In this two-part series, we examine the thematic investment opportunities arising from the world’s energy transition. The physical and transition risks of climate change are expected to intensify over the next 10 to 30 years, and we believe that the energy transition is a major economic theme that will impact capital markets and the securities we invest in on behalf of clients. 

In this first article, we focus on the clean energy transition universe and how we think a thematic lens can help make the most of the structural opportunity associated with decarbonisation and the successful development of next-generation energy provision. 

Our second article in the series examines the energy transition from the perspective of the current generation of energy, recognising that in a world that needs to manage both energy security and affordability alongside decarbonisation, “traditional” energy sources and commodities will be an essential part of a successful net-zero transition.

Among our key conclusions: 

• The decarbonisation process represents the biggest capital cycle in our lifetime, requiring sustained capital spending for at least the next 20 years. The scale of this spending will create a revolution in terms of capex, returns and earnings power. 
• We see tremendous opportunity for growth but also potential for significant misallocation of capital as both the pace and path of the transition to a low-carbon economy remain uncertain. We think that bottom-up research and a capital-cycles lens can help identify mispricings and uncover attractive areas of underinvestment.
• Transforming the energy system will require enormous investment in new technologies as well as in the re-engineering of legacy infrastructure. Likely key beneficiaries include the enablers of the energy transition, such as companies within the renewables supply chain and grid infrastructure and utility companies.
• The transition will not be linear as implementing decarbonisation goals has to be balanced with energy security and affordability. At the same time, energy consumption is increasing due to population growth and improvements in living standards. We believe that in the short to medium term, as supply decarbonises, a mixture of traditional energy sources and renewables can best ensure access to clean, reliable and affordable energy.
• Investors may wish to consider a holistic perspective, looking across both current and next-generation sources of energy, leveraging active engagement to ascertain whether traditional energy providers are committed to participating in the transition.  

Where are the investment opportunities and risks?

Building out sufficient alternatives to carbon-intensive fuels to power the world and the distribution of that energy is the ultimate goal of the global energy transition. But how can we decarbonise our energy systems while also ensuring that energy remains secure and affordable as we ultimately achieve our decarbonisation goals? This question is at the core of the “energy trilemma” — the balance of three often competing challenges of energy security, affordability and decarbonisation.

This balance is complicated by macroeconomic and geopolitical challenges, such as:

• Geopolitical conflicts, with the European energy crisis of 2022 seeing countries prioritising security of supply over decarbonisation. 
• Increasing energy demand, driven by population growth, urbanisation and higher standards of living. 
• Technological breakthroughs like generative AI requiring enormous amounts of energy, even if efficiency gains also prove helpful in advancing towards a low-carbon future over the longer term.  

Faced with this challenging backdrop, governments around the world are seeking to ensure the provision of affordable, secure energy and use it as a key lever for maintaining support for governmental decarbonisation goals. 

Many governments have introduced policies and legislation to help drive investment in green energy, such as the US government’s Inflation Reduction Act and the EU’s European Green Deal. Driven in part by these policies, investment in renewables has been growing (albeit insufficiently at this pace to meet net-zero goals), but global investment in infrastructure is severely lacking, presenting a significant risk to energy security and placing a limit on how rapidly the world can decarbonise. Moreover, with significant capital being directed at limited opportunities, there is an increased risk of capital misallocation.

As a result, we believe that a capital-cycles approach, seeking areas of the market where we believe capital is most needed and avoiding areas where capital is abundant, can be a powerful way to identify opportunities and potential sub-themes within the energy transition theme. 

How a capital-cycles approach can help uncover areas of opportunity

Despite progress, investment in clean energy is projected to be insufficient for a net-zero scenario, according to the International Energy Agency (IEA) (Figure 1). 

Figure 1

The infrastructure shortfall

The shortfall is even more pronounced for infrastructure. Insufficient investment in grids presents a significant risk to decarbonisation goals, hampering electricity security and placing a limit on the pace of electrification. 

To accommodate growing demand for electricity and reach national goals, the IEA estimates that a total of over 80 million kilometres of grids will need to be added or refurbished by 2040 — approximately the same length as the existing global grid.¹

Additionally, new grid infrastructure often takes five to 15 years to plan, permit and complete, compared with one to five years for new renewables projects and less than two years for new EV charging infrastructure. Figure 2 illustrates how the IEA estimates that delays in grid investment could impact the usage of different energy sources, increasing use of coal and gas and decreasing use of solar and wind power.

Figure 2

A promising outlook for renewables?

Applying a capital-cycles approach allows us to isolate potential sub-themes that may be overlooked or experiencing underinvestment. For instance, our research has uncovered promising potential in the renewables supply chain as well as among utilities. Energy storage systems, which enhance grid stability by smoothing out fluctuations in renewable energy generation, may be another area of interest. 

Some companies in the renewables space are suffering from depressed valuations, but in our view, this can be a strong set-up for future return potential. Back in 2020, capital flooded into this area, driven by momentum behind ESG and aspirational decarbonisation goals by companies and governments. For example, 370 companies joined the Science Based Targets initiative (SBTi) between November 2019 and October 2020, at an average rate of 31 companies a month — more than double the average rate from 2015 to 2019².

However, this period of investment was followed by 2022’s spike in commodity prices, concerns around energy security, and structurally higher rates and inflation. This led to funding bottlenecks for renewable projects and accordingly, we saw increased use of traditional energy sources. But with inflation moderating and global central banks signalling rate cuts ahead, we believe that a potentially more accommodative funding environment could support renewable project pipelines.

The utilities opportunity 

Utilities are another strong area of interest for us. As enablers of the transition, we view utilities as positioned to benefit from numerous secular tailwinds in place for decades to come. This includes the electrification of power, greening of generation, electrical grids and network upgrades, which will drive capex not just for generation, but for the expansion and modernisation of transmission and distribution systems. 

After a period of low, and in some cases no, demand growth, we view utilities as beneficiaries of increasing demand from electrification. Decarbonisation of the power generation fleet, for example, provides utilities with opportunities to grow their rate base and earnings.

While we see promising opportunities within renewable energy technologies, especially where we see a capex investment gap, we believe keeping a balanced view is key. Investors should remember that traditional energy companies are likely to continue to play a role in the global energy mix for the foreseeable future and renewables are more likely to offset incremental additional demand rather than displace existing power generation in the short to medium term. An active engagement-driven approach, coupled with strong ESG research integration, can help to inform actions issuers are taking to decarbonise in order to meet energy demand in a responsible manner.

Bottom line

As with any investment theme, there are risks to our outlook, such as government policy. We track and constantly evaluate this within our thematic research and framework. Idiosyncratic risk arises from our bottom-up investments, driving our pursuit of companies with a culture of good governance and operational excellence. Looking ahead, we believe that the opportunity within the energy transition is significant, and that long-term-orientated investors can potentially benefit from the disruption and structural change that is poised to transform the industry. 

¹"Electricity grids and secure energy transitions", IEA, 2023 (Licence: CC BY 4.0) | ²SBTi, SBTi Progress Report 2020