Why Energy Transition?

We believe it would be helpful to describe what constitutes the ET and, more importantly, what does not. The ET is, most obviously, a shift from traditional sources of electricity generation to more sustainable sources. However, we define it to be more nuanced than this. We believe it to include how we deploy energy and the end use cases. For example, switching from a traditional furnace to a cutting-edge heat pump constitutes the energy transition. The transition from internal combustion engines to electric vehicles, from centralized generation and transmission to virtual power plants, from jet fuel to sustainable aviation fuels all constitute the energy transition. Even more subtly, the ET informs how we interact with technology to make the world more sustainable (such as the transition from traditional agriculture to precision agriculture). There’s a few things we know for sure: the ET will happen (over what time frame is up to debate), it will be subsidized and incentivized by governments, it will be the largest engineering project, it will require the most international cooperation of any human endeavor, and it will create mega winners and a long-tail of losers.  

There’s ample evidence supporting the need for the energy transition – and we don’t see a need in repeating it. This begs the question: if the entire world knows that this is going to happen, where is the opportunity for alpha generation? We believe there are three main reasons for the underweight of energy transition stocks in the traditional L/S hedge fund and index-investing world:

1. Underappreciated Scale and Speed

2. Complicated Environment

3. Binary Risk

Let’s examine each of these reasons in more depth. 

Underappreciated Scale and Speed:

The world is warming – and the effects are starting to impact a broad range of people. Extreme weather, wildfires, rising sea levels, rising temperatures, etc. are all at the forefront of our minds. Governments have begun to spur some investment (the IRA, China’s 14th 5-year plan, EU Renewable Energy Directive, etc..) and market perception extrapolates this information linearly. After all, the government has rarely had such a heavy hand in influencing public markets (comparable examples include agriculture subsidies, but those are mostly private). The government’s consistent subsidization of domestic production and tariffs on external competition artificially lower the costs for the energy transition to take place. At those reduced costs, the positive feedback loop can begin and turn artificial gains into technological improvements into real gains. At that point, the technology can stand alone. 

Complicated Environment:

Understanding the ET means understanding a few seemingly disjoint fields:

1. Utilities and Infrastructure (sensitivity to rates, low correlation across geographies)

2. Politics and Lobbies (subsidies, tariffs) 

3. Nascent Technologies (VC-like investing, but too many get caught up in ungrounded fantasies)

4. Asset-Level Modeling

There already exist silos within finance (equities, structured products, credit) and the rare people that can understand all three can extract alpha from market dislocations (i.e. cap-structure arbitrage). We see this as an analogous situation. If we can (and we have demonstrated we can) comprehensively understand the entire energy transition value chain, we can reliably extract alpha. 

Binary Risk:

The ET carries many risks that are 1) hard to monitor 2) hard to predict. These risks are usually binary in nature: will the new administration continue Biden-era tariffs on Chinese PV manufacturers? Will green hydrogen ever become cost competitive? A lot of these technologies are extremely cost and technology competitive. Take photovoltaics (PV) as an example. The marginal difference between 2 PV’s makes all the difference. And the better one gets all the business while the others slowly bleed market share to the better product. We aim to take advantage of these binary risks, when we have conviction, and stay out of the game when we have no additional insight to the situation. Too often, investors stay out of the game altogether when the potential to lose is so stark. 

A rising tide will lift all ships, but some of these ships aren’t made to sail the seas. A change of this magnitude across the world will give rise to companies that aren’t commercially viable. If (when?) we can short, these would be prime candidates. 

An environment like this necessitates a long time horizon. Increased volatility creates increased potential alpha; and our investment universe is extremely volatile. The investors who can identify the winners and have the conviction to hold (and even increase their exposure) through bad earnings, bad regulatory environments, and bad press will reap the benefits of compounding growth. Tiger Sustainable Investment Group is that type of an investor. While we are naturally bullish on the ET, we are cautious to not let our innate biases get in the way of the fundamentals of a company. We actively encourage educated disagreement and contrarian opinions (and look for that throughout our recruitment process). We know we will miss a few of the big winners, but we also know we will miss 80% of the losers. The greatest tech investors also missed out on the Ubers and Facebooks of the world.