Rethink Perspectives: Energy – crisis or opportunity?

After centuries of reliance on coal, oil and gas, the world’s energy systems are being fundamentally redrawn. In some regions, renewable energy is already outcompeting fossil fuels, as falling cost curves, technological improvements, and public policy combine to push clean energy solutions beyond economic tipping points. Now, though, following a “year of shocks,” and with economies slowing and fears of further escalation in the Ukraine war, is energy facing crisis – or opportunity?

That was the question at Lombard Odier’s recent ‘Rethink Perspectives’ event in London. Moderated by Duncan MacIntyre, UK CEO, the audience heard from Senior Managing Partner Hubert Keller and Managing Partner Frédéric Rochat, who were joined by Chief Economist Samy Chaar and Jeremy Oppenheim, co-founder and Partner at systems change company Systemiq. Together, they explored the momentous changes taking place in the world’s energy systems, and the impact of today’s geopolitical and economic environment on the pace of the transition.

Are we nearly there yet?

The good news is that “inflation trends are moving in the right direction,” Samy Chaar said, opening the panel with a detailed outline of the current macroeconomic picture. “Inflation, the energy crisis, zero Covid policy in China – we are putting these shocks behind us.”

However, he warned, “We are nowhere near normal. We must not think we are nearly there. 2023 will be a story of underperforming economies and of central banks maintaining the pressure to bring down inflation.”

In the US, he said, “the leading indicators are that price pressures are falling. Growth is slowing because demand and consumption are weak. Meanwhile, supply chain disruptions have eased, and energy prices are coming down. We are heading towards a more benign inflationary environment.”

Not everything is correcting in tandem, however. While goods inflation is back to normal, service inflation remains high, driven by high rents and a hot labour market: “Wage growth needs to slow further. As a result, in 2023, rates will stay in restrictive territory.”

In Europe, he said, collapsing gas prices are creating a greatly improved economic outlook. “Despite the fact that winter is here, and despite the risk of an escalating war in Ukraine, we are seeing gas prices near mid-2021 levels. In Europe, two thirds of gas used to come from Russia. Today, gas imports are 100% liquefied natural gas, with no gas imports from Russia. It has come at a cost, but we have avoided major disruptions this year. Europe has shielded itself.”

Meanwhile, China, he explained, is pivoting irreversibly from the harsh restrictions of zero-Covid to a strategy of living with the virus: “Many think that as China reopens it might be inflationary. We see a limited impact, at least in the near-term. China is the manufacturer of the world. As the economy reopens, exports will rise, and disrupted trade flows will resume, which will have a disinflationary effect. There will be upward pressure on commodities, but we don’t believe the oil price, for instance, will exceed the average price last year.”

What does the outlook mean for investors? “China’s re-opening will support emerging market commodity exporters and close trading partners in the region, for whom goods exports to China make up a big share of GDP,” he said. “We have increased our exposure to emerging market equities.” More broadly, he concluded: “Equity markets may be volatile this year, given many potential sources of instability. We favour high quality fixed income in this environment as there will be yields we haven’t seen for a decade.”

Read also: China’s Great Reopening

Rewiring the economy

Systemiq’s Jeremy Oppenheim began his session by outlining the pressure that human activity is putting on our planetary boundaries and how this is pushing our bio-systems to the “cusp of collapse.” He urged the audience to go on a “carbon diet” as the need to reduce emissions has become critical. He went on to draw a link between the short-term macroeconomic story and long-term shifts in the global economy, explaining that Europe’s response to the energy shock is accelerating a structural shift towards sustainable energy systems.

“A deep, fundamental rewiring of the global economy is beginning to take shape. It is happening already and it is accelerating dramatically through the macroeconomic story. Over the next 20 to 30 years there will be a rewiring of the economy on the basis of clean electrons and electrification. This will change everything.”

While tectonic economic shifts will be seen in nature, and in materials, it is energy systems that are leading the sustainability transition, he said. “The clearest success story is the way renewable energies are moving ‘into the money’. We are seeing inflection points as new solutions outcompete traditional technologies. We are hitting peak oil. The oil companies understand this. It will shift geopolitics in a profound way and the speed at which this is happening is breath-taking.”

Read also: Planetary boundaries: the safe operating limits of humanity

Beating the incumbents

For technologies to reach the rapid-growth tipping point, Jeremy Oppenheim explained, three conditions must be met – new solutions must match or beat incumbent technologies on price, they must offer improved performance and they must be widely accessible.

Crucially, he said, sustainable energy solutions are becoming radically cheaper, with the costs associated with wind power, solar power and battery storage all falling by at least two thirds since 2010. In addition, many solutions are now technologically superior. Heat pumps, he said, are more than three times more efficient than gas boilers, electric motors are four times more efficient than internal combustion engines, and in heavy industry, electric furnaces used in steel production have proven to be more than five times more efficient than traditional blast furnaces.

Thanks to these advantages, adoption rates are rocketing. LED lightbulbs, for example, are now the norm in many regions; electric vehicles (EVs) are expected to make up more than half of new vehicle purchases by 2030; and, in some places, renewables are already dominant in the energy mix. In the UK, renewables produced more energy than fossil fuels in 2020, and in the last quarter of 2021, wind power alone produced 26% of the country’s power grid needs.

As energy system tipping points are reached, Jeremy Oppenheim explained, cascading effects will be seen in other sectors. The growth of the EV sector, for instance, “will drive the growth of residential solar. And as the economics of solar continue to improve, this will change the economics of producing green hydrogen, which in turn will accelerate green steel production. It’s the strength of these links across the economy that will feed big change.”

Read also: Breaching planetary boundaries – Rockström warns the window to act is closing

Profit pools in unexpected places

Picking up on Jeremy Oppenheim’s theme of cascading impacts, Hubert Keller turned to the question of how investors can take advantage of the emerging opportunity.

“When confronted with these tectonic shifts, we need to ask ourselves four important questions,” he said. “First, have we actually crossed these economic tipping points, and where? Second, how much capital expenditure (capex) is needed to achieve scale? Third, is there a solid business case for capex to flow? And lastly, will this create new profit pools, and where will they appear?”

“There will be profit pools in unexpected places,” he continued. “For instance, as fertiliser companies produce green ammonia they will be able to get involved in shipping fuels. And as residential solar increases, buildings will begin to integrate into the broader energy economy. They will start to become distributors by selling back to the grid. This changes the business case for buildings – it won’t just be about income flows from tenants.”

“In the automotive industry, the business model of manufacturers is also changing. Car manufacturers will make batteries that are needed in other sectors. They can also develop their own energy distribution networks, rather than relying on the fossil fuel sector. We believe the profit pool of the automotive industry will double by 2030 because of these new opportunities.”

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