Sustainable Investing weekly blog: 12th Nov 2021 (Issue 15)
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 COP26 comes to an end (although talks may continue over the weekend), we could not resist picking up a story from the proceedings. Our top story examines energy efficiency, the dog that didn’t bark at COP, and why solving the issues around it could be one of our biggest contributors to reducing green house gas missions. We follow with a report from RAP on the long term challenges coming up for gas regulators (& gas utilities), then we examine how (in our new demographics segment) the stay at home revolution has not benefitted everyone, plus in Agtech, we review the possible impacts (or lack of) of the strike at Deere. We finish with a guest story from our human rights expert on the climate consequences already hitting Africa and how they will impact human rights in the region. Our last thought looks at how unwilling we appear to be to really make our clothes buying greener.
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 : energy efficiency, the dog that didn’t bark (apologies to Sherlock Holmes)
Main points of the article as published
There is no “energy efficiency zone” or “energy savings pavilion” at COP26, and there wasn’t in any COP that I recall. The terms “energy efficiency” rarely makes the UNFCCC texts which makes it the elephant in the room, especially as it’s the activity that will drive the major share of all Paris-aligned emissions reductions needed, and hence money invested. The IEA’s Sustainable Development Scenario has energy efficiency delivering more than 40% of the global reduction in energy-related greenhouse gas emissions over the next 20 years. So, one of the most material programmes. Why does it seem to get so little attention.
It’s not all silence. On COP 26 “Energy Day” the IEA described the role of energy efficiency in an event hosted by the UK government and together they announced that Australia, Indonesia, Japan and Nigeria had joined the other ten countries signing the COP26 Product Efficiency Call to Action. This aims to double the efficiency of lighting, refrigerators, air conditioners and industrial motor systems by 2030 in order to help drive reductions in global greenhouse gas emissions and consumers’ energy bills. Interestingly, together these four products account for over 40% of global electricity demand and over 5 billion tonnes of annual global CO2 emissions – which is roughly equal to the current US CO2 emissions.
Additionally, on day 4, the EU’s Energy Efficiency Financial Institutions Group (EEFIG) launched two landmark reports in a side event hosted by the EU Pavilion. The first updates EEFIG’s 2015 report that provides policy and market-led recommendations on how to increase the energy efficiency investment flows in European buildings, industry and SMEs. The second provides statistically significant evidence that shows that lending against energy efficient buildings produces lower defaults and arrears (energy efficient borrowers are less risky). This data came from 800,000 mortgages from four EEFIG members across four European countries, and for the first time is controlled for income, wealth, typology and other possible leading factors.
Our take on this
This is one of the most frustrating topics to write on for us, from the perspective of investors seeking interesting opportunities. As the article above highlights, lighting (mainly via switching to LED’s) is an important element, and its one that often gets highlighted by analysts (along with building insulation). But the potentially big wins are in the less visible areas of refrigeration, air conditioners and industrial motor systems.
The recent IEA report (IEA energy efficiency report 2020) highlighted that global energy demand for cooling could triple between 2020 and 2050, driven mainly by growth in emerging economies, as air conditioning becomes more affordable to greater numbers of people. A recent assessment conducted by the IEA with the 4E Technology Collaboration Programme showed that in 2018, in the nine countries or regions for which there was data, higher standards and labelling saved over 1,500 TWh of electricity consumption. This is equivalent to the total electricity generation of wind and solar energy in those regions during that year.
One of the most common concerns about applying such standards to appliances is that they will raise the purchase price for consumers. However, the data shows that those countries with long‑running appliance standards in place have actually seen the average purchase price of these appliances falling steadily, by around 2-3% per year. This means consumers are benefiting from lower emissions, lower purchase costs and lower running costs. For example, in the United States such programmes delivered annual electricity cost savings of USD 40 billion in 2020, which translates into an annual reduction in the average household energy bill of around USD 320.
In a report published to coincide with COP26, (net zero road map for buildings) the UK Green Building Council highlighted the importance of shifting away from fossil fuel heating for buildings, toward a greater use of heat pumps and district heating. At the moment, some 70% of existing non domestic buildings in the UK are heated using gas or oil. Under their transition scenario, the use of heat pumps and district heating rises to nearly 50% of buildings by 2030 and close to 70% by 2040. One important point they make is that these are not new unproven technologies, they are already commonplace in many European markets.
Gas Utilities – facing a declining future ?
Main points of the story as published
The way we use fossil gas as a fuel for heating buildings and other end uses is rapidly changing. Efficiency gains and improved electric end-use technologies are constraining demand for gas. These shifts are happening as gas utility distribution systems in many places are aging — meaning that utilities may be seeking approval for major investments while the size of their customer base is poised to shrink.
Regulators and utilities that do not get ahead of these trends may face the need to impose unsustainable rate increases on customers, likely imposing high costs on those who can least afford it. These changes mean that the current paradigm for gas utility regulation is coming under pressure, and regulators need a range of practical options to consider as they confront the changing circumstances.
Our take on this
To us, this is something that investors thinking about the gas transmission and distribution sector need to pay a lot of attention to. The transition away from gas for both building heating and cooking will be slow. But these are very long life assets and so investment decisions made now will create infrastructure assets that will be around (& earning a regulatory return) for many decades. If the analysis is correct, and we move to using largely electricity (via heat pumps or district heating) to heat both homes and commercial buildings, then gas consumption will fall (the end of Europe’s largest gas field ?).
From a regulatory perspective, one option is for the lower number of users to pay more each to keep the existing gas network operating and maintained. Another alternative (which to us makes little sense) is to pivot to hydrogen. The third, and perhaps most interesting, is to follow the thoughts of the team at RAP and incentivise the gas utilities to not only provide the standard energy efficiency programmes (including transitioning customers into more efficient gas appliances etc), but to actively begin to switch customers over to electric.
At first read this makes little commercial sense. Why would a gas utility want to deliberately lose customers ? One obvious answer is incentives, but taking a longer term perspective, it would actually make sense for gas utilities to switch from selling a commodity product (gas) to selling a service (heating).
Demographics – work from home gains not for everyone
Main points of the story as published
The last two decades has seen increased participation rates among older workers, especially those aged 60-69. This reflected changing attitudes to work, new pension freedoms as well as economic pressures. Post pandemic, this trend has halted. In the US, there have been 3m “excess retirements” according to the St Louis Fed, representing more than half of the 5.3m workers who exited the labour force post the start of the pandemic.
There has been a similar trend in the UK with 0.3m fewer older workers in employment than pre-pandemic trends would have implied, according to the Institute of Employment Studies. It’s not clear what is driving these early retirements. Possible explanations include job losses, health risks and a surge in retirement assets driven by the global rally in equities. The trend will likely prove temporary as the drivers of later retirement remain in place while working from home makes it easier.
Our take on this
While we don’t normally flag stories in the FT, demographics is an important topic that is too often ignored. Demographics will transform the economic landscape, every bit as much as the push towards Net Zero 2050 will. And like Net Zero 2050, while the direction of travel is very clear, the investment implications are less so.
The two biggest demographic trends impacting developed economies are rapid ageing of the population (which is well known) and a decline in the number of people aged between 18 and 65, the traditional working ages (which is less discussed). But while these population trends are very clear, the investment implications are more nuanced. Yes, there will be more older people needing healthcare or wanting to travel, but without the taxes or retirement savings to pay for them, the expected demand will not materialise.
We believe the macroeconomic implications of demographics are critical but that they are too often ignored. Ageing is likely to be deflationary, for example, as the impact on demand (old people consume less) will likely outweigh the impact on supply (from fewer workers). In turn, this has implications for interest rates. The traditional tax bases of income and consumption will likely prove insufficient given the demographic trends suggesting increased wealth taxes. And back to the original story, there is compelling evidence that the vast majority of workers are saving too little for retirement. We plan to explore all these topics in more detail in later blogs.
Deere Strike Sows Worry in Farm Country
Main points of the story as published
The strike at Deere & Co, over a new labour contract, has entered its fifth week. The strike, covering 13% of their global workforce, exacerbates shortages of new equipment and spare parts for farmers brought about by the wider post-Covid disruption to supply chains. With delays in deliveries of new equipment and spares, and a tight market for used equipment across the ag OEM space, farmers fear that it will impact planting and therefore crop production next season.
US farmers have enjoyed a bumper 2021 with higher crop prices more than offsetting a 7% increase in production expenses, leading to the USDA forecasting the highest net farm income in the US since 2013. This in turn has driven demand for new ag equipment. With robust demand and constrained supply, Deere has increased the prices on early-order equipment for next year by 8%.
Our take on this
Agtech is one of our four key transition themes on the journey to Net Zero 2050. Investing in agtech offers attractive, long-term returns in a US$300bn+ market growing at 7% p.a. Precision ag and robotics, both fields in which Deere is an emerging leader, are two of the most interesting sub-themes in agtech. So what are the implications of the strike and the broader disruption to supply chains post Covid? While farmers are long versed in keeping equipment going, shortages of parts will make this much more difficult. Equipment shortages risk impacting next season’s planting leading to lower production and potentially higher crop prices.
At the same time, farmers’ costs are being squeezed by higher input prices (fertilisers, pesticides etc), higher equipment prices and the availability of labour. Farm incomes will likely be volatile as a result. This all suggests a blip in the theme. Yet history is clear. Contrary to received wisdom, farmers will invest in new technology that delivers clear cost and yield benefits, leading to rapid increases in adoption rates regardless of short-term volatility in farm incomes. This was seen with the adoption of tractors 100 years ago and more recently with biotech seeds and autosteer. Both precision ag (eg smart sprayers that cut pesticide use by up to 90%) and autonomous tractors have the potential to materially cut farm costs while extending critical operating windows such as planting and harvesting to the benefit of yields. Farmers will therefore likely continue to buy.
Social and Legal factors
Photo by Mahosadha Ong on Unsplash
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 into the impact that climate change is having in Africa, with obvious implications for human rights & fairness in our global society.
The story we link to below is actually a YouTube video from COP26 courtesy of the NY Times climate hub. Its well worth a watch for those (like me) who have a limited understanding of the growing use of climate change litigation. One of the presenters is from the Grantham Institute at Imperial College London, they are a great resource for those who want to learn more about climate litigation. Next week Kristina will focus on the issue of environmental migration
As of 25 September, flooding has affected around 1.7 million people in West and Central Africa, with many regions recording excess rainfalls. The impact in 2020 is particularly severe, and the number of people affected exceeded last year’s totals, when floods affected 1.1 million people in 11 countries. While seasonal rains are expected to subside in parts of West Africa, notably the Sahel, they will affect more areas in Central Africa. The resulting destruction of houses, goods, crops and fields, and land degradation are threatening the livelihoods of communities whose majority rely on agriculture. The impact of additional shocks of extreme weather events pushes vulnerable families deep into crisis.
The State of the Climate in Africa 2020 report highlights the continent’s disproportionate vulnerability. Estimates reveal that by 2030, up to 118 million extremely poor people on the continent will be exposed to drought, floods and extreme heat, which will hinder progress towards poverty alleviation and growth. In sub-Saharan Africa, climate change could further lower gross domestic product (GDP) by up to 3%, by 2050. This presents a serious challenge for climate adaptation and resilience actions because not only are physical conditions getting worse, but also the number of people being affected is increasing. The report estimated that the investment in climate adaptation for sub-Saharan Africa would cost between $30 to $50 billion each year over the next decade, or roughly two to three per cent of GDP.
Effective disaster management systems in support of the UN 2030 Agenda for Sustainable Development Goals (SDGs) can be found from the UN Sendai Disaster Risk Reduction (DRR) framework of actions. It clearly highlights the need for effective actions to be undertaken before, during, and after a flooding event, since such actions will determine the consequences for exposed communities. Improved flood monitoring, forecasting, early warning as well as capacity of the community, disaster response policy systems among others will determine the losses resulting from local hazards including extreme rainfall events.
Kristina’s take on this
Vulnerable populations are particularly at risk, as their homes are often built on available land in flood plains and they have limited financial resources to recover from disasters. If flood risk is not addressed, it will continue to drain financial resources and endanger lives and livelihoods. Flooding impacts the rights to property, housing, food, & livelihoods as well as generating a general state of vulnerability – and exacerbating existing poverty and vulnerabilities.
Climate change will increase the vulnerability of the poor throughout Africa. Already many are forced to live in hazardous places, building their homes and growing their food on floodplains in towns and cities. Others construct their shelters on steep, unstable hillsides, or along the foreshore on former mangrove swamps or tidal flats. Already vulnerable to destructive floods, damaging landslides or storm surges, climate change is making the situation of the poor worse.
The effects on arable lands as well as the potential loss of livestock is evident and has a direct impact on the ability of even resilient people to continue to make a living without help. Flooding has an impact on drinking water and may create vulnerabilities in relation to health. The current, ever increasing flooding is therefore having a direct impact on people’s enjoyment of their human rights. This will in turn lead to increased migration movements spurred on by climate change and as large areas of land become unliveable. UN Agencies and Entities such as UNDRR are working on how to create resilience and prevent disasters and more collaboration between such agencies and investors and industries could have positive impact.
One last thought
One issue that we keep coming back to is the willingness of some parts of the population to make the changes to their life styles necessary to reduce climate change. To be clear, we could have picked many other brands, this one just happened to be in the news recently. According to a recent story in the Guardian “citizens are alarmed by the climate crisis, but most believe they are already doing more to preserve the planet than anyone else, including their government, and few are willing to make significant lifestyle changes” (willingness to change their lifestyles is low). This has also been picked up from the other direction by a recent FT story (fashion industry to miss emissions targets).
In a podcast recently re-released by the Columbia Business Exchange, Dr. Katharine Hayhoe, climate scientist and evangelical Christian, talks what we think is a lot of sense about how we need to reframe the discussion, focusing much more on shared values. How we talk about climate change