Applying an investment lens

Alex Brazier, Managing Director at BlackRock Investment Institute

Quick read
• As economies embark on their low-carbon transition, sectors and companies will be transformed. To maximise returns, investors should consider the impact of the transition to a low-carbon economy.
• We think market prices do not yet reflect the transition. This creates opportunities in investments set to gain from the shift. But carbon-intensive sectors will still be needed for many years and offer protection during the process.
• During the transition, mismatches between supply and demand are likely to emerge, sparking shortages and price spikes for carbon-intensive production – and driving more persistent inflation. Portfolios need protection against this.

Investors are always asking if their views are reflected in market prices – including views on interest rates, technology trends and prospects for consumer demand. A key addition to that list is a view on how government policies, technologies and consumer preferences will reshape economies and reduce carbon emissions. And like other factors investors consider, the transition path is uncertain and constantly evolving. BlackRock’s fiduciary role includes helping our clients navigate economic transformations to meet their investment objectives. We help investors position portfolios to be resilient to energy-transition risk, seize its opportunities and strive for higher and more stable long-term returns. When considering the transition, we see three key investment implications: First, we don’t think market prices fully reflect the gains some companies will make relative to others as economies reshape and carbon emissions are reduced. That makes an investment case for assets linked to the transition, as we discuss in Positioning for the net zero transition.

Currently, enacted policy and available technology are insufficient to achieve climate goals. But technology is developing rapidly, societal preferences are changing, and governments are enacting new policies: economics are shifting in favour of zero-carbon production, and the transition could well accelerate. The Ukraine war – and the West’s decision to wean itself off Russian energy – may hasten the transition in Europe. With the REPowerEU Plan, Europe wants to increase energy security and affordability – objectives that can be achieved by building out clean energy supply and infrastructure. The recent Inflation Reduction Act in the US will unleash enormous investment to help sectors cut emissions. The strong market reaction to this news supports the view that the risks and opportunities of the transition are not fully priced in. That creates investment opportunities in companies and sectors set to benefit. But these opportunities are not limited to lower-carbon companies. Most of the investment needed for economies’ low-carbon transition is in today’s carbon-intensive sectors. Climate transition investing is the repositioning of portfolios to build resilience to the risks and take advantage of the opportunities associated with the transition to a low-carbon economy and adaptation to the physical impacts of climate change.

Supply constraints
A second investment implication: investors should consider how to mitigate the portfolio impact of possible supply constraints during the transition. Take energy – even with a rapid build-out of clean energy supply, growing global energy demand means traditional energy, especially gas, will be needed for years to come. Shortages and price spikes could occur over time if carbon-intensive energy production falls faster than alternatives are phased in. Making portfolios resilient to these shocks means investing in traditional energy too. But that comes with its own investment risk, which investors will need to weigh up: e.g., if fossil-fuel demand erodes faster than expected.

Inflation
Over US$30tninvestment needed in high-carbon sectors Capex needs by 2030 and carbon intensity, by sector A second investment implication: investors should consider how to mitigate the portfolio impact of possible supply constraints during the transition. Take energy – even with a rapid build-out of clean energy supply, growing global energy demand means traditional energy, especially gas, will be needed for years to come. Shortages and price spikes could occur over time if carbon-intensive energy production falls faster than alternatives are phased in. Making portfolios resilient to these shocks means investing in traditional energy too. But that comes with its own investment risk, which investors will need to weigh up: e.g. if fossil-fuel demand erodes faster than expected. The third implication relates to inflation. Faster low-carbon transition might be beneficial for growth and inflation relative to the only alternative – serious climate damage. But it is likely to mean higher inflation in the future. Our Global Outlook explains the challenge that poses for central banks: crush growth to stabilise inflation or live with higher, more volatile inflation. Investors should build in protection to that as well – for example, through inflation-linked bonds.

Over US$30tninvestment needed in high-carbon sectors

Capex needs by 2030 and carbon intensity, by sector.

Read the article online: BlackRock