Change or decline: the acceleration of the net zero transition, in three charts
We’ve all done the question in our history exams: “What caused [a major historical event]?”. And the answer is never – the Boston Tea Party, or the assassination of Archduke Franz Ferdinand. The roots of big events lie much further back.
The same holds true for the net zero transition. The big breakthroughs we need in the years ahead are underway and accelerating – and governments and investors need to get ahead of the curve.
We’ve already seen how it works in energy policy: in my time in government, I helped introduce the Capacity Market – an intervention in the electricity market designed to keep the lights on by providing additional revenue to providers of reliable capacity.
Its introduction was not without controversy – many argued that it wasn’t needed. But it went ahead. And if you read the government publications, the decision to introduce a Capacity Market was taken in July 2011.[i]
But in fact, the decision was an inevitability earlier than that, in the Coalition Agreement of 2010. Hidden away on page 16 was the statement that “We will reform energy markets to deliver security of supply”.[ii]
The smart investors read that; saw the way the wind was blowing; and adjusted their strategies accordingly. While the decision wasn’t taken in 2010, the direction of travel was clear, and the outcome inevitable. The introduction of a Capacity Market was confirmed, and investment flowed.
The same logic applies to the transformation of our economy to reach net zero. While all the policies are not in place – and there is much still to do – the stars are aligning for a rapid acceleration in the transition. The new commitments from the US, China, EU, UK and others; the rapid fall in costs of key technologies; and the increasing public pressure for action, all mean the direction of travel is clear.
The key question now is how governments, markets and investors respond to seize the growth opportunities – identifying where and how to secure domestic growth, and capitalise on falling costs. Those who act quickly, by investing to drive the development of new markets instead of pinning hopes on those in decline, can surf the wave; those who do not will be engulfed by it.
Chart 1: Vehicle purchases in Germany, 2020
But catching the wave means moving fast. Three trends illustrate just how quickly change is happening.
First, in electric vehicles. Battery and plug-in hybrid vehicles massively outperformed the rest of the market in German car sales – with a market share more than four times larger in 2020 than 2019. This is what Michael Liebreich calls “the sneeze” – “The first 1% takes forever; 1% to 5% is like waiting for a sneeze – you know it’s inevitable but it takes longer than you think; then 5% to 50% happens incredibly fast.”[i]
As battery costs continue to drop, range increases, charging times fall, consumer experience improves, and charging infrastructure expands, we can expect this trend to accelerate in the next five years. So investors and policy makers need to treat this as a change that is happening – not one that might happen – and respond accordingly.
Chart 2: wind deployment in China
The UK’s total installed wind capacity is around 25 gigawatts. In 2020, China installed almost treble that in one year. While there’s a few things going on here – including installations to access subsidy regimes at the end of the year – the trend is clear. And this is before the market has had time to respond to the Chinese commitment to hit peak emissions by 2030, and net zero emissions by 2060, made in September last year.
Chart 3: price to earnings ratio in the energy sector
The third chart shows the price to earnings ratio of Orsted, the Danish energy utility; Vestas, the wind turbine manufacturer; and key oil and gas majors. Orsted has pivoted its business model from oil and gas to renewables and is reaping the rewards. Vestas is benefiting from the rapidly growing global deployment of wind power. Those companies still principally focused on oil and gas have seen nothing like that level of optimism. They will need to respond fast or risk being left behind.
Source: Factset; © FT; https://www.investorschronicle.co.uk/ideas/2020/12/30/oersted-has-the-wind-at-its-back/
What it means
Three factors - the falling costs of technologies like wind and electric vehicles; governments’ commitments to net zero and ambitious 2030 goals; and investor behaviour – all point in one direction: the economic transition to net zero is happening. This doesn’t mean the transition will be easy, or happen as quickly as the climate emergency demands without decisive action – this year’s COP26 summit will be crucial in upping the pace. But it is gathering momentum at breakneck speed.
Governments and investors need to treat the net zero transition not as a possibility, but an inevitability – and plan accordingly. Those in the forefront of this revolution – governments, investors, and businesses – can access new domestic and global markets, and deliver growth based on the sectors of the future, not those of the past. Change, or decline.