Last week The Times reported that Ofgem, the regulator of the UK's electricity and gas markets, has warned it is time for a 'revolution' in the way people save energy if they are to mitigate soaring utility bills and keep the lights on.  While the UK government prevaricates over the country's future generating capacity and how to fund it, we suggest that investors could focus on the opportunities in global energy efficiency markets.

Energy efficiency represents a large, diverse and high growth investment opportunity with a significant role to play in reducing global emissions.   Estimates by the McKinsey Global Institute show that the implementation of energy efficient products, processes and systems could lower global greenhouse gas emissions by around 14% by 2030 and the International Energy Agency estimates that every US dollar spent on energy efficiency avoids a $2 investment in electricity supply.

Impax has been investing in global energy efficiency companies for thirteen years.  In 2012 it was our largest sector exposure and a major contributor to performance.  The attractiveness of this sector is based on strong economics without subsidies and the exposure these markets have to recovering industrial and construction markets.   Positive global developments on policy and on-going tightening of regulations should provide additional momentum for investors.  For example, the EU Energy Efficiency Directive that was ratified in October 2012, dictates that the 27 member countries must now legislate to ensure their national energy companies implement energy efficiency measures leading to at least 1.5% annual energy usage reductions for all their customers. 

We see strong growth in a range of segments, including buildings, industrial, power network and consumer energy efficiency.  But here we discuss the sectors of most interest to consumers: heating, lighting and transport.

• Heating - there are numerous attractive opportunities in insulation markets as a means to reduce energy bills.  Kingspan, one of our top ten holdings (in Impax Environmental Markets plc),  produces  high efficiency building insulation with 65% higher thermal efficiency than the traditional more commoditised glass wool products and looks set to benefit from expansion of this market.  The company has gained significant market penetration and developed rapidly, despite challenging construction markets.  We anticipate robust growth in heat pump markets, which can reduce heating bills by up to 30% and are positioned for rapid growth following technology innovation and falling prices.  Nibe, another of our top ten holdings, is the market leader in heat pumps in Europe.  While initial implementation has been sub-optimal, the UK "Green Deal" and "Renewable Heat Incentive" programmes represent a positive medium term driver for these businesses.

• Lighting - we believe that LED lighting is set for exponential growth in the coming years.  The technology is proven and the product matches existing technology.  LEDs are 10 x more efficient and have a lifetime of up to 50 x longer than incandescent bulbs.  Regulatory targets are in place - for example Japan is targeting 30-50% penetration of the domestic lighting market in 2013 and China is anticipating a 20% level by 2015.  Most importantly, however, economies of scale have substantially reduced the cost of technology, with a 60 Watt replacement bulb for residential  use now selling for less than £10 in the UK, and commercial lighting payback periods of less than 1 year.  We forecast technology costs will continue to fall by around 30% a year to up to 2015, driving strong growth of more than 50% in the sector and increasing penetration of this technology.  By 2015 Phillips expects 45% penetration of a global market in the region of €75-80 billion.  We see investment opportunities across the value chain, including the machinery suppliers), chip manufacturers, suppliers of controls and packagers/integrators.

LED lighting expected to be around 45% of the global market by 2015*

*excludes Automotive Lighting and LED components market.

 Source: Philips Lighting global market study 2010, updated for 2011.

• Transport - automotive and truck markets are subject to increasingly stringent regulation to towards increased fuel efficiency and reduced emissions.  The European framework of regulations is well understood, but in 2012 the US Environment Protection Agency raised the automotive manufacturers' average fuel efficiency standard from 35.5 miles per gallon by 2016 to 54.5 miles per gallon by 2025.  We remain most interested in opportunities linked to improving the efficiency of internal combustion engines - specifically engine downsizing combined with turbochargers.  BorgWarner, the market leading supplier of turbo-chargers should benefit from this trend, as does Ricardo, the UK based consultancy which provides engineering services to car manufacturers in relation to power train design.  We also anticipate growth in natural gas vehicles in markets with fuelling infrastructure, driven by the substantial differential between diesel and LPG/CNG.  We continue to monitor the progress of electric vehicles, but the lack of charging infrastructure and high prices will likely limit this to a niche market in the short to medium term.

Notwithstanding increasing global policy support, the energy efficiency sector is primarily driven by the financial logic underpinning investment - both for both the domestic and industrial markets and for domestic consumers relatively small investments can result in considerable savings to their energy bills.   From an investment perspective we continue to seek out companies offering technology advancements that open the door to new investment opportunities and attractive valuations in the sector.