The transition in 2024 - reality bites

Decarbonisation, supply resilience, affordability: is it possible to solve all three? The old adage of the transition trilemma (balancing all three components of energy policy) has come starkly into focus again over the last 12 months. To some, the energy transition seemed unstoppable. But throw in some post-pandemic supply chain issues, stubborn inflation, cost-of-living pressures, a hefty dose of geopolitics, and the juggernaut is starting to stutter. It's going to be a bumpy ride and investors need to understand the implications.

Decarbonisation in Europe

The pace of decarbonisation in the European energy system has been impressive over the last decade. Around 70 gigawatts of renewable generation capacity was added in 2023 - a 17% increase on 2022 - and the bloc is well on the way to exceeding its target of 42.5% of energy consumption from renewables by 2030. The UK has also made substantial progress in some areas, such as reducing the emissions intensity of electricity by 64% since 2015.

But since Russia's invasion of Ukraine there's been a noticeable rebalancing of attention towards energy security and affordability. This has become more pronounced over the last 12 months.

Energy security and affordability

In the UK, the wind industry's cost problems were brought into sharp focus in 2023, when there were no bids for the fifth round of offshore auctions. In the transport sector, cost pressures also led to a slowing of electric-vehicle uptake across Europe, and policies to ban the sale of conventional passenger vehicles have been pushed out.

The focus of policymakers, so far, has been firmly on decarbonising electricity generation, while other parts of the jigsaw have been neglected. This remains the case in the 'space and time' elements of the transition: getting renewable energy to where it is needed at the right time. This mismatch creates delays and adds costs for developers. The lack of storage, meanwhile, has led to periods of negative electricity prices and unused renewable energy. In order to retain system resilience, governments are forced to rely on gas-fired (or in some cases coal-fired) generation to do the hard work for longer.

Facing the reality

All of these factors add up to a slower decarbonisation pathway. The UK's independent Climate Change Committee has major concerns about the country's progress against targets. Some analysts now consider it highly likely that the 2050 net-zero objective will be missed. In Scotland, the recent scrapping of the country's 2030 climate target was the catalyst for the collapse of the coalition government's power-sharing agreement.

Similar patterns are playing out across the globe. Despite impressive progress, the energy transition is now facing some cold, hard economic and political realities. It's clear that the transition can't and won't happen without balancing energy security and the consumer's pocket.

Case study - biomethane in Italy

For infrastructure investors, we are used to navigating this complex situation to find opportunities to deliver long-term value for our clients. Our most recent investment in Italy provides an excellent example of combining the decarbonisation imperative with energy security and locking-in price certainty for the taxpayer.

The country is looking to produce 30% of its energy needs from renewables by 2030 and, in line with overall EU ambitions, to fully decarbonise by 2050.

With the support of the EU, the Italian government has decided to move away from using biogas for electricity generation. Instead, it's upgrading to biomethane to directly displace fossil gas in the grid. There's now a €4.5 billion incentive programme in place for biomethane in Italy. This is part of the EU's wider strategy to increase domestic production to 35 billion cubic metres by 2030. The strategy can support new biomethane plants, or the upgrading of existing biogas plants to produce biomethane, to reduce greenhouse gas emissions by at least 80% compared with conventional fossil gas. Importantly, the shift to incentivising more green molecules also reduces the country's reliance on imported fossil fuels.

We established a partnership with Blu-H Energy, which has unrivalled knowledge of the market. It is helping us identify small-scale opportunities and build our platform. But not all sites are equal. There are several crucial criteria we consider when selecting appropriate sites. First and foremost is the control of feedstock. It's not like installing solar panels in a field and waiting for the sun to shine. These plants need large quantities of inputs like manure and other agricultural waste. Securing this at the right price and quality is a key determinant of success.

We like rolling up our sleeves and getting involved in this type of investment. Taking our time, getting to know a sector, and building the right relationships on the ground is how we create the opportunities and risk-adjusted returns for our clients.

Final thoughts...

The energy transition is at a crucial point. There's a recognition that it won't happen at any cost and a rebalancing towards resilience and affordability is underway. This creates complexity for investors. But as exemplified by the case of our biomethane investment in Italy, sometimes it's possible to tackle all three of the trilemma's imperatives at once.

Author: Ruairi Revell, Head of Sustainability, Infrastructure

We have semiconductors snatching the sector title in equities as penny stock activity also rise in the US (not so much in Australia; and no mention of GameStop here, sorry). B2B SaaS growth moderates - as have tech EV/Revenue multiples - and strategists are now looking at strong US corporate earnings growth - will it drive capex or will it fall short itself as demand cools? The Atlanta Fed's GDP indicator has certainly dropped in recent days. Over in the US bond market, we are witnessing possibly the longest ever drawdown. Meanwhile, the Federal Reserve last held rates steady for over a year in the lead-up to the global financial crisis. Finally, we take a look at Starlink satellite customer numbers scaling up and the varying productivity chasm between small and large enterprises across nations.

Semiconductors emerge with the heaviest weighting in the S&P 500

Source: FactSet (via @jessefelder)

Share of US equities volume accounted for by "penny" stocks (trading at <$US1 a share)

Source: Financial Times

Estimate of ex-S&P/ASX 300 volume relative to total ASX volume

Source: Equitable Investors, Iress

Net new sales for all "B2B" SaaS companies on ProfitWell Metrics since Jan 1, 2022 (seven-day growth rates, seasonally adjusted)

Source: ProfitWell

Technology sector EV/NTM (next 12 months) revenue multiples

Source: Mostly metrics

Strong S&P 500 earnings growth as lead indicator for capex spending 

Source: Apollo Chief Economist (BEA, S&P. Haver Analytics)

Evolution of Atlanta FedNow GDPNow real GDP estimate for 2024 Q2

Source: Atlanta Fed

US Bond Market in a drawdown for 46 months

Source: Creative Planning, @CharlieBilello

One precedent for the Federal Reserve undertaking a long hold

Source: Bloomberg

Starlink customer ramp-up 

Source: ARK

Productivity of "Micro-, small, and medium-size" enterprises relative to larger firms by country

Source: McKinsey

June 2024 Edition