Understanding the scale of energy transition opportunities in the US and globally
Around the world a global buy-in to renewable energy is taking place, driven by a range of powerful factors from environmental imperatives to national security. In the second of two articles, Adam Farstrup talks to specialist investors David Boyce and Mark Lacey to discover the scale of the opportunities for investors – and where exactly they lie.
The rush to build and grow secure, clean forms of energy is underway around the world. We think this trend of “decarbonization” is one of the most powerful forces that investors today are needing to grapple with – and from which they can benefit.
Public policy is one of the key drivers of this trend. In the US, for example, we have the Inflation Reduction Act, while in Europe – where conflict in Ukraine has resulted in a particularly severe energy shock – we have the Repower EU initiative, among others. China, too, is rolling out a raft of policies to support decarbonization.
But to what extent is the momentum of global energy transition linked to these state-led initiatives? What are the other drivers of investment and growth? To explore these issues, I put three key questions to David Boyce, CEO of Schroders Greencoat in North America, an investor specializing in renewables infrastructure; and Mark Lacey, a London-based Schroders fund manager focusing on global energy transition.
Question 1: Is the energy transition thesis reliant on government policies – and on environmental policies in particular – or can the sector move ahead even without these policy supports?
Mark Lacey: I think investors can get too hung up on policy as a long-term driver. Look at what the Inflation Reduction Act is. It's not about merely stimulating investment in renewables. It's about onshoring of capability for the US; onshoring skills and growing a long-term investment base for these industries in the US.
It's a well thought-out policy because businesses have to be generating profit in the first place to benefit.
At the same time as an investor you have to be aware of a potential risk if too much of this is priced into equities. If, for example, a Republican government chooses to dilute the policy, what is being priced into those equities could be jeopardized. You have to factor this into decisions in relation to individual equities.
But if you look globally, renewables are enjoying a widespread buy-in. Whether it's Brazil getting to 28% of electricity from renewables by 2027; or India targeting 450 gigawatts of renewable power generation by 2030 (which would almost use up today’s entire existing international offshore wind market); or whether you're focusing on the EU plans – altogether these are creating huge collective demand.
It's about accelerating energy transition from a climate need perspective. And it's about not being left behind from an energy security perspective. These are the twin drivers.
The added benefit of renewables – which is different from oil and gas – is that oil and gas assets have typically been found in inaccessible or geopolitically difficult regions. Most countries can have access to wind or solar and they will own the assets themselves: this is highly attractive from an energy security point of view.
David Boyce: From my perspective the Inflation Reduction Act (IRA) is little bit of a mixed bag. For wind and solar there was a time in the US when those subsidies were a difference-maker. They drove down the effective price of power and that took a nascent industry and gave it a necessary jump-start.
Where the technology and the cost of wind and solar power production is today, it would probably be in good shape without the federal subsidy. The tech has advanced and the costs have been driven down.
What's exciting to me is that even without the subsidy, these energy sources can go head to head with fossil fuels.
The more interesting parts of the inflation Reduction Act are the other things that it touches on, such as standalone storage and hydrogen manufacturing. Those are the next technologies that need a bit of support to get over the hump. And I think that's really the value for the American people in the IRA.
There is another group here as well – which is often overlooked – which is the conventional energy players Shell, BP, Exxon, Chevron and Conoco: they also benefit from the Inflation Reduction Act.
All these companies are in hydrogen; they're all in carbon capture, and they're all in biofuels. They will have the tax liabilities to benefit from these subsidies, and we could be talking considerable sums.
Question 2: We have increases in electricity demand coming from economic growth and from the electrification that we see happening all around us. But can you give me a sense of the scale of investment needed in global energy infrastructure globally and specifically in the US?
Mark Lacey: If you take the conventional oil and gas market globally, you are looking at just under $500 billion per annum of investment. This peaked at just under a trillion back in 2014 – and we went to an oversupply situation – but it's now comfortably running at $500 billion per annum to service an oil market which is around 102 million barrels a day; and a global gas market which is almost comparable in size on an equivalent basis.
At the moment, we are spending roughly in terms of clean energy generation – that’s offshore wind, onshore wind and solar – around about $450 billion per annum. It needs to be just under $1 trillion per annum in order to meet the 2050 net zero targets, which would take renewables from 20% of the overall energy mix to closer to 85%.
The above calculation doesn't include the fact that electricity, as your final share in energy consumption, is going to go from 20% to 45% as drivers switch to electric vehicles (EVs).
Nor have I included the capex numbers on batteries and storage, or improved energy efficiencies. When you add it all up, it is comfortably over $2 trillion per annum, feeding into the energy transition market. That's outside of the traditional oil and gas market. Totaling it all up, it’s comfortably in the region of $100 trillion over the 2020 to 2050 period. Never has the energy market, from a public perspective or a private perspective, ever seen this much capital required over a period of just three decades. It will be transformational from an infrastructure perspective – but also from an investment perspective. It’s a staggering set of figures.
David Boyce: Taking a step back and thinking about the US market alone, our electricity needs – and this does not include EVs or massive transition from gas to electric heating – are growing at a rate of 1%.
Just to keep up with that 1% increase in demand would require the equivalent of replacing every power plant in the state of Massachusetts every year.
No power plant lasts forever, and old power plants need to be retired. That too adds to demand for further investment – and that’s just to maintain the status quo.
Then start to add the goals around decarbonization, and the numbers just start ballooning. It’s not just the generating assets, it's all the infrastructure required to distribute, store and supply the energy.
Question 3: Many will wonder what this transformation will mean for their investments. Is it possible to capture that enormous energy transition opportunity in a broad portfolio, or does it benefit from a more specialist approach?
Mark Lacey: I think a holistic approach to investing in the energy sector is going to be absolutely critical in coming decades.
It is not just pure-play energy transition equities. Right now they're a tiny portion of the global market, and of course they will grow, but the big companies like Shell and Exxon are still going to be here in 30 years, too – it’s just that by then they're going to be completely different companies.
Active management is absolutely key. Energy plays a very important part in everyone's portfolios, but obviously there will be cycles, which is why active management is essential.
David Boyce: Specialist expertise counts. With opportunities this big, it’s possible investors with no steer could get in the way of some of the benefits. But I think what investors really want is more than mere exposure.
They will want to see some intelligence behind the process and in the case of physical assets in particular, they will want to know why those assets were selected – and how the risks are being managed.
Anyone can throw darts at a board and some assets will be great and others not so – but investors should demand more. Given the enormity of the change in this space in the decades ahead, I think we will find that investments guided with specialist knowledge will generate better results.