Video: How will AI drive energy demand?
Alex Monk discusses the outlook for energy transition equities and the way AI is influencing energy demand.
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How did the energy transition sector perform in Q1 2024?
After a strong close to an otherwise difficult 2023, energy transition equities continued to be challenged by adverse cyclical forces at the start of this year.
Stickier-than-hoped inflation, resilient economic data, and continued fiscal largesse led to a return to higher bond yields, once again straining valuations in the sector. At the same time, subdued earnings expectations in key consumer markets, and for those companies exposed to easing merchant power prices, added to the difficulties facing the space.
However, amidst these short-term struggles, there are early signs of a brighter outlook emerging.
Demand in consumer-focused markets is starting to stabilise, with inventories clearing in electric vehicle charging and heat pumps, and residential solar companies expecting a pick-up in demand throughout the year. Utility-focused markets are also seeing brighter fundamentals, with demand resilient, supply chains normalising, and regulators adapting to new macroeconomic regime. The strength in earnings across electrical equipment and other markets with lower cyclicality should also not be overlooked.
Positive share price reactions over the quarter to some of this news highlight the improved risk-reward as earnings uncertainty across the universe starts to reduce.
Valuations in the energy transition sector continue to look attractive here, as evidenced by new share buyback and acquisition activity throughout the space.
How is AI impacting the energy transition space?
The rapid growth of generative AI is accelerating the shift towards higher electricity demand. The combination of data centre expansion, the higher energy intensity of AI compute needs, and the ambition for decarbonised power presents exceptional earnings growth opportunities for companies across the energy transition space.
Meeting AI's growing energy needs in a decarbonised manner can’t just rely on nuclear or gas with carbon capture. It will require cheap and ready-to-build renewable energy sources too, including wind, solar, geothermal, hydro, back-up storage and e-fuels too.
Moreover, even if gas turbines or nuclear become the power sources of choice for data centres, the resulting tightness in these conventional energy markets would increase power prices and benefit sustainable energy providers too.
At the moment, the market is very focused on the immediate beneficiaries of AI, including the big technology and data centre companies, and those providing baseload power to the grid. But there is a wider pool of companies, including those in sustainable energy, that can benefit from the ongoing structural shift.
The divergence in valuations between electrical equipment and renewable equipment, as well as conventional and renewable power generation, despite comparable levels of future earnings growth, highlights the potential for energy transition equities to benefit from AI growth.
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