The latest annual International Energy Agency (IEA) World Energy Outlook report, published on 27 October, argues that the Russia-Ukraine War has prompted governments, in aggregate, to target significantly faster adoption of Renewables.
The drivers for the IEA are a permanent loss of a portion of Russian oil and gas supply, which is not offset by increases elsewhere in production (and requisite supply infrastructure, particularly for gas) and a reluctance of some fuel importers to be so exposed to a concentrated source of supply.
Faster fossils-to-renewables shift, says IEA
On the basis of stated government targets, the IEA models that, by 2050, global energy supply will be driven 39% by fossil fuels, of which oil and gas account for 32%. A year ago, these figures were 53% and 42%, respectively.
In our view, the risks to even faster adoption of Renewables are the following.
Insufficient global coordination – agreeing to C02 emissions controls (eg total emissions or per capita ones, adjusted for stage of development, ie GDP per capita, or not) or cross-border compensation for climate change-induced damage (eg floods, droughts-wildfires) that incentivise adoption of cleaner energy.
Higher cost of financial capital – particularly in an environment of slower growth and higher cost of funding.
Insufficient political mandates – tolerance of the population (expressed either via elections or vested interest groups) to absorb higher costs (eg associated with the capex for renewables transition, higher fossil fuel prices as capex in fossil fuels is curtailed).
Environment scrutiny on renewables supply chain – greater regulatory scrutiny and cost associated with the supply of key inputs for the transition, eg local environmental damage wrought by metal mining and processing.
Geographic concentration in the current renewables supply chain – eg China has 75% of global battery cell production capacity and 97% of the production capacity of semiconductors used in solar panel photovoltaic integrated circuits.
It is worth noting that, even with more aggressive renewables targets this year, they still, collectively, fall well short of those required to achieve net zero C02 emissions by 2050.
EM equity investor dilemma
Whatever the time-frame, the transition from fossil fuels to renewables is, for emerging market equity investors, ultimately negative for hydrocarbon-endowed economies – eg Saudi Arabia-GCC and Nigeria – but positive for copper, lithium and nickel – eg Chile, Peru, Indonesia and the Philippines.
The dilemma for EM equity investors is that the transition phase is being accompanied by high prices for hydrocarbons, as global capex in the sector is cutback (ie higher cost of capital driven by the fear of ultimately stranded assets or of falling foul of ESG criteria).
And currently, commodities like copper, which are central to the renewables transition, are driven more by global, or specifically China, construction activity, which is under pressure from slowing global, specifically China, growth.
To a degree and in theory, Russia straddles both sides. But its position in hydrocarbons is greater in terms of share of global reserves, c5% of oil and c25% of gas, compared with c5% in copper and nickel. And, of course, sanctions (and, perhaps, price caps) resulting from the invasion of Ukraine are going to substantially impair its ability to monetise those natural resources.
For those EM investors with the luxury of a long-term perspective, we note that valuations relative to the historical average are much more attractive in the largest copper exporter equity markets (Chile, Peru) than in the largest oil ones (Abu Dhabi, Saudi Arabia).