The three key changes in the energy sector for the year ahead

The way countries source energy is under scrutiny as the Ukraine crisis has exposed the vulnerability of supply. Mark Hume, Co-Manager of the BlackRock Energy and Resources Income Trust plc, explains how the invasion of Ukraine is changing the energy landscape.

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

The Ukraine crisis has forced governments, companies and citizens across the world to take a long look at how they source and use energy. In many cases, there have been accelerated commitments to renewables, while reconsidering alternative energy sources such as nuclear. In our view, the crisis has three main implications for the energy sector as a whole.

The energy transition is happening faster

The energy transition – the move to decarbonised energy usage across the world – was already in progress. The Ukraine crisis has brought a reassessment of energy policy across many markets as governments, companies and individuals have recognised the urgency of the transition.

Governments now realise that the energy transition is not only important for the planet, but also for energy security. Sourcing energy from unstable regimes increasingly looks politically precarious, given the impact of volatile pricing on household bills across Europe. This has seen governments step up their commitments to renewables. The EU is targeting 45% renewables by 2030, up from around 20% today1. The UK says it will increase offshore wind capacity to 50 gigawatts by 2030, a five-fold increase2. It wants to increase solar by a similar amount by 20353.

There is also likely to be an increased focus on the way energy is used and an emphasis on doing more with less. This is vital to sustain and grow standards of living. There are a broad spectrum of companies that help manage energy usage ranging from insulation to smart buildings technology. Clean transportation is also likely to become a priority for policymakers. This does not just benefit electric vehicle manufacturers, but also other areas such as battery storage.

Fossil fuels still have a role to play

The global supply base for hydrocarbons has expanded by 14% since 2014. In contrast, investment levels have fallen by 40% over the same period4. With demand for hydrocarbons as high today as we’ve seen at any point in history, this presents a significant challenge. Looking to the medium term we continue to believe that supply will struggle to meet demand resulting in higher-for-longer commodity prices. This supply-demand tension is creating record free cash flows for traditional energy companies offering scope to not only return capital to shareholders, but also to reinvest significant amounts of capital into low- and no-carbon projects. In short, many of these companies are helping to meet the twin challenge of the energy needs of today as well as the decarbonsiation required for tomorrow.

We believe it is vitally important to have the flexibility to invest across the energy and commodities spectrum as this transition unfolds.

The importance of mined materials

Since we want to grow standards of living and support a growing population, we will need newly mined materials every year for the foreseeable future. The new technologies require different materials and as decarbonisation ambitions increase, there will be increasing demand for specific materials. That may be the copper needed for the electrification of transport systems, or the lithium for electric vehicle batteries, or some of the heavy rare earths used for the magnets in wind turbines. As the energy transition intensifies, it could add as much as 20-25% to copper demand by the end of the decade, at a time when mining companies have struggled to increase supply5.

Historically, mining companies have generally been seen as non-ESG friendly. The reality is that mining companies are increasingly focused on their social license to operate consistently raising ESG standards across their global mining operations. Moreover, the energy transition will be impossible without certain mined commodities. We continue to hold these in the trust, aiming to position the trust in areas seeing structural demand.

The way the world sources energy is in flux. The transition to low carbon fuels is a once in a lifetime shift with far-reaching implications. We believe it is vitally important to have the flexibility to invest across the energy and commodities spectrum as this transition unfolds.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are as of May 2022 and may change as subsequent conditions vary.

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