How will the Ukraine crisis affect the energy transition?

The Russian invasion of Ukraine represents a devastating attack on Ukrainian and European democracy and our first thoughts are with the people of Ukraine, who are courageously fighting to defend their freedom and sovereignty.

As investors, we have to consider the implications of this crisis for our clients. We see three major risks affecting equity investments in the energy transition, as well as financial markets more broadly.

Risk 1: Inflation, especially prolonged higher prices for energy and raw materials

Inflation around the world was already at multi-decade highs before Russia invaded Ukraine. This was particularly the case for energy prices.

Given that Russia accounts for a significant part of the world’s oil (c.12%) and gas supplies (c.17%), the current situation creates clear risks around energy flows. This concern has caused oil, gas and power prices across Europe to continue their steep recent rise.

Russia is also a major supplier of platinum group metals (PGM) and agricultural commodities. It also has production capacity tied into many industrial value chains. The inflationary impulse from the conflict – and associated ratcheting up of sanctions from the West – could be quite significant.

These further inflationary pressures and constraints in supply chains across Europe may continue to weigh on corporate earnings.

Risk 2: Economic outcomes of inflation

The second risk concerns the potential economic outcomes of inflation. These include tighter financial conditions, higher energy prices, and potential wage increases – and what they may mean for economic growth.

History has shown that energy shortages and conflicts resulting in higher energy prices can slow down economies significantly. The risk of such a slowdown was already there before the escalation in Ukraine, and it is certainly higher now.

Risk 3: Potential shift out of equities

The final risk is around a broader shift in investors’ attitude to risk and a resultant sell-off in the wider stock market.

This could result in equity outflows (after a period of enormously strong flows into equity funds around the world) and a return to bonds as investors look for perceived safe havens.

How will these risks affect energy transition equities?

We believe that all three of these risks could impact energy transition shares to some extent.

The sector has been more exposed than most to higher raw material prices and logistics bottlenecks. The current situation will not help these ease.

Valuations in the space have retraced from their 2021 highs. However, the equity risk premium (ERP) still remains lower than previous levels, creating a risk that valuations could fall further. (The ERP is the extra return, over the yield on government bonds, that equity investors expect to receive. The ERP shrinks when stock prices rise, because their future growth potential shrinks, and grows when stock prices fall).

Global energy transition

The threat from a broader economic slowdown will likely be less impactful because of the structural nature of most energy transition markets. But those sectors that are more exposed to the economic cycle (autos, electrical equipment, etc.) will likely suffer. We should also not rule out the potential impact that shifting consumer demand could have on more customer-facing energy transition goods.

What could be the longer-term consequences of the crisis?

There may be some potentially interesting consequences of the higher conventional energy prices and the current conflict in Ukraine from an energy transition perspective.

Russia is a major supplier of the world’s oil and gas. It has the ability to use this natural capital to its advantage, particularly given Europe’s reliance on its fuels. One of the benefits of renewable power is that the resources that energise it are more equally spread and can help reduce dependence on key suppliers.

What’s more, as conventional energy prices spike higher, the relative economic attractiveness of renewables continues to grow. This is the case even after taking into account the higher costs of equipment from supply chain constraints.

The situation in Ukraine adds further credence to the argument for transitioning our energy system to one based on cheap, clean, reliable power.

However, we would stress that this does not change the near-term growth and earnings forecasts for companies. Indeed, they could potentially be outweighed by more prominent inflationary risks. Supply chains are still disrupted and it takes time for new demand and projects to come through.

Important information: This document is marketing material. This document is provided by the author and may not necessarily represent views expressed in other Aspect8 communications, strategies or funds. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Exchange rate changes may cause the value of any overseas investments to rise or fall. The sectors, securities, regions and countries shown above are for illustrative purposes only and are not to be considered a recommendation to buy or sell. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Aspect8 does not warrant its completeness or accuracy. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Aspect8 has to its customers under any regulatory system. Regions/sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. This content is issued by Aspect8 Limited, Holmwood House, Broadlands Business Campus, Langhurstwood Road, Horsham, West Sussex, RH12 4QP. Registered No. 07572431. Aspect8 Limited is a member of Best Practice IFA Group Ltd which is authorised and regulated by the Financial Conduct Authority FCA No. 227247.


Topics: