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Energy transition still a good investment despite Covid-19
Long-term investment opportunity will transform entire energy system over next 30 years and beyond
11 May 2020 | Bayani S Cruz

ONE good thing arising from the coronavirus pandemic is that the level of global pollution has improved dramatically as a result of the widespread lockdowns and closure of factories and industrial sites around the world.

Nitrogen dioxide levels, produced from car engines, power plants and other industrial processes, across eastern and central China which is home to hundreds of factories, for example, has dropped to 10-30% lower than normal, according to NASA (The National Aeronautics and Space Administration), following the enforced lockdowns to stem the pandemic.

But while the reduction in pollution levels is a good development it does not minimize the importance of reducing greenhouse gas emissions and addressing the overall need to slow down the pace of climate change, which is crucial for the overall development of ESG investing, to say the least.

Addressing environmental problems in the long term requires a sustained transition to sources of non-polluting clean energy, particularly in the form of investment in energy transition companies which include power and energy companies, manufacturers of electric vehicles and batteries, solar panel manufacturers, as well as producers of renewable and clean energy.

With respect to the energy transition, there are three main risks to power companies, namely: an impact on consumer demand, supply chain difficulties, and the effects of uncertainty and travel restrictions, according to Mark Lacey, head of commodities at Schroders.

In the wake of the pandemic, Lacey thinks that the sharp stock market sell-off in February and March opened up opportunities in energy stocks that were previously trading on lofty valuations, thus, paving the way for investment in energy transition stocks in the long term.

“We remain convinced of the long-term opportunity in the energy transition. If the world is to limit temperature rises to less than 2 degrees, as per the 2015 Paris Agreement, then the energy transition is essential. This is a long-term investment opportunity that will transform the entire energy system over the next 30 years and beyond,” Lacey says.

In the wake of Covid-19 the general slowdown in the global economy will likely impact consumer demand in key end markets such as electrical goods, electric vehicles and residential energy applications. This would undoubtedly have a short-term negative impact on companies in the electrical equipment and battery markets.

The second major risk for energy transition companies concerns the supply chain and the logistical risks to companies across the different energy transition sub-sectors. Global transportation networks have been restricted, and coupled with logistical challenges created by the lockdowns many facilities are unable to receive raw materials and components.

“The most material impact of any supply chain disruption could be to the renewable energy developers, with disruption in equipment deliveries potentially delaying project construction schedules across the world. It could also have the effect of increasing component pricing, which is an important assumption when considering project returns,” Lacey says.

While the supply chain risk has already started to play out, the full extent of any impact will depend on the manufacturing time lost to the virus and whether this continues into the coming months. Many project developers, especially those in the US, will have already received equipment for 2020 projects.

The final risk to energy transition companies comes from heightened global uncertainty and restrictions on travel. These two forces may have the effect of seeing new renewable energy projects delayed or postponed.

“For instance, 2020 was meant to be a record year for both wind and solar installations globally. However, with restrictions on travel and challenges in securing investment for projects to be built, projects are likely to be delayed. Again, the full extent of any impact will depend on the policy response worldwide,” Lacey says.

Also, for the energy sector in general, global equities have been the worst performer in the wake of Covid-19 dropping by 28% since February 2020. But in spite of this the sector remains a good investment in terms of dividend earnings, according to Standard Chartered’s Global Market Outlook.

The oil sector currently offers a good dividend yield of 6.5%. Historically, US oil majors have maintained dividends, even during the prior price collapse in 2008. For European oil majors, there is however a risk of dividend cuts. European oil majors have historically adjusted dividends to reflect the oil price environment, cutting dividends in 2010 following the 2008 price collapse. Energy is a less preferred sector in the US, Europe and China, according to Standard Chartered.

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