How to play the shift to net-zero emissions

The shift to renewables. We all know it’s coming. To meet net-zero emission targets by 2050, experts predict that we need to hit peak emissions by 2030. In just nine years we must begin a downward trend to lowered emissions. What this means for the already struggling energy sector is that a rapid overhaul is needed and needed soon. 

A major shift in global energy production is easier said than done. 80% of the world’s energy is produced by fossil fuels and the main priority for many of these nations is the recovery from the health and economic crisis brought on by COVID-19.

To navigate this difficult landscape set to undergo rapid changes, I spoke to three experts to determine how the coming shift to net-zero emissions impact the energy industry and its largest players?

Responses come from

• Daniel Sullivan, Portfolio Manager, Janus Henderson
  
• Tim Zhao, Equities Analyst, Lazard Asset Management
• Kanish Chugh, Head of Distribution, ETF Securities

Oil facing a major threat

Daniel Sullivan, Janus Henderson

Over the coming decades, the move toward net-zero carbon will see the consumption of oil greatly reduced. This has been witnessed in the shift away from coal and while oil has uses beyond energy, such as in plastics and polymers, there is also a shift away from single-use plastics due to their environmental impact, meaning the commodity could face pressure on two fronts. 

This will materially impact the industry and its largest players. As in all commodities, the lowest cost of production is a highly sought after and geologically and technically determined prize. The most competitive producers can survive and even induce downturns to weaken their competitors to gain market share. In the oil world, the risk of stranded assets (assets that aren’t economically viable) is extremely high. 

Old-world goods to peak then fall

Tim Zhao, Lazard Asset Management

The Australian Equity team at Lazard believe the energy transition will occur over the next 30 years in line with the net-zero emission targets of major energy importers. It is also critical to understand the very different starting points and trajectories between the eastern and western hemispheres.

Fossil fuel still accounts for over 80% of global primary energy consumption today and over 85% in non-OECD countries. For now, fossil fuels remain the backbone of global energy demand and supply shortages may actually be supportive for prices in the short term. The oil and gas industry, as an example, has now endured six straight years of relatively low capital investment. In simple terms, the world is adding far less resource than it consumes each year. This could result in significant upside risk for energy prices if demand overshoots in the short to medium term. We expect global fossil fuel demand and carbon emissions to peak in the next five to ten years.

From 2030-2050 we expect to see a tipping point for renewable energy and electrical vehicles with costs coming down faster and fit for purpose infrastructure improving. We believe we will see a more uniform carbon price globally including both developed and developing nations which will further accelerate the exit of coal and oil. This should be the boom period for large renewable players.

We believe gas is the only fossil fuel that will experience growth in this transition period – as gas can be supportive and complementary with renewables. Gas also has a much less carbon emission per energy unit when compared with oil and coal. Gas can also be used to produce blue hydrogen to displace oil and coal consumed in heavy industry to reduce carbon. We also expect to see further cost reductions in green hydrogen through the transition period. As many people have noted, green hydrogen is the Holy Grail to achieve the shift to net-zero emission targets by 2050.  

The biggest winners are outside the energy sector

Kanish Chugh, ETF Securities

Even under conservative projections of global warming, there is no bright future for fossil fuel businesses. And in a low-interest-rate environment, companies share prices are heavily impacted by the market’s reading of their futures, due to the way that discount rates compound over time. As such, we would expect that if interest rates stay low, and governments remain committed to cutting greenhouse gas emissions, that oil majors, coal miners and the rest continue to see their share prices fall. 

(Source: Source: ARK Investment Management LLC, 2020)

We believe the biggest winners of net-zero will fall outside the energy sector. That is, the real share price growth will be captured at other points in the value chain. One likely group of winners will be tech companies. Here, Tesla is a classic example. While Tesla is a car company, it is also playing a leading part in ending internal combustion engines. It is therefore crucially implicated in lowering greenhouse gas emissions. Indeed, part of the reason that its share price has surged the past two years is due to renewables uptake.

Another group of winners are likely to be mining companies. Lithium miners – Australia is the world’s foremost lithium producer – have seen their share prices surge as well in recent months, thanks to swelling demand for solar and battery materials. Galaxy Resources, based in WA, is one example. Pilbara is another.

(Source: Source: BP, Statistical Review of World Energy, 2020)

Summing it up

Our fundies see the shift to net-zero emissions to be a significant threat to the producers of old-world fossil fuels. But then one industry suffers, another grows, as tech companies and battery miners take the main stage to lead the globe to net-zero emissions.

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