How to Navigate Energy Transition Risks

The amount of investment needed for this enormous task is $4 trillion yearly, but the effort is gearing up now.

Reported by Larry Light

Art by Valeria Petrone


How can the considerable risks of energy transition away from carbon-based fuels—the primary danger being falling short of what is necessary to combat climate change—be overcome? The answers include finding the capital to pay for transition’s vast needs, building out the infrastructure to support the effort and enhancing data gathering needed to coordinate it all.


But what if those efforts are not enough? The consequences to humanity would not be pretty. Conversely, if things do work out, there is also risk in failing to get on board this endeavor now and missing out on potential investment gains.

Riding the transformation trend is an achievable imperative for asset allocators, says Jonathan Krane, CEO of KraneShares, which sponsors climate exchange-traded funds and advises institutions: “Regardless of views on climate change, institutional investors are recognizing that the global energy transition is underway, and there are risks around not being proactive with their portfolio allocations.”

Billions in federal tax breaks from President Joe Biden’s climate bill, enacted in 2022, are starting to be distributed in the U.S. Institutions are at the forefront of what they believe is required for a healthy planet, and perhaps good portfolio gains.

For institutions, energy transition promises good potential returns. To Christopher Ailman, CIO of the California State Teachers’ Retirement System (assets: $327 billion), investing in solar, wind and other non-carbon alternatives will end up making money for the pension plan. “We believe the energy transition will create significant investment opportunities across asset classes,” he says. CalSTRS is making major commitments to renewables.

The scratch needed from public and private sources to achieve the transition worldwide is daunting: $4 trillion yearly by 2030, more than double the current outlay, per the International Energy Agency. What if raising such a sum falls short? Then so will energy transition, with unknown, and perhaps scary, environmental consequences.

A headwind in recent years has been higher interest rates, which hinder the borrowing that large, capital-intensive projects, such as new electricity transmission lines, require. The good news is that central banks, in particular the Federal Reserve, intend to reduce rates this year.

Investing in the Transition

The money targeted for the transition is growing. The worry is that, as with any investment, a lot of this spending may prove to be wasted, with the technology it backed ending up a dud.

Still, global spending on clean energy transition jumped 17% last year, to $1.8 trillion, by the reckoning of Bloomberg NEF. China, which has a heavy emphasis on making electric vehicles and adding solar and wind capacity, is the largest transition spender, with 38% of the total. Of course, China also continues to build more coal-fired plants—and has five times more coal power than does the U.S., which is closing its coal-generating facilities.

Aside from government spending, significant private capital is pouring into the transition. Private equity and credit are big forces. Blackstone Inc., the world’s largest private equity company, announced in 2022 that it would invest $100 billion into energy transition and other climate-fixing efforts over the following 10 years.

Often, allocators will sub-contract energy transition investing to PE and other limited partnerships. Example: New York State Common, which last year committed $1 billion to funds with equity positions tracking the MSCI World ex USA Climate Change Index. These portfolios overweight companies expected to benefit from the transition. The index’s largest holdings are Danish health care corporation Novo Nordisk A/S, Swiss food company Nestlé SA and French luxury goods purveyor LVMH Moët Hennessy Louis Vuitton.

Canadian pension funds are more likely to make direct investments in renewable energy businesses. Caisse de dépôt et placement du Québec ($316 billion), for example, last year invested $339 million into Japanese renewable developer Shizen Energy Inc.  

The Canadian pension giant has been at this for a while. Over the past 10 years, CDPQ has increased its position in Chicago-headquartered Invenergy Renewables LLC and now controls the company, one of the largest operators of wind and solar projects in North America. In 2017, CDPQ made a $113 million loan to Innergex Renewable Energy Inc., the Quebec owner of hydro, solar and wind facilities.

For value investors, now may be a great time to invest in renewables, which are cheap and presumably have a big future. The thriftier electricity prices of solar and wind power, once they have broader distribution, should give them an edge over oil and gas, the reasoning goes.

“They offer some of the cheapest power on the grid,” says Frances Aderhold, sustainable research analyst at asset manager Fiduciary Trust Co. International. Carbon-based electricity costs between 5 and 17 cents per kilowatt hour, while solar is between 3 and 6 cents and wind less than 5 cents.

Consider NextEra Energy Inc., one of the world’s biggest producers of solar and wind power. Over the past two years, as interest rates climbed, its share price slumped by one-third. Nevertheless, NextEra’s price/earnings ratio is a below-market 16. The same is true of its peers. “These are healthy multiples,” says Jackson Garton, co-CIO of Makena Capital Management LLC. “These stocks are very attractive.”

Infrastructure

Power generation and carbon reduction are growing areas: By 2030, the world will need to quadruple its spending to upgrade aging electricity infrastructure and construct new capacity, a McKinsey & Co. study found. Will the funds be found to accomplish this gigantic undertaking?

There are currently 36 power line projects about to start construction around the U.S., according to a report published by the Grid Strategies consulting firm for trade group Americans for a Clean Energy Grid. In addition, the Biden administration, tapping funds from 2022’s infrastructure law, is committing $1.3 billion to help utilities build three new power lines across six states in the West and the Northeast.

New projects come from a variety of places. When the Hawaiian Electric Co. shuttered its last coal plant in 2022, the utility had to replace 180 megawatts of power—and turned to 150 giant batteries from Tesla Inc., better known for its electric vehicles, but also a presence in the rising field of batteries. The batteries supplement the company’s burgeoning solar capacity. They have the ability to absorb excess power from the grid, perhaps from a surge of solar energy, and release it in down times, such as when a generating plant goes offline.

To be sure, supply of the minerals used in batteries is problematic. China, a U.S. antagonist, has half of the world’s lithium, a vital part of batteries.

Lowering greenhouse gas emissions is another capital-hungry area of innovation. In late 2023, asset management titan BlackRock Inc. announced it was investing $550 million in a joint venture with an Occidental Petroleum Corp. subsidiary. They intend to construct what they billed as the world’s largest facility for direct air capture at a plant in Texas’s oil-rich Permian Basin. Air capture means sucking carbon out of the atmosphere and storing it underground.

Data

Marshaling the information to move an energy company into the future is a big challenge. Consider BKV Corp., a natural gas producer that seeks to achieve what is known as “net zero” by the early 2030s. This means reducing carbon emissions to offset what the company releases.

With the aid of consultancy KPMG LLP, the company established a cloud-based framework to integrate the output data from BKV’s more than 5,000 far-flung gas wells, from Texas to Pennsylvania. The next steps are to start a carbon capture system—trapping and storing carbon dioxide at the point of emission, so it will not seep into the air—over this vast network, including extraction and shipping of the gas.

The process rests on BKV setting up a cloud-based data pool into which information from different systems could be deposited, allowing the company to perform analysis on data from those wells without increasing its headcount.

Last October, for an undisclosed sum, Blackstone and another PE firm, Vista Equity Partners, acquired Energy Exemplar, a leading provider of energy market simulation software. The Australian company helps utilities and other transition players figure out how much power to generate and how to do that more efficiently.

Certainly, energy transition could run into roadblocks. But even red states, which defend fossil fuels, are hardly hindering the expansion of solar and wind power. Oil-rich Texas is a leading location for these alternative energy sources.

No one can tell what clean energy initiatives will succeed and which will fail in the years ahead. Just the same, the transition in general appears to be gathering serious momentum.

Related Stories:

Finding Investment Opportunities in the Energy Transition 

For Energy Transition Investing, Allocators Eye Private Assets

Norway Pension Giant Buys 49% Stake in Spanish Renewables Portfolio

Is Big Oil’s Renewable Energy Push Credible—and Good for Investors?

 

Tags
Blackstone, CalSTRS, CDPQ, China, Christopher Ailman, coal, energy transition, ESG Investing, Gas, grid, New York State Common Retirement Fund, NextEnergy, oil, Private Equity, Renewables,