Our weekly summary of the key news stories, developments, and reports that are impacting investing in the wider transition to net zero carbon and a greener/fairer society.
As we roll toward the end of 2021 the pace of change continues to be rapid. For many people the complexity of this creates challenges, which we often try to over come with simplification. One area where this has been prevalent has been the so called “learning curve”. This links cost of a good to its cumulative production. This weeks top story plugs some gaps in this analysis, showing that R&D explains most of the cost reduction, not cumulative production . We follow up with a piece on value destruction in the “urban air mobility” market (which has a surprisingly personal angle for our team), plus in Agtech, we examine progress on taking salmon farming offshore. We finish with a guest story from our human rights expert on how local regulation and international human rights law are coming together to create potential material risks for companies …. Our last thought highlights the next German government’s key climate and energy plans.
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 firstname.lastname@example.org. 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’s top story : R&D matters more than cumulative production
Main points of the article as published
- Lithium-ion batteries, those marvels of lightweight power that have made possible today’s age of handheld electronics and electric vehicles, have plunged in cost since their introduction three decades ago at a rate similar to the drop in solar panel prices, as documented by a study published last March. But what brought about such an astonishing cost decline, of about 97 percent?
- Some of the researchers behind that earlier study have now analysed what accounted for the extraordinary savings. They found that by far the biggest factor was work on research and development, particularly in chemistry and materials science. This outweighed the gains achieved through economies of scale, though that turned out to be the second-largest category of reductions. The new findings are being published today in the journal Energy and Environmental Science, in a paper by MIT postdoc Micah Ziegler, recent graduate student Juhyun Song PhD ’19, and Jessika Trancik, a professor in MIT’s Institute for Data, Systems and Society.
- Overall, Trancik says, “we estimate that the majority of the cost decline, more than 50 percent, came from research-and-development-related activities.” That included both private sector and government-funded research and development, and “the vast majority” of that cost decline within that R&D category came from chemistry and materials research.
Our take on this
- I don’t know about you, but I was brought up on the learning curve, which implied that much of the cost reduction in technologies such as solar panels, Li Ion batteries and the like came about from increased production. At least that was what many of the charts implied, showing cost reduction against cumulative production. The link between cumulative production and cost never sat totally comfortably, and this research explains why, because it not totally true.
- This research follows other work that Trancik and her team did to analyse the similarly precipitous drop in costs of silicon solar panels over the last few decades. They also applied the approach to understand the rising costs of nuclear energy. What we found especially interesting was this quote “there were so many variables that people were working on through very different kinds of efforts,” including the design of the battery cells themselves, their manufacturing systems, supply chains, and so on. The cost improvement emerged from a diverse set of efforts and many people, and not from the work of only a few individuals.”
- What implications might this have ? The first is it raises questions about the argument that there is a longer term floor on the cost of Li Ion batteries. Yes, using current materials its hard to see costs falling materially any time soon, unless the raw materials themselves get cheaper, which seems less unlikely. But if this analysis is correct, we could see a scenario where continual improvements in battery chemistry continue to drive down costs. As Trancik says “their work suggests that there is still considerable room for further improvement in electrochemical battery technologies”.
- It also raises some questions about the argument that scaling up production of small scale modular nuclear power will generate cost reductions. Plus it poses some interesting questions on the cost curve for hydrogen electrolysers, especially given that “the R&D contribution didn’t end when commercialization began. In fact, it was still the biggest contributor to cost reduction.”
Urban air mobility – a really really tough nut to crack ?
Main points of the story as published
- This article by Michael Barnard examines the investment record of urban air mobility companies. It was clear to him that they were going to be much more expensive to operate than purported, that their total addressable market was tiny, that they were betting on complexity instead of simplicity, and they were betting against battery energy density. He was surprised at the market capitalization of the leaders in this space. Excluding Blade Urban Mobility, which is a platform which provides affluent people with charter jets and runs a scheduled helicopter service in Manhattan, one of only two in North America, and excluding aerospace giants such as Embraer, Airbus, and Bell (Textron), all of which have eVTOL aircraft in prototype, and including Vertical’s announced $2.2 billion SPAC, still theoretically pending this year, the market capitalization recently was still over $12 billion. At peak in 2021, the stocks, including Vertical’s SPAC, were worth $27.92 billion.
- It was a bubble, it’s deflated massively, it has no basis to reinflate, but the pure play companies are still left with a lot of money and the odd support of NASA to lobby for urban vertiports and a Blade Runner future. Never underestimate the power of billions of dollars to make a lot of people behave stupidly, so expect that one or two cities will buy into this idea and spend money that could have been much better spent to the benefit of their citizens.
- The Innovator’s Dilemma tells us that the major aerospace firms will be slow to electrify, slow to bring useful electric cargo and passenger aircraft to the market, and slow to realize that they are losing market share at the bottom of the market. Let them figure it out. Christensen and Raynor provided them the insights they needed to survive the transition in 1997, so if they can’t figure it out, that’s on them.
Our take on this
- We have two reasons for highlighting this article, other than that most commentary by Michael Barnard is worth reading. First, we expect this to be a recurring pattern in the transition. Whole industries are going through massively disruptive change. Some incumbents business models will not survive, and others will need to pivot and reorient quickly. In some cases the winners will be new companies, emerging with smarter business models – BUT not all new business models will prosper. The age of the SPAC has made it perhaps too easy to raise capital. Part of our reason for existing is to help highlight (hopefully in advance), which “emperors are wearing no clothes”.
- The second reason is more personal. In 1934, the Bureau of Air Commerce (link here) recognized the Waterman Arrowplane as one of the two award-winning designs for its flivver (i.e., light, easy-to-fly and affordable) aircraft competition. Waldo Waterman’s improved Arrowplane, the Aerobile #6, fulfilled his dream of designing a tailless roadable airplane. This aircraft (I think you call it that) hangs in the Smithsonian (photo in the linked article), many of us have probably walked past it. Those among you who know our team might recognise the name … Dan Waterman is one of our founders and he is rightly proud of his predecessor.
Salmon fishing – moving to increased use of technology
Main points of the story as published
- There were a couple of stories that caught our eye this week addressing critical sustainability issues within salmon farming. In Norway the new government, which took office last month, plans a new licensing regime for offshore salmon farming, the government’s preferred expansion route for the industry given the environmental footprint of open cage production in coastal waters. With no new licences being granted for traditional, near-shore nets, the only other growth option in Norway is closed facilities either in near-shore waters (typically used for post-smolt production) or land-based facilities.
- Separately, Stanford University published research looking at the economics of making fish feed from methanotroph bacteria fed on methane. The resulting protein-rich biomass can replace the fish or plant-based feeds traditionally used for fishmeal. The research found that, depending on the source of the methane, production costs were lower than for conventional fishmeal. It also highlighted opportunities to cut production costs by a further 20%.
Our take on this
- Aquaculture is seen as an important source of protein to feed a growing global population given the sustainability issues faced by wild fish capture and livestock farming on land. It is not, however, without its own environmental challenges including pollution, disease, fish escapes and the source of fish feed.
- Increasing salmon supply globally faces a number of challenges. Expansion into new coastal locations has been blocked in Chile and Canada for example over environmental concerns. There is a limit to the biomass existing locations can support without destabilising the broader ecosystem while full grow out of salmon on land is yet to be scaled successfully given challenges with the technology. Offshore farms are thus an important potential source of industry growth but also a capital intensive one (pioneer SalMar’s Ocean Farm 1 cost US$110m to develop).
- The source of fish feed ingredients has also been controversial. In 1990, 90% of salmon feed in Norway was derived from wild fish, today it is still 27%. Alternatives to fishmeal include vegetable matter (often soya bean based which brings its own sustainability issues), insects and fungi.
- Using methane-fed bacteria as fishmeal is not new (the technology was developed by Statoil in the 1980s) but commercialisation has been held back by high natural gas prices, the traditional source of methane. Stanford’s research found however that methane from waste streams is potentially competitive (buying gas from the grid remains uncompetitive). Regulatory approval for its use in fish feed has been granted by the EU and at least two companies (including Calysta) are developing the technology.
- Salmon farming is not without its sustainability challenges but addressing these is key to future growth and is likely to increase barriers to entry through increased capital and technology intensity.
Social and Legal factors
- This week our good friend Kristina Touzenis, who has many years experience in the human rights field (LinkedIn profile here), has again kindly guest written the social & legal section of the weekly. Thank you Kristina. Just a reminder, this section is not written and prepared by Sustainable Investing LLP. Quite frankly, we are not experts in this field, so we leave the topic to those that are. This week she looks at how a combination of local (& regional) regulation, with an increased use of international human rights law, could create some long term risks for companies who don’t stay on top of the shift. This comes from a direct challenge from us to highlight how quickly this field is developing and how its moving from an issue for companies to an issue for investors.
- On June 25th 2021, the strive to ensure more socially and environmentally sustainable business practices reached a new level. That day, the Bundesrat, the German upper chamber of parliament, approved the German Supply Chain Due Diligence Act (Lieferkettensorgfaltspflichtengesetz), which is now set to enter into force on January 1st, 2023. The aim of this law? To better protect human rights and the environment in a global economy by obliging German companies of a certain size to perform better due diligence on their supply chains. This is no longer a voluntary CSR activity, but required by law, and companies who do not comply risk facing penalties.
- Germany is not the first country to have passed a law on supply chain due diligence, and it will certainly not be the last. Already in 2015, Great Britain passed the Modern Slavery Act, which includes “Transparency in Supply Chain Provisions”, requiring companies with a turnover higher than GBP36 million to publish statements on the actions they take to avoid human trafficking and slavery happening in their business and supply chains. France passed a Vigilance Law (“Loi de Vigilance”) in 2017, which mandates French companies with more than 5,000 employees in France, or 10,000 worldwide, to adopt plans in order to address risks around human rights, occupational health and safety, and environmental damage in their supply chains. Lastly, in 2019 the Netherlands adopted their Child Labor Due Diligence Law which will, once it enteris into effect in 2022, require Dutch companies to inspect their supply chains for child labor. If they find any instances, they are required to prevent it.
- In March this year, the EU parliament adopted the Resolution of 10 March 2021 with recommendations to the Commission on corporate due diligence and corporate accountability. In it, the Parliament sets forth recommendations for mandatory due diligence and corporate accountability directives. Among the requirements raised in the document are a monitoring of a company’s direct and indirect adverse impacts on human rights and the environment, as well those of their business relationships.
Kristina’s take on this
- What should investors be tracking. First of all – the increasing importance of the extra-territorial obligation. What is emerging very clearly, in several jurisdictions but perhaps the most evident in Europe, is that companies are being increasingly held accountable for actions taken on territory which is not their country of domiciliation nor necessarily the country of the jurisdiction. This is the extra-territorial obligation to protect human rights which comes into clear play! Be mindful that the rules being applied are NOT new – but it is getting increasingly impossible to operate in a way that disregards rights, which companies have been used to respecting in the “home state” for decades, abroad.
- There is a legal strand that make companies responsible for the externalities that their operations generate, making 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. So, as an example of this – 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 (something we covered in issue 7). At a country level the German supply chain due diligence act enters into force in Jan 2023. And at one level the proposed carbon border tax also falls into this group. This strand will have a fairly immediate impact, with the potential for fines and negative publicity for breaches.
- What some investors seem to be missing is that while Europe may be at the forefront on the regulatory aspects, but in today’s interconnected world that means that any legislation passed in the EU will have a trickle out effect on ANYBODY even remotely connected to companies working in or from Europe – who isn’t??
- Second – Europe is also formalising international law directly into their own regulatory framework with a focus on companies and investors. The international laws being used have been the basis of a number of laws already – from labour regulations to rules on housing and health – but it is clear that the power of companies and investors on societies have made it clear that specific regulation for these actors has become necessary.
- This means that the scope for legal action against European companies increases. Examples of this tend to be higher profile, such as the Shell case, and the various US & UK cases we have highlighted. While these cases have received considerable publicity, the underlying legal principles are often poorly understood by investors. And yet these changes are likely in the future to have the biggest impact on companies and hence investors. Change here will be slower … but the emergence of enforceability of human rights in the courts of Europe and the US – and elsewhere!! is likely to become a massive challenge for companies as we go through the decade – unless they start putting in place adequate policies and internal mechanisms NOW.
- These would need to address issues around: labour standards (non-exploitation) in supply chain (as well as HOW is this enforced and controlled); fair recruitment practices; effects on societies where operations take place (including land and property issues; access to clean water; access to education); influences on participation (including positive multi stakeholder engagement but also avoiding undue influence of democratic processes); do no harm (a holistic evaluation of the impact of investments/practices); results based reporting (including transparency in challenges met and how they were dealt with). This is something all forward looking investors need to track & if necessary, start asking some tough questions of the companies in which they are invested.
One last thought
There is too much detail to cover in a quick last thought, but given the response of the carbon price, parts of the market rightly see this as a big deal. Targets such as the 80% electricity renewables by 2030 are possible from a technology perspective, but they will clearly need a lot of ground work to clear the current slow permitting process. The coal phase out, ideally by 2030, is not a real surprise, but the “end of gas” by 2045 is. We could go on, but you get the drift. This is a very aspirational plan – even if they just get close, it could re-establish Germany as a global leader in green technology. Not all of the plan will work, but its a good start. What it does highlight is the potential in those areas that haven’t got the attention they deserve. For investors, grid strengthening, built environment & agriculture will need to move to the fore.