Workers stand on a platform lifted by a crane during the construction of a new wind turbine at a wind farm near Dortmund, Germany, on July 14.INA FASSBENDER/AFP/Getty Images
The world is undergoing a paradigm shift, both politically and economically. This article is the second in a four-part series that examines several changes, including the energy transition opportunity, evolving dynamics with emerging markets, and how North America can leverage its comparative advantages to strengthen its position in the global market.
History is replete with pivotal moments that redefined the nature of investing: the Industrial Revolution, the emergence of globalization out of the despair of war in the 20th century, the advent of the internet. Because investing is ultimately an act of faith in the future, these megatrends are important to understand. Those who “see the future” can be rewarded immensely, while those who fail to spot a shift can be left holding the bag.
For Part 2 of my four-part series on the changing nature of risk and return, I will examine perhaps the most inevitable megatrend for investors: the energy transition. The shift to renewable energy sources, like all macroeconomic changes, is highly dependent on multiple factors, including government and regulatory policy, public sentiment and technological innovation. Beyond recent noise and backlash against the ESG (environmental, social and governance) framework, incredible long-term potential lies within the opportunity to finance the global transition to a lower-carbon economy. The leap from grey to green will eventually turn gold.
Bumper profits in the hydrocarbons industry should not obscure the fact that we are headed toward a greener future. While not everything that glitters will be gold, the overarching reality is that demand for electricity is expected to grow seven times faster than demand for other end-use energy sources.
With the continuing electrification of the construction, transport and industrial sectors, the growth rate of electricity already surpasses those of oil, gas and coal. What’s more, increasing digitization across industries has led to a surge in data flow, processing, storage and server capacity, further amplifying electricity requirements.
In order to meet this insatiable demand for electric power, governments everywhere are backing the shift toward renewables. The United States has offered unprecedented incentives for new renewable infrastructure investments through its Inflation Reduction Act. Canada is in hot pursuit. Europe’s major economies have been, and will continue to be, hubs for low-carbon energy development in wind, solar, nuclear and certain forms of hydrogen production.
And it’s not just the West. In 2022, China’s investments in renewable energy surpassed those of the United States by nearly four times, at US$546-billion. This is the same country that is producing and exporting more electric vehicles than anywhere else in the world. Even Saudi Arabia, one of the most fossil-fuel-dependent economies on earth, plans to generate half of its electricity from renewables by the close of the decade, and is undertaking a broad government-led effort to diversify its economy.
Not only is there an environmental, economic and political case for a renewable-energy transition, there is a security one. Unlike oil and gas, your adversary cannot shut off your supply of wind or sun, should that be in their interest.
This isn’t about shunning the old for the sake of the new or pushing a political agenda; it’s about embracing the investment opportunities that come with the inevitable and irreversible shift to decarbonization.
If you don’t believe this, just look at the activity of financial institutions, for example. At COP26, the UN climate change conference in 2021, financial institutions with more than $130-trillion in assets under management committed to reaching, before 2050, a state of net-zero carbon emissions among the companies they invest in or lend to. This commitment will fundamentally change the way they deploy capital.
In Canada, the Office of the Superintendent of Financial Institutions has issued guidelines for banks and federally regulated insurers that will require disclosure of Scope 3 greenhouse gas emissions – that is, emissions produced indirectly through a company’s activities or investments – at fiscal year-end 2025. This means these institutions will have an incentive not only to reduce their own emissions, but to finance net-zero companies, further contributing to the available pool of capital, which in many cases will create additional benefits to equity holders in green companies and investments.
Capitalizing on this transition is not merely a socially responsible or politically astute choice – it’s smart investing. Investors who fail to align their strategies accordingly risk being left in the lurch.
Concerns about high electricity generation costs and uncertainty regarding production and storage capacity are gradually being mitigated by technological improvements. With continuous scientific advances and increasing government supports, the costs of both solar and wind energy have plummeted below traditional fuels in some jurisdictions.
Investors can hedge their bets across the broad range of renewable energy options, including green bonds, carbon capture technology, grid infrastructure and hydrogen. There are opportunities across the risk spectrum, with technologies, services and products that are proven, and others that are riskier but offer huge potential. Basically, wherever there’s CO2, there’s a need for capital, and no shortage of options to choose from.
Institutional investors from every corner of the globe are sensing the magnitude of this opportunity and racing to stake their claims. North American and European pension funds and institutional managers, global insurance companies and Middle Eastern sovereign wealth funds are all on the front lines of this new gold rush. They are in search of innovative green technologies, sustainable infrastructure projects and companies with robust transition strategies that can tap into this historical alignment opportunity.
With any emergent industry, there’s inherent uncertainty. But consider this: not long ago, solar and wind energy generation were prohibitively expensive and solely reliant on government subsidies. Today, these technologies are cheaper, politically attractive and supported by an abundant inflow of institutional capital, with many big players amassing multibillion-dollar funds to deploy across renewable portfolios. This is a big part of why climate-related investment increased significantly in 2022, outpacing the broader market and moving against major geopolitical and macroeconomic trend lines.
Investors play an essential role. Just as the original gold rush was as much about providing tools, infrastructure and services to miners as it was about the actual extraction of gold, the energy transition also holds vast potential beyond the generation of renewable energy itself. It’s about creating and financing the entire ecosystem that will support a decarbonized economy.
The investments that help organizations overhaul their operations, adopt carbon-conscious practices or innovate toward digital solutions and infrastructure will yield bountiful returns. Consider entire sectors, such as agriculture and land use – currently responsible for nearly a quarter of global greenhouse gas emissions – that are primed for renewable reformation.
It is clear renewable-energy development will happen across the globe – potentially amounting to as much as $12-trillion in investment opportunities by the end of the decade. The only question that remains is which players will benefit most greatly from financing it.
In short, investors have to pay attention to the energy transition. It presents both an opportunity to those who can look into the future and a massive risk to those who ignore it. Investors must be more attuned to technological, political and consumer trend lines affecting the pace, scale and direction of the transition. It is a fundamental change to the risk and return dynamics that I spoke about in the first article in this series.
To be clear, getting up the curve on this change is a colossal task, yet it is undeniably an era-defining opportunity for all investors. The course of this “green rush” will be dictated by those who understand the economic potential beneath the sustainability ethos, and who invest wisely to steer a course toward profitability in a decarbonized world. This isn’t just an environmental imperative – it’s an economic revolution in the making.