A smart investment approach for the Energy Transition

The International Energy Agency (IEA) reports a remarkable increase in renewable energy investments in 2023. Noteworthy gains include an 85% increase in solar PV installations, totaling 420 GW—comparable to 400 nuclear reactors. Wind energy capacity rose by 60% to 120 GW, while electrolyser capacity essential for hydrogen production jumped by 360% to 580 MW. The electric vehicle market also saw significant growth with a 35% increase, reaching 13.5 million units sold. Additional progress was made in producing more efficient heat pumps, enhancing carbon sequestration technologies, developing better batteries, and implementing advanced electrical infrastructures like smart grids. Innovations didn’t stop there; developments in compact nuclear reactors, sustainable aviation fuels, geothermal energy, and cleaner steel production were also prominent.

Globally, governments are not just supporting but actively promoting these investments through economic incentives to significantly cut CO2 emissions. The rising consumer awareness of global warming risks further fuels this momentum, though the full impact remains hard to gauge.

However, the financial performance of companies in this sector has been remarkably unstable, as evidenced by the MSCI Global Alternative Energy USD Index. After soaring by 108% in 2020, the index experienced declines of 18% in 2021, 7% in 2022, 25% in 2023, and an additional 16% by April 2024. Factors influencing these downturns include:

• 1. Overvaluation of stocks by the end of 2020, requiring market corrections.
• 2. Increased interest rates that have affected the financing of capital-intensive renewable projects.
• 3. A reduction in certain government regulations and incentives, notably in California.
• 4. Overcapacity in industries like solar, batteries and wind, leading to overproduction.
• 5. Aggressive competition from China, compressing profit margins in key sectors.

This volatility highlights the dual nature of the energy transition: it is a significant shift that will inevitably determine winners and losers. For example, hydrogen production is still developing, with no companies currently turning a profit, suggesting potential risks in early investment. Similarly, in the electric vehicle sector, while demand is rising, the supply is expanding even more rapidly, which could lead to an oversupply scenario affecting all players.

To effectively navigate this evolving landscape, investors may need to consider strategies beyond traditional long-only investments. Employing a sophisticated long/short investment strategy, managed by seasoned hedge fund professionals, could leverage these rapid technological changes and market dynamics. Such strategies involve supporting promising companies while hedging against those expected to underperform, offering a nuanced way to potentially profit from this significant transformation. For instance, the variation in stock prices (dispersion) within the MSCI World Index is 24%, while it reaches 52% in the Alternative Energy sector—a difference of 2.2 times. Although there are few skilled long/short hedge fund managers, the ones who are available have demonstrated their ability to effectively manage these complexities in the market.