Research: The 'Green Swan' challenge

Investors, financiers, company executives and government leaders who gathered at CERAWeek by S&P Global offered a range of answers to the same question: "What is a Green Swan for you?" The shape of the present risks and potential opportunities for the coming decade became clearer in prompting this thought exercise about what sort of breakthrough could further accelerate the energy transition.

➤ Accelerating speed, technology breakthroughs and shifts in the macro economy are all baseline characteristics of the energy economy in 2023, but investors, financiers, government leaders and corporate executives who gathered in March at CERAWeek 2023 were hungry for more of each to drive a comprehensive transition investment case.

➤ Senior leaders at the Houston-based conference wanted more, faster. They highlighted speedier permitting and deployment of already-allocated clean technology and energy capital, accelerated technology innovation and rapid adoption of new technology among consumers. The accumulation of marginal but meaningful improvements in performance, cost, speed and regulatory structures could add up to a significant shift in energy markets perceptible only in retrospect.

➤ The extent to which truly transformative events are aggregated with ordinary investing risk presents a challenge for investors in energy transition assets. The capacity to delineate between different technologies, capital structures and market types is an essential skill at this stage of acceleration in the energy transition.

➤ The macroeconomic and geopolitical environment into which new large-scale energy infrastructure is delivered could make or break a "Green Swan" evolution. If governments have already adopted a "whatever it takes" attitude to the energy transition, then the disruption that they may be unleashing on existing markets will need to be carefully managed both within and across national borders, companies and project developers warned.

➤ Much of the technology "Green Swan" discussion focused on battery and energy storage technologies, while much of the dealmaking discussion at CERAWeek was around hydrogen and carbon capture opportunities.

The S&P Global Commodity Insights' Investing in Energy team asked more than 100 panelists and attendees for their "Green Swan" ideas during CERAWeek 2023 in Houston, and the answers, while wide-ranging, fell into some clearly delineated and illuminating categories.

Often the way leading investors approached answering the question was as revealing as their specific ideas for a "Green Swan." Popularized after the global financial crisis of 2007-'08, the term "Black Swan" has become a common component of business analysis, with news headlines consistently evaluated for their potential to transform forward planning and capital allocation.

The idea has gone far beyond its original statistical meaning in a reflection of the disruptive and opportunistic period of economic transformation that has accompanied the technological and political revolutions of the post-global-financial-crisis period and was embraced by investors at CERAWeek as a way to widen the aperture on their thinking about potential high-impact external events.

The potential for accelerating compounding gains in the energy market transition was palpable among the leaders who were engaged on the "Green Swan" question. The outline of a transition acceleration cycle rooted in faster deployment of cleantech infrastructure that brings down per-unit costs and, in turn, triggers more technological gains to preserve value capture has already been established by the experience of renewable energy buildout in the last decade. As more investors and companies move into an accelerated cycle of deployment/cost decline/technological gain, the more embedded energy transition financing becomes across both the capital markets and the energy sector.

Vectors identified at CERAWeek for transformative and opportunistic change included faster permitting processes, accelerated deployment of investment capital by private funds and governments that have allocated but not invested, changes to battery technology and the emergence of broad political acceptance of rising greenhouse gas emissions pricing. Successful and commercially viable nuclear fusion, a perennial answer to the problem of cheap, clean and stable electric supply, also appeared in the answers from CERAWeek conferees.

One former oil company executive now advising a major investment bank said the sweeping change was most likely to emerge from a collection of "green signets" — the correct term for a baby swan. As marginal changes to pricing, technology, consumer usage patterns and policy pile up over time, the full-sized "Green Swan" of the energy transition itself might be perceptible only in retrospect.

Need for speed

Permitting reform was a common theme across the CERAWeek panels and sessions and was reflected in the urgency with which both buy-side and sell-side financiers urged governments in the US, Europe and elsewhere to accelerate everything from mining permits to regas facilities. When it came to the energy transition, transport permitting for the cleantech midstream was the biggest 'Green Swan' challenge after the Inflation Reduction Act's passage turned the potential of federal government backing for cleantech-facilitated energy production into part of current business planning.

Even technologists and early-stage venture capitalists in Houston, whose projects were far from commercial scale, said that without the promise of rapid market access, there would always be hesitation among their investors and corporate counterparts.

Accelerated permitting would have implications across the energy sector, with decarbonization efforts at existing oil and gas firms as dependent on pipeline construction as more established business lines.

And while sheer capital sufficiency largely was held to have been achieved — a 'Green Swan' in the rearview mirror for many CERAWeek attendees — the comparatively slow pace with which extensive investment capital has moved into the actual construction of energy infrastructure was characterized by one international oil company CFO as his choice for a new 'Green Swan' opportunity still on the horizon.

The capacity to move capital into project investments quickly and then connect those projects to markets could have a cumulative transformative effect across the energy transition.

Technology leaps

In an era and an economy defined by the competitive advantages accruing to those companies and investors who embrace cutting-edge technology at scale, the prevalence of technology breakthroughs among the answers to the "Green Swan" opportunity was unsurprising.

With technology already moving so quickly in both outright improvements and in terms of adoption willingness among consumers and corporations, the CERAWeek attendees who offered a technological answer to the "Green Swan" question were the most likely to focus on solutions that require completely new scientific leaps, rather than marginal changes to existing trends.

Nuclear fusion at commercial scale and cost is a constant favorite, but it was outrun in the conversations at CERAWeek by the battery and energy storage revolution. The rapid decline in cost and equally rapid improvement in the capacity of existing battery technologies prompted "Green Swan" predictions predicated on even more significant leaps in performance.

One private equity manager focusing on mining and critical minerals assets said that early signs of improved extraction technologies and even recycling process improvements could make expansion of the battery supply chain so easy and cheap that it would unleash distributed renewable energy in a completely transformative moment for the energy transition.

Another senior executive at a private capital firm said that new technology able to leverage the power of the ocean tides was at a similar stage to the advances in solar and wind that had already transformed energy markets over the last 30 years. A technology leap in harnessing yet another source of existing zero-carbon energy but with improved reliability characteristics compared to intermittent renewables could be considered a "Green Swan."

With sufficient capital and the technology showing signs of accelerating improvements, the resolution of permitting and investment roadblocks would trigger an unprecedented "Industrial Revolution 4.0," as one corporate venture capitalist responding to the "Green Swan" question reframed the idea. But the world into which those new industries come to maturity must be prepared to handle the inevitable market disruption and too entrenched interests that any reindustrialization would trigger.

Macro moves

Countries, economies and companies that are insufficiently prepared for revolutions in technology, finance and industry are bound to lag those that have sought to lay the groundwork for the necessary infrastructure and prepared their workforces and institutions to handle the often-unpredictable changes that follow.

One senior government official echoed the messages of elected politicians on the main CERAWeek stages, noting that countries across all levels of the current economic and political structure had adopted a "whatever it takes" approach to competing for energy transition leadership. To the same extent that fossil fuels had become intrinsically correlated to economic growth throughout the 20th century, the paths national governments and international institutions take to meet the twin challenges of electrification and decarbonization could form the biggest "Green Swan" moment of all.

A capital markets advisor to a major European financial institution said that widespread social recognition of the necessity for a "greenium" that would allow energy transition assets to attract more capital would be a game-changer. A venture capitalist looking at advanced decarbonization technology for natural gas production said the biggest "Green Swan" for energy transition was a "generational shift change" already underway, as a new group of senior leaders in governments and banks was pushing forward the energy transition in ways that would inevitably follow at energy and commodities companies.

The connection between economic growth propelled by high-productivity energy infrastructure investment and the broader political outcomes of the societies in which that economic growth happens was part of the background to the macroeconomic 'Green Swan' debates at CERAWeek.

The important versus the urgent

Several senior leaders at CERAWeek challenged the concept of needing a 'Green Swan' event, arguing that the tipping point in the energy transition had already been achieved or that most of the problems energy investors face today are part of the normal course of infrastructure asset development.

By depicting normal business challenges as existential issues requiring a crisis response, investors in the energy transition were training themselves to be oversensitive to issues of speed, technology and macro economic environment. With so many government balance sheets firmly reweighted in favor of cleantech over the last two years, one agency leader said it was time for "ordinary risk appetite" among capitalists to drive the next stage of the energy transition.

Investors who have historically managed and accepted various risks in legacy energy markets have still not found their footing when it comes to deploying investment capital already allocated into energy transition funds. While estimates vary, at least $500 billion of cumulative investment capital from governments and private investors targeting energy transition appeared to be sitting on the sidelines as CERAWeek ended.

And while the Inflation Reduction Act has accelerated project development activity markedly, investors and financiers accustomed to established risk metrics remain wary of new varieties of risk embedded in energy transition assets. This hesitation showed in CERAWeek engagements - even when an overall project, market or technology has been de-risked through either direct government action or via maturing operational performance histories that provide benchmark investing parameters.

Suppose capital allocation into energy transition funds over the last two years required confidence in the overall shift in technology and markets; in that case, the dawning capital deployment stage of energy transition investing featured at CERAWeek will require skilled asset-specific discernment between ordinary business risks and new transition risks.

Analyst contact information:

Roger Diwan, Vice President, roger.diwan@spglobal.com

Peter Gardett, Executive Director, peter.gardett@spglobal.com

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