- Macro Strategist
United Kingdom, Institutional
Change
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The shift toward a lower-carbon economy is accelerating amid a period of escalating geopolitical tensions, including a deteriorating US/China relationship. These concurrent secular trends may have significant impacts on manufacturing and trade activity, as well as financial markets.
Climate policies, falling renewables costs, and the ongoing war in Ukraine have governments focused on establishing both climate resilience and energy security, primarily by reducing dependence on fossil fuels. In 2023, nearly 80% of power-capacity additions worldwide came from renewables, including solar, wind, and hydroelectricity.1 At the current pace, I believe 100% of new capacity could be from renewables within five years. While this increase has been aided to some extent by policies like the US Inflation Reduction Act (IRA) and REPower EU, it is the fossil fuel industry, not renewables, that continues to see the largest government subsidies. I maintain that the shift to lower-carbon energy sources and broad-based electrification represent the most significant economic transformation of the past one hundred years, and it will continue to shape our world for the foreseeable future.
The race is on for energy-transition dominance and the massive market opportunities that go with it. Winners will likely be countries and regions that create a pipeline of raw materials and a manufacturing base for the components necessary to electrify power production and distribution, transportation, and industrial processes. Getting a head start matters, mainly because renewable energy has economies of scale: The cost of renewables decreases as production increases.
Today, China has a clear head start in the energy-transition race. China controls between 65% to 95% of the supply of resources across renewable technologies (Figure 1).2 In 2020, exports of electric vehicles, batteries, and solar cells were barely 1% of China’s total exports; within four years they are on track to be almost 5%.3 Because of renewables’ economies of scale, China may benefit from the lowest global incremental costs and the ability to invest in research and development to advance technologically. (Notably, China has leapfrogged to the head of the line in electric vehicle production as well, which similarly accrues advantages from economy of scale.)
Figure 1
The US and EU, among others, know they must be able to compete with China to secure their domestic energy supply and establish economic and geopolitical advantages. The IRA and REPower legislations have been written expressly for this purpose. The domestic urgency to establish production capabilities is compounded by a troubling development in global trade, which has begun to bifurcate along geopolitical lines. Research from the International Monetary Fund (IMF) and the World Trade Organization (WTO) shows that trade within geopolitically aligned blocs — that is, countries that vote similarly at the United Nations — is rising significantly faster than trade across non-politically aligned blocks.4 This polarization, coupled with the growing complexity and geographic specialization of products supporting the energy transition, is beginning to create a bottleneck for these critical inputs, which could have downstream effects on cost and availability.
Investment and trade implications
I believe the energy transition and ongoing geopolitical tensions will continue to turn global trade on its head. In the near and longer term, investors should expect:
- The continued rise of protectionism and inward-looking industrial policy. Countries in all regions will likely focus on ensuring domestic supply for products across the supply chain to support the energy transition and establish energy independence, from critical minerals to minerals processing technology to finished products.
- Accelerated investment spending. Ensuring that domestic supply chains are vibrant and resilient will require substantial capital investment, largely facilitated by transition-focused industrial policies and supported by falling input costs. Higher investment spending may put upward pressure on interest rates, as the financing requirements will be substantial.
- Higher inflation. The localization of supply chains — including for renewable technologies —means that production will no longer take place predominantly where it is cheapest to do (currently, in China). By definition, the reshoring of energy production by developed economies may make inflation reduction more difficult than it would be otherwise.
- The rise of the US as an oil supplier. An inherent irony of the low-carbon transition is that its progression, at least for the next decade or so, relies on fossil fuels. Today, renewables alone do not supply sufficient power capacity to support economic growth and expanding electrification. As China becomes “the Saudi Arabia of renewables,” the US has been becoming the Saudi Arabia of oil. The US state of New Mexico produces more oil than the nations of Venezuela or Mexico, for example. US exports of oil and gas used to be less than 2% of total exports; in less than a decade they have become more than 10%.5
1 “Renewable Energy Market Update: Executive Summary,” International Energy Agency, June 2023. | 2 International Energy Agency and BloombergNEF. | 3 China National Bureau of Statistics.| 4 “World Trade Report 2023: Re-globalization for a secure, inclusive and sustainable Future,” World Trade Organization. | “World Economic Outlook, Chapter 3: Fragmentation and Commodity Markets: Vulnerabilities and Risks,” October 2023. | 5 Wellington Management calculations, based on data from the US Bureau of Economic Analysis.
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