Last Friday, I wrote to you about an incredible week for the energy transition.
I made a call, that the starting gun had been pulled on a global arms race to net zero.
The last 18 months has seen a palpable reversal in the mood on climate change.
Before it was a cost and a burden, to be ignored for as long as possible. Everyone knew we had to do something, but no one wanted to be the first as they thought of saving the planet like putting weights on their horse in the Economic Grand National.
Today, the feeling is very different. Making haste to fight climate change is not seen as a hindrance or a curse – but as an opportunity.
Now people (governments, companies and voters) are realising that the rewards will accrue to those who transition the fastest and the best to the new world which is coming.
Suddenly, there has been an explosion of tit-for-tat climate claims.
UK: Hi, my name’s the UK and this is what I can do (78% reduction in total emissions by 2035).
US: Blimey, better get my skates on, how about this (50% reduction by 2030).
EU: Damn… Gotta compete here, okay well our aim is to be the first continent to reach net zero.
Expanding our carbon-investing footprint
Until now, I have been a keen advocate of the energy transition as a thematic investment.
As legendary investor Jeremy Grantham put it, the growth rates of these companies are going to dwarf those in the rest of the economy.
In the meantime, I’ve also been writing about things like central banks, inflation, rotations into value, gold, and cryptocurrencies.
The broader picture has been one of two primary risks – a deflationary crash in financial markets, and a resurgence of inflation, in one form or another.
Suddenly though, I am struck that any broader, what investors might call “macro” view or forecast should now be factoring in the energy transition as a key theme in how the economy and markets develop over the next two or ten years.
For 200 years, fossil fuel assets have grown in dominance. Every economic action we take depends on them – for fuel or electricity.
Everything you eat, wear, visit, read, watch or listen to relies on fossil fuels. They are the foundation of modern society.
But now, Western society is leading the way into a new world.
Unprecedented levels of spending, new infrastructure, new products, new technologies, new businesses and new consumption patterns are going to develop on a wholly different superstructure.
To try and boil this down, I want to try and marry two of the biggest themes we have looked at – inflation and the energy transition.
I have written on numerous occasions about the threat of a regime change, moving from 50 years of falling inflation and falling interest rates to one where inflation and interest rates begin inching upward again.
In short, we are in the foothills of two enormous and fundamental transitions – inflation and energy.
But are they linked? How might they interact? Could the energy transition exaggerate or mitigate the inflationary narrative?
There will be numerous things to consider here… For a start, the highly deflationary nature of the key technologies – solar, wind, and lithium-ion batteries which have fallen between 60% and 90% over the last decade alone.
This naturally highly deflationary impulse from key technologies might be balanced out by demand for the materials which go into them, however. Lithium and copper are two pretty classic examples where we can expect to see supply shortages, bottlenecks, and price spikes.
It will also be important to see to what extent the increasing relevance of certain things (solar panels, copper) is in the actual calculations of CPI – consumer price inflation. Currently, fuel accounts for a high portion of headline inflation data, but its significance to the average consumer will dwindle over the next decade.
Will the CPI data, calculated from a basket of goods and services, adapt quickly or slowly to the changing significance of fuel and clean technologies?
Then, what will the implications be of stranded fossil assets – oil wells left un-monetised, petrol cars not used, gas boilers disposed of.
“Stranded” means projects and assets which have been bought or invested in, but from which the full return will not ultimately be generated, because demand has shifted away from fossil fuel. Think of an oil well purchased today in the North Sea, or a coal plant built in China.
Oil majors used to be able to project the lifetime return on such an asset. But the next 25 years looks awfully uncertain from where BP is sitting, let me tell you.
Given the new global green arms race, the race to net zero, governments will be using their newfound spending muscles to fuel this transition. (A key shift after coronavirus is that stimulus will come in the form of government spending, on top of central bank money printing, quantitative easing, which wasn’t the case after 2008.)
So is that how all of this will be funded? If the extraordinary amount of money being printed in the US right now finds a home in energy transition infrastructure like wind farms, home refurbishments and research and development, will it, in fact, soak up a lot of the inflationary pressure?
Put more simply, supply of money is currently rising faster than the stock of goods and services which can be bought with that money – hence the fear of inflation.
But if that gigantically powerful monetary supply hosepipe is met by a demand sponge of epic proportions, could this balance the scales somewhat? Could this mitigate inflation fears?
Look, the key point here is that clearly I don’t know – these are the earliest and most formative of thoughts.
All I know is that the energy transition is not a standalone sector.
It’s all encompassing. It’s going to be on agendas for every government, every sector and every company.
Power, transport, food, materials, mining, textiles, construction, investment, banking… and more.
It certainly won’t be a straight ride for all. Copper may soar but the cost of power will still plummet.
Steel might get more expensive to make, while farms become more productive.
The point is that whatever sector you are now looking at, wherever you are operating, getting to net zero is no longer a future concern.
Energy transition isn’t just a sector. It’s the base on which all sectors now sit.
Central banks, governments, companies and individuals are racing to net zero, and we as investors must start thinking about how this all-encompassing societal upheaval is going to impact everything: returns from different sectors, monetary policy, the economic outlook, and more.
I myself will be digging deeper over the next week or two, trying to see how the energy transition might interact with or impact upon the changing inflation cycle.
If I come up with anything good, you will, as always, be the first to know.
All the best,
Editor, UK Uncensored
PS One part of the energy transition is going to have to be highly deflationary – hydrogen. Its costs are going to have to come down hugely, but if they do, it could play a huge role in decarbonising the global economy. For investors, the story is clear.