Quarterly Investment Forum 1Q 2023

Green spending & reshoring: Investment opportunities

Ellis Eckland, Active Equities
Alex Leung, Infrastructure
Andrew Farnell, Active Equities

Energy transition

The energy transition may be the biggest investment opportunity in history. History shows that energy usage grew rapidly during the 21^st century. But during this period, no energy source was ever replaced – new sources were layered on top of older ones, and grew until they surpassed them. It took 150 years for coal to supplant wood as the most common energy source, and just 50 years for oil to become more dominant than coal.

The energy system of the future calls for use to largely replace oil, gas, and coal in just 30 years, much faster than other transitions. We are in a thirty-year period of massive investment concentrated around the following themes:

• Renewable electricity: to build this out, we need to address supply chain constraints. The world needs much more copper, silver, rare earths, lithium, iron, and steel – this is the biggest bottleneck, since building new mines takes a long time.
• Advanced biofuels: these may be the future of air transportation.
• Hydrogen: industrial processes that require high heat, for instance in making steel or cement, are critical to building out renewable energy sources.
• Carbon capture: we are heading to “net” zero, but will still be using fossil fuels. By 2050 we need to capture roughly 25% of what we emit today. There’s been a little investment in this space now; we will need a lot.
• Grid stability: a grid system with massive renewables – which are intermittent/unstable sources of energy – will need to be stabilized by the likes of batteries as well as artificial intelligence applications to predict load.

Inflation Reduction Act and implications

The US’ Inflation Reduction Act will help augment this energy transition. This legislation has three key features: First, it covers a 10-year period, which will make it easier to invest compared to the past when tax credits were extended year-by-year in a piecemeal fashion, or not at all. Second, the scale and breadth of tax credits and subsidies, along with a superior financing model, should lead to substantially more clean energy infrastructure investment. Third, it has a heavy element of industrial policy: there is a focus on shoring up the domestic US clean energy supply chain, manufacturing, and onshoring.

For infrastructure investors, a lot of the near-term opportunities will be in traditional renewables like wind and solar. Other technologies may take more years to establish themselves before they receive as much investment – it won’t come overnight, but will come eventually. And as the old adage goes, it can be better to sell a shovel during a gold rush, so we’re also looking at potential adjacent opportunities created by this clean energy boom.

Opportunities in Electrification

Electrification is one of the primary vectors that facilitates decarbonization – electricity needs to go up a lot as a share of the total energy mix.

It’s also important to bear in mind that if electricity is wasted in buildings that have not been modernized, the impact will be much less. The European Commission estimates that the EU renovation rate needs to double, at least, in order to make the building stock more energy efficient. So far, investment in energy efficient buildings is rising globally, but not close to levels that would be consistent with a net zero scenario.

In the EU, harmonized standards are removing barriers to investment. The private sector is recognizing the value of modernized office buildings, as well: there is a rising premium for sites that have had an energy-related renovation.

The alignment of public and private interests makes this a powerful investable theme. In public markets, there are a lot of ways to gain exposure to this dynamic in capital equipment, semiconductors, automation, construction materials, and equipment rental companies.