The idea of a sustainable economy, described in the UN’s 1987 Brundtland Report, is one that meets the needs of the present without compromising the ability of future generations to meet their own needs. This is achieved through an economy that is low carbon and that efficiently and equitably uses resources. Across the transition, we’ve identified four broad areas of investment opportunities in the public markets today that present an alpha thesis for investors: clean energy, electrification, circular economy, and human health and development.
Last quarter, we asked best-in-class sustainable portfolio managers on our platform to describe the top sustainability theme they are focused on this year for investment, engagement, and research. A resounding chorus of electrification came back to us, and it’s no surprise.
EVs, data centers, and AI—Oh my!
In the first quarter this year, we dug into the alpha thesis for clean energy and the upside potential for investors as the industry presents a substantial discount relative to broader market indices today. While a slew of headwinds in the clean energy value chain have driven a pricing dislocation, the upside potential for investors is also driven in large part by the projected demand for more and cleaner energy in the decades to come.
As many of the portfolio managers we spoke with last quarter pointed out, that demand is being driven primarily by three trends: the rise of electric vehicles, the expansion of artificial intelligence to the masses, and the data centers powering that AI revolution. According to the International Energy Agency (IEA)’s 2023 Global EV Outlook, 18% of all cars sold last year were electric, compared with only 2% of all cars sold in 2018. And that share is only projected to rise. Meanwhile, a recent analysis by the Electric Power Research Institute found that internet searches using AI require about 10x the electricity of a typical Google search. And the data centers that power AI, among other things, are projected to double their share of energy consumption in the U.S. by the end of the decade. Looking at global consumption, data center’s energy demand could as much as quadruple.
Modernizing a one-way grid
The key to meeting this demand does not rest solely on the ability to generate sufficient energy, but also in the ability to transmit and distribute it. As of 2023, the backlog of new clean energy projects waiting to be connected to the grid totaled 2,600 gigawatts of energy and storage capacity. For context, that’s enough energy to power roughly 250,000 homes in the U.S. for an entire year. Transmission line projects face delays for a variety of reasons including regulatory hurdles, opposition from local governments, and other logistical challenges.
But regulators in the U.S. have finally begun to lower some of those hurdles. In May, the Federal Energy Regulatory Commission (FERC) issued two rules aimed at speeding up transmission planning and build-out, which will be crucial for connecting these new projects to the grid. The first rule, the Interstate Transmission Siting Rule, essentially helps to speed up cross-state transmission projects, while the second rule, the Transmission Planning and Cost Allocation Rule, requires regional operators to take a long-term view in forecasting demand and planning, including updating existing infrastructure in a way that increases capacity.
Updating existing infrastructure is not only necessary for connecting clean energy projects, but also for harnessing the benefits that clean energy offers. In the U.S., grid infrastructure was built for a different era defined by one-way power flows that travel from large, centralized plants to consumers. Modernizing the exiting grid means upgrades to handle intermittent power—the sun doesn’t always shine, and the wind doesn’t always blow— and geographical differences, but it also requires a reimagining of our entire grid system that allows flows in both directions including from consumers back to the grid. These two-way flows allow for a more dynamic management of supply and demand. Investing in local energy infrastructure, like solar panels on homes or community wind farms, also creates more decentralized and resilient energy systems, making the grid overall less vulnerable to large-scale disruptions. The rise of virtual power plants, where networks of homes and businesses generate and share power, further underscores the transformative potential of electrification technology.
Beyond a cleaner planet
Beyond being low-to-no carbon emitting sources of energy, renewables are cheaper and more efficient, offering greater energy security and potentially even greater economic growth. Energy independence from imported fossil fuels curtails vulnerabilities from supply chain disruptions and price volatility that result from global market fluctuations and geopolitical tensions. In 2022, Russia’s invasion of the Ukraine underscored the liability of importing fossil fuels, as oil prices skyrocketed and energy security across the EU and around the world was put at risk. Conversely, renewable energy sources like wind, solar, and hydroelectric power can be harnessed locally, making energy independence much easier to achieve across various scales from neighborhoods to regions. And because the cost of locally produced renewable energy is fixed compared with fossil fuels which require costs for extraction and transportation, clean energy offers more predictable, stable energy prices for consumers and businesses.
But energy independence also means energy diversification and investment in storage technologies; as we said before, the sun doesn’t always shine, and the wind doesn’t always blow. To manage intermittency, energy storage solutions, including short-duration solutions like lithium-ion batteries and long-duration storage solutions like pumped hydroelectricity and thermal storage, have become necessary to store excess energy generated during periods of high production. According to the U.S. Energy Information Administration (EIA), the installed capacity of electricity storage is projected to have grown 1900% between 2020 and 2025. Over the past few decades, the cost of key battery technologies has plummeted thanks to economies of scale and technological advancements. Lithium-ion battery packs now trade at about one-tenth of their price 15 years ago. This trend is only expected to continue thanks in large part to the Inflation Reduction Act (IRA) and Infrastructure Investment and Jobs Act (IIJA) which have allocated nearly $100 billion to advancing energy storage.
As technology costs continue to decline and more and more economies commit to increasing their clean power capacity to enhance energy security and price stability, the alpha thesis for investing in electrification technologies becomes even stronger.
Next on the horizon
The reality for the global economy, however, is that even if we were to decarbonize every energy source and electrify every system on the planet overnight, the carbon that’s already been emitted into the atmosphere still presents challenges, particularly for agriculture and industrial output. A key component of the transition to a sustainable economy therefore requires investment in carbon removal. But more to come on that next quarter.
To learn more about supporting your clients with sustainable investing solutions, reach out to our team at sustainable@envestnet.com or visit envestnet.com/sustainable.
