Invest now to keep a lid on rising temperatures

Time is running out if the world is to limit global temperature rises to less than two degrees Celsius. The framework set out in the 2016 Paris Climate accords was unequivocal in establishing the need and scale of the problem. As the clock has ticked on, scientific research has served to focus minds on the dangers of temperature rises. Even if warming reaches two degrees Celsius, more than 70% of Earth’s coastlines would see sea-level rise greater than 20cm, according to the Intergovernmental Panel on Climate Change, a UN body set up to assess the science related to climate change. This would result in increased coastal flooding along with many other impacts on humans and ecological systems. Further temperature rises would have far more devastating consequences. To reach the two-degree goal, global emissions need to fall by 33% from 2010 levels by 2030. That is a tall order – but it is achievable.

Exciting developments are under way across the globe to meet the challenge ahead. Many countries are now formally aiming for “carbon neutrality” – balancing their CO2 emissions with those that are removed or offset. In June 2017, Sweden became the first country to put into law its intention to reach carbon neutrality by 2045. It was soon followed by the UK, France, Denmark and New Zealand. The growing momentum finally culminated in China and Japan becoming the latest dominoes to fall last year. In 2020, China contributed over 25% of global emissions and so the importance of delivering the environmental targets, as set out in its latest five-year plan, cannot be overstated.

Despite a fall following Covid-19, global energy demand is expected to continue rising in the years ahead, driven by the growing global population and emerging middle class in Asia. The way we generate electricity will fundamentally have to shift – away from hydrocarbon-based sources to renewable ones if we are to stand any chance of reducing global emissions.

To deliver the changes needed, investment will need to be scaled up significantly in the coming years. The chart below highlights the gap between where we are now and where we need to be. The bulk of investment is required in renewable power generation, though significant expenditure is also required in infrastructure to support a cleaner energy system. Much is already planned. As things stand, global renewable energy capacity is on track to expand by 1,200 GW over four years, according to the International Energy Agency (IEA). This is roughly equivalent to the entire total installed power capacity in the US alone in 2018.

Required annual investment vs current annual investment


Source: BNEF, IEA, Schroders, 30 June 2020.

Solar will account for around 60% of the forecast growth in renewable capacity over the next four years, according to the IEA forecasts. Manufacturing solar equipment is now incredibly competitive, with low margins. Production is heavily dominated by Chinese firms, which currently lead the way in production of polysilicon, a key material in solar cells. We think a more attractive way to invest in solar is through companies generating solar power. They can rely on predictable, inflation-linked returns, with investments backed by the underlying solar energy converter systems.

Wind is another key driver of growth in renewable energy. It is an area that the UK, as an island nation, is well suited to. In 2018, the UK was the fourth largest producer of wind energy in the world – and the largest in offshore wind. Indeed, as part of the government’s 10-point plan for a green industrial revolution, the UK is aiming to produce enough offshore wind to power every home, quadrupling production to 40 gigawatts by 2030.

Wind has also become increasingly attractive from an investment perspective as the technology underpinning the sector has improved. Larger turbines have steadily increased efficiency within the sector. Besides being better suited to the UK climate, wind has other advantages against solar. One is that the space occupied by wind turbines is largely above ground, meaning land beneath them can also be used in other ways. Solar farms, by contrast, need to be spread over vast distances. Initial costs can be higher for wind, but once operational the returns are also attractive.

Renewables set to overtake coal this decade


Source: Refinitiv Datastream, Cazenove Capital

The chasm between where we are now and where we need to get to remains large, but is closing. Progress is being made and the scale of new investment is gathering momentum. As the market for renewables continues to develop, more segments will hopefully start to look like the solar industry in delivering consistent and stable financial returns. Much remains to be resolved and solutions will need to be broader in range than just putting up wind turbines and solar farms - but solar farms and wind turbines are an excellent place to start.

The opinions contained herein are those of the author and do not necessarily represent the house view. This document is intended to be for information purposes only. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Cazenove Capital does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This does not exclude or restrict any duty or liability that Cazenove Capital has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Cazenove Capital is part of the Schroder Group and a trading name of Schroder & Co. Registered Office at 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. For your security, communications may be taped and monitored. 

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James Brennan

James Brennan

Portfolio Director