The reason the energy transition is a fantasy is not because somehow it won’t happen. It will happen. Ultimately, the world’s energy supply will evolve to where the use of renewables surpasses coal and oil and EV’s will overtake internal combustion cars and trucks in annual sales. Buildings will be built to be far more efficient than ever before. Battery storage systems will become more effective and integrated allowing renewables to scale from providers of intermittent to base power.

The reason the energy transition is a fantasy is not because it shouldn’t happen. To the contrary, it is imperative that we address climate change globally and in earnest. The manifestations of climate change already exact massive humanitarian and economic costs. The slower our transition takes, the more we emit greenhouse gases anywhere near current rates, the more we will see global temperatures rise and at an accelerating rate as the feedback loops of melting permafrost and melting ice caps and glaciers exacerbate the crisis.

The energy transition is a fantasy because, in the developed world, we lack both the economic and the political will to make the investments and decisions necessary to credibly put us on a path to anything close to the IEA (International Energy Agency) Net Zero Emissions by 2050 prescription. Net Zero by 2050 is what the IEA estimates will be necessary to limit global warming to 1.5 degrees centigrade. As for the developing world, we also lack the kind of international cooperation necessary to impact the likes of India and China on their path of higher emissions. Unfortunately, the current trend toward a bifurcated and bipolar geopolitical environment suggests the international cohesion necessary to address emissions is going in the wrong direction.

The fantasy is that there will be a seamless handoff from coal and petroleum products to renewables and that this handoff could occur without a meaningful impact to global inflation. (The arguably more important second fantasy is that we will actually make the transition in a timely enough manner to avoid long-term catastrophic consequences, but my focus will remain on the inflationary part.) The inflation will stem from both the current underinvestment in oil and gas both upstream and downstream and the many trillions of dollars of investment needed to update and build the infrastructure: the grid, the PV systems, the wind turbines, the battery storage systems and the EV’s. Mckinsey released a study with this staggering estimate: “We estimate that global spending on physical assets in the transition would amount to about $275 trillion between 2021 and 2050, or about 7.5 percent of GDP annually on average.” That isn’t happening. Nothing remotely like that is happening. 

That new and renewable infrastructure will require a level of investment in minerals that is anathema to the current investment landscape that demands companies in cyclical industries like energy and materials return cash at the expense of resource growth.  Below is a chart from the IEA that shows just how much more development of mineral resources the transition will require. We will need multiples of current production of copper, nickel, cobalt, rare earths, etc. when the reality is that the companies that produce these commodities are largely unwilling to make the necessary investment (and incur the necessary risk) to start these 5 to 20 year projects.

“Our analysis suggests that it has taken on average over 16 years to move mining projects from discovery to first production. These long lead times raise questions about the ability of suppliers to ramp up output if demand were to pick up rapidly.” IEA. The Role of Critical Minerals in Clean Energy Transitions 2022. Robert Friedland, Chairman of Ivanhoe Mines has spoken often about chronic underinvestment in critical minerals and believes that, “We are going to have a sustained long-term shortage of critical minerals for the new economy.” Friedland makes the point that many executives in the energy and material sector make, which is that the world wants to see an energy transition but there is no willingness to allocate the trillions of dollars of investment necessary to develop the kinds of huge projects required to build the infrastructure for the transition.

While the US has finally taken a critical step via the Inflation Reduction Act to allocate public investment toward more EV’s and more solar systems, the existing supply chain for those technologies and the minerals required to make them are largely found outside the US. The chart below, also from the IEA Critical Minerals report, shows the geopolitical challenges to the transition. The US is the world’s largest producer of both oil and natural gas, but when it comes to the minerals critical to the transition, the US and Europe will have no choice to work with China for rare earths and graphite, with Russia for Nickel and the DRC for cobalt.

The energy transition is rapidly becoming an issue that every investor and every fiduciary must consider, because of the inflationary risks enumerated above. The transition will likely mean higher inflation pressures globally via higher energy costs and lower potential global GDP. If this sounds too pessimistic, consider that both Blackrock and KKR share our concerns. 

In their 2023 Market outlook, Blackrock’s macro team opined, “The [energy] transition is set to add to production constraints, in our view. It involves a huge reallocation of resources. Oil and gas will still be needed to meet future energy demand under any plausible transition. If high-carbon production falls faster than low-carbon alternatives are phased in, shortages could result, driving up prices and disrupting economic activity.” This is a key point they make because ironically the entity doing the most to restrain high carbon production are the investors who own the public energy companies by demanding that they return cash instead of investing in resource growth.

KKR’s Head of Global Macro Henry Mcvey wrote recently “While the Internet was a deflationary global force, the energy transition is an inflationary one. Most commodities required to support growth in onshore wind, offshore wind, batteries, etc., need a lot of energy to mine and process. Moreover, many of these commodities are sourced from unstable areas of the globe.”

The inflationary pressures from the energy transition will play out over many years and has already begun. It is likely that as long as we have global GDP growth and an inexorably growing global middle-class, we will face higher traditional energy prices and, over time, we will be faced with sharply higher mineral commodity costs as we enter Friedland’s “sustained long-term shortage”.

One final point is that while the costs of building solar and wind projects have fallen sharply over the past decades, that trend is now reversing as the cost of capital rises and these relatively labor-intensive industries face the same cost pressures as virtually every other industry. Well intentioned policy makers must be cognizant and honest about all of these challenges.

For more from Tim, follow his podcast The Weekly Bull and Bear wherever you listen to your podcast or read his weekly blog posts here.

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