Sustainable Investing weekly blog: 30th July 2021 (Issue 2)

This blog does not constitute Investment Research as defined in COBS 12.2.17 of the FCA’s Handbook of Rules and Guidance (“FCA Rules”). See the end of this blog for links to important information and disclaimers.

Our weekly summary of the key news stories, developments, and reports that are impacting investing in the wider transition to net zero carbon .


 

The format is simple, first 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. Our approach is unashamedly long term, so we ignore short term noise. If you would like to subscribe, please contact Dan at dan@sustainableinvesting.co.uk. For the next few weeks (during August), we will focus on just four key stories, and then we will ramp up coverage.

This week we look at the growth of the offshore wind industry in the UK, the surge in EV sales in Europe, the new French climate law and how it might impact fertiliser use, and our partners at BST-Impact review the implications of the recent EU draft social taxonomy.

We also note (with a smile) that the FT recently covered (in its EnergySource email carbon capture gains traction in the US), the story we highlighted last week on the apparent increasing support for carbon capture among US politicians.

Electricity production




UK energy statistics 2020 show surge in offshore wind generation (UK Govt – BEIS)

  • On the 29th July, the UK government released its 2020 annual energy statistics. On electricity, demand reached a record low in 2020 of 330.0 TWh, down 4.6 per cent compared to 2019. Although electricity demand has been declining year on year since 2015, the larger reduction seen in 2020 was primarily a result of the response to the Covid-19 pandemic.
  • Renewable technologies generated more electricity than fossil fuels in 2020 for the first time in the published time series. Renewable sources generated 134.6 TWh in 2020, a 12.6 per cent increase compared to 2019 and higher than the 117.8 TWh from fossil fuel. Note that solid biomass, including wood, waste wood, animal and plant biomass, represented 33 per cent of total renewable demand in 2020 with approximately two thirds being used in electricity generation and the remaining third to produce heat.
  • The high renewable generation was driven by increased wind generation, up by 18 per cent compared to 2019 to 75.4 TWh. This reflected favourable conditions for generation and increased capacity, particularly for offshore wind, which generated 27 per cent more electricity in 2020 than in 2019. The bulk of this was due to exceptionally high windspeeds particularly during the first quarter when Storms Ciara and Dennis hit the UK. Capacity growth was modest at (0.5 GW, or 5.0 per cent), mostly from the opening of the East Anglia One offshore wind farm .

Our take on this

  • While the growth in offshore wind electricity generation has been strong, the really interesting issue from an investing perspective is what happens next. This is not just about capacity increases (with 2020 being a weaker year in the UK, but not in the rest of Europe), it’s also important to consider what happens to the financials of the current wind farms when reach the end of their governmental funding support. Plus, how much do we need to worry about a higher supply of wind generated electricity creating more days when power prices are low ?
  • The UK is a global leader in terms of installed off shore wind capacity, at just under 11GW. This puts them just ahead of China and Germany, with the three countries currently making up c. 2/3 of global supply. The UK government’s target is to have 40GW of capacity by 2030, so a big step up. Hitting this target is possible, with a recent article from Airswift Offshore wind in the net zero targets listing 31 projects with a total capex of c. $93bn, slated for the next five years.
  • There are a few things we think investors need to watch, in terms of the profitability of these projects. The first is what happens when government financial support ends and the second is “will the industries very success lead to weaker profitability in terms of more days of lower pricing”. Finally, how concerned should we be by the “new (ish)” entrants and what this might mean for the cost of project licences and IRR’s.
  • On the end of government support – a recent report from LCP (for the wind farm operator SSE)  Net Zero power without breaking the bank  suggests that “under the current trajectory, large amounts of existing low-carbon capacity reach the end of their CfD or RO support from around 2030 onwards and will close prematurely as they are unable to cover their ongoing  costs or the cost of life-extensions or refurbishments. This is due to a combination of low market income, due to low wind-captured power prices, and high ongoing fixed costs”.
  • With regard to lower pricing as supply rises, a number of industry analysts have pointed to the growth in low or even negative price days  power prices dip as winds batter Britain , mainly during very windy periods when demand is depressed. This is not just a UK issue instances of negative pricing more than double across Europe .  The concern is that more wind generation, mostly co-located, will increase this, although we also need to be aware of the flip side, low wind days can push prices up as well power prices spike to £720/MWh as low winds continue.
  • In our view, while these issues will become more important as the industry grows, the big one to watch is competition. The increasing interest from Oil & Gas companies and financial players, plus the push for growth among the utilities, means that competition for licences is increasing. At a leasing round held by the Crown Estate earlier this year for seabed options around the coast of England, Wales and Northern Ireland, BP and German utility EnBW paid a record price to secure two sites, representing 3 GW. The option fee, paid prior to taking a final investment decision (FID), amounted to around £1bn ($1.38 bn) in the case of BP and EnBW – made in four annual payments of £231m for each of the two leases high stakes in global rush for offshore wind
  • When you put all of this together, the picture is consistent with what we are hearing from industry players, returns (IRR) have already come down and they will probably fall further. There are a number of companies and groups with the expertise to build large off shore wind farms, all chasing a relatively small number of opportunities. Something for investors to watch, especially with the popularity of the renewable electricity generators as investments.

Electrification applications



Plugin share doubles in Europe as diesel hits record low (cleantechnica)

  • Europe’s auto market saw diesel share fall below 20% for the first time in Q2 2021 from nearer 30% a year ago. Meanwhile plugin electric vehicle share more than doubled year-on-year to 16.9% in Q2.
  • Diesel share peaked in Europe in 2011 with a huge 55% of the market, but started falling after the late-2015 diesel-gate scandal. Still at almost 35% share at the end of 2018, diesel’s rate of decline has dramatically accelerated over the past two-and-a-half years due to the rapid growth of electrification, especially plugins.
  • Non-plugin hybrids (HEVs) also doubled their share (to 20.3%) helping to speed the decline of diesels. Note that, despite eating into non-electrified combustion powertrains, HEVs themselves are only a temporary quick-fix to reducing emissions, and have no long term future in Europe. The EU is mandating an end date of 2035 for sales of any non-plugin powertrains, and most European markets are anyway moving towards plugins much faster than this.
  • If last year’s trendline serves as a decent guide (see top graph), we can estimate that Q3 2021 will see plugins accelerate to close to 20% share, and there’s an odds-on chance that we will witness 25% share or higher in Q4.

Our take on this

  • We thought long and hard about covering this story, after all we don’t really look at the automotive OEM’s and although we plan to cover the supply chain in the future, surely this is already a well understood theme (remembering our mantra – only cover what might change the consensus investment case). Ultimately, we went with it because of the possible second order effects of battery technology.
  • The consensus view still seems to be that the natural progression is for batteries to become more and more advanced as customers want more range. So a shift to more complex and expensive battery technologies so NMC, NCA and eLMO. In our previous roles (hi Asad – how is life on the buyside) we argued that while this would be the case at the premium end of the market, we expected the mass market to go for much cheaper, and safer, LFP (lithium iron phosphate) batteries.
  • It all comes down to cost. Put simply, many consumers will likely be content with a 200- to 250-mile-range vehicle that’s thousands of dollars cheaper than an expensive one with a range of 300 to 350 miles. As we shift along the innovation curve, consumers become more pragmatic. This was picked up in a recent TechCrunch article  what Tesla’s bet on iron based batteries might mean, which also highlighted that the current LFP patents, that were licenced to Chinese manufacturers a decade ago, are due to expire in 2022.
  • This could give battery manufacturers outside of China the ability to gear up production of LFP batteries for the mass market. Although China has a cost head start due to high production levels, the attraction of local sourcing for OEM’s could tip the balance. We note however that most, if not all, of the planned European Gigafactory’s are for the more advanced battery technologies  Gigafactories: Europe´s major commitment (CIC energi GUNE). Regardless of where the batteries are made, a switch to lower cost LFP powered EV’s could further accelerate the demise of diesel in Europe.

Agriculture & Natural Capital


Charl Folscher from unsplash

France’s climate law takes aim at fertilisers (Euractiv)

  • France has adopted a long-waited climate law introducing a series of measures that impact the agricultural sector, including the reduction in the use of nitrogen-based fertilisers. The French National Assembly and the Senate adopted the Climate and Resilience law on Tuesday (20 July) following months of tense debate.
  • The law includes measures to reduce the use of mineral nitrogen fertilisers in a bid to lower nitrous oxide emissions by 15% of 2015 levels by 2030 and ammonia emissions by 13% compared to 2005 levels over the same period. Article 62 sets up a national action plan to meet these goals, dubbed the “eco-nitrogen plan,” which must accompany the evolution of cultivation and agronomic practices.
  • If, for two consecutive years, the emission reduction targets are not met, the law calls for the introduction of a levy on the use of the fertilisers in question – a point that caused tensions between the Senate and the National Assembly because of its punitive nature.

Our take on this

  • This law has been coming for some time and to be honest, we expected the strong French agricultural lobby to water the bill down. This has happened to some extent, with caveats around protecting “the economic viability of the agricultural sectors concerned and not increasing possible distortions of competition with the measures in force in other EU member states”. Plus there are measures that call for the recognition and better valuation of “positive externalities of agriculture, particularly in terms of environmental services and land use planning.”
  • These could mean the impact of the new law is more muted than expected, but if this process is rolled out across Europe, as we expect, the potential impact on fertiliser use could be material (on a mid to long term view). This feels to us like the beginning of a long term trend, supported by technologies such as precision ag, which help farmers reduce fertiliser consumption without reducing yields.
  • We also note that “Farm Tech” VC investing soared to $7.9 billion in 2020, topping 2019 investments by $2.3 trillion, or 41% 2021 Farm Tech Investment Report (Agfunder)in collaboration with Upstream Ag Insights. As difficult as 2020 was globally, the pandemic seems to have buoyed Farm Tech because it “exposed cracks in the industrial agricultural system,” particularly the vulnerability of the food supply chain. This is a big theme we plan on picking up coverage of as we roll through the summer.

Social factors – a BST Impact view

Charting the course for a social taxonomy (esginvestor)

  • Investors, corporates and policymakers are beginning to understand the need to address social-related issues in conjunction with tackling climate risks, particularly when it comes to ensuring a just transition to low-carbon and sustainable economies. The European Green Deal has a climate-first agenda, ranging across eight policy areas: biodiversity; sustainable food systems; sustainable agriculture; clean energy; sustainable industry; building and renovating; sustainable mobility; eliminating pollution; and climate action.
  • But this emphasis is changing. The recent publication of a draft Social Taxonomy signals that the European Commission is expanding its scope beyond environmental factors. The draft is open to feedback until 27 August, with a finalised report to be submitted to the Commission for review in October.

The BST-Impact take on this

  • First – a quick reminder. This “take” on the news is from our partners, BST-Impact. Unlike us, they have a deep and thorough knowledge of this topic, based on many years of practical experience, so their views are worth listening to. If you want to follow up with detailed training or consulting, you can find them here. Given how complex (and important) this topic is becoming, we will be publishing more on this theme, starting shortly with a blog piece. Something to watch out for.
  • While many asset managers and asset owners are starting to include social and governance factors in their investment appraisals, we are not sure that the majority understand just what a big change the proposed social taxonomy represents. To us, it is no great surprise that a regulatory body such as the EU is broadening its focus from the environment to social aspects of ESG and Sustainable investing. The UN SDGs’s, which make up the foundation of much of the regulation, consider “sustainability” from a 360 degree perspective. So, they not only focus on the environment but rather connect social and environment – not just at goal level but at the levels of targets and indicators as well.
  • The social taxonomy plan is only one part of what the EU is creating in terms of regulations on social sustainability and governance. A number of directives are currently being drafted in parallel which have a great “how do you ensure social sustainability in reality” component to them. The EU is clearly linking sustainability to what has always been at the core of the EU: strengthening the social market economy and helping the guarantee that the Union is capable of ensuring stability, jobs, growth and investment on a long-term basis.
  • For our industry, these new regulations and directives may be new. But it is wrong to think of it as the nation states or the EU “putting THEIR responsibility on others”. In a legal sense it is simply the competent legislative body doing what they are supposed to and requiring relevant entities (ie companies and asset managers) to follow the law. Interestingly, it is clear from the proposed plan that the social taxonomy goes beyond the labour space, also looking at the broader effects on society.
  • The current surge in activity at the judiciary level, for instance hearing cases on environmental damage based on human rights law, is a factor that will spur the EU to create clear regulations focusing on investors and businesses. This will reflect the actions and impacts of cross border operations and investments in non-sustainable activities (environmental as well as social) and gives clear basis for what constitutes legal and illegal actions.
  • If the current EU socially focused legislation programme follows the path we expect, the impact on asset managers and companies will become material. The good news is that there is time to prepare, the bad news is like environmental impact, the wider “costs” of not preparing could be very significant. Now is the time to start preparing.
Sustainable Investing LLP is an appointed representative of Varramore Partners Limited which is authorised and regulated by the Financial Conduct Authority (“FCA”) in the United Kingdom (“UK”). Sustainable Investing’s FCA Firm Reference Number is 946165.

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