2 June 2023

Electrification: The biggest opportunity in the history of capitalism?

The transition to an electrified energy system constitutes a new industrial revolution, but it is unfolding at the speed of digital revolution, José Lazuen writes.

Access to energy has always been at the heart of human development. The need for a secure supply of low-cost energy has been a strategic imperative for most national governments, a key aspect of economic development, and an essential part of most people's lifestyles.

But economic growth has also been historically linked to rising greenhouse gas emissions. This is because 80% of our energy consumption is based on fossil fuels, obtained through combustion processes which generate 73% of global greenhouse gas emissions.

These emissions are the most pressing and complex negative externalities not yet adequately priced by companies, regulators and society. Worse, their impacts disproportionately fall on people living in developing countries, and their impact will also be experienced by future generations.

However, technological innovation, initially triggered by policy action, is now delivering clean mass-market solutions that are often cheaper than their fossil-powered counterparts.

We have seen this before with other technology-led transitions. They tend to follow an S-shaped pattern. At first, change is almost imperceptible but as corporations start to invest, costs start to plummet, and adoption rises fast.

Clean technologies at tipping points

José Lazuen As we speak, clean technologies in the demand side of energy are reaching socio-economic tipping points, which arise when conditions allow new technologies or practices to out-compete incumbents in terms of cost, functionality and access.

The tipping point has already been reached in road transport and residential heating in many countries, with many more likely to follow soon.

Similarly, prices of wind and solar power have plunged in the past decade, leading to solar power now being the cheapest source of electricity in history. Cheaper electricity instantly triggers additional demand for electric vehicles and heat pumps.

As a result, things are changing quickly on our roads. Sales of electric cars reached more than 10 million worldwide in 2022, around 13% of overall car sales, from a mere 2 million in 2019 (just 2% of car sales).

Growth in one sector however can have system-level ramifications, especially cost-wise. For example, the cost declines in EV battery production (down 90% since 2010) are enabling mass adoption of batteries in the power grid. Similarly, as residential heat pump sales accelerate, the same feedback loops can be expected on the electrification of industrial heat.

A redesign of the geopolitical chessboard

The transition from the ephemeral fossil fuels to the infinitely recyclable "electrification" metals will bring a complete redesign of the geopolitical chessboard.

Entire new supply chains and arrays of new services to mine, process, manufacture, install and maintain the new electrified assets will need to be created, especially in places of high demand.

"The transition from the ephemeral fossil fuels to the infinitely recyclable 'electrification' metals will bring a complete redesign of the geopolitical chessboard"

While this will create new job opportunities for a highly skilled "green" workforce, it will also mean some nations will lose their dominance of the current energy landscape.

For example, while the US is the world's largest oil producer, China has emerged as the undisputed leader in the battery supply chain. To turn the tide, the US passed the largest package of domestic climate measures ever under the Inflation Reduction Act (IRA), with substantial funding for a domestic battery supply chain. Europe is following closely.

The 2022 landmark: $1 trillion in clean energy investments

In light of these trends, it could be argued that internal combustion engines have concluded their role in economic development. As they are main sources of consumption of fossil fuels, so too will the everyday use of fossil fuels inevitably decline.

Just look at the investments. In 2022, global low-carbon energy technology investment passed $1 trillion. Also, for the first time, more capital is being pumped into renewables instead of oil and gas. This means renewable energy, wind and solar power grids and energy storage now account for more than 80% of total power sector investment.

For some technologies, investments are now growing at rates consistent with reaching global net zero emissions by 2050.

The "green" alpha

Despite these overwhelming signs of progress, we believe markets are yet not pricing the upcoming opportunities. Indeed, the nature of the energy transition is complex, cutting across different sectors and rapidly shifting established supply-demand dynamics. The result is some companies tapping into the profit pools of different but adjacent sectors.

They are able to do this because sectors are suddenly connected through their common use of electricity. For example, automakers are now able to tap into the energy sector's profit pools (e.g. EV charging infrastructure, rooftop solar, battery manufacturing), the technology sector's profit pools (e.g. software) and eventually into transportation services (e.g. a fleet of autonomous vehicles to transport people and goods). As this cross-cutting reality is yet to be integrated into the conventional wisdom, the "green alpha" emerges: a source of potential outperformance, linked to the environmental transition but not yet priced by the market.

The investment opportunity: $25 trillion

At Lombard Odier Investment Managers, we estimate that $25 trillion of capital investment will be unleashed between now and 2030 to push forward the electrification of the global economy.

To put this figure in context, this is equivalent to the GDP of the US in 2022. This enormous capital deployment will lead to surprisingly rapid shifts in revenue pools.

For example, by 2030, electric vehicles sales will become a $1.7 trillion market growing at 20% per year, while the market for combustion vehicles will diminish at 8% per year to reach $700 billion the same year. In addition, demand for the technologies that are creating this historic shift like semiconductors, transition metals or software companies will experience exponential growth too.

These realities constitute a clear message for investors: Align with the overwhelming scientific consensus around the exponential growth of electrification, observe the already visible signs of decline of fossil fuels and leverage the improving cost competitiveness of mass-market technologies like renewable power generation, electric vehicles, or residential and industrial heat pumps.

Technology revolutions are exponential, not linear.

José Lazuen is a senior sustainability analyst at Lombard Odier Investment Managers.