CPD: The investment case for climate

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What are the investment opportunities presented in meeting the net zero carbon targets by 2050?

While the world has been preoccupied with the COVID-19 pandemic, another epidemic has emerged alongside it: the accelerating rush among nations and corporations to announce carbon reduction targets to address climate change. This article from GSFM discusses the investment opportunity presented by addressing climate change.

While the advent of the internet has been life changing for most of us, it was a slow start. When Australia joined the global internet on 23 June 1989, via a connection made by the University of Melbourne, it was mostly used by computer scientists[1]. In the 32 years since then, there’s been enormous innovation to enable faster download speeds and greater points of access. Over 89 percent[2] of the Australian population now has access to the net, with nearly 50 percent of access via smart phones. Its applications are integrated into our daily life and it’s hard to imagine work, leisure, education, shopping or communication without it.

Today, all the largest companies in the world are internet businesses. The biggest media company is Facebook (now known as Meta), the biggest advertising company is Google, and the biggest retailer is Amazon. Twenty-five years ago, these companies either didn’t exist, or were mostly unknown.

Nick Griffin, Chief Investment Officer at Munro Partners, has often described the internet as the largest S curve in his lifetime. And while it might seem like the internet was a once-in-a-lifetime paradigm shift, it seems there’s a second. According to Nick Griffin, there’s another paradigm shift staring us all in the face: decarbonisation. And just like the internet changed our lives and our businesses, so will decarbonisation.

The S-Curve revisited

The S-Curve tracks how a company or industry grows over its lifecycle. There comes a point in a lifecycle when growth inflects, driven by a structural change. It is the tailwind created by the structural change that allows a company to deliver and create wealth.

To recognise companies likely to grow and create wealth, investors need to identify both the next round of structural changes and the companies that will benefit from them. Importantly, this needs to be as close to the start of the S-Curve as possible, and not at the end.

The simplest way to understand the S-Curve is by way of example. Using smartphone adoption to illustrate, figure one shows the development of the global mobile phone market. The mobile phone market in 2008 was 1.6 billion phones; today, that market is 1.7 billion phones. However, in the move from basic mobile phones to smart phones, we’ve seen smart phones moving from a 10 percent market share to an 80 percent share. Apple’s revenue went from US$27 billion to $US250 billion, and its market capitalisation went from US$50 billion to over US$2 trillion.

When it comes to climate, it’s at the beginning of its S-Curve. Whichever climate sub-sector you consider, the S-Curve has a long runway of growth. For example, if you consider wind power in terms of onshore wind – which has been around for a long time – it has targets that indicate decades of growth ahead of it. Offshore wind power is at the beginning of that cycle. These forms of power will need a to harness battery technology to make them efficient; another, integral component of the move to decarbonisation that’s at the beginning of its runway of long, continuous and sustainable growth.

The climate investment opportunity

In 2020, global investment in the transition to low-carbon energy broke the $500 billion barrier for the first time[3]. This was spent on renewable power, electric vehicles and other technologies to cut the global energy system’s dependence on fossil fuels. The investments in the transition to a low-carbon economy showed a 9 percent increase over 2019 expenditure and came despite the Covid-19 pandemic.

Munro Partners likens the climate opportunity to the early stages of the technology boom, with many climate change companies set to get dramatically bigger.

However, funding this climate epidemic is going to be extremely costly. Given the ambitious carbon goals now being announced, Munro expects it to cost over $30 trillion US dollars between now and 2050. Figure two shows the estimated breakdown of where this huge investment will need to be made, and thus where the sectors of opportunity exist. In Europe alone, Munro expects $8.3 trillion US dollar investment potential across areas such as renewables, energy efficiencies and charging stations for electric vehicles.

Over the past 12-18 months, every European country has effectively committed to zero carbon by 2050. The recent COP26 summit in Glasgow saw more countries take this pledge, including the US and Australia. China has committed to zero carbon by 2060. It’s not just countries making these pledges – individual states and local government areas, companies and others are committing to net zero by 2050.

It’s important to note that the “zero carbon” 2050 target does not mean emitting any more carbon; it means emitting no carbon.

These ambitious political commitments are being mirrored in the corporate world, which rather than taking a ‘wait and see’ approach, is transitioning to a low carbon future independently of government mandates. Many corporations are changing their behaviour – or promising to – in the face of overwhelming demand for ESG and other socially responsible initiatives from customers, employees and shareholders.

It’s also important to note that zero carbon by 2050 is not simply driven by politics; there is, in fact, a strong economic argument for decarbonising. If we continue on the current trajectory, it is estimated that the planet is likely to warm 2.9 degrees Celsius by 2050; a net zero target is estimated to reduce this increase to 1.5 degrees. The cost of no action is estimated to impact global GDP by US$23 trillion per annum (figure three), which puts the cost of decarbonisation into stark perspective.

Closer to home, professor of environmental economics Tom Kompas from the University of Melbourne[4] estimates climate change will cost the Australian economy at least $584 billion by 2030 and $762 billion in 2050 under the current trajectory for a 2-degree rise in average global temperatures on pre-industrial levels.

Governments, corporates and people around the world have to decide; do they want to deal with the outcome of failing to address climate, which is already costing trillions of dollars in terms of natural disasters, or do they want to spend the money to reduce the temperature on the planet? The cost benefit analysis is clearly in the favour of taking action.

This is supported by the convergence of strong tailwinds (figure four). Investors are scrutinising companies in terms of corporate governance, social governance and their environmental footprint. ESG is increasingly important to investors and there are a number of rating agencies around the world that are rating this. In response to this scrutiny, companies respond to investors by committing to zero net carbon over the next 30 years. Many companies today have announced targets to be net carbon neutral by 2050.

Finally, governments are also under growing pressure from their constituents to commit to net zero by 2050; as such, the convergence of these tailwinds converged mean it’s inevitable that we’re going to attempt to decarbonise the planet.

Munro Partners has identified four structural categories from which will emerge the climate success stories that will enable the decarbonisation of our planet:

  1. Clean Energy: Companies at the forefront of renewable energy generation covering wind, solar and renewable diesel.
  2. Energy Efficiency Companies at the forefront of insulation products, electrical switches, lighting and metering technology.
  3. Clean Transport Companies benefitting from the growth of electric vehicles, battery technology and alternative transportation.
  4. Circular Economy Companies most likely to benefit from efforts to improve recycling, alternative packaging materials and management of wastewater.

Case study: clean energy

Clean energy is the starting point to decarbonising the planet – everything needs to move to electricity, and the electricity that we generate needs to be renewable. Companies at the forefront of renewable energy generation cover wind, solar and renewable diesel.

Figure five indicates global energy consumption in 2018; just 19 percent comes from electricity, with the majority generated by oil, gas and coal. To meet net zero goals, in 2050 at least 50 percent of all global power generation needs to electricity from renewable sources. This represents approximately ten times global growth over the next thirty years. At the same time, the cost of these technologies are falling, so there is an economic imperative to adopt renewable energy sources.

Figure six examines the size of the opportunity in the global wind market. In the both the onshore wind market (LHS) and offshore wind market (RHS), a significant ramp up in capacity is required by 2050 to meet net zero targets. Interestingly, there have been more offshore wind projects commenced in 2020 than are currently installed across the planet. As such, there is exponential growth that investors can exploit here looking to invest in companies that benefit from this growth.

From Munro Partners’ perspective, the obvious place to look for investment opportunity is the wind turbine manufacturers, who will clearly be beneficiaries of this trend. The total addressable market for building and servicing wind turbines is expected to grow dramatically, from US$45 billion in 2020 to US$100 billion (excluding China) in 2050[5].

Stock example: Ørsted

Listed in Denmark and already with a market capitalisation of over $100 billion, Ørsted is the world’s largest offshore wind developer. While onshore wind energy has been around for a while, offshore wind is at an earlier stage on its S-curve, as shown in figure six.

Offshore wind is coming from a lower market share base than onshore wind and solar; and hence one of the fastest growing parts of the renewables industry. Offshore wind only really exists in Europe today, with US and Asian opportunities now starting to open up. Analysis of net zero targets around the world suggests that Offshore capacity can grow from ~40GW today to ~200GW in 2030 and then substantially again beyond this to 2050.

Although not without competitors, Ørsted’s experience and strong lead in offshore wind makes them the global developer of choice – for example, it is helping Taiwan Semiconductor develop the largest offshore wind farm in Taiwan. Munro Partners sees decades of growth ahead for Ørsted and while it is expected that Ørsted will lose some share as the industry matures and oil companies enter, the increasing complexity of projects and the company’s considerable head start should see it maintain a strong industry position.

Climate is at the very start of its S-curve. Many new climate technologies are still early in the adoption phase and therefore have the potential for significant growth. Globally, fighting climate change is about far more than just clean energy and electric vehicles. The principles that underpin the transition to net zero by 2050 is something that will impact nearly every company around the globe. While climate as a stand alone investment opportunity should be viewed as a satellite investment to complement broader core global equity strategies, investing in the decarbonisation of the planet is not only likely to add value to investor portfolios, it’s likely to add to the quality of life.

 

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[1] https://theconversation.com/30-years-since-australia-first-connected-to-the-internet-weve-come-a-long-way-118998
[2] https://www.statista.com/topics/5261/internet-usage-in-australia/#dossierKeyfigures
[3] https://www.bloomberg.com/news/articles/2021-01-19/spending-on-global-energy-transition-hits-record-500-billion
[4] https://www.theage.com.au/politics/federal/a-real-hail-mary-experts-say-net-zero-2050-plan-fails-to-account-for-billions-in-climate-costs-20211116-p599dv.html
[5] BNEF, Bernstein, Munro Partners
The information included in this article is provided for informational purposes only. The information contained in this article reflects, as of the date of publication, the current opinion of Munro Partners and is subject to change without notice. Sources for the material contained in this article are deemed reliable but cannot be guaranteed. We do not represent that this information is accurate and complete, and it should not be relied upon as such. Any opinions expressed in this material reflect our judgment at this date, are subject to change and should not be relied upon as the basis of your investment decisions. All reasonable care has been taken in producing the information set out in this article however subsequent changes in circumstances may occur at any time and may impact on the accuracy of the information. Neither Munro Partners, GSFM Pty Ltd, their related bodies nor associates gives any warranty nor makes any representation nor accepts responsibility for the accuracy or completeness of the information contained in this article.

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