Sustainable Investing weekly blog: 3rd September 2021 (Issue 7)

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 next weekly blog will be Friday 24th September, I am off on what I believe is a well earned break. Happy reading.

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 dan@sustainableinvesting.co.uk. 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 potential for grid forming inverters to allow us to have more renewable electricity generation on our grids,; then we look at the arguement that the shift to EV’s will make “all cars look the same” ,  we begin to examine the debate around how should we think about our forests in a net zero world, and our BST-Impact partners examine the potential implications of the proposed EU Human Rights Due Diligence Legislation (trust us, its one you need to watch) 

This week’s top story : Renewable electricity generation




Grid forming inverters – modelling, control and applications (IEEE)

Main points of the story as published

  • This (very techncial) paper surveys current literature on modeling methods, control techniques, protection schemes, applications, and real-world implementations pertaining to grid forming inverters. Electric power systems are increasingly being augmented with inverter-based resources (IBR) such as solar, wind and battery storage. Conventional synchronous generator-based voltage and frequency control mechanisms are still prevalent in the power industry.
  • Therefore, IBRs are experiencing a growing demand for mimicking the behavior of synchronous generators, which is not possible with conventional grid following inverters (GFLIs). As a solution, the concept of grid forming inverters (GFMIs) is currently emerging, which is drawing increased attention from academia and the industry. This paper presents a comprehensive review of GFMIs covering recent advancements in control technologies, fault ride-through capabilities, stability enhancement measures, and practical implementations. Moreover, the challenges in adding GFMIs into existing power systems, including a seamless transition from grid-connected mode to the standalone mode and vice versa, are also discussed in detail.
  • Recently commissioned projects in Australia, the UK, and the US are taken as examples to highlight the trend in the power industry in adding GFMIs to address issues related to weak grid scenarios. Research directions in terms of voltage control, frequency control, system strength improvement, and regulatory framework are also discussed.

Our take on this

  • I have wanted to right about this in the weekly blog for some time, and this has given me the excuse. This is a very technical paper, written for other electrical engineers, but the messages are fairly straightforward. Some of the grid instability problems that adding more renewable electricity generation creates, can potentially be solved without massive capex spend. To be clear, this is not a silver bullet, but when used with other technologies including battery storage and interconnectors, electricity generation systems made up of c. 80% plus renewables look achievable. In advance, I apologise for over simplifying the argument, we are going to prepare a longer, more detailed research piece shortly.
  • First, what is the problem. Solar panels, wind turbines and batteries, use inverters and power electronics to convert their direct current (DC) output to alternating current (AC). This is done at the frequency of the grid they’re connected to (either 60 hertz or 50 hertz).  The type of inverters most commonly used with renewables (grid following) are generally designed to follow the grid voltages. This is fine when the grid is working normally but not so good if the frequency or voltage on the grid is unstable.  This characteristic means that a major challenge with the increased penetration of renewable generation sources in power systems is voltage and frequency regulation. This sounds a bit technical and geeky, but it can have very real implications, such as in the wide spread blackout in the South East of the UK in 2019. The exact sequence was complicated, but part of the cause was a grid frequency drop that lead protection systems to trip out some renewable resources. This problem cascaded and the end result was power cuts until the system could be brought back into balance and frequency stabilised.
  • What might part of the solution be – grid forming invertors. Rather than just follow the frequency on the grid, they actively create the frequency that the grid should be operating on. Theis means they can positively contribute to returning the grid to a more stable configuration, reducing the incidence of blackouts and potentially allowing weaker grids to support a much higher percentage of renewables in the supply mix. This technology is not widely used, more work is needed to achieve this, but it has already been used on a number of real world renewable and battery storage projects. So, it’s well past the pilot stage. Australia has been active, with projects including the Dalrymple Battery Energy Storage System (BESS) (supplier – ABB) in South Australia, the Hornsdale BESS (Tesla), also in South Australia and the Alinta Energy BESS (ABB) In Western Australia. Other examples include two GE projects in the US and Dersalloch Windfarm in Scotland (National Grid UK, Scottish Power & Siemens Gamesa). Other advanced inverter capabilities have been tested in Canada and Texas, dating back to 2010.
  • What are the big barriers to its wider adoption? Some relate to a wider acceptance by grid operator and renewables developers, which will take time. But the big one is probably regulatory. Current payment structures will need adaption, but changes are already taking place in some markets that give us confidence that over the coming years the use of grid forming investors will become more common.

Electricity applications – EV’s 



This is why all electric cars look the same (Wired )

Main points of the story as published

  • The future of car design is all about skateboards and top hats. The former refers to the flat, often self-supporting chassis of an electric vehicle, housing a large battery pack in the middle and motors at either end, along with the suspension, brakes, and wheels. With far fewer moving parts than an internal combustion engine, the battery pack and motors sat in this skateboard chassis perform in a near-universal way, no matter which manufacturer the vehicle comes from.
  • So what happens in 2035, when the sale of new internal combustion cars in the UK and elsewhere is to be outlawed? Unless there is an explosion in electric motor diversity between now and then, bold new design and a renewed emphasis on brand identity through aesthetics, rather than drivetrain character, will take centre stage. Car brands that used to rely on engineering superiority will no longer have such an advantage. Simply put, the car’s power plant will no longer be the key battle ground. 
  • Change will not happen overnight. Even when facing the existential crisis summoned by the looming ban on internal combustion, the automotive industry is a glacial beast not used to sudden changes of direction.  Meanwhile, Rimac Automobili chief executive Mate Rimac says that with EV platforms “performance is being commoditised, or democratised,” and believes commonality between brands has already occurred.

Our take on this

  • This is a topic I find fascinating, will the shift from internal combustion engines to EV’s really change what drives consumer behaviour in car buying? I suspect that the short answer is yes, but its not the shift to EV’s alone that drives this, it’s when this is combined with other social changes.
  • What other changes? The first one is the shift to buying online. A recent McKinsey article ( seven key steps) highlighted what they saw as the seven key skills automotive OEM’s will need for the future. No 4 was creating a full omnichannel approach, and No 5 was reskilling the sales team. When combined with other changes they see coming around brand image and an after sales service re boot, you can see a different model for selling vehicles, built around online. The other longer-term change is the shift to transport as a service. Uber, Lyft, Ola, Grab  etc are a big part of this, and I venture to suggest that what brand the vehicle is, is less important to the driver than reliability, cost etc.
  • We are not suggesting that the industry business model will change overnight, but with OEM plants and platforms having long life cycles, now is the time to start preparing for this shift, as its will not just impact OEM’s.

Agriculture & Natural Capital



Finland’s forests fire up debate (FT)

Main points of the story as published

  • This article in the FT looks at the debate in Finland, around how their forests are managed and what the timber is used for. Finland is pretty much at the epicentre of this debate, with forestry being an important sector and c. 73% of the country covered by woodland. The industry accounts for c. 20% of the country’s exports.
  • The big debate, not just in Finland but across the world, is basically about forests as carbon sinks as against their use as a possible alternative raw material source to replace fossil fuels. The article highlighted moves by companies such as UPM, to “reinvent” themselves as producers of feedstocks for conversion into biochemicals. These could then be used in everything from aviation fuel through to textiles. According to the FT, the debate caused issues within the countries five party coalition, pitching the Centre party (big in rural areas) against the more urban Greens.

Our take on this

  • This is an emerging topic from the generalist investor perspective. We are working on a more detailed piece but for now we want to highlight some topics we think investors need to be thinking about. The first is the bio fuel debate. The current state of play in Europe is that some biofuels do not meet the EU taxonomy rules as a green investment. This has been controversial.
  • The debate is largely about their sustainability. As an example, looking at sustainable aviation fuel, crop-based biofuels are excluded “because of their limited environmental benefits, limited greenhouse gas savings potential, and the fact that such biofuels are in direct competition with the food and feed sectors for access to feedstock.” Under the EU executive proposal, SAFs must be derived from advanced biofuels, which stem from agricultural and forestry waste, and from electro-fuels, such as green hydrogen. (biofuel reform risks undermining waste based solutions).
  • The second debate is carbon offsets. There is a broad philosophical debate in the sustainability sector around are removals better than offsets (removal vs offsets) . Plus, what is the value of a forest carbon offset if it disappears in a forest fire. From an accounting perspective, does this equate to an asset write off ? And of course, you cannot discuss this topic without touching on the topic of do they work, are they being properly monitored (do carbon offsets work) and even the extra thorny question of paying owners not to cut down their forests (even if they weren’t going to anyway) (not cutting down trees)
  • We broadly agree that carbon offsets and even carbon extraction will have to be part of the solution. We would love to believe that nations could deliver on the measures that are necessary to deliver net zero 2050 – but based on what we have seen we are sceptical. There are a lot of promises and while there is some progress, some of what is being delivered seems to be around kicking the can down the road some more (blue hydrogen, carbon capture etc).
  • When we talk with some investors and corporates, we increasingly hear the argument that we need to fix the economy first, or that we want to change, but not just yet (what we are starting to call the St Augustine argument “Lord, please make me chaste – but not yet”) or that we will do it if the government will pay. It maybe that some expansion of the carbon pricing model might work – in the European case a super ETS ? It’s a big debate and its one we are coming back to in a more detailed research piece later – but for asset owners and the generalist portfolio manager, its definitely one to start going up the learning curve on.

Social and Legal factors – BST Impact


Photo by Mahosadha Ong on Unsplash

European due diligence regulation (cbi.eu)

  • Over the last few weeks our partners at BST-Impact have been looking at the fact that that business enterprises have increasingly defined legal roles and responsibilities when it comes to respecting human rights. Plus they have explored how recent UK cases have opened the way for parent companies to be held accountable for the acts of their subsidiaries, as well as for acts they commit on foreign soil. This week they extend this analysis, looking at the implications of the proposed EU Human Rights Due Diligence Legislation.
  • The legal approach being followed in Europe seems to be clear (at least to us) – 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. It is clear to us that a combination of the application of national law (such as the UK cases among others) and the increasing alignment of European law with the United Nations Guiding Principles on Business and Human Rights (UNGPs) means that companies, and investors, need to become more aware of risks all the way through the supply chains.
  • Just a reminder. This news story and the views are from our partner BST-Impact. 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. This blog comment is a short version of a longer article, which we will be publishing shortly as a stand-alone blog.  For follow up, consultancy and training etc, BST-Impact can be found here.

BST- Impact take on this

  • In early summer 2020 the Policy Department for External Relations the within Directorate General for External Policies of the Union published the proposal “Human Rights Due Diligence Legislation – Options for the EU”. This is now working its way through the EU regulation making process.
  • More and more legislation is being proposed in the EU as well as in EU Member States individually on Human Rights Due Diligence in value chains. This means that the main concern of responsible business can no longer be only how to mitigate negative externalities of business practices, or even how to find ways in which businesses can anticipate and prevent negative impact in the first place – but also how to carry out EFFECTIVE human rights due diligence missions in your value chain.
  • There is a clear focus on concepts such as “accountability”, “transparency” and “redress” as well as “effective control”. This means that if you are able to carry out human rights due diligence you should  1) be transparent about your challenges; 2) set up processes that will allow you to identify how to mitigate negative effects in a step by step way and with a reasonable time line; 3) create target mechanisms for redress (and avoid being fined or dragged to court because you did not act); 4) determine where your social sustainability strategy needs to be strengthened to avoid the same issue popping up elsewhere; 5) report meaningfully on progress.
  • The concept of human rights due diligence is understood in proposed EU regulations as being in line with the United Nations  Guiding Principles on Business and Human Rights (UNGPs), which described it as a process aimed at operationalising corporate responsibility to respect human rights. If future human rights due diligence regulation is formed as per current proposals it would require companies to engage actively in analysing, mitigating as well as remedying any adverse impacts on human rights based on and connected with their own activities in business relations.
  • This influences not only effects of exploitation of labour in supply chains but effect on rights such as the right to health, education, decent standard of living, housing, property, participation and non-discrimination will have to be considered widely in the societies affected by your investments. The concept of “effective control” is paramount in this context. Something we will examine further in  future blogs and research.

One last thought

My job as a director is not to challenge management

Research from a team at Texas A&M implies that many company boards “viewed their jobs as primarily supporting managers, not monitoring them”, with many saying that “the best way to protect shareholder value or help their company thrive was by collaborating with the chief executive officer”. From my time in active portfolio management, I always suspected this was the case but ….

I am hoping this is just a US phenomenon, but I wouldn’t bet on it.

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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