Why BlackRock CEO Larry Fink’s Annual Letter Signals “Beginning of Second Wave of Decarbonization Era”?
“We believe we are on the edge of a fundamental reshaping of finance”, Larry Fink, CEO, BlackRock
Housing, insurance, interest rates, inflation are all big drivers of today’s financial markets and climate change has no obvious impact on these drivers – TODAY. But this may be changing rapidly – the frequency of occurrence of major climate events around the globe continues to increase and as investors extrapolate this frequency and start pricing climate risk into valuations, CEOs are going to start taking proactive actions.
We believe this virtuous cycle should drive more investment into decarbonizing technologies and infrastructure. While we have arguably seen this transition in renewable technologies such as wind and solar, where government incentives and global supply has led to a surge in overall demand, we believe several other hard to decarbonize sectors are still lagging. In particular, the heavy-duty transportation, shipping, maritime, air transportation and heavy industries are still dependent on fossil fuels and emissions from these sectors are harder to mitigate.
As the developing countries such as India/China continue to move up the economic ladder, the stress on harder to mitigate sectors would continue to increase. Our thesis is that sectors such as renewables have received sufficient investment attention (and dollars). However, investment in the harder to decarbonize sectors still lags the growing need and as such emissions from these sectors continue to increase. This widening gap will reverse in our view as corporations (driven by responsible management and shareholders) as well as policy makers act to take advantage of the technological improvements or follow regulatory/shareholder pressures. Larry Fink’s letter to the CEOs really drives home this point.
Second Wave of Decarbonization
We believe we are entering the second wave of decarbonization – fueled largely by a healthy mix of corporate involvement and policy initiatives. Even the policy initiatives are more conducive to private investors (as they are sustainable regulations and not unsustainable subsidies in our view). The transition from first wave to second wave of decarbonization will be seamless in or view as renewables are now a meaningful driver of second wave. Hydrogen plays a critical role in the decarbonization toolkit. Until renewables reached the tipping point, it was not feasible to envision a “green hydrogen” world. We believe the technologies are now in place to produce and develop the infrastructure required to reach scale and decarbonize industries such as shipping, chemicals, steel among others. We believe digitization and progress within carbon capture should also accelerate emissions reduction within this decarbonized world.
We Need A Lot More Teslas (or Elon Musks)!
Transportation, Energy and industrial sectors represent majority of the global emissions and we would argue that Elon Musk and his peers are really only addressing 9% of the emissions problem by providing technologies/solutions to the light duty transportation and power generation sector. Even within the power sector, there is no clear pathway to achieving emissions reduction even if lithium ion batteries become cost competitive. For longer term (seasonal storage) and other transportation vectors – hydrogen becomes a very critical decarbonization tool. Our view is that the hydrogen decarbonization opportunity is even larger than the renewables and light duty transportation opportunity combined! Roughly $2.5 trillion have been invested in these 2 sectors over the past 15 years and we believe the hydrogen/decarbonization sectors could see an investment of 20x that amount over the next 30 years in our view. Carbon capture and energy efficiency (using AI/big data/drones etc.) are other tools that can be used to improve overall carbon footprint and achieve decarbonization goals.
Does China Stand A Chance to Win? What About Other Countries?
At least for now, it appears to us that China is lagging the US and other developed countries in terms of materials and technology development. This is the reason Chinese companies such as Weichai have acquired large stakes in US companies such as Ballard Power. That said, the Chinese government and private companies are even more focused on decarbonization compared to the US and as we have seen in the past, it is possible that China could catch up. More importantly other counties such as Japan, Korea, several European countries and Australia are very keen to take a leadership role in this second decarbonization wave and are making large investments in these sectors.
Bottom line:
We are still at the beginning of the second wave of Decarbonization era. The first wave of decarbonization resulted in almost no emissions reduction, limited action from corporations (much more action from governments in the form of subsidies) and resulted in a significant investment in the renewables infrastructure space. There were several losers – (i) Private Cleantech companies where investments were driven by venture funds that raised billions of dollars and placed disproportionate bets on science projects; (ii) Utilities, oil/gas companies & auto companies. Few winners – (i) Tesla, (ii) Renewables focused infrastructure funds to name a few. The second decarbonization wave has just started in our view – this time the transition will be driven by corporations and hence will be more sustainable in our view. The winners will be private companies that either get acquired by leading corporates as well as more specialized infrastructure funds that develop the expertise to invest in next generation decarbonization projects. In terms of losers, could the shareholder pressure seen by oil & gas companies to report and mitigate emissions continue over the next decade and could other harder to decarbonize industries (such as shipping, chemicals etc.) also see similar shareholder pressure? Could we see another Tesla emerge in the heavy-duty transportation sector and become a nightmare for the existing players? The good news is that several incumbent players are taking cues from the past and are definitely being more proactive (Cummins acquired Hydrogenics; Linde acquired a stake in ITM Power). So we may see more winners and few losers in the second decarbonization wave!