Sustainable Investing weekly blog: 1st October 2021 (Issue 9)
Our weekly summary of the key news stories, developments, and reports that are impacting investing in the wider transition to net zero carbon .
In case you were not aware – COP26 is coming. It’s likely it will dominate both the sustainability debate, and to a smaller extent, how financial markets behave. Expect lots of talk, lots of “commitments” and lots of net zero pledges. COP26 31st Oct to 12th Nov – Glasgow
We are excited to announce that we have a new research partner starting on Monday. Many of you will already know Nick Anderson (LinkedIn profile). Nick & I first worked together back at James Capel (yes, we have been doing this for that long) and more recently, we ran the Berenberg thematic/sustainability team. Nick is passionate about Agtech/Natural Capital and the impact of demographic change, so expect to see more blogs and research on these topics, once he gets up to speed.
This week our top story examines the potential in Canada to unlock its massive hydro and wind potential via enhanced grid interconnectors; then we look at a ShareAction report on how investors can strengthen returns by improving health outcomes, we examine the UK move to loosen rules on gene edited crops, before finishing with our BST-Impact partners on the technical issues around legal responsibility and how that works and who is accountable under international law.
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 : Renewable electricity generation
Main points of the story as published
Decarbonising the grid is an important component of supporting net-zero economies. The latest analysis by the International Energy Agency (IEA) concludes that developed countries need to achieve a net-zero grid by 2035 to keep global warming within safe limits. A study by the Canadian Institute for Climate Choices (Canada’s Net Zero future) found that all paths to net-zero emissions required more electricity — anywhere from 38% to 70% more from 2018 levels. Canada’s current goal is to generate 90% of electricity from emissions-free sources by 2030 and net-zero before 2050.
Several Canadian provinces are at a planning crossroads right now as they phase out coal-fired generation. A total of 8,928 million watts (MW) of coal capacity will be retired from Alberta, Saskatchewan, Nova Scotia, and New Brunswick. As provinces and utilities move to replace this capacity, they will make critical infrastructure investment decisions that will shape the electricity sector — and its greenhouse gas emissions — for decades to come.
Connecting provincial grids is essential to make the best use of the clean electricity resources available in each province, allowing renewable energy to be developed in areas with the best conditions and distributed elsewhere. New transmission is also expected to lower the costs of “deep decarbonization.” This is particularly true in a country like Canada where some jurisdictions have plentiful hydroelectric resources while others have abundant wind and solar resources. However, currently more electricity flows between Canadian provinces and American states than between Canadian provinces.
One pivotal measure (but by no means the only measure required) to address the supply side of the clean electricity equation is interprovincial connections between electricity grids. However, significant on-the-ground work is needed to secure strong environmental outcomes and community support for the large infrastructure projects needed to deliver the clean electricity that is the key to decarbonizing Canada’s economy.
Our take on this
This is an issue that is key to the net zero transition and one where, with the right support from governments and regulators, the private sector can contribute, while generating a positive financial return for their shareholders, and unlocking massive growth potential in renewable electricity generation supply. While our electricity grids will require a raft of technologies to prepare them for net zero, the most immediate need is to get new renewable electricity supply connected and then have the ability to get it from regions of cheap supply to our cities, where demand for green electricity is high. Without this investment, our grids will not be able to support the level of renewable electricity supply being targeted.
Among the other grid supporting technologies, battery storage gets a lot of attention, quite rightly. We already need short duration supply buffers and grid support (mostly via Li Ion batteries) but we are unlikely to need mid and long duration support until we get to the stage where well over 50% of our electricity comes from renewables. Outside of this, we need more work on demand management & smart grids. But, coming back to interconnectors, the really pressing need, in part because they take so long to get built, is to start planning work for the upgrades of our transmission and distribution networks.
The main barriers here are political and regulatory. In Europe, the challenges are known, including the well publicised problem getting renewable electricity around Germany, and the need to unlock the Iberian electricity “island”. The recent opening of the new interconnector between the UK and Norway, allowing hydro power to flow south, and wind to flow north, is a positive step forward (North Sea link). Looking Europe wide, the TEN network programme is helping, although it needs reform to better reflect the increasingly important sustainability agenda (Is TEN fit for a decarbonised future).
Its in the US where the biggest challenges exist. Interconnectors specifically, and transmission upgrading in general, has become very politicised. Regular readers will remember that this is something we touched on back in August (the battle to match Canadian hydro with US demand). The moves by the Biden administration look encouraging. It appears to us that even if the spending plans partly “die on the floor of the house”, there are still measures that can be taken on a regulatory and administrative level that could really help unlock the potential. This is a topic we will return to, so watch this space.
Electricity applications – we need low carbon solutions : if only for our health
Main points of the story as published
Good health is an asset. It allows us to thrive, to live independent and fulfilling lives and to contribute productively to society and our economy. As a society, we value health above all else. It is in our interest for our money to be invested in a way that supports good health – and like climate change, poor health is a systemic risk that investors cannot just diversify away from. It is for these reasons that the investment sector must incorporate health into their stewardship. Yet currently it remains a blind spot – which is leaving them (and society at large) vulnerable.
Good health is not a result of good healthcare alone. As much as 80 per cent of health outcomes are driven by environmental factors; by the social, commercial and physical environments in which we live and work. The report highlights the key risk factors, at least for high income countries, as being occupational risks, drug use, non optimal temperature, tobacco (a big one), dietary risks (another big one), air pollution and alcohol.
They found that investors do not currently prioritise health, which has allowed companies to overlook their impact. Vast amounts of capital are still flowing into health-damaging sectors – and even in ‘ethical’ and ‘sustainable’ funds, health is still undervalued. But the tides are turning. Most asset owners they spoke to said improving health was a ‘clear priority’ and expressed an interest in their beneficiaries (such as pension savers) having a “healthy society to retire into”. Asset managers, meanwhile, acknowledged this demand as well as seeing the value in a holistic approach to health which would enable them to bring coherence across a range of engagement topics.
Our take on this
Last week (blog issue 8) we highlighted the risks from air pollution, especially in emerging countries, and how electrification, especially of transport, could be a material positive for the societies impacted (WTO says air pollution is worse than we thought). This week its developing countries, and while the risks are slightly different, many of the solutions are similar. Our take on this from an investing perspective is short – as well as the obvious shifts away from tobacco and alcohol, investors can have a role to play in supporting alternative and healthy food, better agricultural practices, more efficient building heating and cooling, and reduced air pollution. Plus of course investing in net zero positive companies can assist in the planet delivering its climate change and green objectives.
Many of these investments, if chosen wisely, make financial sense on their own, tapping as they do into both social and technological changes. In addition, for large asset owners, including sovereign wealth funds etc, the whole issue of poor health being a systemic issue, means its better to help solve it. The impact is so wide that its tough to diversify it away.
Agriculture & Natural Capital
Main points of the story as published
The FT reported that the UK government plans to relax rules on research into gene edited crops by the end of 2021. This is expected to pave the way for commercial production. This follows a consultation on departing from the EU rules, which currently treats gene editing (using DNA from within species) in a similar fashion to genetic modification. Officials hope that gene editing will pave the way for new solutions to pests and diseases such as virus yellows, which attack sugar beet.
The new system will just require researchers to notify the relevant government department, removing the need for a “long and costly” licencing process. This will be followed by primary legislation, adjusting the legal definition of genetic modification to exclude gene editing. The change came despite opposition from environmental groups, who broadly favoured the status quo. They argued that such crops were often designed to tolerate repeated spraying by weed killers, which could lead to increased pesticide use.
Our take on this
Again our take on this is short. We leave the debate on the rights and wrongs of gene editing to others, better qualified than us. Relaxed regulation only solves half of the challenge. Our question is simple – will consumers buy the products. Being “labelled” GM is still very negative in Europe (obviously less so in the US). In the UK, we expect gene edited products to require some form of labelling, to advise the consumer. We argue if consumers are resistant, supermarkets will not stock the products, and farmers will not use them – as evidenced by the UK cage free chicken egg campaign (Tesco to go cage free by 2025). Its too early to be sure, but we are seeing some signs that lessons have been learnt from earlier mistakes made by Monsanto etc on GM crops, where they pitched the product at the farmers, and forgot about the consumer backlash.
Social and Legal factors – BST Impact
Photo by Mahosadha Ong on Unsplash
This week our BST-Impact colleagues are continuing their examination of how national courts are using international human rights to hold companies accountable, but this time going into the technical issues around legal responsibility and how that works and who is accountable under international law. To us this is both important, and often poorly understood by investors. Taking legal action against governments who fail to fulfil their obligations under treaties etc is on the rise – as reported by a World Bank blog earlier in the year (taking governments to court over climate change).
What seems to be less well understood is that the same legal process can often be used against companies. In many cases, once a government has signed an international treaty and implemented it into national law, then all companies in that country (including their overseas subsidiaries) are also bound by the same obligations. It’s worth digging down into this as we expect more and more companies to be subject to legal challenge – where their operations “impact” the human rights, both of people in the countries where they are based (such as the Shell case referred to it the World Bank blog) and elsewhere (the BHP/Vale Fundao dam collapse case – see blog 5 – 20th August 2021).
Over to the BST-Impact team for the legal definitions, which gives a solid foundation to investors to help make sense of the growing wave of legal cases.
What we call the “duty bearer” under international law is the State. And the State has an obligation once it ratifies an international treaty to implement that treaty on its territory. This entails an obligation “to protect individuals on its territory and under its effective control from violations of the provisions in the treaty”. This means enacting good and effective legislation and implementing it fairly. This should protect individuals and groups of individuals not only from the State’s own actions but also the actions of other private actors (including companies). This is known as horizontal protection.
All companies are subject to this sort of “horizontal” effect of international law – an individual or a company cannot expect impunity from murder or kidnapping (right to life; right to freedom of movement) or from unlawfully evicting someone from their property (right to housing and a decent standard of living). The implementation of these (and every other right directly enshrined in Human Rights Conventions or derived from other international law) is the obligation of the States that have ratified such Conventions. The first thing they do to live up to these obligations is to enact legislation that protects all of us from their violations and ensures redress if we experience violations. Up until recently, there has been a presumption that detailed legislation directly targeting investors and companies specifically was either not desirable or not necessary. Not so now.
Realizing the importance, power, and relevance that private sector actors including companies and investors have on sustainable development, environment and human rights issues, the European Union is now regulating what such “actors” are doing. This action is not only via indirect regulation through the complex web of relevant national and EU legislation and standards, but increasingly directly – with legislative acts addressing the responsibility of these private actors on society and the environment. These legislative acts open up the companies to both direct legal actions by individuals who consider their human rights have been infringed, and to expensive redress and mitigation. For companies its better to stay ahead of the trend, than to constantly be playing expensive catch up.
Just a reminder. 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. For follow up, consultancy and training etc, BST-Impact can be found here.
One last thought
You may have spotted that the UK is going through a bit of a gas industry supply crisis, with smaller suppliers failing and their customers being transferred to larger (safer ?) competitors, under the supplier of last resort process. One reason for the failures is that many of the smaller gas suppliers were unhedged (or under hedged). So when wholesale gas prices surged, and with regulation preventing retail prices rising above the “cap”, their costs massively overwhelmed their revenues. One reason for the lack of hedging was a 2014 hearing – at which the regulator and the Competition and Markets Authority, criticised the industry for their then hedging policy, stating that “over the period reviewed, the six largest suppliers had reduced their retail prices, but not to the extent that might be predicted by the trend in wholesale prices”, going on to say that “these slight price reductions did not accord to what was expected in a competitive market”.
Roll forward 6 years or so and ….