Climate disruption: keys to the transition to renewable energy

The energy sector accounts for nearly three-quarters of global greenhouse gas emissions every year. While this shouldn’t come as a surprise, it’s nonetheless a staggering sum, and clearly, the energy sector’s transition away from fossil-based production and consumption is central to successfully curbing rising temperatures. Fundamental shifts don’t happen overnight, however, and despite many pledges by governments to tackle the cause of global warming, CO₂ emissions from energy and industry have increased by 60% since the United Nations Framework Convention on Climate Change was signed in 1992.¹

The good news is that efforts to drastically reduce carbon emissions have ramped up considerably in recent years, with global resolutions such as the Paris Agreement committing governments to measurable, multi-year targets. The cause of this accelerated pace is largely due to the growing recognition that we have a small window of opportunity in which to correct the current trajectory of global temperatures. Global temperatures have already increased by about 1°C since preindustrial levels, and left unchecked, they’re predicted to rise by between 2°C and 4°C by 2100, which would have devastating impacts on ecosystems, human health, and well-being. To put that into context, increases of between 1.5°C and 2°C are already considered to have damaging consequences, but going any higher means serious and potentially irreversible economic and environmental impacts such as extreme weather, food shortages, and disease.

Making the pledge

Government progress on climate regulation

Investing for the future

As the major source of global emissions, the energy sector holds the key to responding to the world’s climate challenge, but a huge amount of work is needed to turn today’s ambitions into real change. Although investment into clean energy has increased, with some $501 billion committed to decarbonization in 2020 and $304 billion specifically allocated to renewable energy sources, these significant sums still pale in comparison to what will be required to achieve net zero by 2050. Research by the International Energy Agency (IEA) estimates that the investment in clean energy needs to more than triple by 2030 to around $4 trillion to achieve net zero emissions by 2050. Over the next three decades, that equates to more than $100 trillion in clean energy investment.

Are we doing enough? 

Global investment in the energy transition (US$ billions)

Looking ahead, however, there are reasons for investors to be optimistic about the transition to clean energy. In addition to signing up to initiatives such as the Paris Agreement, governments are increasingly pledging to “build back better” in the wake of COVID-19. Companies are also setting carbon neutrality goals and investors are serious about seeking climate action. While transition can be a complex process, we believe it creates significant pockets of opportunity for investors able to carefully time their decisions to benefit from the inflection points. We discuss the major themes we see playing out in the energy system, namely: decarbonization, deglobalization, the rise of new technologies, the role of new supply chains, and the development of future energy sources.

Decarbonization and shifts in the energy mix 

Achieving net zero emissions will require the massive deployment of all available clean energy technologies—such as renewables, electric vehicles (EVs), and energy-efficient building retrofits—between now and 2030. For solar power, the IEA suggests the scale of change required is “equivalent to installing the world’s current largest solar park roughly every day.” Although the pandemic has had a significant impact on the pace of transition, we see several trends forming on the horizon.

• We expect to see higher levels of renewables in the power sector mix, particularly solar photovoltaics, over the next decade. Wind power is also likely to continue to see a greater share of future energy supply, as the supermajors and global utilities invest in offshore wind projects.

• Demand for oil could plateau around 2030 or perhaps even sooner, as a greater EV fleet is expected to affect gasoline demand. We expect to see a decline for oil demand in the aviation sector over the next few years with increased use of biofuels, but also a continued demand for oil and gas in petrochemicals until alternatives for plastic are developed.

• The decline of coal will continue as policies seek to replace the higher carbon intensive fuel source and the power sector sees competitive pricing in natural gas and renewables.

• The energy transition can’t happen without the participation of the major oil and gas energy providers given the magnitude of spending required, but there’s significant pressure from investors and other stakeholders to set science-based targets and curb greenhouse gas emissions in the short to medium term. The ability of incumbents to achieve these targets will be a key factor in deciding which companies emerge as winners in the energy transition.²

A changing world 

Total energy supply, 2019–2050 (exajoules, predicted)

Deglobalization and the impact on energy security 

One overlooked element that will likely have a significant impact on the energy transition is the trend toward deglobalization. The focus on energy security will affect oil and gas, as the primary traded fuels globally, as countries such as China, India, and the United States seek to minimize their dependency on imported fuels and encourage domestic production. This will help spur the growth of renewables, but could also create a lingering dependency on thermal coal given the abundance of the resource. We could also see a greater focus on natural gas as a transition energy source with fewer implications for air pollution than coal.

Meanwhile, strained geopolitical relationships may affect China’s willingness to make the switch to natural gas, given much of it will need to be imported. While the European Union and United Kingdom aim to be climate neutral by 2050, China’s carbon neutral pledge extends to 2060. And although Beijing claims that CO₂ emissions will peak before 2030 and carbon neutrality will be achieved before 2060, the bulk of transition activity shouldn’t be expected before 2030. This commitment leaves a good deal of uncertainty on the trajectory of global warming, given China’s emissions are greater than those of the United States and EU combined.³

New technology and the decline of the internal combustion engine

Technological advances have also improved energy efficiency across generation, transmission, and distribution, and paved the way for new models of distributed generation such as microgrids, community solar, and peer-to-peer energy trading. New technologies such as solar and wind power also allow utilities to reduce ongoing plant maintenance costs compared with managing coal-fired plants. The intermittent nature of renewables such as wind and solar power remains a challenge, and we expect innovations in storage systems, and hydrogen as a backup power fuel, to be part of the solution.

The power sector is expected to face much higher demand as a result of the movement to electrify transportation and the rise in popularity of hybrid and EVs. The industry is already making progress on the production and storage of green hydrogen to help accommodate the expected demand, and some companies are now assessing whether green hydrogen can provide a fuel replacement for gas turbines and a feedstock for industrial use. With the early and rapid success in ramping up renewables, energy storage, and green hydrogen, we expect to see winners and losers in the power sector’s energy transition, but overall, the success of the power sector’s transition will be critical for the delivery of an emissions-free power source and decarbonization of the transportation and industrial sectors.

An important driver of increased electrification is national vehicle emission standards and, as these standards tighten, auto companies will be increasingly incentivized to sell electric cars. Global automakers have clearly started the shift toward going electric and are introducing battery cars or hybrid options to their model lineups. Some of the large global automakers have even set dates as to when they’ll only produce electrified cars or stop developing internal combustion engines. In more advanced economies, stricter environmental standards are expected to result in a phasing out of the internal combustion engine by around 2040 and we could see this timeline shift earlier, following the example set by the United Kingdom in 2020.

Driving change 

Governments with defined targets to fully phase out sales of new ICE cars

Supply chains for critical materials

Clean technologies depend on a secure and growing supply chain of critical minerals and metals. Yet ensuring that these technologies have a stable supply chain to support the acceleration of the energy transition around the world is a significant and underappreciated global challenge. Lithium, cobalt, and nickel, for example, give batteries greater charging performance and higher energy density. Copper is essential for the increasing use of electricity throughout energy systems due to its conductive abilities. The prevalence of these materials in the transition is significant: an EV uses up to five times the amount of copper needed by a traditional car, and an onshore wind plant can require eight times as much as that of a gas-fired plant of the same capacity.⁴

Copper culture: the rising cost of minerals, 2020–2050 (predicted)

Despite the promising growth in clean technologies, their rapid growth has put a strain on the supply chain, leading to price volatility. There has been a five-fold increase in cobalt prices between 2016 and early 2018. Supply chain security has been further tested by geopolitical concerns given the geographical concentration of supply and processing. To successfully navigate the transition, investors need to understand the volatility of prices as well as how companies and governments in turn will respond to the importance of reliable mineral supplies in the energy transition.

The birth of a megatrend

Few investors appreciate the scale of disruption under way. We believe that the energy transition and simultaneous impact from global warming will result in long-term outperformance of companies that are able to provide solutions that contribute to this transition and address the challenges of a warming world. In particular, we believe that the revolution will favor companies providing low carbon energy, electrification and efficiency, and materials such as copper for the electric grid and EVs. Investors have largely ignored many of the companies actually required to achieve the global climate targets.   

With an anticipated $100 trillion of spending required by countries and companies to fund the transition to renewable energy, investors need to think about which companies will be the beneficiaries of this massive inflow of spending.

1 Net Zero by 2050, International Energy Agency, 2021. 2 See here for more information on how companies are setting science-based targets. 3 “China’s Greenhouse Gas Emissions Exceeded the Developed World for the First Time in 2019,” Rhodium Group, May 2021. 4 "Clean energy progress after the Covid-19 crisis will need reliable supplies of critical minerals" – Analysis - IEA .