'We need to be patient and look through these shorter-term dynamics,' says portfolio manager
As the issue of climate change takes on increased urgency across the world, the global energy transition has emerged as a strong megatrend that’s opened a plethora of opportunities for investors. And in many ways, the tsunami towards alternative energy is a wave that’s been a long time coming.
“It's really been a theme that we've been looking at for quite a long time, and it's become much more topical in the last couple of years,” said Martin Grosskopf, VP and Portfolio Manager at AGF Investments. “But certainly, the movement towards reducing the emissions intensity of energy has been ongoing for a couple of decades.”
According to Grosskopf, investors can benefit from the energy transition by owning companies that are developing solutions to reduce emissions, such as solar, wind, and hydroelectric power. They may also allocate their capital toward industrial enterprises that help companies reduce their emissions through energy efficiency technologies, or carbon capture and storage. Beyond that are businesses that manufacture components to reduce emissions from combustion engines and other present-day technologies that spew carbon into the atmosphere.
One striking sea change has been the emergence of companies that are making transitions a strategic business imperative. In decades past, investors could draw a bright line between alternative energy firms and fossil-fuel companies. But today, many fossil-fuel firms have committed to being net-zero by 2050, and are exploring ways to reduce the emissions intensity of the actual production processes, as well as pivoting away from exposure to carbon-based energy commodities.
“We see traditional energy firms developing hydrogen technologies, as an example. And the enthusiasm around the electrification of vehicles has opened up a huge opportunity set across the value chain to get into all the technologies needed for electric cars,” Grosskopf said.
While carbon credits as an asset class have roots stretching back several decades, they’ve only recently blown up in popularity among investors. The emissions trading markets have come into their own as an opportunity to invest in the global energy transition, though whether they can drive that change is an open question.
“If the price of carbon credits goes up, it's going to incentivize industry to reduce their intensity more quickly,” Grosskopf says. “There’s also a multibillion-dollar opportunity in carbon offsets as companies are unable to reduce all of their emissions.”
Across the world, inflation is emerging as a major theme in capital markets. As central banks pull out all the stops to bring price stability back to the global economy, interest rates are rising dramatically. Increasing interest rates are eating into the net present value of companies’ long-term cash flows, which has posed a challenge for capital-intensive cleantech companies that are counting on revenue streams far into the future.
“These companies really need a lot of investment to come into their own, and we have patience for companies to make long-tailed investments that may take a few years to pay off. But as rates go up rapidly, it focuses investors more on shorter-term opportunities, and those long-duration opportunities become less attractive,” Grosskopf says. “You’re seeing so much interest in the price of oil and cash flow from existing fossil-fuel companies, because these companies actually benefit from inflation.”
Challenges are also coming from the political front. In the U.S., support for the clean energy agenda pushed by the Biden administration has weakened, raising concerns that the energy transition is a waning trend. But while there will always be short-term hiccups and periods of apparent stagnation, Grosskopf sees a longer-term dynamic toward more efficient economies, which naturally lends itself to the development of a more diverse and sustainable energy mix.
“We’re focused on those longer-tail opportunities,” he says. “We need to be patient and look through these shorter-term dynamics, because the opportunities from the energy transition are actually multi-decade long … it’s a long path, and it’s going to be rocky in places.”
