With new technologies and the risk of regulatory intervention, there will inevitably be winners and losers, and single asset exposures will be increasingly difficult to manage.
Investing in energy markets just got a lot more complicated.
Cheap and reliable energy has been a key foundation for much of the industrial revolution that has driven higher living standards in Western economies. With the focus on climate change and the broad global commitment to net zero by 2050, the mix of energy production that will be required to drive continuing economic development will be very different.
While the goal is clear, the pathway to a stable new market equilibrium can be bumpy.
Policymakers understand the need to balance the economic, environmental and security goals of their energy policy. When then chief scientist Alan Finkel presented the Independent Review into the Future Security of the National Electricity Market in 2017, the report was focused on producing a system with increased security, reliability and, most importantly, lower emissions.
Much of the report centred on the blueprint for managing the transition to renewables in an orderly way, introducing better procedures for planning the system and a stronger governance framework.
The conflict in Ukraine and the global sanctions on Russia have sent oil, coal and gas prices to multi-year highs. In economics, higher prices might be painful in the short term, but they are an important signal to attract new supply or allow space for alternative solutions.
What is clear is that the supply side response in fossil fuel energy markets will be limited. Investment dollars have avoided coal, oil and gas over recent years as boards have become worried about their environmental, social and governance (ESG) credentials, shareholder activism and stranded assets. Even if approvals could be fast tracked, it takes years to establish and operate new projects.
Race to review reliability
With elevated fossil fuel prices likely to persist for some time, investors willing to own assets in these sectors are likely to be rewarded by strong dividend streams.
With disrupted energy supply chains, governments across the globe are racing to review the reliability of their energy supply – particularly countries such as Germany, which is heavily reliant on Russian gas.
Change is never easy and the transition to the net zero emissions world will not be a straight line. Governments need to balance the incentive for change with a consistent supply of base load power.
About half of Australia’s existing coal fleet in the national electricity market could retire as early as 2030. While this would make a wonderful contribution to bringing down emissions, it also raises significant challenges for the reliability and price volatility over the next decade. Price spikes and blackouts are a real possibility in a destabilised market.
A focus on dispatchable capacity on demand such as gas-fired power stations, pumped hydro and batteries will be needed to increase the reliability of renewables and level out volatility.
While Australia is the world’s second-largest producer of uranium, the debate about building nuclear power plants in this country has never gained much traction. Fukushima in 2011 and the recent Russian attacks on the Ukrainian plant at Zaporizhzhia have probably killed off that conversation for another generation.
The flip side is that there will continue to be strong demand for our uranium exports by countries with established nuclear industries.
The transition to net zero will include important investments in agriculture, clean tech innovation, energy generation and storage, hydrogen, infrastructure, property, transport and waste management. But the profitability of renewable investments can be challenging, and there has been extreme price volatility in listed renewable assets in many markets.
Along with the economics of renewables, there can be other significant non-financial issues to navigate. About 70 per cent of the global production of photovoltaic (PV) panels are produced in China – mainly in the Xinjiang province, which principally uses coal-fired power.
Transmission line investment connecting renewable power needs to be carefully planned, and the recycling of panels is emerging as a difficult issue. Onshore wind assets have attracted significant local opposition, and offshore wind assets are more expensive to build and maintain and are more prone to breakdowns due to tidal movements.
Hydrogen is gaining in popularity as an alternative energy source, although the economics around green hydrogen are quite prohibitive versus grey or blue (carbon capture) versions.
Along with lower-emission electricity generation, all sectors will improve the efficiency of their energy use, particularly the transportation sector which produces about 17 per cent of Australia’s emissions.
Electrifying cars, and light and heavy commercial vehicles is an important step in meeting Australia’s emissions reduction targets. Vehicles in the heavy transport sector have ultra-heavy payloads with high usage rates and cannot afford to be off-road recharging for extended periods. Investment in these assets and fast-charging capability is likely to attract decent returns over time.
With new technologies and the risk of regulatory intervention, there will inevitably be winners and losers, and single-asset exposures will be increasingly difficult to manage. It will be important for investors to adopt a portfolio approach to manage their risks across the energy investment spectrum.