ESG Series: Energy transition’s “shortage of returns”

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Executive summary │ Energy transitions "shortage of returns"

Profitability (not capital) remains a critical barrier to decarbonisation

 

The "shortage of returns" challenge

 

 

 

 

 

 

 

 

Why going green does not always pay

 

 

 

 

 

 

Bridging the "shortage of returns" gap

 

 

 

 

 

 

Making the math work

 

The "shortage of returns" challenge

• The core to our 2024 ESG outlook was anchored on the corporate trilemma of (i) growth; (ii) profitability; and (iii) sustainability (see here). That is, in a world wherein ESG’s decibels of debate are rising and corporate budgets are being squeezed on the back of a higher for longer rates environment, we asked whether making growth sustainable and inclusive requires inscrutable trade-offs – forgoing revenues and profits for the sake of sustainability.
• We hone in on the profitability dimension of the corporate trilemma in this ESG thought leadership report and emphasise that the limited return on investments (RoI) – rather than the access to capital – is increasingly cited by our clients as a leading barrier to scaling the energy transition.
• We hone in on the profitability dimension of the corporate trilemma in this ESG thought leadership report and emphasise that the limited return on investments (RoI) – rather than the access to capital – is increasingly cited by our clients as a leading barrier to scaling the energy transition.

 

Why going green does not always pay

• What are the major obstacles as to why going green does not always pay? Slow permitting, taxing legal processes, supply chain constraints, regulatory disparities, a lack of organisational capabilities and tepid technology availability (especially across emerging markets) are predominant roadblocks to the growth of low-carbon and renewables businesses.
• Critically, the most pertinent impediment to inadequate returns from the transition in our view, has been higher interest rates. Renewables are fuel-free, but that means almost all of their expenditure is incurred upfront – financed with debt. That makes them more dependent on the cost of finance than carbon-intensive alternatives, which incurs a larger share of costs later. Thus, finance is crucial.

 

Bridging the "shortage of returns" gap

• Government policy and regulatory support can help bridge the gap of low returns.
• The unparalleled Inflation Reduction Act (IRA) – the largest climate legislation in US history – is a testament of how receptive corporates can react to favourable policy signals (see here and here). The European Green Deal, Japan’s Green Transformation (GX) and the UK’s Powering Up Britain, all aim to equally maintain competitiveness by incentivising green investments.
• Yet, the challenge in most developed markets is that it may prove difficult to pay for these initiatives with higher-for-longer rates, elevated debt-to-GDP ratios or shifting budget priorities (towards more defence spending in a geopolitically charged de-risking world).

 

Making the math work

• All in, companies have ample access to capital markets. Yet, capital seeks returns, and delivering on the energy transition’s ambitions comes down to economics – economic returns are a first-order scarcity.
• If the global economy was on the pathway to the USD4.6 trillion per year that the International Energy Agency (IEA) estimates is required by 2030 to achieve net zero emissions by 2050, the energy transition would generate a new USD55 billion earnings pool each year – a low-end estimate if one assumes an average 20% equity weighting for projects and a 6% return on that equity.
• That’s the generational upside that companies are pursuing as they work to scale their green businesses. Though, despite the opportunity, less than USD2 trillion per year is being deployed into clean energy worldwide.