Transitioning between elements 

Long at the top of environmental agendas, climate change now features more prominently across political, economic and investment agendas around the world. With energy use contributing three-quarters of global greenhouse gas emissions — and recent geopolitical events reminding us of the fossil fuel supply chain’s inherent vulnerabilities — the shift towards renewables is garnering interest from an expanding spectrum of stakeholders, in what is the most urgent energy transition so far for humankind.

At Mercer, we continue our work with investors to mitigate risks and seize opportunities associated with this energy transition, which will be underpinned by an evolving array of elements as we move away from fossil fuels, composed of elements like hydrogen and carbon, towards greater reliance on other elements, like copper and lithium.

I recently shared our thoughts on the energy transition at Mercer’s Global Investment Forum in Singapore, beginning by framing the current transition in the context of history.

Human development has relied on combustion energy from new materials, with a shift from wood to coal in the 19^th century facilitating the Industrial Revolution. Later, oil and gas also became significant energy sources. But it took 60 years for coal to grow from 5% to 50% of global energy consumption, with oil and gas growing from 5% to 40% and 25%, respectively, over a similar length of time.¹ Energy transitions take a long time, partly because they require massive infrastructure investment and extensive “system” changes.

With net zero goals ever closer, we simply do not have a long time for this transition. Renewables (ex-hydropower) represented 5% of global energy consumption in 2012, growing to 10% in 2022. So we are moving in the right direction.² Unfortunately, to meet carbon reduction targets, renewables should supply 45% of energy consumption by 2030.³ Investors have a critical role to play. To reach net zero by 2050, it is estimated that we need an additional US$25 trillion of clean energy investment by 2030.⁴

Separately, there is a popular perception that diversifying away from petrochemicals will finally free us from the geopolitical shackles of fossil fuel location. The Russia-Ukraine crisis provides a recent example of those shackles. National resiliency and energy independence are often celebrated as supplementary benefits of the pivot to renewables, but this glosses over fundamental truths of the energy transition. Although we will eventually be less reliant on the petrochemical supply chain, which is dominated by a few countries, we will become much more reliant on a range of minerals vital to clean energy generation, transmission and storage (also known as “green minerals”).

The amount of minerals required for renewables is in many cases a different order of magnitude to that of fossil fuel energy, and most countries will be heavily reliant on other countries for minerals supply. That is before we even consider reliance on other countries for processing these minerals, and fabricating the key equipment needed for clean energy. Given the replacement cycles of components used for renewable energy — such as batteries, wind turbine rotor blades and solar panels — there will be an ongoing need for more minerals, so we may never be liberated from the geopolitical manacles of mineral reserves.⁵

What does all this mean for investors? It makes sense to start with the elements that will underpin the transition, which we can access via investments in green minerals mining companies, for example. With breathtaking increases in demand for green minerals on the horizon, and considering that it can take a decade for a mine to go from discovery to production, it is easy to imagine the investment opportunities and risks that could lie ahead. Exposure to these minerals also bolsters portfolios’ resilience to inflation, which could be valuable with the potential for so-called “greenflation”.

Given the geopolitical realities of the green minerals supply chain, investors should consider the strategic alignment between the domicile of mining assets and their home country. Put bluntly, you don’t want all your eggs in your strategic competitor’s basket. In view of the uncertainties ahead, neither should you be too concentrated in any individual market.

Many investors are uncomfortable with mining exposure, because it has typically been viewed with antipathy from an ESG perspective. But the green energy transition will not happen without mining companies, many of which are taking a more active approach to sustainability. While it is true that mining is a high emissions industry, an investor’s climate transition plan should be more focused on the emissions of the planet than the emissions of their portfolio.

The good news is that some aspects of the energy transition are relatively straightforward, like scaling up wind and solar in certain parts of the world to achieve low-carbon electricity. The bad news is that one-third of emissions come from hard-to-abate sectors like steel, cement, chemicals, aviation and shipping. Fortunately these sectors are only hard to abate, not impossible. Substantial investment and innovation is needed for workable technologies to reach commercial readiness as replacements for fossil fuels, providing investment opportunities across public and private markets, even in hard-to-abate sectors.

In our view, investors should not rely completely on broad market exposures to navigate portfolios through this energy transition. Specialist strategies are better positioned to address strategic gaps in portfolios, forming part of a broad lifecycle of investment opportunities tied to the transition.

In the established energy transition sectors there are high-growth and mature-growth opportunities in solar, wind, green minerals and natural gas; accessible via growth private equity, sustainably-themed public equity strategies, and sustainable bonds, for example. There are also early-growth opportunities in storage and other transition infrastructure. At the more innovative end of the lifecycle, there are start-up and research stage opportunities for hydrogen and fusion technologies, which can be accessed through venture capital and research funding. Towards the mature and declining end of the lifecycle, there are investment opportunities in oil and coal, although some investors may choose to access this area opportunistically or avoid it. There are also opportunities across the lifecycle to use less energy — focusing on the demand side of the problem as well as the supply side.

The next decade entails a whole new capital investment cycle, with sweeping changes in the ways we generate, store, transmit and use energy resources. This is not just about obvious benefits to the planet and humankind, but also about enhancing investment outcomes, taking a holistic total portfolio approach that acknowledges the need for flexibility in decarbonisation pathways. Even if you are unconvinced about “doing good” for humanity, you cannot afford to ignore the energy transition if you want the best for your portfolio.

^{1 Our World in Data; Vaclav Smil, Energy and Civilization. A History (Cambridge: MIT Press, 2017); BP Statistical Review of World Energy (2021, 2022) Mercer estimates.}

^{2 BP Statistical Review of World Energy (2021, 2022) International Energy Agency; Mercer estimates.}

^{3 Net Zero by 2050: A Roadmap for the Global Energy Sector (International Energy Agency, 2021); Mercer estimates.}

^{4 Net Zero by 2050: A Roadmap for the Global Energy Sector (International Energy Agency, 2021).}

^{5 Mark P. Mills, Mines, Minerals, and “Green” energy: a reality check (Manhattan Institute, 2020).}