Russian atrocities in Ukraine have triggered a strong desire among Western governments to wean themselves off the Kremlin’s energy supply as fast as possible. The European Union has devised a strategy to cut its huge dependence on Russian gas by two-thirds by the end of this year and is fast-forwarding plans to make the bloc entirely independent of the country’s fossil fuels by 2030.
This means finding alternative partners for its gas in the short term, as well as boosting efficiency and accelerating the transition to greener alternatives. But while policy-makers scramble to fill the void, which is likely to deepen as sanctions against the Kremlin may eventually include gas imports, consumers are seeing spiralling energy prices.
The risk is countries may have to burn coal for longer to reduce reliance on Russian gas, until further renewable sources are developed, which could be detrimental to the environment in the near term.
“The war in Ukraine has been a wakeup call for policy-makers,” says Andrew Patrick, senior investment manager, discretionary, at asset management firm Abrdn. “But they need to balance between addressing climate change, keeping products affordable for consumers and maintaining security of supply, which is the big issue now.”
“From a sustainability point of view, the big debate today revolves around putting environmental concerns over ensuring security of energy supply, or E versus S within ESG,” adds Treasa Ni Chonghaile, senior portfolio manager, environmental strategies team at KBI Global Investors.
More than 60 per cent of leaders of financial institutions believe a likely effect of the war and energy crisis will be to hamper the path to net zero in the short term, according to the second annual PWM/Global Leader Group leadership survey. Forty-eight per cent, though, believe the crisis is going to accelerate the energy transition and decarbonisation of the economy (see Fig 1).
Dynamics in the investment world reflect this complex scenario. The conflict has attracted investment to traditional fossil fuel players, as investors look to hedge themselves from multi-decade high inflation, exacerbated by oil and natural gas prices. But renewables such as onshore and offshore wind, solar power and hydrogen have been performing well too, fuelled by the EU’s push towards decarbonisation and investments into cleaner energy.
The rerating of the renewables sector follows strong volatility over the past 12 months, when investors moved away from long duration growth stocks, such as ‘clean’ energy companies, citing concerns around inflation and interest rate rises.
“Investors realise inflationary cost pressures relating to fossil fuels are unlikely to persist in the very long term, as Europe looks to ‘immunise’ itself from traditional forms of energy,” says Zane Bezuidenhout, senior equity analyst, Investec Wealth & Investment. “Moreover, the renewable side is more durable in the investment thesis, given governments’ net zero ambitions, over and above creating energy independence.”
Burning fossil fuels represents the largest source of greenhouse gas emissions and the dominant cause for temperature rises and extreme weather events. Renewables, which today represent 10 per cent of the energy mix, will need to represent 65 to 80 per cent by 2050 globally, to limit global warming to 1.5°C above pre-industrial levels and avoid the worst impact of climate change. Global temperatures have already increased by 1.1°C.
Decreasing costs
Thanks to advances in technology and scale, the cost of renewables and batteries has decreased by up to 85 per cent since 2010 for solar and wind energy, according to the Intergovernmental Panel on Climate Change (IPCC). The rise in gas and oil prices has further fuelled the financial case for governments to invest in renewable energy.
“For the near term, the Ukraine conflict is swinging the pendulum back towards conventional fuels, as energy security outweighs other concerns. But strategically, the cost of fossil fuels and the supply security imperative will flag the need to move away from fossil fuels as renewables are cheaper, particularly at current coal, gas and oil prices,” says Norman Villamin, CIO Wealth Management at Union Bancaire Privée.
But the energy transition cannot be done overnight. Developing energy sourcing strategies is very complex. It requires expensive infrastructure, which takes time to build, and international partnerships, which bring “collateral consequences”, says Victor Allende, director of CaixaBank Private Banking.
“This will come at a high cost and governments will have an essential role to play in managing the public discontent that may arise.”
Policy-makers will need to speed up process planning and the issuing of permits to accelerate roll-outs of renewables, such as solar and wind. They will also need to accelerate the building of storage solutions, such as batteries, which are key to arbitrage renewable intermittency and better match supply to demand.
“Current renewables are intermittent and cannot be switched on and off like natural gas or coal, or remain operating at a high degree of capacity constantly, as is the case with nuclear,” explains Robert Lambert, senior corporate analyst at BlueBay Asset Management.
They are also somewhat inefficient given their reliance on environmental conditions. Solar panels are usually able to process just 15 to 22 per cent of solar energy into usable energy, while wind is typically 30 to 45 per cent efficient. This was evident in 2021, as a poor summer for wind and solar resulted in a high draw on natural gas in early winter.
“Efficiency improvements and large-scale batteries to smooth energy flows offer the biggest investment opportunity,” says Mr Lambert.
Enormous opportunities are found in rooftop solar installers. A low penetration rate of rooftop solar globally offers “huge potential” for both residential and industrial, says KBI’s Ms Ni Chonghaile. “With the electricity cost increasing, the economic value of switching to solar and generating power from your own roof is more attractive now.”
While renewables are facing challenges around cost inflation in raw materials and logistics, over the longer term growth is supported by technology developments, such as floating offshore wind turbines, the opening of new geographies and growing economies of scale.
“Even if competition in the renewables space has increased, driving returns down, industry growth is fuelled by rising demand for primary energy, driven by GDP and population growth, and the urgent need to move away from fossil fuels,” says Abrdn’s Mr Patrick.
According to Bloomberg New Energy Finance, energy transition will cost $100tn to $130tn. This is equivalent to the size of global GDP, but also the potential investment opportunity related to a whole new global economy.
No silver bullets
The scale and timeline of the energy transition will create significant investment flows to energy production, transport, storage and distribution, as well as energy use and conversion, says Juan de Dios Sánchez-Roselly, global CIO, Santander Private Banking.
“Transition technologies are deeply interlinked, and in some cases interdependent. Any discussion on green hydrogen, for example, must account for developments in renewable electricity, hydrogen storage and transport systems, and end-use technologies such as fuel cells,” he says.
But there is no single solution or ‘silver bullet’ to speed up energy transition. It is key to invest in a variety of alternatives to obtain flexibility and speed.
1.5 degrees Celsius
Limiting warming to around 1.5°C and thus avoiding the worst impact of climate change requires global greenhouse gas emissions to peak before 2025 at the latest, and to reduce to net zero by 2050, according to IPCC
“We believe the most appealing opportunities arise in the combination of solutions and technologies and in the combination of solar, storage solutions and smart grids,” explains Mr Sánchez-Roselly.
The war in Ukraine has reignited debate about sustainability of nuclear power, recently included in the EU green taxonomy together with natural gas. Being able to produce zero carbon energy may be a huge win, but there are significant uncertainties attached to dealing with waste and long build times.
There is some potential for a “nuclear renaissance”, which France has already announced, and up to eight more nuclear reactors could be built in the UK. “But the long build time and the fact most European countries have been exiting nuclear would suggest this is unlikely to be widespread,” believes BlueBay’s Mr Lambert.
Moreover, Russia taking control of power plants in Ukraine and the threat from a radioactive leak will not help the case for new nuclear.
While it takes a long time to establish new power plants, Investec’s Mr Bezuidenhout would have liked to see Germany take a slower approach to winding down nuclear plants, in efforts to wean itself off Russian natural gas.
“Nuclear and natural gas need to be part of the solution, facilitating both transition away from more carbon intensive fossil fuels but also providing stable baseload power, when renewables are variable and intermittent,” he says.
Leopards and their spots
Rather than investing in narrow themed renewable energy funds, which are volatile, investors should target a world where the focus is on better usage of scarce resources, following the concept of a circular economy, based on “repairing, reusing and recycling goods and services” as opposed to linear economy, which is the “take, make and waste paradigm”, says Edmund Shing, global CIO, BNP Paribas Wealth Management.
Energy transition is one aspect of the circular economy, as are better resource utilisation and the sharing economy. But investors may need to invest in funds and ETFs including fossil fuel production companies, as “the demand for fossil fuels will remain significant for many years to come”, he predicts.
He also highlights the importance of engaging with fossil fuel companies, including mining firms, crucial to the energy transition, as industrial metals are required in massive quantities to generate clean energy. The goal is to push them to become more environmentally friendly and socially sustainable.
“We need to make sure oil and gas companies use that extra cash flow they’re generating today and put it to good use, reinvesting in renewable areas, in carbon capture, in hydrogen production and investing in R&D for new technologies that help reduce our reliance on fossil fuels faster.”
Fifty-eight per cent of leaders in our survey believe R&D in green energy solutions and technologies at oil majors will increase as a result of the war. Stewardship efforts with fossil fuel companies are also likely to grow, say a third.
Investing in the “more forward-thinking” fossil fuel companies, progressing in renewables and green technologies, will pay off financially too. Opportunities missed by market participants are probably greater within high emitting sectors.
“In a sense, you must invest in leopards trying to change their spots,” says Mr Shing.
Other analysts believe the crisis is taking political pressure off traditional energy companies around climate change, with the balance shifting towards portability and energy security.
Oil companies are today benefiting from high prices, but it is unlikely they can change their nature and the energy crisis will lead to an acceleration of technical innovation, argues Frédérique Carrier, head of investment strategy at RBC Wealth Management.
International co-operation and massive funds put into scientific research greatly accelerated the production of Covid-19 vaccines, but she is sceptical there will be such a big global effort in the energy sector.
“This over reliance on Russian oil is still seen as a European issue,” she says, expecting an acceleration of renewables roll out and another EU package focused on energy, food independence, and Ukraine’s immigration crisis.
Yet, the climate crisis is a global issue. Limiting warming to 1.5°C requires global greenhouse gas emissions to peak before 2025 at the latest, and to reduce to net zero by 2050, according to the latest IPCC report from 278 leading climate scientists. On our current
trajectory, we are heading for a catastrophic temperature rise of more than 3°C.
Divestments in high-risk regions
In response to Russia’s invasion of Ukraine, large energy companies such as BP, Shell, ExxonMobil and Equinor have committed to divest Russian assets, exit joint ventures with Russian state energy firms, or pull out of operations in Russia.
Shell lost $1bn of investment in the Kremlin-backed Nord Stream 2 pipeline, which Germany suspended as part of international sanctions against Russia, even before gas started flowing through it.
“Unless there is a significant regime change in Russia, companies will not be reinvesting in Russia, because of massive political pressure, operational risk and intense shareholder pressure,” says Edmund Shing, global CIO, BNP Paribas Wealth Management.
More than a third of leaders of financial institutions taking part in the PWM/Global Leader Group leadership survey predict that a key effect of the war will be divestments from fossil fuels in all high risk political countries (see Fig 1).
The crucial question, highlighted by the war, is whether excluding companies makes not only financial sense but also sense for the environment, points out Zane Bezuidenhout, senior equity analyst, Investec Wealth & Investment.
“Many traditional energy sources are in areas that don’t fit with what we deem are Westernised democratic standards and where there are breaches of various degrees of human rights. But at the same time, we cannot exclude these regions from ambition of achieving net zero by 2050,” he says.
Energy companies should rather be encouraged to invest in these nations to support their technological advancement towards low carbon and renewable energies.
“If we’re not going to be putting new capital into certain regions for geopolitical sensitivities, then their governments have no vested interest to change the status quo, which is based on fossil fuels.”
As people switch to renewable energies, aggregate demand for oil will decrease, negatively impacting oil price. Fossil fuels may just become stranded or valueless.
This explains why Saudi Arabia, for instance, is investing heavily into renewable energy and particularly green hydrogen. It is building a city from scratch out of the desert, Neon, and is developing a facility to produce green hydrogen, which it will then ultimately export to
Europe.
“For oil rich countries, it is of key strategic importance to diversify their income from oil and ultimately ensure the durability of their prosperity,” says Mr Bezuidenhout.
The world in 2050
To reach net zero emission targets, the world in 2050 will look vastly different to today, predicts Frédérique Carrier, head of investment strategy at RBC Wealth Management.
We will live in decarbonised homes, which, globally, will receive 95 per cent of their electricity from wind and solar versus 40 per cent in 2020. Most fossil fuel-powered furnaces and boilers will be replaced by heat pumps.
It will also be important to “green” heavy industries such as steel and cement used in homebuilding, and by using emerging technologies involving hydrogen. These two sectors account for roughly 7 per cent of total global emissions each.
Transport will be transformed. Electric vehicles will be ubiquitous, with capabilities far more efficient than today’s models, while hydrogen-fuelled propulsion systems will be central to a new generation of zero-emissions commercial aircraft.
As wind turbines and solar panels proliferate, transmission infrastructure including pylons and substations will be needed to carry energy to homes and factories.
Tram-style overhead power cables will hover above truck lanes on highways, while direct air capture facilities to extract carbon dioxide directly from the atmosphere may be built on the edge of urban areas.
“High emission companies that do not adapt will incur difficulties, while those that adapt and develop new technologies, and are given support to scale them to reach commercialisation, will benefit from this transformation,” says Ms Carrier.
