Commentary November 02, 2021 at 07:44 AM Share & Print
What You Need to Know
- It is estimated that global energy-related emissions must fall 30% from 2019 levels by 2030.
- Advisors can tap into decarbonization investments for solid returns and a positive social and environmental impact.
- Private capital is financing innovations that look to improve the reliability of renewable energy, such as smart grid and battery storage technologies.
The climate crisis we collectively face may be the defining story of our age. We already are witnessing its devastating impact through rising temperatures and frequent destructive weather events. Limiting global warming to the Intergovernmental Panel on Climate Change’s target of 1.5°C above pre-industrial levels will demand unprecedented levels of global will and coordination.
Advisors who are struggling to determine where and how to impact invest for clients can use the ideas here as a pathway.
It is estimated that global energy-related emissions must fall 30% from 2019 levels by 2030, decline 75% by 2040, and drop to net-zero by 2050. Road transport emissions must be cut 11% by 2030 and fall to 80% below 2019 levels by 2040.
Thankfully, more than 130 countries have set or are considering a target of net-zero emissions by mid-century, supported by numerous cities and companies.
This broad support should provide tailwinds for investments that help reduce greenhouse gas (GHG) emissions. For investors, decarbonization investments offer the opportunity for solid returns and a positive social and environmental impact.
The vast majority of decarbonization investment falls into five categories: electricity and power generation, food and agriculture, mobility and transport, industry, and the built environment. This built environment refers to the human-made environment that provides the setting for human activity, including homes, buildings, zoning, streets, sidewalks, open spaces and transportation.
1. Electricity and Power Generation
Government subsidies have encouraged the decarbonization of power generation since the early 2000s. indeed, solar and wind technologies have become a key part of the energy mix, and new-build renewables are now cheaper than coal in much of the world.
However, the burning of fossil fuels for electricity still accounts for 25% of U.S. GHG emissions. Private capital is financing innovations that look to improve the reliability of — and thereby facilitate greater adoption of — renewable energy, such as smart grid and battery storage technologies. Meanwhile, for businesses that will struggle to transition to cleaner fuel, significant capital is flowing into carbon-capture technologies.
2. Food and Agriculture
Globally, food systems account for over a third of GHG emissions. Decarbonization efforts across agriculture are expected to drive the value of the AgTech market up to $22.5 billion by 2025, from just $9 billion in 2020.
Numerous innovations have emerged across the value chain. The vertical farming sector, for example, in which crops are grown on stacked surfaces, is expected to grow six-fold globally from 2018 to 2026 to reach a market value of $12.8 billion. Elsewhere, artificial intelligence (AI) and machine-learning algorithms are helping optimize growing conditions and improve crop yields.
Alternative proteins are also booming. With cattle farming responsible for nearly 10% of global emissions, people are increasingly turning to plant-based meat alternatives, according to the Food and Agriculture Organization of the United Nations. The global meat substitutes sector is worth $21 billion and expected to grow by a further 12% by 2024.
3. Mobility and Transport
Transport is responsible for nearly 30% of U.S. GHG emissions, with most coming from cars, trucks and buses. However, significant innovation in the electric vehicle (EV) space, including in supporting technologies like batteries and charging networks, is helping slow the pace of vehicle emission growth. The overall EV market is expected to grow nearly five-fold by 2026 to more than $700 billion.
Beyond EVs, there also are tailwinds in areas such as eco-friendly micro-mobility— for example, solar-powered e-bikes — and low carbon fuels in areas such as trucking and aviation, for which battery technology is not yet suitable.
Heavy industry is responsible for 23% of U.S. GHG emissions, largely via manufacturing processes and the material inputs they use. Decarbonization technologies can help make manufacturing more efficient by, for example, reducing energy consumption via industrial robots and developing low carbon alternatives to traditional inputs.
Various heavy industries also can contribute to decarbonization by moving toward a circular economy in which resources are used, then reused, in a closed loop that does not extract more from the earth.
5. The Built Environment
The buildings, streets and spaces in which we live are significant GHG emitters. Real estate represents approximately 15% of global GDP, but the construction and operation of buildings is responsible for nearly 30% of emissions. There are opportunities for innovation across the real estate value chain, from more efficient construction methods such as 3D printing to the use of smart devices to monitor and manage buildings.
Potential solutions also include the creation of smart cities that harness new technologies such as interconnected smart street lighting, waste management, and water and gas metering.
The Private Market Advantage
Climate change mitigation is likely to be a secular growth trend for several decades, as capital is funneled into an array of sectors that can make a difference in the quest for carbon neutrality.
Accessing these opportunities, however, increasingly will require investing in private markets. With most decarbonization investment opportunities in the earlier stages of their development, venture capital (VC) and private equity (PE) funds are positioned to take the lead.
These funds raised $111 billion in the 2019-2021 vintage years for investment in climate tech, according to Pitchbook, as of Aug. 16, 2021. And nearly $60 billion was invested in the United States alone in the first half of 2021.
Further, returns from the sector have been strong. Nine out of 10 impact investors reported that their portfolios either had met or exceeded their financial performance expectations, according to the Global Impact Investing Network.
Those same investors, according to a 2020 analysis by GIIN, have generated an average gross realized return of 16% on their developed market impact investments, and this refers to PE market-rate seeking investments only.
Year of first impact investments ranges from 1956 to 2019, with 2010 as the median year, while the Cambridge Associates PE/VC Impact Investing Index (Developed Markets) benchmark shows pooled returns over a three-year period of 17%.
While public market investors can gain some exposure to climate tech, private companies in the space outnumber public ones by 13 to 1, and most are likely to remain private for a while yet: The median age of a tech company going public rose from just five years at the turn of the millennium to 12.5 by 2020.
Considering its advantageous positioning for investing in decarbonization, private capital makes a compelling case to become the primary way that investors can both support climate action and gain exposure to its financial upside.