Investing in energy business

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INVESTING IN ENERGY BUSINESS

BACKGROUND TO ENERGY INVESTING

Access to modern energy is intrinsically linked with improvements in quality of life. Over the next few decades, increasing populations and rising prosperity will increase demand for homes, businesses and transportation - and the energy that powers them.

The trend to further electrify buildings, factories, cars and buses, along with smart appliances and greater automation, spurs the need for more electricity everywhere. Solar, wind and natural gas contribute the most to meeting growth in electricity demand. New homes and roads will be constructed and household appliances produced as a result of rising population and urbanization. Steel, cement and chemicals are essential materials to satisfy these needs which, today, are energy-intensive products.

Valued at around $7 trillion globally, energy is the most valuable market segment on earth. Delivery of usable forms of energy to the world’s more than seven billion people is responsible for 10% of the world’s annual gross domestic product.

According to the International Energy Agency, global energy demand will grow by more than 30% by 2035. China, India, and the Middle East will account for two-thirds of that growth. By then, global oil demand will be around 100 million barrels per day (mb/d) — up from 89 mb/d in 2012 — as the number of cars on the road will double to 1.7 billion. Demand for electricity is forecast to grow twice as fast as total energy consumption, leading prices to rise 15% by 2035.

To meet rising energy demands, the world must invest $37 trillion in related production and supply infrastructure across all sectors of the energy industry over the next two decades. Over half of that total — $19 trillion — will be required by the oil and gas sector for exploration, transportation, and production increases. The remainder will go toward the electricity sector, with $17 trillion slated to be invested in upgraded natural gas and renewable generation, and an upgraded transmission and distribution network that maximizes efficiency.

The fact is the energy market is so big that it encompasses a diverse array of market sectors. Oil, gas, coal, and nuclear energy only scratch the surface of the industry’s offerings.

Biofuels require input crops, so energy investing is also agriculture investing. Most electricity plants, no matter the energy source, need water to be cooled, so energy investing is also water investing. And in the case of solar and other clean technologies, investments and revenue more resemble the semiconductor market, so energy investing is also technology investing.

The energy sector is a large and all-encompassing term that describes a complex and inter-related network of companies, directly and indirectly, involved in the production and distribution of energy needed to power the economy and facilitate the means of production and transportation.

The companies within the energy sector are involved in various types of energy. For the most part, energy companies are often categorized based on how the energy that they produce is sourced and will typically fall into one-of-two categories:

Non-renewable

Petroleum products and oil
Natural gas
Gasoline
Diesel fuel
Heating oil
Nuclear

Renewable

Hydropower
Biofuels such as ethanol
Wind power
Solar power

The energy industry also includes secondary sources such as electricity. Energy prices—along with the earnings performance of energy-producers—are largely driven by the supply and demand for worldwide energy.

It is almost beyond reasonable arguments that Renewables bring far reaching benefits in terms of human health, energy access, environmental protection and the response to climate change, along with the potential to create new jobs around the world. It is thus imperative that renewables would not only expand into new frontiers but would gradually start replacing non-renewables over a period of time. However, scaling up renewable energy calls for mobilizing a massive investment increase. Amid rapidly falling technology costs, meanwhile, renewable energy technologies have become increasingly cost-competitive with fossil fuels, even amid low global oil prices.

Yet global investment in renewables has remained far below its potential. The investment shortfall reflects enduring market barriers and perceptions of high risk that deters private investors and financiers.

Five main action areas whereby policy makers and development financial institutions can address risks and barriers for renewable energy projects are:

o Advance renewable energy projects from initiation to full investment maturity.

o Engage local financial institutions in renewable energy finance.

o Mitigate risks to attract private investors.

o Mobilize more capital market investment.

o Create facilities dedicated to scaling up renewable energy investment.

Continued innovation will help OECD economies expand while reducing their energy demand by about 5 percent and energy-related CO2 emissions by nearly 25 percent. In the non-OECD countries however, energy use and emissions will rise along with population growth, increased access to modern energy and improving living standards.

Increased on-road efficiency and more electric vehicles will lead to a decline in light-duty vehicle liquid fuel demand. Overall transportation fuel demand growth is driven by increased commercial activity - moving more people and products by bus, rail, plane, truck and marine vessel. Energy-dense, affordable and widely available oil will remain the predominant transportation fuel.

The three drivers of energy demand are 1) Policy 2) Technology and 3) Consumer preferences. All three impact how the world uses energy. Each driver influences the other. The interplay between these can vary depending on local circumstances (available resources, public support) and can change over time.

Shifts in policy can stimulate new technology and influence consumer choices. For example, policies can encourage adoption of new technology (free parking for electric vehicles) or discourage the use of an existing technology (restrictions on coalbased power). The corollary is also true: policy not enabled by competitive technology or not aligned with consumer preferences can be difficult to implement because it is hard to mandate something that isn’t better than current options in the eyes of the consumer.

Deploying new technology allows society to do more with less. Most successful technologies often have the supporting policy and commercial frameworks to achieve scale. A policy, like tax incentives, can spur development of new technology, but these technologies ultimately need to compete without subsidies to reach a large enough scale to impact global markets. Consumer preferences can also create a "pull effect" that increases demand in the marketplace for new technologies.

Demand for energy begins with the numerous choices consumers make in their daily lives. These preferences can shift as new technology enables options that better meet a consumer's needs, such as lower energy costs and lower emissions. Consumer preferences can also be altered over time by policies that incentivize choices, like a carbon tax that encourages more lower carbon electricity supply.

WHAT REALLY MATTERS

Investors underscore that even though climate change is not a direct driver of their investment decisions, addressing ESG concerns is critical to address public pressure and reduce risk.

In the words of a major North American private equity firm: “Companies need to focus on articulating their story [on climate] to demonstrate what they are doing. Being good stewards from an ESG standpoint is risk-reducing. It is not just about being a good citizen but also about making your business better.”

As energy is essential for human development, society faces a dual challenge: to provide reliable and affordable energy to a growing population, while reducing environmental impacts, including the risks of climate change.

A significant portion of the world’s population remains energy-deprived, facing living conditions that would be considered dire by most people in developed countries. Access to modern energy improves a community’s quality of life; it is closely correlated to increased life expectancy, reduced poverty and malnutrition, and higher levels of childhood education.

As growing populations gain increased access to energy, rising living standards in many parts of the world will create the largest expansion of the global middle class in history, meaning more demand for homes, transportation, electricity, consumer goods, and the energy to power them all. The challenge is to satisfy this growing demand, while reducing the risks of climate change.

When considering companies that diversify into clean tech and zero- or low-carbon initiatives, most investors base their view on the merits. They foremost look at the return profile of the investment compared to other uses of capital. Second, they weigh the strategic rationale and core competencies of the business to determine whether it will create meaningful value.

The renewable energy industry seemed poised to enter a new phase of growth driven largely by increasing customer demand, cost competitiveness, innovation, and collaboration at the beginning of 2020 when the COVID-19 pandemic caused major disruption across the sector. Yet undefined short-term challenges lie ahead for the industry in the aftermath of COVID-19. And long term trajectory projection seems rather illusive with shelter-in-place orders, labor constraints, and supply chain disruptions. Although the industry is still grappling with the full impact of the crisis, the outlook is changing rapidly. The latter half of 2020 could be crucial for the short-term renewable energy pipeline, depending on how the pandemic situation unfolds.

Declining costs and rising capacity factors of renewable energy sources, along with increased competitiveness of battery storage are expected to drive growth in this sector. Significant demand from most market segments has helped overall consumer sentiment remain positive. Although Industrial consumption has witnessed decline, renewable energy consumption by residential and commercial customers has increased. The prospects for short-term solar and wind energy growth appear favorable, with about 96.6 percent of net new generation capacity additions (~74 GW) expected to come from these two resources in 2020.

The year ahead promises further growth in the renewable energy sector. This will likely come against a backdrop of increased innovation and collaboration among multiple stakeholders. Renewables are likely to continue moving into the driver’s seat in electricity markets as utilities and regulators prefer them to replace retiring capacity and customers increasingly choose them to save costs and address climate change concerns.

Increased energy efficiency and a shift to lower carbon energy sources will help curb CO2 emissions, but not sufficiently to reach a 2°C pathway. Innovative technology solutions and supportive policies are still needed to achieve society’s emissions aspirations.

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