The role of indexes in the energy transition

A technological revolution is driving the energy transition, improving energy efficiency and drastically reducing costs in renewables. Notably, the price of solar photovoltaics dropped 86% from 2010 to 2023. Cost reductions in onshore and offshore wind energy, along with advancements in energy storage and smart grids, support a decentralized energy system, according to the International Renewable Energy Agency.

This shift is being propelled by strong market forces, including rising investor interest in sustainability and heightened consumer demand for clean energy. As a result, renewable solutions are viewed as ethical choices and viable financial investments, positioning the renewable revolution as a transformative force across industries.

Indexes play a critical role in facilitating the energy transition by providing market participants with diverse options across various asset classes. They serve as benchmarks to assess performance, mitigate risk and enable market participants to identify and navigate the complex energy market. By aligning portfolios with the associated risks and opportunities of the low-carbon transition, indexes can help investors capitalize on the potential of this evolving ecosystem.

Several indexes are available for market participants to consider, each highlighting different facets of the energy transition. Among these, the S&P Global Carbon Credit Index, S&P Global LargeMidCap Carbon Efficient Index, S&P Global Clean Energy Transition Index, Dow Jones Global Select ESG Real Estate Securities Index and S&P Green Bond Index illustrate various index investment strategies that accommodate diverse financial goals.

At the 2024 UN Climate Change Conference (COP29), world leaders adopted crucial rules for carbon trading under Article 6 of the Paris Agreement on climate change, establishing mechanisms for decentralized and centralized carbon markets. A recent Organisation for Economic Co-operation and Development analysis suggested that, on the supply side, carbon credit markets can create revenue for projects such as clean energy technology deployment. On the demand side, buyers can leverage the greenhouse gas mitigation impact of these credits for various purposes, such as meeting tax obligations or making voluntary claims regarding their climate performance. This approach can support net-zero targets and offer cost-effective options for buyers while financially incentivizing sellers.

The S&P Global Carbon Credit Index captures the most active segment of the tradable carbon credit futures markets. This includes futures contracts linked to EU allowances, UK allowances, California carbon allowances and the US’ Regional Greenhouse Gas Initiative.

The index utilizes pricing data sourced from Intercontinental Exchange futures pricing, offering a comprehensive overview of carbon credit trading trends

Our research shows that the S&P Global Carbon Credit Index exhibited low correlations to many asset classes across three years. This finding suggests that the inclusion of carbon credit futures in a portfolio of traditional asset classes could provide diversification benefits.

Another possible advantage of carbon credit futures lies in equity investors’ significant exposure to carbon prices, driven by various climate-related opportunities and risks. These encompass the potential impacts of different climate policy scenarios, such as 1.5 degrees C, 2 degrees and 3 degrees of warming, with the financial sensitivity assessed using Trucost Physical Climate Risk data. Consequently, investors may consider leveraging carbon futures to shield themselves from adverse shifts in carbon prices, particularly within high-carbon-emitting sectors such as energy, utilities and materials.

Launched July 17, 2018, the S&P Global LargeMidCap Carbon Efficient Index is designed to measure the performance of companies in the S&P Global LargeMidCap, overweighting or underweighting companies with lower or higher levels of carbon emissions per unit of revenue, respectively.

The primary design principle of the S&P Global LargeMidCap Carbon Efficient Index is to systematically minimize exposure to high-carbon companies while preserving a risk/return profile comparable to its benchmark, the S&P Global LargeMidCap. As of Dec. 31, 2024, the index accomplished a mere 0.8% tracking error relative to its benchmark over a three-year annualized period, along with a 44% reduction in carbon emissions. This is based on a weighted average carbon intensity (metric tons of CO₂ equivalent per $1 million of revenue) measured as operational and first-tier supply chain greenhouse gas emissions.

Given this minimal tracking error and the substantial decrease in carbon exposure, this index can present a viable option for market participants seeking to lower their portfolio's carbon footprint without exceeding their low tracking error tolerance.

Launched in 2007, the S&P Global Clean Energy Transition Index is designed to measure the performance of global clean energy-related businesses from developed and emerging markets, with a target constituent count of 100. The index serves as a performance benchmark for companies in this growing sector, reflecting its increasing competitiveness and swift changes. 

In reaction to such changes, the  S&P Global Clean Energy Transition Index has shown considerable fluctuations in performance since its launch. S&P Dow Jones Indices offers further insights through its report on the market dynamics and company performance of the clean energy transition.

The  S&P Global Clean Energy Transition Index peaked in 2007, with green energy investments overtaking fossil fuels in 2008 due to rising oil prices and government support. However, it declined from 2008 to 2012 due to fluctuating silicon prices and the financial crisis.

The index stabilized from 2012 to 2019, then rose significantly in 2019 as clean energy costs decreased. Following a second peak in 2021, the sector faced challenges due to inflation, increased borrowing costs, supply chain disruptions and geopolitical tensions, particularly from the Russia-Ukraine war.

Despite these issues, over $2 trillion has been invested globally in clean energy since 2020, according to the International Energy Agency, with strong government support expected to drive innovation and expedite the transition, highlighted by major US investments as well as commitments from the EU and China.

Moreover, it is crucial to highlight that, as of Dec. 31, 2024, the  S&P Global Clean Energy Transition Index achieved a carbon reduction of 59% compared with the S&P Global BMI Energy (Sector), thereby representing a choice for market participants seeking to capitalize on opportunities in the rapidly evolving clean energy sector while reducing their carbon footprint.

The buildings sector accounts for about 37% of global energy-related CO₂ emissions and over 34% of energy demand, according to a UN Environment Programme report. Implementing efficiency policies could reduce greenhouse gas emissions by up to 90% in developed countries and 80% in developing countries, potentially alleviating energy poverty for 2.8 billion people, the report said. However, significant construction by 2050 poses risks to mitigation goals. Investing in building efficiency may create nine to 30 jobs for every $1 million spent, with an economic value of $24.7 trillion in emerging markets by 2030.

The Dow Jones Global Select ESG Real Estate Securities Index (RESI) is designed to measure the performance of publicly traded real estate securities in its benchmark, the Dow Jones Global Select RESI, that meet sustainability criteria. The index attempts to improve the GRESB Total ESG score exposure with respect to the benchmark index by overweighting companies with relatively high GRESB scores and underweighting those with lower or zero scores. GRESB is a global environmental, social and governance benchmark for real assets used by investors to understand and measure the performance of funds and assets against the most important ESG metrics. The GRESB Total ESG score is an overall measure of ESG performance represented as a percentage (100% maximum). An index constituent’s GRESB score gives quantitative insights into its ESG performance in absolute terms, over time and against its peers.

As there appears to be significant room for improvement in building performance regarding sustainability issues, market participants could see a positive impact on market values by considering sustainability in their property investments and resource use. This may, in turn, offer price premiums, lower default risks, reduced volatility and possibly slower depreciation rates. The Dow Jones Global Select ESG RESI could represent a valuable resource for navigating the evolving landscape of sustainable real estate investment, inviting market participants to consider financial and environmental benefits.

Green, social, sustainable and sustainability-linked bonds (GSSSBs) are classified into two main types:

1. Sustainability-linked bonds (SLBs), which have financial characteristics tied to achieving sustainability goals
2. Use-of-proceeds bonds, whose funds are exclusively allocated to eligible green or social projects

Within use-of-proceeds bonds, there are:

1. Green bonds for environmentally beneficial projects
2. Social bonds to address specific social issues
3. Sustainability bonds that support both

As of July 2024, S&P Global Ratings had rated over $2.6 trillion in outstanding GSSSBs, with maturities increasing to $1.2 trillion from April 2024 to 2028. Annual maturities are estimated to peak at $307 billion in 2026, but the market's depth suggests refinancing needs can be met, as issuance has been roughly double that of recent annual maturities. Notably, over 90% of GSSSBs were rated investment-grade, with green bonds comprising 51% of maturities. This was followed by sustainability bonds at 22% and social bonds at 20%, with Europe being the primary issuing region at 41%.

Launched in July 2014, the S&P Green Bond Index tracks the global green bond market. This pioneering index maintains stringent standards to include only bonds whose proceeds are used to finance environmentally friendly projects.

As the green bond market evolves, the S&P Green Bond Index may provide more opportunities for market participants seeking green investment options, further funding the energy transition.

Indexes can be essential instruments in the energy transition, offering various options across different asset classes for market participants. They act as benchmarks to evaluate performance and manage risk as well as empower market participants to navigate the complexities of the energy market. By aligning investment portfolios with the unique risks and opportunities accompanying the low-carbon transition, indexes can provide a pathway for market participants to tap into the potential of this dynamic ecosystem.

Moreover, the availability of numerous indexes highlights the diverse investment strategies that cater to varying financial objectives. These indexes represent different facets of the energy transition, enabling market participants to choose those that best align with their values and goals. As the world increasingly embraces renewable energy solutions, these indexes will be vital for market participants seeking to position themselves strategically.