The Russian invasion of Ukraine has shifted the landscape for the global energy sector, highlighting both the dangers of an energy policy based on sourcing fossil fuels from unfriendly nations and the need for greater security of supply. While this should shore up demand for renewable energy, it has also shown the extent to which the world remains reliant on fossil fuels and its infrastructure is unprepared for any transition.
The situation has also prompted a rehabilitation of some previously pariah industries. Notably, the nuclear industry’s role in the overall energy mix has been subject to some revision, with France’s ongoing commitment to nuclear energy helping it deal with the crisis far better than many of its European neighbours. This has prompted other governments to revisit their own approaches, although nuclear remains an excluded sector for many ESG-focused investment strategies.
The Ukraine crisis has prompted two immediate responses from policymakers: greater short-term commitment to alternative sources of fossil fuels and greater long-term commitment to renewables. In Europe, this has manifested as a short-term boost for another persona non grata of ESG – coal. Germany, Austria, France and the Netherlands have all delayed the scheduled closures of some coal-fired power plants and thinktank Ember estimates 13.5 GW of coal-fired power generation capacity has been placed on standby in Europe. The region has also turned to floating liquid natural gas (LNG) carriers as a temporary fix. These moves are designed to help EU countries meet a targeted short-term 15% reduction in gas demand and get member countries through the winter.
At the same time, this is accompanied by greater commitment to renewable energy. The European Commission is now targeting 45% of its energy mix from renewables by 2030. The REPowerEU plan was announced in mid-May and covers four main areas: energy efficiency, energy diversification, acceleration of renewables and smart grid investments. “The plan seeks to double solar capacity by 2025 from prior planned levels as well as doubling the rate of deployment of heat pumps,” says Mark Hume, co-manager on the BlackRock Energy & Resources investment trust. “Both would be positive long-term tailwinds for renewables.”
Speaking at September’s Green Deal Summit in Prague, executive vice-president Frans Timmermans, who is leading the European Commission’s work on the European Green Deal and its first European Climate Law, made clear the region’s commitment to renewables. “At the beginning of the war, the end of February, 40% of our gas came from Russia,” he said.
“Today, only 9% of our gas comes from Russia, which is quite an achievement, in quite a short period of time. The only way we can increase our energy sovereignty over the long run is by no longer being dependent on hydrocarbons. We have very little of our own gas, we have no oil, coal is really on its way out. So the only way to do that is through renewables and of course, in parts also through nuclear.”
It is a similar picture elsewhere in the world. The new government in the UK has outlined plans to grant new oil and gas licenses and lifted the moratorium on fracking for shale gas. Prime minister Liz Truss has also said, however, there will be investment in new sources of energy supply, including nuclear, wind and solar. In the US, meanwhile, the Inflation Reduction Act will direct around $370bn (£346bn) towards energy security and climate change, putting incentives in place to encourage the development of clean technologies, including significant subsidies for electric vehicles.
Benign backdrop
Most investors believe this is likely to be a benign backdrop for renewables, creating a supportive environment for investment. Isabella Hervey-Bathurst, global sector specialist at Schroders, points out that it is not all plain sailing, however. “The price of nickel, which is widely used in EV [electric vehicle] batteries, and aluminium, which is used in solar panel frames, cabling and EVs, have both risen as the Ukraine/Russia crisis has unfolded.
“Energy is a key input cost for these metals – particularly aluminium – and Russia is responsible for 7% of global nickel exports and around 6% of global aluminium exports, so there is a significant risk of supply disruption. Aluminium prices have risen by more than 20% in the year to date, having jumped almost 50% in 2021. Nickel prices meanwhile spiked dramatically as concerns around disruption to Russian exports were then compounded by a Chinese metals producer covering its short position.
“All of this means further cost headwinds for energy transition companies, which have already been struggling with higher costs following the pandemic – particularly in areas such as steel and logistics.” While demand is strong, then, margins may be under pressure.
Policymaker support also shores up the argument for improving energy infrastructure. The UK Government’s Energy Digitalisation Strategy report recognised the UK’s infrastructure needs to change, with better storage facilities to deal with the intermittency of renewables supply. “It’s getting the millions of low carbon-technologies across Britain talking to each other – solar panels, wind turbines and battery storage, to heat pumps, electric vehicles and smart appliances,” the report notes. The demand for new infrastructure has been reflected in share prices for related companies – 11 out of the 18 trusts in the renewable energy infrastructure sector have seen double-digit returns this year.
Here too, however, there are concerns. Rising interest rates are influencing the way the long-term cashflows from infrastructure assets are valued. This has hurt share prices in recent weeks as markets have started to price in higher interest rates in the UK and US. While this should not affect the long-term demand for energy infrastructure, it could dent share prices in the short term.
Fossil-fuel dilemma
The current environment also creates a dilemma for investors on fossil fuels. The major energy companies have been among the only strong performers over the year to date and excluding them from a portfolio has hurt investor returns. What is more, they are also major players in renewables in their own right.
BP owns Chargemaster, for example, which operates 6,500 EV charging points across the country, while Shell has ambitions to be a major player in the nascent hydrogen technology industry, developing integrated hydrogen hubs to serve industry and heavy-duty transport. Even long-term environmental laggard Exxon has been investing in carbon capture technology. The Russian invasion of Ukraine has handed the energy companies a significant cash windfall and it is plausible they will continue to make renewable commitments.
A recent Morningstar report into the energy sector shows fund management groups wrestling with this dilemma. A decade ago, energy stocks stood at 11% of the Morningstar Global Equity index, but this had dropped below 3% by late 2020. The war in Ukraine has since seen them tick higher – to around 5% of exposure in the index – but the average global equity manager is still underweight even at this level, with around 4% exposure.
Morningstar believes that ESG considerations are still deterring global managers from investing in traditional energy companies, but sees scope for Article 9 funds to invest in companies that are improving their ESG credentials, growing their revenue from renewables while gradually reducing their reliance on their historic fossil fuel business.
One final consideration for investors is, if the crisis goes away tomorrow, will the energy complex simply revert to ‘business as usual’? Will governments across the world quietly drop their commitments to renewables and revert to traditional sources of fuel? Amin Nasser, the CEO of Saudi Arabia’s state oil giant Aramco, recently said that an end to Russia’s war in Ukraine would do little to reverse rising energy costs, and that underinvestment and poorly thought-out energy transition policies were the root cause of problems in Europe.
“When you shame oil and gas investors, dismantle oil and coal-fired power plants, fail to diversify energy supplies – especially gas – oppose LNG-receiving terminals, and reject nuclear power, your transition plan had better be right. Instead, as this crisis has shown, the plan was just a chain of sandcastles that waves of reality have washed away. And billions around the world now face energy-access and cost-of-living consequences that are likely to be severe and prolonged.”
The Ukraine crisis looks to have exposed the naivety of energy policy across the globe and it is to be hoped a more robust, better-considered approach will take its place. Having received such a jolt, even if the Ukraine conflict resolves quicker than expected, it seems unlikely world governments would be so foolish to revert to business as usual. The energy complex is in flux and this should create real opportunities for investors on the right side of this change.
