Raj Shant on rethinking the energy transition and how a wider scope means more opportunities
Focus is a publication that aims to bring you face-to-face with a selection of key investment managers, advisers, and providers from across the market.
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Net zero has made investors rethink their exposure to energy investments. While some avoid fossil fuels entirely, it is increasingly apparent that this is unrealistic. Indeed, to effect change on a global scale, investors should broaden their scope and include often overlooked sectors, according to Raj Shant, managing director at Jennison Associates, PGIM’s fundamental equity manager. In this Focus guide, Shant discusses why investing in fossil fuels is not necessarily a binary choice and how lower carbon transition fuels can help bridge the gap to a cleaner future. He also unpacks why opportunities in the carbon market are much larger than many believe and explains the critical role Scope 4 emissions can play in achieving global carbon reduction goals.
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THE INTERVIEW
who want to solely invest in the zero carbon sources like renewables.
et zero is now a well-covered topic in the investment world and forcing investors everywhere to reassess their exposure to current energy practices. Fossil fuels have become increasingly controversial holdings as a result, shunned by those
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The vital role of fossil fuels in the energy transition
However, this approach – while well-intentioned – risks being too narrow in scope according to Raj Shant, managing director at Jennison Associates. For a cleaner, more sustainable future, investors should be pragmatic about how progress must be made and the potentially uncomfortable compromises that may be required in the near term.
has helped drive risk asset valuations ever higher despite the damage wrought by COVID-19, compressing yields and making portfolio income distribution objectives harder to achieve in both equities and fixed income.
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Shant, who is part of the management team overseeing the PGIM Jennison Carbon Solutions Equity Fund, explains why investing in fossil fuels is not necessarily a binary choice.
Raj Shant, managing director at Jennison Associates
With all the noise and the people gluing themselves to the M25, how much [progress] have we actually made? Very little
£1trn is invested in current accounts with High Street banks, meaning that cash is currently earning around 0.1%
Out of the £1.7trn cash that is held by individuals or households, £260bn is held in accounts that earn no interest at all
£1.7trn
How much of that £1.7trn is held in accounts that earn no interest at all
£260bn
The amount of cash that is held by individuals or households
0.1%
The importance of cash is reflected in the overall size of the cash savings market. In the UK, the market is huge. According to the Bank of England, total cash savings are £2.6trn and of that, £1.7trn is held by households. From a long-term investing and savings perspective, cash has always had a necessary and inevitable place in a diversified portfolio.
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“How much progress have we made?” asks Shant. “With all the noise and the people gluing themselves to the M25, how much have we actually made? Very little.”
Here, he points to the sheer practicalities that still need to be overcome to make this energy transition successful. He likens decarbonisation to looking at a burning building and reasoning that because water exists, the problem is solved – but the water needs to get to the fire and in sufficient quantities first, before the fire can be put out.
When asked about the potential concerns that could be raised by a fund entitled ‘carbon solutions’ investing in gas, Shant understands investors may react negatively. However, he argues that investors need to recognise the necessity of this, as a bridging mechanism to allow progress in reductions in carbon emissions whilst continuing to increase the share of zero carbon fuels in the global energy stack.
Combatting perceptions
Paul Hampton, Head of International Funds
Our mantra has been if you forget the occupier, if you forget who is using your buildings, you do that at your peril
Jennison Associates’ Raj Shant explains why investors should think about the energy transition theme as a process and not an event to understand the significance of transition fuels
Paradigm Shift
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56.8
20
NG/LNG
10
79.3
Oil
130
100.8
Coal
Natural Gas and LNG among the cleanest fossil fuels
300
250
200
150
100
50
0
Combustion
Precombustion
Average Emissions Factor by Fuel (gCO2e/MJ)
Source: The imapct of decarbonization on the gas and LNG industry, McKinsey & Company, June 2021. Grams of carbon-dioxide equivalent per megajoule. Precombustion figures are estimates based on weighted average GHG emissions. Based on Nature; Sustainability, UK Government and US Department of Energy research.
In this vein, he argues that lower carbon fossil fuels, like natural gas, should be viewed as ‘transition fuels.’ They can help displace far dirtier and more carbon-intensive fuels like coal in generating electricity. These offer portfolios investment opportunities today while still making progress in the wider energy transition journey. “That's why we call [our fund] carbon solutions, plural,” he explains. For the world to make progress, we ought to be asking at every step of the way: How can we use a lower carbon emission fuel to achieve what people are trying to achieve?”
Recognising the role of transition fuels
Although it is still a non-renewable fuel, gas is far less polluting than coal, which is the most widely used fuel for generating power. Investing in gas may not be an ideal solution, but Shant sees this as an important step in the right direction. Transitions from coal to gas over the past 20 years in the US and Europe may not appeal to the idealists and purists but represent major progress in the context of the journey to net zero, this is something Shant highlights and wants to see spread.
“If we were to make a shift from coal to gas, we'd make a massive amount of progress,” said Shant. “You then want to be thinking about that globally because in India and China they're still building coal-fired power stations because they don't feel comfortable or confident that they would get the supplies of natural gas if they shifted.”
“In reality, the goal isn’t just getting to a low carbon economy – it’s to get to a low carbon economy without engendering a big drop in living standards. That isn’t possible without transition fuels.”
“Some of the most well-intentioned and passionate people who understand a lot about the risks of climate change oppose anything to do with fossil fuels,” he says. “From an investment and a commercial perspective, it’d be a lot easier to just go with the flow and leave out all those transition fuels. But we can't in good conscience do that when we know that if the world stopped using coal tomorrow and went entirely to natural gas, the emissions reduction would be incredible.”
Bridging the gap is required due to the complexity related to facilitating a complete overhaul of established energy systems. Shant attributes this to two key areas: intermittency and scale. With the former, renewable energy solutions are reliant upon weather patterns, which are inconsistent by nature. And the latter highlights challenges throughout global energy supply chains stemming from the sheer vastness of the undertaking.
Each year, record levels of renewables capacity is installed, but even then it isn’t enough to keep up with the global growth of total demand for energy. Additionally, a wholesale energy transition will require a radical change in all the enabling energy infrastructure according to the managing director: “If only we could just click our fingers and be at the magical end stage, great. And every year we do it we learn how to do it more efficiently with lower costs and less wastage.
“Again, that's great but it's still not at the scale where it could replace - it's not even at the scale where it's able to deal with the annual increases in global demand for energy.”
Market's recognition as a solution
Contribution to reducing emissions
Source: Jennison. The views expressed herein are those of Jennison investment professionals at the time the comments were made. They may not be reflective of their current opinions, are subject to change without prior notice, and should not be considered investment advice. For illustrative purposes only; opportunities can span multiple pillars.
Solar panels
Electric vehicles
Wind blades
Smart meters
Grid modernisation
Biofuels
Renewables developers
Batteries
Semiconductors
Power electronics
Natural gas providers
HVAC and building management
Hydrogen
CCS - Carbon capture and storage
Mining
A key transition in the fossil fuel supply chain
A wide spectrum of opportunities
Redefine the path to a low-carbon future at PGIMFunds.com
Three pillars of decarbonisation
Companies that harness and/or produce lower- or zero-emissions fuels with the ultimate goal of replacing fossil-fuel power generation with clean sources.
SUPPLY
demand
Companies that improve the energy efficiency of existing infrastructure and replace fossil fuels in industrial processes.
Companies that provide technical innovations, equipment, infrastructure, materials, goods, and services that enhance power processing capabilities and create intelligent infrastructure.
enable
The energy transition fund investing in fossil fuels
FUND SNAPSHOT
sometimes electric vehicles and batteries may feature but Jennison Associates managing director Raj Shant argues this scope must be broadened. The PGIM Jennison Carbon Solutions Equity Fund, which Shant helps oversee, targets the less obvious opportunities within energy transition that he says investors risk missing if they exclusively focus on high profile assets like windfarms and solar panels.
s the energy transition has grown to prominence as an investment theme, the number of strategies targeting this have exploded. However, most of these invest heavily in the same areas; renewable energy assets such as wind and solar,
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Raj Shant, managing director at Jennison Associates, explains why the PGIM Jennison Carbon Solutions Equity Fund is so different than its peers
“Really traditional climate products in some senses only look at the tip of the iceberg,” says Shant. “With an iceberg, the bit you can see above the sea level is only about 10% and 90% is below. With traditional climate products, the focus ends up being very much wind, solar, renewables and batteries - the most visible 10%.”
Looking below the surface
Battery reuse and recycling
Power grid architecture
Smart buildings
Energy efficiency and storage
Fuel replacement technologies
Industrial applications
Wind turbines
$2.5 T
market for 2030 Net-Zero Pathway
Source: Jennison. The views expressed herein are those of Jennison investment professionals at the time the comments were made. They may not be reflective of their current opinions, are subject to change without prior notice, and should not be considered investment advice. Addressable market size based on Princeton Net Zero America Report, October 2021.
This is where the PGIM Jennison Carbon Solutions Equity Fund differs from its peers, as it makes allocations to a wider range of investments linked to energy transition. Sometimes this can involve making allocations other funds could not, with Shant giving the example of investing in certain fossil fuel assets as ‘transition fuels.’ These are defined as fossil fuels that are much cleaner than others (such as gas versus coal) and can be considered as contributing to decarbonisation as they release less CO2 per unit of energy generated. An example holding is Cheniere Energy, a US provider of liquified natural gas.
Portfolio construction also benefits from this approach. On top of a wider investment universe and, with it, greater diversification, Shant and the team can access companies that are potentially more mature than those solely operating in the renewable energy space.
“Fundamentally this strategy is built around the idea you can generate long-term outperformance of the broader market because the companies genuinely helping to find solutions to these problems should benefit at the revenue level and the profits level over a multi-year period,” explains Shant.
This strategy is going to appeal much more to thoughtful investors who want to think for themselves
A broader investment universe means more work, and Shant points to the investment team’s years of accrued active management experience as evidence of being up to the task. In-depth research is vital in order to uncover and examine companies that merit inclusion. This includes a multi-disciplinary team dedicated to finding carbon solutions opportunities over numerous sectors, including energy, utilities, tech, consumer, industrial and materials.
A bottom-up approach
“We've got three lead portfolio managers who have worked in a range of related sectors, so utilities, infrastructure, natural resources, all of these industries play a really tremendous part in the transition to that low carbon economy,” explains Shant. These lead portfolio managers are Neil Brown, Bobby Edemeka and Jay Saunders, who have a combined 78 years of experience.
They are supported by nine research analysts and four ESG specialists. Shant adds: “[We have] a team of analysts who have looked at all these interconnected sectors from a bottom-up point of view for many years. So, they know that the companies that do best in some of those sectors are companies that are looking at these problems and saying this needs a solution and I can find it.”
~45 – 65 stocks
PGIM Jennison Carbon Solutions Equity Portfolio
Companies involved in energy supply, and associated equipment required for energy production of low- or no- carbon fuels
Companies involved in promoting energy efficiency to better manage demand and changing how energy is consumed
Companies that enable advancement in technology; produce materials, goods/ services, or infrastructure required to decarbonize
The views expressed herein are those of Jennison investment professionals at the time the comments were made. They may not be reflective of their current opinions, are subject to change without prior notice, and should not be considered investment advice. Characteristics are intended to provide a general illustration of the investment strategy and considerations used by Jennison in managing that strategy during normal market conditions and may change over time. Characteristics do not represent actual portfolio guidelines, which are negotiated with clients.
~8,000 stocks
~250 names
capex, revenue or EBITDA lowering global CO2
>30%
MSCI ACWI Investable Market Index
Focus List
Business Model Assessment
ESG Evaluation
Valuation Analysis
Portfolio Construction
The team’s efforts also mean the fund has a better chance of avoiding the ‘green premium’ that can be associated with companies in the most visible 10% of the decarbonisation universe. Shant says: “With some of these other companies, they're really making enormous strides and you may even have a brown discount rather than a green premium.”
For a fund geared towards decarbonisation, to be investing in fossil fuel (and fossil fuel adjacent) assets, may be a difficult concept for some to stomach. Shant recognises that potential investors may have misgivings and says it is imperative for people to be pragmatic if we are to make any progress, for sure we are not making any with the narrow approaches taken so far.
“This strategy is going to appeal much more to thoughtful investors who want to think for themselves,” says Shant. “Already you can see in the way that we’re approaching it, it’s not about the groupthink and it’s not about jumping on the bandwagon. It is putting holistic and pragmatic thinking ahead of commercial considerations.”
“Investors who are taking a long-term time horizon, and for whom this topic really matters and they're thinking for themselves, this strategy is going to appeal a lot. If the whole world moves this way, it's much more likely to push the world in the right direction than the many different approaches that frankly, if you look at the outcomes, have failed so far.”
The Carbon market is much larger than many may believe
Analysis of a company's fundamentals drives our investment decisions
Investment process summary
exposure to current energy practices. Fossil fuels have become increasingly controversial holdings as a result, shunned by those who want to solely invest in the zero carbon sources like renewables.
et zero is now a well-covered topic in the investment world and forcing investors everywhere to reassess their
Fund Focus
Broader scope invites comprehensive carbon solutions
Market outlook
In the journey toward a low carbon economy, Jennison Associates managing director Raj Shant explains the critical – but often overlooked – role that Scope 4 emissions play
“To focus only on the supply side of the decarbonisation journey is missing a massive part of the overall solution, which is also thinking about demand,” says Shant. “When you start thinking about demand, if we want to live in a world where there are eight billion people with similar standards of living to today but where the carbon emissions are much lower, we're going to need to do a ton of things in a really different way, in a much more carbon-efficient way.”
To be sure, solar, wind, and electric vehicles play important decarbonisation roles. Still, according to a 2020 Princeton University report, spending on these solutions represents only an estimated 40% of the capital needed to get to net zero by 2030. Jennison believes the path forward is clear: Investors need to embrace many solutions beyond renewables and electric vehicles to recognize the complexity of the decades-long challenge of reducing carbon emissions while maintaining and improving living standards.
As an example of how Scope 4 can enhance the value proposition of a company, Shant points to one of the holdings of the PGIM Jennison Carbon Solutions Equity Fund: Ameresco. This US company specialises in integrating cleantech and supporting renewable energy assets. Said simply, Ameresco helps other companies reduce emissions and save money. In addition to an appealing fundamental profile, the company’s Scope 4 emissions call attention to its potential in the context of the energy transition.
Together with Jennison, Ameresco has calculated its work in energy-efficient retrofits and microgrid power systems saved an estimated 17.7 million aggregate metric tons of carbon in 2022. These Scope 4 emissions are the equivalent of 36 billion miles being driven by an average passenger vehicle.
Just because it's difficult doesn't mean you shouldn't be trying to do it - and we think the industry is guilty of taking that approach to Scope 4
direct emissions, supply chain emissions, end-use and end of life emissions of its products and services, respectively. Largely left out of decarbonisation discussion is Scope 4, the part of the protocol designed to account for avoided emissions.
ince the establishment of the Greenhouse Gas Protocol in 2001, three ‘scopes’ of emissions measurement standards have entered the daily lexicon of investors with sustainable or net-zero mandates. Scopes 1, 2 and 3 cover a company’s
S
Raj Shant, managing director at Jennison Associates, sees that as a fundamental flaw in the investment category. Shant contends that ignoring Scope 4, as most traditional decarbonisation strategies do, is tantamount to neglecting opportunities to reduce emissions that in many instances can exceed Scopes 1, 2 and 3 combined. His firm maintains that a broader embrace of Scope 4 would accelerate carbon-reduction progress while enhancing the decarbonisation investment universe.
Decarbonisation is a complex and mammoth undertaking. By aligning themselves with regulatory designations (such as Article 9) to achieve a low-carbon footprint, traditional strategies tend to emphasise exclusions and companies with low reportable emissions (Scopes 1-3). That is a very quick way to reduce a portfolio’s reportable emissions, with little or no benefit in the real world. To Jennison, that approach oversimplifies the carbon-reduction challenge and fosters crowded trades among traditional renewable investments, which sport robust valuations as a result.
Overlooking the opportunity
Scope 4 emissions, commonly referred to as avoided emissions, are captured when the use of a product or service avoids emissions due to a new technology or process associated with that product or service. Replacing existing technology with cleaner alternatives aids decarbonisation by eliminating carbon that would have been emitted had the original technology remained in place.
“If you compare what the emissions would have been versus what they turn out to be in the year after you make a change, the difference between the two can be regarded as Scope 4,” explains Shant.
Proposing a Scope 4 solution
Waste generated
Company facilities
Distribution
Production
Carbon capture & storage
Natural gas
HVAC & building management
Emissions Avoided
2020
Global Carbon Emissions
2050+
Timeline
Scope 4
Reportable Emissions
Scopes 1, 2 and 3
Source: PGIM, for illustrative purposes only. Opinions expressed as of September 2023 and subject to change without notice.
The biggest impediment to wider Scope 4 utilization is quantification. Unlike other scopes, Scope 4 information is not readily available from ESG data vendors. Incorporating Scope 4 into investment research means adding another level of granular in-house analysis to the process, extra work that Jennison considers to be well worth the effort.
“We take the view that just because it's difficult doesn't mean you shouldn't be trying to do it,” says Shant. “And we think the industry is guilty of taking that approach to Scope 4.”
Calculating Scope 4 emissions
Shant and his team at Jennison want carbon-conscientious investors to know that accounting for avoided emissions greatly expands the range of solutions that can help the world move toward a lower-carbon economy. They believe including companies beyond the renewable energy sector can better align portfolios with the multifaceted nature of the decarbonisation mega-theme while potentially enhancing portfolio resilience and returns.
Evolving opportunity set poised be larger then Scopes 1, 2 and 3 combined
Our approach targets avoidance not just reduction
have exploded. However, most of these invest heavily in the same areas; renewable energy assets such as wind and solar, sometimes electric vehicles and batteries may feature but Jennison Associates managing director Raj Shant argues this scope must be broadened. The PGIM Jennison Carbon Solutions Equity Fund, which Shant helps oversee, targets the less obvious opportunities within energy transition that he says investors risk missing if they exclusively focus on high profile assets like windfarms and solar panels.
s the energy transition has grown to prominence as an investment theme, the number of strategies targeting this
