Looking at the opportunities in energy transition across conventional and renewable energy
As the world moves towards a more sustainable and decarbonized future, investors are seeking opportunities in the energy transition. Experts from Schroders and Schroders Greencoat discuss the role renewables and conventional energy have in decarbonizing the power system, and how technology and infrastructure will support the energy transition.
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In our latest video on the topic of the energy transition, Marina Severinovsky, Head of Sustainability, North America, Alex Monk, Fund Manager, Global Resource Equities and James Samworth, Partner and co-head of Schroders Greencoat’s Energy Transition team, Schroders Greencoat discuss the role renewables and conventional energy have in decarbonizing the power system, and how technology and infrastructure will support the energy transition in the future.
Where should investors be focused on when it comes to the energy transition?
James Samworth, Partner and co-head of Schroders Greencoat’s Energy Transition team, Schroders Greencoat:
Investors should consider renewables when thinking about the energy transition. The power sector needs significant capital investment, estimated at $2 to 4 trillion per year, to decarbonize. There are areas like electric vehicles (EVs) that are a little trickier for private markets to play except for sectors like charging infrastructure, where will require huge amounts of capital. However these areas may take longer to develop. In the example of EVs, although EV sales are growing fast, they still represent a relatively small percentage of the fleet as a whole. Similarly for heating, heat pump industries need to scale up. District heating schemes take a long time to design, procure, install, commission and convert over. Additionally decommissioning and managing the existing gas network infrastructure will take time.
Alex Monk, Fund Manager, Global Resource Equities:
I’d agree with what James was saying in terms of renewable power, to some extent being the skeleton key that unlocks every other technology. There is no point driving around in electric vehicles if the power is coming from gas and coal. Regardless of how you look at the energy system, renewable electricity is going to have make up a large chunk of the system. I guess by proxy, energy storage is going to have to be a large part of the equation, too, to help balance some of the intermittency.
In addition to renewables, the electrification of the economy is going to be a very interesting piece of the puzzle. A significant portion of this involves converting technologies, processes and industry that currently rely on fossil fuels today and electrifying them. Additionally, electrification also encompasses the growing demand of electricity, as we continue to digitalize our economy, which I think is super exciting with regards to data center usage, artificial intelligence (AI), etc. Anything involved in management of electricity, build-out of the grid, heating and cooling of data centers remains a really interesting part of the space as well.
When considering the energy transition from a conventional energy perspective, we are often asked, what is the role of existing oil and gas companies and energy field services companies in the energy transition? We still remain excited about these businesses. In fact, when you examine the substantial investments these businesses are making in the energy transition, they rank among the top players in the field. This is especially true for integrated energy majors, particularly those in Europe, as well as energy services companies. Although traditionally known as oil field services companies, in reality they are now energy services companies operating in different pockets of the market.
What's really interesting about these businesses for us is that they're benefiting in the short term from the tightness of energy markets. As they go through their transition period, they are also extending their growth pathways as well. At the same time, given the tightness of the energy markets, they're generating cash flow, which allows them to distribute that cash back to shareholders.
What do you think the energy transition will look like over the coming decades?
Alex Monk:
When we think about what the energy transition will look like across a multi-decade time horizon, we can think about structural and cyclical drivers of underlying demand, company earnings and performance. Structural drivers include renewables becoming more cost-effective and efficient, policy support and consumer demand. Cyclical dynamics include interest rates, short term policy support that may cause fluctuations in the structural drivers to move above and then below trends.
If we think about what happened in the post-pandemic period where we saw strong performance in the energy sector, we had the structural trend in place and then significant positive cyclical support: interest rates were low, consumer demand for EVs and residential solar were high and immediate subsidy support and stimulus to promote economy growth. We probably started adopting some of these technologies quicker than we otherwise would have done on the consumer side. Over the last two years, some of those positive cyclical drivers have started easing off. Interest rates have risen, some of the subsidy support has been pulled away at the margin. But when we think about those long-term structural drivers, nothing has really changed.
The energy transition will not be a straight line. There are going to be bumps along the road, but this is a multi-decade change in our energy system.
Again, the earnings growth and investment that is required across this time period is enormous. The potential for earnings growth over the long-term is vast across different areas of the sector but there are always going to be moments where you see outperformance and underperformance. I think it's useful for investors to step back, remember where you are, look at valuations, look at where we are in the cycle, and think about timing in that respect. But on a long-term view, this transition still looks like it's firmly in place.
To learn more, read our article: ‘Energy transition: Is the sector ex-growth?’
James Samworth:
Interest rates play a crucial role in the transition, as renewables require large upfront costs and minimal ongoing costs, while fossil fuels have lower upfront costs but higher ongoing fueled costs. Changes in interest rates can significantly impact the balance between the levelized costs of renewables and fossil fuels, leading to market volatility.
How will technology and infrastructure support decarbonization over time?
James Samworth:
Renewables are already mainstream power sources, and their adoption will continue to increase. The focus now is on balancing the grid and managing demand through technologies like compressed air or liquid air storage, pumped hydro, and hydrogen as a storage medium. All these technologies exist. What needs to play out in the market is what alternative energy source will be the lowest cost or most flexible and resilient way to manage the demand so that we can successfully transition away from fossil fuels for both baseload and peaking / balancing energy.
Alex Monk:
Companies in public markets are adapting to the changing landscape, even in a world with slightly higher interest rates. We have already witnessed a readjustment of pricing, regulatory frameworks, and business practices in sectors like offshore wind and US markets in this higher rate environment. Despite short-term disruptions caused by rate fluctuations, these markets continue to generate value.
Ultimately, the fundamental drivers of underlying power demand and the need for decarbonized power are what we believe will drive returns in the energy transition space.
Learn more:
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The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.
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