Are we on the cusp of a golden age?
In this concluding piece, we introduce some more concrete investment options in the global listed equity space that we think may benefit from increased investment in renewable energy, the electrification and energy efficiency improvements of homes, cars and businesses, and the decarbonisation of industry.
This follows on from Part I, ‘Blackouts, misinformation, and a climate of opportunity‘, where we used the example of the recent Texas blackouts to highlight the persistent and deep misunderstanding of how grids work and the role renewable energy plays in their reliability to posit that there may be opportunities for investors to take advantage of those misunderstandings and Part II, ‘A 3-step process towards zero emissions‘, where we outlined the three broad areas of opportunity in decarbonisation.
Update: As we were preparing these pieces, the Biden administration announced the outline of its infrastructure stimulus plan, which if passed has the potential to not only inject capital to invest in renewable energy, but to also provide the policy foundation for private investment to accelerate. The timing is looking increasingly attractive for a global boom in investment.
Opportunities in renewables, electrification, and energy efficiency
Put very simply, if the world is to meet its emission targets, investment in renewable energy needs to accelerate significantly. We estimate that annual installations of wind and solar must increase around four-fold from current levels in short order. While we believe there will be a mix of technologies, solar and wind have the steepest learning rates, which is likely to lead to a snowballing effect, where the more we make the cheaper they get, further entrenching their dominance. The two are quite synergistic too, with solar generating power when the wind it often weak while wind picking up in the evenings when the sun isn’t shining.
In the wind space we particularly like offshore wind, where the wind resource is typically more reliable and there’s less impact on local communities. Costs have collapsed too, meaning offshore installations are likely to rise well above the 10% or so of total wind installations today. Both Vestas and Siemens Gamesa have strong offshore wind divisions and newly listed Siemens Energy captures both the wind business of Siemens Gamesa, of which it owns two-thirds, but also includes electrical distribution infrastructure, which we believe will require significant investment to incorporate all this new wind and solar, support the additional loads as things such as transport and home heating moves to electricity, as well as making the grid more resilient. Relative to solar, wind (especially offshore wind, which is essentially a three-player market) is relatively consolidated and through time we expect service revenue to grow too, as the installed fleet grows.
In solar, we are generally cautious given the commodity-like nature of silicon and the cells and panels. Instead, we recommend looking at different parts of the value chain, such as semiconductor components that go into the inverters, for example, where companies such as Infineon, Texas Instruments, Analog Devices are particularly strong. Semiconductors have huge technological barriers to entry, and in analog semiconductors especially, lower capital intensity and less pricing pressure than other parts of the industry. We would also look at companies that provide unique software solutions on top of what is mostly commoditised hardware to add value. In this regard, companies like Enphase and SolarEdge are developing systems that enable households to take control of their home solar and battery systems.
Automotive electrification is an obvious large and disruptive opportunity, and like solar, we like opportunities in the component space, where content is expected to grow significantly. Again, companies like Infineon and Analog Devices will benefit as drivetrains switch from burning gasoline to shuffling electrons back and forth. (We would also note that there are lots of component overlap between EVs, solar inverters and energy efficient appliances such as inverter-driven heat pumps.) The significant investment required in the manufacturing of these new vehicles presents an opportunity for suppliers of factory automation and robotics too – a space where Japanese companies are particularly strong, including Fanuc, Yaskawa and Keyence. We are generally cautious on the battery cell makers themselves, given the extreme price pressure the industry is facing, but watch it closely for signs of consolidation.
Unlike electrification, industrial decarbonisation is less mature, and as such, higher risk for equity investors. Conversely, the rewards will be greater for those who can get the transition right.
The most important near-term development will be the commercialisation and maturation of water electrolysis to produce green hydrogen, to supplant the current carbon-emitting hydrogen sources, which are typically natural gas and coal.
For example, most ammonia going into fertilizer manufacture today comes from fossil fuels. Put another way, a big chunk of the nitrogen in the vegetables that we eat (and the animals we feed those vegetables to and then eat) comes from fossil fuels. In terms of emissions, it’s almost as large as cement as a single source of CO2.
While still early, we think the modular nature of Polymer Electrolyte Membrane (PEM) electrolysis gives it the potential to see massive cost declines as manufacturing capacity ramps up while electricity costs fall. The decarbonisation of fertilizer is itself a large opportunity, but longer term there are other promising applications of green hydrogen, such as replacing coking coal in the steel manufacturing process and potentially as a store of energy or source of carbon-free synthetic fuels – though we are very cautious on these given the system energy losses compared to the direct electrical route.
There are many small hydrogen electrolyser makers that have had wild share price rides over the last two years, and we are very cautious about the long-term viability of most. In these early days it’s not yet clear where the value will accrue. That said, given the complexity and large scale demanded of the larger industrial applications, it may play to the strengths of the large experienced industrial businesses – again, Siemens Energy has significant experience, not only in hydrogen electrolysis but also the grid infrastructure and wind generation.
There are significant sources of emissions that we’re not yet sure how to address – agriculture and land use changes, cement, air travel, as just a few examples. They will require time and significant investment, ideally supported by strong government policy. It’s not yet an area where we have found listed businesses with attractive valuations, though we watch Beyond Meat closely given its early mover advantage in the plant-based meat substitute space.
That there are some large unsolved problems only highlights the urgency with which we should be tackling the emissions for which we have solutions to. The quicker we bring down emissions from electricity, transport, and industry the more time we have to find solutions to the other hairier challenges.
So, to repeat – assume renewable investment has to quadruple, combined with significant grid investment to support these renewables and the added load of broad electrification of everything; look for innovative companies adding value on top of commodity products or finding ways to improve the energy efficiency of the devices we use; watch closely how quickly battery and hydrogen electrolysis costs fall; and, most importantly, look for the pressure points where value is likely to accrue while trying to avoid commoditised markets with significant price pressure.
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