“I wish there were a painless way [to reduce inflation]. There isn’t.” Jerome Powell, US Federal Reserve Chairman, September 20221
And boy has it been painful as the Fed, along with central banks around the world, accelerated their fight against stubbornly high inflation. The 230bps move higher in the US 10-year interest rate since the beginning of the year2 has been the steepest and most destructive shift higher since the index was created, leading to the dual collapse of both equity and fixed income markets.
In retrospect, the surge in inflation should not have come as a surprise. First you take huge real-world supply shocks triggered by a global pandemic and subsequent lockdown, then add a war between two of the world’s most resource-rich nations. Finally, you combine this with a phenomenal demand boost from central banks combining forces with fiscal policy to flood their nations with cash to create a severe demand/supply imbalance which has squeezed prices higher across most segments of the economy.
Through what has been another quarter dominated by macro and geopolitical factors, we did also see positive sustainable developments with a strong step forward in the US climate transition with the passing of the Inflation Reduction Act. We delve into this deeper below.
Sustainable theme focus: The climate transition – policy and economics combine as a powerful force for change
There is a reason the world transitioned to oil and gas from around 1940-1970: they offered a reliable and cheap energy source to diversify away from the reliance on coal. Since the discovery of oil in the US Permian basin, the world has enjoyed both plentiful and cheap energy to drive its economic growth. Sadly, the true economic cost of fossil fuels has not been reflected in their price, i.e. the negative impact of their emissions on both the environment and the health of populations.
Despite climate rhetoric, governments have generally done very little to curtail fossil fuel consumption as access to cheap energy has supported economic growth. Suddenly, however, fossil fuels are not as cheap or as plentiful as they once were. In fact, with the recent surge in natural gas and coal prices, clean energy is now by some margin the lowest cost source of new-build utility scale power across the world (Figure 1).
Figure 1: energy cost comparisons
Source: IRENA, Renewable Power Generation Costs, July 2021. Fuel-only generation costs for coal and gas for 2022 relative to the levelised cost of energy (lifetime costs including capital costs versus energy production) of new solar, onshore and offshore wind power projects commissioned in 2021
This has started to accelerate investment into clean energy. In the EU, for example, an increase in wind and solar power capacity meant clean power covered 24% of the bloc’s energy needs between March and September this year – the highest ever for the six-month period. It has also resulted in economic savings of €11 billion from avoided gas imports4.
In addition, we have seen vital progress this quarter in terms of policy support for the climate transition, which has reinforced the relative economic case for renewable energy.
In August, the Indian government finally approved an updated national climate plan under the Paris Agreement. This sets out the framework for the country’s transition to cleaner energy from 2021-2030 and its commitment to slash the emissions intensity of its GDP by 45% by 2030 from 2005 levels, versus its previous target of 33%-35%. A key part of this decarbonisation framework is to achieve the installation of about 50% cumulative electrical power capacity from non-fossil fuel-based energy resources – wind, solar, nuclear and hydro – by 20305.
But it was in the US that we saw the most significant milestone in climate policy support. In August, President Biden secured a major win with the passing of the Inflation Reduction Act (IRA) into law. Through a policy of sizeable tax credits and financial support, the act incentivises the deployment of clean energy supply and transformation of energy demand across sectors that are key to decarbonising the US economy – namely the power, transportation, construction and agriculture sectors. Under the guise of combatting inflation through access to cheap energy, a key goal of this legislation is to put the US on a path towards its target of 40% emissions reductions by 20306.
The Act provides at least $369 billion in support over the next decade for renewable energy, green hydrogen, electric vehicles (EVs), carbon capture and storage (CCS), energy efficient buildings and sustainable agriculture (Figure 2). Key to this is that for at least the next 10 years, companies will have visibility of government tax credits. This provides a sizeable boost to the economic attraction of renewable energy and other green technologies, which is vital to drive their adoption. Given the uncapped nature of tax credits and the multiplier effect of federal grants and loans, it is estimated that private investments and green financing programs could propel total spending to nearly $1.7 trillion over the next decade.7
Figure 2: major areas and spending of IRA climate provisions
Source: Committee for a Responsible Federal Budget, September 2022
By introducing a clean hydrogen production tax credit the IRA also supports domestic hydrogen production, helping to make the cost of green hydrogen in the US among the lowest in the world. Green mobility also gets a significant boost from the expansion of subsidies for consumers of domestically produced EVs. This scaling of green hydrogen and EVs will in turn drive higher demand for clean energy sources, providing further tailwinds for the sector.
Another important aim of the IRA is to make the US a global leader in clean technology and reduce its heavy reliance on China in its solar and battery supply chains. It does this by incentivising domestic manufacturing of solar panels, wind turbines, batteries and EVs. While the US already has the key ingredients to be a leader in clean technologies, including access to natural resources, infrastructure and technology talent, the IRA provides the catalyst for greater investment in both early- and late-state clean technologies, allowing it to challenge China’s current dominance.
In addition, Korean battery manufacturers such as our holding in Samsung SDI10 should benefit from strong growth in US demand for their EV batteries and stationary storage batteries for renewable grids. This should also affirm Samsung SDI’s plans for a $2.5 billion battery factory in Indiana11.
Ultimately, the holy grail for any energy system is to offer cheap, reliable power without greenhouse gas emissions. Renewable energy now solves for two out of those three – it is cheap and clean. Sadly, however, it is not yet as reliable as we would like, suffering from both daily and seasonal intermittency. Battery storage can help with daily intermittency but remains expensive to scale, and while hydrogen fuel cell storage may provide a long-term solution, the technology is still in its infancy.
So given current technology limitations, renewables cannot yet meet 100% of our energy needs. But coal, the most polluting of all fossil fuels, can have no future role in energy systems, while methane emissions from natural gas limit its role to that of a transition fuel. We are, however, seeing a growing trend of renewed support for nuclear power which can provide a reliable, emission-free base energy source with innovation limiting safety and waste risks:
- The IRA offers new tax credits to existing nuclear plants to keep up to 20GW of nuclear online by 2030 that would otherwise have been shut down
- Countries across Europe are either extending the life of existing nuclear plants (Germany, for example, which historically has been heavily opposed to nuclear energy12) or investing in new “clean” nuclear power stations ( for example, France building 14 new nuclear power stations13)
- In July, the EU parliament approved the taxonomy proposal to add nuclear as a taxonomy-aligned activity, subject to rigorous checks around safety and waste disposal14
Ultimately though, even renewable energy has an environmental cost – the equipment and batteries used for renewable grids are both mineral and carbon intensive to produce, while solar and wind farms utilise extensive amounts of land. As such, unchecked energy consumption – particularly in western economies – fueled by access to cheap energy needs to end. This has already been put in motion by the current energy crisis, and it is a process that will involve some social sacrifices – and we all have a part to play in that.
Company Q322 engagement highlight
We have had a busy quarter, meeting with our holdings’ management teams. Here we highlight one particularly interesting company meetings:
Company: Schneider Electric
Sustainable Theme: Energy & Climate transition (SDG 7, 12, 13)
Sustainable Category: Leader
Although there are concerns around the impact of an economic downturn on demand for Schneider’s products, management noted that the structural demand for energy efficient solutions remains robust given the energy crisis. In fact, the current need for such solutions in Europe has cut the payback period for Schneider’s products from between three and five years to one year, making them more attractive for customers. In addition, European stimulus plans, namely RePower and Fit for 55, stipulate energy efficiency targets by sector, which in turn is supporting adoption of Schneider’s solutions.
The meeting really highlighted the crucial role that Schneider plays in helping customers achieve both their energy security and decarbonisation targets. As such, management have been able to increase their growth outlook for the year despite a weakening macro environment.
Threadneedle Global Sustainable Equity Composite
GIPS Report: Columbia Threadneedle Investments EMEA APAC
Reporting Currency: USD
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Inception Date 31.12.2018