Navigating the race up the renewables S curve

‘Gradually and then suddenly’. That’s the way that one of the characters in Hemingway’s The Sun Also Rises describes how he was bankrupted. It neatly captures the nature of change. Change is a constant, but it’s speed varies. Sustainable investing has changed a lot over the last decades – from ethical investing for a few to responsible for some and on again to ESG for most of us as we recognised the need to capture material ESG risks in valuation and portfolio construction. That change has been gradual. We are at the edge of a more sudden change.

In Instagram reels, we see people approach situations cautiously only to catapult down slopes, into rivers and over handlebars as events evolve too rapidly for them to respond. If we do not prepare, we run the risk of experiencing the same in the investment world. We are moving into a new phase – a transition to a new energy system.

Kingsmill Bond, CFA, spoke eloquently to this point at CFA UK’s conference last month on ‘Investing in the Net Zero Transition’. His views were also summarised in Rocky Mountain Institute report that he wrote with Sam Butler-Sloss on the renewable revolution. As he pointed out, renewable technologies have experienced and are likely to continue to experience exponential growth. Fossil fuel demand has peaked. Renewables are set to hit price tipping points across different areas of demand. Solar energy and electric vehicles will dominate their sectors by the end of this decade. Stranded assets will become a reality, and investment professionals that fail to respond to the energy system transition risk becoming ‘stranded experts’.

Bond isn’t the only one talking about tipping points and the transition to a new energy system. Last month Fatih Birol, the of the IEA said, “Clean energy is moving fast – faster than many people realise. This is clear in the investment trends, where clean technologies are pulling away from fossil fuels. For every dollar invested in fossil fuels, about $1.7 dollars are now going into clean energy. Five years ago, this ratio was one-to-one. One shining example is investment in solar, which is set to overtake the amount of investment going into oil production for the first time.” That investment is supported by the demand for energy security and by new policy initiatives such as the US’ Inflation Reduction Act but is primarily a function of simple economics.

Renewable energy is getting to be a cheaper option than fossil fuels and is getting cheaper again. The RMI report points out that the costs of offshore wind and solar have fallen by 73% and 80%, respectively, over the past decade. In 2016, gas and coal were the cheapest ways to generate electricity. Now, the Levelized Costs of Electricity from solar and onshore wind are 62% and 56% of the cost of generating electricity from coal, and the cost of offshore wind is equal and falling. Capital is moving towards renewables, and renewables capacity is expanding exponentially. As Kingsmill put it at our conference, ‘Climate is the spark, but economics is now the driver’.

The implications for investors are profound. Not only do investors need to figure out how to steer away from sectors facing structural decline, but they also need to identify who the winners will be from this rapid transition. Sure, it might be possible to gain exposure to materials and sectors that will see growth, but which companies will succeed within those? Which new companies are most likely to use investors’ capital well? Which incumbents are going to manage best the shift from tactical responses to external pressures to strategic embrace of revolutions in power, transportation, production and consumption.

Our recent survey of climate investment skills suggests that investment professionals understand the challenges ahead and are responding to them. Just 21% of respondents thought that their climate skills were weak, and 84% of respondents acknowledged that climate considerations had become an integral part of discussions with clients in the past year.

Nevertheless, respondents were also clear that they had more to learn. The specific skills that they highlighted as being necessary to be climate capable are the integration of climate considerations into security analysis and valuation (65%), climate materiality assessment (50%), and scenario analysis (42%). These three came out as the top skills for future learning and are all key elements within CFA UK’s Certificate in Climate & Investing – the qualification that we have developed to provide investment professionals with the knowledge and skills that they need to be effective in this new environment and to serve their clients well by understanding the materiality of climate across and within sectors. 

Investment is about risk and return. It’s about identifying growth and value. It’s about steering clients away from losses and helping them to achieve their return goals. Understanding how the energy system transition will change the investible universe and drive the patterns of returns from within that universe will determine investment professionals’ success and failure over the course of this decade as we race up the renewable S curves. Be prepared.