2025 climate change outlook

The past year has clearly been volatile for climate-related equities. High interest rates, falling energy prices and declining electric-vehicle demand expectations all continue to weigh on the climate change theme. The valuations of related equities remain depressed relative to recent history, in our analysis, despite significant decarbonization efforts and investments planned by corporations and countries. In a year driven by exceptional performance for the “momentum” factor, climate-related equities tended to trade inversely, with negative earnings revisions and declining earnings multiples.

Given the ongoing volatility, we continue to remain active in our effort to take advantage of potential long-term opportunities where we think the market is too focused on the short term. We believe the share prices of many companies in the climate change theme now reflect expectations for little earnings growth despite limited changes to our long-term earnings expectations. Hence, we are optimistic as we move past a difficult 2024.

How 2024’s headwinds affect expectations for 2025

We would categorize 2024’s headwinds in three main areas: interest rates, policy weakness and subsequent oversupply. We believe each issue has improvement potential looking ahead to 2025:

• Interest rates have now started to decline globally. The capital-intensive clean technology sector has tended to trade inversely to global interest rates. We expect (and market consensus expects) for rate declines to continue through 2025. While yields on long-term debt continue to show significant volatility, assuming that long-term rates decline along with short-term rates, the sector should rebound, as economics for clean technology investment also improve, and demand picks up.
• Policy weakness has been a significant headwind, particularly in Europe. Support for markets such as electric vehicles and solar has declined with the removal or reduction of subsidies in several key markets. The industry has now largely digested this trend, and we believe the risk/reward balance now skews positively given the commitment in Europe to various 2030 decarbonization targets. Recent positive moves in the United Kingdom are an example. While the US election outcome has likely stifled any chance of positive US legislation changes, we expect changes to the Inflation Reduction Act (IRA) to be more marginal than is currently being factored into the share price of major beneficiaries.
• Oversupply issues have been a drag on a variety of sectors due to the above-mentioned macroeconomic headwinds. In markets such as electric vehicles (EVs), lithium, aluminum, solar inverters and power semiconductors, we have seen negative surprises on both volume and pricing through 2024. Many of these industries have gone through difficult capacity corrections, suggesting that even if demand remains broadly flat, we should start to see better pricing and margins going forward. Several sectors look to have found a trough level through 2024 and are poised for improvement as we move into 2025.

The second Trump administration and climate-related equities

Donald Trump’s victory in November’s US presidential election has clearly cast a long shadow over climate-related equities, as most observers anticipate his administration is likely to be hostile to climate policy. Amid a charged campaign, Trump promised a variety of policies, including sizable deportations of immigrants, across-the-board tariffs, a dilution of US Federal Reserve (Fed) independence, restrictions on offshore wind energy, removing the United States from the Paris Climate Accord and a rollback of some tax credits under the IRA.

The most immediate impact on climate investing has not been expected legislation, but simply in higher long-term yields. Climate investing tends to be a capital-intensive space, and a higher cost of debt is likely to weaken the economics for such long-term investments. Given the inflationary nature of many of Trump’s expected policies, the Fed is expected to be slower to cut interest rates, all else equal. This is likely to push out the recovery in some areas where we are seeing weaker demand growth, such as wind and solar power.

When it comes to policy, we believe that unwinding the IRA is unlikely, as it might involve legal challenges that could stretch on for several years. We believe a full repeal remains unlikely due to the investments under the legislation that has gone overwhelmingly into majority-Republican districts (~80% of the total so far, by some estimates). In the medium term, we expect tax credits that offer a high jobs-to-cost ratio would be likely to survive, such as the Production Tax Credit (PTC) and Investment Tax Credit (ITC), which apply mainly to wind and solar, respectively. However, it might be possible to move up the planned phase out of these credits, or place a cap on total spend. We would note there have been multi-billion-dollar investment announcements in solar manufacturing across states such as Ohio, Alabama, Tennessee and North Carolina, and companies may push for certainty on these credits before going ahead with investment.

We see greater uncertainty around EV subsidies. Trump appears likely to seek to repeal the EV purchaser’s tax credit while maintaining manufacturing credits that promote domestic production of EVs. We believe companies have already been operating under such expectations, and we believe the transition to EVs depends upon company commitments to making EVs, which remain largely intact. We expect the United States will begin to accelerate the transition to EVs through 2025 and 2026, as pricing becomes more competitive compared to traditional combustion engine vehicles. State-level mandates (of which there are 31, at varying levels of commitment and timeline) also support further growth in US EVs going forward, with or without federal tax credits. The key risk here is a slowing of EV adoption rather than a reversal of the trend.

Aside from the above areas, we see certain aspects of the IRA at greater risk, particularly those that incentivize what we consider more speculative areas, such as hydrogen or carbon capture. We expect energy companies are pushing for less aggressive subsidies in these areas and see this as a low-jobs and high-subsidy part of the act that remains at risk. From an investment standpoint, we do not see these as industries that are likely to achieve profitable growth, and we expect to continue to avoid investing in such companies until we see more evidence of sustainable profitability.

Lastly, we see little risk to aspects of the IRA that have an impact on farming, such as corn and ethanol-related fuel subsidies that drive production of renewable fuels. Given the largely rural support for Trump, we expect the status quo to be maintained in this area, with any regulatory changes likely to have the intention of enhancing returns to farmers. Meanwhile, the continued commitment to construction and infrastructure should be positive for building materials companies, including energy-efficiency-driven names.

While there is understandably some more pessimism surrounding climate investment than there was before the election, it is important to emphasize that many industries in the climate and climate-adjacent space should continue to grow in the United States—as they did during the first Trump presidency—through a variety of state-level initiatives, company commitments and simple economics.

Opportunities ahead

One consequence of the past year’s negative news flow is that valuations now look notably more attractive in many parts of the clean technology space. We have been able to add names to our portfolio that we could not own previously due to unattractive valuations. We think valuations in late 2024 have reached a level where the market is no longer affording any “green premium” to companies and, in many cases, is not pricing in the potential for a long-term, above-GDP growth rate, either. This is a trend we hope to capitalize on further in 2025.

More broadly, we believe that valuation will be an important driver of stock returns going forward. With various metrics on valuation spreads and momentum close to all-time highs, it is appropriate and perhaps healthy to expect some normalization. The climate change theme remains even more necessary, as the world is drifting beyond any plausible global warming scenario limited to a rise of 1.5°C. We believe there remain substantial opportunities in what we consider to be undervalued companies that are driving meaningful positive impact on climate change mitigation and/or adaptation.

Areas where we are most excited in 2025

Here are some of the opportunities we are most positive about in 2025, with reasons for our enthusiasm:

1. A UK-headquartered agricultural equipment provider, which has shown its resourcefulness as both gross and operating margins have remained fairly robust despite being in the middle of a steep downturn in the agricultural equipment cycle. We purchased the stock on the belief that valuations had already discounted the cycle downturn. With sales likely to trough in the first half of 2025, the company’s focus on profitability, the stock’s low valuation, and favorable industry dynamics, we believe the company and stock are likely to perform better as end demand begins to recover.
2. A global leader in offshore wind power, which heads into 2025 with a clear plan, continuing to grow but with a much greater focus on risk and returns following a year of rebuilding credibility after 2023’s annus horribilis. We built a position in the stock at what we believed to be peak levels of pessimism and have subsequently seen a strong recovery in the fundamental economics of offshore wind in key markets like the United Kingdom. Delivery, both in terms of project construction and planned divestments, will be critical to its success in 2025 and beyond, in all likelihood.
3. A US-based renewable diesel producer, which suffered in 2024 as prices for renewable diesel collapsed following a significant overbuild of capacity combined with weaker-than-expected demand growth. We took advantage of this decline to enter a position in the company late in the year. With diesel prices deep into the cost curve, supply additions will dramatically slow in the coming years, in our view, while policy changes such as California’s Low Carbon Fuel Standard and Europe’s RED III should re-accelerate demand growth. The company has already demonstrated its cost leadership and the competitive advantages of its fully integrated business model, and we believe it will benefit significantly as the market for renewable diesel recovers.
4. A leading player in the global lithium market. Following slower growth in 2024, lithium pricing has fallen well below its peaks of 2022 and 2023, but more importantly, we believe it remains well below the marginal cost needed to incentivize new production. Recent merger-and- acquisition activity in the space, along with significant capital spend reductions and capacity shutdowns, would also suggest this is the case. The company has reacted well to the downturn, raising capital early and cutting costs to remain profitable, putting it in a strong position to benefit from improved supply/demand dynamics and the long-term growth from electric vehicle demand. Assuming lithium pricing rebounds to the level of marginal cost in the medium term, we estimate the stock is trading at a single-digit price-to-earnings ratio. Based on this approach, the stock price is near five-year lows. 
5. A global leader in paper-based sustainable packaging. We believe there is strong value here as the company trades at depressed valuations near the bottom of the packaging cycle, which we consider to be improving, and at the beginning of a company-specific synergy creation program. Additionally, there is a timely opportunity for increased penetration of value-added, sustainable and “shelf-ready” packaging in the US market, which we think could lead to higher structural profitability and higher valuation multiples for their stock.