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BlackRock Commentary: A lopsided energy transition

Alex Brazier, Deputy Head of BlackRock Investment Institute together with Wei Li, Global Chief Investment Strategist, Elga Bartsch, Head of Macro Research, Chris Weber, Head of Climate and Sustainability Research, BlackRock Sustainable Investing and Mark Everitt, Head of Investment Research and Strategy, BlackRock Alternative Investors all forming part of the BlackRock Investment Institute, share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.

Surging natural gas and coal prices amid a powerful economic restart have exposed a lopsided transition toward low-carbon power. We still see an orderly transition in the medium term – but with bumps on the way that could lead to growth and inflation volatility. We expect the transition to reinforce a shift to a higher inflation regime, supporting our new nominal theme that points to a more muted central bank response to rising inflation than in the past.

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Sources: BlackRock Investment Institute, with data from Refinitiv, October 2021. Notes: Prices are based to 100 at the start of 2017. We use the European Energy Derivatives Exchange futures, ICE Rotterdam coal futures and Brent crude oil futures to represent natural gas, coal and Brent crude oil respectively. The dots show futures prices for contracts that expire in December 2022, December 2023 and December 2024.

 

The powerful restart has driven up oil prices to multi-year highs. Coal and gas prices have surged far more. See the chart above. Why? On top of the restart, a range of weather and geopolitical factors have restricted supplies of coal and renewable energy. It’s been difficult for other sources of power to be brought on stream. This is putting sharp pressure on prices of available sources of power. With governments looking to minimize carbon emissions, gas prices have risen even further than coal. All these events have exposed an underlying issue: The transition to net zero so far has been lopsided, as clean energy investment has not increased enough to make up for the decline in fossil fuel investment. Futures markets are pointing to lower coal and gas prices by the end of next year. Much depends on the temperature in the coming winter. And while the transition remains lopsided, we can expect more volatility of energy prices, inflation and economic activity in future.

For now governments may find themselves compelled to support greater use of fossil fuels – particularly gas – amid energy supply shortages. Natural gas may emit less carbon than oil or coal, but its largest component methane is another potent greenhouse gas. It too will ultimately need to be phased out if the world is to reach net-zero. The phase-out of natural gas and momentum toward net zero therefore rest on accelerating the development of clean energy supply.

There has been massive investment in clean energy – an average of $1 trillion a year between 2016 and 2020 according to the International Energy Agency (IEA). More is needed to build a clean, resilient energy infrastructure. A net-zero transition by 2050 will require an average annual investment of nearly $4 trillion between 2026 and 2030, says the IEA. A successful transition will not only need clean energy, but also new technologies to store and distribute clean energy, to decarbonize manufacturing, agriculture and transport, and to capture carbon emissions.

The pace and precise nature of the net-zero transition will be guided by government policy, which will vary across countries. More clarity on climate policies will help encourage the private sector to invest in clean energy and related technologies. That’s why commitments from governments at the upcoming United Nations climate summit (COP26) will be key to watch. The pace of transition around the world will vary by country, and emerging markets are in urgent need of funding for low carbon investment at scale.

The bottom line: An orderly – albeit lopsided – net-zero transition will have bumps along the way that could lead to greater inflation and growth volatility. We view the net-zero transition as modestly inflationary overall, and via higher inflation contribute to a new nominal environment (see our investment themes). The transition creates investment opportunities in both public and private markets. Over a strategic horizon we like the sectors that stand to benefit more from the transition, whether for being solution providers or by being less exposed to climate risks, such as tech and healthcare. We also see strategic opportunities in the infrastructure space that are related to the development of new technologies that are needed to reach net zero. We prefer inflation-linked bonds over their nominal counterparts over a strategic horizon due to the inflationary pressure.

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Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and do not account for fees. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from Refinitiv Datastream as of Oct. 21, 2021. Notes: The two ends of the bars show the lowest and highest returns at any point this year to date, and the dots represent current year-to-date returns. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in U.S. dollars, and the rest in local currencies. Indexes or prices used are, in descending order: spot Brent crude, MSCI USA Index , MSCI Europe Index, ICE U.S. Dollar Index (DXY), MSCI Emerging Markets Index, Bank of America Merrill Lynch Global High Yield Index, J.P. Morgan EMBI Index, Refinitiv Datastream Italy 10-year benchmark government bond index, Bank of America Merrill Lynch Global Broad Corporate Index, Refinitiv Datastream Germany 10-year benchmark government bond index, Refinitiv Datastream U.S. 10-year benchmark government bond index and spot gold.

 

Market backdrop

U.S. stocks rallied to all-time highs, boosted by better-than-expected corporate earnings. Nearly a quarter of S&P 500 companies have reported earnings so far, and more than 80% of them have beaten expectations, according to Refinitiv. Earnings season reaches a crescendo next week, with 164 companies representing 47% of the S&P 500 market cap due to report earnings, including most of the big-cap tech names. Crude oil prices hit multi-year highs.

Week Ahead

  • Oct 26 – U.S. consumer confidence
  • Oct27 – U.S durable goods
  • Oct 28 – European Central Bank policy decision; U.S. advance Q3 GDP
  • Oct 29 – Euro area flash inflation and GDP; U.S. personal income and outlays

Market attention this week will be on the flash estimates of GDP for the U.S., euro area and Germany. We will be looking out to assess the impact from supply disruptions on the growth outlook.


BlackRock’s Key risks & Disclaimers:

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of October 25th, 2021 and may change. The information and opinions are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain ’forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets. 

Issued by BlackRock Investment Management (UK) Limited, authorized and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL.


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