In the latest report from the Intergovernmental Panel on Climate Change, there’s precious little room for error in our collective efforts to fix the worsening climate problem that humankind has created.¹ At this point, we can only hope that the world’s most serious efforts to combat climate change—backed by real commitments, policies, and funding—will be successful in turning the tide of this gravest of threats facing humanity and the world.
What’s driving the current global shift to combat climate change?
We see two primary drivers causing a global shift in sentiment around climate change. First, climate change is no longer perceived as a theoretical concept; it’s happening right now. According to the U.S. National Oceanic and Atmospheric Administration, the 10 hottest years on record have all occurred since 2005,² and the years of 2014 to 2020 have been the top 7 hottest. While no individual storm or weather event can be tied to climate change, scientists are increasingly pointing to the impact of global temperatures on storm intensity and frequency.³
For example, in February 2021, millions of Texans were huddled in dark, frozen homes as the state suffered a major power crisis, as a result of three severe winter storms that swept the country. While there are many reasons for the failure of the state’s energy grid and generation capacity, climate change is almost certainly one of them.⁴ As the lights slowly came back on and pipes thawed in Texas, the New York Times published a devastating catalog⁵ of infrastructure failures caused by erratic weather that drinking water and sewage plants, pipelines, dams, roads, and the electric grid weren’t built to withstand, but increasingly are subject to.
Similarly, within a single week in late August 2021, Americans in different regions simultaneously dealt with catastrophic, deadly flooding in Tennessee, severe drought leading to water restrictions in the Colorado River basin,⁶ raging fires across California threatening Lake Tahoe,⁷ Hurricane Ida toppling all of the electric grid transmission lines into New Orleans leaving the entire city dark, and days later the storm’s remnants flooding the New York City subway system.⁸ While meteorologists and the media were previously hesitant to attribute any particular event to climate change, the tide seems to have turned, and news outlets are increasingly pointing out the link between climate change and the intensity and frequency of extreme weather events.
Second, the tools to combat climate change—electrifying our economy, powered by renewable energy—are now economic and cost competitive with fossil fuels. According to the International Renewable Energy Agency, between 2010 and 2019, solar PV⁹ energy costs fell 82% and onshore wind fell 39%.¹⁰ Solar and wind are increasingly becoming cost competitive¹¹ with existing fossil fuel generation and are expected to be 70% of new generation in the United States in 2021.¹² And of course, electric vehicles (EVs) are rapidly becoming mainstream, with GM pledging an all-electric future¹³ and Ford doubling production plans¹⁴ for the much-awaited electric version of its iconic F-150 pickup truck.
Solar and wind are expected to be 70% of new generation in the United States
Source: U.S. Energy Information Administration, January 2021.
These factors together create a perfect storm for the much-needed shift in the way investors understand the markets they work within. As the results of the 2020 elections became clear, investors were quick to react. Many green stocks, such as renewable energy companies, suddenly began trading at high valuations, having quickly attracted investor attention.¹⁵ These obvious company examples are unlikely to be the only beneficiaries of the electric revolution, as we expect the change from a combustion-based economy to an electric one will be similar to the transition from the analog economy to the digital one. It’ll touch many aspects of people’s lives, and we expect there will be a lot of invention and creative destruction—and therefore investment beyond renewable energy stocks.
In the transition from a combustion-based economy to an electric one there will be a lot of invention and creative destruction—and therefore investment beyond renewable energy stocks.
Opportunities and disintermediation due to electrification
By now, it’s well understood that combusting fossil fuel in a home has negative climate and health impacts. A recent academic study found that fossil fuel pollution causes one in five premature deaths globally, and that the northeastern United States, where many homes rely on natural gas for cooking, is one of the most affected areas.¹⁶ Electrifying homes may therefore have climate benefits, as well as direct indoor air-quality benefits for residents. It’ll also give traditional heating, ventilation, and air-conditioning and appliance manufacturers reasons to expand their sales and integrate themselves into customers’ lives through future service agreements.
Similarly, EV charging at home will give utilities the opportunity to expand their relationship with customers and take share of the energy budget that’s normally spent at gas stations. This presents opportunities for companies making charging infrastructure, as well as the ones making EVs. In addition, upgrading the power grid to prepare it to manage two-way flows of electricity may provide many opportunities for component companies, grid specialists, consultants, and data managers.
The flip side of opportunities is disintermediation, and just as we saw during the digital revolution, there will be companies facing potential risk in the electric revolution. Two decades ago, the presence of a video rental shop was something that made a neighborhood livable and attractive. Now, referencing Blockbuster Video is a shorthand way of referring to a time that predates the digital revolution. In 20 years, will people marvel that we stood around breathing toxic fumes next to giant tanks of flammable fuels at gas stations, instead of using excess wind energy on the grid to charge car batteries at night? While we think that's not a far-fetched scenario, few traditional energy companies in the United States seem to be doing anything to avoid being the next Blockbuster.
In 20 years, will people marvel that we stood around breathing toxic fumes next to giant tanks of flammable fuels at gas stations, instead of using excess wind energy on the grid to charge car batteries at night?
Exxon, for example, recently made a splashy announcement about dedicating billions of dollars over the next few years to green technologies. However, the commitment amounted to only about 5% of annual CapEx¹⁷ spending, while the other 95% will continue to be spent on drilling for the same oil and gas its historically sought. We believe that won’t be enough for Exxon to last as a large company as the electrification revolution unfolds, and definitely not enough to help reverse the worst effects of climate change.
Some market participants, perhaps less skilled at separating substantial corporate sustainability actions and commitments from marketing ploys, recently heaped praise on Exxon, creating the sense for end asset owners and beneficiaries that their portfolios are prepared for the electric revolution. But other investors didn’t fall for Exxon’s greenwashing attempts and successfully pressed for change at the company’s board.
A road map to the electric revolution
We believe combating climate change through the electric revolution will touch every aspect of our lives and the economy, and every type of company and investor needs to plan accordingly. Insurers will struggle to rely on existing actuarial tables as physical climate risks change. Banks are already facing consumer and investor pressure about what they’re funding. We foresee food companies’ supply chains becoming vulnerable to shifting physical climates, resulting in new opportunities in different locations around the world. We believe healthcare will also likely need to adapt as health risks shift—for example, as tropical diseases become endemic in regions not historically considered tropical. The Zika virus outbreak in 2017 cost Florida’s Miami-Dade County¹⁸ alone $1.6 billion in lost taxes due to decreased hotel revenue, not to mention the impact on airlines, restaurants, and retail sales.
Over the next few years, we believe the electrification revolution will pick up steam as the economics of clean energy continue to be competitive with or surpass that of fossil fuels, and as the threats of climate change continue to fuel action by policymakers. We believe this presents investors with a unique opportunity and challenge.
Sustainable investors, who already take a holistic approach when analyzing company performance, seem better prepared, in our view, to face the future’s risks and take advantage of its opportunities. In our opinion, all investors will have to account for the impact of physical risks and policy changes due to climate change, understand the transformative power of emerging business opportunities, and navigate a minefield of stranded assets and fading business models. In light of these changes, we believe that sustainable investment analysis will be more critical than ever before in the years ahead.
1 “Sixth Assessment Report of the Intergovernmental Panel on Climate Change,” Intergovernmental Panel on Climate Change, August 2021. 2 “More Near-Record Warm Years Are Likely On Horizon,” National Centers for Environmental Information (NCEI), noaa.gov, January 29, 2021. 3 “Global increase in major tropical cyclone exceedance probability over the past four decades,” Proceedings of the National Academy of Sciences of the United States of America, pnas.org, June 2020. 4 “Texas Power Outage Crisis A Foreboding Sign Of Climate Change,” The Organization for World Peace, February 2021. 5 “Texas Blackouts Point to Coast-to-Coast Crises Waiting To Happen,” The New York Times, February 2021. 6 “Anatomy of a drought: How the West may change for decades to come,” Deseret News, deseret.com, August 2021 7 “Caldor fire continues to rage outside South Lake Tahoe,” The Washington Post, September 2021. 8 “Flooding From Ida Kills Dozens of People in Four States,” The New York Times, September 2021. 9 Photovoltaics (PV) is the conversion of light into electricity using semiconducting materials that exhibit the photovoltaic effect, a phenomenon studied in physics, photochemistry, and electrochemistry. The photovoltaic effect is commercially used for electricity generation and as photosensors. 10 “How Falling Costs Make Renewables a Cost-Effective Investment,” International Renewable Energy Agency, June 2020. 11 “Renewable Energy Prices Hit Record Lows: How Can Utilities Benefit From Unstoppable Solar And Wind?” Forbes, January 2020. 12 “Renewables account for most new U.S. electricity generating capacity in 2021,” U.S. Energy Information Administration, January 2021. 13 Committing to an All-Electric Future | General Motors (gm.com) 14 “Ford doubles Lightning production target on strong pre-launch demand,” Reuters, August 2021. 15 “How Sustainable Is the Rally in Renewable Energy Stocks?” The New York Times, January 2021. 16 “Global mortality from outdoor fine particle pollution generated by fossil fuel combustion: Results from GEOS-Chem,” Environmental Research, February 9, 2021. 17 Capital expenditures (CapEx) are funds used by a company to acquire, upgrade, and maintain physical assets such as property, plants, buildings, technology, or equipment. CapEx is often used to undertake new projects or investments by a company. 18 “Zika's impact on tourism,” International Travel & Health Insurance Journal, itij.com, April 2019.