Sustainable Investing weekly blog: 10th June 2022 (issue 35)
Story tags for this blog
Our weekly summary of the key news stories, developments, and reports that are impacting investing in the wider climate related transitions and a greener/fairer society.
This week our top story follows moves in New Zealand to regulate agricultural methane emissions. Next up, in Distributed Energy we ask, is the proposed EU regulation on cross border carbon tax dead, and what might this mean for efforts to tackle the hard to decarbonise sectors. Then in Built Environment, we cover a report on barriers to domestic demand side management in Europe, we promise its much more interesting than you think. Finally, in Transport, we pick up on moves in the US to accelerate EV charging systems. In our One Last Thought, we cover a report that looks into the increasing use of a legal framework known as the investor-state dispute settlement process (ISDS) to claim compensation for moves by governments to limit fossil fuel supply.
Before we start on the stories, you may have spotted there was no blog last week - the Queens Platinum Jubilee gave all of us a long break. So this is a bit of a catch up weekly. Plus, we have been working on a new blog series called The Bigger Picture. As we build out our audience, moving away from specialist PM's toward educating asset owners, we get more questions about "how does this news story fit into the bigger picture". We have started answering this question with renewables and distributed energy, and the blog can be found here. Its a long read (no apologies for that - its a big topic), but it should give you the all important context. More Bigger Picture blogs to come, with Agriculture/Food/Natural Capital coming up next.
Top story : Can we really cut agricultural methane emissions
Main points of the story as published
The pitch is that while dairy contributes nearly one in every three dollars earned from total New Zealand goods exports, the sector is beset by multiple problems. There is pressure to farm more sustainably and meet environmental standards. There are acute labour shortages and mental health concerns. And dairy farming is more political than it has ever been in New Zealand. Town and country are increasingly polarised, driven by groups purporting to speak for both sides, whether it is Greenpeace in the cities or Groundswell in the country.
The latest challenge the industry is facing is methane. Almost half (48%) of the countries green house gas emissions come from agriculture, mainly methane. If New Zealand is to get even close to its current 2050 targets (a 67% reduction on 2020 levels), technologies to mitigate methane and other emissions cannot come on stream fast enough. This is the holy grail, or the promise of the near future. But cutting methane will not be easy.
Our take on this
Its good to be writing about New Zealand (where I grew up & the country I still think of as my other home). The first point to make is that this is not just a New Zealand problem, although for most other countries agriculture is not as material a contributor. For instance, methane accounted for 12% of the UK’s greenhouse gas emissions in 2019, and its 9.6% for the US.
The New Zealand proposals, tabled by a joint industry and government working party, are for a mixture of levies and incentives, with different rates for methane and nitrous oxide emissions. The framework is expected to lead to an estimated reduction in methane emissions of between 4% and 5.5% (by 2030), depending on the availability of technology options. So not really moving the dial. The proposals will now be considered by the New Zealand government, with a final decision due by the end of the year.
The proposals have been criticised by environmental groups as being insufficient, but the reality is that other than materially cutting livestock numbers, there are currently few meaningful mitigation measures. Options include breeding lower emitting animals, alternative feeds and methane inhibitors/vaccines.
Good progress has been made regarding lower methane emitting sheep, but work on cattle and feeds is less advanced. The other side of the debate is around mitigation, so land use changes to improve carbon sequestration. Here the science is still encouraging but still evolving, with challenges around measuring the impact, as this article highlighting concerns about the Australian carbon sequestration programme illustrate.
Given the scale of the problem globally, there is massive potential for those companies that can make the required breakthroughs.
Distributed Energy – is the EU cross border carbon tax dead
Main points of the story as published
The European Parliament voted to reject a proposed reform of the EU carbon market, the Emissions Trading Scheme (ETS). Parties on the far-right and the far-left, as well as the Greens and Social Democrats, formed an unlikely alliance on Wednesday by rejecting the proposed overhaul. The rejection was by a clear majority, with 340 votes against and 265 in favour, with 34 abstentions.
According to Liese, an influential German MEP from the centre-right European People’s Party (EPP), left-wing parties tried pushing the reform too far by calling for a 63% cut in emissions under the ETS, higher than the 61% initially tabled by the European Commission in its proposal last year. The Greens and the Social Democrats, for their part, accused Liese’s EPP of caving in to the fossil fuel industry by seeking to water down the proposals.
Initially tabled in July last year, the reform of the EU’s carbon market will now be sent back to the European Parliament’s environment committee, which will attempt to forge a new compromise. As a consequence, related votes to introduce an EU carbon border tax and climate social fund were postponed until further notice as both proposals are closely tied to the ETS reform.
Our take on this
Expanding the European emissions trading system (ETS) was always going to be a challenge. One area of controversy was the planned removal of free allowances from large portions of the industrial sector. Given what was at stake, we could always see the risk of that process becoming mired in political lobbying.
As early as August last year, analysis was indicating that the plan was not as ambitious as first thought. The proposals as drafted meant that even by the end of the first stage, some 53% of total free allowances would still remain. This meant sectors such as glass, chemicals, and refinery products, would see no change and hence no pressure to decarbonise. Perhaps more importantly, the introduction of the phase out of free allowances for the other impacted industries would have taken place over more than 10 years (ending around 2035), so very gradually. Hardly in the spirit of "we need to act now".
The proposed carbon border adjustment mechanism (CBAM) was another mechanism thought up to give European industry relief, this time from "unfair competition" from companies outside of the bloc who did not face a similar price on their carbon emissions. In principle it makes sense, but the practicalities of its implementation are immense.
China and the US very quickly raised objections on the basis of a violation of the principles of free trade, with talk of appeals to the WHO and reciprocal tariffs. More recently, certain industries sought export rebates, to make up for the lost free allowances and to allow them to compete in international markets.
Its possible the EU will persist with the plan, but they are finding it increasingly difficult to square the contradictions inherent in the scheme - largely arising from the unwillingness of key trade partners to move forward. The CBAM is not yet dead, but its very ill, and sorting out the moving parts is likely to take longer than the initially proposed 2023 start date. This could have material implications for efforts in the hard to decarbonise sectors.
Built environment - household level demand management
Main points of the story as published
We must create environments in which electricity customers are willing and able to modify the flexible, non-time-specific proportion of their electricity demand in response to system conditions. By doing this, we can harness the natural advantages of high renewables penetration; mitigate the inherent challenges of variable generation; and avoid unnecessary costs of backup power, network management and upgrades, and more expensive alternative flexibility options.
Demand-side flexibility is therefore essential to balance supply and demand and make best use of renewable generation. Because it increases system flexibility and enables local grid constraints to be managed more efficiently, demand-side flexibility creates a virtuous cycle by facilitating faster decarbonisation via electrification of end uses such as transport and heat, as long as smart readiness is built into new products.
Demand-side flexibility is already mobilised to some extent, largely through commercial or industrial users contracted to turn energy-using operations off or down at times of extreme system stress. But household level demand management is still new. despite the fact that collectively, households offer the greatest source of demand flexibility.
Our take on this
Like the Spanish building refurbishment proposals we covered in the last weekly blog, lots of this report makes sense to us. Some very practical examples of what can be done include controlling heat storage systems, residential scale on-site renewables, variable EV charging, smart appliances, and building wide energy management systems.
One specific use case example in the report is around electric home heating, assuming of course that we actually get around to replacing existing gas boilers. The majority of Nordic homes are all-electric. Home energy company geo has developed a system through which heat in each room or zone is smartly controlled from an app.
Users set parameters for how warm they want their rooms at which times and the system calculates the time it needs to heat the room while taking power market spot prices into account. Initial analysis, excluding spot pricing, shows that homes can on average save around 15% on their energy bill. And modelling suggests that including spot prices could deliver a further saving of 10%, resulting in a total savings of around 25% or €500-€750 per year per household.
At a time when utility bills are rising rapidly across Europe, this report seems very timely. But, the concept will remain just that unless regulators start incentivising the use of flexibility through market pricing signals. Its not just the individual household consumer that could benefit, its the entire electricity system.
Transport - EV growth needs more chargers
Main points of the story as published
The current charging experience in the US is intensely fragmented, especially for people who don’t own a Tesla. There are approximately 41,000 public charging stations in the United States, with more than 100,000 outlets. But finding one that actually works or isn’t locked inside a gated parking garage can be a bit of a scavenger hunt.
The Biden administration is revealing a new set of standards to help accelerate the installation of 500,000 electric vehicle chargers across the US by 2030. The new standards give states guidelines on awarding contracts for EV charging projects, And they outline the types of projects that won’t receive federal money, including proprietary charging stations that can only be accessed by one company’s vehicles, like Tesla’s Supercharger network.
Earlier this year, the administration announced that it will direct the $5 billion to states to create a network of EV charging stations along designated “Alternative Fuel Corridors,” defined as approximately 165,722 miles of the National Highway System, covering 49 states and the District of Columbia.
Under the new standards, EV charging stations would be built every 50 miles along major highways, and no more than 1 mile off those corridors. They direct states to ensure that EV charging stations are also built in less dense parts of the country, like rural and tribal communities.
And, they require EV charging companies to provide customers with real-time information, so they can tell when a charging station is occupied or broken. Plus they require at least four 150kW DC fast charging ports per station — which would go a long way toward addressing the concerns of people who worry about the utility of electric vehicles on road trips or other longer journeys.
Our take on this
While there are a number of barriers to mass EV market adaption, it looks as if the most important is charging. We fully accept that this is not totally rational, but its people who buy cars and people are often emotive in their decision making.
A recent World Bank report suggests that subsidising charging infrastructure is much more cost effective than subsidising the purchases of electric vehicles. In fact, their analysis suggests that investing in charging infrastructure is 4x to 7x more cost effective than subsiding the purchase of the car.
The EV market share ranges from 67% in Norway, to over 20% in Sweden and Netherlands, and 3-5% in China, Spain, Canada, and USA. Analysis shows that these differences owe much more to variations in the density of charging infrastructure than they do to the level of financial incentives. In terms of consumer subsidies, the total financial incentives amounted to $43 billion from 2013 to 2020 in the top 13 EV markets. So the $5 billion the US Federal government is proposing to spend, could make a material difference.
Our last point though, which we have discussed before, is that its not obvious that there is money to be made from providing stand alone charging stations. What looks like a better model is providing cheap or even free charging as a way of increasing dwell times at shops and other consumer destinations.
One last thought
We have discussed this before, but its worth repeating. Many governments, supported by the wider public, NGO's and lobby groups, have sought to legislate to reduce fossil fuel supply. These efforts, if they succeed, will financially affect asset holders, particularly in the upstream (exploration and production) and midstream (transportation and storage) portions of the supply chain. Demands for compensation will ensue, and when the companies involved are foreign, legal claims may be brought to international arbitration in a process known as investor-state dispute settlement (ISDS) .
The Intergovernmental Panel on Climate Change (IPCC) has recently acknowledged that ISDS cases could lead to states refraining from, or delaying, measures to phase out fossil fuels. Thousands of bilateral and plurilateral investment treaties have been signed by states over the last 50 years .
Although only a small number of ISDS cases to date concern climate actions, this will likely change if governments begin to adopt more stringent policies, particularly if those policies directly affect fossil fuel investors. States can argue that investors should have anticipated that they would be affected by climate policies, given long-standing scientific consensus that fossil fuels are the primary source of greenhouse gas emissions and international agreements on climate change mitigation dating back 30 years.
A recent report on investor-state dispute settlement (ISDS) actions found that when such cases were decided on by their merits, fossil fuel investors emerged victorious 72 percent of the time — earning, on average, $600 million in compensation.
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”).