Expect choppy waters as we navigate a just transition

16 February 2022

As ESG (Environmental, Social and Governance) momentum gathers pace, investors and consumers should brace themselves for the inevitable costs that the energy transition will bring.

We are already starting to see the first waves of the ESG storm breaking around the world. One has to look no further than the recent power supply crisis in California or the record energy price increases in Germany over the past year to see the real-world examples of how the most aggressive green policies can manifest themselves in everyday life.

But few can argue against the spirit behind current ESG efforts.

There is a real urgency required to stem the harm that mankind is having on the environment. However, this does not mean that we should lose sight of some of the practicalities required to reach the desired end state. A level of pragmatism is required to ensure that our energy transition in managed in such a way that we balance the urgency of the problem and the inevitable cost of transitioning away from hydrocarbons. Without a level of pragmatism, costs will spiral out of control, and we will risk losing broad public support of the ultimate important objective.

Investors too need to be ready to navigate their way through the inevitable financial market imbalances related to this transition. The current spike in oil and thermal coal prices are evidence of the type of volatility that the lack of greenfield investment into new replacement hydrocarbon capacity can have on commodity prices. When you consider coal’s share of the world’s installed baseload power generation capacity, there was an element of inevitability to recent energy price increases. Unfortunately, the sun does not shine 24-hours a day and wind is variable. These factors, coupled with the current cost of energy storage technologies and budget constraints, makes the goal of completely displacing coal from the global baseload energy mix in the immediate future unrealistic. This is especially true while nuclear power remains somewhat of a pariah when it comes to acceptable solutions to future energy needs.  

As is often the case, market participants tend to overestimate the impact of new disruptive technologies in the short term but underestimate their long-term impact. Given the amount of capital and research going into new greener energy solutions, there is no doubt that the cost and efficacy will see dramatic improvements over the coming decade. A few years from now, these new less carbon intensive sources of power may well be able to meet more of our baseload power requirements - both from a reliability and affordability point of view. However, the period in between is likely to remain extremely volatile.

Developed markets will need to step up to the funding plate.

Much of their populations’ generational wealth was built on the back of the carbon intensive industrialisation of their economies. It is unrealistic for them to now expect emerging market populations to foot the bill required to convert existing baseload generation capacity to greener alternatives in the immediate future - especially as large swathes of emerging market populations are living on the breadline.

In South Africa, our economy is already struggling to absorb the significant electricity price escalations that have been required to rehabilitate Eskom. Energy and transport make up a significantly greater share of the average South African households’ monthly budget. Our ability to continuously absorb double-digit power cost increases is considerably less than our wealthy developed market counterparts.

Markets are complex systems with multiple feedback loops. ESG is a new and evolving driver affecting market sentiment and hence asset prices.

Investment managers will need to be nimble when deploying capital into such a volatile environment. They will need to take care not to get swept up in the hype of new technologies and solutions which lack substance and only play to prevailing sentiment. At the same time, they need to realise the importance of their role in ensuring that the companies in which they invest make tangible efforts to reduce immediate environmental harm and play their part in transitioning responsibly.