Source: Investec Asset Management, November 2018
For clarity, the first two energy transitions are based on changes in market share of primary energy (which refers to energy before human intervention). The third transition refers to the market share of sources used for power generation (or electricity). Although inconsistent, the comparison provides an informative historical template. The latter approach is more relevant due to the rapid electrification of the global economy; electrification (of transport and heating from renewable sources) will help power generation become the largest component of primary energy usage.
3. Ramp up of electrical vehicle production
Electric vehicle (EV) production is on the cusp of a step change in 2019-20, as key auto incumbents are moving beyond the internal combustion engine. China leads this transformation, now producing over 50% of EVs worldwide.
New EV models planned through 2025
Source: Wolfe Research, Autos & Auto Parts Initiation, October 2018
Established producers are putting the brakes on vast sums of capital that until recently had been invested in internal combustion technology rather than in EV growth. Now, as evidenced by the number of new EV model launches scheduled for 2019 and 2020, there is wide acceptance in the industry that the electrification of car fleets is going to proceed rapidly.
4. “Beautiful China”
China under President Xi is firmly committed to becoming a leader in renewable energy. The ‘Beautiful China’ policy was announced at the 19th National Congress meeting of the Communist Party of China in October 2017. Moreover, renewable energy and electronic vehicles were referenced in the ‘Made in China 2025’ policy document as two of ten technological priority areas.
The impact of this policy shift has been remarkable. In 2017 China alone was responsible for 40% of the world’s renewable energy capacity growth and has already surpassed its 2020 solar capacity target as set out in the 13th five-year plan. The International Energy Agency (IEA), a global energy authority, expects China to exceed its wind power generation target in 2019.
In China’s New Policies Scenario, growing energy needs will be met increasingly by renewables, while gas & oil will lose market share
Source: IEA World Energy Outlook, November 2017
While China remains heavily reliant on fossil fuels – particularly coal which saw 39 GW of new installed capacity in 2017, ahead of wind with 20 GW but behind solar with 53 GW – the previously overwhelming focus on industrial growth over the environment is undoubtedly shifting. Air pollution, environmental damage and their attendant risks to the health of the population had become so bad in key urban areas that conditions threatened to damage the ruling Chinese Communist Party’s legitimacy.
The investment implications for investors
Asset owners are powerful, long-term actors. Globally, pension funds account for more than US$ 41 trillion* of assets and the international mutual fund market is even larger at US $53 trillion**. Sovereign wealth funds and pension funds have been active in developing strategies that shift asset allocation to address some of these longer-term systemic issues. They need assets that generate returns to meet their long-term liabilities and these returns are increasingly threatened by climate change-related (and, indeed, other ESG) issues. In response, unprecedented numbers of pension funds, globally, have developed ESG polices and expect ESG to be integrated throughout the investment process. Most of the activity has been voluntary but regulators are increasingly stepping in to set a minimum standard that explicitly addresses the responsibility of asset owners to consider all risks, including ESG.
An investment manager has a fiduciary responsibility to maintain and grow the wealth of its clients. Today, any investment approach which fails to incorporate sustainability-related factors, such as climatechange considerations, is likely to fall short of that responsibility.
The first step towards optimising investment portfolios in the face of the energy transition is to recognise the scale of the challenge and the changes required in all segments of society. This means a robust investment policy with goals and objectives reflecting the impact of global warming and sufficient flexibility to deal with the dynamic changes in the global growth model. The required action for investment managers can be split into three distinct motivations:
|Engaging with regulators and policy makers to participate in the development of regulations that will help steer our sustainable investing future.|
Asset markets will of course move to discount tomorrow’s world today. After a number of false dawns, our decarbonised future is increasingly being recognised in today’s asset values.
Adopting a decision-making investment framework for a decarbonising world
It would be all too easy to adopt an Orwellian ‘carbon bad, renewables good’ approach to investment decision making. The investment journey towards decarbonised portfolios requires an ability to understand the nuanced impact of the transition at the macro, asset class and security level. Some carbon-dependent assets will still have a role to play in the near term and their valuations must reflect that. Equally, renewable assets will not be exempt from periods of mania and associated valuations as green bubbles form and burst.
This Energy 3.0 series proposes a decision-making investment framework which recognises materiality, the time scale over which assets are likely to be affected and the factors that influence asset pricing. New thinking and new approaches are vital if investors are to obtain positive outcomes within their investment opportunity set.
The climate challenge, the energy transition and the role investors can play in redirecting capital towards low-carbon technologies and behaviours are all unprecedented. None of them are insurmountable, provided all parties act now – and for investors this means rapid reassessment and action on their weightings towards carbon and decarbonisation.
* Source: Willis Towers Watson as at end of 2017
** Source: Source: ICI Global, June 2018
1Footnote: Climate Action Network Europe
This content is for informational purposes only and should not be construed as an offer, or solicitation of an offer, to buy or sell securities. All of the views expressed about the markets, securities or companies reflect the personal views of the individual fund manager (or team) named. While opinions stated are honestly held, they are not guarantees and should not be relied on. Investec Asset Management in the normal course of its activities as an international investment manager may already hold or intend to purchase or sell the stocks mentioned on behalf of its clients. The information or opinions provided should not be taken as specific advice on the merits of any investment decision. This content may contain statements about expected or anticipated future events and financial results that are forward-looking in nature and, as a result, are subject to certain risks and uncertainties, such as general economic, market and business conditions, new legislation and regulatory actions, competitive and general economic factors and conditions and the occurrence of unexpected events. Actual outcomes may differ materially from those stated herein.
All rights reserved. Issued by Investec Asset Management, issued November 2018.