Vladimir Putin’s war in Ukraine has sent energy prices sky-high and accelerated the renewables transition to ‘lightning speed’.
Vladimir Putin’s war in Ukraine is as much about the geopolitics of fossil fuels as it is about attempting to restore the imagined glories of Russia’s imperial past. In assuming that Russia’s position as producer of c.10% of global oil and supplier of 45% of Europe’s gas would result in the West standing by while his army occupied Ukraine, Putin has scored a remarkable own goal that will have long-lasting consequences.
Just as the arrival of COVID-19 proved to be a leapfrog moment in the uptake of new technology, the war in Ukraine is accelerating the shift to renewable energy as Europe and the UK reassess their reliance on fossil fuels and the regimes that deliver them. The EU is already in leapfrog mode with the announcement in early March of its REPowerEU plan to rapidly scale up renewables infrastructure and quadruple current 2030 targets for green hydrogen (hydrogen created using renewable energy).1 The EU’s objective is no less than to slash its use of Russian gas by two-thirds by end of 2022 and become independent of Russian fossil fuels “well before 2030”.2
Back to the future?
At inflection points such as the invasion of Ukraine, it is useful to step back and consider how the overall shape of world markets could change. During the past decade we have grown used to equity markets that are dominated by information technology and e-commerce. These have vastly outperformed the wider market over the past ten years as internet platforms gained extraordinary economic power from first mover advantages, scale and near-zero marginal costs.
It is worth remembering, however, that the previous decade was very different. Following China’s accession to the World Trade Organisation in 2001, materials and energy outperformed on the back of China’s remarkable growth, while technology languished near the bottom of performance tables.
Today, we are in a situation where investors can no longer take consumer technology’s market leadership for granted as regulators begin to introduce controls. It seems increasingly likely that we are entering another decade where energy will dominate markets, headlines and portfolio returns. However, in contrast to the decade of rising energy prices caused by rising demand from China, this energy decade is about falling demand for fossil fuels.
Ukraine is forcing us to address climate change
The need to stop relying on hostile regimes for our energy is urgent, but climate change is a far more significant imperative and fundamental driver of the transition to renewables, which are essential if we are to keep the rise in average global temperatures to below 1.5°C. Published on 27 February, the apocalyptic warnings contained in the IPCC’s Climate Change 2022 report have been overshadowed by events in Ukraine. The IPCC highlights that this is a massive current problem, not something in the far future: 3.5bn people are vulnerable to climate impacts and half the world’s population already experiences severe water shortages. Even if average global temperatures are kept below 1.6°C by 2100, around 8% of today’s farmland will become climatically unviable just as the global population exceeds 9bn people.3
The resources required to tackle climate change will be enormous. According to management consultants McKinsey, capital spending on energy and land use must rise by $3.5tn per year for the next 30 years if we are to have a chance of avoiding the most catastrophic effects of climate change.4 The investment that we are currently seeing applied in renewables is only in the
low hundreds of billions, simply the tip of a very large capex iceberg.
Advances in technology are also acting to accelerate the transition: the respective costs of wind and solar energy have been falling at around 4% and 8% per annum over the past five years. The levelized cost of electricity generated from wind and solar were already significantly cheaper than coal and were becoming competitive with natural gas before Putin’s invasion and the hike in fossil fuel prices. Now renewables are more competitive against all fossil fuels, making the EU’s radical action to cut its dependency on Russian gas logical in terms of both geopolitics and cost.
In the first instance, the EU will increase its gas storage and replace some Russian gas with liquefied natural gas (LNG). Its longer-term objective is to ensure energy security by increasing energy production within the EU via fast-tracked solar and wind projects, extending the lives of existing nuclear power stations and ramping up development of biomethane and green hydrogen. For us, as thematic investors who focus on identifying companies that will thrive as society mitigates and adapts to climate change, this is an exciting moment in which a number of our key investment ideas are gaining traction.
Being part of the solution
The most obvious beneficiaries of fast-tracked renewables in our clients’ portfolios are companies in our Low-Carbon Power sub-theme. These include Paris-aligned Orsted (offshore wind) and Next Era (onshore solar and wind), whose businesses centre on the construction and operation of wind and solar farms. Another of our buy-listed beneficiaries in this area, and one which is making its own transition to renewables, is the European utility giant Enel.
Perhaps the most intriguing development is the EU’s proposed hydrogen accelerator programme, which hopes to produce over 20mn tonnes of renewable hydrogen per annum by 2030 (hydrogen is very light, so this is a lot). This plays to the strengths of one of our favourite 'quiet disruptors': Air Liquide, the world’s second-largest supplier of industrial gases. Despite being instrumental in expanding the world’s ability to generate clean hydrogen (using power generated by the likes of Orsted), Air Liquide does not yet command a rich valuation and offers both growth and defensive qualities.
A second tier of buylist companies that are instrumental to the renewables transition, but are not directly involved in generating renewable power, includes Siemens and Schneider. Both companies have expertise in equipment and processes that improve energy efficiency – in other words creating ‘negawatts’, the fifth fuel.
Many new renewable energy projects are being funded privately rather than by public listed companies and Sarasin accesses some of these via third-party listed vehicles such as VH Global Sustainable Opportunities plc, Octopus Renewables Infrastructure and The Renewables Infrastructure Group, which are held in the alternatives portion of our clients’ portfolios. These include wind and solar farms, alongside more niche areas such as solar arrays and power storage for, amongst others, supermarkets, warehouses and health facilities.
Doing the right thing is not straightforward
The epiphany provided by Putin’s invasion of Ukraine has catalysed a fundamental shift to renewable energy in Western Europe, and accelerated the economics and politics of energy transition elsewhere. However, not every country is aligned with the West’s position on Russia and sanctions: 40 countries, representing more than half the world’s population, did not vote in favour of UN Resolution ES-11/1 deploring Russia’s invasion of Ukraine. This reflects China’s widening rift with the US but it is also notable that the OPEC+ cartel has united with Russia – it controls over 50% of global oil supplies and about 90% of proven oil reserves and its goal is to exert control over the price of oil. It will take considerable time for the world to wean itself off oil and gas and in the meantime OPEC+ will likely try to keep prices high.
Once demand begins to fall significantly, probably towards the end of the decade, fossil fuel producing economies face a bleak future. This may have been in President Putin’s calculations. The list of OPEC+ countries is notable for the lack of free democracies – they are nearly all governed by authoritarian regimes. As well as the environmental benefits of accelerated transition to renewable energy, we should also beware the social risks associated with the economic consequences. Europe’s “dash into renewables at lightning speed” may well tackle its vulnerabilities and create clean, cheap, endless energy, but other vulnerabilities are emerging and the new energy decade is likely to offer both opportunities
3 Intergovernmental Panel on Climate Change (IPCC), Climate Change 2022: Impacts, Adaptation and Vulnerability, February 2022
4 McKinsey & Company, The net-zero transition. What it could cost, what it could bring. McKinsey Global Institute in collaboration with McKinsey Sustainability and McKinsey’s Global Energy & Materials and Advanced Industries Practices, January 2022.