Regulated Utilities: The epicentre of the global energy transition
Renewable energy companies are the typical ‘go-to’ exposure for the multi-generational thematic of energy transition. However, some renewable energy investments can carry higher risk. An alternative way to play this transition, and one we argue with less risk, is through the regulated utilities sector. Utilities have a critical role in the energy transition, with attractive investment characteristics for long-term infrastructure and ESG focused investors. The opportunity lies in the fact that utilities have been overlooked by markets, so far, as an essential part of the transition to renewable energy. We believe that is about to change.
Key points
• The opportunity to participate in the secular energy transition is rich with options.
• We have seen governments increasingly focused on accelerating the pace of the energy transition, and specifically infrastructure investment.
• The current and emerging policy backdrop will continue to create more and more investment opportunities in utility and renewable energy companies.
• Despite improving fundamentals, the share prices of many renewable energy companies globally have been under pressure, creating attractive opportunities for long-term investors.
• While regulated utilities are largely overlooked by the equity markets, there is huge potential for long-term, low-risk secular investment across major thematics such as the energy transition and climate change.
• Global renewable leaders Ørsted and NextEra, together with regulated utilities like Elia and Ameren, are prime examples offering a chance to participate in this once in a generation transition to a cleaner world.
Q: What is the energy transition, and why does it matter?
A: The world has long relied upon fossil fuels, fuels that are typically mined (coal) or drilled (oil and gas), then burned for energy conversion either through combustion engines for propulsion, or in furnaces for the powering of electricity generators. The carbon intensive nature of fossil fuels has contributed to climate change, and other detrimental environmental and health consequences.
Now, organisations like the United Nations have set targets for the transition to new types of cleaner and renewable energies, including wind, solar, geothermal, hydro-electric, hydrogen gas, and carbon capture utilisation and storage (CCUS), amongst the many examples. The Paris Agreement seeks net zero carbon emissions by 2050. The capital-intensive nature of energy development and conversion along the entire value chain means that the transition to full renewable energy may take several decades. More and more governments are signing up to a ‘net zero by 2050’ target. For investors, this means we are still at an early stage in the development of renewables, and in the transition towards renewable energy dominated economies, and thus the opportunity to participate is rich with options.
Q: Can you provide an update on net-zero momentum with regard to the energy transition?
A: In June 2019, the UK became the first major economy to enshrine a net zero by 2050 commitment into law. Since then, more and more countries have quickly followed suit. Currently, around 53% of the global economy (as measured by GDP) has set or are intending to set a net zero by 2050 target. This is a fundamental shift in the driving forces behind the energy transition, moving from an economic motivation to a normative ESG-focused motivation with clearly defined legal requirements.
We have also seen governments increasingly focused on accelerating the pace of the energy transition, and infrastructure investment more generally. In most instances, this forms part of a nation’s recovery plan from the COVID-19 pandemic. For example, the EU has agreed to a €670bn COVID recovery fund, with around €265bn to be made available for the green transition in the form of grants and loans. Additionally, in July 2021 the EU proposed ‘Fit for 55’, an ambitious undertaking of measures for cutting greenhouse gas emissions by 55% by 2030 (compared with 1990 levels). ‘Fit for 55’ proposes some significant policy measures, including a carbon border adjustment mechanism (CBAM), a major overhaul of the emission trading system to apply to shipping, aviation, and transport, and acceleration in the development of renewable energy while banning the sale of new fossil-fuel based cars from 2035.
In the USA, the election of the Biden administration in 2020 also gave renewed impetus to the energy transition. President Biden announced a goal to create a carbon pollution free power sector in the USA by 2035, and a net zero emissions economy by no later than 2050. During a leaders summit convened by the US in April 2021, President Biden announced a new target for the US to achieve a 50-52% reduction from 2005 levels in economy-wide net greenhouse gas pollution by 2030. In doing so, he has challenged the world to increase ambitions with respect to combatting climate change.
The Biden administration has proposed a 10-year extension to the production tax credit (PTC) and investment tax credit (ITC) for renewable energy. Not only are they proposing to extend the tax credit and change it to a cash refund, they also seek to widen the eligibility criteria for the federal investment tax credit (ITC) to include energy storage and green hydrogen projects, and transmission grid investments. While there is an expectation that the eventual policy settings will be watered down somewhat in order to successfully pass Congress, there is no denying the growing momentum to decarbonise the US economy.
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