ESG At A Crossroads: Time For A New Risk Direction
PGIM Quantitative Solutions discusses why meaningful ESG investment results require risk management and transparency.
As governments around the world pursue long-term carbon-reduction policies, investments in renewable energy and related technologies are expected to soar. It is estimated that the United States’ net-zero carbon emission goals will require $2.5 trillion of incremental spending over the next decade.1Meanwhile, Europe’s “Fit for 55” initiative reflects its target of reducing net greenhouse gas emissions by at least 55% by 2030,2 an effort that will also require significant capital expenditure. Even more conservative estimates like the International Energy Agency’s Stated Policies Scenario3 (which assumes that many governments will be unable to fully meet their current carbon-reduction goals) show a dramatic increase in spending for renewable energy and associated technologies over the next several decades.
The bottom line is that the energy transition represents a tectonic shift in supply and demand that goes far beyond power and transportation. For example, meeting carbon-reduction goals will require an overhaul of existing infrastructure and the modernization of buildings and factories across the global supply chain. The energy transition will also increase demand for a different set of commodities like lithium, copper, cobalt, and nickel, which are key inputs for the transition to cleaner technologies. In addition, the technology required to improve efficiencies and costs, as well as to store alternative sources of energy like wind, solar, and hydrogen, will evolve over time.
Given the massive scope of the energy transition, a full pivot is expected to take a very long time. It is also important to note that fossil fuels like oil, gas, and coal are not expected to be fully replaced. Rather, estimates suggest these energy sources will not grow at the same pace as renewable energy (Exhibit 1).
As Exhibit 1 shows, petroleum-based fuels are expected to remain a critical component of overall energy supply. Renewables, while rapidly growing, are still a relatively small part of the current energy mix and, as the energy transition unfolds and evolves, an “all of the above” approach to energy production will be needed to meet demand.
The resulting shift in commodity market supply and demand dynamics will undoubtedly pave the way for new winners to emerge in the renewable energy space. At the same time, the opportunity set among oil and gas companies will also evolve as more mature companies race to keep up with sustainability trends and changes in the supply chain.
Take natural gas as an example. Europe is among the largest consumers of Russian-supplied oil and gas. With its “REPowerEU” initiative in response to the conflict in Ukraine, Europe accelerated efforts to diversify its sources of energy and fast-tracked the roll-out of renewable gases like renewable hydrogen. In addition, as emerging markets seek to displace coal as a primary fuel source, demand for US natural gas has grown dramatically over the past several years. This trend is expected to continue given the ongoing shift in global commodity trade flows (Exhibit 2). Lastly, as the move toward electrification continues, electricity generated from natural gas could help complement the inherent intermittency that comes with the growth in electricity generated by renewables.
As the energy transition evolves, so will the opportunity set and this should provide fertile ground for fundamental investors. We expect the pursuit of carbon-reduction goals to drastically alter a wide range of industries, including electricity generation and transmission, building infrastructure, vehicles, industrial users, forestry, and agriculture. At the same time, we do not expect fossil fuels to be fully replaced. Broadly speaking, we believe the opportunity is most compelling among companies that are positioned to help drive this transition and keep up with changes in the supply chain.
In these early innings of the energy transition, our real assets and carbon-related strategies maintain a healthy exposure to oil and gas companies, favoring high-quality exploration and production companies, and large, fiscally-conservative, integrated energy companies. Among renewables, we are currently focused on companies in the relatively more mature wind and solar markets, where near-term fundamentals remain strong.
*Note: petroleum and other liquids includes biofuels, and electricity generation from renewable sources is converted to Btu at a rate of 8,124 Btu/kWh. Provided for illustrative purposes only. Forecasts may not be achieved and are not a guarantee or reliable indicator of future results. Although Jennison believes that the expectations reflected in such forward looking statements are based on reasonable assumptions, actual results may differ materially from those projected.
1Net Zero America, Princeton University, December 2020.
2The European Council
Certain third party information has been obtained from sources that Jennison believes to be reliable as of the date presented; however, Jennison cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. Jennison has no obligation to update any or all such third party information. Any references to third party trademarks and data are proprietary and confidential and cannot be redistributed without Jennison's prior consent.
Risks—Investing involves risks. Some investments are riskier than others. Foreign investments may be volatile and involve additional expenses and special risks, including currency fluctuations, foreign taxes, and political and economic uncertainties. Investments in securities of growth companies may be especially volatile. Due to the recent global economic crisis that caused financial difficulties for many European Union countries, eurozone investments may be subject to volatility and liquidity issues. Illiquidity risk exists when particular investments are hard to sell; geographic concentration can result in more pronounced risks based upon economic conditions that impact one or more countries or regions more or less than other countries or regions; and derivative securities may carry market, credit, and liquidity risks. Emerging markets are countries that are beginning to emerge with increased consumer potential driven by rapid industrial expansion and economic growth. Investing in emerging markets is very risky due to the additional political, economic, and currency risks associated with these underdeveloped geographic areas.
The views expressed herein are those of Jennison Associates LLC (“Jennison”) investment professionals at the time the comments were made and may not be reflective of their current opinions and are subject to change without notice. This commentary is not intended as an offer or solicitation with respect to the purchase or sale of any security or other financial instrument or any investment management services. This commentary does not constitute investment advice and should not be used as the basis for any investment decision. This commentary does not purport to provide any legal, tax, or accounting advice.
Certain information in this commentary has been obtained from sources believed to be reliable as of the date presented; however, we cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. The manager has no obligation to update any or all such information, nor do we make any express or implied warranties or representations as to the completeness or accuracy. Any projections or forecasts presented herein are subject to change without notice. Actual data will vary and may not be reflected here. Projections and forecasts are subject to high levels of uncertainty. Accordingly, any projections or forecasts should be viewed as merely representative of a broad range of possible outcomes. Projections or forecasts are estimated, based on assumptions, subject to significant revision, and may change materially as economic and market conditions change.
Jennison Associates and PGIM, Inc. (PGIM) are registered investment advisors and Prudential Financial companies. PGIM Quantitative Solutions is the primary business name of PGIM Quantitative Solutions LLC, a wholly owned subsidiary of PGIM. PGIM Fixed Income and PGIM Real Estate are units of PGIM. © 2022 Prudential Financial, Inc. and its related entities. Jennison Associates, Jennison, PGIM Real Estate, PGIM, and the PGIM logo are service marks of Prudential Financial, Inc. and its related entities, registered in many jurisdictions worldwide.