This is the first of many upcoming columns about specific investment topics our co-founder Raphael will be writing in the coming months. The aim is to provide our community with more knowledge and more details about interesting products and potential investment cases.
This article has been produced with the help & collaboration of Invesco.
No investment advisory, just more knowledge ✌️
Status quo of sustainable investing
The practice of investing money has always been a fairly straightforward equation. You invest a certain sum of money and hope to achieve a financial return above market rate. However, over the last few years, a new variable entered into the equation: sustainability.
It’s not a secret that energy demand has been soaring globally, mainly on the back of fast-growing emerging economies and non-OECD nations. Alone by 2050, worldwide energy consumption is poised to grow by nearly 50%.
But since 1992 and the Kyoto Protocol, developed economies have been trying to find a smart way of reducing human-made CO2 emissions. Whether that treaty (and the ones that followed) are being used as a mere political tool, or are in place to stay and be implemented, one thing is clear: fossil fuels cannot be the way forward and there is a need for a transition towards more renewable energies. Global warming is a real concern, not only environmentally speaking but as well from a societal point of view. Recent climate disasters such as wildfires seen in Australia or hurricanes in the US, underscore the extent to which a few additional degrees can have lasting side-effects. Since the cusp of the Paris Agreement in 2016, countries finally recognized the need for common action, which helped policies and legal frameworks being moved forward. This finally set the path for more innovation and additional investments in the sector.
Alone since 2020, over $501bn has been injected into the energy transition via clean tech products and projects, according to Bloomberg’s New Energy Finance 2021 report.vThis surge is a welcomed consequence of the unprecedented commitments major economies have been promising over the last few years to reach for carbon neutrality.
A big signal came from the US by re-joining the Paris Climate Agreement (which they should have never left), and their $2tr investment plan in clean energy to deliver carbon-free electricity by 2035. At the same time, the world’s largest greenhouse gas emitter, China, laid down a plan to have its CO2 emissions peak before 2030 and reach carbon neutrality before 2060. In the meantime, the fossil fuel industry is feeling the heat in their back to invest in clean energy. Last month alone, a Dutch ordered Shell to cut its carbon emission, while an activist hedge fund placed two candidates on Exxon Mobil’s board of directors, to give a few recent examples.
So is the world shifting to renewable energy? Not quite yet. Let’s take a look at current consumption levels:
As it currently stands, we still have around 80% of all our energy coming from fossil fuels.
To reach carbon neutrality, we would need at least 60% of energy sources to be renewable by 2050, and 10% by 2025.
It’s easier said than done, particularly when considering the fact that fossil fuels are extremely energy dense and are almost ready to be used anywhere where the appropriate infrastructure exists. Only a few alternative energy sources can compete with fossil fuels when it comes to producing on-demand power. On top of this, having used them for the last centuries as the main source of energy, means that logistics are well established and a complete rethinking of how we consume and understand energy is necessary.
Green energy to compete on unit economics with fossil fuels
While a lack of political attention in the past has for sure been one of the headwinds to the use of renewable energies, it’s weak cost-competitiveness has been even a bigger problem.
In 2010, solar PV energy was still about six times more expensive than coal. Today, the cost is almost on par with fossil fuels and is expected to become even cheaper. Before 2040, renewables will cost less than oil, natural gas and coal power, according to the International Renewable Energy Agency (IRENA). Besides, large-scale projects, such as hydroelectric dams or onshore solar-wind parks, can’t be built just anywhere. Hydro plants need a consistent supply of water, while wind-parks a large amount of land. Some countries have plenty of these; others do not. This coupled with limited funding from local governments, meant that investors were shying away from putting their money in such projects.
While hydropower has so far been the biggest contributor, and still is, wind and solar are catching up and clearly dominate the growth in renewables. New wind and solar projects are finally getting cost-competitive, driven by economies of scale, more competitive supply chains and technological improvements. Alone between 2021 and 2019, the costs for solar PV declined by 82%, onshore wind by 38% and offshore wind 29%.
Besides pure renewable plays, clean fuel such as hydrogen have as well been hyped recently, to say the least. While renewables need a specialized infrastructure, both in terms of energy production, stocking and transportation, hydrogen can rely on existing infrastructure such as gas stations and oil transporting trucks that will need little transformation, to be usable. Furthermore, hydrogen is extremely energy dense, with 1 kilogram of hydrogen gas containing around 3x as much energy as oil.
However, hydrogen can be produced from both renewable power and fossil fuels. Hence, the differentiation between green and grey hydrogen. There is an intermediate solution too, the blue hydrogen, but this we will cover separately! The problem with clean hydrogen is the production chain and whether enough can even be produced to fulfil its growing demand. That’s why we see scientists increasingly lobbying for using it to decarbonize energy intensive sectors such as goods transportations or production of chemicals. Batteries would deserve a mention here too, but like hydrogen, deserve to receive their own article!
So what about investments?
One thing is clear, besides improving economics, for the energy transition to be successful, countless investments are still needed. Alone to reach the goal set in the Paris Agreement - to limit global warming to less than 2°C and ideally to 1.5°C - annual global investment in renewables would have to increase significantly. Investments in renewable energy amounted to an average of $300bn worldwide in 2018. But this amount would have to almost triple to $800bn by 2050. Limiting global warming to 2°C will not only require scaling up investments in renewable investments in renewable energy, but also the entire associated technological ecosystem will need to be significantly expanded and reformed.
While this will be challenging, it means from an investment perspective that even more firms will enter the sustainability revolution, not only as a pure energy production play but as well as supporting companies. For investors, this results in an increasing spectrum of stocks that can be bought. Unfortunately, as we’ve seen over the last few months, a few companies have been overpromising (i.e. Nel) or merely trying to surf on a trend without any useful product or service (i.e. Nikola Motor).
As always on stock markets, a good solution is to go for an ETF. And quite a few investors have recognized this opportunity to put their money into a world-changing trend. The most prominent product has been BlackRock’s Global Clean Energy that registered record inflows following Biden’s election with many anticipating an upcoming vast clean energy infrastructure spending. With over 40% of their old-basked US-focused, there was some justification over these inflows. However, its rapid growth raised questions of over-inflated valuations and concentration-risk in its basket of 30 relatively small renewable energy utility stocks. This prompted the product provider to broaden the basket size to 82 constituents.
While theme purity is very relevant, so are improved liquidity and risk-return profiles.
Capture global climate solutions with Invesco's ETF
So I decided to take a look at different possibilities and found Invesco’s Global Clean Energy a very interesting alternative, or potentially better substitute - you tell me!
Invesco’s ETF tracks WilderHill New Energy Global Innovation Index (NEX). Launched in 2006, it was the world’s first benchmark for global clean energy. The Global Financial Crisis unfortunately made us forget that good sustainable investment products were already available back then. It is composed of 125 companies across seven sectors in the clean energy industry, with a focus on renewables and energy transition.
A point I always closely watch when buying an ETF, is the concentration in the product. Particularly when investing in thematic ETFs, you will naturally find a higher top 10 weight compared to more generic ETFs. The latter usually run around 10-15%. So I find it smart that WilderHill’s index widened their investment horizon and decided to limit the weight of the big companies. Diversification is still one of the most important investment rules, so let’s try to stick to it!
Looking further into the index’s differences, what I found almost more appealing was that only 27% of the constituents are US-listed. Although I can understand the focus on the US given Biden’s plans, innovation can as well be found across different markets.
Over 80% of the index’s constituents provide solutions to the energy transition. In comparison, the MSCI World Index lies here at 5%.
Lastly, the majority of the available ETFs around clean energy, have a strong focus on large caps. This product looks as well at mid and small-caps. Sure small-caps tend to carry a higher investment risk but are often under-reported and under-analyzed due to their short history, and can thus be undervalued.
In terms of performance, I compared the last five years, so as over the last 12 months (since 24 of June 2021). Setting aside more US-centric products such as First Trust index, WilderHill’s index was by far the best performer amongst the more generic products.
Invesco’s product is since two weeks available here in Germany at Scalable Capital (here) or Comdirect (here), amongst others. And if you feel like discussing the product a bit more, you can find it of course in our app too 👇.
Successful energy transition? What's next?
Whether you decide to contribute to the energy revolution by investing or simply by changing some of your habits - or maybe both - here are a few changes I would personally like to see tackled in the coming years:
- Shorter approval time for projects (it currently still takes on average 10 years to get offshore wind project approved in the US)
- Besides China, more emerging powers need to commit to a cleaner future (in 2019, India attracted only a tenth of China’s clean-energy finance)
- There needs to be a legal & regulatory framework in place that clean investors can trust. And often countries with interesting wind & solar prospects are lacking those and hence can attract less of the funding.
- Ensure that the entire value chain use of renewable energy is sustainable too (i.e. wind turbine blades are still too often made from Balsa wood that comes from Ecuadorian forests)
- We do not speak enough about recycling. Let’s start rewarding people for recycling vs. throwing away (i.e. as of today, the cost of producing a new lithium battery is cheaper than to recycle it)
- Long-haul freight is responsible for 22% of global CO2 emissions. The solution is not only to change their combustion methods, but as well to match supply & demand better as over 40% of freight is empty.
Thanks for reading, hope you enjoyed it as much as I did to prepare it. You have feedback or additional context you feel like adding, then feel free to reach out to me in the feed of the App. Simply write a post and add @TheRealRapha 😊