Energy enters a paradigm shift

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By Matt Scott, Senior Strategic Investment Research Specialist 

This time last year it seemed inconceivable that Germany would sign a 15-year deal with Qatar for natural gas supply, and yet it has happened. Progress on emissions has been poor, with only the economic standstill provided by COVID having had a significant dampening impact so far. Scalable renewables’ share of energy generation has grown from 5% to 10% of total supply in the last 10 years, but it must reach 45% by 2030 for the world to stick to a 2050 net-zero emissions trajectory.4

While we are all well aware of the consequences for Europe of the Western world’s sanctions on Russia after its invasion of Ukraine, geopolitical frictions are not only a risk in traditional energy. Tensions between Europe and the United States on one side and China on the other are critical as China controls 85% of overall solar manufacturing capacity and 97% of polysilicon wafer production5 (these wafers are the underlying component of the solar cell). Security and decentralization are becoming key components of energy planning for the future.

But there are reasons to be positive. The conflict in Ukraine has accelerated European plans to transition to renewables, and China has taken up the green gauntlet as it is forecasted to install almost a half of new renewable energy capacity in the next five years.6 Whether the motivator is energy security, air pollution reduction, or cost effectiveness, renewable energy production looks set to boom. As Figure 4 shows, many renewable sources of energy are now cost competitive, with onshore wind and solar photovoltaic cheaper than fossil fuels.

Making use of cheap, renewable energy is not as easy as it might be. There can be intermittency problems (the wind is not always blowing nor the sun always shining), there is a need for infrastructure reform, and renewable component supply chains are not infallible. Energy production in the future must be diversified, and progress must be made on energy storage (electrochemical batteries as well as equivalents such as molten salt storage or cryogenic systems) and capacitance.

Looking beyond infrastructure, investors can position for the ongoing energy transition by looking at mining and the production of advanced materials. The MSCI ACWI Metals and Mining index has a price-earnings ratio of 7.1x as at 30 November 20227 , less than half the parent index (17.2x for the MSCI ACWI). China comes into play again as it accounts for over 40% of the supply of vanadium, graphite, molybdenum, aluminum and lead, which are all crucial elements in the energy transition.8 Investors will want to choose approaches that are not subject to the vagaries of international relations.

Energy has assumed an extra dimensionality in recent times. Whereas investors have in the past mainly focused on energy supply, they will now have to supplement this by focusing increasingly on efficiency, security, technology and materials. Transition-aware infrastructure and transition-aware natural resources approaches could benefit from the paradigm shift.

4 See Transitioning between elements | Mercer. Hydropower excluded from calculation due to lesser scalability.

5 Source: International Energy Agency Executive summary – Solar PV Global Supply Chains – Analysis - IEA

6 Source: International Energy Agency, Renewables 2022

7 Source: MSCI

8 Source: IMF Metals Demand From Energy Transition May Top Current Global Supply (imf.org)