Between the first COP in Berlin in 1995 and the COP28 in Dubai in late 2023, the environmental transition has gathered pace. Although much work still needs to be done, new dynamics are at work in order to achieve the ambitious climate goals. The transition to a more sustainable economy has prompted a far-reaching transformation of industries, particularly in terms of energy, as well as a change in the investment professions. In this context, the advent of renewable energy and green technologies has been accompanied by numerous value-creating innovations. It has also given rise to the principles of financial sustainability, which a growing number of players subscribe to. Despite this, there is a struggle to contain greenhouse gas production. So how can we benefit from the opportunities offered by the supply chain around the environmental transition? From hurdle to catalyst, we look at the state of play.
The paradox of the sector
At the Climate Ambition Summit held in New York in September 2023, UN Secretary-General Antonio Guterres once again warned governments and economic players about their dependence on fossil fuels. He reasserted the need to reduce demand while accelerating the revolution of moving towards renewable energy. Even so, there is growing awareness. Climate change is central to public stimulus plans, and 80% of players in the global economy have committed to achieving carbon neutrality by 2050-2060. But why is the world so slow to act?
While political will and geopolitical unrest bear some responsibility for the slow progress in the environmental transition, the macroeconomic environment also plays a part. This is the paradox of the sector – a paradox that doesn't make it easier for investors involved in this universe, with shares experiencing valuation problems and projects struggling to take off or become profitable. This is evident in offshore wind for example, where the current cost per kWh is nearly double the cost of onshore wind. One of the causes is the inflation that emerged alongside the COVID-19 pandemic. But there are others, not forgetting the rise in interest rates, which is still a disruptive factor.
Convictions about tech maturity
Despite this, Banque Edmond de Rothschild remains convinced that achieving carbon neutrality will require three times the current pace of investments in the green transition. This vast sum will make this theme the driving force for investment and therefore growth in the coming decades. In this context, innovation and the long term will certainly play their part. However, we must ensure we have a good mix in the portfolio between well-established players, the leaders of tomorrow and facilitators, i.e. all those that directly or indirectly support the theme and integrate climate risks and opportunities.
To identify the right companies, technologies and innovations, it is vital to also consider the maturity of a business project, whether it concerns renewable energy, the circular economy, energy efficiency, electric vehicles or any other subject related to the environmental transition, as the maturity will to a large extent determine an investment's relevance.
Innovation supporting growth
Offshore wind for example, which is currently very costly, could ultimately become more profitable through the development of floating offshore wind turbines, which require less infrastructure and perform better on energy efficiency (50% vs. 35% currently). Meanwhile, the history of solar power is a perfect example of how technological advances can support an accelerated transition. In the space of 20 years, the cost of a solar panel has fallen 300-fold thanks to several innovations. Since 2022, solar power has even become cheaper than gas in terms of electricity production (€20-30 vs. €50-60 per MWh). In this context, China is playing a driving role. Shifting from a subsidy-dependent model to a more sustainable, market-oriented model, China's solar power industry has a strong future, and the innovations under way should still offer new growth opportunities.
While inflation is affecting the development of some projects, causing a slowdown in growth for many players, other events can also serve as catalysts. The war in Ukraine that halted Europe's supply of cheap gas is one. This tragedy, which has revived the debate on energy sovereignty, has also forced us to think about alternative measures. In France, for example, we know that 10% of needs covered by gas could be replaced by the recovery – at lower cost – of discharge methane or putrefaction gas. Here, innovation could come to the rescue again. The emergence of biofuels also illustrates this – such as second-generation biofuel or renewable diesel (made from used oils and animal carcasses) – because it allows new circular processes to be introduced in waste. Naturally, it could be argued that this technology costs twice as much as hydrocarbons. Even so, it is still promising. In any case, it emphasises the importance of governments, alongside private investors, in financing the environmental transition. One example is the European Union, which through its RePowerEU plan supports the diversification of energy sources, the increase in renewable energy and greater energy efficiency. Also worth mentioning is the Inflation Reduction Act (IRA) in the US, which uses subsidies to combat climate change, among other things. These efforts are encouraging, as the more support there is, the more innovation, and ultimately growth, there will be – hence the importance of continuing to invest sustainably and responsibly to support the 2°C trajectory that the vast majority are calling for.
But take heed! Not everything green is necessarily profitable or beneficial. Some technologies are too early, not very mature or not relevant enough. However, this shouldn't limit our vision or investments. Although the environmental transition is of course a challenge, it also drives innovation and value creation. This is why it is now so important to direct financial flows towards sustainable solutions by integrating strict ESG criteria. Only in doing so will we address the societal, environmental and technological changes we are facing.
Alexis Bossard and Bing Yuan, International Equity Portfolio Managers.
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