Investment Strategy

Three things to watch in the race to net zero

Oct 29, 2021

Clean energy, electric vehicles and semiconductors may be the keys to a sustainable future.

Sitara Sundar, Equity Specialist

Patricia Behling, Equity Strategist

Ian Schaeffer, Global Market Strategist

 

Our Top Market Takeaways for October 29, 2021.

Markets weren’t so scary in October

U.S. equity markets headed into Friday at fresh record highs. The S&P 500 (+1.1%), NASDAQ (+2.4%), and Dow Jones (+0.2%) were all up for the week. The busiest week of earnings was something of a mixed bag, as some of the megacap tech companies reported disappointing results stemming from - you guessed it - supply chain issues. Still, the broad index is on track to see earnings per share growth of +36% in Q3, the third best quarter since 2010. But the big story this week was the big moves in rates.

U.S. Treasuries, British gilts, and German bunds all priced in more imminent hikes in benchmark interest rates. Investors in the U.S. saw the yield curve flatten in a big way as the 2s10s curve dropped to its lowest level since August and the 2-year yield moved above 50 bps for the first time in the pandemic era. An announcement from the Bank of Canada seemed to follow one from the Bank of England by signaling an accelerated hiking cycle in response to inflationary pressures. Although the BoC and BoE did not actually hike rates, their tone and that of other central banks seems to have rather quickly shifted to a more hawkish stance. The Fed is up next. Surely, all eyes will be on Powell next week. We expect a taper announcement, but little incremental news about the timing of rate hikes.

Meanwhile, political leaders in Washington continued spending bill negotiations all week. President Biden unveiled a framework for a revised $1.75 trillion tax and spending plan on Thursday. House progressives appeared to largely support the new framework, but it remains unclear if they will support the separate $550 billion infrastructure bill that has already passed in the Senate. Now, the President is off to Scotland for COP26, which investors are watching closely as a catalyst for sustainable investing.  

3 things investors should know about sustainable investing

 

Still need a Halloween costume? How about a climate scientist? As political, business and scientific leaders all prepare to gather in Glasgow for COP26 (a massive climate summit hosted by the United Nations), many have high expectations for new emissions targets and climate goals.

With the summit top of mind, today’s Top Market Takeaways focuses on the benefits of sustainable investing. Here are three things we think investors should know:

1) The COP26 could be a major near-term catalyst for investment.

Running from October 31st to November 12th, COP26 is the fifth conference since the adoption of the Paris Agreement (which, as a reminder, is a legally binding international treaty on climate change). Five years (excluding 2020 due to COVID) after the Paris Agreement, participating countries must now resubmit their goals for reducing emissions, which could trigger additional investment in climate change mitigation. The expectation is that the countries submit ambitious enough goals to limit global warming to around 1.5–2.0°C above pre–Industrial Revolution levels.

Cue clean energy. The good news: Technological advances in clean energy and cleaner emissions are allowing more and more industries and countries to work toward environmental goals. The cost of many clean energy sources used to be prohibitively high to adopt on a mass scale. That is all changing. Over the past 10 years, solar energy costs have declined 80%, onshore wind costs have declined 45%, and energy storage costs have declined by 88%. Given the technological innovation in the space, it is expected to be more cost-effective to build new energy capacity with solar PV (photovoltaic, or solar panels) or wind turbines than to continue using existing coal plants.

2) New industries and technological advances will enable the transition to net zero.

There are many ways the world could move toward a “net zero” future (where carbon sinks fully offset carbon emissions), including reducing dependency on fossil fuels, increasing use of carbon capture technologies and integrating cleaner energy sources.

First, the world needs to evaluate how we supply electricity to the energy grid. All industries that rely on fossil fuels (transport, buildings, heating, etc.) will need greener sources of power in order to reduce their emissions. The IEA estimates that almost 90% of global electricity generation in 2050 must come from renewable sources (up from 29% in 2020), and in the next eight years alone, wind and solar capacity will have to increase 4x to keep us on track to reach net zero. Governments are already pushing for adoption, largely thanks to falling costs that make clean energy sources economically viable.

This chart shows the capacity additions in gigawatts for global renewable energy from 2020 and what is estimated to be needed in 2030 to stay on the path toward net zero. In 2020, there were 134 GW of capacity additions of solar PV, and 114 GW of capacity additions of wind. In 2030, estimates suggest that 4x that level would be needed: 633 GW of solar PV and 390 GW of wind.
Another way to reduce emissions is to electrify heavily polluting industries and make them more energy-efficient. Take the global transport sector, which accounts for almost 20% of annual greenhouse gas emissions. To reach net zero, emissions in this sector will need to decline…but mobility is expected to increase in the years ahead. As such, electric vehicles have a key role to play. To reach net zero by 2050, it is estimated that sales of electric vehicles need to increase from currently around 5% of new global sales to over 60% by 2030.
This chart shows the projected global electric car sales in millions of units sold from 2020 to 2030 estimated to be needed to stay on path to reach net zero. In 2020, electric car sales were 3.1 million units, and would need to jump 18x to reach 56.1 million by 2030.

We will also need to develop carbon removal technologies to reach net zero, particularly in industries that will be more difficult to fully de-carbonize. There are two different carbon removal technologies (which are described in more detail here). However, to date there are only ~20 commercial CCS (carbon capture and storage) operations worldwide. CCS projects are highly complex and require significant upfront investments, as well as large ongoing operational expenses. Nevertheless, the opportunity set is huge and as the technology matures, costs should come down and investment opportunities should become easier to access.

3) Semiconductors…HUH, what are they good for? Absolutely everything!

Semiconductors are just about ubiquitous when it comes to clean energy. Semiconductors play key roles in solar panels, wind turbines and other types of renewable energy, thanks to their abilities to conduct electricity while simultaneously acting as insulators to increase efficiency and prevent unwanted flows of electricity.

Semiconductors not only enable the generation of electricity through renewable energy sources, but they are also playing an increasingly large role in next-generation vehicles. Many new passenger vehicles today come equipped with back-up cameras, navigation screens and other relatively recent technology. All these new features have pushed up the amount of semiconductor content in vehicles. In fact, a Tesla has 4x the semiconductor content of a traditional automobile. 

This chart shows the cost contribution of semiconductor content in new passenger vehicles by decade from 2000 to 2030. The semiconductor price in U.S. dollars per car is shown on the left hand axis. The semiconductor content as a percent of the total cost of a vehicle is shown in the right hand side. The semiconductor price per vehicles begins in 2000 at $150. It rises to $300 in 2010 and $475 in 2020. It peaks at a 2030 estimate of $600. The semiconductor content as a percent of the total cost of a car is 18% in 2000. It rises to 27% in 2010 and 40% in 2020. It is estimated to peak at 45% in 2030.
Next-generation vehicles will not only be electric, but will also become more and more autonomous. Fully autonomous or semi-autonomous vehicles will require much larger—and more sophisticated—semiconductor content than traditional cars thanks to the army of cameras and sensors needed for the car to drive itself. The ADAS (advanced driver-assistance systems) features in a car will require more advanced and expensive semiconductors.
This chart shows the average percent of new vehicles that have or are expected to have advanced driver-assistance systems (ADAS) come as standard equipment from 2014 through 2030. The global average is calculated using automotive OEM estimates from the following companies: BAIC, BMW, BYD, Daimler, Ford, GAC, Geely, General Motors, Honda, Hyundai- Kia, Mazda, Mitsubishi, Renault-Nissan, Stellantis, Subaru, Suzuki, Tata, Tesla, Toyota, Volkswagen. In 2014, the global average was about 2%. The average steadily climbs and reaches 16% in 2020. The estimated average continues to climb consistently and by 2030 peaks at 93%.

Semiconductors are set to play a key role in the future of clean energy and the overall shift toward a net zero economy. As many investors turn their focus toward COP26 beginning on Sunday, keep in mind the essential tools such as semiconductors that will be needed to achieve almost any environmental goal put forth by policymakers.

While investors have spent October debating the short-term risks of supply chain disruptions, inflation and rising short-term rates, the month will close with a milestone in the long-term transition toward a net zero future. We don’t think investors should ignore this trend.

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