The world is getting warmer. Temperatures are up 1.2°C from the 1800s, and headed higher, unless we act swiftly. While the inter-nation tussle on who contributes how much to reduction in climate harm will play itself out, all know that a collective reduction is imperative. So, they’ll reach common ground at some point.
Given the direction, it is clear that life and business for many will never be the same again. And as an investor, you need to be cognizant of the risks emerging and position your portfolio away from them, and towards emerging opportunities. Here, the attempt is just to provide an overarching view of the changing landscape. You’ll need to do the hard work of figuring out the implications for your own portfolio companies, and course correct where required.
THE GREEN AGENDA
The United Nations’ climate action agenda highlights a few interesting aspects of the green shift. First, the world is not yet on course to limiting the rise in temperature to 1.5°C above pre-industrial levels, posing risk of a big impact on climatic conditions. So, nations will need to act fast. And to get there, we’ll need to lower fossil fuel use by 6 percent each year till 2030. We are nowhere near this, rather an increase is projected. But as things start to get worse, the pace of action to curb use should accelerate.
There are broad economic implications of this too. It is estimated that the green economy sectors can deliver direct economic gains of $26 trillion till 2030 and 65 million new jobs, much more than the economic and job losses such a move would result in. Of 163 sectors, only 14 are expected to have job losses of more than 10,000 and only two, refining and petroleum extracting, could lose more than 1 million jobs.
As an investor, you need to be alive to where it is going to hurt and where growth is going to come from. Just today’s news of First Solar, US investing $684 million in a 3.3GW integrated solar module facility in Tamil Nadu and yesterday’s announcement by Ashok Leyland of its EV arm seeing a $18 million investment by drivetrain major, Dana, suggest how the sands are shifting.
THE AUTO SHIFT
A move to EVs and hydrogen powered vehicles can spell a big shift for many auto suppliers to Original Equipment Manufacturers (OEMs). Many of the critical, high value-add components used in internal combustion engines (ICE) may increasingly be required less and less. So pistons, crankshafts, camshafts, gaskets, bearings, valves and spark plugs could be passe. Oddly, companies supplying less critical components like plastic mouldings, lights and air-conditioners will be better off. What’s more, given that the current batteries account for just about 2 percent of a vehicle’s current value compared to about 40 percent in an electric vehicle, the impact could be significant for battery makers, as many OEMs will look to set-up these facilities themselves, in partnership with technology leaders.
Here, companies like Exide and Amara Raja Batteries face an uncertain future, though they have taken steps to make the shift. Exide already has an 80:20 joint venture with Nexcharge for lithium-ion batteries, which according to a report by brokerage BOB Caps is targeting revenues of Rs 1,000 crore in 4 years, with a market share of 25-30 percent. An estimate that puts the total industry size four years down at about Rs 4,000 crore.
For context, Exide’s revenues last year were over Rs 15,000 crore, so the EV shift won’t have a big impact in the short-term, but if you think longer, the writing is clearly on the wall: transform or perish. Amara Raja too has made plans in this direction with its recently announced “new energy & mobility” initiative. And I find critique from some analysts on RoE (return on equity) impact misplaced here—longevity, survival and growth of a business pips short-term profits any day.
Short point, while ICE may not be dead, inroads into the market by alternatives like EV and hydrogen fuel cell powered vehicles can clearly dent growth. This even as bio-fuels and advances in emission control by fossil fuels aid in their survival. So, if you are invested in engine component makers, you need to reassess your position. Even associated sectors like lubricants could take a hit.
While Castrol is riding on BP’s early moves into developing specialised lubricants for EVs, that are much pricier, the risk of the loss of business from ICE not being offset by the lower volume, but higher realisation EV lubricants remains.
NO GOODBYE OIL, YET
Despite the big shift to electric and renewables, oil is not likely to go out of fashion anytime soon. Its uses, though, could see some shift. Estimates by most research agencies and oil experts, besides consulting firms like McKinsey, expect more investments in oil will be needed to meet future energy needs, at least till 2040 (that most projections are till). McKinsey, for instance, says: “While most of the offshore-oil-producing regions will be under pressure in an accelerated energy-transition scenario, the sector will still require new production of nearly 23 MMb/d to meet demand after 2030.” Even ExxonMobil’s reading of the scenario is similar: “Oil and natural gas make up about 55 percent of global energy use today. By 2040, 10 of the 13 assessed 2oC scenarios project that oil and gas will continue to supply more than 50 percent of global energy. Investment in oil and natural gas is required to replace natural decline from existing production and to meet future demand under all assessed 2oC scenarios.” More conservative estimates also assess a no less than 40 percent share for oil & gas in the energy basket in 2040.
What’s more important from a business perspective, though, is that this isn’t going to be a high growth sector, gaining share. It is going to be one losing ground. So, Hindustan Petroleum Corporation (HPCL) positioning itself for revenues from EV charging facilities at its gas station, through a tie-up with Tata Power, is the right way to go.
There are other developments in the segment too, that hold out hope of longevity. Industry majors like Exxon and BP are pursuing carbon capture options to deliver clean energy. For instance, Exxon is working with an expert in Genoa, Italy, to research how fuel cells can be used to capture carbon emissions. Moves in the bio-fuel space also hold out some hope. Global Clean Energy’s biorefinery in California will produce renewable diesel exclusively for ExxonMobil. The unit scheduled to begin production in early 2022, uses Global Clean’s patented camelina crop, which can significantly reduce life-cycle greenhouse gas emissions.
Besides, near half the world’s energy is consumed for industrial activity, like making steel, cement and chemicals to build houses, infrastructure and household goods. And these are energy intensive industries that could see a shift to use of fuels like gas from other fossils.
A SWEET OPPORTUNITY
One man’s loss is another man’s gain. And one notable gainer of the shift away from carbon emitting fuels is the biofuels sector. In India, the sugar industry is seen as a key beneficiary, though grain-based biofuels are also set to gain traction.
Ethanol production is estimated at about 332 crore litres in 2020-21, up from 173 crore litres a year ago. And at this level of output, the blending share in fuel is about 8.5 percent, which is targeted to be increased to 20 percent by 2025-26. Indian Sugar Mills Association has estimated the ethanol demand at between 700-900 crore litres in 2025-26, a 2-2.7x jump from current levels.
After the recent expansions in distilleries to produce ethanol by sugar producers, the capacity stands at 426 crore litres. Another 93 crore litres is expected to be added by March 2022. That will still leave the industry supply significantly short of the targeted demand in 2025-26.
Using a targeted 684 crore litres of ethanol from sugar in 2025-26, ISMA estimates that 60 lakh tonnes of sugarcane will need to be diverted to ethanol production, up 3x from the 20 lakh tonnes diversion in 2020-21. This is expected to address the sugar surplus problem of the industry.
But there are not just challenges in augmenting capacity swiftly, though incentives are available under various schemes, there are also challenges in ensuring offtake. Oil marketing companies (OMCs) need to prepare for more ethanol, storage, blending and dispensing, while auto makers need to prepare their vehicles to function on higher blends of ethanol.
These, though, are happy challenges for ethanol producers, and the recent results of sugar producers clearly bear this out. Balrampur Chini reported a 14 percent share of revenues from its distillery segment, but the profit contribution from this ethanol producing line was 50 percent. And that could well be the shape of things to come.
REORDER YOUR PORTFOLIO
The old order changeth, yielding place to the new. That’s an old saying, but very relevant today as the world shifts its energy mix towards a greener future. And there lies in this both risks and opportunities. You need to be alive to the coming changes to profit from them. Study the shift closely, there’s no need to rush decisions as the equilibrium will shift slowly, but it will. And the faster you position your portfolio right, the better returns you can expect.
In the emerging scenario, my personal vote would be for nimble OEMs, green positioned auto ancillaries and businesses in the emerging energy spaces.
