2022 was a very eventful year. Inflation, the continued spread of COVID-19 — which led to divergent government reopening responses — and a land war in the breadbasket of Europe were all new things many of us have not seen in our lifetimes. As we look ahead, we still believe we are in the initial stages of the Fourth Industrial Revolution, we still believe innova-tion is accelerating, and we still believe in the value of active management, particularly when investing in innovation. 2022 and 2023 will be remembered as the period when developed markets, specifically Western Europe and America, increased their focus on and investment in energy transformation from fossil fuels to renewables. The war between Russia and Ukraine was the spark. The resulting legislation from the US in the form of the Inflation Reduction Act and the expected matching legislation from the EU provide the economic incentive.
SHOCKS ARE ACCELERATING THE ENERGY TRANSFORMATIONWhen making predictions as an investor, we think it is best to invest and make predictions where one has the highest confidence. Over the past several years, we have framed our views on innovation around five distinct platforms: Disruptive Commerce, Genomic Advancements, Intelligent Machines, New Finance, and Exponential Data. These platforms were never meant to be static; they are intended to change and rise and fall in importance as new themes emerge, evolve and dissolve.
For example, 20 years ago, our platforms may have reflected expectations for growth in personal computers, client-server software, and biotechnology. Today, we see New Finance dissolving into two already existing platforms: Exponential Data, as data generated and blockchain technology lead to further pricing efficiencies in capital and lending, and Disruptive Commerce, as payments have become a major piece of e-commerce infrastructure.
Innovation is everywhere. As one platform is dissolved, another platform emerges: Energy Transformation. This is not a new idea; addressing climate change and lowering carbon emissions has been a goal for industrialized economies for decades. However, as we wrote early last year,1 external shocks can accelerate growth. We believe the Russia-Ukraine war coupled with — not coincidentally but, in part as a response to the war — the passing of the US Inflation Reduction Act (IRA) encourages new types of energy generation in the United States. Taken together, this represents a turning point that should lead to materially higher implementation of new innovations in the energy space.
Transforming our energy sources from fossil fuels will be one of the largest capital expendi-tures in history. Historically it has taken 50 to 60 years to transition an economy to a new energy source.2 It will require increased production from multiple sources including solar, wind, hydrogen, nuclear, water, geothermal and new forms of energy.3 Each of these production methods will likely receive more funding, which we believe will lead to more innovation and new solutions.
In addition to production innovation, the increased complexity of the grid4, 5 will lead to more investment in the distribution of energy, not only on a commercial scale as intermittency will become more frequent and will make energy more complex to route, but also on a residential scale, as resilience against power outages encourages more individual homeowners to choose to generate their own energy or backup power.
Finally, we believe energy consumption patterns will change, with a focus on optimization through energy efficiency, electrification (when feasible), data-driven feedback to improve processes, and distributed solutions to provide flexibility at smaller scales. Energy is the lynchpin to an industrialized economy, and economies with structurally lower energy prices — those with a resilience to shocks — have an embedded cost advantage. As the world becomes more multi-polar, energy security will rise in importance and be more critical for economic competitiveness.
We therefore recognize the innovative potential of Energy Transformation technologies to seize this moment and believe active management is necessary to navigate the hype cycles and find the profit pools. n
1 Moberg, Matthew, Rogal, Kelly, “Innovation insights: War, pandemic & inflation — do shocks accelerate innovation? We think so,” Franklin Templeton Insights, June 22, 2022.
2 Vaclav, Smil, “A Global Transition to Renewable Energy Will Take Many Decades,” Scientific American, Jan. 1, 2014.
3 “Annual Energy Outlook 2022: with projections to 2050,” US Energy Information Administration, 2022.
4 “The Future of Electric Power in the United States,” The National Academies Press, Washington DC, 2021.
5 “How to increase grid resilience through targeted investments,” McKinsey & Company, Dec. 20, 2021.
Matt Moberg is a portfolio manager at the Franklin Equity Group.