A different approach to gaining access to growth in clean energy

17 June 2022

Markets have seen a rough start to 2022 with inflation levels higher than expected, rising interest rates, and continued global supply chain disruptions amplified by China’s zero-Covid policy. In addition to this, the escalation of the Russia/Ukraine conflict has highlighted the world’s heavy dependence on fossil fuels as our main source of energy. It’s become clear that we have not been transitioning to lower-carbon fuels quick enough to meaningfully reduce this reliance, even though the theme of clean energy has been gaining momentum for years now.

We expect that recent events will see even more investment go into clean energy, at an ever more urgent pace, which makes it a great secular growth trend to gain exposure to for long-term equity investors. Countries globally are embarking on clean energy projects which will see clean energy companies benefit from increased investment and government incentives for many years to come.

Unfortunately, the excitement around such secular growth opportunities has, in our opinion, been priced into many clean energy companies already. Investors may be at risk of paying too much for the growth expected, especially as interest rates rise and in turn, the fair value of growth companies retreat. We have already seen the iShares Global Clean Energy ETF fall back quite a bit after rising by 300% in under a year from the lows of the pandemic.

IShares Global Clean Energy ETF

We believe that there are ways to avoid paying high prices to gain exposure to the green energy theme. We seek out companies which will indirectly benefit from the expected growth in the sector, however, trade at more attractive valuations. One area of particular interest in this regard are electrical companies. These companies will benefit from several secular trends that we are seeing in the world today. The drive towards a sustainable future, the clean energy transition, increased connectivity, and more things becoming electrical are key to driving electrification over the next 20 years.

Electricity is the fastest growing source of final energy demand, and it’s expected to outpace overall energy consumption growth over the next few decades. BP’s Energy Outlook sees electricity going from 20% of the energy consumed today to around 40% depending on the low-carbon path the world ends up taking, as indicated in the chart below. The reason for this expected growth in demand is because electricity will play a pivotal role in decarbonisation as it can be generated with a relatively cleaner energy mix versus other sources of energy. Further to this, low-carbon energy sources will increasingly be used to generate electricity thereby making it an even more attractive sector to grow as we decarbonise.

The benefit to electrical companies is that globally we will need to expand, modernise and digitise our electrical grids to support this growth. A recent report by Bloomberg New Energy Finance estimates that to keep pace with renewable energy additions, the annual power grid investment will need to increase from roughly $235 billion in 2020 to $636 billion by 2050 as we move to a more decentralised grid. In the past electricity has flowed in a linear fashion from the power utility along transmission lines to the distributor. The nature of renewable energy is different in that solar energy is generated where the sun shines and wind energy where the wind blows. As such, the electrical grid is becoming far more decentralised with renewable energies attaching to the grid at different points. These increased connections create more demand for the products and services of electrical companies.

Electrical companies which employ technology to collect, aggregate and analyse data from the electrical grid will also benefit from efforts to make energy usage more efficient and more reliable by selecting where the cheapest and most reliable source of energy is at any point in time.

The growth of electric vehicles also means more business for electric companies as they have much more electrical content than an internal combustion engine vehicle. In addition to this, for electric vehicles to be a viable solution to petrol cars we need to invest in infrastructure such as electric vehicles chargers. Office buildings were not originally set up to take the electric load of several electric vehicle charges and as such, we should see electrical companies benefitting from the retrofitting of commercial buildings in order to install these chargers.

Eaton content per light vehicle

Source: Eaton Group Presentation

As we decarbonise there will not only be a push to use clean energy as a preferred energy source but using less energy will be a focus too. Buildings and industry are the largest consumers of energy and we have seen and will see further regulation and government incentivisation to drive energy efficiencies through retrofits or new build standards. The EU alone has plans to improve energy efficiencies in 35m existing buildings by doubling the renovation rate from 1% to 2% which will mean more business for electrical companies.

A final point worth mentioning is the immense growth we are seeing in hyper-scale data centres which are very energy intensive. The electrical content of these data centres is high but so is the spending to make these facilities as energy efficient as possible due to their high energy usage. As we create more and more data, the expected growth in these centres will continue to be a benefit to electrical companies.

There are a few global electrical companies that are worth taking a closer look at to gain access to these trends. One such company is *Eaton Group, a power management company which produces electrical products for residential, commercial and industrial construction, utilities, vehicles, and aerospace. It also helps customers manage electrical and mechanical power with efficiency and safety. Eaton is diversified across its product range and regionally and is among the top four large global players in the worldwide low-medium voltage electrical industry with the strongest distribution network in the US.  Eaton is well-aligned with the global secular trends of electrification, digitalisation and the energy transition and does not trade at a hefty valuation.  

It's not an easy time to be optimistic when markets are heading south, and global growth is slowing. However, secular trends such as the growth in clean energy will persist regardless of economic slowdowns and cycles. It’s worth being prudent though, on how much you want to pay to access these opportunities directly - there may be more attractive ways, as described above, that are not conventional.

*Ashburton Investments holds Eaton Group stock in the Ashburton Global Leaders Equity Fund.