The blockage of the Strait of Hormuz has left the world facing another energy crisis and warning bells of a global recession are growing increasingly shrill.
Ostensibly, the crisis could also push the energy transition back as governments and companies scramble to shoulder the cost of $100 per barrel of oil and prepare for higher interest rates and a jump in borrowing costs. More coal is already creeping into the energy mix in Europe, Japan and South Korea, and in countries with domestic coal reserves, like India and China.
But the argument that the oil shock could accelerate the transition is also persuasive. Top1000funds interviewees reflect that a renewed quest for energy security could see policy makers step up the transition, and say the conflict has already highlighted the outperformance of companies with secure energy sources.
A higher cost of capital
If governments raise interest rates in response to inflation, it could scupper large-scale transition projects, predicts Chris Greig, senior research scientist in the Andlinger Center for Energy and the Environment at Princeton University.
“Companies in markets that rely on energy imports are at a particular disadvantage, with increasing inflation and a more challenging financing environment. As the cost of capital goes up, the ability to allocate capital to decarbonization projects will reduce.”
The cost of capital will hit decarbonisation progress in hard to abate sectors particularly, he continues. The development of innovative technology like sustainable aviation fuel, carbon capture and storage, and emissions reduction in the cement sector, is challenging to finance and structure at the best of times and will get much harder now.
Moreover, corporate commitment to transition projects will depend on the strength of internal policies and governance just as the ability of investors to apply pressure on companies has got more challenging. UK pension scheme Nest has just updated its voting policy, honing its focus on companies that have materially scaled back their climate strategy without adequate explanation.
“One reason holding companies to account, particularly in the US, has become more difficult is because of the decline of fund managers in collaborative initiatives that means corporate engagement is now frequently bilateral rather than multilateral, diluting consistent messages to companies,” says Nest’s director of responsible investment, Diandra Soobiah.
But the war’s many unknowns also hold a longer-term scenario where the high oil price actually spurs corporate decarbonisation efforts.
When energy costs rise, the strategic business case for electrification fuel switching and efficiency investment strengthens, argues Jan Rosenow, Professor of Energy and Climate Policy at Oxford University who says that the 1970s energy crises and Russia’s invasion of Ukraine both triggered significant investment in new energy technologies.
“History suggests these crises ultimately accelerate the transition,” he reflects. “The companies most likely to struggle are those that have been slow to invest in transition technologies, because they’re now facing higher operating costs and a more urgent need to act.”
Lucas Kengmana, senior investment strategist in the sustainable investment team at NZ$ 84 billion ($48.6 billion) NZ Super Fund points to the recent performance of the MSCI’s Paris Aligned All Country World Index relative to the market weighted index to argue the same point: companies with green energy sources, outperform.
“The MSCI’s Paris Aligned All Country World Index has outperformed the market weighted index by 28bps since the start of the war.”
David Ross, senior executive, managing director, and global head of liquid assets, at Canada’s OPTrust sees today’s oil crisis as another example of the extreme disruption companies face that spans AI to tariffs and which will increasingly separate corporate winners and losers.
“The oil shock has made the separation between firms with credible plans for the future and financing to support those plans, and those that are unprepared and not in a position to pivot, even clearer,” he says.
Will investors allocate more to oil and gas?
The possibility that investors might allocate more to oil and gas is front of mind for Johan Florén, chief ESG and communications officer at Swedish buffer fund AP7.
“What clearly speaks in favor of a slower transition is that the entire oil and gas sector suddenly makes much more money with rising oil prices, while investments in renewable energy with lower return expectations become more difficult to defend in the foreseeable future,” he says.
In the UK, the conflict has highlighted reasons to accelerate Scottish North Sea oil and gas projects, for example. But Nest’s Soobiah says the pension fund won’t actively increase its allocation to oil and gas.
“We are continuing with our decarbonisation trajectory and what is happening in the world is validating that decision to invest more in climate solutions and green energy.” She adds that drilling in the North Sea wouldn’t solve the UK’s energy crisis anyway. “Oil would be exported at global prices. Tapping into fossil fuels is not going to help bring down prices for UK residents.”
Meanwhile investors with long-term oil and gas exposure aren’t planning to increase their allocations.
“We haven’t added to energy in recent times and our expectations is that market will correct once the war is over. We don’t have a house view on fossil fuels or oil, but we are broadly underweight the 5 per cent equity index exposure,” says Amy McGarrity, CIO of Denver-based Colorado PERA where energy exposure sits across a $67 billion portfolio.
Effective inflation hedges exist outside oil and gas too. Careful portfolio construction and diversification across returns gives shelter from inflation and won’t see investors necessarily buy crude futures or energy companies to hedge.
NZ Super’s Kengmana suggests renewable energy plants could benefit from an upside in the electricity price as could sustainable farms that use less fertilizer, or green buildings that consume less energy. Moreover, oil and gas producers won’t all benefit from the crisis because the nature of the conflict has also left marooned cargoes, he says.
“It is only those upstream producers who can currently get their fossil fuels to the regions where there is an energy shortage who will benefit from elevated prices. Downstream energy companies may suffer from elevated fossil fuel prices depending on their ability to pass on costs.”
governments distracted by cost of living crisis
In another potential dent to the green transition, the crisis is shifting governments’ attention away from the transition and ambitious climate policies to energy affordability and security, already visible in policies like fuel subsidies and looser emission pricing.
“Climate goals don’t go away, but in the near term at least, they become deprioritized in terms of narrative and attention, slowing down the pace of capital allocation,” says Greig.
However, policy makers could also prioritise the transition because the narrative has shifted to energy security, reframing clean energy investment as a strategic necessity rather than environmental preference. Coupled with the fact the cost curves of renewable energy have collapsed, the policy stance might strengthen in favour of renewables, argues OPTrust’s Ross.
“Now countries are left with the need to secure energy independence and the cheapest way to do that is with renewables because price of the technology has come down a lot,” he says.
Nest’s Soobiah adds, “Renewables now play a significant part not only in net zero but in also driving energy security in the face of geopolitical risk and when oil and gas is weaponized in war.”
Rosenow is similarly convinced the quest for energy security will see governments maintain their policy ambition.
“I’d expect to see more policy ambition, not less, particularly in Europe, where the link between fossil fuel dependency and geopolitical vulnerability has been exposed. The countries and blocs that move fastest on electrification are the ones that insulate themselves from this kind of external shock. That’s a powerful political argument that cuts across traditional left-right lines.”
