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What in the energy transition is investable?

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By Steven Bowen

· 6 min read

Delivering net zero – a sustainable investing perspective

Based on my social media feeds, the sustainability industry is largely happy with the US Inflation Reduction Act 2022. In the excitement, it’s important to remember that such actions, however welcome, are not the total solution. Sustainability investors need to remain aware that subsidies, grants, and other financial support are only part of the answer. We still need to focus on what’s important to us, rather than what governments decide is right. And we need to take every opportunity to step up engagement, getting companies to invest in the “right” projects. Finally, we need to help with the emergence of new business models that will make the transition established rather than transitory, creating the goods and services of the future.

Where will the private capital come from

Back in November 2021, at the time of COP26, the Glasgow Financial Alliance for Net Zero (GFANZ) made three announcements. The first two, on their estimate of the capital needed (US$125 trillion in total investments by 2050), and that over 450 firms had “committed” over $130 trillion of private capital, got most of the attention. They were deliberately designed to be eye catching and headline friendly. What was possibly lost was the third announcement, which summarised work from Vivid Economics, looking at where this capital might come from. This didn’t get the attention it deserved, maybe because it was about the boring nitty gritty of delivering the changes. But revisiting this in the light of the Inflation Reduction Act, and other new legislation, gives us some good pointers as to where sustainable investors need to focus their efforts.

Companies and households are the likely big contributors

Much of the Vivid analysis was consistent with our work, for instance identifying the sectors needing investment. But unlike most other analysis, they also estimated where this capital might come from. Their biggest contributor was direct investment from corporates, making up over a third of all pre 2030 investment. Then, unsurprisingly came commercial financial institutions (banks etc to you and me), big, but still under half of the possible contribution from corporates. After this, were a few surprises. Institutional Investors were actually small contributors, NGO’s and Philanthropists were big, and perhaps most interestingly, Households came in not much smaller than Commercial Financial Institutions.

Engagement will be key to pushing companies

What should this mean for sustainable investors? We see three big lessons. First, we need to focus a lot more on engagement with corporates, and all corporates, not just the listed ones. Not just via divestment or voting at AGM’s, but rolling up your sleeves and getting involved in the detailed work required to get corporates to modify their strategies. This could be getting them to invest in greener electricity, it could be modifying supply chains or production methods, or it could be upgrading their buildings and transport fleets. As an ex active investor, I know this work is costly and time consuming, but its where the most important progress can be made, even if the short term financial returns may be limited. And , this work should not just focus on Banks and the Oil & Gas sector, the sustainability transitions are going to need material changes in nearly all industries.

Households will need more subtle persuasion

Second, focus a lot more on decision making by households and individuals. What can drive them to better insulate their homes, switch to heat pumps, install rooftop solar, buy EV’s and sign up for electricity demand management. This was one of the big pushes in the US Inflation Reduction Act, where the main thrust was subsidies. That will help, but even with this these are very tough changes to push through. Some of the barriers are personal inertia and a lack of infrastructure/installers, but the big ones are mostly cashflow - how do households, especially in developing markets, justify a large up front spend that delivers what can be perceived to be distant savings. We are going to need new business models, including heat/cooling/electricity as a service, and bundled offerings, such as new approaches to EV’s that include charging.

Investors need to think about what is investable and when

Third, we need to differentiate between solutions that can make a difference soon, and hence are investable now, and projects that are risky and could take much longer to reach commercialisation. Some of the near-term wins are large and obvious, such as wind and solar farms. The technology here is mature and regulation/incentives are more certain. Over the next five years or so we will also see a surge in demand for electric vehicles, especially cars and vans. In many global markets, the regulations are already in place to phase out fossil fuel powered vehicles – but from an investing perspective we need to watch the historic low financial returns at the automotive OEM’s.

Other opportunities are less obvious, but still investable. Over the next decade we need material investments in strengthening electricity grids. Think battery storage, grid interconnectors, new infrastructure, stability software, and demand management. Regulation is still a barrier, but progress is being made.

If you put all three of these electrification themes together, Vivid Economics estimates you get a potential private sector opportunity out to 2030 of US$21trillion, roughly split ¾ in electricity and ¼ in transport.

Investment opportunities go well beyond electricity generation

The growth in these segments also implies a major increase in demand for mined raw materials. If we invest here, we need to square this with the impacts mineral extraction can have on local communities and environments. Looking outside of electricity and transport, we are expecting strong growth in agriculture, this includes food supply chains, robotics, and precision ag. The good news is that farmers and retailers will invest in technology that makes their businesses more viable. This, again according to Vivid Economics, could be a US$1.5 trillion segment over the next decade.

For a sustainable investor with a five-year focus, these are all potentially investible segments right now.

Long term investors might want to look at the hard to decarbonise potential

Looking further forward, we have the more challenging themes to get to full commercialisation. These include EV charging infrastructure (challenging because its not clear who pays) plus the massive opportunity that is building retrofits, especially residential. These opportunities will likely need new business models, so we think of them as being maybe five or more years out. Riskier for investors, but solving these challenges could be game changing, with investment needs out to 2030 of more than US$5 trillion . And then further out again, maybe toward the end of the decade, we have the potential commercialisation of solutions to the hard to decarbonise sectors such as steel, cement, chemicals, shipping, aviation and fertiliser.

It’s an exciting time to be a sustainable investor.

There are growing opportunities to invest in solutions that can make a difference to the sustainability transitions, and that can generate fair financial returns. And many use already existing technologies. But we also suggest a note of caution. It’s still important to be clear which challenges you are aiming to help solve and over what time period. There are a lot of well publicised opportunities to fix the really challenging transitions, but we need to be realistic about the level of financial returns they could generate. Plus, experience tells us that many solutions will take a lot longer than hoped to come to commercialisation. Yes, sustainable investing is about sustainability, but its still investing and we need to see a reasonable prospect of a fair financial return.

Illuminem Voices is a democratic space presenting the thoughts and opinions of leading Energy & Sustainability writers, their opinions do not necessarily represent those of illuminem.

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About the author

Steven Bowen is an engineer and investor with 30 years of experience in sustainability, equity and debt investing. He also writes for The Sustainable Investor blog​.

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