2023: a new record year for renewables

What happened

Last week, the International Energy Agency (IEA) released its annual "Renewables 2023" report. This report provides a comprehensive analysis of the year's progress as well as forecasts (which are typically cautious in nature) about renewable energy production.

In 2023, a record of ~507GW of new renewable electricity capacity was deployed, marking a ~50% YoY increase, a new two-decades high.

Solar energy led this growth with a 64% YoY increase, contributing 374.9GW, followed by wind energy with a 45% increase, adding 107.8GW. Other renewable sources like bioenergy and hydropower also contributed, but at a slower rate.

The IEA's forecast for the 2023-2027 period has been revised upward by 33%, an addition of 728GW, due to better economics in solar photovoltaic (PV) and wind projects, policy changes, and faster consumer adoption of distributed solar systems, especially in response to high electricity prices.

The report anticipates several key milestones for renewables in the coming years. Notably, renewable energy is expected to surpass coal as the largest source of electricity generation by 2025. Furthermore, both wind and solar are projected to individually overtake nuclear electricity generation by 2025 and 2026, respectively.

Impact on our Investment Case

The unstoppable rise of renewables

Contrary to the perception that the growth phase of renewables might be tapering off, the next five years will witness the addition of more renewable capacity than has ever been installed before. In this respect, the "Renewables 2023" report serves as a stark reminder of the continuous growth in renewable technologies, even amidst periods of disappointing market performance.

It's crucial to recognize that rapid growth in installed capacity (measured in GW) doesn't always translate into proportional market growth in dollar terms.

This is especially true in the Solar PV sector, which experienced cost inflation in 2022, followed by oversupply and a sharp drop in prices in 2023. The global supply capacity for solar PV is anticipated to reach 1'100 GW by the end of 2024, nearly tripling the expected demand, with over 80% of this supply originating from China. However, our portfolio exposure steers clear of Chinese solar panel manufacturers due to their commoditized nature, high competition, and low margins. Instead, our strategy involves tapping into the broader solar industry ecosystem, focusing on components like power inverters and niche non-Chinese solar module manufacturers that offer unique technological advantages and benefit from global supply chain shifts.

The wind energy sector presents a different scenario. Outside of China, the IEA's forecast is less optimistic due to financial constraints slowing project development. Long permitting wait times, supply chain issues, and higher financial costs hinder rapid adoption in various regions.

Economically, the report underscores that 96% of newly installed utility-scale solar PV and onshore wind projects are more cost-effective than new fossil fuel plants, highlighting the improving economic appeal of renewables, mainly due to technological advances (e.g., larger wind turbines) and decreasing material costs.

China’s dominance reaffirmed

China continues to dominate the global renewable energy sector, and is expected to contribute nearly 60% of all new renewable capacity by 2028. The country's deployment rate of renewable capacity for the 2023-2028 period is projected to be three times that of the previous five years, with solar PV accounting for the majority of this growth. This expansion is fueled by an excess in solar module production, favorable policies, and declining interest rates.

In the realm of wind energy, China stands out with optimistic forecasts for both onshore and offshore wind. The country is home to some of the world's largest turbines, like the [THERE IS NO LABEL ASSOCIATED FOR: CNE100000PP1] GWH252-16MW, supplied at the most competitive prices. This technological and economic leadership positions China as a global wind energy leader.  

From an investment standpoint, the challenge lies in identifying companies within rapidly growing segments that have high entry barriers and strong pricing power. Consequently, our investments in China's renewable sector are concentrated on select players in the offshore wind market. 

One notable example is Orient Cables, a leading manufacturer of subsea cables that connect offshore wind turbines to the shore. This aligns well with our investment philosophy. It targets the key segment of offshore wind, set to accelerate at a CAGR of >50% for the next two years, now that the government approval overhang is resolved. Also, the subsea cable industry is benefiting from both accelerated offshore wind deployment in China and the increasing distance of new offshore wind farms from the shore. Additionally, the limited availability of ports capable of accommodating subsea cable factories, coupled with the requirement for specialized technological expertise in the tough sea environment, makes it an attractive investment.

Climate goals: tracking progress

In the context of climate objectives set at COP28, the report's projections lead to a significant gap to bridge. The political ambition is to triple global renewable capacity by 2030 from 2022 levels, aiming for around 11'000 GW. However, the IEA's forecast falls short, as it sees capacity reaching 7,300 GW by 2028 and only 2.5x 2022 levels by 2030.

The IEA report identifies key challenges hindering faster renewable adoption, including policy uncertainties, inadequate grid infrastructure investment, lengthy permitting processes, and limited financing in developing countries. Overcoming these barriers is essential to meet COP28 targets and could unveil new investment opportunities not currently factored into forecasts.

Prioritizing grid integration

As the world increasingly adopts intermittent renewable sources like solar and wind, the challenge of grid integration becomes paramount. The IEA projects that by 2028, solar and wind will account together for 25% of the global power mix (double today's level), with some countries exceeding 50%. The power grid faces a twofold challenge: accommodate distributed, intermittent generation, and adapt to evolving demand patterns from electric vehicles (EVs), heat pumps, data centers for AI training or crypto mining, and other high-energy consumption technologies.

To address these challenges, substantial investments in grid infrastructure are essential. This includes both expansion and modernization to avoid exacerbating grid bottlenecks. The development of grid infrastructure typically has longer lead times than solar and wind projects, necessitating immediate action from governments, grid operators, and utilities. The IEA underscores the need for a significant increase in grid investment, projecting that annual spending on transmission and distribution should rise from the current $300 billion to $600 billion by 2030. This creates significant opportunities in smart/digital technologies (e.g., digital monitoring, sensors, advanced simulation, substation automation, etc.) which already form a crucial part of our strategy. 

Digital technology investments, as a share of total grid investment, have been steadily increasing from 12% to 20% and are expected to become even more significant in the future. These solutions enable grid operators to enhance grid observability for real-time monitoring and control of energy flows. Improving grid efficiency and resilience aligns not only with our theme but also provides resilience against market volatility and variations in consumer demand as it represents a long-term cost-saving opportunity for grid operators.

Our Takeaway

From the IEA report, it's clear that renewable energy continues to expand rapidly. The decreasing cost of solar and wind energy is reinforcing their status as the most economical options for electricity generation. Importantly, the challenge of grid integration, already a key focus of our investment strategy, emerges as a crucial area for continued attention and expansion.

While the IEA often adopts conservative forecasts, the reality frequently surpasses these projections, suggesting a more robust growth potential. Simultaneously, the current market dynamics in the renewable sector, including elevated rates and inventory pressures, appear to be already factored into stock valuations. This suggests that the market may be approaching a potential turning point, with room for a subsequent resurgence.