Why we remain optimistic about energy transition despite recent challenges
How is the energy transition sector holding up in 2022 so far?
2021 proved to be a volatile year for energy transition equities as supply chain bottlenecks, logistics disruption and inflationary pressures all around the world weighed on company earnings and valuations across the energy transition universe.
The big picture set up into 2022 was sadly not dissimilar with inflation accelerating to multi-decade highs and supply chain bottlenecks still very much constrained. The big difference this time however, was that valuations, particularly after a difficult January had very much reset. And so we were certainly optimistic of a more positive performance outcome over the full course of 2022. Then just as we were starting to see tentative signs of supply chain pressures easing, we saw the aggressive invasion of Ukraine by Russia, with the conflict adding further fuel to the inflationary fire and throwing supply chains globally back into risk.
Implications of the war in Ukraine on energy transition sectors
Our first and foremost thoughts during this difficult time are with the people of Ukraine, but stepping back from the humanitarian crisis, we need to consider the potential investment implications.
Broadly speaking, we see three potential risks associated with the war in Ukraine, most of which either extend or amplify existing market pressures.
1. Prolonged and severe inflation
With energy prices now well above a hundred dollars per barrel and key metal and agricultural prices rapidly accelerating, it seems difficult to see a world where inflationary pressures ease, at least in the near term.
2. Disrupted supply chains
Together, Russia and Ukraine are key exporters of critical metals such as nickel and platinum, as well as neon, one of the key materials used in the manufacturing of semiconductor chips in clean technology. Companies across the energy transition universe that are reliant on these key materials could see their earnings come under threat if tensions in the region continue for some time.
3. Economic slowdown
Input costs around the world have reached such high levels that they are starting to show signed of constrain on demand. Companies within more economically exposed parts of the energy transition value chain could be under threat.
What are the key tailwinds for energy transition investors?
The current outlook is clearly troubling, but it is important to step back and remember there are many positive potentials.
The first and most important is that the bigger picture need to transition our energy system is completely unchanged. Our world is still emitting 36 billion tonnes* of carbon globally per year and we need to get this to zero if we're going to meet our climate goals. And the only way to do that is to increase the amount of clean technologies that we are using globally. The energy transition sectors are evolving rapidly.
It is important to also think that the current tensions in Ukraine potentially add further credence to transitioning our energy system towards a new, cleaner more secure environment. For example, building out more renewables and green hydrogen could offer a potential solution to many of our planets goals, not only with respect to the climate, but also with respect to energy security.
Where are we seeing the most interesting investment opportunities?
As valuations have pulled back in certain sub-sectors, opportunities are emerging but we have been surprised by the remarkable rebound in renewable names as concerns around energy security have emerged. Whilst certainly positive for the space, we are conscious that we don’t want to be sucked in given the speed at which valuations have retraced and the other inflationary risks that still exists in the markets today.
Whilst there are market risks around inflation, supply chain bottlenecks and economic growth, the long term structural opportunity behind energy transition equities really has not changed. We expect to see particularly strong growth in demand for batteries, an acceleration in hydrogen projects after a year of delays, and continued strength in solar, driven as much by smaller-scale applications as the larger utility projects that have dominated the market today. Demand for electric vehicles should also continue to accelerate higher, with penetration rates in many countries (particularly in Europe) reaching almost 20% in the second half of 2021.
Companies like Vestas in the provision of wind turbines, Alfen in the provision of EV chargers and energy storage and smart grids and companies within the green hydrogen supply chain are looking increasingly attractive, as we need to meet our decarbonisation and energy security goals. We remain focused on investing client’s capital across the supply chains in those companies that have strong balance sheets, sustainable business models and where the long term structural earnings outlook remains strong.
As long-term investors in the energy transition, using short-term disruption as an opportunity to buy is critical, especially given the theme’s long-term growth potential.
*Source: International Energy Agency, 2021
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