This article is part of NordSIP Insights – ESG Integration Case Book 2020. Read or Download the entire publication here.
by Carlo M. Funk, EMEA Head ESG Investment Strategy, State Street Global Advisors and Kingsmill Bond, New Energy Strategist, Carbon Tracker
Growing fears around the threat of man-made climate change combined with the increasing attractiveness of renewable energy have led to a paradigm shift that is driving a steady transition towards renewables.
Globally, we calculate society stands to reap a massive $1 trillion windfall from the energy transition, and potentially much more once all positive externalities are included. We believe that this shift offers incredible opportunities for investors who are positioned correctly.
Encouragingly, we see growing investor awareness of the importance of factoring in climate change scenarios into their portfolios. In a recent SSGA survey of over 300 institutional investors and world-leading institutions, among the most significant factors driving adoption of ESG principles were risk mitigation and meeting or getting ahead of regulation. Climate change is the central ESG issue that is driving these results, as long-term investors understand that the systemic risks associated with climate change — and the policy response to it — can no longer be ignored.
Renewable energy will play an increasingly important role in tackling climate change as technological developments result in ever cheaper, more efficient and flexible renewables solutions that will drive down demand for fossil fuels. While investors will face climate-related risks in the coming years, there will also be opportunities for those who can mitigate risks and adapt their portfolios for the coming energy transition.
What is driving the shift and what are the implications?
Today’s renewables are cheaper than ever before. This has transformed the renewable energy industry from one subsidised by governments to one driven by economic gain.
The pace of change has been remarkable. Only five years ago, variable renewable energy (solar and wind power) were the most expensive source of new electricity in 99% of the world. In 2019, they are the cheapest in two-thirds of the world, and by the early 2020s, we believe they will be the cheapest source in all major markets.
Currently, solar panel costs are falling and new technologies are increasing yields. Technological advancements are also creating cheaper batteries that will allow solar and wind energy to be dispatched on demand according to market needs. Technological advancements in the form of taller wind turbines, standardised installation costs and improvements in material efficiency will likely result in falling costs, driving further growth.
The 4 Tipping Points for Renewable Energy
Aside from the favourable economics of renewable energy adoption, we believe other drivers will accelerate the energy transition.
The world is heading for 3°C warming above pre-industrial levels by the end of the century, far above the targets set in the Paris agreement. Policymakers can help meet the Paris targets by increasing the deployment of renewables in the electricity sector.
Ambient air pollution kills four million people a year and is a major public health issue in the emerging markets. It will only worsen if fossil fuel use continues.
80% of people live in countries that import fossil fuels. With growth, energy dependency will only increase. Renewables are a local and continuous energy source and will reduce import dependency, increasing countries’ geopolitical influence.
The new environment allows countries an opportunity to seize dominance in the new energy technology sectors, as China has done in electric vehicles.
Renewable energy is very popular across the world as shown in a 2017 survey of 28,000 people across 13 countries conducted by Orsted, a Danish renewable energy company. Over 80% want to move to a world powered by renewable energy and over 80% want to phase out coal.
The fossil fuel sector employs 30 million people and according to the International Renewable Energy Association, a shift to renewable energy would require an extra 17 million jobs by 2030.
A world powered by renewables would create abundant energy for the billion people lacking energy in emerging markets and the energy poor in rich countries.
We can categorise countries and markets along two lines — exporter or importer of coal and gas, and high-income versus the rest. High income is a proxy for weak demand growth and lower pollution problems (both indicative of greater resistance to renewables adoption).
Through this categorisation, four groups of markets emerge. The group that will be least resistant to the energy transition live in low-income importers of coal and gas and account for 65% of the world’s population (including China and India). The smallest group, just 7% of the world population (including Australia, the US and Poland) is the most intractable group — the high-income exporters.
The 3 phases of Energy Transition
The falling costs of renewables combined with the rising penetration of renewables in the energy mix promises a huge energy windfall, which we refer to as a ‘Gigafall’. We can estimate the value of the Gigafall over the next decade with some simple calculations on the size of the opportunity, the value of each new MWh and a capitalisation factor.
Over the course of the next decade, solar and wind can add 6,000 TWh to the global energy mix without running up against the intermittency ceiling. The cost advantage of renewables technology over the cheapest fossil fuels will vary by country and location but a conservative estimate of the average annual cost advantage is $10 per MWh.
Combining the size of the opportunity (6,000 TWh) and the benefit ($10) we get an annual windfall of $60 billion. However, this also needs to be capitalised because the benefits accrue every year. If we take a 5% discount rate that implies a capitalisation factor of 20, which gives a total opportunity of $1.2 trillion.
If we include avoiding the costs of global warming and ambient air pollution from fossil fuels (at least $50 per MWh), the Gigafall would reach $6 trillion. The vast rewards of renewable energy will be reaped by society as a whole. Critically, these vast rewards will be reaped by society as a whole. This is in contrast to the beneficiaries of fossil fuel discovery and exploitation, who are the owners of resources and governments
Catching the Gigafall
At State Street Global Advisors, we use our influence as a large global asset manager to encourage corporate boards and management teams to proactively address climate-based issues that could impact on long-term performance. Our investment capabilities include climate-specific reporting so that clients can align their portfolios with the evolving science, regulatory landscape and investment risks and opportunities related to climate change.
The Gigafall is one large-scale example of the many climate-related opportunities that investors can already begin positioning their portfolios for.
Our research is helping us develop breakthrough climate investment products that can transform your portfolio’s carbon profile while maintaining the returns you need. For more information and to try our interactive carbon profile tools, please visit our website.
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