10 Aug 2023
A turbulent year has increased the opportunities for companies that are helping the world transition away from fossil fuels and use energy more efficiently.
Q&A with Deirdre Cooper and Graeme Baker
Global environment
Hear Graeme and Deirdre discuss the outlook for investing in climate-solutions companies.
In the short term, emissions will go up. In Europe particularly, more coal is being used this winter. But ultimately, the conflict will accelerate the move to a decarbonised world. High energy prices massively incentivise investment in energy efficiency, and they increase the imperative for governments to develop clean-energy systems.
We typically think about three main drivers: regulation, technological change and changing consumer behaviour. The biggest regulatory development in 2022 was the US Inflation Reduction Act. This is a complex piece of legislation and consequently we think its impact has been underestimated. But some of the solar tax credits, for example, are so generous that in parts of the US you could probably build a solar power plant and give the electricity away for almost nothing. The Act also makes it much cheaper to produce green hydrogen – i.e., using renewable energy – than the fossil-fuel alternative. In addition, there are big incentives for manufacturing electric-vehicle (EV) batteries and EVs themselves.
In terms of behaviour change, there has been a notable shift in Europe, where people view becoming more energy efficient as a way to respond to the Russia-Ukraine conflict. Finally, in terms of technological change, we are seeing some interesting developments in China’s EV industry. Almost one-third of new cars sold in China are now electric, and relatively new auto companies are making models that are proving very popular with Chinese consumers.
The two big macro concerns at present are inflation and recession. Taking them in turn, inflation is clearly a challenge for many businesses, including some climate-solutions providers. One of the things we focus on in our analysis is whether a company has pricing power, which can help to mitigate the headwinds in times of rising prices.
An economic slowdown is also clearly difficult for many companies. But climate-solutions providers are relatively well placed in a cyclical downturn because they are positively exposed to the structural-growth trends linked to decarbonisation. For example, the trend in EV sales is much stronger than that in petrol and diesel cars. The same is true across the decarbonisation universe. The fact that, unusually, high energy prices are a feature of this slowdown is another advantage for climate-solutions providers, since it strongly incentivises investment in energy-efficiency solutions and in non-fossil- fuel power.
Finally, investors should keep an eye on the easing of COVID restrictions in China, which is home to a number of leading climate-solutions businesses. That would also be a positive for the universe of companies we focus on.
There are underappreciated companies across all three of the main decarbonisation themes: renewable energy, electrification, and resource and energy efficiency. In the former, we don’t think people yet realise the extent to which the declining cost of renewable energy over the last 10 years has changed the relative economics of producing clean power vs. fossil-fuel power. That is creating investment opportunities across the renewable-energy value chain.
Within electrification, we’re seeing very strong structural growth within the EV value chain, including among companies that make specialist connectors, smart-vehicle architecture, and EV batteries and related components.
Within resource efficiency, there are several areas where we don’t believe the market fully appreciates the contribution companies are making to decarbonisation. For example, there are businesses producing bio-based alternatives to petrochemicals that are helping the chemicals and industrials sectors to decarbonise, for example via solutions that enable washing machines to run at lower temperatures or that improve crop yields. Engineering and simulation software is another underappreciated area, from a decarbonisation perspective: buildings and infrastructure generate a significant amount of carbon emissions and waste, and specialist software companies are creating smart solutions to make these industries much more carbon-efficient.
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