By: Ken Locklin, Director, Impax Asset Management
Conventional wisdom can be seductive. Pundits are quick to predict that even the slightest shift in public policy breezes augur for imminent, wholesale change in direction. But, as fiduciaries we are called upon to make investment decisions grounded in reality, and based on rigorous, rational analysis. Reality is typically more resilient, and not necessarily deflected by policy zephyrs.
One reality that investors and policy makers alike face is the increasing impact of climate change. It increasingly impacts our physical world and significantly heightens investment risk. While these impacts impose challenges for investors in general, they simultaneously offer compelling opportunities for investors in climate solutions.
The incoming administration campaigned as pro-coal, climate change sceptics. But against these political headwinds, we see more powerful economic forces at work. The underlying drivers advancing many environmental technologies are increasingly beyond most regulatory intervention. And consumers are progressively seeking more sustainable products and services.
The broader environmental markets sector is in fact composed of 30 discrete sub-sectors. In our estimation, opportunities in all of those sub-sectors are set to expand as the broader economy inevitably responds to the challenges of climate change.
The new Administration appears to be all for lightening the burden of unnecessary regulation for American businesses, while reducing corporate taxes. Such changes could provide general economic uplift for all US investors. Rollbacks of more fundamental environmental laws such as the Clean Air and Clean Water Acts would prove more difficult, bolstered as they are by settled law and judicial precedent. There does not appear to be broad Congressional support for significant legislative shifts of this sort, and unwinding these laws cannot be undertaken by Executive action alone.
The infrastructure sector in general has been cited by incoming Administration officials as a top priority target for incremental Federal spending; poor water quality has been cited as a major issue and a priority for public investment. Other proposed infrastructure investment could include upgrading the nation’s power grid, which can have positive if indirect impacts for climate solutions investments.
Solid prospects across climate solutions
Enhanced energy efficiency remains attractive to commerce, industry and consumers alike. LED lighting, for example, is well on its way to displacing legacy incandescent systems. The US EIA tells us that LED’s will achieve 80% market penetration by 2040, and reduce US lighting energy consumption by almost half. This from a technology that had single digit market penetration at the beginning of this decade.
Energy storage is already poised for accelerating price declines, equivalent to drops seen in solar panel costs in recent years. Specialty power storage applications are cost competitive today in a variety of wholesale markets. Consumer demand is soaring, as evidenced by the sellout of the initial offering of the Tesla PowerWall home storage system. Experts anticipate US power storage deployment will increase 6X from current levels over the next 5 years, becoming commercially competitive and broadly disruptive.
Similarly, electric vehicles appear poised for a global market breakthrough, buoyed by the falling costs of their lithium ion batteries. We believe that up to a fifth of new vehicles worldwide could be fully or partially electric by as soon as 2025. Given the market’s competitive dynamics, we see the most interesting investment opportunities in the component suppliers to the industry rather than the vehicle manufacturers.
Many commentators have predicted dire outcomes for the renewable energy industry under the new Administration. But even here the potential for relevant climate solutions investment remains solid. In the US, the currently supportive tax incentives for the nation’s ongoing renewable energy buildout appear likely to survive unscathed. They were renegotiated only a year ago, are supported by significant bipartisan majorities and are already on a self-extinguishing path. Perhaps even more importantly, the increasingly attractive economics of onshore wind and solar power means that they can increasingly compete directly with coal- and natural gas-fired power generation on price alone, without subsidies.
Only the EPA’s proposed Clean Power Plan is expressly opposed by the new Administration. But state level support for renewables, historically the more important force in US clean energy market development, actually appears to have come through the last election cycle with enhanced prospects. In fact, a dozen states are already implementing their own programs which meet or exceed the proposed Clean Power Plan targets, including California which sets the tone for many other markets
Net/net, near term US clean energy prospects remain largely unchanged from prior levels. Perhaps even more importantly, the US represents only 16% of the global renewable energy market. Many other nations remain poised for further significant renewable growth. We see particularly interesting renewable project investment in Europe, with wind and solar farms offering long-term, inflation-linked returns. In 2017 we expect finalization of the European Union’s latest directives on energy and climate that target the cutting of greenhouse gas emissions 40% by 2030 (on 1990 levels). They call for improving renewable energy production by at least 27%, while simultaneously increasing energy savings by 27%.
Beyond the energy marketplace, there are also investment opportunities in helping companies adapt to the consequences of climate change. Water efficient manufacturing and processing, water recycling technologies, even increasingly cost competitive seawater desalination systems are all seeing rising demand. At the same time, sustainable real estate is also generating opportunities, with tenants and buyers increasingly seeking assets with higher environmental standards – and associated lower energy and water operating costs.
International climate action commitments continue
The new Administration has indicated a lack of interest in supporting last year’s Paris climate accords. While this would certainly be disappointing in climate impact terms, the mood at COP22 was defiantly optimistic in the face of negative US rhetoric. A number of factors explain this continued commitment. First, the science of climate change continues to become more compelling; record breaking high polar temperatures and associated ice shelf collapses are only the most recent indicators. Second, as we have seen, the economic opportunities presented by the clean energy transition are becoming increasingly attractive. Finally, the associated problems of local air pollution in many developing countries provide a persuasive reason to curb fossil fuel use.
Many developing markets would ignore these local pollution-related political realities at their peril. China in particular can’t afford to roll back its carbon emissions reduction targets for domestic commercial and political reasons. Recent record setting, fossil fuel-triggered urban air pollution has stirred domestic disruption like no restriction of civil liberties or abridgement of political rights ever has. Rather than reversing its carbon emissions reduction targets, China is maintaining its Paris Accord commitments. And it seeks to steal a march on the US by further expanding its commitment to clean energy technology research and manufacturing supremacy, as it has previously done in a number of other manufacturing sectors.
Given all these realities, investing in climate solutions clearly remains an attractive avenue for fiduciaries seeking to pursue sound, responsible investment strategies. While the new Administration may have effectively overturned much conventional US political wisdom, it has not yet overturned the laws of physics that have created climate risk. Charting an investment course by these realities, rather than being guided by vacillating policy predictions in Washington, will remain essential to prudent portfolio navigation.