By Andrew Wetzlel, CFA®, Managing Director of Sustainable Investing
As we head into 2025 and a new administration in Washington, the levels of concern, and even fear, are elevated across the sustainability ecosystem. There is no doubt that the operating environment will change, and perhaps materially in certain areas. While some of this concern is certainly valid, it’s important to take a step back, consider the momentum in place and keep focused on the long term.
It is reasonable to expect that pressure on corporations to dial back ESG and DEI initiatives will continue and perhaps become more pronounced in the near term. Many companies have already changed the way they characterize these programs, and more are likely to do so, though in the background, the work continues. This work will be communicated using different language and will likely be more tied to tangible business outcomes such as talent retention or resource efficiency. Larger companies will have to continue to navigate European and other regional sustainability reporting directives, so few will dial back the underlying efforts to measure and manage sustainability risks.
It is also reasonable to expect that there will be turnover at both federal and state levels in the US in early 2025, with leadership and staff-level changes. Environmental and social agendas may well be de-emphasized, and existing regulations may be targeted for rollback. Existing legislation supporting the energy transition will likely be targeted to some extent. The new administration’s desire to foster continued economic momentum and offset legal challenges will make major degradation of government programs and support challenging to accomplish.
Within the investment and capital markets industry, the marketing of products with sustainability labels has changed and the way firms communicate with clients around sustainability integration and outcomes will continue to evolve. As we’ve written previously, these changes are healthy and in the best interest of underlying clients as transparency and comparability improve. The teams of people at financial firms focused on various aspects of sustainability will continue to do their work, though like in the corporate sector, materiality and tangible outcomes will be increasingly important.
For investors specifically, the underlying sustainable investment (SI) approaches employed on behalf of clients will in some cases require adjustment, while others will continue to be largely unaffected. As we’ve written previously, each of the underlying approaches (outlined below) have different risk/return profiles and different key metrics used for implementation.
Exclusionary SRI and risk-focused ESG approaches, while quite different, are both likely to be largely unaffected. Any specific values or mission-oriented SRI exclusions are client-directed at the securities or fund level; thus, any changes would be client-driven. ESG risk management responsibility sits with the investment manager and should continue as an integrated part of a sound investment process. As noted above, disclosure of ESG information by large companies should continue, though as always, investors will need to continually assess shifting areas of risk. One recent example involves an auto and battery manufacturer that has rapidly growing water needs for a large new facility in a water-stressed region. Uncovering risks such as this and assessing related financial implications will only become more important in a higher growth, lighter regulatory touch environment.
More material adjustments and tactics will be required across thematic and impact approaches. It is in these areas where environmental regulations, supportive federal legislation, and the flow of international trade are all potentially at risk and could lead to material negative or positive impacts on companies focused on clean technology and the energy transition.
The clean-tech industry will be confronted with a number of risks. Tariff proposals outlined by President-elect Trump may create significant supply chain problems for companies sourcing raw materials in China, with solar and battery materials being two prime examples. Not only could tariffs lead to supply disruptions and higher component prices, but more broadly could drive higher levels of inflation throughout the US economy, forcing the Fed to raise interest rates. Higher interest rates would have a dampening effect on project economics across the clean-tech landscape.
Deregulation is another clear area of focus for Trump, with environmental and energy regulations squarely in the crosshairs. Based on analysis from investment bank Jefferies and agency cost estimates, EPA and energy-related regulations put in place under the Biden/Harris administration are expected to cost businesses and the economy roughly $1.3 trillion over ten years, despite accompanying environmental benefits. Vehicle emissions and greenhouse gas standards represent roughly three-fourths of the total estimated costs, so will likely be early targets. Deregulatory efforts, if enacted, would likely reduce incentives for companies to invest in environmental protection, reduce pressure to invest in cleaner products, and potentially lead to lower traditional energy prices, thus weakening the relative positioning of higher cost cleaner products.
Attacks on recent energy transition legislation such as the Inflation Reduction Act (IRA) are also top of mind for clean-tech companies and investors. Any material extension of tax cuts enacted in Trump’s first term will require cuts elsewhere, with the IRA a prime target. As we’ve discussed in the past, the IRA was the most significant piece of climate legislation ever signed and our only real chance to stay within Paris Accord climate targets. President-elect Trump’s negative sentiment toward electric vehicles and clean energy along with the cost of the IRA make the possibility of changes here likely, with consumer electric vehicle purchase credits most at risk.
While the road ahead for clean-tech sounds challenging, there are still many positive drivers that should provide some counterbalance to the risks noted above, and in some cases may result in improved outlooks for certain companies.
Efforts to roll back environmental and energy regulations will meet resistance through legal challenges from states, NGOs, and others interested in maintaining environmental protections, meaning any progress on deregulation will be difficult to achieve. On the other hand, when it comes to regulatory reforms, there are areas of bipartisan agreement, such as power transmission and interconnection. According to Bloomberg New Energy Finance, roughly three times the existing total installed capacity of renewable energy and storage is waiting for grid connection in the US. Reform here could bring renewable power to market more quickly.
Wholesale repeal of the IRA appears unlikely as more than 80% of funding to date supports fixed asset investment in states where Republicans won elections in November. States where economic growth and job creation are occurring will seek to protect these gains. There was evidence of this in August when 18 Republican House reps wrote to Speaker Johnson in support of IRA energy and manufacturing credits. It’s also clear that there is bipartisan agreement that a US manufacturing renaissance should be supported to create jobs and reduce dependence on China.
Perhaps most importantly, the underlying economics and availability of clean technologies are increasingly attractive. Solar, wind, batteries, and other components are at scale and costs—which continue to decline—are attractive relative to other forms of energy and propulsion in many markets. A read through the annual Lazard Levelized Cost of Energy report makes this point clear. Beyond attractive cost profiles, these technologies are available for deployment, whereas building a new natural gas-fired power plant would take many years given construction time and equipment backlogs. Power demand is rising now as discussed last quarter, and the companies driving this demand have serious and ambitious decarbonization targets that are well-established and unlikely to be rolled back.
Tying all this together for the IRA, we believe electric vehicle purchase credits are likely to be quickly phased out, offshore wind will likely be held up by more stringent permitting, while production and investment tax credits for other forms of clean energy and storage may well revert to a phased step-down schedule similar to what existed before the IRA. Other provisions related to supply chain manufacturing, critical materials, nuclear, hydrogen, carbon capture, and other areas are likely to remain in place.
Within our proprietary sustainable thematic investment strategies, we have deemphasized electrified transportation and most renewable energy exposure, while selectively emphasizing exposure to companies focused on clean water, sustainable food, energy efficiency, the circular economy, and nuclear power. As noted in our coverage of natural capital last year, environmental thematic investing is quite broad, enabling flexibility to manage risk in a dynamic environment.
This same research and positioning informs our ongoing evaluation of outside managers with strategies centered on private thematic and impact investments.
We, and so many others, will continue to do the work that matters, evaluate ESG risks, seek thematic opportunities, and direct capital to areas of impact. Sustainability professionals in other industries will continue to do their work. There is a level of scale and momentum that has been built over many years, with costs falling, volumes rising, and capital being invested. Nowhere is this more evident than in energy transition investment, where clean energy investment is now well above investment in fossil fuels based on IEA data.
The transition to a more sustainable future will continue because it has to and because all of the people passionate about change will not stop moving forward with a focus on what is important in the long run.