Decarbonization of the global economy driven by climate change may be the backdrop to one of the largest societal and economic transformations since the industrial revolution. All sectors of the economy will face challenges arising from the geographic footprint associated with the clean energy transition and opportunities related to decarbonization and its larger supply chain.
One sector that’s currently in the spotlight is battery electric vehicles (BEV), riding tailwinds from the generous incentives established by the Inflation Reduction Act of 2022 (IRA). Despite strong consumer demand, the BEV supply chain will not only set the pace for widescale adoption, but also the tone, as organizations determine the role sustainability will play. Since battery production requires sourcing precious metals from challenging parts of the world, industry leaders will need to tactfully navigate issues related to environmental degradation, forced labor, and the circular economy. While there is no roadmap, a close examination of the BEV supply chain will help operators and investors get to the starting point in the ICE to BEV capital deployment story ahead of the competition.
According to the International Energy Agency (IEA, 2022), not only has the global electric vehicle market seen a strong upward trend in terms of the total number of vehicle registrations over the last several years, but the percentage of electric vehicles as a function of total automobile sales has increased (see chart below). As emissions from greenhouse gases (GHG) related to transportation are estimated to comprise just under one third of total emissions in the US, the shift away from the Internal Combustion Engine (ICE) to battery electric vehicles (BEV) will lead to significant changes on the demand side of the oil equation.
While an inflection point on the demand curve seems inevitable, some are more bullish than others regarding the speed and timing of this transition. For example, Cathie Wood, CIO of ARK Invest, has stated that over the next five years, the acceleration of BEV adoption will lead to a 30% decrease in the demand for oil as compared to January 2023 levels. Whereas BP describes a more gradual transition away from fossil fuels in its 2023 Energy Outlook.
The aggressive decarbonization view massively underestimates factors such as strong fossil fuel demand in non-North American geographies, the time and capital required to spur such a shift, and other non-forecastable variables including the price of oil itself. More importantly, the required investment affects not only automobile original equipment manufacturers (OEMs) but also its upstream and downstream partners, such as the material supply chain, the mobility and charging infrastructure, and consumer preference.
As the saying goes, nothing cures high prices like high prices, and if oil prices remain elevated or constructive in the next 1-2 years, prices will by necessity stabilize and decrease. However, this does not prove Ms. Wood’s 5-year demand destruction thesis. As oil prices drop, more expensive alternatives, including BEVs, may lose some of their demand strength. Discretionary consumer income is a finite resource, and we should expect mass adoption to be driven first and foremost by price. If the ICE is cost competitive, barring other drivers, gas cars will still be the dominant mode of transportation on the highway. Again, we see this ICE to BEV shift as inevitable, it just may be a slower transition than some anticipate.
Let’s now take this one step further and look at the supply side of the transition. The Biden Administration signed the IRA in August of last year, providing a significant catalyst ($370B) towards ensuring that the US economy remains at the forefront of a clean energy economy. While the usual suspects will benefit, the law goes beyond capital for wind farms, power generation and scrubbers on smokestacks. Capital will be directed towards the entire upstream and downstream supply chains in industries that will help to support a green economy, including industries ranging from mining, agriculture, textiles and transport. This is a great windfall for innovative industries, however, a true sustainable energy economy will still be largely enabled, or limited, by the foundation for all commerce: commodities.
If we examine the example of BEVs, a move to emission free mobility can only happen as fast as a sustainable material supply chain can support. As oil demand drops, demand for energy will not, so we should expect significant increases in the need to extract critical minerals including Lithium, Cobalt, Manganese and Nickel, among others. As every OEM with a BEV target date scrambles to ramp up production, this will only occur as fast as these crucial materials can be extracted from the Earth.
To further complicate the equation, mining is a notoriously dirty industry, operators need to be mindful of solving one problem while creating another. We need to consider what the BEV means for overall environmental quality and social equity. Do we move to secure cleaner air and energy independence, at the expense of poisoning water, supporting child labor and corrupt regimes? Moving away from oil sounds nice, but where and how these critical materials are sourced needs to have a seat at the table.
For firms looking to capitalize on the ICE to BEV transition but don’t know where to start or are looking to enhance an existing strategy, Climate Alpha can help. We help operators and investors get to the starting point in the ICE to BEV capital deployment story early. There is no perfect forecast in this space; however, being early and directionally correct provides a significant advantage.
Climate Alpha’s platform will help customers and partners by highlighting the geographies, sectors, and supporting industries best positioned to capitalize on these impending seismic economic shifts. In relation to the transition from ICE to BEV, our platform will help you navigate complexities related to:
What geographies are going to be resilient to trends that will shape, for instance, the next cluster of EV battery manufacturing centers?
With the IRA windfall as a catalyst for an industrial renaissance in US manufacturing, where are the regions poised to accelerate and expand the existing network of EV charging stations and supporting infrastructure?
Where are the cities and towns located along these expanding corridors that should benefit from increased commercial opportunities and appreciating property values?
Where geographies are currently being overlooked - those where investment now can have a massive payout as these emerging trends materialize?
To use the tired trope, we are in the early innings - some may even argue pre-game warmups - of a decades-long transformation that will ripple across every sector of modern life. Thinking about where to shift and deploy capital will foster this transition in an economically and environmentally sustainable manner.
To learn more about Climate Alpha, please check out www.climatealpha.ai.