Talking Heads - Ist es für die Umwelt wichtig, wenn KI boomt?

This is an audio transcript of the Talking Heads podcast episode: Talking Heads – Is it ouch or aye for the environment as AI blooms?

Hello and welcome to the BNP Paribas Asset Management Talking Heads Podcast. Every week, Talking Heads, we’ll bring you in-depth insights and analysis on the topics that really matter to investors. In this episode, we’ll be discussing environmental strategies and in particular recent issues and developments in this sector. I’m Andrew Craig, Co-Head of the Investment Insights Centre. And I’m joined today by Ed Lees, Co-Head of our Environmental Strategy Group. Welcome and thanks for joining me, Ed.

EL: Thank you very much for having me. It’s great to be here.

AC: Let’s start by talking about the recent developments in the energy transition investing space. There’s a lot of talk at the moment about new technologies with tech and artificial intelligence in particular very much in focus these days. What are the environmental implications of the expected boom in artificial intelligence? It is, I understand, a big guzzler of natural resources, and there’ve even been warnings that in the future, artificial intelligence could consume so much electricity it would require an energy breakthrough to power it. What’s your take on this?

EL:  Everyone is talking about AI, and it does have the potential to disrupt many industries. But what about our industry? Notably we think about AI in autonomous driving robot taxis, but also A.I. in analysing large data sets to help make optimal decisions in a way that could be relevant for battery tech, when to charge and discharge, when to sell back to the grid. Going back to your question, AI requires huge amounts of data and power. Given the importance of data to large language models, this is definitely going to rise. And as it rises, of course, energy requirements will rise. And of course, with this comes increased hardware needs, power consumption. AI models with neural network transformers are actually increasing their needs about 275 times every two years, and those without transformers about eight times every two years. This dramatically outpaces our rise in power. So, this is a non-trivial problem. How are we going to power this? We see the rise of economies of scale, [the use of] datacentres versus standalone servers, the various key hardware components that can offer meaningful energy efficiency and as well as the providers that service and build all of this. There’re the energy suppliers that can offer power, both primary and backup. Above all is the required investment in terms of transmission, distribution, and interconnections to handle all these new sources of [the] intermittent [green] power grid. Resiliency is a key theme for us; we see huge amounts of global grid buildout being required. Lawrence Berkeley National Lab thinks that more than two terra-watts of power capacity in the US alone is waiting for interconnection. That gives you an indication of just how material this AI trend is for our space and the general question and considerations around energy production and storage, and transmission and distribution.

AC: And with regard to the earnings season, how do you assess the earnings season and earnings guidance? There are some signs that economies might be beginning to slow a little. Is this affecting the outlook for demand? What about comments from companies on the prospects for lower interest rates and how that could affect valuations? What do you think the outlook is there?

EL: Interest rates and earnings are other key considerations for us. And earnings were mixed. Hydrogen has been on the weak side: it’s taking more time for that [to] ramp up and get to profitability. And we’ve seen continued oversupply in solar equipment. And we’ve also seen a pushing-out of some utility-scale solar projects in part due to permitting. So, there’s been a couple of headwinds. But on the flipside, we’ve seen signs of bottoming in residential solar with demand now hopefully bottoming in Q1 and picking up heading into Q3. We’re certainly seeing [an] improved outlook in offshore wind. On the non-energy side, food, ingredients, and water have been resilient on the natural capital side. There’s been pockets of strength. Uranium has been strong. Overall, I’d say mixed but encouraging signs in terms of [the] outlook and coming out from under some of the headwinds that have been prevalent over the last 12 months. Rates and access to capital continues to dominate price movements to a degree. And we have companies that have to raise capital being punished. That’s a recurring theme. Earlier this year, our sector was reset as rate cut estimates were pushed out. So, key indices in our space were down 15-20%, maybe a little bit more over the first two months of the year. Post that derating, those indices are trading about 1.2 times EV [enterprise value] to next year’s sales. That compares to the overall market MSCI ACWI [trading at] about 2.1 times. If you want to look at the Magnificent-7, they are [trading at] about 5.5 times – quite a gap is opened up. We’ve seen rates now back on a downward trend. From this point, even though it might be slow, but from here to the yearend, rate declines should happen and should gradually help us. Especially in an election year, I would not be surprised to see cuts coming into November. So, going into the second half, between the outlook for rates as well as what we’re seeing from some of the company earnings and some of the headwinds dissipating is more constructive.

AC: Yes, 2024 will be a bumper year for elections and hence there’s considerable potential for political change in Europe. We’ve seen farmers taking to the streets to protest, among other things, about regulations, including the tough environmental rules. Green Party rankings in the opinion polls seem to be slipping. In the US, there are concerns about the Inflation Reduction Act not surviving under a second Trump presidency. And of course, all this uncertainty makes investors somewhat hesitant. How would you reassure them in this context?

EL: This is a very important point, and this is going to dominate or at least be part of headlines between now and November. And there are a lot of hawkish headlines in respect to sustainability coming from the Republican Party in the US. I would remind people there’s a difference between what people say on the election trail, what they promise for the future and what actually happens. The reality is that we see the probability of the Inflation Reduction Act being repealed to be low. Full control of both the House [of Representatives] and the Senate in addition to the Presidency by Republicans would be required. Otherwise, we would expect not too much to change to the IRA if there’s a split Congress. Even in the event of a Republican Presidency in control of Congress, given the amount of investments that’s going to red states and the IRA incentivising domestic manufacturing and creating jobs, we wouldn’t expect a full repeal. We would expect perhaps a more stringent approach to protect domestic interests, especially in respect to China. Even more focus on domestic content being pushed forward by Republicans. Perhaps the EV tax credits could be more at risk and there’s a chance Republicans could shorten the timeline on some of the tax credits. Carbon capture and storage, clean hydrogen, clean fuel is having more bipartisan support. A number of analyses have shown that red states are disproportionately benefiting from the IRA compared to blue states. Part of the reason why red states are attracting more clean energy investments is just because of where they are. Many red states line the wind belt or have high-capacity factors. That’s why the top-five states with the largest percentage of wind power in their electricity mix are controlled by Republicans. In addition, there’s an emerging battery belt now that’s forming with battery and electric vehicle plants spanning from Michigan down to Georgia. It includes many red states, and several Republican governors have announced state incentives to attract clean energy and manufacturing plants in their own home territory. And they were quite keen, by the way, as well on the announced hydrogen hub projects from the Department of Energy. So, we would anticipate actually there to be pushback from these red states. To put this into perspective, we still need huge amounts of money – trillions of dollars – to be spent to transition our energy systems. Despite all of these worries, in Europe, in 2023, 55.9 gigawatts of solar was installed across 27 EU member states. That’s 40% growth over 2022 and a doubling of the market in two years. The US added 33 gigawatts of new solar capacity in 2023. That’s a 55% increase from 2022. These are big numbers, even if in other markets, there’s been a slowdown. We talk about the slowdown at EVs and pulling back and we know that the US is less dynamic on the EV front than Europe. People hold on to their big gas guzzlers. Even there, for EVs in 2023, for the first time, US annual sales surpassed 1 million. In Q4 of last year, sales were up 40% year-over-year. Now admittedly, in Q4 2022 versus Q4 2021, sales were up 52%. This market is not dead. And let’s have some common sense. In every year, petrol cars improve a little, but in EVs, you can get a step change in improvement. I’ll just give you a couple of examples of new technologies that are appearing. So CATL, the leading Chinese battery maker unveiled a new battery at Auto Shanghai last year. It has an energy density of about 500-watt hours per kilogram. Now, as a reference to the batteries in the Tesla Model Y are about 245-watt hours per kilogram. It’s twice the energy density. EV battery maker Goshen High Tech, which supplies Volkswagen, revealed recently a battery with a range of 1 000 kilometres, [one that] doesn’t rely on nickel, manganese, cobalt. It achieves 18 minutes of fast charging [and] passes all safety tests. So, imagine now you get an EV, you charge it overnight at home. And you never have to go fill it up with petrol. You have fewer repair bills and with one charge you can go 1 000 kilometres. That’s a pretty good value proposition. So, I highly doubt that EVs are dead. So, the future is actually quite interesting and collectively we’ve gotten too caught up in negativity that’s been driven more by macro[economics] and interest rates than anything else. But when you look under the hood, so to speak, the underlying growth prospects are actually quite interesting.

AC: Well, thanks for joining me, Ed.

EL: It’s a pleasure. Thanks for having me.