Don’t get lost in the enormity of the carbon challenge
The following article featured on InvestorDaily, 20 April 2021.
It’s easy to look at the scale and complexity of getting the world to zero carbon emissions and lose hope.
Annual greenhouse gas emissions today are about 50 gigatonnes of CO2 equivalent, which needs to get to zero by 2050 to stay within 2 degrees Celsius of warming. While we do not downplay how hard this is going to be, it can broadly be broken into three pieces, each with a different set of risks, opportunities and time frames.
1. Decarbonisation of electricity, the electrification of everything… and a focus on energy efficiency
Put very simply, electricity production is our largest single source of carbon emissions, but low-emission substitutes for fossil fuels are mature and cheap, and while wind and solar are intermittent by nature, we can get to 90 per cent renewables cheaply and quickly while long-term storage solutions mature. At the same time, other fossil-fuel energy uses that can be electrified will be. Electric vehicles are the most well-known innovation on this front, but there are lots of other areas where there are mature, cost-effective pathways today for things such as home and building heating, which in many parts of the world still use gas and oil.
2. The decarbonisation of industry
While we are accelerating the decarbonisation of the grid, work needs to continue on some hairier challenges, such as finding zero or low-carbon substitutes for fossil fuels used in industrial processes – think coal in steel and cement manufacture, natural gas and oil in plastic, fertiliser and other industrial processes. We believe that these applications are the most promising opportunities for the nascent green hydrogen industry, but unlike wind and solar electricity, significant cost progression needs to be made and the technologies need to mature further.
3. And, well, everything else
About a quarter to one-third of our emissions come from agriculture, deforestation and other land-use changes and waste. Many of these are complex issues, that require cooperation and coordination across many different groups and cannot be solved by technology alone. Many of these may take longer to solve but are just as important as the lower-hanging fruit mentioned so far.
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 fourfold 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 are 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 is often weak while wind picks 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 per cent 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 keep up with developments.
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 analogue 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 obviously large and disruptive opportunity, and like solar, we like opportunities in the component space, where content is expected to grow significantly. 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 electric vehicles presents an opportunity for suppliers of factory automation and robotics too – a space where Japanese corporates 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 fertiliser 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 electrolysis gives it the potential to see massive cost declines as manufacturing capacity ramps up while electricity costs fall. The decarbonisation of fertiliser 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. However, we are very cautious on these given the system energy losses compared to the direct electrical route.
There are many small hydrogen electrolyser companies 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, for example. They will require time and significant investment, ideally supported by strong government policy. 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.
In the meantime, assume renewable investment has to quadruple and that significant grid investment is needed to support these renewables and the added load of broad electrification of everything. Look for innovative companies that add value on top of commodity products or find ways to improve the energy efficiency of the devices we use. Watch closely how quickly battery and hydrogen electrolysis costs fall and, importantly, look for the pressure points where value is likely to accrue.
Original Article: InvestorDaily
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