News in Charts: Renewable energy demand set to soar

One of Joe Biden’s first actions as US president was to re-join the UN Paris Agreement. A Biden presidency, coupled with a Democrat-controlled Senate (albeit by the smallest of margins), will boost the US effort to reduce greenhouse gas emissions, as well as the global effort to do the same and prevent a catastrophic rise in global temperatures.

The World Renewable Energy Index, which reflects the equity price performance of 30 firms that produce and distribute renewable electricity, has been boosted by Mr Biden’s victory in November’s election. However, as the chart below highlights, the index began outperforming global equities well before Mr Biden’s win; the announcement of the EU’s Green Deal in December 2019, and perhaps the Australian bushfires which visually drove home the dangers of climate change, were catalysts.

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There is some debate about whether the rally has gone too far. We do not comment on the valuation of individual stocks and a PE ratio for the index is unavailable, but, given the huge shift from carbon-intensive fuel sources to renewable sources that is underway, firms in this sector are well placed to benefit from a significant increase in demand for their products and services. To achieve the IPCC’s goal of limiting global warming to 1.5C above pre-industrial levels, realistically, most, if not all, of the global electricity grid will need to be powered by renewable, nuclear or hydroelectric sources. Based on the energy mixes, replacing electricity generated by burning fossil fuels with renewables would result in a more than 200% increase in demand (for renewable energy) in the EU, a 9-fold increase in the US, and a nearly 20-fold increase in China. The switch away from coal to renewable electricity sources in emerging markets like South Africa and India, would create big opportunities too.

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Of course, this shift in demand will not occur overnight and more competition will enter the market, pressuring margins for incumbents and those firms in the RENIXX. But the cost of renewable energy has been falling and is likely to continue to fall further given technological advances and economies of scale in the production of inputs. Moreover, demand for electricity itself is likely to increase significantly as vehicle fleets become electrified and/or powered by hydrogen. Reducing greenhouse gases from certain industrial processes, such as steel making (by, for example, switching production to DRI — direct reduction iron production) is also likely to push up demand for renewable electricity further.

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Of course, talking about net zero and making the tough policy and economic choices to get there are two different tasks — overcoming powerful lobbies and vested interests is easier said than done. But both momentum and support from business, voters and politicians for net zero policies are growing. Advanced economies have their work cut out, but convincing and nudging China and other fast-growing and coal-reliant emerging markets to do the same is another challenge. A Biden presidency will help. The US signing up to the Paris Agreement again is important and may mean that the US can play a leadership role in this field during the next four years. It will boost international cooperation which is key to the effort, and the US is likely to be more serious about finding new ways to provide both carrot and stick (such as a carbon border tax) to achieve these aims. Countries higher up and further to the right in the chart below are likely to feel this pinch most.

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The material presented above is a snippet of some of the topics that now make up Fathom’s research agenda into the area of climate economics and covers some of the material that we presented to clients in our Global Economic and Markets Outlook for 2021 Q1.

Subscribe to join our upcoming event Climate economics: leading the way to net zero and beyond. Laura Eaton, Erik Britton and Brian Davidson from Fathom will be joined by Paul Fisher (Fellow, Cambridge Institute for Sustainability Leadership) and Leon Saunders Calvert (Head of Sustainable Investing, Lipper and I&A Insights, Refinitiv) to discuss crucial issues related to climate economics, including the economic consequences of global warming itself and the pathway to beyond net zero. For more on Fathom’s climate-related services please get in touch with Brian Davidson, Head of Climate Economics.