‘Real generosity toward the future lies in giving all to the present’[1]
Albert Camus
A recent interview given by John Kerry, now the United States’ Special Presidential Envoy for Climate, served to publicise a debate that has been intensifying for the last few years. The need to decarbonise the world’s economies is undisputed, but how we go about achieving this extraordinary feat is still heavily debated. During the interview Kerry stated that he was “told by scientists that 50% of the reductions we have to make (to get to near zero emissions) by 2050 or 2045 are going to come from technologies we don’t yet have.” This statement led various factions of the decarbonisation movement to furiously debate the merits of what some parties deem to be damaging techno-optimism, and others deem mathematical necessity.
The debate over novel - mitigating or adaptive - technologies in the fight against climate change is probably misunderstood. One side fears that projected technologies will be used as an excuse not to change existing, destructive human behaviour. The other side fears that a lack of development will ensure that net zero remains forever out of reach. To our mind the answer lies somewhere in the middle, and this is an opinion shared by the International Energy Association and many governments and NGOs. Progress will need to be made on both sides of the argument to successfully decarbonise the world’s economies.
Uncertainty is particularly rife in the arena of combatting climate change. The sheer number of dimensions in which uncertainty exists makes predicting the pace of climate change very difficult. The reason being that self-reinforcing feedback loops of thawing permafrost, melting ice caps, and tropical rainforest degradation, are expected by scientists to accelerate the warming process. As James Lovelock wrote in 2009, “Do not expect the climate to follow the smooth path of slowly but sedately rising temperatures . . . the real Earth changes by fits and starts with spells of constancy, even slight decline, between the jumps to greater heat.”[2]
Given the uncertainty surrounding climate change, we should embrace the potential impact of emerging technologies, however the language used is particularly important. When Kerry spoke of new technologies, some may have imagined that he was talking about creating technology out of concepts not yet dreamt of, rather than applications of existing technologies that have not yet been invented. This may seem like semantic hair-splitting, but the difference is essential: there are many emerging technologies focussed on both reducing the energy intensity of existing activities, as well as negative emissions solutions.[3]
The current financial climate enforces an even greater need to be discerning when viewing this technological proliferation. A significant amount of capital is washing about the system, catalysed by the emergence of financial vehicles such as special purpose acquisition companies (SPACs). To illustrate the point, in just the first four months of 2021, over US$300bn was raised by 300 companies solely through SPACs.[4] So while the question of which are worth making commercial remains unchanged, the difficulty of determining which can become commercial is compounded further as more ideas are being seeded.
Superficially this may not appear to be an immediate issue for investors in public equity markets; many of the technologies are still early stage and unlikely to appear in listed markets just yet. However existing companies are actively investing in these new and emerging technologies via R&D and M&A. It therefore becomes important to remain abreast of the underlying technologies in order to thoroughly analyse the strategies of these corporates and their capital allocation decisions. This allows investors to determine how they are positioned for the future and thus their terminal value proposition today.
There are a number of areas where decarbonisation technology appears to be gaining traction. Hydrogen has long been suggested as a potential clean energy source and now that necessity has focussed research in this area, both as a fuel and feed stock, there are signs it may play a significant part in the future of energy resource. Carbon capture and storage (CCS)/utilisation (CCU) has progressed significantly in recent years, whereby greenhouse gases are sequestered and safely stored, or in the case of the latter transformed into new resources such as bioplastic feedstock and aviation fuel. Electrification of cities and vehicles remains a major way to reduce CO2 emissions, but progress is currently hampered by limitations in battery technology. The development of higher energy density batteries, as well as batteries that can be swapped out of existing vehicles and devices, is helping to accelerate electrification.
Unfortunately for investors, many of these technological innovations can have fairly binary outcomes, i.e. if the technology is successful it can result in mass adoption and prove vital to the broader decarbonisation effort, but if unsuccessful, then the company may simply dissolve. This uncertainty is amplified by the fact that successful technologies may take years to generate positive earnings. One way of helping to sift through these nascent technologies is to look at their patents in an attempt to analyse the potential application and commercialisation path of the innovation. In addition, patents help illuminate various aspects of an emerging technology. This is by highlighting existing hurdles to adoption, showing the pace of innovation across industries, the identification of moats and emerging competitive advantages. Finally, they can help to identify those companies that may well be overhyping their progress in the already much-hyped area of decarbonisation technology.
Patent analysis is no golden ticket however. Global patent filings have risen at an average compound annual growth rate of 4% per year since the 1920s, while the recent acceleration to 9.5% per year suggests the fastest pace of global innovation in fifty years.[5] As such, on top of all the aforementioned uncertainties, the sheer volume of technological ideas coming through adds to the difficulty of profiting from early stage investment. Instead, the ultimate beneficiary is society at large, or the end consumer. Venture capital and private equity assets hunt here in quest of the next big thing and, if successful, the returns are considerable, but if not, these ventures can be financially painful. This is perhaps inherent in innovation and should therefore not surprise investors, especially when one looks back at the history of technological innovation.
For those with less access, or indeed risk tolerance, our experience suggests that the stability of high quality companies will ultimately benefit investors in the long run. Through their well-governed business models, emerging technologies which are at a stage of commercialisation will be incorporated in an appropriate economic manner. Innovation in this arena is a necessity, and if successful will ultimately benefit everyone. How and when investors come to the fore is a rather different question.
To read 'Decarbonisation part 1: Opportunity in disruption', click here.