How to profit as the world lags its loft

The easiest way to combat climate change is to save on energy. Matthew Partridge looks at the latest innovations in energy efficiency, and picks the best shares to profit.

Regardless of your views on the causes of, and potential fall-out from, climate change, cutting global emissions of greenhouse gases such as carbon dioxide remains a major talking point and target for the world's governments. And that will have a major impact on your investment decisions in the years to come.

For years, there have been two big obstacles to agreeing a new deal on cutting global carbon dioxide emissions America and China, the world's biggest emitters of greenhouse gases (with China on top, in this instance). However, ironically enough, the progress that the two have made independently in recent years may make it easier for them to cut a global deal at UN climate talks in Paris in 2015, reports the Financial Times.

China's emissions from burning coal and gas grew at the slowest rate in a decade last year because it "used more renewable electricity and significantly improved its energy efficiency". America, meanwhile, saw its own emissions fall to levels last seen in the 1990s, as the shale gas revolution saw a big switch from coal.

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The question is: what sorts of areas will reducing emissions affect the most? Simply changing the energy mix won't be enough. Renewable energy and nuclear power will remain minority sources of energy for a long time and are more costly than fossil fuels. Shale gas will help, as it's less dirty than coal, but it's still a fossil fuel and it will only be favoured for as long as it remains cheap.

There's a smarter area to focus on, suggests the International Energy Agency (IEA), which can be achieved at "no net economic cost" improving energy efficiency. This simply involves making better use of the energy we already have, by cutting down on waste from devices, processes and even whole industries. Consultancy McKinsey reckons that, with a concerted effort, non-transportation energy consumption in America could be cut by around 25% by 2020. In terms of cutting emissions, that would be like taking every car off the road.

Better yet, there's a clear incentive to use energy more efficiently it saves money, both for firms and for individuals. Bank of America Merrill Lynch suggests this will be a key investment megatrend' of the future. It will involve changes across the whole economy, but the biggest impact will be felt in the construction, information technology and lighting industries. Here's how each area will be affected and how you can profit from it.

Better housing

Any serious attempt to improve energy efficiency needs to involve the housing and construction industries. That's because energy consumption within buildings accounts for two-fifths of global energy use, according to the US Environmental Protection Agency (EPA), and a third of carbon emissions. Much of this is down to temperature control. Making the process of heating or cooling a building more efficient offers huge potential energy savings. Investment in better building technology tends to pay for itself within nine years, says the IEA.

To help things along, governments have various incentive schemes to reward early adopters and penalise laggards. The British government has launched the Green Deal, offering households cheap loans to fund energy-saving home improvements, such a improved glazing or insulation.While the loans have to be repaid, the long-term savings should outweigh the costs.

On a larger scale, the European Union has set minimum energy performance requirements for new buildings. The aim is for all new buildings to achieve zero energy' status by 2020 these are buildings that actually produce more energy than they consume, via the installation of wind turbines or solar panels.

To help achieve this, the European Investment Bank and the European Bank for Reconstruction and Development have helped facilitate nearly €15bn-worth of investment since 2002. Even governments in emerging markets are updating building codes to emphasise energy efficiency. These regulations are voluntary in India and Brazil, but China has made them compulsory for new commercial and governmental buildings in large cities.

As a result of this push, global spending on energy-efficient building technologies has risen tenfold in the last eight years, to $106bn, estimates Pike Research. The consultancy expects this figure to more than double again over the next three years, to $248bn, with the sector growing at around 8% a year in the longer-term. This will spur demand for energy consultants to advise firms and households on how to upgrade their premises.

The high cost of lighting Another, related area with massive room for efficiency improvements is lighting. Lighting accounts for around a fifth of global energy usage and nearly a tenth of carbon emissions, according to the EPA. But as the world grows richer and infrastructure expands, total demand for lighting is going to surge. That means that, without efficiency improvements, lighting's share of global energy consumption could rise by 60% over the next 20 years, says the IEA.

Clearly, we can't all wander around in the dark. The good news is that there is huge scope for savings, because the classic incandescent light bulb which has remained unchanged since it was first invented at the end of the 19th century is incredibly inefficient. Just 5%-10% of the energy it uses is emitted as light, with the rest escaping as heat. As a result these bulbs are being phased out across the world (often in opposition to the wishes of consumers). In Europe, rules restricting the sale of these bulbs came into force as long ago as 2009, while America has passed legislation to set up tough efficiency standards.

The trouble is finding decent alternatives. Sodium-based lamps are very efficient, but their orange hue makes them suitable only for street lighting. Compact fluorescent lamps (CFLs) are cheap alternatives for households, but produce a poorer quality of light than incandescent lamps, and take between a few seconds and a few minutes to achieve full brightness. The fact that they contain mercury also makes disposal difficult.

So far, the most promising long-term solution lies with light emitting diodes (LEDs). These switch on immediately, emit relatively little heat and have a much longer lifespan than CFLs. The light they produce is generally regarded as more aesthetically pleasing than most incandescent alternatives (although some still prefer inferior traditional bulbs). The trouble is, they are expensive to buy and require new light fittings and control systems. This seriously limits their use for the typical householder.

However, for businesses that can benefit from economies of scale and take a longer-term view, the economics are simpler. Lighting design firm Digital Lumens believe that, by spending on consultants and specialised software, firms could cut their lighting costs by up to 90%. Giant American retailer Walmart has already decided to replace all lighting in its stores in Puerto Rico with LEDs. It expects to recoup the initial layout through energy savings within two years, and plans to do the same in its Chinese stores. In Britain, the Royal Mail is following Walmart's lead.

These companies are relatively pioneering LED technology is still in its infancy. McKinsey estimates that LEDs currently account for less than 10% of the combined residential and commercial market. But as prices tumble, and traditional bulbs continue to disappear from shelves around the world, market penetration should increase dramatically. Lighting consultants Lux Research predict that by 2020 60% of all office lighting and even 42% of the domestic market will be powered by LEDs.

Making computers more efficient

The information technology sector has traditionally been associated with saving, not consuming, resources. From the paperless office' to video-conferencing rendering flights unnecessary, innovation in computers and communications technology will certainly play a key role in reducing carbon emissions and waste.

But all those screens and tablets and laptops and server banks consume electricity an awful lot of it. And we are only going to need more of them. We are using more and more computing and mobile devices, giving rise to ever-larger quantities of data for companies (and of course governments) to collect and store and analyse. As a result, the carbon emissions of the global information technology industry are now on a par with those of global aviation.

One obvious area where energy efficiency could be radically improved is in the designand operation of data centres the large banks of servers that companies hire out to use for storage and processing power. With investment in the sector growing by more than 20% a year, operators of these data centres are finding that it also makes a lot of economic sense to pay more attention to cutting energy waste.

Computing giant Hewlett-Packard is already taking radical steps, adjusting the location and design of its centres to take advantage of the natural cooling provided by the local winds. Similarly, online group Yahoo! has developed a unique chicken coop' design that accomplishes a similar objective.

There are other ways to cut waste, beyond more efficient cooling. Most computer servers rarely operate at anything close to full capacity. So Portuguese researchers have developed a software programme (named Spirit) that automatically turns sections on and off, according to demand. This wastes less energy on keeping idle servers switches on.

Having successfully tested the programme on a university network, they believe that if adopted globally Spirit has the potential to save as much energy each year as that produced by a 1,000MW nuclear power station. It would also cut annual carbon emissions by about five million tons. To put that in perspective, that's roughly the amount of carbon emitted by two years' worth of London to New York passenger flights.

Computer-chip manufacturers are also working on ways to make their chips more efficient, while still increasing speed and capacity. IBM believes that using new materials to build chips, such as carbon nanotubes instead of silicon, is the way forward. At present, industry leaders Intel and ARM are both investing large sums in researching this area. ARM has also floated the idea of building processors that use energy-efficient chips for simple tasks, such as email andword-processing, only drawing on the computer's full resources when needed.

An even more radical solution is to allow chips that occasionally make mistakes. Researchers at Rice University in Texas found that allowing chips to make a small number of errors could dramatically cut energy consumption, as well as reducing size and boosting speed. While such technology would not be appropriate to home computers, devices such as hearing aids and surveillance cameras, where perfect accuracy is not vital, could benefit. Indeed, the Indian government has said that it will use such technology in an ultra-budget tablet that it plans to give away to schoolchildren.

The six stocks to buy now

One group that could profit from the tighter regulations on energy-efficient construction comprises firms that can offer expertise on improving energy usage. Specialist consultancy Ameresco (NYSE: AMRC) advises firms on how to reduce the energy they waste by investing in better equipment and cutting non-essential energy use.

While Ameresco mainly focuses on US public-sector clients, who are being hit by budget cuts, it has an extensive pipeline of contracts that have already been agreed and are due to start over the next two years, which will provide a degree of stability. It also has a growing list of private-sector clients, including BMW. It trades at 14 times forward earnings.

The drive to make buildings more energy-efficient should also help builders' merchants SIG (LSE: SHI). Given that the British market accounts for nearly half of group revenue, it should benefit from the rise in demand associated with the Green Deal. The government's schemes to loosen mortgage lending and increase the level of housebuilding in Britain should also help the company. SIG trades on 12.9 times 2014 earnings and pays a dividend of 1.8%.

As the largest lighting firm in the world, Koninklijke Philips (Germany: PHIA) has been investing heavily in LEDs to maintain its dominance. Its sales of LEDs are up by 38% year-on-year and now account for nearly a quarter of total lighting sales. Phillips has also released a LED lighting strip designed for use in offices, which is twice as efficient as fluorescent lighting. Brokerage Natixis believes that a firm-wide cost-cutting programme should help boost profit margins. Philips currently trades at 12.7 times forward earnings with a dividend yield of 3.4%.

If you're looking for a purer play on rising LED lighting demand, then CREE (Nasdaq: CREE) fits the bill. It is involved in all aspects of LED lighting, from the lights and lighting systems themselves to the components and materials used to make LEDs.

While Cree has mainly focused on the commercial market, it has recently brokered a deal with Home Depot to sell its own-brand LED bulbs direct to the public. These bulbs are designed to fit into traditional light sockets, helping households to swap from their existing incandescent bulbs. As a rapidly growing company, it trades on a hefty multiple of 35 times 2014 earnings, but this is more than justified by its collection of nearly 1,000 LED-related US patents and sales that are growing by more than 20% a year.

A far more speculative option is Vu1 Corp (OTC: VUOC). It specialises in electron stimulated luminescence (ESL) technology. This is another energy-efficient alternative to conventional bulbs. Like CFL, it is based around the use of electrons to stimulate phosphor, but it doesn't use mercury and claims to produce a better quality of light. Its main selling point is that it is cheaper to make than LEDs, and can be used in existing fittings. Bear in mind that shares in Vu1 are sold over the counter', which means that your broker will need to be able to deal in them, and they will also be less liquid than main-market-listed shares.

As for more efficient computing, Intel chips and processors still have the edge when it comes to raw power. However, ARM Holdings (LSE: ARM) is the acknowledged industry leader when it comes to minimising energy usage and size. This gives it a major advantage as computing shifts away from desktops towards larger smartphones and mini-tablet devices. As a result of this lead, ARM has been bid higher, and trades at 38 times forward earnings. But with sales growing at 25% a year, this looks justifiable.

Dr Matthew Partridge

Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.

He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.

Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.

As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.

Follow Matthew on Twitter: @DrMatthewPartri