KATHY DAVEY: Increasing demand for electricity will see growth of clean energy producers
Companies in the sector benefit from increased investment and government incentives
Markets have seen a rough start to 2022, with inflation levels higher than expected, rising interest rates and continuing global supply chain disruptions amplified by China’s zero-Covid policy.
In addition, the escalation of the Russia-Ukraine conflict has highlighted the world’s heavy dependence on fossil fuels as our main source of energy. It’s become clear we have not been transitioning to lower-carbon fuels quickly enough to meaningfully reduce this reliance, even though the theme of clean energy has been gaining momentum for years now.
We expect that recent events will see even more investment into clean energy, at an ever more urgent pace, which makes it a great secular growth trend to gain exposure to for long-term equity investors. Countries globally are embarking on projects that will see clean energy companies benefit from increased investment and government incentives for many years to come.
Unfortunately, we believe the excitement around such secular growth opportunities has been priced into many clean energy companies already. Investors may be at risk of paying too much for the growth expected, especially as interest rates rise and in turn the fair value of growth companies retreats. We have already seen the iShares Global Clean Energy exchange traded funds fall back quite a bit after rising 300% in less than a year from the lows of the pandemic.
We believe there are ways to avoid paying high prices to gain exposure to the green energy theme. We seek out companies that will indirectly benefit from the expected growth in the sector, but trade at attractive valuations.
One area of particular interest is electrical companies that will benefit from several secular trends we are seeing in the world today. The drive towards a sustainable future, the clean energy transition, increased connectivity, and more things becoming electrical are key to driving electrification over the next 20 years.
Electricity is the fastest growing source of final energy demand, and it’s expected to outpace overall energy consumption growth over the next few decades. BP’s Energy Outlook sees electricity going from 20% of energy consumed today to about 40%, depending on the low-carbon path the world ends up taking.
Demand is expected to rise because electricity will play a pivotal role in decarbonisation, as it can be generated with a relatively cleaner energy mix compared to other sources of energy. Low-carbon energy sources will increasingly be used to generate electricity, thereby making it an even more attractive sector to grow as we decarbonise.
The benefit to electrical companies is that globally we will need to expand, modernise and digitise our electrical grids to support this growth. A recent report by Bloomberg New Energy Finance estimated that to keep pace with renewable energy additions the annual power grid investment will need to increase from roughly $235bn in 2020 to $636bn by 2050 as we move to a more decentralised grid.
In the past electricity has flowed in a linear fashion from the power utility along transmission lines to the distributor. The nature of renewable energy is different in that solar energy is generated where the sun shines and wind energy where wind blows. As such, the electrical grid is becoming far more decentralised, with renewable energies attaching to the grid at different points. These increased connections create more demand for the products and services of electrical companies.
Electrical companies that employ technology to collect, aggregate and analyse data from the electrical grid will also benefit from efforts to make energy usage more efficient and reliable, by selecting where the cheapest and most reliable source of energy is at any point in time.
The growth of electric vehicles also means more business for electric companies as they have much more electrical content than an internal combustion engine vehicle. In addition, for electric vehicles to be a viable replacement for petrol and diesel cars we need to invest in infrastructure such as electric vehicle chargers. Office buildings were not originally set-up to take the electric load of electric vehicle chargers, and we should see electrical companies benefiting from the retrofitting of commercial buildings.
As we decarbonise there will not only be a push to use clean energy as a preferred energy source, using less energy will be a focus too. Buildings and industry are the largest consumers of energy, and we have seen and will see further regulation and government incentivisation to drive energy efficiencies through retrofits or new build standards. The EU alone has plans to improve energy efficiencies in 35-million existing buildings by doubling the renovation rate from 1% to 2%, which will mean more business for electrical companies.
A final point worth mentioning is the immense growth in hyperscale datacentres, which are extremely energy intensive. The electrical content of these centres is high, but so is the spend to make them as energy efficient as possible. As we create more data the expected growth in these centres will continue to be a benefit to electrical companies.
There are a few global electrical companies worth taking a closer look at to access these trends. One is Eaton Group, a power management company that produces electrical products for residential, commercial and industrial construction, utilities, vehicles and aerospace. It also helps customers manage electrical and mechanical power with efficiency and safety. Eaton is diversified across its product range and regionally, and is among the top four global players in worldwide low-medium voltage electrical industry with the strongest distribution network in the US. Eaton is aligned well with the global secular trends of electrification, digitalisation and the energy transition and does not trade at a hefty valuation.
This is not an easy time to be optimistic, when markets are heading south and global growth is slowing. However, secular trends such as the growth in clean energy will persist regardless of economic slowdowns and cycles. It’s worth being prudent though, especially concerning how much you want to pay to access these opportunities directly. There may be more attractive ways, as described above, that are not conventional.
• Davey is investment manager at Ashburton Investments, whose Ashburton Global Leaders Fund holds Eaton Group stock.
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