The Paris Agreement, adopted by 197 countries at the UN Climate Change Conference (COP 21) in 2015, brought in a legally binding international treaty with an overarching focus on limiting global temperature rises to no more than 2% above pre-industrialised levels. More recently, major economies have committed to achieving ’zero’ greenhouse gas emissions, which is a crucial step in the process of limiting global climate change, underpinned by frameworks to support a global energy transition.
The ‘energy transition’ refers to a move away from a global economy dependent on energy generated through burning fossil fuels towards one that operates and relies more heavily on electricity produced by renewable and low-carbon forms of power generation. On the supply side, renewable energy generation has become a key component of the energy mix. According to the World Economic Forum, in 2022, renewable forms of energy accounted for 40% of the total electricity generation in the United Kingdom¹, while the US Energy Information Administration says this figure is 23% in the US². Meanwhile, on the demand side, consumption of energy is slowly transitioning away from fossil fuels. Two key objectives are the ‘electrification’ of end users (i.e., shifting away from fossil fuels to renewable energy sources) and the decarbonisation of energy intensive industry. In this regard, consumers are incentivised to switch to electric vehicles (EVs) and to install heat pumps, while the potential exists for greater use of green hydrogen and carbon capture technologies to help decarbonise large industrial users in future.
Short-term challenges
Despite what has been, and remains, a supportive backdrop for the clean energy industry, the sector has proved a challenging area for investors over the past few years. Indeed, the (predominantly US-focused) iShares Clean Energy UCITS ETF Index has lost approximately 60% in value between its peak in January 2021 and the end of October 2023. The high point certainly coincided with a peak frenzy for environmental, social and governance (ESG) investors (i.e., those with a focus on ethical and sustainable investing) attracted to the sector’s environmental credentials, but more recently the sector has suffered from the high inflationary backdrop and aggressive tightening of monetary policy in key jurisdictions like the US, the UK and other European countries.
Inflationary pressures and higher interest rates have increased the costs for development projects that were struck at prices that no longer appear economically viable. Supply chain constraints pinching at key project delivery points in coming years serve to compound the problems. Developers and component manufacturers have faced margin pressures for some time in a highly competitive industry, while higher reference yields have proved a headwind to the perceived value of operational projects, where value is essentially driven by discounting expected future cash flows at an appropriate rate.
Long-term opportunities
With influential central banks signalling that the interest rate hiking cycle is finished and key governmental initiatives in the US and Europe priming the clean energy sector with huge stimulus packages, we believe the sector is potentially reaching a positive inflection point following its material de-rating (i.e. downgrading of its perceived investment potential).
There are incentives to drive greater adoption of electric transportation and biofuels among consumers, and hydrogen hubs and carbon capture within industry.
The most powerful example of stimulus is the combination of the Inflation Reduction Act (IRA) and Bipartisan Infrastructure Bill in the US, which allocate US$260bn and US$80bn³, respectively via tax credits and incentives for investment in the energy transition. The legislation – labelled as a ‘game changer’– provides a decade-long growth runway for projects including wind generation, solar generation, and energy storage solutions by introducing predictability over governmental support. There are incentives to drive greater adoption of electric transportation and biofuels among consumers, and hydrogen hubs and carbon capture within industry. There are also credits for domestic manufacturing supporting the clean energy power sector and allocations for grid enhancement and EV charging infrastructure. Some industry players have suggested the IRA could catalyse total investment approaching US$3 trillion over the next decade.
We would contend that the energy transition is a multi-decade, structural trend that will provide many opportunities for investors at all levels of the value chain. After a period of reset for the industry, largely driven by macroeconomic factors, the prospects for recovery should not be overlooked.
William Argent
Fund Manager, Gravis Advisory Limited
William Argent, Fund Manager at Gravis Advisory Limited
Gravis Advisory Limited.
Registered Office: 24 Savile Row, London, W1S 2ES. Registered Number: 09910124
¹ World Economic Forum, 6 January 2023
² World Energy.org, 28 February 2023
³ EIA, EPA, Joint Committee on Taxation, IRA, November 2023
