In April 2022, the International Panel on Climate Change (IPCC) confirmed that the critical target of limiting global warming to 1.5°C by 2050 will be reached only if we halve CO2 emissions by 2030.
Although the world is not currently on track, the goal is still within reach if action is taken now – according to the IPCC. Russia’s war in Ukraine and the consequent threats to energy security have heightened the risks of remaining behind these targets and failing to fulfil national pledges made at COP26 in Glasgow. Yet, the war has also served to highlight the need to invest more in energy infrastructure.
Energy consumption is the starting point. To reach the required trajectory, governments must decouple energy consumption and GDP growth (see Figure 1). As economies grow, energy demand rises; when energy is constrained, GDP growth slows. Decoupling the two will enable one measure of limiting global warming.
Further adaptation measures, behavioural changes and energy efficiency are essential to reduce energy demand without reducing GDP growth.
Critical issues to be addressed in determining the future energy mix include:
• Consensus on future energy sources
• How these will be sustainable and sustained into the future
• Behavioural change leading to lower consumption
• Greater energy efficiency and effective offset mechanisms
Figure 1: 2050 GDP growth forecast vs energy consumption/demand modelling
Challenges in modelling the optimum energy mix
While there is broad public consensus on the need to change our energy mix to meet the Paris climate goals, agreement on the optimum mix remains elusive. Major international bodies like the International Energy Agency (IEA), IPCC and International Renewable Energy Agency (IRENA) have carried out extensive modelling. Their expectations about future energy sources vary significantly (see Figure 2).
Analysis of these models does reveal three clear trends:
1. Fossil fuels’ share of the mix should fall from about 80% currently to 20–30%.
2. Renewable energy needs to replace fossil fuels, by growing from a 15% share to 60–80% (see Figure 3).
3. While there is no consensus on nuclear, most models envisage its share remaining significant (even doubling from around 5% currently to at least 10%).
More specifically, fossil fuels’ decline would see the phasing out of coal and a reduction of up to 80% in oil consumption. Solar and wind energy would be the driving forces behind the expansion of renewable energy, growing respectively by 20 and ten times from 2020 levels and, ultimately, accounting for more than half of renewables (see Figure 3). Hydrogen and bioenergy will play a part too, with double-digit percentage growth in annual production expected (initially “green” hydrogen and “blue”, at a later date, if it becomes cost-effective). What’s more, there will be a significant scaling up of carbon capture, utilisation and storage (CCUS).
Such a fundamental shift requires solving some key interconnected challenges, which would otherwise constrain the scaling up of renewable technologies. For instance, how should strategic metals and minerals be sourced? What is the role of the circular economy in managing e-waste and energy storage? What are the potential renewable energy headwinds from climate change itself, such as lowering wind speeds and photovoltaic obstruction from forest fire dust and debris?
Figure 3: Current renewables energy mix and future renewables energy mix forecasts
Differing pathways lead to uncertainty
The various international bodies base their scenario planning on differing assumptions. This has resulted in uncertainty. For example, the IPCC has tested a huge number of scenarios, with over 100 consistent with a 2°C trajectory and somewhat fewer compatible with the more ambitious objective of limiting global warming to 1.5°C.
Together, this extensive analysis indicates that the probability of success from even the most optimistic models is only 50–66% – and still involves a high degree of uncertainty. In many cases, estimates of success are far lower.
Yet, there is consensus on what is needed for a successful pathway. This includes a commitment by all countries; strong global coordination and cooperation, including aligned energy policies; limited energy price volatility; CO2 pricing in all countries; and a significant acceleration of applying new technologies. Remove any of these factors and the likelihood of success falls.
War emphasises greater challenges
Russia’s war in Ukraine has redirected policymakers’ attention to the concerns of energy security and resilience in addition to exposing supply chain weaknesses for the materials needed for renewable energy technologies. War has also emphasised the need for a socially just transition to cleaner energy infrastructure. Furthermore, the reliance of so many European countries on Russian energy has forced the continent to address long-standing differences of opinion about base load options, most notably around nuclear energy.
The immediate priority of supplying affordable energy is stirring up uncertainty about governments’ model projections. Nuclear and renewable energy cannot deliver any near-term relief. Renewable energy sources are already operating at full capacity, and lead times for commissioning new infrastructure are estimated at five to eight years. Similarly, it will take time to ramp up nuclear capacity after a period of structural decline. Almost half of France’s nuclear reactors have either stopped or are undergoing maintenance; there is a significant skills shortage in the nuclear industry; and RTE – France’s transmission system operator – has suggested 2035 is the earliest date for commissioning new reactors.
We are concerned about possible delays in energy transition arising from interim solutions that are not consistent with a long-term decarbonised energy mix.
As Russia turns off Europe’s energy supplies, countries are importing liquified natural gas (with twice the environmental impact of natural gas), recommissioning coal-fired power stations and resuming fossil fuel exploration and production. Notably, new investments in these short-term energy solutions have uncertain returns as they are assets in danger of being “stranded” in the long term.
Investment urgently needed to close the energy infrastructure funding gap
The most inconvenient truth to arise from the current crisis is the shortfall in energy infrastructure investment in recent decades, especially in Europe. The just-in-time economy prioritised cost over resilience and the impact of that is now being felt. Yet that gap means there is a significant opportunity for investment, with the IRENA World Energy Transitions Outlook 2022 report estimating investment needs at $5.7trn annually through 2030.
Just as IRENA lays out a map for the next eight years for policymakers, asset managers are increasingly constructing portfolios with formal climate goal overlays, making use of continuing improvements in climate data and disclosures. As Allianz Global Investors is a member of the Net Zero Asset Managers initiative – and our parent company Allianz is a member of the UN-convened Net Zero Asset Owners Alliance – we have formal portfolio commitments for certain assets under management, with specific climate goals. However, we are also actively seeking opportunities arising from decarbonisation.
We classify the investment opportunities arising from a changing energy mix into three groups.
1. Support the transition from fossil fuels
As the net-zero goals for decarbonisation become increasingly embedded into portfolio construction and outcomes, we expect these to be reflected in several ways:
• Formalised carbon performance outcomes using carbon key performance indicators. These may be “green” (an ambitious threshold versus the benchmark) or “transition” (a less ambitious starting point, but progressively more ambitious).
• Net-zero alignment. This can vary from requiring companies to have a formal decarbonisation strategy to validating companies’ science-based targets.
• Formalised alignment of portfolio carbon intentions and proxy voting.
• Formalised screening of high carbon intensity, or unconventional, energy sources.
2. Seek renewable energy opportunities
• Investing in clean tech. This includes backing firms developing and applying rapidly evolving technologies like energy storage, green/blue hydrogen, and grid technology, as well as mainstream renewable energy, such as solar and wind.
• Investing in the raw materials that support the clean energy transition. Another consequence of war is the vulnerability of access to the strategic metals and minerals required for producing renewable energy infrastructure. Rare earth elements are essential for capturing wind power; magnesium is a key component of fuel cells, as well as wind and photovoltaic technology; cobalt and natural graphite are critical for batteries and fuel cells. As prices for these essential commodities rise, formerly uneconomic sites with respectable provenance and governance can reopen.
3. Invest in climate solutions
• Carbon capture utilisation and storage are vitally important for reaching net zero. CCUS facilities in operation have tripled since 2007, CCUS retrofits of power stations and heavy industries could cut CO2 emissions by more than 2gt annually by 2050, and the global CCUS market could grow to $7bn by 2030.
• Energy efficiency solutions are multifarious. The many options lend themselves to private sector development, especially those concentrating on alternative or clean energy infrastructure. Beyond solar and wind power, potential private sector projects include clean electricity transmission, adapting energy networks to alternative energies (for example, hydrogen or green gases) and building supporting infrastructures such as energy storage and CCUS.
Three final points for investors to consider. First, climate strategies will evolve as the data disclosed by companies improves, especially regarding the key constituents of aligning with net zero. Second, until data improves, engaging with company management is the only way to gain a full perspective of climate goals, especially for those companies at an earlier stage of transition.
Lastly, companies’ activities must be judged within the context of the countries in which they operate – collective engagement through industry body participation can help to promote action by governments.
The Ukraine crisis and the related sanctions against the Russian Federation, the separatist regions of DNR and LNR, and Belarus are constantly evolving. The statements included herein are as of the date provided and are subject to change. The document is for use by qualified Institutional Investors (or Professional/Sophisticated/Qualified Investors as such term may apply in local jurisdictions).
This document or information contained or incorporated in this document have been prepared for informational purposes only without regard to the investment objectives, financial situation, or means of any particular person or entity. The details are not to be construed as a recommendation or an offer or invitation to trade any securities or collective investment schemes nor should any details form the basis of, or be relied upon in connection with, any contract or commitment on the part of any person to proceed with any transaction.
Any form of publication, duplication, extraction, transmission and passing on of the contents of this document is impermissible and unauthorised. No account has been taken of any person’s investment objectives, financial situation or particular needs when preparing this content of this document. The content of this document does not constitute an offer to buy or sell, or a solicitation or incitement of offer to buy or sell, any particular security, strategy, investment product or service nor does this constitute investment advice or recommendation.
The views and opinions expressed in this document or information contained or incorporated in this document, which are subject to change without notice, are those of Allianz Global Investors at the time of publication. While we believe that the information is correct at the date of this material, no warranty of representation is given to this effect and no responsibility can be accepted by us to any intermediaries or end users for any action taken on the basis of this information. Some of the information contained herein including any expression of opinion or forecast has been obtained from or is based on sources believed by us to be reliable as of the date it is made, but is not guaranteed and we do not warrant nor do we accept liability as to adequacy, accuracy, reliability or completeness of such information. The information is given on the understanding that any person who acts upon it or otherwise changes his or her position in reliance thereon does so entirely at his or her own risk without liability on our part. There is no guarantee that any investment strategies and processes discussed herein will be effective under all market conditions and investors should evaluate their ability to invest for the long term based on their individual risk profile, especially during periods of downturn in the market.
Investment involves risks, in particular, risks associated with an investment in emerging and less developed markets. Any past performance, prediction, projection or forecast is not indicative of future performance. Investors should not make any assumptions about the future on the basis of performance information in this document. The value of an investment and the income from it can fall as well as rise as a result of market and currency fluctuations and you may not get back the amount originally invested.
Investing in fixed-income instruments (if applicable) may expose investors to various risks, including but not limited to creditworthiness, interest rate, liquidity and restricted flexibility risks. Changes to the economic environment and market conditions may affect these risks, resulting in an adverse effect to the value of the investment. During periods of rising nominal interest rates, the values of fixed-income instruments (including short positions with respect to fixed-income instruments) are generally expected to decline. Conversely, during periods of declining interest rates, the values are generally expected to rise. Liquidity risk may possibly delay or prevent account withdrawals or redemptions.