Global Weekly Commentary: A lopsided energy transition
Key points
Surging coal and gas prices
The economic restart has laid bare a lopsided transition toward low-carbon energy that has amplified a surge in coal and natural gas prices.
Market backdrop
U.S. stocks rallied to all-time highs on better-than-expected corporate earnings. Oil prices hit multi-year highs.
Week ahead
Investors will watch activity and inflation data from the U.S., euro area and Germany for clues on the impact of supply chain disruptions on growth.
Surging natural gas and coal prices amid a powerful economic restart have exposed a lopsided transition toward low-carbon power. We still see an orderly transition in the medium term – but with bumps on the way that could lead to growth and inflation volatility. We expect the transition to reinforce a shift to a higher inflation regime, supporting our new nominal theme that points to a more muted central bank response to rising inflation than in the past.
Volatile prices
Futures prices of oil, coal and natural gas, 2017-2024
Sources: BlackRock Investment Institute, with data from Refinitiv, October 2021. Notes: Prices are based to 100 at the start of 2017. We use the European Energy Derivatives Exchange futures, ICE Rotterdam coal futures and Brent crude oil futures to represent natural gas, coal and Brent crude oil respectively. The dots show futures prices for contracts that expire in December 2022, December 2023 and December 2024.
The powerful restart has driven up oil prices to multi-year highs, as we argued in the previous Global weekly commentary. Coal and gas prices have surged far more. See the chart above. Why? On top of the restart, a range of weather and geopolitical factors have restricted supplies of coal and renewable energy. It’s been difficult for other sources of power to be brought on stream. This is putting sharp pressure on prices of available sources of power. With governments looking to minimize carbon emissions, gas prices have risen even further than coal. All these events have exposed an underlying issue: The transition to net zero so far has been lopsided, as clean energy investment has not increased enough to make up for the decline in fossil fuel investment. Futures markets are pointing to lower coal and gas prices by the end of next year. Much depends on the temperature in the coming winter. And while the transition remains lopsided, we can expect more volatility of energy prices, inflation and economic activity in future.
For now governments may find themselves compelled to support greater use of fossil fuels – particularly gas – amid energy supply shortages. Natural gas may emit less carbon than oil or coal, but its largest component methane is another potent greenhouse gas. It too will ultimately need to be phased out if the world is to reach net-zero. The phase-out of natural gas and momentum toward net zero therefore rest on accelerating the development of clean energy supply.
There has been massive investment in clean energy – an average of $1 trillion a year between 2016 and 2020 according to the International Energy Agency (IEA). More is needed to build a clean, resilient energy infrastructure. A net-zero transition by 2050 will require an average annual investment of nearly $4 trillion between 2026 and 2030, says the IEA. A successful transition will not only need clean energy, but also new technologies to store and distribute clean energy, to decarbonize manufacturing, agriculture and transport, and to capture carbon emissions.
The pace and precise nature of the net-zero transition will be guided by government policy, which will vary across countries. More clarity on climate policies will help encourage the private sector to invest in clean energy and related technologies. That’s why commitments from governments at the upcoming United Nations climate summit (COP26) will be key to watch. The pace of transition around the world will vary by country, and emerging markets are in urgent need of funding for low carbon investment at scale, as we have highlighted in a recent publication The big emerging question.
The bottom line: An orderly – albeit lopsided – net-zero transition will have bumps along the way that could lead to greater inflation and growth volatility. We view the net-zero transition as modestly inflationary overall, and via higher inflation contribute to a new nominal environment (see our investment themes). The transition creates investment opportunities in both public and private markets. Over a strategic horizon we like the sectors that stand to benefit more from the transition, whether for being solution providers or by being less exposed to climate risks, such as tech and healthcare. We also see strategic opportunities in the infrastructure space that are related to the development of new technologies that are needed to reach net zero. We prefer inflation-linked bonds over their nominal counterparts over a strategic horizon due to the inflationary pressure.
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