Sustainable Energy - January Commentary

This is a marketing communication. Please refer to the prospectus, supplement and KID/KIID for the Funds before making any final investment decisions. Past performance does not predict future returns.

The election of Donald Trump, slower-than-expected interest rate reductions and low-cost Chinese competition drove sentiment and earnings for sustainable energy lower in 2024. The solar, wind, battery and EV industries all reached record deployment levels, as did global clean energy investment, while a rapid uptake in AI querying and data centre demand promises more pressure on global power grids and power generation. Renewables remain at the bottom of the cost curve and we expect investment to grow, helping sentiment to recover, and for 2024 to be seen as a cyclical low. A high level of M&A in 2024 shows that there is value in the long-term growth opportunity. Our portfolio, which offers broad exposure to companies that are well placed to benefit from the energy transition, now trades at a 26% one-year forward discount to the MSCI World Index despite offering greater earnings growth potential.

Sentiment towards sustainable energy globally, especially in the United States, was dominated by the US election cycle in 2024. The outcome was a backward step for the energy transition, and uncertainty persists in early 2025 around Presidentelect Trump’s plans to unwind components of the Inflation Reduction Act. As a result, IRA-led investment was less than expected, but Republican desire to retain the manufacturing jobs and investment associated with it appears strong.

In contrast, China reaped benefits in 2024 from decades of investment in sustainable energy technologies, building nearly twice as much wind and solar capacity as the rest of the world combined, delivering the lowest clean energy costs globally and manufacturing over 60% of the world’s electric vehicles. Despite rapid renewables growth, Chinese added around 80 GW of new coal-fired power capacity in 2024. In contrast, there seemed to be little real progress from Europe around commitment and investment as part of the Net Zero Industrial Act while COP29 passed with less progress than hoped.

Global investment in clean technologies grew and is likely to have hit nearly $2trn in 2024 (up from $1.7trn in 2023, almost twice the spend on coal, oil and gas in the year) reflecting that fact that renewable electricity is the cheapest form of new electricity supply in most situations. This came despite the broader macro-economic backdrop being less supportive than initially expected, with only three US interest rate cuts in the year. Despite this, there was a clear trend of M&A activity in the sustainable energy space which suggests that acquirers, especially privately owned and private equity companies, see the weakness in the sector as merely a cyclical slowdown, meaning that public market business valuations are attractive.

Around 690 GW of new renewable generation capacity was installed in 2024, 170 GW higher than the record installations seen in 2023 and more than triple the 194 GW installed pre-COVID in 2019. Solar was dominant (at around 460 GW) with wind in second place (around 110 GW) followed by hydropower, then bioenergy. A rebound in hydro meant that renewable electricity generation in 2024 increased around 13%, outpacing global electricity demand (estimated 3% growth in 2024). Lower energy prices reduced the desire for efficiency, with investment in energy efficiency falling by around 3%.

Electric vehicles (EVs) saw continued adoption in 2024. After growing at over 50% and 35% in 2022 and 2023, sales of plugin vehicles grew by around 20% to around 17 million units, reaching a 20% penetration rate in 2024, one year earlier than our long-held forecast. Global lithium-ion battery demand grew by 29% and prices (across all applications) fell a further 20% to $115/kWh in 2024 due to rapid growth of lower-cost Chinese manufacturing based on lithium iron phosphate chemistry. EV penetration surpassed 50% in China in the second half of the year and 60% of all Chinese EVs were cheaper than their internal combustion engine (ICE) equivalents in 2024. Tariff tensions rose as President Biden more than tripled tariffs on Chinese imports of batteries and EVs.

Solar deployments grew rapidly in 2024, with installations of around 600 GW, up around four times (40% per annum) since 2020. Module costs fell to just 9 cents per watt, below the cash cost of manufacturing, pressuring margins for manufacturers.

The wind industry delivered record installations of around 124 GW as manufacturers continued to recover from supply chain bottlenecks as well as raw material and labour cost inflation.

Rapid uptake of AI querying and growth in data centres brought strong renewable power demand and put pressure on developed world power grids, causing shortages for key products like transformers. Renewable power prices increased, and we saw a renaissance for nuclear power in the United States.

Against this backdrop, the Guinness Sustainable Energy Fund delivered a total return (USD) of -11.8% in 2024 vs its benchmark the MSCI World Index (net return) of 18.7%. For comparison, the MSCI Alternative Energy Index delivered -32.3% and the iShares Clean Energy ETF delivered -25.7% reflecting the poor sentiment. Recent weakness has led some to view the clean energy equity sector as already discounting the IRA completely; the ICLN index is down 50% since August 2022 (when the Act was passed) with the number of shares outstanding having halved and the price/earnings (P/E) multiple down more than 50%.

At the end of 2024, the Guinness Sustainable Energy Fund traded on a one year forward P/E ratio of 14.1x (a 26% discount to the MSCI World Index at 19.1x) despite three-year forward consensus-derived earnings growth expectations for the fund being greater than the MSCI World Index. Since repositioning six years ago, the fund has delivered a return in excess of its investment universe, based on an equal weighted average calculation.

Looking ahead to 2025 and beyond, we expect the following:

President Trump will struggle to make substantial reforms to the IRA and will enjoy more success using his executive powers to promote fossil fuels. Republican support for the jobs and investment coming from the Act may restrain Trump’s ability to repeal it and the final outcome may be that Trump’s election is more positive for fossil fuels, via lower regulation and environmental protection, than it is negative for clean energy directly. Expect his focus to be on domestic content requirements for tax credits, Foreign Entity of Concern (FEOC) definitions and subsidies for offshore wind. Greater tariffs on clean energy imports, lower environmental restrictions, greater liquefied natural gas (LNG) exports and the departure of the United States from the Paris Agreement are possible in the short term.

Politics aside, US electricity demand will continue to surge due to AI querying, data centres, re-shoring and the broader trend of electrification. Significant grid upgrades, a record interconnection backlog and skilled worker and product shortages will keep this market – which has seen little growth in the last 20 years – very tight, benefiting equipment manufacturers and contractors. New nuclear is unlikely to impact before the mid-2030s, meaning that renewables and gasfired power generation will be in demand. Globally, renewable power generation is expected to grow 7-8% in 2025.

Clarity from Trump and electricity supply/demand realities will allow the US industry to address its substantial backlog of IRA-related investments while Europe likely recoups some investment from the US as a result of the election-related hiatus. In stark contrast, we see further rapid growth in China as renewable energy was again listed among the “strategic industries” whose development is expected to receive long-term support from policymakers. Broadly speaking, investments requiring subsidy or consumer incentivisation will continue to be less well placed as a result of pressured government finances, meaning that economic competitiveness will likely be more important than decarbonisation.

Electric Vehicle sales will grow and likely reach around 20 million in 2025. If current adoption S-curves are followed, EVs will make up over 80% of new vehicle sales in China and Europe by 2030, with the US reaching that level by 2035, as they become cheaper to buy, cheaper to run and cheaper to maintain. Lithium-ion battery prices likely deflate further (down around 5% in 2025) and will reach $70/kWh in 2030 if historic learning rates hold. Demand growth and increased industry concentration should allow battery manufacturers to increase utilisation and benefit from positive operating leverage.

Solar will remain at the bottom end of the renewable cost curve and installations will grow across all major geographies in 2025, reaching around 670 GW. China will be around half of the market with North America and Europe seeing demand increases due to the desire of hyperscalers for quick-to-market, zero-carbon electricity with long-term price visibility.

Wind installations will reach a record level of around 145 GW, with China being less than half of the market. Faster permitting and raw material cost deflation will support the outlook for growth and margins. Installations will continue to grow to around 200 GW by the end of the decade.

The energy transition is generally progressing well and the multi-decade positive outlook remains. However, within this secular trend, there are cycles at play, some of which are in an ‘up’ phase (e.g. electrical equipment, building material, grid investment) and some in a ‘down’ phase (e.g. battery/EV supply chain; solar upstream). We are confident in the structural growth offered by the transition and believe that the challenged industries are at or close to a cyclical trough.

With the US election behind us, we look to a reduction of financing costs (i.e. interest rate reductions feeding into consumer and project financing) to drive investments into the clean energy sector. Together with growing AI and data centre demand bringing higher renewable power prices, stricter energy efficiency requirements, massive grid upgrade programmes and the implicit operating leverage within our manufacturer investments, we believe that confidence in portfolio earnings will start to improve from a low level.

The consensus-derived earnings per share growth outlook for the fund (16.4% per annum for 2024-2027E) sits at a premium of nearly 6% pa vs the MSCI World index. We do not think that the 26% one year forward P/E discount of the fund reflects this earnings scenario but, instead, something that is worse than that implied by current interest rates and inflationary conditions. If valuations do not improve, we would expect to see continued high levels of M&A activity in the sector.

As such, investor interest in sustainable energy equities should start to improve from very poor levels as energy security grows in salience and individual, social and government pressure for consumers to become more energy efficient increases. We believe that the Guinness Sustainable Energy portfolio of 30 broadly equally weighted positions, chosen from our universe of around 250 companies, provides concentrated exposure to the theme at attractive valuation levels that are especially attractive relative to consensus earnings growth expectations.

Key themes in the Guinness Sustainable Energy Fund

Source: Guinness Global Investors (31 Dec 2024)

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