How investors are adjusting to a slower green transition

As the transition to a low-carbon economy shows signs of slowing, investors are making adjustments. While they’re still focusing on technologies that may emerge as winners in a greener future, their focus on large incumbent companies and how they're managing their own green transition has increased, says Goldman Sachs Research’s Michele Della Vigna. 

Della Vigna and his team recently examined the roughly $75 trillion in investment that is estimated to be required to bring global net carbon emissions to zero by 2070. Global carbon emissions have risen higher than previously expected, and the goals set out in the Paris Agreement are unlikely to be achieved. But an ambitious path to containing temperature increases to 2 degrees Celsius of pre-industrial levels may still be attainable, according to Goldman Sachs Research. 

At the 5th Annual Carbonomics Conference convened by Goldman Sachs in London in November, companies and investors showed a growing understanding that the path to net zero will take longer than once believed.

“When we did the first Carbonomics conference, there was a lot of top-down discussion of how we reach a Paris-aligned scenario,” says Della Vigna, the head of Natural Resources Research in EMEA in Goldman Sachs Research. “Now investors and companies are focusing on a bottom-up view to find specific clean tech investments that can deliver returns above the cost of capital, and that can be financed.”

Interest in clean technology investing has not waned, Della Vigna says. The strong attendance at the Carbonomics event, which attracted 30 CEOs, key policymakers, and more than 1,000 investors, is one indication of that, he says. We spoke with Della Vigna after the conference about the forecast for peak oil consumption, the outlook for incumbent energy companies, and how the energy transition is unfolding around the world.

How are investors shifting their view of large producers of hydrocarbons?

Investors are realizing that hydrocarbon demand is likely to grow for decades to come. We have pushed back peak oil demand to the middle of the next decade in our most recent report on the path to net zero carbon emissions. We also have pushed back peak gas demand to 2050. That means we need greenfield oil and gas development beyond 2040, which is very different from how some investors have been thinking about it.

Oil and gas producers will need to innovate to discover new fields and to lower decline rates. They will need to use technology such as digitalization and generative artificial intelligence to improve their ability to do these things.

I also think it’s becoming more important to continue to reduce the direct emissions in the industry — limiting methane emissions and flaring, for example. This is a huge focus for the industry, and it’s a huge differentiator in the minds of investors.

Have expectations changed about which oil and gas assets might become stranded?

I think some analyses about stranded assets were based on extremely unrealistic assumptions. The debate is shifting from concern about stranded assets to worries about insufficient availability of assets to provide the world a stable supply of hydrocarbons.

When we looked at our database of the world’s largest oil and gas developments in our annual Top Projects report, we reached a concerning conclusion: That the industry’s reserve life for oil has halved in the last decade. Also: Non-OPEC production will peak in 2027. Unless technological innovation and increased investment unlocks more resources that come on stream before the end of this decade, we are going to have a very tight market. We are going to consume OPEC’s spare capacity very fast.

What is the biggest motivator for clean-tech investors right now?

Investment in this area is always driven by both market dynamics and regulation. Two years ago, with the introduction of the Inflation Reduction Act (IRA) in the US, we had the most substantial policy support for clean technology in history. Investors got super excited about the regulatory support.

The recent US elections threw some cold water on that thinking. Now there is a greater focus on which technologies are evolving fast enough and moving low enough on the cost curve that they stand on their own financial merits even if some incentives end up changing in the coming years.

What rises to the top when you think about investments this way?

Solar, without doubt. Onshore wind, probably, but not offshore. Batteries and everything that has to do with electrification and grids. That’s because there is tremendous demand growth there, driven by data centers and broader economic growth and population growth. Those are clearly areas that are working.

There are a couple of other places where we’re seeing good development. Carbon capture is becoming more and more widely used, on both sides of the Atlantic. Biofuels, having suffered a really difficult year, are starting to recover and to see better demand in North America and in Europe.

What’s boosting carbon capture and biofuels?

These technologies are needed in an energy transition where emissions will continue for longer. For cleaner industrial processes, electrification and clean hydrogen are taking a little bit longer. Therefore, we need carbon capture to retake some emissions from those plants. In transport, internal combustion engines will probably stay around for longer. Therefore, if we want to decarbonize, we need to blend more biofuels. Both these technologies work on existing infrastructure and don’t require a complete rethinking of the current setup for heavy industry and heavy transport.

How do you explain increased investor interest in large incumbent companies in energy, materials, and other sectors?

There’s a growing realization that the green transition will take a long time. And because of that, it’s important to be invested in companies in transition, rather than just looking for the end game. There’s also an understanding that unlocking capital at large scale from these companies is key in order to finance the $2-$3 trillion in infrastructure investment that will be needed if we want to achieve net zero carbon.

These large companies are demonstrating capital efficiency. They're looking at their capital allocation across more traditional investments and some clean tech investments, and they're trying to balance the two to continue to deliver a double-digit return. That’s something a lot of the pure-play companies in green technology have really struggled to do.

How is this type of investment unfolding differently in the US and Europe?

The US has some big advantages. There is economic growth, and very supportive regulation that is leading to tremendous investment. We estimate the IRA has unlocked something around $800 billion of new investment in two years.

Europe is a more challenging environment. But at the same time, the advantage of Europe is: Being a major hydrocarbon importer, it makes more and more sense to shift the energy network to be more locally supplied and renewables-based. If Europe could find stable regulation and access to capital, the green transition could become a tremendous investment that would really strengthen the region and provide a lower-cost energy supply.

You cite the boost that clean tech in the US gets from the IRA. Does the outcome of the election erode that?

It’s very rare for a government to reverse or unwind a package of incentives like that, even with a change of majority. Our view is that most likely the IRA stays in place. It may be applied more tightly, especially with some of the more marginal technologies, but we believe the bulk of it will remain in place.

A lot of money under the IRA has gone to red states. Texas, for example, is actually becoming the clean-tech capital of the world in many ways, thanks to these incentives and a very efficient permitting system in the state. We believe the IRA will continue to lead to development and job creation in the US.