Energy transition: Is the sector ex-growth?

Investment levels in both renewable and conventional energy need to increase significantly as energy transition infrastructure requires nearly $120 trillion in investment from 2020 and 2050. We’re at the start of an exciting era. However, for investors, timing is essential and there are understandable questions on whether is it too early or late to invest in the energy transition space?

All too often, when thinking about the shift that decarbonization entails, there can be a tendency to simply focus on the future—on where we need to go in terms of renewables. It’s important to recognize that the energy transition also encompasses the current demands that the conventional energy sector does (and will continue to) address.

We are entering a multi-decade investment cycle across almost all areas of the energy market value chain. We’ve reached a point where the world is becoming short of energy. The last 10 years has resulted in the global energy sector facing increasing challenges:

o        A reduction in spare capacity through underinvestment

o        A critical need to decarbonize given the unsustainable emissions path

o        Increased need for independent energy security as deglobalization takes hold

o        An acceleration in demand growth for energy in both developed and emerging economies

As mentioned, it is estimated that we need to spend $120 trillion of investment in energy transition infrastructure. We are currently seeing fossil fuel investment of $500 billion per annum. Ultimately, the magnitude of investment in the energy transition sector is going to have to be almost as much as five times the historic run rate of fossil fuel capital expenditure.

At the same time, the leading companies in the conventional energy sector will need to adapt and transition their business models to continue to be dominant players in the global energy market going forward.

Therefore, when we consider the energy transition, we must consider the long cyclical nature of the sector, both across conventional and renewable energy. The reason why we must consider both is because they all have an important role to play in providing energy security, energy stability and low cost energy as we go through this long transition period.

Renewable energy demand is happening now

In areas such as wind and solar according to BloombergNEF (BNEF), the renewables market is expected to grow about 200% over the next decade. By 2030, renewable generating capacity could triple. And that’s the tried and tested technology. We also think there’s vast potential in hydrogen, not just as a fuel but also as a source of storage. If the promise is realized, the implications for how we currently view electrical grids could be immense.

We also see huge demand for renewables from the increased demand for electricity globally; the market is expected to grow by about 150% between now and 2040 (McKinsey, Global Energy Perspective 2023). This is an unusually strong growth rate in demand that is separate from the energy transition movement. The key drivers being energy consumption per capita, population growth, data center usage and electrification of key industries.

Additionally the transition involves a shift in energy density. Coal is the largest emitter globally, particularly in China and India. In India, about 75% of their entire electricity mix comes from coal at this point in time whereas in China, it’s around 60%. But if you were to switch that coal-fired generation to renewables, it would require 22 times the amount of upfront investment capital just for the same amount of power generation.

Our view of energy transition in 2024

While interest rates and monetary conditions will likely continue to play a crucial role in 2024, we believe the real driver of better returns in energy transition equities moving forward is an improvement in future earnings growth. Last year, earnings consistency and exceeding expectations heavily influenced performance, despite rising and volatile interest rates.

Our 2024 outlook indicates a much stronger fundamental earnings landscape for energy transition equities, while at the same time, the outlook for conventional energy equities goes from strength to strength. Although we can’t predict when the cyclical earnings headwinds that affected the sector last year will subside, our analysis and discussions with companies and industry participants point to an improvement in earnings throughout 2024 and into 2025.

We would stress that within the energy transition sector, we do see selective areas of earnings risk, particularly in hydrogen where activity is slowing, and potentially from external factors such as supply chains disruptions. However, by and large, the earnings outlook coupled with what we now consider attractive valuations, provide a very supportive backdrop for investors.

So, if you’re concerned about being too early or too late, don’t fret. We believe the window is still very much open.