The energy transition's major investment themes

Over two-thirds of the greenhouse gases (GHGs) the world emits each year come from the consumption of energy, including the energy used in buildings, transportation, and industry.¹ As the world’s demand for energy continues to grow, achieving net-zero global GHG emissions will not only require replacing “dirty” energy with “clean” energy, but also changing how energy is consumed throughout the economy.

Three specific shifts appear critical to effecting that broader energy transition, each driven by a common set of factors and offering investors a wide range of investment opportunities:

1. “Greening” the Grid: Investments in renewables, such as solar and wind, as well as supporting infrastructure, such as transmission and energy storage, will likely be critical to cleaning up the supply side of the energy economy.

2. The Electrification of (Almost) Everything: We expect energy demand to increasingly be satisfied with electrons, rather than molecules, as energy-efficient electric alternatives to fossil fuel-based transportation, commercial and residential heating, and, in some cases, industrial heating ramp up.

3. Industrial Decarbonization: Low-emitting alternative fuels such as hydrogen or the use of carbon capture and sequestration may be needed in areas that are difficult to electrify—such as heavy industry, aviation, and shipping—while carbon removal solutions will likely be necessary to address the remaining emissions.

Ready or Not, the Future Depends on Climate Solutions

The energy transition represents a significant investment opportunity, in our opinion, but investors will need to be selective. As with any long-term forecasting challenge, there is a significant amount of uncertainty around how the transition might play out and which technologies will be deemed the winners. The International Energy Agency anticipates that between now and 2030, roughly 80% of global emissions reductions will come from scaling proven technologies that are already in the market.²

Beyond this time frame, new technologies will need to make a larger contribution to emissions reductions. McKinsey estimates that 25-to-30% of the total emissions reductions through 2050 will come from technologies that are not yet commercially viable, including some technologies that are still in the research and development phase.³

We place priority on market-ready solutions that can generate emissions reductions over the next decade. We consider GHG emissions reduced today to be more valuable than future promised emissions reductions, particularly since delaying steps to reduce emissions will only accelerate the rate of change needed in the future. McKinsey estimates that the growth of demand for net-zero offerings across sectors such as transportation, buildings and power could generate $9 trillion to $12 trillion of annual sales by 2030.⁴

With the decarbonization of the global economy, new climate solutions will likely gain market share from incumbent technologies, with potential first-mover advantages available to both existing corporates and new entrants. Over the next three decades, capital will be reallocated from high-emitting to low-emitting assets, with analysts forecasting that investment in the physical assets related to the energy transition will at least triple to between $4.4 trillion and $6.5 trillion per year.⁵ The private sector will likely play a key role in driving this opportunity set, with corporations—including the financial sector—representing 60% of annual spending.⁶

Capital Comes to Clean Energy, Boosted by Falling Costs and Policy Preferences

Efficiency gains, particularly within the renewable energy sector, have been among the most important drivers of the transition to date. Shifting towards solutions that are cleaner and more efficient relies on driving down costs of low-emitting alternatives. Over the past decade, the costs of building and operating wind and solar power plants have reached parity with fossil fuels in most parts of the world.⁷ While challenges remain for renewables to completely replace fossil fuels as a source of reliable base load power, the advancement of storage technologies has contributed to the competitiveness of renewables as a viable alternative to traditional energy sources.

As costs have declined, investments in the clean energy economy have also increased rapidly. In 2022, for the first time, as much capital was invested in sectors such as clean energy, electric vehicles, heat pumps, hydrogen, and carbon capture as was invested in fossil fuel-related investments, totaling about $1.1 trillion.⁸

Policy carrots and sticks have been the other indispensable accelerants of change. More than 90 countries, representing over 78% of global GHG emissions, have communicated a net-zero target and two of the largest emitters in developed markets, the U.S. and the EU, have pledged billions in funding to support clean energy spending. Analysts estimate that across the Inflation Reduction Act, the Infrastructure Investment and Jobs Act, and the CHIPS and Science Act, the U.S. will set aside almost $80 billion of annual climate-related spending over the next decade.⁹ In Europe, the REPowerEU Plan seeks to double the bloc’s renewable energy production to 45% by 2030 and tightens its emissions reduction targets to at least 55% below 1990 levels by 2030.¹⁰ The Plan targets an additional €210 billion of investments in renewable infrastructure and energy efficiency by 2027.¹¹

Progress has been more mixed in China, the world’s largest GHG emitter. Even as China continues to permit new coal-fired power plants, it is responsible for nearly half of the world's total investment in the energy transition, spending nearly four times as much as the U.S. in 2022.¹² The Xi government has yet to announce a formal net-zero target, but the 20th Party Congress affirmed President Xi’s expectation that China’s emissions will peak by 2030 and that the country will achieve carbon neutrality before 2060.

In addition to subsidies, countries are also establishing carbon pricing regimes, through taxation or trading programs, that cover about 23% of global GHG emissions.¹³ Most trading schemes cover power and heavy industry with supply derived from emissions caps set by regulators. In the EU, the emissions trading system covers 40% of emissions. In the U.S., 13 states, representing more than a third of U.S. GDP, have initiatives in place to reduce emissions.¹⁴ California, the second-largest state emitter, was the first state to put in place a multi-sector cap-and-trade program that covers its entire economy. China launched an emissions trading system in 2021, though its scope is still limited.

Role of Corporations in Achieving Net Zero

Finally, though they have often been greeted with skepticism, we believe that corporate commitments to reduce emissions are an important contributor to the energy transition. According to the Science Based Targets Initiative, companies representing more than one-third of global market capitalization ($38 trillion) have made commitments to reduce emissions in line with climate science.¹⁵ While some firms have backed off their commitments over the past year, most continue to face pressure from customers, shareholders and the public to manage their climate risk.¹⁶ In response, companies are increasingly looking for ways to reduce the emissions associated with both the production and use of their products or services.

 

This article is part of the Plugging into the Energy Transition series. Click here to download the complete report.

 

 

1 Mengpin Ge, et al., “4 Charts Explain Greenhouse Gas Emissions by Countries and Sectors,” World Resources Institute, February 2020, https://www.wri.org/insights/4-charts-explain-greenhouse-gas-emissions-countries-and-sectors

2 International Energy Agency (IEA), “Net Zero by 2050: A Roadmap for the Global Energy Sector,” last modified October 2021, https://www.iea.org/reports/net-zero-by-2050

3 Mekala Krishnan et al., “The net-zero transition: What it would cost, what it could bring,” McKinsey Global Institute, January 2022, https://www.mckinsey.com/capabilities/sustainability/our-insights/the-net-zero-transition-what-it-would-cost-what-it-could-bring

4 Michael Birshan et al., “Playing offense to create value in the net-zero transition,” McKinsey Quarterly, April 13, 2023, https://www.mckinsey.com/capabilities/sustainability/our-insights/playing-offense-to-create-value-in-the-net-zero-transition

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

6 UN Climate Change Conference, “Net Zero Financing Roadmaps: Key Messages,” November 2021, https://assets.bbhub.io/company/sites/63/2021/10/NZFRs-Key-Messages.pdf

7 George Bilicic et al., “2023 Levelized Cost of Energy+,” Lazard, 2023, https://www.lazard.com/research-insights/levelized-cost-of-energyplus/

8 Albert Cheung et al., “Energy Transition Investment Trends 2023: Tackling global investment in the low-carbon energy transition,” Bloomberg New Energy Finance (BloombergNEF), January 2023, https://assets.bbhub.io/professional/sites/24/energy-transition-investment-trends-2023.pdf

9 Lachlan Carey et al., “Congress’s Climate Triple Whammy: Innovation, Investment and Industrial Policy,” Rocky Mountain Institute (RMI), August 2022, https://rmi.org/climate-innovation-investment-and-industrial-policy/

10 European Commission, “RePowerEU: A plan to rapidly reduce dependence on Russian fossil fuels and fast forward the green transition,” May 2022, https://ec.europa.eu/commission/presscorner/detail/en/ip_22_3131

11 Jennifer Laidlaw, “How the EU aims to transform its energy mix and boost investment in renewables, S&P Global, August 2022, https://www.spglobal.com/esg/insights/how-the-eu-aims-to-transform-its-energy-mix-and-boost-investment-in-renewables

12 Albert Cheung et al., “Energy Transition Investment Trends 2023,” Bloomberg New Energy Finance (BloombergNEF), January 2023, https://assets.bbhub.io/professional/sites/24/energy-transition-investment-trends-2023.pdf

13 The World Bank, “Carbon Pricing Dashboard,” accessed May 2023, https://carbonpricingdashboard.worldbank.org/

14 Center for Climate and Energy Solutions, “Market-Based State Policy,” accessed May 2023, https://www.c2es.org/content/market-based-state-policy/

15 Science Based Targets Initiative (SBTI), “SBTI Progress Report 2021,” accessed May 2023, https://sciencebasedtargets.org/reports/sbti-progress-report-2021

16 Attracta Mooney et al., “Investors defy Goldman, Wells Fargo and BofA in vote for climate plans,” Financial Times (London, UK), April 27, 2023, https://www.ft.com/content/8318f146-a41c-49f8-94df-811799b0c60f