Tracking the energy transition

It takes skills worthy of a Swiss watchmaker to fully comprehend all the moving parts involved in the energy transition.

Fossil fuel production is expected to peak by 2030, not least because of the rise of electric vehicles. This shift will drive a significant increase in electricity demand. And so will the boom in power-hungry artificial intelligence (AI), the rapid economic development of emerging countries and global population growth. Climate change concerns mean this demand for electricity must be met with renewable energy sources like solar and wind energy, possibly also nuclear power, and not with fossil fuels. This will also be accompanied by the vast expansion of power storage systems, particularly batteries, requiring major growth in metal and mineral extraction.

Tracking the economic implications of all these elements is perhaps one of the most important challenges investors will face over the next five to 10 years, and beyond.

Burying fossil fuels

Peak demand for fossil fuel is in sight. Electric vehicles are already having an impact on oil consumption. Transport makes up 45 per cent of global oil demand, of which a large proportion is cars. Sales of petrol and diesel cars peaked in 2017, while sales of electric vehicles soared from 3 million in 2020 to 20 million in 2023. This trend is expected to continue as trucks become increasingly electrified, while more than half of global rail is already electrified, with the proportion rising.

Even demand for gas is slowing, with gas-fired boilers being increasingly replaced by heat pumps. However, cutting fossil fuel use enough to meet net zero commitments will be challenging, given that total energy consumption is dominated by industry (at 38 per cent), building consumption (at some 30 per cent) and transport (26 per cent).

Many industrial applications – particularly in iron and steel, chemicals, glass, and paper production – still rely on fossil fuels to achieve the very high temperatures they need to operate. This is a major issue because emerging economies, as they develop, tend to require heavy industries which are the largest consumers of fossil fuels.

Meanwhile, coal remains a major fuel for industrial applications and power plants. And although it’s a good sign that it is being relegated to back-up for spikes in electricity demand or when solar and wind power ebbs, it is still a major input for developing economies and, outside of China, is expected to remain so over the coming decades.

Heavy metal

The shift to electrification is unrelenting. More than 500 gigawatts (GW) are estimated to have been added to global renewable electricity generation in 2023 – one gigawatt is enough to power 700,000 homes or 100 million LED lightbulbs. Renewables now account for some 40 per cent of total electricity generation globally. This, together with consequent growth in demand for power storage, is driving rampant demand for key commodities necessary to build generators, motors, power linkages and batteries, among other applications.

The market for critical minerals used in the energy sector doubled in the five years to 2022 when it reached USD320 billion. Over that time, demand for lithium tripled, while demand for cobalt and nickel jumped 70 per cent and 40 per cent, respectively. To meet climate change targets, installed capacity of renewables needs to triple by 2030, according to the International Energy Agency (IEA). That, in turn, will drive more than a tripling of demand for key minerals.

Opportunities (and risks) abound

For investors, the drive towards renewables and electrification represents a major set of opportunities – and also risks. Critical mineral production and extraction will require major infusions of capital. But with the top three producer countries representing some 90 per cent of rare earths, lithium and platinum extraction, 80 per cent of cobalt and 60 per cent of nickel, geographic concentration is a concern. These countries tend to be in the developing world – 70 per cent of platinum comes from South Africa, 70 per cent of cobalt from the Democratic Republic of Congo and 60 per cent of natural graphite from China. And inelasticity of supply sets the stage for significant price volatility, even under relatively minor swings of demand.

On the other hand, the shift to renewables has the potential to accelerate the development of emerging markets. For one thing, these countries tend to be rich in sunlight, which would allow many to relinquish dependence on imported oil. For another, demand for their commodities has the potential to cut poverty and boost government coffers, as happened in Peru and Chile when real wages grew by 30 per cent and 45 per cent, respectively, between 2003 and 2008, spurring employment growth.

The road to renewables is a bumpy one and there is a significant risk that climate change targets will be missed. But progress could yet accelerate thanks to innovation as the articles that follow show. Ignacio Sánchez Galán, executive chair of the utility giant Iberdrola, outlines some of the key innovations power companies are introducing to push forward the energy transition in a conversation with Pictet Wealth Management’s Chief Investment Officer César Pérez Ruiz. What’s important is that in seeking moonshot solutions, we don’t lose sight of the incremental changes that can become hugely important as they accumulate – as Pictet Asset Management’s Investment Manager Katie Self argues. One of those could be the use of biofuels to make aviation cleaner.

But renewables are only one of a number of critical avenues into which capital needs to be allocated. Another is biodiversity. Climate change threatens widespread extinction, leading thus to wholesale changes to our environment. Here we offer a summary of the latest research by Pictet Asset Management’s Investment Manager Viktoras Kulionis into biodiversity finance. More generally, a new report by Pictet Asset Management and the International Institute of Finance highlights the financing gap we face in achieving net zero.