The energy transition is unlikely to be a linear journey, for countries, companies, or investors. However, active managers are well-positioned to identify investment opportunities during this multi-decade opportunity.
When thinking about where the risks and opportunities of the climate response will fall for investors, first consider the implications of a tighter policy response on an industry-by-industry basis.
Policy
Given that the majority of emissions can be traced back to predominantly five sectors—transport, buildings, agriculture, power and industry—it is reasonable to expect additional policies that accelerate the pace of the energy transition to be focused here.
Already, countries such as France are looking to discontinue activities involving the exploration and exploitation of hydrocarbon fossil fuels by 2040. At a higher level, the EU has also committed to the largest stimulus package ever financed by the bloc to become more resource-efficient, greener, and improve resilience to the impacts of climate change as part of its Green Deal and Recovery Plan for the region.
In some ways Europe is leading the rest of the world in terms of its commitment to greening the economy through policy and disclosure requirements.
However, the climate crisis is a global problem that requires a multilateral response. Increasing realisation of this—some of which may start to emerge at COP26 in Glasgow—presents a wide variety of investment opportunities. Transitioning to a carbon neutral world should, over time, drive the financial productivity of companies that pivot to or support greener activities, as these actions increasingly become rewarded, incentivised, and reflected in the cost of capital and valuations of companies that support the transition over the longer term.
But the path isn’t without its challenges. The recent surge in coal and oil prices has highlighted the tension policymakers face between delivering on the political will to solve the climate crisis and managing the negative externalities created. Spain recently announced a €3bn clawback on energy companies’ profits, alongside temporary tax cuts for consumers, as energy prices have soared.
Themes
There are two major sources of long-term returns for investors during this energy transition. Principally among companies that enable the transition, i.e. those that supply products or services that support the transition to a low carbon economy, and transformers, companies that address climate risks by reorienting their business models. These businesses will either directly help companies reduce carbon emissions through technological innovations that drive energy efficiencies, or re-orientate their own business models away from activities that have significant negative externalities for the environment.
Examples could include power generation companies replacing fossil fuel-powered generation with renewables, or car producers shifting their mix from internal combustion engine powered vehicles to electric vehicles.
There are a range of energy transition themes from which opportunities may arise, including renewable energy, electricity distribution, smart grid operation, electric vehicles, autonomous driving, manufacturing and process automation, battery technology, clean hydrogen, buildings efficiency and agricultural solutions.
However, investors will need to dig deeper to find the opportunities that are yet to be fully understood by the market. This can be achieved by thorough analysis across value chains on a global basis in order to assess and understand the products and services that are likely to drive the longer-term changes that are required within the world economy.
