In focus

How commodities can help towards the energy transition


Soaring oil and gas prices have often been attributed to Russia’s invasion of Ukraine. However, a perfect storm of market pressures meant that energy costs were already increasing before the invasion, both for traditional fossil fuels and sustainable energy sources. These are forcing many into poverty and slowing down the energy transition too.

Some of these pressures have been created by well-meaning investors and policymakers looking to reach net zero goals. Fewer investors and lenders are willing to finance new fossil fuel development. 

Oil and gas markets have seen new supply dwindle as a result of underinvestment in recent years. This is partly because energy companies have been reluctant to increase production: “The international focus on reaching net zero means that many management teams have been looking down the barrel of a gun, not knowing what demand there is going to be for their end products in ten years,” says Felix.

The combination has led to a tighter market, higher prices and strong returns from conventional energy markets.

There was no lack of demand for renewables last year, but issues lay in the high cost of providing a more sustainable energy future.

Catherine Hampton, Sustainable Investment Lead at Cazenove Capital, points out that inflation and ongoing supply chain issues have created margin pressures for many sustainable energy firms.

Wind turbines are a good example. They require lots of raw materials and it is complicated to move them around the world due to their size. Additionally, supply constraints have made it difficult to get the semiconductors and other components needed to build them. Inflation and supply chain issues meant that costs rose for these firms, potentially affecting earnings and making returns less attractive for investors. “From an investment perspective, there was no lack of demand for renewables last year, but issues lay in the high cost of providing a more sustainable energy future,” says Alex Monk, Portfolio Manager for the Schroders Global Energy Transition Team.

In order to reach net zero goals, demand for fossil fuels must go down and the supply of critical metals must increase. Supply chains will have to adapt to the shifts in demand and we can expect challenges as suppliers acclimatise.

“There is, largely speaking, enough metal in the world for the transition. Improvements in recycling will also build out the available stock of these raw materials. But there will be mismatches in supply and demand at different points in time,” which will inevitably lead to short-term increases in price, says Felix Odey, Portfolio Manager for the Schroders Global Energy Transition Team.

If we start seeing more extreme weather, we will see more supply chain disruption.

Winners in this space will be in the right areas when demand is strongest and supply is weakest. “Investors will find value in companies that can manage their supply chains and pass through temporary inflationary costs better than their competitors,” says Catherine.

The energy transition may contribute to a tapering off of inflation in the second half of this decade, Catherine says. Once we have the infrastructure to create abundant renewable energy, costs are likely to come down. This will have a knock-on effect on other commodities and goods, including food prices, as they all rely on fuel to be produced.

The transition could also help to reduce the inflationary impact of climate change itself. “If we start seeing more extreme weather, we will see more supply chain disruption,” says Alex. “This isn’t talked about enough,” he adds. By speeding up the energy transition and, therefore, decreasing emissions, the number of extreme weather events will hopefully be reduced. This would relieve some of those inflationary impacts of climate change-related disasters.

Commodities are essential for generating renewable power

Of course, green energy technology requires more raw metals and semiconductors than conventional energy. Catherine argues that a shift in how investors think about commodities from a sustainability perspective is required. “We have seen the oil and gas markets tighten meaningfully due to underinvestment over the past few years. This is partly because of volatility in the commodity prices and partly due to uncertainty of long term demand. The same thing is happening in mining with underinvestment in companies mining lithium and the other raw materials that are essential for electric cars,” she explains.

Felix argues that there is a difference between a company producing a “good” or “bad” product and how they are producing that product. For example, an oil company that tries to limit its carbon footprint and uses profits to transition towards renewables, can be supportive of the energy transition. Equally, a company that produces healthy food but employs questionable farming practices may not be supportive of Environmental, Social and Corporate Governance (ESG) goals.

Sustainable investors often avoid commodities because they have been associated with oil, gas and coal, but despite good intentions this can actually hinder the energy transition. So much of the technology required to make renewable power accessible depends on commodities like lithium and copper. Investing in these commodities and throughout the whole energy transition value chain is critical to increasing the supply of these vital resources that increase the pace of the transition and help to fight climate change.

Fossil fuel companies can be part of the energy transition too

“We are seeing more fossil fuel companies shift their capital expenditure towards more renewable sources, investing in sustainable fuels like biomass, renewables and green hydrogen,” says Catherine. However, this needs to be done faster and on a wider scale in most instances. Of course, not all fossil fuel companies are doing this. The need for active ownership is clear, as active owners have the power to engage with these companies and push for positive change.

If you can pick a basket of the best conventional energy companies that will still be around in 20 years on the multiples they’re still trading at – that will be an opportunity.

There are returns to be made in both the conventional energy and renewables space. Active investors that pick the right companies and avoid the ones that can’t keep up will see the strongest returns here, predicts Alex. “If you can pick a basket of the best conventional energy companies that will still be around in 20 years on the multiples they’re still trading at – that will be an opportunity,” he explains.

Equally, renewable energy firms that can manage supply chain pressures, increase market share and use this more difficult environment as an opportunity will be long-term winners, generating returns. “Blindly investing in green energy companies across the space, including the ones that can’t keep up from a cost perspective, can’t manage the logistics and struggle in this new environment, will not work,” Alex adds.

Ultimately investors’ portfolios should reflect their own views and preferences. If you would like to discuss any of the issues raised in this article or would like to find out more about our sustainable investment offering, please email wmteam@cazenovecapital.com or call 0207 658 3100.

This article is issued by Cazenove Capital which is part of the Schroder Group and a trading name of Schroder & Co. Limited, 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. Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested. This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements. All data contained within this document is sourced from Cazenove Capital unless otherwise stated.

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