informed perspectives of our investment professionals. You may contact your financial advisor to discuss the content of this publication in the context of your own unique circumstances. Published 4/1/2021.