Seven reasons behind the resilience of "green" investments in the pandemic
In contrast to previous economic slowdowns, climate change and energy transition investments have performed well so far in the Covid-19 crisis. We examine the reasons for this.
Climate change and energy transition investments have generally performed remarkably well since the start of the Covid-19 crisis and the associated economic slowdown. We have identified seven trends that we think can help explain this resilience. At the same time though, the risks posed by the pandemic have not gone away as the crisis continues around the world.
We are encouraged by the trends seen so far. But the need to reduce carbon emissions remains crucial and more action is needed if we are to meet the Paris agreement goal of limiting warming to 2 degrees above pre-industrial levels.
Trend 1: Stronger financing and policy support than in previous recessions
Following the Global Financial Crisis in 2008, growth in global renewable energy investment slowed dramatically as utilities reduced discretionary spending and financing from banks to developers dried up. This time around, things are clearly different.
Firstly, banks across the world are far better capitalised than they were in 2008. Given most renewable projects are financed using some form of project finance, the relative strength in the banking system should provide more support this time around.
Second, and perhaps most importantly, renewable energy economics are in a much better place. Back in 2008, wind and solar projects were still very expensive compared to conventional coal and gas, and were really only financially viable due to subsidy programmes (which had limited capacity). As a result, when utilities were looking at their expenditure, renewables projects were often the first investments to be cut. Today, renewable economics are now far stronger and it is conventional power projects that are seeing the cuts.
This improved financial environment has already been reflected in the investment seen in the first half of this year, where spending on new renewables capacity alone increased 5% year-on-year despite Covid-19 (see chart below).
On top of this more robust financing environment has come hugely significant green fiscal stimulus – both in scale and scope – that will provide a further underpinning of capital. While the stimulus outlined by the EU has so far been most material, individual country commitments have also been impressive.
Alongside major European nations, South Korea is aiming to spend US$9.3 billion on renewable energy out to 2025 and a further US$1 billion on electric vehicles. A significant chunk of China’s US$ 1.7 trillion investment into new infrastructure is being targeted at the power sector.
But it is important to recognise that risks still remain – particularly as the full effects of the economic slowdown and recession play out. While investment in conventional energy has been the first to be cut during this slowdown, a prolonged pandemic and the associated weakness in power demand and transportation use could cause investors to turn more cautious on renewables too.
Equally, although the current low interest rate environment is undoubtedly helping project finance today, and making projects that would otherwise be unviable financially attractive, there is every risk that this changes in the future given current government debt levels. This may not be a near-term risk, but is certainly something to consider when taking a long-term view.
Trend 2: Demand for clean energy technologies has proved remarkably robust
The second major takeaway from the last six months has been the resilience seen in end-market demand for energy transition technologies.
Our biggest concern at the start of the crisis was the impact that an economic slowdown and prolonged recession could have on employment and consumers’ willingness to spend. But across the board we have been surprised by how robust demand for clean energy technologies has been.
The most obviously reflection of this is in the global electric vehicle market, where in Europe in particular, sales of plug-in hybrids and battery vehicles have surged, while conventional sales have dropped aggressively.
The strength in Europe can be attributed to a combination of things, including the delivery of previously booked orders, the release of new models, and the fact that European automakers are prioritising electric vehicle sales to avoid regulatory emissions fines. But, even accounting for these factors, the underlying demand growth has been incredibly strong.
Alongside electric vehicles, similarly robust demand has been seen in the US residential solar market. Initial estimates were for the market to be down between 20-30% this year, but as sales have picked up it is now thought the market will be closer to flat, which would mark a remarkable turnaround even if down on original hopes for 25% growth. This is partly reflective of a broader uptick in the home improvement market, but also the underlying economic benefits that residential solar now presents.
We do still see short-term risks as the full effects of the recession come through – particularly if and when direct fiscal support packages and furlough schemes are removed – and we must be mindful of this.
Trend 3: Corporates have stepped up their commitments
Despite the significant business challenges posed by Covid-19, we are encouraged to see companies continue to step up their commitments to decarbonising their own operations. More than 450 companies have now adopted emission reductions targets which have been independently approved by the Science-based Targets Initiative.
Over 250 companies have committed to using 100% renewable power by an average target year of 2028. If these companies were a country, they would be the 21st largest electricity consumer in world.
The ambition shown by some leading companies is striking, and will have a catalysing effect across whole supply chains. In July, Apple announced a target to make its entire supply chain carbon neutral by 2030. Microsoft has gone even further, pledging to be carbon negative by 2030 and to remove all of its historical carbon emissions by 2050.
Within consumer goods, Unilever announced a plan in June to reach net zero in its own operations and its supply chain by 2039, and is putting €1 billion to work on replacing the fossil fuel-based components from its products with climate-friendly alternatives.
Trend 4: Covid-19 accelerated changing electricity mix
One positive side-effect of the pandemic has been the impact it has had on energy markets, where it has not only offered a glimpse into the energy mix of the future, but also accelerated certain trends.
This effect has perhaps been best seen in electricity markets, where the share of renewables in the energy mix has grown substantially as power demand reduced. This is due to the relative priority of cheap renewable power in most power merit stacks (the merit order enables the lowest net cost electricity to be dispatched first, thus minimising overall electricity system costs to consumers).
Indeed, a number of countries around the world saw the share of renewable power in total consumption hit all-time record highs over the last six months. For example, China saw combined wind and solar output exceed 10% of total power generation for the first time ever as renewables took priority over thermal coal.
Covid-19 also creating significant disruption to electricity demand patterns. Changing patterns of usage as people shifted to working from home and have subsequently slowly returned to work, have forced utilities to better understand how to manage more volatile balances between demand and supply.
With more renewables in the mix, balancing supply becomes increasingly important and the crisis has provided a useful fast-forward to a world where high renewable loads will be the norm.
Trend 5: New technologies have emerged
Another positive trend that we have seen this year has been the emergence of new energy transition technologies. Alongside innovations in the battery cathode space and the release of new residential storage systems, the remarkable surge in hydrogen interest has been particularly impressive.
Boosted by improving technologies, increased supply and falling technology costs, demand for electrolysers and fuel cells started to build at the start of the year – and was further lifted by the significant focus placed upon it in recent stimulus proposals, especially from the EU.
Although we believe green hydrogen still has significant hurdles to overcome from a cost and technology perspective, its potential to help decarbonise harder-to-abate parts of the economy is absolutely huge. This creates an enormous opportunity for companies involved in this space.
At present, hydrogen is one of the few fuel sources that would enable zero-emission activities in a variety of different sectors, such as heavy industrial processes, manufacturing and aviation. Its emergence this year is a important step in the journey to net-zero emissions, even if there is a long way to go. Add on developments in floating offshore wind, marine solar, flow batteries and nuclear fusion and it is clear that innovation across the energy transition space is accelerating.
Trend 6: Economics continue to improve with lower costs and greater efficiencies
While not necessarily new to 2020, it would be remiss to overlook the continued improvement in economics across the sustainable energy space. According to Bloomberg New Energy Finance, solar PV (photovoltaics) or onshore wind is now the cheapest source of new power generation in countries that make up two-thirds of the world’s population and 85% of electricity demand.
This trend – which is being driven by improving technology efficiencies as well as falling costs – is continuing to drive investment in renewables at the expensive of legacy conventional power plants.
One trend that is more notable, however, is the falling costs of renewable-plus-storage projects. As well as providing attractively priced power, these projects have the added benefit of solving grid stability and resource adequacy concerns by being able to dispatch power when required. These issues are only going to grow as more renewables are added to the grid.
Trend 7: Mixed picture on sustainable mobility
While the trends above are all very positive, the picture has been mixed when it comes to the sustainable mobility theme. Alongside the electrification of vehicles, mass transport (trains, buses) and micromobility (bicycles, scooters) have roles to play in reducing the carbon intensity of travel.
While demand for bikes has surged during the pandemic, train travel has unsurprisingly been hit hard, with travel app Trainline reporting that rail passenger volumes are still down around 75% in the UK. Promoting rail travel remains on the political agenda, however, and Europe’s Green Deal stimulus promises a ‘Renaissance of Rail Investment’ in a bid to shift passengers and freight to rail on key routes.
As we’ve written previously, Covid-19 lockdowns forced many businesses to rapidly adopt remote working technologies. While it is too early to say how enduring these trends will be, what is clear is they have come at a time when many corporates are scrutinising their carbon footprints and looking to meet newly instated net zero targets. Making a permanent reduction in business travel, particularly aviation, could be an easy win.
More needs to be done to meet climate commitments
Thinking more broadly about the progress towards the ‘two degree world’, it is important to recognise that despite the massive contraction in economic activity and huge behavioural shifts caused by the response to Covid-19, carbon emissions are only projected to fall by 8% according to the International Energy Agency. The headline indicator on the Schroders Climate Dashboard still stubbornly points to a 3.9 degree temperature increase.
What all this tells us is that real structural changes must accelerate if we are to avert the damaging impacts of climate change.
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.