Sustainable Investing weekly blog: 13th August 2021 (Issue 4)
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. 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, that focuses on stocks.
This week we look at how blue hydrogen might be worse for the environment than some assumed; how thinking differently about cooling could take us closer to net zero; methane and cows, especially beef; and we look at how many governments, especially at the local level, are unprepared for the impacts of climate change.
Electricity & Energy Production
A paper published in Energy Science & Engineering by Howarth & Jacobson (Cornell University) questioned the argument that Blue Hydrogen (produced using fossil fuels but with carbon capture) is really a low emission energy carrier. Currently, most hydrogen is produced by steam reforming of methane in natural gas (“grey hydrogen”), with high carbon dioxide emissions. Increasingly, many propose using carbon capture and storage to reduce these emissions, producing so-called “blue hydrogen,” frequently promoted as low emissions.
Far from being low carbon, greenhouse gas emissions from the production of blue hydrogen are quite high, particularly due to the release of fugitive methane. Using their default assumptions (3.5% emission rate of methane from natural gas and a 20-year global warming potential), total carbon dioxide equivalent emissions for blue hydrogen are only 9%-12% less than for grey (traditional fossil fuel generated) hydrogen.
In addition, while carbon dioxide emissions are lower, fugitive methane emissions for blue hydrogen are higher than for grey hydrogen because of an increased use of natural gas to power the carbon capture. Perhaps surprisingly, the total greenhouse gas footprint of blue hydrogen is more than 20% greater than burning natural gas or coal for heat and some 60% greater than burning diesel oil for heat, again with their default assumptions. Plus – the analysis assumes that captured carbon dioxide can be stored indefinitely, an optimistic and unproven assumption.
Our take on this
This week we get two stories with a methane angle (also see agriculture below), picking up from a key issue highlighted by the recent IPCC report (here). Regular readers will know that while we see a role for green hydrogen in replacing existing grey hydrogen in uses such as oil refining and fertiliser production, we struggle to see many other commercial applications until well into the 2030’s. And even then, we see a smaller end market than many commentators are forecasting.
And we have some practical concerns around the use of blue hydrogen as a bridging technology until green hydrogen production becomes cost competitive (requiring cheap renewable electricity). We discussed some of the challenges around carbon capture in blog 1, back at the end of July (here). And we note that if you do a full end to end production analysis, blue hydrogen is not as low carbon as its painted, as highlighted by a recent report from the Pembina Institute carbon intensity of blue hydrogen.
Despite all of this, blue and green hydrogen seem to be getting political support, both in Europe and the US. One reason we can see is jobs. Carbon capture has got support from unions in the US, as it maintains well paid (& unionised) jobs. In Europe, part of the support seems to be for similar reasons, expanding the use of hydrogen (both green and blue) is seen as consistent with keeping well paid industrial jobs.
It’s an issue we think doesn’t get the attention it deserves. It came up in the coal phase out debate in Europe, and it was front and centre in the UK’s governments softening of its position on banning gas boilers. Many of the “easy” decarbonising and greening decisions have been made. From here on in, most decisions will involve trade-offs and groups will lose out. Changing behaviours is really hard and given this is perhaps understandable that governments choose a line of least resistance. Its why we examine social, political and regulatory drivers as well as thinking about the technology and its green impact when we evaluate what makes an investable stock or theme.
The cold chain today is very dependent on diesel and fossil fuels to drive the cooling demand of a warehouse and in the vehicles moving everything around. And while the diesel engines that drive refrigerated trucks have to meet stringent emissions standards in Europe, the refrigeration unit on the back also runs on diesel and is relatively unregulated by comparison.
The refrigeration unit accounts for about 12%-20% of the energy consumption of the vehicle, and six times more nitrogen oxide emissions and 29 times more particulate matter than the engine pulling it around. And there are large indirect impacts. Food wastage is a huge source of unnecessary emissions. About 1.3 billion tonnes of edible food is lost or wasted each year, and it’s responsible for about 4.4 gigatonnes of carbon dioxide each year, and around 1 gigatonne of that is due to a lack of cold chain. In the developing world, this is a particular cause of food loss.
Cooling currently accounts for about 7% of global greenhouse gas emissions. As many parts of the world become wealthier, that is being accompanied by a massive, rapid growth in demand for air conditioning and refrigeration. At the same time, as global temperatures increase due to climate change, there is going to be more and more need for cooling.
It is going to need a different way of thinking. Generally, when we talk about green energy, we mean electricity. But cooling is really a thermal energy issue – we don’t necessarily need to convert energy to electricity to cool things down. There are large amounts of low-grade waste heat from industry, for example, that could be used to enhance cooling with the help of absorption chillers (which refrigerate through a sudden change of pressure, driven by heat). Refrigeration units also produce a lot of heat out of the back end, and that could be used to provide hot water and heating for nearby buildings.
Buildings and systems can also be designed better to mitigate the need for cooling. A good example of this is a project in Africa set up by a drone company called Zipline to deliver blood to rural clinics. They have a central warehouse where they store the blood, it is taken out of the chiller, put into an insulated pack and flown to the location in 20 minutes and parachuted down.
Our take on this
Every now and then we like to highlight the more hidden corners of the fight against climate change. These are activities that don’t normally get as much publicity as renewable electricity and electric vehicles. In part this is because their impact often goes almost unseen, plus the solutions are harder to industrialise and scale up…. and many investors do like something that is scalable.
The cold chain and building cooling is one of these challenges. As the article points out, a recent UK government report highlighted that c. 7% of global greenhouse gases come from cooling and refrigerants, compared with c. 2% from aviation. There is no single solution to reduce these emissions. Many of the technologies required already exist, but changing behaviours and practices is going to take a mixture of concerted government action and relatively small-scale innovation and investment.
From the government side, we need new regulations and rules for how we cool (and heat) our homes and how we keep our food cool during transport. This will need to consider the fact that many cooling systems use fluorinated gases (F–gases), which can be potent GHGs when they leak. The good news is this has parallels to the fight against the use of CFC’s (how the world closed the hole in the ozone layer). For those with longer memories, you will recall that back in 1974 a group of scientists published research suggesting that chemicals used in everyday products like aerosols, packaging and refrigerators could deplete the ozone layer – vastly increasing the incidence of skin cancer, cataracts and other harms to humans and wildlife on earth.
By 1987, just two years after the ozone hole over Antarctica was discovered, an international treaty was in place that cut the use of CFCs in half. Three years later in 1990, the Montreal Protocol was strengthened to ban the use of CFCs altogether in industrialised countries by the year 2000 and by the year 2010 in developing countries. Today, the use of CFCs is outlawed by 197 countries around the world and scientists concur that the ozone layer is slowly recovering as a result.
What can be done from the investing side? As well as innovative projects such as the Zipline project (website here), there are also investment opportunities in more traditional logistics. CBRE (reported here) estimates that in the US alone “demand for cold storage space will rise by 100 million square feet during the next five years. That’s an increase of roughly 47% from the current level of 214 million square feet”. Cold storage has become a new asset class, and the increasing interest is likely to lead to a focus on process efficiency, including the possible use of new technologies such as cryogenic energy storage (briefing paper here).
Longer term, the role of heat pumps, for both building cooling and heating is also expected to increase. A recent IEA report (the future of heating Dec 2020) highlighted that “three-quarters of emissions reductions required in the buildings sector under the Sustainable Development Scenario can be achieved through widespread implementation of technologies that are today mature and at early stage of adoption”. The report forecasts that while buildings space cooling needs currently only required 15% of the energy used for heating (generating about 1 Gt of CO2), space cooling is the fastest-growing building end-use. It is expected to grow at more than 3% a year for the next three decades, 8-times faster than demand for heating in the last 30 years.
Agriculture & Natural Capital
Charl Folscher from unsplash
The United Nations’ Intergovernmental Panel on Climate Change dropped a landmark report on the state of the planet which—spoiler alert—ain’t looking great. The archvillain of the assessment is carbon dioxide, but it also called out CO2’s less-famous sibling: methane. Atmospheric concentrations of this greenhouse gas, which is 80 times more potent than CO2, are now higher than any time in at least 800,000 years, the report notes.
“Methane is the next crucial, fast, climate-stabilization prize,” said Rick Duke, senior director and White House liaison for the Special Presidential Envoy for Climate Change, at a press conference on Monday following the release of the report. “There’s simply nothing that comes close for securing our near-term climate future, buying us crucial time to decarbonize energy and to develop advanced options like negative-emissions technologies.”
“A pound of methane being emitted can trap heat over 100 times more than CO2 when it’s first emitted,” agrees Tianyi Sun, a climate scientist at the Environmental Defense Fund who specializes in methane. But, she points out, methane vanishes faster. “It only lasts in the atmosphere for about a decade, and it’s gone.” Carbon dioxide, by contrast, can last centuries.
Sun recently quantified the potential effect in a paper published in the journal Environmental Research Letters. Using existing technologies—for instance, capturing CH4 emitted from oil and gas production, and better managing agricultural manure—she estimated that humanity could halve its methane emissions by the year 2030. “It would avoid about a quarter degree C of warming by mid-century, and about half a degree of warming by the end of this century,” says Sun. “And it can also slow down the rate of warming in the near term by about 30 percent. And that is very significant when we’re thinking about trying to keep warming below 2 degrees C.”
Quantifying emissions sources can help inform social and policy questions, says NYU environmental scientist Matthew Hayek: “Do we want to stop drilling for oil and gas? Do we want to stop eating beef? Or do you want to regulate oil and gas and beef to be a little less methane-emissive?”
Our take on this
We touched on the fossil fuel aspect of the methane debate earlier, so in this section we want to discuss cows, specifically beef but also diary. Coming as I do from New Zealand, it’s a topic that is close to home. Just to clarify, its cow’s burping that is the problem, as this 2015 National Geographic story highlights burp by burp. Just to give the problem some context, on average beef production emits 2 to 9x the greenhouse gas emissions of other animal products and more than 50x those of most plant based foods (per unit of protein).
However, as with most net zero debates, its more complicated than the headline numbers suggest. First up, making beef net zero looks “very challenging”. It is sometimes claimed that rearing cattle on grasslands can stimulate soil to uptake more carbon, helping to reduce climate change. However, an analysis by the Food Climate Research Network in 2017 found that grass-fed cows release more greenhouse gas emissions through belching and manure than they are able to offset through boosting soil carbon levels. Grass feed beef can be better, but its generally not a panacea.
The good news is that its possible to cut emissions materially. A study led by Colorado State University and published in Global Change Biology, found that emissions differed materially (around four-fold) around the world. Beef management strategies to reduce GHG emissions generally fall under two broad categories: (1) increased efficiency to produce more beef per unit of GHG emitted, and (2) enhanced land-based carbon sequestration to offset cattle GHG emissions.
In the study, a 46 % reduction in net GHG emissions per unit of beef was achieved at sites using carbon sequestration management strategies on grazed lands, and an 8% reduction in net GHGs was achieved at sites using growth efficiency strategies. As an aside, it’s not clear if they included new technologies, such as seaweed, in the study. Recent research from UC Davis suggested that its use could cut emissions by 82% (although it did only cover 21 cattle in a supervised environment).
Consistent with the Food Climate Research Network study, net-zero emissions were only achieved in 2% of studies. The bottom line seems to be that land-based measures have better chances of success than those based around changes in feed or genetics. This suggests we need to focus on changes such as Integrated Field Management (including organic compost application, silvo-agro-forestry, and seedings to increase plant cover on grazed lands) and intensive rotational grazing. Obviously, reducing our beef consumption is the best solution, but assuming we keep eating beef, the big commercial question, is how do we get consumers to pay a premium for cattle raised this way ?
Social and Legal factors
A report quietly released by the Ministry for the Environment shows most public bodies, including government departments, local councils and state-owned enterprises, are not prepared for the impacts of climate change. That’s despite a landmark study from the global authority on climate science, which found New Zealand could experience increases in flooding, fires, droughts, extreme heat and the melting of our remaining glaciers. Global sea levels are projected to continue to rise even if warming is halted at 1.5 degrees.
Nonetheless, more than half of government departments, councils, state services (including state-owned enterprises, Crown entities and public finance companies) and council-controlled organisations around New Zealand reported they had “limited or no understanding of [their] vulnerability to climate change impacts”.
Just 36 percent of respondents said they had a plan or strategy to improve resilience in the face of climate change. This included the 8 percent of organisations (and just one central government department) which said that plan was specifically focused on climate change impacts. Another 35 percent said they were in the process of developing a plan or strategy.
Less than half of organisations said they require climate impacts and adaptation options to be considered in decision-making and two-thirds of those respondents said this applied only to some projects.
Our take on this
This week we end the blog on a more philosophical note. The story is from New Zealand but it seems to be a common theme around the world. In fact, a UK story out on pretty much the same day had a similar message (council policies inconsistent with climate goals). Having spent much of the last few days working through the IPCC report, it’s clear that regardless of the actions we take to transition toward net zero by 2050, we will very likely face more frequent droughts (and associated fire risks) and heavy precipitation events (potentially leading to more frequent flooding), plus a very real risk of material rises in sea levels (so more flooding again).
What is less clear is how willing and able we are to spend the capital needed to reinforce and protect our critical infrastructure, including our natural resources, food systems, utility networks, flood protection, and transport. Research leads us to expect that as climate change accelerates, insurance will become harder to obtain for many, at least at a cost they can afford. Florida will not be the only one (homeowners insurance in Florida).
This may seem an odd topic to write about in a blog aimed at investors. Our point is a simple one – when we invest, we implicitly make assumptions about the sustainability of long-term profits and cashflows. As Michael Mauboussin is fond of saying – nearly every investment is a DCF here. We suspect we have reached the point where this assumption might no longer be universal. A combination of stranded assets, and business models that potentially no longer work, mean we need to directly include climate change, the transition to net zero and the greening of our economy in our financial analysis. In some cases this is already happening, but for many its hard to bridge the gap between ESG scoring, UN SDG measures and what it means for cashflows and valuations. We argue we need to take investment appraisal back to its roots, and consider what a company and the industry that it sits in, might look like in 5 or 10 years time. Only then can we begin to determine if its a sustainable investment.