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Investment views

The third energy transition

17 September 2018

Tom Nelson tracks the shift in the global energy supply mix and discusses how China is setting the tone in terms of renewable energy.



Lindsay Williams: Earlier this year I read an article in the Financial Times, the headline of which was the following: “Investors must face energy’s third energy transition”. The first paragraph goes on to the say the following: “The global energy system is on the cusp of a revolution and investors in the sector risk sleepwalking into a period of momentous change”.

With me now is Tom Nelson, who is Head of Natural Resources at Investec Asset Management in London. The third energy transition, Tom, let’s just define that first of all.

Tom Nelson: Yes. Well, we define this energy transition as a significant change in the primary make-up of global energy supply and, if we look back over the last 300 or so years, in essence we see mankind moving from biofuels, particularly burning wood to coal, and then over the course of the 19th century moving from burning coal towards – or rather over the course of the 20th century moving from burning coal to burning oil and gas and we believe that we are now in effectively the third energy transition and what is really interesting if we look back through history is what we can learn from the previous iterations.

Lindsay Williams: Yes, indeed. So we have gone from burning to burning to burning and, of course, now what we want to do is phase out burning altogether. At what stage do you think that the traditional burning of fossil fuels will be equalled by renewable energy sources? Lots of different theories on this one but it seems to me to be catching up at quite a pace.

Tom Nelson: It is and again that is why I think studying the history and these previous transitions can teach us a lot. We are seeing a very, very rapid rise in the role played by renewable energy and we are seeing a phasing out or the early stages of a phasing out of coal for power generation but I think the two things that we really learn from history, looking back over the previous transitions:

  1. is that typically these transitions take a little longer than people expect in the sense that it just does take time for new systems, for new infrastructure, new technology, new policy, etc., to take over; and
  2. the other thing we learn is that the incumbent supply sources typically continue to play a role. In other words, it isn’t a complete “out with the old, in with the new”. Rather it becomes more of a diversification of energy supply source.

Lindsay Williams: So the diversification element, how long typically would that take, given the previous iterations that you spoke about?

Tom Nelson: We think – and there are lots of very, very good and interesting models out there and estimates and forecasts – we think, based on the work that we have done and the work that we have digested from others, that the global energy system could be approximately 50/50 between renewables, including hydro and hydrocarbons, by mid-century; in other words, in a little over 30 years. That is the approximate framework that we are working around.

Lindsay Williams: Which, in the big scheme of things, of course, is just a heartbeat away. Before we get on to the role of China and the role or lack of role of the United States, I was flying recently from Amsterdam to London and the first thing that you see as you leave the land and hit the ocean from Amsterdam is a giant windfarm and the last thing you see when you go from the ocean to the land approaching the United Kingdom, the south-east of the United Kingdom, is a windfarm. What is the mix likely to be in renewables?

Tom Nelson: Well, that’s a very interesting question and, arguably, the most difficult one to answer. I mean our starting point is that the energy supply system will be diversified (point number 1). Within renewables, wind, both onshore and offshore, will have a huge role to play, as will solar, as will a number of other sources but at this point in time, based on what we call the LCOE (which is the levelised cost of electricity), i.e. the effective economics of the technologies, we see solar and wind, both on and offshore, as being the structural winners.

When we think about growth rates from this point forward over the next 30 years, we think it is reasonable to assume that global adoption of those two technologies could run at between 5 and 10% annualised growth over the next 20-30 years, which, in an increasingly challenging and low growth investment environment, we think that getting exposure to those sort of growth rates or growth trajectories is enormously exciting.

Lindsay Williams: Yes. What is also enormously exciting from an observer’s point of view is the lead role being assumed by China and, because of certain political developments over the last year two years, the US being pushed into the background. Is that a reality and is it just a moment in time or has China really set the tone for what renewable energy economies should look like?

Tom Nelson: We think it is more than just a moment in time. We think that China has achieved a genuine global leadership in renewable energy technology. There are a number of reasons behind it. The first is technological advancement and manufacturing capability. There is also the strong incentive or sense of domestic urgency driven by security of energy supply. There is centralised, joined up government policy. There is also, of course, the environmental impact and the greater understanding around environmental threats in China.

So it is really phenomenal what is happening in China. We have been on two extensive research trips taking in industrial expositions and exhibitions as well as looking at facilities and meeting a significant number of companies. We think that China has really seized this and see no reason to believe that their leadership in this sector will be surpassed any time soon.

Lindsay Williams: And on the other side of the coin is the United States of America. When you see Mr Trump on one of his electioneering campaign shows (for want of a better phrase), you will see these banners saying “Trump digs coal”. Is this a moment in time and it can be turned around quite quickly, i.e. back to renewables?

Tom Nelson: You know I may be accused of over-optimism or a rose-tinted perspective on this one – I think actually that Trump’s attempts to derail the move towards renewable sources of electricity and power generation and energy supply in the US, I think actually Trump’s intervention will go down as a short-term footnote/interruption.

I think that the US at a national level will move in a large way towards renewable sources of electricity and energy, not to say that the domestic endowment and legacy of oil and gas and coal won’t have a role to play (I come back to the diversified make-up of energy supply on a global basis) but I think that Trump will be a setback on an otherwise reasonably concerted move towards renewables in the US over the coming decades.

Lindsay Williams: Let’s put all this together now and refer back to the Financial Times article where they, in their first couple of sentences, talked about investors. What is the investment case? How easy is it to invest in renewable energy? Do we automatically go to China and Chinese companies? Please give us an idea.

Tom Nelson: No. The really exciting thing about getting exposure to the rise of renewables is that it is happening on a global basis. We have talked about China’s leadership and there are fantastic domestic Chinese companies across all of these technologies and sub-industries but there are also very, very strong businesses across the global spectrum.

I think the attractive thing for investors, aside from the overarching growth environment in which these companies are operating, is that they are much stronger and more stable financial businesses than they were 5 and certainly 10 years ago. So what we are seeing is this maturing of the sector at precisely the same moment that investor awareness and understanding of what these businesses could achieve on a 10 or 20 year basis is coming to the fore.

So it has been a long time coming and we have seen a lot of bad companies driven out of business or marginalised by investors but we think that this is a good time to be looking, given (as I say) the combination of growth outlook and increasingly strong financial characteristics.

Lindsay Williams: So would you say this is a stand-alone, viable asset class?

Tom Nelson: I would say that anyone who is thinking about structural themes that are likely to prevail over the next decade, two or three decades, need to think very carefully about what the energy transition means for their portfolios and a lot of people’s knee-jerk reaction is to think about the risk – the risk of stranded assets, the risk of carbon pricing, the risk of having emitters within a portfolio. That, of course needs to be understood and thought about very deeply but I think that people are spending too little time thinking about the opportunities from what we call the enablers and, to a great extent, that is renewable energy and environmental businesses.

I think if you can harness those two sides of it, in other words avoiding the big risks and possibly actually taking advantage of businesses that are perceived to have significant carbon risk but actually are generating excess cash, while also allocating to the enablers and the decarbonisers, I think that is a fantastically exciting opportunity set.

Lindsay Williams: Tom, thanks very much for your insight. Tom Nelson is Head of Natural Resources at Investec Asset Management in London.


Important information

Investment involves risks. Past performance figures are not indicative of future performance.
This podcast is provided for general information only and assumes a certain level of knowledge of financial markets. It is not an invitation to make an investment and should not be construed as advice. The views in this podcast are those of the contributors at the time of publication and do not necessarily reflect those of Investec Asset Management.In South Africa, Investec Asset Management is an authorised financial services provider. In Hong Kong, this content has not been reviewed by the SFC and is issued by Investec Asset Management Hong Kong Limited. In Singapore, this content is issued by Investec Asset Management Singapore Pte Limited (Co. Reg. No. 201220398M).

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