Finding Investment Opportunities in the Energy Transition

Art by Valeria Petrone

As nations around the world push toward net zero greenhouse gas emissions targets, significant investment in energy and infrastructure will be required to meet their goals.

According to the International Energy Agency’s most recent Net Zero Roadmap, released in 2023, the world would need to invest nearly $4.5 trillion per year until 2030 to cap global temperature increases at 1.5 degrees Celsius. For perspective, according to the report, renewable energy spending in 2023 is expected to reach $1.8 trillion.

According to the road map, the economies of the countries that have made net zero pledges represent 85% of global energy–related energy emissions and 90% of global gross domestic product.

Institutional investors are increasingly allocating within their portfolios to green energy and environmental, social and governance-focused investments, such as the United Arab Emirates $30 billion which plans to deploy $250 billion in global climate solutions by the end of the decade.

According to research from XPS Pensions Group, 60% of pension funds in the U.K. have a net zero target for some time in the next few decades.

The California State Teachers’ Retirement System, which has embraced energy transition investments, has a goal to reduce emissions in the fund’s portfolio by 50% by 2030 and 100% by 2050. The fund has also invested more than $20 billion in low carbon solutions and approached the issue through aggressive proxy voting campaigns.

Institutional investment is crucial to achieving net zero goals, said UN Secretary-General António Guterres in a 2021 meeting with the CEOs of some of the world’s largest asset owners. “The private sector has a crucial role to play in building a more equitable and sustainable world,” Guterres said. “Our simple objective for 2021 is to make sure that we are able to build a truly global coalition for carbon neutrality by 2050.”

Some regulatory hurdles exist, especially in the U.S., where numerous states, including Kansas, Kentucky and South Carolina, have blocked public pension funds from making any ESG investments. The outcome of this year’s presidential election could shift policy even further, noted Benjamin Walter, director and portfolio manager at Allianz, in the firm’s energy transition commentary.

“The uncertainty associated with changes in administration can lead to the reversal of supportive policies, adding another layer of risk,” Walter wrote. “As such, a thorough understanding of the exposure at various stages of a project’s lifecycle, but also of the broader regulatory framework and policy aims is crucial for managing these risks.”

Nuclear, Both Fission and Fusion

‘Nuclear’ was a dirty word for much of the 20th century, but attitudes toward it as an energy source have shifted in recent years, as many have realized the necessity and opportunity for nuclear fission to help meet energy demands in a net zero world.

“As the world gears up to tackle global warming, renewable energy sources such as solar, wind and hydro power are at the forefront of solutions offered to avert a climate catastrophe,” wrote Steven Quattry, executive director of the emerging markets equity team at Morgan Stanley, in a September 2023 report. “Yet half a century after the environmental case for nuclear power first became clear, it is making a comeback, as a way to fight climate change.”

Some see nuclear energy—currently only produced by nuclear fission reactions—as necessary in order to reach net zero goals. This camp includes Brookfield Asset Management, which published a white paper about the need to expand nuclear adoption worldwide for the world to be net zero by 2050.

Nuclear fusion energy has also become a focus of institutional investors and allocators. While the technology has seemingly been 20 years away for more than the last 50 years, some are hopeful. Few are as hopeful as Microsoft, which recently signed a contract with fusion energy startup Helion Energy Inc. for it to supply fusion power to the tech giant, starting in 2028. Helion faces financial penalties if the company does not meet this deadline.

Companies like Helion and peer Commonwealth Fusion Systems have raised billions from venture capital firms such as Mithril Capital, Capricorn Investment Group, TIME Ventures, and Tiger Global Management and big tech names, including Bill Gates and Sam Altman.

They are hardly alone; according to data from McKinsey & Co., only one private company was studying fusion energy between 2001 and 2005, but that number increased to 25 by 2021. Private fusion investment increased to $4.44 billion in 2021 from $0.06 billion between 2001 and 2005.

Minerals

Minerals and raw materials are the most important piece of the energy transition, with minerals such as copper, lithium and many rare earth elements needed in large quantities to meet transition targets and net zero goals.

According to the Energy Transitions Commission—a coalition of leaders from industrial companies, environmental groups, investors and experts working to identify achievable ways to limit global warming —in its July 2023 energy transition report, 6.5 billion tons of critical end-use materials will be needed between 2022 and 2050 to meet transition and net zero goals.

“There are enough resources and minerals in the world for the energy transition. But in some key minerals—particularly lithium and copper—it will be challenging to scale up supply fast enough over the next decade to keep pace with rapidly rising demand,” said ETC Chair in the report. “Governments, regulators, producers and consumers must work together to increase recycling, improve material efficiency, invest in new mining, and regulate environmental and social standards.”

Geopolitical factors are at play too. Many of the critical minerals and rare earth elements are located in China. According to an August 2022 report by the Brookings Institution, China was responsible for refining 68% of global nickel output, 40% of copper, 59% of lithium and 73% of cobalt. According to Brookings, demand for these minerals will quadruple by 2040.

Emerging Markets

Emerging and developing markets account for two-thirds of the global population and just one-fifth of the world’s investment in clean energy, according to the IEA, thus representing a critical market for the energy transition. With so much investment going to developed countries, there is also the potential for emerging markets to miss out on the energy transition, according to the IEA.

“Current policy settings already put advanced economies and China on track to achieve 85% of their contribution to this global goal, but stronger policies and international support are required in other emerging market and developing economies,” the IEA noted in its Net Zero Roadmap.

“Most green-transition investments are required in developing and emerging market countries, where emissions have risen the fastest in recent decades and will continue to do so,” wrote Christian Keller, head of economics research, and Maggie O’Neal, global head of ESG research, at Barclays .

According to the The IMF noted that these countries will need, and benefit the most from, private investment, because the growth in public investment will be slow. According to the IMF, 90% of capital needed for the energy transition in emerging markets must come from private investors.

“There’s potentially going to be a lot of volatility in commodity markets and other asset classes like the emerging markets around some of these structural changes if they do happen in a big way.” says Paul Eitelman, the chief investment strategist for North America at Russell Investments. “I think having an active approach in those spaces—investors that have an insight at the ground level around risks to physical assets, where they’re seeing sort of the cutting edge and demand and supply dislocations and commodities, for example—is likely going to be advantageous for investors’ success going forward.”

Fossil Fuel Benefits ‘Hard to Replicate’

Despite many funds announcing plans to go carbon neutral in their portfolio as early as the 2040s or 2050s, some see this as a lofty, unrealistic and difficult goal.

In a December 2023 “The energy transition and what it means for institutional investors,” panelists from Russell Investments discussed the challenges faced by institutional investors when approaching the energy transition.

“Over the years, we’ve refined this technology and infrastructure around fossil fields to a point where they are not just abundant, but also economically viable,” said Pierre Dongo-Soria, a senior strategist at Russell Investments. “It’s difficult to transition away from fossil fuels because their energy, density, versatility and affordability are hard to replicate.”

In a poll conducted during the webinar, respondents listed the inefficiency of renewables, high costs, poor policy, public resistance, supply risks and outdated infrastructure as some of the most significant challenges facing the energy transition.