Electrification of (almost) everything: The shift to electric alternatives

Electricity currently satisfies just 20% of global energy demand, but to reach global net-zero greenhouse gas emissions, the world’s primary source of energy needs to be generated from renewable sources.¹ As a result, nearly everything will need to be electrified. We believe transportation and building heating and cooling are among the economic activities with significant near- to medium-term opportunities for conversion via proven solutions, while most forms of industrial-process heat will require new technologies.

Today, transportation accounts for 15% of greenhouse gas emissions, 45% of which comes from passenger cars, buses and taxis; 29% from heavy-duty vehicles; 12% from aviation; and 11% from shipping.² Road transportation must shift from internal combustion engine (ICE) vehicles to battery electric vehicles (EV), which will increase demand for critical components of the EV value chain including batteries and relevant minerals, electric drive trains, and charging infrastructure.

The viability of electrifying vehicle fleets depends on the range and weight-to-power limitations of lithium-ion batteries and the availability of charging infrastructure.³ Currently, electrification is most appropriate for light- and medium-duty vehicles, as well as for fleets where vehicles drive short distances from centralized hubs, like local trucking routes. As battery technology improves, electrification of longer-distance transportation—including heavy-duty vehicles, light-duty ships and short-range aviation—may also be possible. However, we anticipate that batteries will have to compete with hydrogen fuel cells and sustainable fuels for viability and market share of long-haul transport.

After excluding the indirect emissions from electricity use and the emissions associated with construction, buildings are responsible for about 6% of global emissions from space and water heating and cooking. Achieving net zero will require replacing heating, ventilation, and air conditioning (HVAC) systems that run on fossil fuels with electric heat pumps, converting gas stoves to electric, and improving building insulation to enhance energy efficiency. These upgrades are expected to be included in new buildings, while existing structures will need to be retrofitted.

Finally, heavy industry is responsible for about 24% of global emissions, after excluding the emissions associated with electricity use. The chemical reactions and industrial heating needed to create essential products such as steel, concrete, plastics, and fertilizers all emit greenhouse gases. This sector will be the most challenging to decarbonize because powering industrial processes with electricity is often impossible. New solutions will be needed in these cases, as we explore in our articles on industrial decarbonization via carbon capture and green hydrogen technologies.

The “electrify everything” theme is expected to triple electricity demand,⁴ creating the need for digital solutions that facilitate the integration of smart assets onto the grid and improve the energy efficiency of appliances. Software can help these connected appliances act as virtual power plants with the combination of demand response software and dynamic load management. While electric alternatives often have higher upfront installation costs, their lower operating costs and energy savings typically reduce the total cost of ownership over time.

Efficient and Cost-Effective Electrification to Offset New Energy Demand

The electrification of existing buildings and transportation systems represents a significant portion of the energy transition market, but we believe the near-term opportunity will be focused on electrifying new energy demand. McKinsey estimates that $3.5 trillion of annual spending on EVs and charging infrastructure, and $1.7 trillion directed annually to improving the energy efficiency of buildings, will be needed to reach net zero.⁵ Many of these technologies are mature and deployable today, with easier implementation for new vehicle and housing stock than to replace existing assets.

The EV market is driven by lower costs, increasing consumer demand, supportive public policy, and targets set by auto original equipment manufacturers (OEMs). As of 2021, EVs accounted for 9% of global auto sales and just 1.5% of vehicles on the road.⁶ But by 2030, the IEA estimates that EVs will reach 60% of new car sales and that ICE vehicle sales will decline to zero by 2035.⁷ EV sales are forecast to grow 30% annually over the next decade, and analysts expect profit pools for EVs to increase from $1 billion to $110 billion by 2030.⁸

In the U.S., the Inflation Reduction Act provides tax credits to encourage EV adoption and charging infrastructure. The EPA’s recent proposals would require more than 67% of new light-duty vehicle sales and 46% of new medium-duty vehicle sales to be EVs by 2032.⁹ In the EU, the European Green Deal targets 3 million charge points and 30 million EVs by 2030, mandating all new vehicle sales to be EVs by 2035. Meanwhile, China leads global sales for EVs.¹⁰

EVs are expected to reach cost parity with their ICE counterparts by around 2025.¹¹ Battery packs still represent about a third of overall EV production costs, but EVs are twice as efficient as ICE vehicles with fewer ongoing maintenance and energy costs.¹² The battery supply chain is geographically concentrated, however, which could stunt the sector’s growth. Despite a significant drop in prices—from over $1,000/ kWh in 2010 to $141/kWh in 2021—lithium-ion battery prices have been trending upwards recently due to supply chain disruptions and increased raw material prices.¹³ China also produces more than 70% of global EV batteries and controls most of the manufacturing capacity for the four key Li-ion battery components: cathodes, anodes, electrolytes and separator parts.¹⁴

Building energy-efficiency improvements can make significant contributions to reducing energy demand and providing energy savings. For buildings, electric heat pumps are becoming increasingly cost-competitive and viable as an alternative to gas furnaces, as they are 2.5 to 4.5 times more efficient,¹⁵ and better insulation can reduce heat gains and losses. Public policies in the EU and in U.S. cities are focused on banning gas connections in new construction and setting zero-emissions goals. However, for existing commercial real estate, public policies have yet to bridge the issue of “split incentives” in landlord-tenant relationships, limiting the potential for upgrades.

Finally, there are opportunities to electrify some elements of industrial heating. About a quarter of industrial energy use is for heating processes that require temperatures less than 100 degrees Celsius, which are areas that have potential to be electrified.¹⁶ In addition, electric arc furnaces can replace blast furnaces to melt recycled scrap metal into green steel. However, direct electrification in the industrial sector is still limited. Most industrial heating processes require much higher temperatures or harness waste heat from fuel combustion for related processes. For these reasons, decarbonizing heavy industry will rely on technological innovations such as green hydrogen, carbon capture, and recycling.

Investment Activity in Fleet Electrification and Energy Efficiency

Listed equity strategies offer exposure to electrification via auto and charging OEMs, fleet operators, and component parts providers. Venture and growth managers have seen compelling opportunities to invest in niche markets within fleet management, as well as enabling technologies to help optimize fleet logistics, manage the uses of energy within buildings and cars, and promote smart building design. Real estate managers have also taken advantage of opportunities to incorporate energy efficiency solutions and retrofits. While there are some early-stage companies working to electrify steel production, they carry high technology risk more appropriate for patient long-term capital.

10 Bloomberg New Energy Finance (BloombergNEF), “Electrified Transport Spending Soars, Transition Rolls On,” February 2023, https://about.bnef.com/blog/electrified-transport-spending-soars-transition-rolls-on/

11 Christer Tryggestad et al., “Global Energy Perspective 2022 Executive Summary,” McKinsey & Company, April 2022, https://www.mckinsey.com/~/media/McKinsey/Industries/Oil%20and%20Gas/Our%20Insights/Global%20Energy%20Perspective%202022/Global-Energy-Perspective-2022-Executive-Summary.pdf

12 Stan Miranda et al., “Global Energy Transition Investment Framework,” Partners Capital, April 2022, https://partners-cap.com/insights/partners-capital-energy-transition-investment-framework/

13 Bloomberg New Energy Finance (BloombergNEF), “Increase in Battery Prices Could Affect EV Progress,” December 2022, https://about.bnef.com/blog/increase-in-battery-prices-could-affect-ev-progress/

14 Goldman Sachs, “Electric vehicles are forecast to be half of global car sales by 2035,” February 2023, https://www.goldmansachs.com/intelligence/pages/electric-vehicles-are-forecast-to-be-half-of-global-car-sales-by-2035.html

15 Gustav Bolin et al., “Building decarbonization: How electric heat pumps could help reduce emissions today and going forward,” McKinsey & Company, July 2022, https://www.mckinsey.com/industries/electric-power-and-natural-gas/our-insights/building-decarbonization-how-electric-heat-pumps-could-help-reduce-emissions-today-and-going-forward

16 Michael Cembalest, “Growing Pains: The Renewable Transition in Adolescence,” Eye on the Market Annual Energy Paper: 13th Edition, J.P. Morgan, 2023, https://am.jpmorgan.com/content/dam/jpm-am-aem/global/campaign/energy-paper-13/growing-pains-renewable-transition-in-adolescence.pdf