As several trends reshape the global energy system in the coming decades, PGIM sees both opportunities and hidden risks on the horizon for investors.
In its latest report on fuelling the future, it highlighted that there is “no silver bullet” when it comes to the energy transition, meaning that multiple energy sources will be required to meet the growing global demand.
“No source of energy and electricity is perfect,” said Shehriyar Antia, PGIM’s head of thematic research.
“Whether an investor has decarbonisation objectives or not, it’s critical they understand which companies will power us through the energy transition and which technologies may not live up to the hype.”
Delving into what it referred to as “speculative innovations”, PGIM described companies involved in areas like hydrogen as “plucky upstarts challenging large energy incumbents”.
“However, few of the start-ups behind these speculative technologies are likely to operationalise and scale their businesses sufficiently on their own to displace global energy players.
“In fact, global energy players will probably be among the biggest suppliers and customers for innovative technologies – and many start-ups in this space may choose to partner with large energy incumbents to leverage their expertise in operations, refining and transport,” PGIM observed.
The investment manager noted that the risk-reward propositions of early-stage innovations may not be appealing for investors, considering the challenges they must overcome to become viable in real-world applications.
In the case of hydrogen, which it admitted holds some compelling attributes, PGIM flagged numerous challenges in its transportation and storage before it can be dispersed widely.
“Multiple start-ups are working on resolving the challenges around production, storage and transport of hydrogen. However, they remain far from providing an efficient and viable solution,” it said.
Interestingly, however, Global X Hydrogen ETF (HGEN) was the most popular ETF throughout the month of May, according to recent data. Speaking with InvestorDaily last week, the firm’s CEO Evan Metcalf said hydrogen got its time in the spotlight due to the prevailing focus on renewable energy.
“I think [hydrogen] has been another interesting area, definitely, with interest rates moving higher over the last few years,” Metcalf said.
PGIM unsure about nuclear
The asset manager also pointed out appealing characteristics of nuclear fission, like its zero-carbon nature and ability to provide baseload power, while acknowledging numerous challenges associated with it.
It said permissions and cost challenges have stunted the development of the technology since the 1970s. Moreover, it flagged slow progress on small-scale modular reactors (SMRs).
“China is the only country to have a land-based SMR currently in operation. While many new SMR projects are announced, few make it to the end because of supply chain challenges as well as cost overruns and delays that make the projects no longer economical,” the asset manager pointed out.
In contrast, Global X’s head of investment strategy, Scott Helfstein, recently said nuclear energy, particularly SMRs, could be the missing piece of the puzzle in the growing demand for electrification across the globe, despite the naysayers.
“We have to rebuild the energy ecosystem and use all of it, so yes, while nuclear has had a stigma, already we’re starting to see around the edges that that will change,” he said at a media briefing last week, pointing out that Virginia, otherwise known as “the data centre capital of the United States”, recently passed legislation to help advance the deployment of SMRs in the state.
“It will take time, don’t get me wrong, that’s why I mentioned the Virginia legislation, because that, to me, is a little bit of a canary in the coalmine.
“I think states are going to do this first – which by the way, in environmental policy, states have always led the federal government and been out front, and then the federal government eventually gets there – and I think this will be one more case of that.”
Importantly, while he expects renewable energy sources like wind and solar to “continue to improve”, he said these won’t be adequate.
That’s where the case for nuclear arises, Helfstein said.
Hunting for opportunities
But, according to PGIM, companies involved in supplying, facilitating, and adapting to the energy transition will present the most promising opportunities for investors.
“Renewable power generation is soaring in every region. The global need for complementary infrastructure, like power storage and transmission, should drive demand for critical metals like copper and grid components.
“Additionally, emerging markets where renewables are just taking off, like India and Latin America, can present opportunities,” it said.
Meanwhile, in mature markets like the US and Europe, PGIM believes that better opportunities may lie in debt rather than equity for renewable power projects, especially in senior debt instruments.
“Debt financing tends to be less plentiful than equity in this space. Specifically, senior debt offers attractive opportunities,” it noted.
“And given higher interest rates globally, some opportunities may emerge in mezzanine and structured debt as well – especially in projects where offtake agreements are in place, permitting of new projects is not wide open, grid connections have already been established and projects are located relatively close to end customers.”
Additionally, it sees opportunities in natural gas, which can serve as a “transitionary” fuel source while renewable power generation, storage and transmission infrastructure are further developed.
PGIM elaborated: “Companies across the natural gas supply chain – from producers to processing to liquifying and transport – can provide attractive opportunities for investors.
“Pipelines are another way to invest in natural gas globally. Often these firms have long-term purchase agreements in place. The ‘toll collecting’ from pipelines offers investors a different risk-return proposition in the natural gas space: exposure to booming demand with less exposure to short-term price volatility.”
PGIM highlighted debt opportunities in mid-size oil and gas producers, particularly during a period of reduced bank lending, as they often seek capital through debt markets for the lower-risk, capital-intensive phase following initial exploratory work financed by equity.
“This kind of mid-stage development offers reliable cash flows and tangible collateral – making for solid credit fundamentals,” the asset manager said.
