Putting Your Money Where the Carbon Is: Climate Investing in the Real Economy
The transition to a low-carbon economy is about a lot more than windmills and solar panels. The development of clean, renewable energy sources is an important piece of putting the global economy on the path to sustainable growth, but this is only part of the solution. Lowering greenhouse gas emissions to limit global warming will also require the participation of today’s highest-emitting companies and the transformation of the hardest-to-abate sectors beyond energy, including agriculture, buildings, heavy industry, and transportation.1
Investors increasingly realize that decarbonizing the real economy will require channeling capital into sectors with higher emissions, such as producers of cement, chemicals, and steel. This is a shift from the early days of sustainable investing, when many investors focused on carbon-light sectors that were viewed as more positive for the environment. This evolution can be seen in the growth of forward-looking “transition” and “improver” strategies that tend to invest more in companies expected to improve their operations and products relative to environmental, social and governance metrics. While funds in this category presently account for a small share of overall ESG fund assets under management, they are poised for further growth, according to Goldman Sachs Global Investment Research.2
Identifying investment opportunities in the low-carbon transition, especially in hard-to-abate industries, will require separating the signals that reveal companies’ progress in key areas such as carbon efficiency from the noise of unrelated data. A forward-looking approach that encompasses companies’ long-term sustainability ambitions, revenue sources, capital allocation plans, and alignment of expenditures with sustainability targets may help investors discover transition leaders. While high-emitting companies with credible transition plans present the greatest opportunity for carbon reduction, investors should also be aware that investing in these companies may increase the carbon footprint of their portfolios in the near term.
Given the complexity of the transition to a low-carbon economy, we think a flexible, multi-asset-class approach that looks across value chains is the best way to capture opportunities in public and private markets. This approach can complement allocations to green solution providers, because these smaller and mid-size companies, many of which are still in private hands, can become core suppliers to heavy-emitting corporations pursuing their own emission-reduction plans.
Identifying the Opportunities
Understanding the economics of the low-carbon transition will be important to capitalizing on the investment opportunities it creates. Focusing on labels, whether “green” or “sustainable,” won’t be enough. Investors will need deep knowledge of key markets, allowing them to spot demand from companies and governments for new climate solutions and responses from the entrepreneurs who develop them. Given the systemic nature of the transition, investment opportunities could arise across regions and sectors, and at many points in the supply chain, from start-ups to global corporations. Finding the best bets will involve determining when a technology is ready to take off, what is required to scale it up and the unit economics needed to encourage adoption.
The current climate response from governments, companies, and investors around the world is largely focused on mitigating the impact of human activity on the environment by reducing greenhouse gas emissions and putting the world on course to reach net-zero emissions by 2050. These mitigation efforts span everything from renewable energy and electric vehicles to sustainable consumption and waste management.
Attention has recently begun to shift to helping companies and communities adapt to the changing climate and improving their resilience. This could lead investors to seek out opportunities where mitigation and adaptation converge in areas such as biodiversity management, infrastructure, and the circular economy, according to Goldman Sachs Global Investment Research.3
Investing at the Intersections
The rise of artificial intelligence (AI) and the shift to clean energy are two of the main forces that will shape the global economy in the years ahead. They also demonstrate how investors can find opportunities by examining carbon-intensive sectors to understand the pain points they face as they seek to reduce their carbon intensity. This understanding can help identify corporations making real progress with credible decarbonization plans and the solutions they will need to achieve their goals.
AI relies on a consistent and abundant supply of energy. Processing a ChatGPT query, for example, consumes far more energy than a Google search. By 2030, this simple fact and the expected rapid expansion of generative AI will help drive a 160% increase in power demand from the data centers that process all those requests.4 As a result, the available supply of sufficient energy could become a constraint on the AI revolution, affecting companies up and down the value chain, from innovative start-ups to global tech giants.
One way to alleviate this pain point is by making data centers more energy efficient. Public and private companies have been developing solutions to address this issue for years, including integrated control systems that optimize the energy used to keep data centers cool, improve their resilience and reduce vulnerability to unplanned downtime. Solutions like these are critical because when AI chips are running, they return most of the cost of running a data center. When these chips are underutilized, however, the downtime can prove even more expensive for operators than steep hikes in the price of power.5
Developing Circular Solutions
Waste management is another complex challenge that faces nearly every sector of the economy, including agriculture, construction, industrial, commercial, and healthcare.6 Waste poses a triple environmental threat: pollution, biodiversity loss, and greenhouse gas emissions. The United Nations has warned that inaction on waste management carries a high price for human health, the economy, and the environment. It has called for the expansion of waste prevention and management solutions, and a circular-economy approach that aims to minimize waste and contribute to the sustainable use of natural resources.7
A growing number of companies are pursuing circular solutions at the intersection of waste and energy. Turning waste into “biogas,” or renewable natural gas, helps alleviate greenhouse gas emissions from landfills and provides a renewable source of energy for companies and households. Solutions like this are driving market expansion, with production of biogas expected to increase by 32% over the five-year period through 2028.8 This growth is creating investment opportunities in the providers of solutions as well as the corporations adopting them to curtail their own carbon emissions.
Another widely used circular technology that converts organic waste into biogas is called anaerobic digestion, in which bacteria break down organic matter in the absence of oxygen. This natural process generates methane, a powerful greenhouse gas responsible for at least a quarter of current global warming.9 By converting organic waste in sealed “reactors,” companies are keeping it out of landfills and capturing the biogas to sell as a renewable power source. The solid matter left over after digestion can be sold as natural fertilizer and turned into products such as animal bedding.10
Business of Transition
While the goals and targets associated with climate change set future dates, such as achieving net-zero carbon emissions by 2050, the business of the transition to a low-carbon economy is happening now. Investment is on the rise as investors, companies, and governments compete for new growth opportunities. For example, global investment in the energy transition increased to a record $1.8 trillion in 2023, up by 17% from a year earlier.11
Climate solution providers are developing a vast range of innovative technologies in areas as diverse as advanced batteries, biofuels, low-emission building materials, sustainable farming and green steel. These companies, many still in private hands, won’t all necessarily become global giants, but they may be integrated into the supply chains of larger corporations, creating scope for expansion. We think some of the corporations that are using these solutions as part of credible transition plans are currently undervalued, and those that evolve successfully could emerge as leaders in the new sustainable economy.
All this activity is creating investment opportunities for those with the precise insight to uncover them and the practical ingenuity to put capital to work. An investment partner with experience navigating global economic transitions and deep expertise across markets and asset classes could be instrumental in helping climate investors achieve their twin goals of financial returns and positive environmental impact.
1. In a landmark report on global warming, the United Nations Intergovernmental Panel on Climate Change underscored the complexity of the low-carbon transition, emphasizing that achieving a key climate goal – limiting global warming to 1.5°C – would require “rapid and far-reaching” transitions in land, energy, industry, buildings, transportation and cities. See “Special Report on Global Warming of 1.5°C,” IPCC. As of October 8, 2018.
2. “Navigating Sustainable Investing Uncertainty and Opportunity in 2024,” Goldman Sachs Global Investment Research. As of January 2, 2024. This contingent of funds accounts for 3% to 4% of overall assets under management in ESG-related funds. The focus on the real economy is particularly clear in improver funds, which have historically had twice the exposure to fossil fuels as the average ESG fund. The universe of transition and improver funds examined in the report includes Article 8 and 9 labeled funds with “transition,” “Paris-aligned,” “decarbonization” and “improver” in their names. Climate transition funds, which invest in companies that are adjusting their business strategies to align with the low-carbon transition, are also on the rise. These funds saw global assets under management increase by 25% in 2023 to $210 billion, according to Morningstar. See “Investing in Times of Climate Change: 2023 in Review,” Morningstar. As of April 2024.
3. “GS SUSTAIN: Adaptation: Physical Risk, Financial Risk, Opportunity,” Goldman Sachs Global Investment Research. As of January 10, 2024.
4. “AI is poised to drive 160% increase in data center power demand,” Goldman Sachs Global Investment Research. As of May 14, 2024.
5. “GPU Cloud Economics Explained – The Hidden Truth,” SemiAnalysis. As of December 4, 2023.
6. “Beyond an Age of Waste: Turning Rubbish Into a Resource,” United Nations Environment Programme. As of February 28, 2024. In addition, towns and cities across the globe generate more than 2 billion metric tons of solid waste each year.
7. Ibid.
8. “Renewables 2023: Analysis and Forecasts to 2028,” International Energy Agency. As of January 2024.
9. “Methane,” UNEP website. As of May 26, 2024.
10. “How Does Anaerobic Digestion Work,” US Environmental Protection Agency website. As of May 26, 2024.
11. “Energy Transition Investment Trends 2024,” BloombergNEF. As of January 30, 2024. Electrified transport accounted for the largest share of this spending at $634 billion, followed by renewable energy at $623 billion.
