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Beyond oil: The world’s changing energy mix

The way the world fuels its transport, heats its homes and powers its industry is changing, but the path to renewables will not be linear, says Mark Hume, co-manager of the BlackRock Energy and Resources Income Trust plc (LON:BERI).

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

The world’s energy mix is in motion. The most recent data from the International Energy Agency shows that while around a quarter of the world’s electricity is powered by renewables, capacity is expected to expand by 50% by 20241. The path ahead if clear: dominant fossil fuels are being replaced and a new energy infrastructure is emerging.

The adoption of renewables has been strongest in the electricity sector, where solar and wind power have seen rapid growth driven by policy initiatives and falling prices1. The size of the global wind power market grew 35% in 2018 and is expected to reach $124.5bn by 2030 as the Asia-Pacific region drives growth2.There is similar growth potential in solar, hydro and biofuels as the world transitions to a less carbon intensive energy system.

Any energy strategy needs to reflect this shift and the BlackRock Energy and Resources Income Trust recently moved to incorporate more companies linked to the global energy transition in its portfolio mix. Today’s GDP growth is less energy intensive, which means that there is less growth in core energy markets. As such, this shift is important to build sources of new growth into the portfolio.

The role of oil

However, electricity accounts for only a fifth of global energy consumption1. There are still areas such as heating where renewables are a relatively small part of the mix. Renewables met only 10% of global heat demand in 2018 and is only expected to reach 12% by 20243. Within transportation, dependence on oil is partly being addressed through electrification, but although this is growing fast, it is from a small base.

As such, the energy mix is likely to include some traditional sources of power for some time. There is also the question over whether the current coronavirus outbreak may put a temporary pause on the move to decarbonise as governments turn their attention elsewhere. It is our view that the pace of the energy transition will evolve and shift over time, which may change the opportunity set at any given point in the cycle.

Equally, it is important to note that many ‘traditional’ energy companies – oil majors and so on – are likely to play a key role in the energy transition. Many of them have championed renewable fuels. BP for example, is the UK’s biggest name in electric vehicle (EV) charging, while also holding investments in biofuels, wind and solar. It has committed to becoming a net zero company by 2050 or sooner4.

Changing business models

Royal Dutch Shell has developed wind and solar-power projects, encouraged the adoption of hydrogen electric energy and invested in low-carbon start-ups — spanning electric vehicle charging to home energy storage5. In early 2020, Rio Tinto shared plans to invest around $1 billion over the next five years to support the delivery of its climate change targets6. It is also working towards net zero emissions from operations by 20506. Increasingly, it is not a question of a company being on one side or another but all being part of a broader transition.

The question is what happens in the meantime. A side effect from the COVID-19 outbreak has been extreme volatility in the oil price including, at one point, a dip to a negative rate. There have been many questions over whether the oil producers can weather the short-term shock. We estimate that oil demand may be as much as 10% lower for the year ahead. While some of the recent price fluctuations have been anomalous, there can be little doubt that the oil price could remain under pressure for some time.

Vulnerability

Certainly, there may be bankruptcies among those companies with the highest costs of production – the US shale companies look particularly vulnerable. However, for larger companies, with lower debt and strong management teams, these low oil prices should not disrupt their longer-term strength and it may even accelerate their adoption of alternative energy sources. Many entered this crisis in a good position with strong balance sheets, advantaged assets and a clear and well-articulated strategy to be part of the solution.

The world’s energy mix is fluid. While the path of travel is clear – towards renewables and away from fossil fuels – it may not be linear. Active management can help direct investment to those companies with the greatest influence at any given point in the cycle.

Risk: The specific companies identified and described above do not represent all of the companies purchased or sold, and no assumptions should be made that the companies identified and discussed were or will be profitable.

For more information on this Trust and how to access the opportunities presented by the energy and resources markets, please visit www.blackrock.com/uk/beri

Unless otherwise stated all data is sourced from BlackRock as at May 2020. All amounts given in USD.

  1. IEA, Feb 2020
  2. Power Technology, Nov 2019
  3. IEA, Feb 2020
  4. BP, Feb 2020
  5. FT, Sep 2019
  6. FT, Feb 2020

Risk Warnings

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Trust Specific Risks

Exchange rate risk: The return of your investment may increase or decrease as a result of currency fluctuations.

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Gearing risk: Investment strategies, such as borrowing, used by the Trust can result in even larger losses suffered when the value of the underlying investments fall.

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