Renewable energy is well on its way to becoming a core part of our energy mix. Clean energy sources are increasingly being used as cost effective and low emission alternatives to coal, oil and gas. This transition simply has to happen from an environmental perspective, in particular due to carbon emissions. This is being supported by politicians and investors globally.
Renewable energy makes up just a small part of the global energy mix at present. This needs to rise substantially if we are to meet climate targets, including the Paris agreement designed to limit temperature rises to 2°C. We therefore need a rapid switch to renewable sources of energy.
Renewables could reach a 30-40% share of the total mix in the next 30 years. While full adoption of coal took around 70 years and full adoption of oil and gas took around 50 years, we think the full adoption of renewables will take closer to 30 years, essentially happening much more quickly. This is because it will be driven by forced change; the severity of the threat posed by climate change means government policy simply has to support the energy transition to renewables.
Investment is ramping up
Switching to energy generated by renewables and away from fossil fuels is only one part of the energy transition. Just as crucial is the development of the infrastructure needed to enable the switch. For example, wind and solar farms can generate a huge amount of power when it’s windy or sunny, but this will need to be stored until it’s needed by consumers.
The scale of investment in renewables is largely under-appreciated at this point. The investment rates are as much as $120 trillion globally across the entire value chain, which is up to three or four times the previous last two decades’ investment rates.
There will need to be huge investment in the transmission and distribution networks to support increased demand for electricity rather than other forms of energy. In addition, a significant amount of investment is needed to make the entire system more efficient and this involves a large amount of technology-driven investment. An important part of this demand is the growing popularity of electric vehicles and therefore new, large-scale charging infrastructure for these will be needed.
Investors still have time
We think investors have not missed this opportunity. If you look at the MSCI Alternative Energy Index, the average return has been -1% per annum for the last five years. But we’ve started to see an inflection in terms of how companies involved in alternative energy are performing, when you look at factors such as EBIT (earnings before interest and tax) margins and return on capital.
This has a huge amount of longevity going forward. It will be driven by increasing use of electric vehicles, the cost of energy coming down in wind and solar, plus the adoption of new technologies such as storage and smart grids which will drive the overall transition.
For more information please visit www.schroders.com/globaltransformation