Capitalising on the low-carbon energy transition

Please note: This article is designed to be thought leadership content, to offer big picture views and analysis of interesting issues and trends that matter to our clients and the world in which we live. It is not designed to be taken as expert advice, investment advice or a recommendation, and any reference to specific companies is therefore not an opinion as to their present or future value or broader ESG credentials.

Reliance upon any of the information in this article is at the sole discretion of the reader. Some of the views and issues discussed in this article may derive from third-party research or data which is relied upon by Barclays Private Bank and may not have been validated. Such research and data are made available as additional information for the reader where appropriate.

Key points

• The latest technology revolution is now under way, with the move to a low carbon world. This article explores the investing opportunities, and potential portfolio risks, the revolution is creating through transition investing.
• Transition investing looks to tackle climate change in an approach that captures the entire economy including currently high-emitting and hard-to-abate sectors. Indeed, it encourages a greater priority on the highest-emitting sectors, given the larger proportion of contribution they make to total emissions. 
• The World Economic Forum estimates that to achieve a net-zero scenario total investment in infrastructure and enabling technologies across eight key hard-to-abate sectors will total $13.5 trillion by 2050.
• The need to create a low-carbon world involves tough choices for investors – whether to avoid or try to improve high emission sectors. Indeed, it may appeal to individuals and families that created wealth in high-emissions industries, in re-aligning their legacy and engaging younger generations, or even take reparative approach.

The industrial revolution, the age of steam and rail, the age of steel and electricity, the age of oil, autos and mass production, and the information age – five technological revolutions that reshaped our modern world¹. Arguably, a sixth technology revolution is now under way, with the transition to a low-carbon world².  

Decarbonising the global economy, while continuing to support inclusive growth, is a multi-decade, structural trend – one that investors should heed for both its risks and opportunities. Your portfolios could face climate risks both from physical risks (as explained in Making portfolios more weather resistant) and transition risks (as outlined in Is your portfolio at risk from the low-carbon transition?). 

For opportunities, investors can look to deploy capital to climate solution providers (as covered in Five sectors for long-term green growth in 2024). Additionally, and the focus on this article, investors can seek to generate financial returns by investing to support countries and companies seeking to make more difficult journeys to a low-carbon future.  

Understanding transition investing  

In June, the International Energy Agency (IEA) emphasised “The world now invests almost twice as much in clean energy as it does in fossil fuels”³. However, the expected $2 trillion in 2024 of capital flowing into clean energy technologies and infrastructure⁴ still falls short of the $4.5 trillion per year by 2030 that the IEA estimates is needed to meet our 1.5°C goals⁵.  

Though more capital is required, clearly, the energy transition is underway. Our path to net zero, though, is unlikely to be smooth or uniform around the world. Countries, industries and companies will move at varying pace. Some sectors will be harder, slower or more costly to decarbonise.  

Notably, the focus of transition finance and transition investing is on these hard-to-abate and/or emission-intensive sectors, such as steel, cement, or agriculture: sectors which remain essential to our modern economies and currently do not have viable low- or zero-emission substitutes.  

Transition finance differs from “green” finance, which seeks to allocate funding to companies with commercial solutions to mitigate or adapt to climate change as well as to those already aligned to a net-zero pathway.  

For Barclays, our provision of transition finance to corporate clients seeks to “support greenhouse gas emission reduction, directly or indirectly, in high-emitting and hard-to-abate sectors towards a 1.5 degree pathway.”⁶  
Extending this concept to investors, transition investing would mean allocating capital to support currently high-emitting and hard-to-abate sectors to move onto credible transition pathways and accelerate the decarbonisation of their processes, business models, and products.  

Or, more simply, investing to green industries, not just investing into green industries. 

Transition investing as a pragmatic approach to climate change 

Historically, climate-aware investors often decide simply to divest from high-emitting companies or reallocate their portfolios towards sectors and companies with lower emission levels. This remains a viable strategy to align with personal, ethical values and/or to mitigate financial exposure to climate risks. However, while this may decarbonise your portfolio, it doesn’t decarbonise the planet.  

Transition investing takes a pragmatic perspective that tackling climate change has to include the entire economy⁷. Moreover, it encourages a greater priority on the highest-emitting sectors, given the larger proportion of contribution they make to total emissions.  

Like the fate of horse-drawn carriages and paper phonebooks, not every high-emitting industry or company will survive the sixth technology revolution. However, certain ones must continue, though transformed into low- or no-emissions versions.  

For investors, transition investing can serve two objectives: finding new ways to generate favourable returns and catalysing the energy transition with their wealth.  

A new option for investors to generate alpha 

Alpha-seeking investors are on the look-out for insights and ideas to provide a performance edge – transition investing may provide an new kind of analytical advantage.  

Climate investing began with a focus on the new technologies and companies that will provide solutions to climate change. Transition investing starts with existing industries.  

This different perspective first opens up a wider investment universe from which to select and, moreover, diversify portfolios. Investing solely into green solutions, such as wind and battery technology, can add concentration risks. As well, these mostly younger and capital-intensive businesses are prone to increases in interest rates, a key contributor to performance drag of late.  

Comparatively, companies needing to transition are in incumbent, older industries. While having downsides from their emissions and associated climate risks, they often start in stronger, established competitive positions, as well as with existing balance sheets and access to capital markets.  

Moreover, these companies, owing to their higher emissions and lack of plans or immediate options to transition, may be ignored or underweighted by stringent ethical or responsible investors. If they’re able to transition, or credibly get on a transition pathway, this provides upside potential as the companies become investible for these investors.  

Secondly, investors may find an information advantage by distinguishing between companies at the front and the back of the transition pack in a single sector.  

Research, comparing three- and ten-year performance through May 2024, found companies deemed transition “leaders” have historically outperformed their “laggard” peers^8,9. Impressively, the findings hold across both time horizons, in both developed and emerging markets, and in both higher and lower emissions sectors.  

This doesn’t indicate every company with a Paris-aligned, or aligning, climate goal will outperform peers who are laggards. Notably, merely having a pledge, or even credible plan, does not ensure a successful transition, let alone financial performance. 

Moreover, laggards eventually will set credible decarbonisation goals whether due to an internal decision, external pressure, or regulation. At that point, they should reach the same minimum level as current leaders, so future performance, as well as being unknown, will be harder to distinguish.  

Overall, whether as diversifier or insight generator, transition investing has potential value-add for portfolios.  

A new option for investors to meet their climate ambitions 

In addition to seeking financial benefit, investors can use their wealth to proactively play a role to address climate change – where carbon emissions are currently highest and hardest to address. 

For some investors, simply allocating to companies with good ESG scores, with focus on environmental practices, isn’t sufficiently rewarding. Instead, transition investing can appeal to those seeking more challenging, exciting, or substantial possibility to decelerate emissions. As well, it may appeal to individuals and families whose wealth has been created in high-emissions industries, to re-align legacy and engage younger generations, or even take reparative approach.  

Similarly, for investors who are also business owners, transition investing may be valuable, or even necessary, to preserve or improve the value of their own companies or assets. One example, from our Inspired Magazine publication, explains how the one of Asia’s best-known steel corporations & families evolved its business and created a family office in Forging a greener future. 

While transition investing has potential positive real-world benefits; it can hit the climate metrics for investors’ portfolios. Holdings in these kinds of sectors mean that the portfolio is likely to have higher levels of absolute and relative emissions compared with alternative “low carbon” alternatives.  

As well, based on current frameworks, these portfolios are unlikely to fulfil net-zero criteria, hit carbon targets or be considered Paris-aligned. For individuals and families, this may not be a concern, but for those with stakeholders or commitments focused on climate change, greater explanation may be needed. As well, to avoid accusations of greenwashing, clear and convincing communications should be made both on the investment rationale and its outcomes.  

Selecting sectors in transition 

Investors wanting start with transition investing will have to strategically consider the sectors and the approach(es) they want to include in their portfolio.  

There is no single, universally-agreed approach to transition investing. Moreover, as ever, individual investors need to consider how the approach fits in with their specific constraints, such as investment goals, risk tolerance and sustainability preferences.  

While the starting point includes high-emitting and hard-to-abate sectors, the underlying differences about their transition readiness will guide investors towards or away from various sectors. For example, technological solutions are at different stages of maturity, therefore the potential types and asset classes of investment will vary. Thus, sustainable aviation fuel produced by refining vegetable oils, waste oils, or fats is the only currently available approach, but only in small quantities.  

Moreover, often there are competing solutions to decarbonisation. For example, whether will be the winning solution to power steel furnaces will hydrogen or electricity, or another technology, has yet to be determined.  

Spotting the differences 

As well, even within the same sector, investors should be more aware of geographical differences. Governmental incentives, regulation, remaining lifespan of existing solutions, even community perception, all will be fundamental to potential success of a transition investment.  

In the end, a bittersweet circumstance of transition investing, is the range of industries that are candidates for transition investing. For example, and as potential reference, Barclays has specified eleven sectors eligible for transition finance: agriculture, cement, chemicals, energy, power & utility, real estate, metals, mining, aviation, ground transport, and shipping. 

These sectors have a clear requirement to transition, and moreover provide substantial growth market for investors. The World Economic Forum estimates that to achieve a net-zero scenario total investment in infrastructure and enabling technologies across eight key hard-to-abate sectors will total $13.5 trillion by 2050¹⁰. Looking at each sector highlights the relative additional annual capital expenditure investment to decarbonise sector (see chart).  

Additional annual capex investment needed to decarbonise sectors 

The amount of investment that the World Economic Forum estimates will be needed to achieve net zero by 2050  

Opportunities today and over decades

Transition investing is an emerging field. Definitions, frameworks and regulation are still under debate and development¹¹. However, the need to transition hard-to-abate and high-emitting industries and the large scale of capital required are certain.  

The sooner the heavy lifting occurs to decarbonise these heavy industries, the greater the benefit to global emissions. So, while transition will take decades, making it an attractive structural theme, it’s also an opportunity for investors today.