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The energy transition – what it means for investors

A closer look at what the move from fossil fuels to more renewable energy sources could mean for investors.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

The market reactions immediately after the agreements at the COP26 conference are instructive for investors.

The EU carbon price, which enables companies with high emissions to buy permits, hit a record €71 on 22 November 2021, just over a week after the conference finished.

The oil price, which had been heading towards $100 per barrel, reversed after both President Biden of the United States and the Chinese Government indicated they could release supplies from their strategic reserves.

The benchmark price of a barrel of Brent crude fell from just under $85 at the beginning of the month, to just under $80 by Friday 19 November.

Meanwhile, the natural gas price headed in the opposite direction. Gazprom, the Russian gas giant, has been building a pipeline called Nord Stream 2 into Germany. There has been international concern that this will bypass the existing route into Europe, via the Ukraine, leaving that nation vulnerable to Russian political interference. In addition, Nord Stream 2 reportedly puts at risk billions of dollars of annual transit revenues Ukraine currently receives.

Ongoing concern about a shortage of natural gas in Europe this winter, saw the benchmark UK wholesale natural gas price shoot up to almost 240p per therm, a standardised unit of heat energy.

While that is still lower than the record 301p per therm it hit in October, it is still substantially higher than the 51p per therm at which it traded last January.

What should investors make of these market movements?

First, the higher carbon price indicates that regulatory moves to reduce carbon emissions, of which the COP26 process is just a part, are a permanent and real trend. The price mechanism is being used to permanently shift our energy system, especially in Europe, to a lower carbon model based around renewables, hydrogen and nuclear.

For those countries signed up to the net zero commitment, it means that by 2050, any residual carbon emissions, for example from aviation, will have to be neutralised. That will be through either carbon capture and storage projects or offset via, say, tree planting.

Second, the high and volatile prices of both oil and gas give a somewhat contrary signal. Despite the progress with renewables and international agreement to 'phase down’ coal, we remain dependent on hydrocarbons for the majority of our energy in the short to medium term. Latest figures from the Department of Business, Energy and Industrial Strategy show that of primary inland UK energy consumption, 41.9% came from natural gas and 31.2% from oil.

Interestingly, the proportion of natural gas consumed continues to grow, not fall. Natural gas has lower emissions than other hydrocarbons, especially coal. In fact, natural gas has 50% lower emissions than coal when used in electricity generation. As coal is phased out, natural gas is being used as the ‘transition fuel’ as we move to net zero emissions over several decades.

Low carbon sources, including nuclear and biofuels are growing fast and currently provide 21.5% of primary energy consumption. The table below, from the BEIS 2021 Energy Brief, shows how they are growing.

Proportion of UK energy supply from low carbon sources

2000 2005 2010 2018 2019 2020
Nuclear 8.4% 7.8% 6.3% 7.4% 6.5% 6.6%
Wind 0.0% 0.1% 0.4% 2.6% 3.0% 4.0%
Solar 0.0% 0.0% 0.0% 0.6% 0.6% 0.7%
Hydro 0.2% 0.2% 0.1% 0.2% 0.3% 0.4%
Bioenergy 0.9% 1.6% 2.3% 6.1% 6.7% 7.8%
Transport fuels 0.0% 0.0% 0.6% 0.7% 0.9% 1.0%
Other 0.0% 0.0% 0.4% 0.8% 0.9% 1.0%
Total 9.4% 9.7% 10.1% 18.5% 18.9% 21.5%

What to consider

If you’re looking to invest in innovative, but riskier, new technologies such as hydrogen and nuclear, it should only make up a small part of a portfolio. That way it will benefit if these areas grow, but shouldn’t suffer too much if they disappoint. The best answer, as ever, is to hold a diversified portfolio and review it regularly.

Remember, we are in a transition phase and large energy companies, such as BP and Shell, are being committed to that transition. They are themselves increasingly diversified, investing in renewables, as well as carbon capture, carbon trading and natural gas. This can also be a good way to gain balanced exposure to the multi-decade journey of energy transformation.

This article isn’t personal advice, if you’re not sure what’s right for you, seek advice. All investments fall as well as rise in value, so investors could get back less than they invest.

George Trefgarne is CEO of Boscobel & Partners, a political consultancy. Hargreaves Lansdown may not share the views of the author.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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