Europe’s race to net zero: an investor’s perspective

Europe, China, Japan, South Korea and many US states have adopted net-zero emissions targets. The Ninety One Investment Institute examines Europe’s planned route-map to carbon neutrality, considers the investment implications, and draw conclusions that will shed light on the net-zero journeys that other parts of the world will take.

May 26, 2021

5 minutes

Sahil Mahtani
Deirdre Cooper
Graeme Baker
Europe, China, Japan, South Korea and many US states have adopted net-zero emissions targets. The Ninety One Investment Institute examines Europe’s planned route-map to carbon neutrality, considers the investment implications, and draw conclusions that will shed light on the net-zero journeys that other parts of the world will take.

The fast view:

  • There are many paths to net zero, and each one has different implications for investors.
  • Europe’s destination is now clear. It is aiming for a high-renewables, high-electrification outcome, with a plan to build a hydrogen economy. It is also heavily incentivising energy efficiency.
  • An analysis of Europe’s pathway sheds light on how the race to net zero is likely to be run differently elsewhere.
  • Early indications suggest China is much more likely to rely on demand efficiencies than Europe or the US, while also relying on nuclear to solve the problem of variability.
  • The US is likely to rely most on carbon capture, while also the most likely to keep a role for hydrogen from natural gas with carbon capture.

Europe, China, Japan, South Korea and many US states have adopted net-zero emissions targets. But there are multiple paths to net zero, each with different trade-offs and likely with different outcomes. Investors therefore need to understand not only the goals of environmental policy, but the approach each region is taking towards a more sustainable economic model.

At present, Europe’s route-map is the clearest. In this paper, we examine the region’s planned course to carbon neutrality, consider the investment implications, and draw conclusions and parallels that will shed light on the net-zero journeys that other parts of the world will take (for the full paper, see the Ninety One Investment Institute’s ‘Europe and the race to net zero’). The research behind this paper is based on published scenarios derived from several integrated assessment models.

Towards net zero: Europe’s strategy

‘Net zero’ means reducing emissions of carbon dioxide (CO2) to zero, either by eliminating harmful emissions or by removing CO2 from the atmosphere. Achieving net-zero is crucial if the world is to avoid 3°C warming by 2100 from pre-industrial levels, the trajectory it is on currently, a temperature rise consistent with major environmental, social and economic problems1.

In Europe’s case, reaching the Paris Agreement’s ‘below 2°C’ target requires reducing emissions by 80-95% by 2050 from 1990 levels. Its strategy for achieving that encompasses extensive renewables and electrification, but with a plan to also build a hydrogen economy based on renewable hydrogen. The region’s governments are also heavily incentivising energy efficiency – for context, regional energy demand has actually been flat-to-declining in recent years.

We would highlight six variables that shed light on Europe’s chosen clean-energy transition pathway, each of which has potential investment implications and which are useful yardsticks to assess other regions’ net-zero pathways:

  1. Energy demand will shrink
    There is likely to be an acceleration of measures to reduce energy demand in Europe, with scenarios clustering at 0.8%-1.00% per annum. This implies a decline in energy demand in the coming years ten times faster than the average rate of the last three decades.
  2. Electrification will accelerate
    Electrification in Europe, including of transport, will have to expand significantly. By 2050, net-zero scenarios converge on electricity accounting for just above 50% of total final energy consumption, up from 19% today.
  3. Renewables will dominate
    Renewables’ share of final energy demand clusters around 80% in scenarios tending towards net zero. The more that decarbonisation relies on supply-related measures (as opposed to reducing demand for energy), the more renewables will be needed.
  4. Hydrogen will be used to overcome renewable intermittency
    The problem of intermittency from variable renewable-energy sources can be solved through renewables overbuilding with battery storage, or renewables overbuilding with hydrogen. Europe is going the latter way, which will involve 80% more gross electricity generation relative to the former scenario’s 40%.
  5. Carbon-capture is a must, but scenarios vary
    Carbon capture — both nature-based and engineered options — are used in nearly all scenarios. However, the range of outcomes is vast, and at the median estimate they will account for just 12% of current emissions.
  6. Transport policy must be watched
    Big decisions still have to be made in transport. For passenger vehicles and light commercial vehicles, Europe’s path has been set towards battery electrification. For heavy trucks, the choices are between battery electrification and hydrogen-based fuels, with the decision on which one to take dependent on institutional factors such as labour laws. Aviation is likely to require fuels, and could be solved by a combination of e-liquids, liquid biofuels, and jet fuels.

How do other regions differ?

Broadly, we see decarbonisation as one of the most powerful structural growth trends of our times, and as presenting a significant investment opportunity and a clear risk to existing portfolios. But the way each region’s economy shifts away from fossil fuels will influence the likely winners and losers of the clean-energy transition, and hence have important investment implications.

An early comparison of Europe’s net-zero strategy relative to other regions suggests China is much more likely to rely on demand efficiencies than Europe or the US, while also relying on nuclear to solve the problem of variability. The US is likely to rely most on carbon capture, while also the most likely to keep a role for hydrogen from natural gas with carbon capture. In all cases, Europe, China and the US need to get renewables to over 80% of final energy demand by 2050 to reach net zero.

The global race towards net zero is on.

Growing momentum

European countries were the first to commit to legally binding net zero targets. In 2017, Sweden committed to achieving net zero by 2045. In 2018, the UK became the first G7 country to do the same, by 2050 this time2. In 2019, those initiatives broadened out into the European Commission’s Green Deal, which targets net zero by 2050.

Since then, the rest of the world has joined in, with 2020 marking a dramatic acceleration in national commitments to decarbonisation. In September 2020, China announced a ‘net zero by 2060’ pledge; Japan and South Korea followed with 2050 targets. The US has been a notable laggard, but President Biden and a Democratic Congress can do much to reverse the inaction of the last administration. In any case, individual US states have been more proactive. In 2018, California Governor Jerry Brown signed an executive order for a net-zero emissions target by 2045. In other words, the global race towards net zero is on.

Much as countries mobilised for ‘total war’ in the mid-twentieth century, societies, economies and energy systems are on the cusp of an energy transformation.

An economic reconfiguration

Much as countries mobilised for ‘total war’ in the mid-twentieth century, societies, economies and energy systems are on the cusp of an energy transformation as they are reconfigured for a world in which nearly all emissions need to go. There was a moment in the early days of the COVID-19 pandemic when the question was raised whether the crisis would distract from the decarbonisation agenda. In fact, COVID-19, as perhaps the most simultaneous, synchronised crisis in history – one felt in every corner of the world at more or less the same time – has only reinforced the threat posed by long-term vulnerabilities such as climate change.

Climate change, of course, is the ultimate crisis of the Anthropocene, the period when human activity is not just leaving a mark on the physical world, but that may eventually overwhelm it. The crisis is of our own making, but clarifying the net zero pathways is the only way they are going to be solved.

Download PDF

 

1 Lieven, A., Climate Change and the Nation State: The Realist Case, Allen Lane, 2020, pg. 2-34.
2Evans, S., In-depth Q&A: The UK becomes first major economy to set net zero climate goal, Carbon Brief, 12 June 2019

Sahil Mahtani
Strategist, Investment Institute
Deirdre Cooper
Portfolio Manager
Graeme Baker
Portfolio Manager

Next article

Meet the investment team: Q&A with Esther Chan

In Perspective caught up with Esther Chan, Investment Specialist in our 4Factor team, on her career journey, travels through developing countries, views on diversity, domestic politics and what inspires her the most.

In Perspective Autumn 2021 Hub Next article

Important information

The information contained in this Viewpoint is intended primarily for professional investors and should not be relied upon by private investors or any other persons to make financial decisions. All of the views expressed about the markets, securities or companies in this document accurately reflect the personal views of the individual fund manager (or team) named. While opinions stated are honestly held, they are not guarantees and should not be relied on. Ninety One SA (Pty) Ltd in the normal course of its activities as an international investment manager may already hold or intend to purchase or sell the stocks mentioned on behalf of its clients. The information or opinions provided should not be taken as specific advice on the merits of any investment decision. We do not undertake to update, modify or amend the information on a frequent basis or to advise any person if such information subsequently becomes inaccurate.

Ninety One SA (Pty) Ltd is an authorised financial services provider.