Low carbon transition – ESG Feature
In 2016, 30% of Drax’s energy was generated by coal; by 2019 this fell to 3%. Indeed, it produces 12% of the UK’s renewable energy, which can power 13 million homes during peak time. “The transition is going to close some doors and open others,” Anderson says.
Drax wants to be carbon negative within 10 years. It will use bi- oenergy as well as carbon capture and storage technologies to achieve this. The plan is to remove 16 million tonnes of CO₂ from the atmosphere annually. However, biomass involves burning wooden pellets to create energy, thus contributing to climate change. Skelton makes it clear that Drax does not cause deforestation as it’s bioenergy is generated from sustainable sources, such as sawmill residues. It also supports forest replanting programmes. Drax, in partnership with the National Grid and Norwegian energy company Equinor, is part of the Zero Carbon Humber initiative, which aims to establish a net zero industrial cluster by 2040. So cutting off Drax’s funding would stop it from contributing to driving to UK towards net carbon neutrality, proving that divestment should be a last resort and not a transition strategy. “Given the growth in demand for energy globally, through GDP growth and population growth, it is impossible to imag- ine how the world could function without fossil fuels in some capacity in the next 20 years,” Lees says. “We are going to need them. We have to encourage big oil companies to become big diversified energy companies, to be part of the solution as opposed to cutting them off completely.”This transition is a marathon not a sprint. There are industries that have a large carbon footprint, but we need them to keep the economy mov- ing, such as transport, energy and concrete. Investors cannot just starve them of new capital. We need them, especially as they may also be huge contributors to funding the sustainable products needed to make oil and coal redundant. Dong Energy in Denmark is the model. It switched from using oil and gas to wind as its source of energy. It changed its name to Ørsted after a physicist to reflect its new identity as a renew- able energy company. So divesting may not be the best option for those looking to decarbonise the world.
A risk-adjusted view “Returns may be lower in absolute terms, but you must risk adjust them,” Sheehan says, explaining that oil companies
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typically sanction projects that have internal rates of return of at least 15%, while a renewable project could earn 10%. “Oil companies warrant a higher return because their projects are riskier,” she adds, pointing out that renewable projects are more stable and have better security of purchase than oil pro- jects, which typically go out to market. Wind farm operators and oil companies are in different indus- tries, are of different sizes, different scales and supply chains. Fossil fuel projects are subject to a fluctuating price whereas, renewable projects could sell their energy for a fixed price to corporates through a power purchase agreement. “Over time, as renewables grow in scale and improve their sup- ply chain, the returns should improve; the market is a moving target,” Atkinson says.
The oil industry has not always made positive returns over the long term as prices can fall sharply. Lees says that putting the Covid-19 induced crash aside, solar and wind companies have strong growth profiles. “There are estimates that suggest that the global offshore wind market is going to grow at double digit compound annual growth rates for the next 20 years.
“There is a huge amount of growth that has to happen in solar, wind and electric vehicles globally (to meet the transition),” Lees adds. “It is a staggering expansion that has to happen. “So you have an area that logically has more of a chance to pro- duce above average returns for investors because you have above average growth,” Lees adds. “A lot of these areas also have shrinking cost curves because solar batteries are getting cheaper year by year, while oil, putting aside the most recent crash, has become more expensive to extract per barrel. “Solar has become factors of 10 cheaper and oil has become factors of 10 more expensive, while solar has improved its cost base relative to oil by 1,000 times or more,” he adds. Technological advancements have changed how we generate energy and there will be further improvements to come. “Only 20 years ago people thought solar and wind energy was way too expensive to make a meaningful difference in the energy mix,” Hengerer says. “Similarly, nobody would have predicted the incredible advance in electric vehicles in just 10 years. “The biggest challenge is not technology, but political will, and resistance from companies that benefit from the current energy regime,” he adds. “Hopefully the current crisis will help to focus the minds of politicians and voters alike on what really matters – a healthy and sustainable society.”
Issue 92 | April 2020 | portfolio institutional | 31
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