Is this the end of net-zero? Europe, Trump, and Tariffs

Is this the end of net-zero? Europe, Trump, and Tariffs
By Freddie Fuller, European Equity team, and Rob West, CEO and lead analyst of Thunder Said Energy.

Freddie Fuller 00:03
Good morning, everyone. My name is Freddie Fuller from the European and International Equity team here at RBC Global Asset Management. Today, I'm really delighted to be joined by Rob West. Rob is the founder and CEO of Thunder Said Energy, a research consultancy who help investors find the economic opportunities in the energy transition world. Welcome, Rob.

Rob West 00:29
Hello, Freddie. Great to be speaking with you.

Freddie Fuller 00:31
Rob, we've been grateful recipients of your research for some years now. It's always interesting, it’s always differentiated; perhaps, most importantly, I think, shares our desk's aim of seeing the world for what it is rather than what we want it to be. Easier said than done, I think, especially with the sheer volume of noise and volatility we've experienced during the last month or so.

That being said, you have been rather prescient in your views coming into this year. Your annual wildcard prediction was a fast escalation in trade disputes that could lead to a recession in an increasingly adversarial world. Firstly, congratulations, always nice to have a slam dunk. Secondly, hopefully, that sets us up nicely to discuss how all of this might affect the energy transition, especially within the context of your thesis, that the last five months may well be looked back on as a paradigm shift.

Rob West 01:38
Thanks for the congratulations. I don't want to take congratulations on something that's been such a negative event for world trade. But I actually do think that a lot of the bluster is going to settle down. Like you said, amidst the volatility, opportunities will become very, very interesting for people who can get behind them.

Freddie Fuller 02:01
I'm glad that there's a positive spin on it.

Rob West 02:05
It's only positives today. It's going to be a positive day, I already know.

Freddie Fuller 02:09
Good, I'm glad. Maybe you could give us the background, give us a overview of your thesis of where we sit and whether you think, actually, the last few months makes much of a difference to energy transition. Indeed, maybe define energy transition as you said.

Rob West 02:29
Great questions there. I started Thunder Said Energy about six years ago, trying to find all the opportunities that would get the world to net zero. I've built roadmaps that decarbonise the entire world for about USD3 trillion, or what will be about 1.5% of global GDP, by the time we get to 2050, with an average CO₂ abatement cost of about USD40 a tonne.

Somewhat to my dismay, we're not walking down that path, and when I tried to update my outlook at the end of last year, some themes of energy transition are going full speed ahead. But generally, things that require people to pay for CO₂ abatement have just been going way more slowly. There's a stat that 40% of Americans wouldn't give USD2 a month for decarbonisation. And maybe you saw that view reflected in election results last year.

The same thing probably happens around Europe when we track the deployment rates of technologies from developed world EVs, to heat pumps, to CCS. Some of this stuff is just going way more slowly than it needs to go. When I look through all the different value chains, and there are about 40 that each explain more than 0.5% of the world's CO₂, my best estimate prediction, not what I want to happen, but prediction, is that we will still be emitting about 30 billion tonnes a year of CO₂ by 2050.

That shatters the illusion of global collaboration. We're all in this together. All the countries are going to pull together and make this work. It's not what we've been seeing. We've been seeing wars. We've been seeing escalating trade tensions. We've been seeing some countries that are very large emitters pulling back on climate commitments.

As a result, some of us in the developed world who've been leading on decarbonisation, I think, are starting to get cold feet. They're saying a lot of the things that we've done have alienated our voters, made our industry more expensive. Hey, the number 1 thing we need to do now is be more competitive, be able to defend ourselves in this brave new world.

That is a huge shift of sentiment that, I think, is really ground zero in Europe. If we get it right and start really focusing on competitiveness, I think it could unlock some amazing opportunities for European companies.

Freddie Fuller 04:52
It's fascinating. There's so much we could unpack. Sadly, I don't think we'll have the time. Apologies if we jump around a bit, but maybe Europe's a good starting point. It's our remit. Maybe we could think about that and the implications for investors, but investors not just on the continent, but elsewhere. Europe in particular, it's become clear over the last few years, the size of the holes in policymaking in Europe. That lack of self-sufficiency is very well known.

Your competitiveness point, especially when it comes to pricing, that's both input and output. What do you think specifically Europe needs to focus on? Energy mix is a big part of it, but what do you think the bloc needs to do to become more competitive?

Rob West 05:42
To answer that question, first, you have to take a step back. What is Europe? Europe is not going to be the world's leader in producing steel or ammonia or very energy-intensive products. We're an energy-short continent. The issue is that we've become more energy short as time has gone on. In 1990, we produced about 65% of our energy in Europe and the rest imports. That number has deteriorated. Most recently, we produced 40% of our energy in Europe and the rest imports.

With what Europe is, well, it's a world leader in services and in precision manufacturing. If you take mechanical capital goods as an example, the global market of traded mechanical capital goods that crosses borders internationally, it's about USD1 trillion a year. Europe is 40% of that. It's bigger than China. If you look at the world's number 1 companies in MOSFETs or semiconductor manufacturing equipment or jet engines or compressors or heat exchangers or niche dry room cooling technologies, you come across European companies at the top of that list in every single one of them.

I don't think we need to have the lowest-cost energy. I don't think we need to try and do the impossible. We just need to have enough energy, sensibly priced, readily available, that we control and we produce. Things are going and could go in the right direction in quite a big way there. One impetus to change this is we need to keep pace in AI and data centres. The US is targeting 10% load growth by unleashing as much electricity as possible with no holds barred. They are struggling to do that load growth.

In Europe, we're trying to close down 10% of our load growth, which currently cuts our load, which currently comes from coal. Is that compatible with doing load growth for AI data centres? Really, I think if you look at the numbers, you can do one or you can or the other, but you can't do both. Those are the kinds of things where I think sentiment is shifting and people are having to make difficult choices about, "Do we want to close the coal plants, or do we want to be relevant in AI?" I think when push comes to shove, people are choosing they want to be competitive.

Freddie Fuller 08:10
You've made a point, previously, around how much this is intertwined with politics, but perhaps from the opposite direction that most people realise, so elections are affected by energy policy and energy mix in a way that perhaps they don't realise.

Rob West 08:20
At the moment, I'm trying to be as apolitical as possible. I think we've really messed things up in our energy system by politicising everything, where, if one party comes out in favor of solar, the other party has to come out against it. I actually just would try and move away from politics when looking at all of this stuff and just try and find the right answers. What you said is exactly true, though - when energy and food prices spike, it is 60% correlated with changes of government at the next election, going back to the 1950s, and a big price spike like we had in 2022.

Historically, that would mean that you'd have a change of government 70% of the time at new elections coming up. So, we live in a world that is quite hard on incumbents politically and quite easy for changes of government to come in. I think that creates policy uncertainty, which is why I don't want stuff that's reliant on policy. I want stuff that's reliant on economics and competitiveness and practicality, and where there's great companies with a moat around them.

Freddie Fuller 09:40
You've mentioned the energy mix within Europe. I'd like to talk about renewables, in particular, and maybe go down the value chain of something like solar, because it's clearly going to become a bigger part of the mix, and you're quite positive on it. To us, it seems quite a lot of the time that the second-order effects on the traditional energy players, the oil and gas majors, is ignored. Maybe you could just dive into the majors of this and see what you think the effect of all of this on them is going to be.

Rob West 10:19           
You asked that great question right at the beginning, "What is energy transition?" and I somehow managed not to answer it. There was a view, several years ago, that energy transition was about, "Hey, let's cut energy use, let's cut it to get the best human outcomes by 2050." I think the IEA even had a scenario where global energy consumption fell 20% between now and 2050.

I think we're now looking at the exact opposite; quite clear that to get the best human outcomes we need more energy, not less. That goes for everything from dealing with the impacts of climate change, to being able to scale AI and what that can do for people, and how it can improve human outcomes, through to addressing energy inequality. 85% of the people alive today have never been on a plane.

We're in a world where what energy transition is, it's just like energy transitions in the past. 19th century was the energy transition of coal. We burned twice as much wood as coal, but coal was new. It laid it on top and unlocked steamboats and mechanisation and railways. The next big energy transition was oil. We burned more coal than oil in the 20^th century, but the oil was new, and it laid it on top and unlocked planes and plastics and cars.

We are having energy transition just like that, where solar is the thing that is new. Semiconductors are the things that are new. They're layering on top. We're still going to have a lot of hydrocarbons in our energy system through 2050. But as we add those new electrons from solar, it's going to unlock new stuff like AI and battery-powered technologies and robotics and automation.

That creates opportunities. In oil in particular, oil and gas, I think the data are really interesting when you start adding them up. What you've seen since 2017 is that national oil companies around the world have increased their CapEx by about 50%. The big oil majors have only increased their CapEx by about 10% over that timeframe. Where it has increased, it's mainly been in the US for shale.

There's a view that what we've pushed on our oil and gas companies over the last seven or eight years, amidst energy transition, has been this, "Don't invest, shed relevance," but really, you're just giving up market share to other people who then produce the energy, and you have to import it without having control of it or the way it's produced. I think there is a tide shifting, where in the UK, we're saying, "Well, maybe we want to produce more of that energy we have in the North Sea rather than having to import it."

Around Europe, there's coal assets in Germany and in Poland, where people are saying, "Maybe we don't want to close that down. I think you are going to see a greater focus on producing hydrocarbons and ramping up hydrocarbons amidst the energy majors, because these are great companies with great engineers who can unlock resources cost-effectively, where other people can't unlock them. We have that capability in Europe, and it gives us self-sufficiency. It gives us clout around the world, and I think there's more call to develop that where we have it.

Freddie Fuller 13:39
I guess there's the other side of the coin to all of this in terms of investment allocation. Your point around the majors is a really interesting one, and it seems that we're heading down that route. The addressable market is very different from what it was a few years ago. A different market must be opening up, and we, as a European equities team, are seeing that.

I said before this call, if you told us, even five years ago, that some of the most enticing areas of the stock market in Europe at the moment are southern European banks and defence companies, we would have probably said you lost the plot.

Here we are today, and that's what happened. From your perspective, where are the less obvious areas of the transition spectrum that, I suppose, are not just unlikely to benefit from it, but are more interesting areas from an investment perspective?

Rob West 14:39
I've got to put semiconductors at the top of my list. People like to put wind and solar together, as though they're both renewables, and so they're both the same. They're really no more similar than pasture and turnips, which in a world of starches are only united by not being bread. Solar is on this path of unbelievable semiconductor-like deflation. 20 years ago, a solar module was 5% efficient. 10 years ago, it was 15% efficient. Today, they're about 25% efficient, and they will get to 45% to 50% efficient.

Every time the efficiency doubles, the cost halves. We're going to be in a world where we have solar everywhere when the sun is shining at between 1 to 3 cents a kilowatt-hour at that point, at the end of that solar panel.

That's a game changer for Europe, because it means that we can produce our own energy at the bottom of the cost curve where we never were able to before. That wasn't true five years ago, at the cost of solar then. It's just about true now, where solar plus gas is cheaper than gas alone. It's going to become more and more true as solar costs deflate from here. I think that's going to be the biggest grower in the future energy system. There are companies all around that value chain. Most of it is controlled by China, especially on the silicon and on the modules. Other parts have interesting, developed world companies attached to them.

For example, the vapor deposition equipment that is used to make those very thin layers of semiconductors that go into a solar module are made by European companies. Silver is screen-printed on the front of solar modules. Again, silver is a global value chain where Western companies have interesting exposure. All the way through to the trackers, where you point the solar modules towards the sun as it arcs across the sky, and you get about 50% to 70% more output from the solar module by doing that right. The leading companies doing that are developed world companies.

And so, I wouldn't just go route 1. I think that supply chain is not one that rewards just going route 1. I do think there are really interesting ideas throughout that supply chain that can benefit from the big growth that is going to come in solar. It also benefits Europe because, for the first time ever, we can add our own energy at the bottom of the cost curve.

Freddie Fuller 17:03
What I'm immediately thinking of is all the things that could go wrong. What's the biggest potential roadblock to this coming to fruition in terms of solar? I'm immediately thinking of rare earth and minerals and critical metals and all the things getting caught up in the trade war. I suppose there's also regulatory issues. There's the grid, the need to upgrade and expand and improve. Where do you see the biggest roadblock?

Rob West 17:33
You've nailed it. That's exactly right. It's the grid. The grid is the roadblock. We would have to increase the size of the grid by 3x to 5x in order to ramp solar where we want to, unless…something changes. The reason we have to ramp it so much is that the average power generation facility in the grid today gets a utilisation factor that is around 50% to 60%, whereas the average solar module globally only gets a utilisation factor that is around 16% because the sun isn't always shining.

Historically, some modules are pointing in the wrong direction. There's summer and winter. There's cloudiness etc. It just stands to reason that if you have a lot of generation adding into the mix that is low utilisation, you need much more wires to move that electricity around, and you need to start storing it.

Storage is a great technology that needs to be depoliticized. I don't think you need storage to get to 100% renewables grid in order to satisfy some ideology. At the margin, batteries can help enormously with peak shaving. For example, in solar, you could get 90%, 95% of a 300 megawatts solar array dispatched through 100-megawatt transmission line if you just put a battery next to it. That avoids having to do very large, very costly transmission line upgrades.

Likewise, if you're looking at a small town of 50,000 homes, you'll find that half of the network capacity exists to meet the upper 5% of times when it's the World Cup final, it's half-time, and everybody turns on their kettle, right? It's those peaks. You build the grid to meet that peak demand, even if that peak demand is quite short in duration of time. Putting batteries around the distribution network can allow you to get twice as much load through that network at about half the cost.

It's not just about net-zero. It's about finding a solution that is low cost, that's practical, that helps people. That's why solar and batteries together, they really are a really winning technology.

Freddie Fuller 19:58
I don't want to get too bogged down on this point, but I was reading a book called The Price is Wrong by Brett Christophers. I'm not sure whether you've come across it.

Rob West 20:07
I don't know it. I'm familiar with the hit game TV show, The Price is Right, but I think that's something else.

Freddie Fuller 20:13
Everyone's done the same thing, as did I. It's very good at giving a layman such as myself a broader view, but the point he makes is that people are too focused on the price of a solar panel, of raw materials etc. Actually, really, it's about energy pricing in terms of what is paid, combined with the IRR that you'll get from a renewables piece. The broader point is around if you've got pricing which is still determined by gas, you're never really going to have the economics that work. Do you think pricing is as much of an issue as he seems to suggest?

Rob West 20:58
There's a great example that some people talk about, which is milk. Milk leaves the farm at 50 pence a litre. It's sold at Tesco's at 80 pence a litre. You can pasteurise it, process it, transport it, build a supermarket, refrigerate it, and sell it, and the price only goes up by 60%. With electricity, it goes up 4x between the point where it's generated and the point where it's consumed.

I think that disparity, just how much is in the wires, is really lost on people. When you buy electricity, what you're paying for at home is you're really paying for the distribution network. That's why I made that point about getting batteries across the distribution network, not just at substations, not just at your metre, but also within smart-charged vehicles, or swap stations, or next generation equipment like drones and robotics when they come, and they will come.

That's going to allow us to do a lot of peak shaving and smoothing and lower the cost of that network. I go back to AI. Everybody talks about the energy consumption. I have 1,000 terawatt hours of global energy consumption for AI by 2030, but it will save cost in the energy system because it will allow you to smartly move the loads around in time, so that you don't have to have such a big, expensive distribution network, which is where all the costs really are.

Freddie Fuller 22:25
That's interesting. I suspect you are probably right, and that's getting bogged down in it.

Rob West 22:32
I don't have a good title like The Price is Wrong, so I've got to work on that.

Freddie Fuller 22:36
We'll find one. Just quickly, because I'm conscious of time, you made a point in a recent paper which I thought was quite a good microcosm of where we are at the moment, where you delineated between CO₂ abatement and competitive CO₂ abatement. It's not an unnecessary delineation, but it does seem quite important. You were comparing carbon capture and storage, CCS, and reforestation. I wonder whether you'd give a bit more color on the point you were making there.

Rob West 23:09
Sure. It's an interesting example because both are motivated by the same idea, which is to avoid CO₂ going into the atmosphere. One avoids it by capturing it. You put an amine plant on the back of the exhaust stack downstream of an industrial facility, and you bubble the CO₂ through amines, and it captures it. Then you re-release the CO₂ and put it down a pipe and put it in the ground. You can do that.

It's generally been quite expensive to do that, about USD400 a TPA of capex, maybe $100 a ton of CO₂ that's captured. It has a 15% to 35% energy penalty because you need to steam treat the amines to get CO₂ back out. You need to compress the CO₂ to 100 bars so that it's a supercritical liquid that you can move down a pipe and into the ground.

The fact is, if your best engineers in your company are spending the next three to five years focused on doing that, they are not focused on improving your product, lowering your cost. It's adding cost to your process that somebody has to be willing to pay, and it's lowering the efficiency of your process, which means it will consume more energy overall and be less competitive with others globally who aren't doing that. Reforestation is different. Reforestation takes place somewhere else. It doesn't distract your engineers. It actually produces wood, which in times of crisis, could theoretically be used as a construction material, keeping the carbon locked away, or as an energy source if you absolutely had no other option. And it doesn't cause any energy penalties in that factory or impinge upon the competitiveness of making products.

We don't tend to look at those distinctions very much, but they really matter. I think that they're going to increasingly matter, and I think that the voluntary carbon market is going to see more demand from companies who want to do the right thing and want to get to net-zero. CCS might not see much more than 400, 500 million tons a year of global demand over the long term.

In a similar vein, compliance carbon markets, which have dogged Europe and its industry with about USD40 billion of costs that just must be borne by industrial companies, again, I think the appetite for why do we have those, what do they really achieve, are we eliminating carbon or are we just taxing it and then leaking industrial activity to emerging countries, these are the sorts of questions that are coming up now quite a lot.

This goes back to that theme, Freddie, we were talking about earlier, of maybe Europe is about to turn the corner and focus more on competitiveness in a way that helps that landscape of European industrial companies.

Freddie Fuller 26:10
It's a good nexus, European rebirth and competitiveness on that. Thank you. It's an interesting example. I thought I'd finish with a deeply unfair question, so I apologise in advance. You've nailed your wildcard prediction for 2025 before the end of Q1. We can't let you get away without giving us a new wildcard prediction for the energy transition. We'll be kind and say you can pick any time horizon that you like.

Rob West 26:41
The common perception in 12-months time will be that the best human outcomes can be delivered by unlocking low-cost, reliable energy and using it. We are going to see ways of using energy appear that just would have seemed like magic three to five years ago.

People will look at those uses of energy and say, "We want it." It will involve AI, robotics, drones, evolving medical technology, even ways of fighting climate change directly. People will say, "If we can get the energy to do that, we can get the best human outcomes," and there'll be renewed industry and interest and focus around doing all of those things. That's my prediction.

I think, like you said earlier, it might be something that people would have laughed at a couple of years ago. As someone who spends my days reading patents and technical papers to try and figure out where the puck is going, that's really what I think is happening. That would be my prediction.

Freddie Fuller 27:52
It feels like a very absolute point to conclude on. Rob, thank you so much for taking the time to speak to us. Thank you very much.

Rob West 28:01
As always, great speaking with you, Freddie. Thank you.