By Tyler Rosenlicht, portfolio manager, global infrastructure, at Cohen & Steers
Conversations surrounding the world’s energy resources have become exceptionally controversial. Global consumers have a desire for clean, cheap, on-demand energy to fuel growth. Energy markets will get there, just later than many pundits expect. The expectation that renewables are ready to fully meet global rising energy demands is currently premature.
At the same time, the demise of traditional, carbon-intensive energy, such as crude oil and natural gas, has been exaggerated. Renewable energy—thanks to policies including the Inflation Reduction Act (IRA) in the US—has taken centre stage and will become the key growth driver.
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For the market to satisfy growth requirements and offset desired declines in “dirtier” sources of energy, such as coal, it must continue to complement alternative energy with selected traditional energy sources. Our belief is that traditional energy will still need to make up approximately 65% of total usage in 2040. The marketplace cannot and will not be dependent on one single energy source. Except for coal, we are in a “more of everything” world for the coming decades.
The drivers of energy demand
Energy demand can be modelled by making some key assumptions: both population and economic growth lead to more demand for energy, all else equal. And energy intensity of the future economy means new technologies are typically more efficient, meaning the economy can grow with less energy input. This can also be influenced by trends in OECD versus non-OECD countries and macro factors such as shifts in consumption from goods to services.
Simply put, wealthier countries and more service-oriented economies generally consume more energy than less wealthy, more goods-driven economies.
How to satisfy the growing demand for energy
Despite the emergence of renewables, the demand for traditional energy will increase meaningfully in the coming years to satisfy the growth in energy consumption.
The use of fossil fuels remains under heavy scrutiny for numerous reasons. Meanwhile, there are three drivers speeding up the development of renewables:
1. Costs. Renewable energy costs are becoming more competitive and are expected to continue declining.
2. Consumer preferences. Consumers are taking environmental considerations into account, electric vehicles being a prime example.
3. Government support. The recently-enacted IRA and other policy approaches offer substantial support for renewable development.
Looking ahead, we believe global energy markets can reach a place where: biomass and coal see significant declines (>50%); crude oil demand grows through the 2020s, then plateaus and declines during the 2030s; and all future growth comes from natural gas, nuclear and renewables.
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We estimate renewables must boost energy output by about 45,000 TWh – nearly the equivalent to the entire oil industry – from today’s count of 30,000 TWh to 2040’s predicted need of 75,000 TWh. But with capital, technology, and incentives, this is achievable and desirable. This will not achieve net zero goals, but it represents an outcome that is possible.
World of energy addition, not replacement
If the industry is to meet energy demand by 2040, record investments must be made. Simply put, the marketplace needs all the reliable clean energy sources available.
Technological advances must (and will) occur for alternative energy to be heavily relied upon, but it will take time. For example, energy produced by renewables cannot be stored for long periods of time due to limitations in battery storage technology, unlike traditional resources, such as oil, which can be stored, transported, and utilised on demand.
Further, a change in narrative is taking place as renewed attention is levied on domestic energy security due to geopolitical uncertainty. The need for dependable energy has never been more critical.
Investing in the overall energy picture
We see attractive opportunities in the future. However, most investment strategies take a zero-sum view, and limit their investment universes to either traditional energy companies, or new renewables opportunities. This is suboptimal and the definition of ‘energy’ needs to be expanded.
Traditional energy companies’ woeful stock performance during 2014-20 alienated investors, and the volatility of many renewables has left a ‘proceed-with-caution’ mindset. However, disruption is afoot. Amid attractive valuations, improving fundamentals, and better capital allocation, we believe active managers can provide superior returns.
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The traditional and alternative energy sectors have performed inversely in seven of 11 periods since 2013. We believe combining these can smooth volatility and create superior risk-adjusted returns. The menu of choices continues to broaden, enhancing the return opportunity and potential for alpha, particularly for active managers adept at managing through disruption.
In our view, investors should be taking a closer look at the energy sector with a wider aperture that recognises the new energy world.
