Asia credit: An outsized winner in the region’s energy transition?

Ross Dilkes, fixed income portfolio manager at Wellington Management, examines the opportunities and risks for bond investors presented by the region’s decarbonisation agenda. Ahead of November’s COP28 meeting in Dubai, Asia’s role in the energy transition remains firmly on the agenda. In a recent address to the UN, COP28 president Dr Sultan Al Jaber specifically highlighted China’s potential to lead the world in turning the Paris goals into reality. Home to five of the world’s top 10 CO2 emitters, concern about Asia’s carbon footprint is understandable. Furthermore, there is an economic imperative: a region’s susceptibility to climate change hinges on its predisposition to climate risk and its resilience. If no action on climate were to be taken, projections show Asia’s economy shrinking 27% by 2048. Risk presents a compelling impetus for action, but Asia’s energy transition could represent a sizeable opportunity for investors. The scale of investment required to decarbonise energy systems and infrastructure is immense; in 2022, global investment in the energy transition totalled US$1.1 trillion. China alone was responsible for more than half of this figure, investing four times as much as the US. Elsewhere in Asia, the energy transition is gathering pace, with Japan, South Korea, and India investing US$23 billion, US$19 billion, and US$17 billion, respectively, in energy transition investments during the course of 2022. Investment in Asia’s energy transition is significant not only in scale but in its sheer speed. The deployment of renewables, novel energy projects and new grid technologies is happening faster in Asia than anywhere else, with China leading the way. As renewables become cheaper and more efficient, emerging Asian economies could “leapfrog” directly to cleaner sources of energy, securing an engine for rapid economic growth — and a key role in the energy transition. Japan’s recent announcement of a new Asia GX Consortium, helping to drive transition finance in Asia, points to an increased focus on regional alignment.

The industries set to benefit from an upward growth trajectory

The technologies that will drive Asia’s energy transition are well-positioned for future growth. Renewable energy accounted for over 43% of total energy capacity in China in 2021, versus almost 38% globally. The world’s second-largest economy is set to increase its non-fossil-fuel-based capacity to almost 52% by the end of 2023. In India, renewables presently account for around 40% of total power generation, with plans to increase this amount to 50% by 2030. Decarbonising transport is another crucial piece of the puzzle, and the electric vehicles (EVs) space is also set to see significant growth. Globally, EVs accounted for 13% of new car sales in 2022, up from just 0.2% in 2013. The move to EVs is empowering Chinese automakers, whose competitively priced products are gaining market share not only in China but worldwide. Moreover, many of the technologies and components needed for these vehicles are made in and sourced from Asia. The top 10 EV battery manufacturers are based in the region, representing 94% of global market share.

The role of fixed income in the energy transition

The enormous amount of capital needed to fund Asia’s energy transition will require a wide variety of instruments and financing mechanisms. This is further supported by policy tailwinds; at the government level, policies are increasingly favouring sectors supporting the region’s energy transition — most Asian countries have committed to net zero by mid-century — and fixed income is already emerging as a preferred means of financing the shift. Last year, for instance, the Japanese government announced plans to issue US$157 billion of transition bonds; and in India, renewables are already the largest subsector in the country’s higher-yielding segment. Investing in a diversified credit portfolio can provide exposure to sectors set to benefit from the energy transition, with opportunities across the entire fixed income spectrum, from investment grade to high yield, and across corporate and sovereign issuers. However, risks persist. Access to timely and accurate data is mixed across the region, with information on the progress of projects not always forthcoming. Disclosure and reporting standards also vary greatly between countries, making it difficult for investors to accurately compare projects' bankability. Yet progress is being made. In Southeast Asia, the recently updated ASEAN Taxonomy for Sustainable Finance is a noteworthy step in the right direction, outlining disclosure and reporting expectations and stipulating which investments can be classed as “sustainable”.

A new driver for Asia credit?

Fragmentation does, however, offer the potential for active investors to navigate risks and capitalise on opportunities when they appear. Asia credit is already one of the most successful emerging asset classes of the past two decades, with its market value growing from less than US$200 billion in 2010 to US$1.3 trillion at its 2021 peak. Credit quality has also improved over time, with investment-grade bonds accounting for approximately 85% of today’s market, compared to 60% in 2010. The potential for Asia credit to benefit from the high-growth sectors at the centre of the region’s immense energy transition could be another important driver for the asset class.

©2023 funds global asia

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