As the energy security imperative rejuvenates the green energy shift, we explore the challenges ahead and illuminate the opportunities that may emerge.
September 21, 2023
Managing Director, Head of Investment StrategyRBC Europe Limited
RBC Wealth Management’s “Worlds apart: Risks and opportunities as deglobalisation looms” series explores the trend away from globalisation and its ramifications for investors, economies, and financial markets. This article in the series focuses on green energy transition.
Is the global energy transition powering down? Dwelling on just the headlines, it’s easy to jump to the conclusion that looming deglobalisation is imperiling the clean energy drive. After all, since Russia invaded Ukraine – a symptom of deglobalisation – fossil fuel production has spiked.
Yet we believe this masks a more significant underlying trend. Although fossil fuel use has been reinvigorated, most nations are also turbocharging the rollout of clean energy as governments are merging environmental agendas with energy security policies.
We delve into the extent of the renewed enthusiasm for green technologies and assess the challenges that threaten their deployment and the achievement of net-zero emissions by 2050. We suggest how investors should position portfolios to tap into industries that we see as likely to benefit from the emphasis on clean energy.
Russia’s invasion of Ukraine marked the onset of an era of renewed popularity for fossil fuels, with oil and coal in particular enjoying a new lease on life. With Russian energy supplies at risk, and European and Asian governments scrambling to ensure energy supplies through the 2022–23 winter heating season, oil drilling increased in the U.S., the UK, the Persian Gulf, and, in particular, Latin America. Global production rose by some 1.7 million barrels per day, according to the International Energy Agency (IEA). This intergovernmental organisation expects global production to expand by close to six million barrels per day over the next five years.
Bar chart showing the increase in global oil supplies on a million-barrels-per-day basis for the period of 2022 through 2028 and breaks down the various regional sources for the increase in supply. Globally, 2023 marks the peak of the increase in production—at two million barrels per day. From 2024 and forward the increase in daily production diminishes annually to 0.6 million barrels per day in 2028. The United States was the source of the largest daily increases in 2022 and 2023. For 2024, the chart shows that non-OPEC countries, in particular Latin America, will be the key contributors. OPEC+ is expected to contribute less than a quarter of the overall increase in supply until 2028, when it is anticipated to contribute more than half of the additional supply.
Note: Assumes Iran and Russia remain under Western sanctions. OPEC comprises 13 oil-exporting countries: Algeria, Angola, Congo, Equatorial Guinea, Gabon, Iran, Iraq, Kuwait, Libya, Nigeria, Saudi Arabia, United Arab Emirates, and Venezuela. OPEC+ comprises 23 countries including the OPEC members as well as Russia and other major producers such as Azerbaijan, Kazakhstan, Mexico, and Oman. The U.S. is not a member of OPEC.
Source – International Energy Agency, “Oil 2023”
Coal has also experienced a revival. Coal-fired power plants in Europe reopened or were granted life extensions in response to Russia shutting off its gas supplies to the continent. This new appetite was a sharp reversal for coal, which had been in decline since 2014. In fact, the IEA estimates that world coal output reached an all-time high in 2022, surpassing eight billion tonnes for the first time.
This apparent new love affair with fossil fuels didn’t stop at production. Many governments in Europe went as far as subsidising the consumption of dirty fuels to shield their populations from crippling increases in energy costs, an ironic twist to existing policies that encourage the use of green energy.
The extent of energy price inflation has varied by country, depending on several factors such as the fuel mix, taxation, and energy bill support strategies. Turkey and Europe have suffered the worst pain as a quarter of households lived in energy poverty (i.e., unable to afford essential energy services) at the peak of the energy crisis, according to the IEA. North America, meanwhile, has not been entirely spared from energy price inflation.
Bar chart showing the year-over-year increase in energy prices for select countries. Most affected was Turkey, where energy prices spiked 137%. Energy prices jumped 59% in the UK and 39% in the EU. The increases were more muted in North America, though prices were still up an uncomfortable 18% and 16% in the U.S. and Canada, respectively. The following countries were also shown in the chart: Netherlands, 100%; Italy, 71%; Ireland, 48%; Germany, 44%; Norway, 29%; Chile and Switzerland, 21%; France, 20% and Mexico, 3%.
Source – International Energy Agency, “Energy Efficiency 2022”; data as of October 2022
Yet higher fossil fuel production and consumption mask a much bigger story: the new impetus for the renewable energy transition as governments combine their environmental agendas with energy security policies that have taken on fresh urgency. As such, renewable power can augment energy self-reliance as these energy sources are mostly generated domestically.
Conveniently for governments fostering the green transition, the economics of renewables have improved. New solar plants and wind farms are now more cost-effective to build than fossil fuel-fired plants, even when factoring in the rising raw material and borrowing costs brought on by the Russia-Ukraine war.
Governments are also attracted to the job creation potential of renewable energy projects. In March 2022, a World Economic Forum study projected that the green transition will create 10.3 million net new jobs globally by 2030, with the largest gains in electrical efficiency, power generation, and the automotive sector.
Line chart showing the progression of the levelised cost of energy for various renewable technologies and the price range for fossil fuels from 2010 to 2021. Since 2010, the levelised costs for offshore and onshore wind power as well as solar and concentrated solar power have declined markedly. As of 2020, all are below the high end of the price range for fossil fuels. The levelised costs of solar photovoltaic and onshore wind are also below the lower end of the fossil fuel price range.
Note: The levelised cost of energy estimates the overall cost of an energy system against the amount of energy it will provide to end up with a cost per unit of energy produced.
Source – International Renewable Energy Agency, “Renewable Power Generation Costs in 2022”
In the wake of the Russia-Ukraine war, most governments have raised their targets for renewable energy generation and announced substantial fiscal support to achieve them.
All in all, the IEA’s current estimate of global renewable energy capacity is 30 percent higher than prior to the war. It expects this capacity to rise almost 75 percent, or by 2,400 gigawatts (GW), between 2022 and 2027 – an amount equivalent to China’s current installed capacity.
In the U.S., the Inflation Reduction Act (IRA), signed into law by President Joe Biden in August 2022, provides over US$350 billion of subsidies for green technology, which should result in a tripling of U.S. clean energy production, according to S&P Global Commodity Insights. By 2030, 40 percent of the country’s energy could come from renewable sources, or close to double today’s level.
Meanwhile, the European Commission has earmarked €250 billion for clean tech companies via its RePowerEU plan. It now targets doubling the bloc’s installed solar capacity by 2025, five years ahead of the previous deadline.
In 2021, in its 14th Five-Year Plan, China announced for the first time an ambitious goal of generating one-third of its power from renewables by 2025.
The UK, the second-largest offshore wind market worldwide, upped the pace of deployment of this technology, aiming for installed capacity to reach 50 GW by 2030 versus the previous commitment of 40 GW, among other measures encouraging renewables.
Indications of the vitality of the clean energy transition were clearly visible in 2022, including:
Despite these renewed commitments, the green energy transition still faces serious challenges which threaten the ambition of achieving net zero by 2050.
One of the most pressing issues is squeezed supply chains. As demand for green products accelerates, so does demand for critical minerals. Increased expenditures on military hardware, particularly from the U.S., EU, and China, exacerbate these issues as these raw materials are crucial to manufacturing and maintaining weapons systems and equipment. Today, for the first time in decades, those three regions, which together represent close to half of global GDP, are all vying for the same limited supplies of resources.
Suppliers of critical minerals and components are struggling to keep up. Investment has been insufficient to meet this surge in demand, while scaling up mining and processing is an expensive and time-consuming process as it takes 10 years on average for a mine to come on stream.
Geopolitical tensions are also rippling across supply chains. China, which dominates the supply chains for most of the metals and minerals required for the energy transition, recently imposed an export ban on germanium and gallium. These two niche metals are used to manufacture electronics and green technologies, and the restrictions are a retaliation to the West’s embargoes on software and chipmaking equipment. Given the risk of further escalation, such tit-for-tat salvos are a wrinkle to keep an eye on.
In an attempt to build more resilient supply chains, the corporate sector is innovating. For instance, EV manufacturers are increasingly turning to joint development agreements. Tesla is now negotiating supply contracts directly with the mines, and General Motors plans to invest $650 million in mining company Lithium Americas to develop a mine in Nevada.
Such collaborations can provide automakers with more control over the supplies and costs of the EV value chain. Vertical integration is becoming increasingly important to car manufacturers as they look to lock in supplies of key battery raw materials at cheaper prices. We think this strategy will become more common in the coming years and may spread to other industries.
Another thorny problem for countries is that antiquated power grids are struggling to keep up with the growing appetite for clean energy. Grids all over the world need to be modernised and enlarged to accommodate renewable energy sources. Still, some renewable generation and storage projects face lengthy delays. For example, it could be a couple of years before projects in some U.S. states are able to connect to the grid, with delays in the UK of up to 15 years. BloombergNEF, a commodity research provider, calculates that 80 million kilometers of new grid is needed by 2050, an amount equal to today’s existing global grid.
Expanding and modernising the grid has not been much of a priority for governments so far, but it’s dawning on them that the lack of grid investment could put renewable targets in jeopardy. Locating transmission lines alongside highways, railroads, or pipelines, where the granting of planning permission is more likely, could be a way to accelerate the process.
Finally, higher costs are another headwind to the green energy transition. The COVID-19 pandemic and other supply chain issues have made many raw materials, such as aluminum, copper, and steel, more expensive. Prices of many inputs have been dropping, but rising interest rates over the past 18 months have driven up the cost of financing projects, a particularly acute problem for solar and wind farms as they require more upfront capital than traditional power plants. Meanwhile, soaring staffing costs are an additional headache.
In extreme cases, spiraling costs are taking their toll and some projects are being abandoned. Recently, Swedish energy giant Vattenfall suspended work on a 1.4 GW offshore wind farm in the UK after a 40 percent increase in costs. The company won a UK government contract to build 140 turbines to provide energy to 1.5 million homes with low locked-in electricity prices. But following the sharp rise in costs, Vattenfall was unsuccessful in obtaining tax breaks from the government and subsequently halted the project; negotiations are ongoing.
Higher borrowing costs are also affecting consumer demand in the U.S. despite growing concerns over the reliability of the power grid, given struggles to cope with extreme heat waves. This slump in demand led many home solar and backup-power companies in the U.S. to recently cut their sales guidance for 2023.
When considering how to invest in this theme, renewable energy equipment manufacturers come to mind. But given the headwinds they face, as well as fiercer competition that could arise from generous subsidies attracting new players, we believe investors would be better served by seeking a broader opportunity set, including:
Timing and stock selection are key, however, in our view. The stock prices of companies in most of these sectors are highly cyclical and could be subject to volatility should U.S. recession concerns heighten.
As nations’ energy security policies converge with their environmental agendas, the energy transition has been given a new impetus. Policymakers are setting more ambitious targets for green technologies and injecting ample financial support.
Yet the green transition still faces serious challenges. The supply of critical minerals, particularly copper, may well prove to be the barometer of how rapidly the energy transition occurs. Antiquated grids and higher borrowing costs amplify the challenges. The deadline for achieving net-zero emissions by 2050 may wind up being pushed somewhat further out, giving fossil fuels some additional respite.
Nonetheless, the increased focus on energy security and the clean energy transition will see some companies emerge in advantageous positions, but given the challenges ahead, we think investors will need to be selective.
This publication has been issued by Royal Bank of Canada on behalf of certain RBC ® companies that form part of the international network of RBC Wealth Management. You should carefully read any risk warnings or regulatory disclosures in this publication or in any other literature accompanying this publication or transmitted to you by Royal Bank of Canada, its affiliates or subsidiaries.
The information contained in this report has been compiled by Royal Bank of Canada and/or its affiliates from sources believed to be reliable, but no representation or warranty, express or implied is made to its accuracy, completeness or correctness. All opinions and estimates contained in this report are judgments as of the date of this report, are subject to change without notice and are provided in good faith but without legal responsibility. This report is not an offer to sell or a solicitation of an offer to buy any securities. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Every province in Canada, state in the U.S. and most countries throughout the world have their own laws regulating the types of securities and other investment products which may be offered to their residents, as well as the process for doing so. As a result, any securities discussed in this report may not be eligible for sale in some jurisdictions. This report is not, and under no circumstances should be construed as, a solicitation to act as a securities broker or dealer in any jurisdiction by any person or company that is not legally permitted to carry on the business of a securities broker or dealer in that jurisdiction. Nothing in this report constitutes legal, accounting or tax advice or individually tailored investment advice.
This material is prepared for general circulation to clients, including clients who are affiliates of Royal Bank of Canada, and does not have regard to the particular circumstances or needs of any specific person who may read it. The investments or services contained in this report may not be suitable for you and it is recommended that you consult an independent investment advisor if you are in doubt about the suitability of such investments or services. To the full extent permitted by law neither Royal Bank of Canada nor any of its affiliates, nor any other person, accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or the information contained herein. No matter contained in this document may be reproduced or copied by any means without the prior consent of Royal Bank of Canada.
Clients of United Kingdom companies may be entitled to compensation from the UK Financial Services Compensation Scheme if any of these entities cannot meet its obligations. This depends on the type of business and the circumstances of the claim. Most types of investment business are covered for up to a total of £85,000. The Channel Island subsidiaries are not covered by the UK Financial Services Compensation Scheme; the offices of Royal Bank of Canada (Channel Islands) Limited in Guernsey and Jersey are covered by the respective compensation schemes in these jurisdictions for deposit taking business only.
As trade and geopolitical tensions persist and global trade becomes more fragmented, will the U.S. dollar continue to be the global reserve currency of choice?