The current inflationary pressures putting strain on global equity markets are impacting energy transition equities more than most, with many of its sub-sectors right in the eye of the storm. But while these short-term threats are painful, they should not detract from the longer-term investment opportunity.
Inflationary pressures have been at the heart of this disruption. Global supply chain bottlenecks, rising input costs, concerns around the underlying health of the economic recovery, and the threat of rising interest rates, have created a very challenging environment for all industries around the world – and certain energy transition sectors are more exposed than most.
Disruptive dynamics are mostly short-term in nature
Although we believe the current supply chain tensions could last well into next year, they will eventually ease. Heightened raw material and shipping costs will trigger a supply response, which will relieve pressures on the costs of goods and services sold. Moreover, the underlying capital investment trends behind the transition to a net zero energy system remain incredibly robust, creating scope for significant order pick-up and returns uplift once near-term difficulties slow.
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The long-term opportunity remains unchanged
While we remain cautious about the time it may take for the current headwinds to settle, the longer-term opportunity behind the energy transition remains firmly in place – and only gets stronger as economics improve, demand accelerates, and policy support grows. As long-term investors in the energy transition, using short-term disruption as an opportunity to buy is critical – especially given the underlying structural growth potential behind this particular investment space.
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Competitiveness of renewable power remains incredibly robust
The cost of developing wind and solar projects has increased with inflation. But these increases pale in comparison to the heightened cost of both the commodity inputs for conventional power assets (for example, coal and gas) and the carbon costs operators of these assets need to pay to produce.
Moreover, renewables are only going to get more competitive as new innovations come to market. Historically, solar modules and wind turbines have seen costs improve at 28% and 11% learning rates (per annum) respectively.
While this rate of improvement will inevitably slow as incremental gains become harder to achieve, forward progress will still be made. Boosting power generation per panel and turbine means developers can deliver the same amount of electricity from a smaller-sized operation – which will be increasingly crucial as costs of land, construction, engineering and other equipment potentially start to rise.
Underlying demand picture remains very robust too
Corporate demand for renewable power also continues to grow, particularly as more companies commit to net zero goals. Demand for residential solar and storage solutions remains incredibly strong, as concerns around energy security build and the economic benefits become ever clearer.
There has also been a remarkable pick-up in the demand for electric vehicles (EVs) globally, as new models are rolled out and consumers opt to go green.
Policy support continues to move from strength to strength
Although President Biden’s infrastructure packages are currently stalling in Congress, it is more likely than not that this will be passed in some sort of amended form. Together with support from the European Union (EU) and the increasingly ambitious targets being laid out by President Xi in China, policy support behind the energy transition continues to build.
We have also seen exciting new traction in carbon markets. With China introducing its emissions trading scheme last year, over 20% of emissions globally are now covered by a form of formal policy.
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