Sustainable Investing weekly blog: 20th May 2022 (issue 33)
Story tags for this blog
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.
This week our top story picks up the agriculture/food shortage theme in Natural Capital, examining the extent to which drought and water shortages seem to be becoming the norm and their impact on agriculture. Next up, in Transport, we look at analysis that suggests that "there is no shortage of raw materials to meet global BEV demand", then in Built Environment, we report on Dutch plans to make heat pumps mandatory. Finally, in Distributed Electricity, we flag plans by the European Union to use contracts for differences to switch current grey hydrogen to green. In our One Last Thought, we cover comments attributed to Stuart Kirk, the HSBC head of responsible investment. There must be a number of long term asset owners around the world now thinking, maybe we need someone to watch over the watchers.
Before covering the weekly news - its good to be back. Some of the gap has been due to Easter but mostly its been about some changes we have made to the business. Sustainable Investing no longer offers regulated services and so from the 7th April 2022 we stopped being an Appointed Representative of Varramore Partners. This means that going forward we are not providing investment research as defined in COBS 12.2.17 of the FCA’s Handbook of Rules and Guidance (“FCA Rules”). Just a reminder, the old blogs were written when we were still an appointed representative, so the disclaimers etc may read rather oddly.
As a result of the changes, there will be a small shift in focus for these blogs. Investing is still front and centre, but we are tilting more to the perspective of the asset owner, so pension funds, endowments, insurance companies, family offices, sovereign wealth funds and private wealth. And we have a new website to go with our new focus. We will be connecting to our sustainableinvesting web address early next week, so if you have any problems accessing the blog, just go to www.sustainableinvesting.co.uk.
We believe that the climate related transitions are not just going to alter what makes a good investment. They will also dramatically change the role that asset owners need to take in the investment process. The future we see is a greater involvement by asset owners in the investment identification process (answering the question - where do we want our money to be allocated) and in engagement (how we want the leverage our investment gives us to be used). Both of these will require asset owners to be better informed about the likely direction of travel for the various climate related transitions. If it is to deliver real change, sustainable investing will need to become more of a partnership between the asset owner and the asset manager. Underlying this will still be the key point - sustainable investing is still investing. We need to make a fair financial return to fund peoples retirement, health care, and education and to preserve our capital.
Top story : Water - no longer everywhere
Main points of the story as published
In the spirit of a picture is worth a thousand words, this article is largely a photo montage of how different Lake Mead in the US looks now. The lake, North America’s largest artificial reservoir, formed on the Colorado River between Nevada and Arizona, has shrunk to historic lows—dropping to about 30 percent of its capacity.
The reservoir is a major source of water for Arizona, Nevada, and California, as well as part of Mexico. It serves nearly 25 million people and its critical for a huge agricultural areas. A mixture of drought, climate change, and growing regional demand for water means the reservoir is now at its lowest levels since the 1930s. Its water level is now 1,050 feet (and falling), down from an all-time high of 1,225 feet in 1983.
Our take on this
It will come as no surprise that we are worried about the future of our agriculture system. A combination of land degradation, water shortages, high fertiliser costs, plus upcoming regulation of nitrogen runoff and pesticide use, mean the system is under increasing stress. And this doesn't just impact food growing companies, it has implications all the way up the food chain, including food price inflation. The good news is we have nearly all the solutions we need, we just need to roll them out at scale.
I was going to write some more about the approaching food crisis, as covered by numerous commenters and news outlets, including this story from the BBC. Instead, I have gone back a bit to first principles, thinking about the inputs we need to make agriculture both successful and sustainable. Problems such as water shortages, have been building for some time, and the end of the war in the Ukraine, while obviously desirable, is not going to make them "go away". In previous weeks we have talked about the importance, and changing nature, of fertiliser. This week its water.
First, the big picture. According to the World Bank, irrigated agriculture represents 20 percent of the total cultivated land and contributes 40 percent of the total food produced worldwide. Irrigated agriculture is, on average, at least twice as productive per unit of land as rainfed agriculture, And according to the OECD, agriculture irrigation accounts for 70% of water use worldwide.
Returning to the Lake Mead story, back in August 2021 (covered here), the US Federal Government declared a water shortage at Lake Mead, which triggered cuts in water supply, initially impacting farmers in Arizona. Beginning this year (2022), they will be largely cut off from the lake, with smaller reductions for Nevada and supplies destined for Mexico.
But the problem goes much wider geographically than just Lake Mead. This report from the US Department of Agriculture (pdf), highlights both the stresses being faced from surface water supplies and the consequential shift to using ground water, This can only be a short/mid term solution as "this response raises sustainability concerns, as groundwater levels in many major aquifers supporting irrigated agriculture are in decline across the United States". The report goes on to suggest possible solutions including " continued shifts in area irrigated, increased irrigation efficiency through system upgrades, enhanced water management practices, changes in regional cropping patterns, and shifts in water supply sources, including potentially novel sources of irrigation water such as recycled or reclaimed water".
Its a topic we have written on before, including the increasing desertification of countries like Spain. It is reported that c. one fifth of Spain is at risk of turning into desert and over 30% is already impacted by desertification. This article reports that over 90% of overall water consumption in Spain (plus Greece and Portugal) goes to agriculture. According to EU data, Spain is the second largest producer in Europe of both vegetables and fruit (after Italy). So problems here impact food supply and prices across the region.
What might the solutions be ? The obvious ones include a more selective application of irrigation (precision ag) and potentially spending more on moving water from regions with high rainfall, although this raises the question of who pays. More challenging solutions could include the use of recycled or reclaimed water, relocating agricultural production (producing locally - potentially using renewable energy to heat greenhouses etc) and maybe changing consumer preferences.
This is an interesting report, from a European Union supported project, that looked at a wide range of alternative technologies and management strategies. None are a silver bullet, but when used in combination with other approaches, they seem to have potential.
From an investor perspective, this is a challenge that is only going to get more material. To solve it we are going to need to think differently about the risks in our food systems (and the companies involved), all the way from farming to food retail. But we will also probably need to push harder to help bring some of the solutions to commercialisation. the potential payback could last decades.
Transport – is there really a shortage of raw materials for BEV's ?
Main points of the story as published
T&E’s study shows that there would be enough lithium and nickel metals to make up to 14 million battery electric cars (BEV) globally in 2023. This level of production is 55% higher than the current market projections. Looking forward to 2025, even if raw material supplies tighten and remain below battery factory capacity, 21 million BEVs could still be produced – almost 50% more than market estimates.
However, the report goes on to say that this does not guarantee Europe’s supply. Growing electric cars sales in China and the US mean that there is competition for the critical raw materials, with both countries introducing measures to ensure access to key raw materials.
Furthermore, there are legitimate concerns about the effect a tight commodities market will have on battery prices. A long period of low commodity prices has seen underinvestment in new metal mining, while short-term Covid-induced disruptions in supply chains, and the war in Ukraine have added to pressure on prices.
But, the T&E study claims this is not expected to last. Mining and recycling companies are already reacting to high prices by announcing expansions, which should lead to prices stabilising in the next few years.
Our take on this
This was very nearly the top story, as it brings together a whole series of interrelated themes. First up, politics. The report makes the point that while much of the political focus has been on Russian gas, Europe also (currently) imports a lot of Russian oil, with two thirds of this used in transport. Although the EU has proposed a complete ban on all Russian oil within the next six months, consensus on this is still being sought. Hungary, the Czech Republic and Slovakia seem to be the main countries holding out. It has been reported that Hungary is seeking an exemption from the embargo for at least four years and wants, as a minimum, €800 million in EU funds to re-tool a refinery and boost the capacity of a pipeline to Croatia.
The second interesting theme is nickel. This is an important raw material for NMC (Lithium Nickel Manganese cobalt) batteries. According to analysis by Fitch 21% of battery grade nickel (class 1) comes from Russia. (Note -you will need to register to read the full article - its worth it though, especially if you are a raw materials geek like me). Sanctions on Russia hit exports, although exactly by how much is unclear. A bigger problem is ""a severe lack of sufficient new Class 1 nickel mining projects in the pipeline". Even back in December 2021 Fitch saw "a tight supply of battery grade Nickel over the next 2-3 years".
T&E however argue that, based on nameplate capacities (yes, we know this has limitations) world production of battery grade nickel could be 380k tonnes in 2022, rising to 400k tonnes by 2025. This means (based on their analysis) there is enough supply to produce the targeted c. 11m nickel based battery packs in 2023 but after that nickel based battery production effectively flat lines (only enough for 12m batteries in 2025).
So what "rides to the rescue". Its LFP (Lithium Iron Phosphate) batteries. This is probably not the place to dig down into LFP vs NMC batteries, other than to say demand for LFP batteries is expected to rise rapidly. And I mean rapidly - there is some interesting commentary from Brenden Jephcott on LinkedIn, covering both expected growth rates, and which automotive OEM's are already committed to LFP.
The big advantage of LFP batteries is that they contain no nickel or cobalt. Tesla already uses LFP in nearly half of its EV's (with the shift being partly driven by supply worries) . T&E estimate that LFP battery production capacity will be able to add 4-5m BEVs annually by 2024, rising to 8m in 2025. This article from Reuters provides a non exhaustive list of proposed LFP battery (or component) factories targeting opening by 2025.
Dutch to make heat pumps mandatory ?
Main points of the story as published
The Dutch government intends to ban new fossil fuel-centric heating system installations as of 2026, while introducing the mandatory use of heat pumps or connections to heat networks. Few countries are as reliant on gas to heat homes as the Netherlands. In 2018, fossil gas covered 71% of residential demand,
The Netherlands will now become the latest country in the EU to mandate heat pumps. The “trigger point” for the mandate will be the replacement of a house’s heating installation, like a boiler. Up to and including 2030, the government has reserved €150 million per year to continue to support homeowners with the purchase of a (hybrid) heat pump.
Additionally, the government will partner with the installation sector and the heat pump manufacturers. The installers’ association will ensure training locations in every region and special courses for “late entrants” to the sector, allowing for inter-industry movement of labour.
Our take on this
Regular readers will know that we have been positive on the contribution heat pumps can make to decarbonising home heating for some time. Our caution about moves like this is that they only partly address the key issues. A recent report from Agora Energiewende and the Regulatory Assistance Project picks up on two big challenges. First, the economics do not work in favour of heat pumps at the moment, Compared to gas boilers connected to extensive urban gas networks or oil boilers used in rural areas, heat pumps can cost four to five times as much to buy and install. Subsidies are a start but not enough on their own. The "sticker shock" is a big barrier, especially for lower income households. Some form of heat as a service (HAAS) offer could help with this.
Second, long-term costs are another barrier. Heat pumps are much more efficient than burning fossil fuels in terms of converting energy inputs into building heat. But in many parts of Europe, electricity is costly and fossil gas is not. So, as well as subsidies, Europe needs a more coherent policy framework
Is Europe's grey hydrogen going green ?
Main points of the story as published
The long-awaited REPowerEU plan unveiled a host of renewable hydrogen measures to help wean Europe off Russian gas. Among them is a plan to roll out carbon contracts for difference (CCfD) subsidies for green hydrogen using cash from its Innovation Fund “to support a full switch of the existing hydrogen production in industrial processes from natural gas to renewables and the transition to hydrogen-based production processes in new industrial sectors such as steel-making”.
As previously announced, the new REPowerEU plan sets a target for ten million tonnes of green hydrogen to be produced in the EU by 2030, with a further ten million tonnes imported. The combined 20 million tonnes would require approximately 600GW of new wind and solar power, and 200GW of electrolysers.
Our take on this
There is a lot of detail in this plan, which is still to be ratified by the member states and the European Parliament. We are sceptical that progress can be as fast as they hope, but the direction of travel is becoming clearer. The intention is clearly to give the European green hydrogen industry a big push. In this regard, we are supportive of the focus on replacing existing grey hydrogen with green - this is the easy win.
There is some more detailed work yet to come before we have total clarity. Although the plan referenced the proposal for the delayed delegated act on the definition and production of renewable hydrogen, and proposals for carbon contracts for difference, such measures were not published with the latest commission announcement.
One last thought
Stuart Kirk, the HSBC head of responsible investing, caused quite a stir at a recent FT Moral Money event by stating that climate risk is not something investors need to worry about. HSBC AM CEO Nicolas Moreau said that the remarks by Kirk do not reflect the views of HSBC Asset management nor the HSBC Group in any way. Post the remarks, which are widely reported in publications such as Forbes, we expect asset owners to increase their efforts to have a greater say as to where their capital is invested and how their asset managers engage. As we say at the start of this blog sustainable investing will need to become more of a partnership between the asset owner and the asset manager, which will lead to change on both sides.
Some process and semi legal stuff . The format of the blog 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 (asset owners, asset managers and companies). We are really keen that you read the original report or article. Lots of people out there are doing some really interesting and valuable work and part of purpose of these blogs is to bring this to your attention, while at the same time giving it context.
The focus is on news flow that we think should change the markets perception of the investment risks and opportunities coming from the big themes around the climate transitions and ESG. So not the place to come to for news about the latest ESG or net zero promise, or that has already been well covered in say the FT. Our approach is unashamedly long term, this is a multi decade investment theme. So we ignore short term noise.
Finally, and very importantly, nothing in this blog should be construed as providing investment advice. For company and/or fund specific investing advice and recommendations, you need to look elsewhere. In more formal language, 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”).