Our weekly summary of the key news stories, developments, and reports that are impacting investing in the wider transition to net zero carbon .
First up – we are excited to announce that we have a new research partner starting soon. He joins us next week and while it will take a little while to get his FCA authorisation sorted out, his arrival will enable us to materially increase our research output. More details next week
Second, one of the joys of having two weeks off is that you get time to stop and think. One of the lines of thought I had while walking the dogs was how relatively little attention seems to be given to the practical challenge how we overcome the political and social barriers to net zero. We largely know the technologies and transition pathways we need to follow to get to net zero carbon and a greener economy. Given this, the really important social debate should be about how do you create a message that persuades politicians, companies and consumers to actually act, and act in a meaningful way. Promises and pledges are a good start, but making the required hard decisions is where the “rubber actually meets the road”. This is key for investors, as the resulting action (or inaction) determines which policies and technologies and hence companies, are most likely to succeed and hence be investible. This is the theme of this weeks blog – I hope you will excuse it being more philosophical than normal. We will revert to our usual format next week.
The format is simple, first our summary of the key points of the story (click on the green link to read the original) and then what we think it means for investors. The focus is on news flow that we think should change the markets perception of the investment case of individual stocks and sub sectors. So not the place to come to for news that has already been well covered in say the FT. Our approach is unashamedly long term, so we ignore short term noise.
If you would like to subscribe, please contact Dan at email@example.com. For the next few weeks, we will focus on just four key stories, and then we will ramp up coverage. For now, the blog will be freely available but at some point we will shift to a public blog and a more detailed client ie subscription version.
This week our top story examines the mess that higher natural gas prices in Europe has created and what this might mean for carbon pricing and net zero policy development; then we look at new WTO data on the health implications of air pollution and what this could mean for the drive for electrification, we examine how degradation of our natural capital could accelerate migration patterns, and our BST-Impact partners prepare the ground for their first upcoming monthly blog.
This week’s top story : Renewable electricity generation
Main points of the story as published
- As of 24th September, six UK energy supply companies have ceased trading, impacting c. 1.5m domestic customers. Under the supplier of last resort system (SOLR) they have been transferred to new suppliers, including E.On and British Gas. Market concentration is likely to rise further since Ofgem is overwhelmingly more likely to appoint one of the larger suppliers as SOLR to the newest failures not least because in these markets it is hard to find people wanting to acquire new customers.
- The UK government is sticking to the mantra that this is not a market failure, its only “badly run” companies that are going under. This is pretty much unfair for the most part, any business is going to fail eventually if its costs rise rapidly and it is prevented from passing those costs to consumers. Despite the Government stating that the crisis is temporary, the UK regulator, Ofgem, has said that higher gas prices may well persist beyond the near-term, as have many analysts, and the press is relaying all of this to a worried public.
- Energy supply is not a high margin business, but the Government appears to believe otherwise. Suppliers do not make large profits (and have not done so for a long time) despite the Government’s successful attempts to persuade the public that rising bills are the result of supplier profiteering rather than the truth: that 23% of electricity bills are a pass-though of green taxes, and that a portion of network costs (c22% of bills) is a result of the costs of integrating subsidised renewable generation into the electricity system.
- Business Secretary Kwasi Kwarteng told MPs that the Government is “looking at all options” when asked if Britain could follow Spain’s lead in introducing a new tax on energy companies’ windfall gains. Aside from the obvious point that windfall taxes, which are by their very nature retrospective, would negatively impact future investment in what is a key UK sector – the nature of the industry and the different hedging arrangements each company follows, would make a wind fall tax hard to structure fairly.
- While the UK government still has a number of levers it can use, most of them have limitations and drawbacks. For instance, a repeat of the 2014-15 rebate system could cost the government of the order of £200-£300 per year or more per household, which would cost £5.6 – 8.4 billion per year.
Our take on this
- I have always found Kathryn Porters blogs interesting and thought provoking, even when I don’t agree, and this one is no exception. The focus is on the UK, but the recent surge in gas prices has created similar problems elsewhere (Spain’s government steps in to halt record rise in power prices). Why this problem has come about has been widely written on. To quote the FT (Britain’s energy woes catch vulnerable sector in perfect storm ) “the natural gas market has been hit by the perfect storm. A prolonged winter left European stocks depleted, lower stocks from Russia and a strong demand for LNG from Asia hampered summer stock piling and UK North Sea production has plunged as companies performed pandemic delayed maintenance”.
- By this point you are probably wondering what this has to do with renewable electricity generation and unblocking barriers to delivering net zero carbon. First, there is no free lunch anymore. All of the decisions we make have costs, someone has to pay, its just up until now this fact has been easier to ignore. To be fair the a number of organisations, including trade unions, have been pushing this point for a while – (carbon price proposal will exacerbate energy poverty), but the message has not been having an impact, until now. The concept of “will the consumer willingly pay”, was often ignored by politicians, or at least swept under the carpet. Not any more, its now a political football.
- As the FT recently reported (energy price surge intensifies carbon plan backlash) the public concern about rising energy prices is encouraging countries such as France and Spain to push back on EU carbon plans. One fear is that as winter kicks in, Europe starts to see a return of “yellow vest” protests, but at a larger and more widespread scale. We need to take the public with us if the push for more renewables and a greener energy system is to succeed. Yes, most public opinion surveys say the electorate is concerned about climate change, both in Europe (UK public concern about climate change & pollution doubles) and the US (public concern about climate change remains at record high). But this can only go so far, especially when it hits already stretched wallets. We note that many opinion surveys say consumers care about where and how their clothes are made, but “fast fashion” continues to grow.
- Second, we need to be aware that we are dealing with a complex and interconnected system. While renewable generation is good and necessary, without storage and/or interconnectors and other grid investments, the electricity system is exposed to volatility of supply. Yes, these problems are solvable, but this will take more investment and that will take time. It may be hard to accept but we are going to need gas and even probably some coal for many years yet. Europe, with its TEN projects, is making some progress, but the US is still some way behind. The Biden administration is making some positive moves, but they will need to make up for decades of under investment. This is a topic we will be coming back to in future research.
- Neither of these points are a reason not to push forward with the transition to net zero. We agree the need is great and the long term cost of inaction is high. But from an investor perspective, we need to be very aware of both the potential for a consumer (& political) backlash, and the need for long term planning, to ensure that the infrastructure we need is in place, preferably before the system gets stressed again.
Electricity applications – we need electrification: if only for our health
Main points of the story as published
- Air pollution is even more dangerous than previously thought, the World Health Organization (WHO) has warned, as it slashes maximum safe levels of key pollutants such nitrogen dioxide (air pollution is the world’s biggest environmental killer). The organisation says an estimated seven million people die prematurely each year from diseases linked to air pollution, with low and middle income countries suffering the most, due to their reliance on fossil fuels.
- It is urging its 194 member states to cut emissions and take action on climate change, ahead of the COP26 summit in November. The good news is that between 2010 and 2017 road transport emissions in Western and Central Europe were found to have fallen by 20-30%, partly due to enhanced efforts on vehicle inspections and the promotion of electric mobility. Meanwhile, stricter vehicle standards saw traffic emissions in South Eastern Europe plummet by 40%. This has had a direct impact on health. In 2018, around 417,000 people are estimated to have died prematurely in the European Union due to exposure to fine particles (directly emitted as particles or formed from gaseous pollutants in the atmosphere). By 2020, this figure had dropped to 240,000, and by 2030 the toll is expected to fall to 170,000.
- On the negative side, emissions were found to be on the rise in Central Asian countries. For example, PM2.5 emissions increased by 21% between 2010 and 2017 in Kazakhstan, while carbon monoxide emissions in the country jumped 34%, and road traffic emissions rose by 20%. Plus, emissions of ammonia increased across Europe and Central Asia during 2010-2017, with the biggest increase recorded in South Eastern Europe. Once emitted, almost entirely from farming, much of the ammonia forms into PM2.5 and can cause respiratory diseases.
Our take on this
- Our take on this is short – for many people some of the impacts of global warming can feel distant, largely falling on “someone else”, often a long way away. Yes, this is changing as flooding, droughts and wildfires directly impact more and more people, but the general point remains valid. By contrast, the impact on our health, and that of our children, is happening now and its frighteningly real. It feels to us that this is a tool that we don’t use enough. Perhaps if we made the link clearer, more people would understand why change is needed. The electrification of industry and transport will reduce air pollution, which will cut deaths. Which brings us back to the point we made above. We need to bring the general public with us, and try to make the impacts of inaction as real and personal as possible.
Agriculture & Natural Capital
Main points of the story as published
- The new Groundswell report from the World Bank includes new projections from three regions, East Asia and the Pacific, North Africa, and Eastern Europe and Central Asia. It builds on the first Groundswell report from 2018, which covered Sub-Saharan Africa, South Asia and Latin America. Taken together, projections across all the regions out to 2050 find that over 216 million people could be on the move by 2050. This includes Sub-Saharan Africa, which could see as many as 86 million internal climate migrants; East Asia and the Pacific, 49 million; South Asia, 40 million; North Africa, 19 million; Latin America, 17 million; and Eastern Europe and Central Asia, 5 million.
- Climate change – particularly impacts such as increases in water stress, drops in crop productivity, and sea-level rise compounded by storm surge – could force people to migrate in distress. Countries could see an emergence of climate migration hotspots, as early as 2030, which will then continue to intensify and expand. In North Africa, change in water availability are likely to be the main driver, while in the Lower Mekong, sea level rises and storm surges pose threats to key local livelihoods, including rice production, aquaculture, and fisheries. In Central Asia, both water availability and crop productivity will create climate in-migration hotspots in already densely populated and economically productive areas, such as the Ferghana Valley, and into new areas of potential livelihood opportunities, such as northern Kazakhstan.
Our take on this
- Again our take on this is short. In looking at agriculture and natural capital, we tend to focus on changes and improvements that can be made, mainly using new technologies and farming/forestry practices. This report highlights the flip side. It’s partly about the impact of climate change, but it also highlights the social pressures that will result. Europe regularly struggles with surges in migration and the challenges facing the US are well reported and documented. Now roll forward 10 years – we could potentially have millions of people on the move as heat stress, water scarcity, lower crop productivity, top soil loss and sea level rises/storm surges materially increase.
Social and Legal factors – BST Impact
- This week we do not have commentary from the BST-Impact team, as we get ready to launch their first detailed monthly blog. This will build on their weekly blog comments to date, and pull it together into a coherent whole. Why are we doing this or being blunt, what does this have to do with investing ?
- To us, the legal approach being followed in Europe seems to be clear, with two linked strands of regulation. Both of these will directly impact most European companies, including their international operations. These regulations will not only impose direct costs, as companies will have to introduce new processes, they will also provide for sanctions and penalties to be imposed on laggards.
- These regulations will make companies responsible for the externalities that their operations generate, make sure that they are doing all they can to manage and reduce these and where they are not, give impacted individuals a route to legal redress. As an example of this, we highlight the story above – by the end of this year, the EU executive is expected to table a proposal for binding due diligence legislation to ensure Europe’s supply chains are more sustainable.
- The second aspect is the extent to which Europe is formalising international law directly into their own regulatory framework. As BST-Impact puts it “the increasing alignment of European law with the United Nations Guiding Principles on Business and Human Rights (UNGPs)”. This means that the scope for legal action against European companies increases.
- We consider that this is going to be an increasingly important issue for investor to be aware of, so watch out for the upcoming blog.
- Just a reminder. The team at Sustainable Investing is unqualified to discuss the legal implications of cases such as these. Fortunately, the BST-Impact team has many years’ experience with international human rights legislation. The importance of international human rights law to investors is becoming material, both from a risk perspective but also with regard to informed engagement. For follow up, consultancy and training etc, BST-Impact can be found here.
One last thought
The latest blog from Aswath Damodaran, slightly controversially titled, is worth a read. In this blog he picks up on points made by commentators such Tariq Fancy and others, but with a strong slant on the valuation arguments around ESG. For those who want a short summary, he argues that “ESG is not just a mistake that will cost companies and investors money, while making the world worse off, but that it create more harm than good for society”. I am normally a big fan of his work. In this case I think that while he makes some valid arguments, I also think he misses a couple of really important points. The most important to my mind is that sustainability is not just about doing a “good thing”. Politically, socially, legally and technologically, the world is changing. The companies that get ahead of this change will be best placed to create value, those that don’t run a real risk of financial failure. This can be reflected in very real valuation metrics and drivers.
Anyway, its worth a read. I am a great believer in listening to pretty much all points of view in the belief that I can always learn something if I keep an open mind.