Renewable sources like solar and wind could be critical to meeting the planet's soaring demand for energy—and addressing the growing threats from climate change and pollution

GLOBAL ENERGY DEMAND IS GROWING and is expected to rise by nearly one-third between 2013 and 2040.1 To meet this increasing demand, the world is continuing to transition to alternative energy sources—also known as renewables—and improve energy efficiency. In 2015, during the United Nations Climate Change Conference, 195 countries signed the Paris Agreement to reduce emissions of greenhouse gases (GHG), agreeing to reach the goal of limiting to 2°C the increase in the global average temperature over pre-industrial levels.2 Private and public investors have also boosted their activities in the renewable sector.

While we expect conventional sources of energy—coal, oil and natural gas—to remain dominant, we believe alternatives will continue to grow in importance. We see the transition to a low-carbon environment and a balanced energy mix as irreversible.


Call to action for renewables

Governments, corporations and investors have become more committed to climate change as environmental pollution is a critical public health issue for many countries. In 2015, companies unveiled more than 8,000 initiatives to reduce GHG emissions globally.3 Some conventional energy companies, such as BP and Shell, have pledged to play a bigger role in alternative energy production and to help control rising temperatures.

Until recently, economic expansion and levels of energy-related carbon dioxide had always been positively correlated. In 2014, however, energy-related CO2 emissions stalled despite global economic expansion of 3%,4 demonstrating the commitment to deep cuts in GHG emissions and proving that a growing global economy does not need to rely on greater consumption of conventional energy.


Solar is a big part of the future

The solar power industry experienced record growth in 2015, adding 50 gigawatts (GW) of capacity, bringing the global total to about 230 GW.5 Another $3.7 trillion is expected to be put into solar investments between 2015 and 2040. 6 With costs for equipment, installation and services falling, we believe solar will continue to transition from a policy-driven to a business-driven industry. Solar energy can be converted into electricity via technologies like photovoltaics (PV) and concentrated solar power. PV is less expensive and more widely used than concentrated solar power (CSP), gaining competitiveness due to declining costs versus conventional energy, and life-time CO2 emissions are about 10% of those of coal-fired power.7 It is also cheap for consumers.

The International Energy Agency has projected that solar power could provide 20% of the world's energy needs by 2030, with China and the United States driving much of the increased demand. Here in the U.S., growth in solar installations should get a boost from a federal income tax credit for residential and commercial properties.8


Wind should get a lift from falling costs

The Global Wind Energy Council has predicted that the number of wind power installations will double in the next five years, driven by China, the U.S. and Europe. 9 Increases in capacity should allow onshore wind generators to achieve economies of scale and attract additional financing. Technology improvements in turbines, better sites and cheap financing make wind the least expensive renewable source of electricity besides hydro power. While offshore wind power remains more expensive, we expect the cost of onshore wind power to fall even further, assuming greater efficiency in manufacturing of wind turbines, which would support the long-term demand for wind power.

Wind, like solar, is at the mercy of nature and its reliability varies by location. Developing a means of enabling excess power to be returned to the grid is key. Additionally, wind turbines require regular maintenance through their 20-to-25-year life, so high-quality service could facilitate further adoption. Also needed are solutions to protect wildlife from a wind turbine's rotating blades, as well as the effect of electromagnetic fields.

Overall, solar PV and onshore wind are the most competitive forms of alternative energy given their lower costs and more mature technologies. They are likely to dominate additions to global generating capacity over the next 30 years.10 However, storage for back-up power is one challenge both sources face. In addition, as solar and wind generators are connected to the electric grid, system operators must manage output to prevent unanticipated fluctuations in voltage and blackouts.


Hydro has advantages and drawbacks

Concerns with climate change and declining variable costs are driving further adoption of hydropower, which is valued for its low emissions. The benefits of hydro include ease of adjusting output to reflect changes in demand, and reservoirs that can offer energy storage as well as flood control and drought protection. However, hydropower has important drawbacks, including the high cost of building new plants and concerns with flooding and other negative impacts on local ecosystems. In the long term, we predict solar PV and wind power will surpass hydro due to these constraints.

While we expect positive strides to continue to be made in the alternative energy sector in the long term, policy uncertainties present a near-term risk. Domestically, President Trump intends to reduce federal spending on climate change by up to $100 billion over the next eight years and he has suggested cutting the Clean Power Plan. Internationally, the President's proposal for potentially withdrawing from the Paris Climate Agreement also remains a near-term uncertainty.

Conclusion: Conventional sources are expected to continue to dominate the energy mix as the world moves toward a low-carbon economy. Given concerns with climate change, we believe the world has reached a tipping point for renewable energy.

We believe that solar PV and onshore wind will likely become the predominant low-carbon energy sources given improving technologies and declining costs.

Alternative energy investments tend to be volatile and call for a relatively long holding period. Investors can target energy efficiency technologies like storage, lighting and smart grid and look to blue-chip companies with a significant presence in these technologies, reducing downside risks. A diversified approach through managers specializing in impact investing is preferred.

1 BP 2015, BofA ML Global Research, "A Call to Action - Climate Change Solutions Primer," November 2015

Note: "Power" energy demand captures the residential, commercial and buildings segments; "Industry" energy demand captures factories, agriculture, mining, etc.

2 U.S. Trust, "The COP21 Paris Climate Agreement and What It Means for Investors," April 12, 2016

3 Ibid.

4 Ibid.

5 Renewable Energy Policy Network for the 21st Century, "Renewables 2016 Global Status Report"

6 Bloomberg, "Renewables to Beat Fossil Fuels With $3.7 Trillion Solar Boom," June 23, 2015

7 BofA ML Global Research, "A Call to Action — Climate Change Solutions Primer," November 2015

8 Solar Energy Industries Association, "Solar Investment Tax Credit (ITC)," accessed at seia.org on August 3, 2016

9 Ibid.

10 BofA ML Global Research, "A Call to Action — Climate Change Solutions Primer", November 2015

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