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Please see the below article from Royal London received over the weekend:

The majority of our assets just over 90% – are invested with Royal London Asset Management (RLAM), and their responsible investment team is doing great work to help drive the move to a low carbon economy and leading the way on the Just Transition.

What is the Just Transition?

Just Transition ensures that social issues are taken into account in moving to a low carbon economy. Rapid climate action that limits global warming to below 1.5ºC prevents the worst human and economic costs of climate change. A Just Transition ensures this climate action also supports an inclusive economy and avoids exacerbating existing injustices or creating new ones.

We care about Just Transition in the industry, because without adequate considerations of the social impacts of accelerating the path to Net Zero, there is a risk that people will not be willing to make the hard choices we need in order to limit the impacts of climate change. This can lead to policy delays and uncertainty. Companies that acknowledge this challenge and plan for a Just Transition, will be more likely to deliver on their commitment to low-carbon growth. We believe energy utility companies should develop formal Just Transition strategies to manage social risk and ensure they continue to deliver good value for society and their investors.

A just transition for Scottish and Southern Energy (SSE)

SSE is an energy utility company that helps produce and distribute gas and electricity to our homes. It is one of the largest producers of wind power in the UK and has committed to become ‘net zero by 2050’ – which means that by 2050 the amount of greenhouse gas emissions produced by SSE will be equal to the amount it removes from the atmosphere.

RLAM’s responsible investment team has been champions of SSE’s strategy to move to wind power and reduce its reliance on coal and gas, which will have a big benefit for our climate. However, they’ve also been talking to SSE about the Just Transition – what the company is doing to ensure that its transition to lower carbon energy also considers any negative social consequences like significant job losses or making energy bills unaffordable. Solving the climate crisis is not straightforward, and the responsible investment team is asking companies to take a more holistic view and look at both the social and environmental consequences of taking action.

Please continue to check back for a range of blog content, from ESG focused pieces like this one to market updates and insights from a variety of the worlds’ leading investment houses.

Andrew Lloyd DipPFS

07/06/2021

Please see the below article from Tribe Impact Capital received yesterday afternoon:

Driven by changing consumer behaviours, increasing choice and affordability, recent net-zero pledges by governments and the desire to ‘Build Back Better’ after the pandemic, the demand for electric vehicles (EVs) continues to grow. According to Bloomberg New Energy Finance, EV sales will rise to nearly 60% of the global auto market by 2040, a huge shift from almost 0% in 2010. With consumer consciousness on the rise and market forces gaining momentum, EVs are quickly becoming the future of the automotive industry and a target market for investors.

However, before any serious adoption of EVs can take place there needs to be significant investment in the infrastructure that supports EVs. This includes the charging points but also the entire electricity grid.

EV charging points

The issue of sufficient access to electric charging points for those who don’t have the access to off-street parking needs to be addressed if there is to be widespread adoption of EVs. A report by the European Automobiles Manufacturers association in October 2020 showed that while EV sales in Europe had increased over 100% during the last 3 years, the number of public charging points had grown by just 58%. Similarly, in the UK, all-electric cars went from 1.6% of the market in 2019 to 6.6% in 2020. The report found the UK is likely to need around 400,000 public charge points by 2030, a considerable increase from the existing 35,000.  The current installation rate of 7000 a year is not enough to meet requirements if the UK is to be ready for the ban on sales of cars with an internal combustion engine in 2035. Installation will need to occur five times faster at a cost of between £5 billion and £10 billion by 2030.

Providing enough residential on-street charge points and charging facilities in public spaces will be critical in high-density residential areas where it’s simply not feasible for every property to have cables running from their electricity supply to their vehicle. National Grid points out that with 20 million EVs on the road there will be at least 8.6 million vehicles that will not have the facilities for charging at home.

This is not just an issue for the UK though. The quantity of public chargers is growing the fastest in China, followed by Europe and then the US. China still has the largest network of public chargers. They had more than 500,000 chargers by 2019, accounting for more than 50% of the global total. However, a large number of chargers does not mean an ideal vehicle-to-charger ratio. While China’s passenger electric vehicle-to-public charger ratio (8.5 to 1) is lower than that of the United States (17 to 1), some European countries have even lower EV to public charger ratios (France: 7 to 1; Germany: 5 to 1; and the Netherlands: 4 to 1).

Electricity demand

The second major infrastructure to consider is the supply and distribution of the electricity itself. At their current trajectory EVs are set to double domestic electricity demand. At scale, this would present significant challenges to the distribution network. As we see increased adoption of intermittent renewable energy sources we might start seeing large imbalances between supply and demand in terms of power provision. Not only do we need to build out our existing network capacity and reinforcement we need to get better at managing system stability, energy storage and smart charging. 

What does this mean for investors?

The UK government recognises that widespread adoption of EVs is key to achieving their climate goals with the Chancellor announcing in the government’s spring Budget that £500 million will be invested into a rollout for charging hubs. Whilst this investment will help play a role in piecing together the UK’s fragmented infrastructure and easing the pressure on public sector organisations, more capital for wider and faster deployment of a national charging grid is needed. Many supermarkets are now providing electric charging hubs in their car parks in partnership with others. Many supermarkets in the UK have increased their commitments to sustainability and investors are now starting to look at these companies with renewed interest.

Despite the noise and potential in companies like Tesla, Nio and others, for example, Volkswagen, the EV story also represents plenty of opportunities for investors outside the main car manufacturing segments. Charging points are the next logical step but looking at the sector more broadly there are opportunities in smart metering, battery storage, network improvement, smart cities and core technology (for example semiconductors, and artificial intelligence). The shift to EVs will have major implications not just for the way we travel, but the way we build cities and our consumption of electricity itself. With this in mind, the opportunities for investors further increase.

For example, smart meters (electronic devices that accurately monitor electricity use and send this information to the user or the utility company to effectively manage and optimise energy consumption) are key to driving efficiency in energy usage. They can potentially manage the demand on the grid by notifying consumers of the best time to charge, helping reduce consumer costs. Renewable electricity providers are also starting to provide ‘free’ tariffs for EV owners to manage potential cost implications.

The market for smart meters is growing rapidly and in 2019 US electric companies installed over 98 million smart electric meters, covering more than 70% of US households. The global smart meter market size was valued at $21.13 billion in 2019 and is projected to reach $39.20 billion by 2027, an annualised growth rate of 9%. Utility companies are keen to install meters, they enhance the energy grid’s resilience and operations and help provide visibility into the system operations, thereby avoiding outages.

Similarly, the battery storage market is set to double over the next 5 years. Batteries provide a critical role in our future power systems as they provide the flexibility required by the grid to support the variability of power generation from renewables when environmental conditions are not favourable for power generation. Not only is demand going up, but input costs are coming down. By 2030, total installed costs could fall between 50% and 60% (and battery cell costs by even more), driven by optimisation of manufacturing facilities, combined with better combinations and reduced use of materials. Battery lifetimes and performance will also keep improving, helping to reduce the cost of servicing. Improved batteries will help support the grid by providing flexibility to store energy and release it when demand for EV charging is high.

With all investment opportunities, however, comes risk. The widespread adoption of electric vehicles comes with some stings in the tail, most notably the use of rare earth and precious metals used in the battery and technology embedded in the vehicles themselves. Complex supply chains, sometimes in politically unstable geographies and/or where the rule of human rights may be less robust, increase the risk of human rights abuses, as well as environmental degradation. As investors it is essential to be aware of and manage these risks. Doing so can uncover solution opportunities, for example, in businesses dedicated to the recycling of these rare earth minerals at end of life in many rechargeable battery applications.

Global governments have built widespread adoption of EVs into their carbon neutral plans which will have major implications not just for the way we travel but the way we build cities and our consumption of electricity itself. For investors, it’s important to look at the bigger picture and recognise that the opportunity set is much wider than a few automobile names.

This is an interesting look at the investment opportunities within the electric vehicle landscape looking beyond just investing in the vehicles themselves or the big EV companies (i.e. Tesla), but looking at the infrastructure around this, charging points, smart metres, clean energy etc.

The pandemic not only changed the world itself, but how people think about the world, the environment and what the future will look like.

This is a growing investment space and another key indicator that ESG has gone mainstream.

Andrew Lloyd DipPFS

04/06/2021

Please see the below article received from JP Morgan this morning:

‘In our view regulatory interventions will increase, and these interventions will underpin carbon prices not only in Europe, but also globally.’ – Vincent Juvyns

European policymakers have been focused on tackling climate change for many years. The launch of the European Union’s (EU’s) Emission Trading System (ETS) in 2005, the first carbon market in the world, has been the cornerstone of the bloc’s policy efforts. Since then, the ETS has been upgraded several times to reflect the EU’s growing climate ambitions and changes are now accelerating further since the EU has agreed to reduce its greenhouse gas (GHG) emissions by at least 55% by 2030. These regulatory initiatives at least partly explain why prices for CO2 emissions allowances in Europe have recently reached an all-time high of 56 euros per tonne of carbon dioxide equivalent (tCO2e).

The EU’s example is being increasingly copied, with several individual countries launching their own emission trading systems. At present, global carbon prices remain well below those seen in Europe. If they fail to move in line with what the EU deem to be acceptable, the subject of carbon taxes at the EU border will be an increasing reality. This is why we believe investors should be aware of the impact of higher carbon prices on their portfolio.

What drives carbon prices? Europe case study

There are two main types of carbon pricing mechanisms: a carbon tax, which is the most direct way to set a price on carbon, but which doesn’t set a pre-defined emission reduction target; and an emissions trading system, which caps the total level of GHG emissions, but doesn’t set a pre-defined price.

The EU chose the second approach when it created its ETS in 2005. The EU’s ETS is the world’s first and also the largest emissions trading system as it covers 45% of the EU’s GHG emissions produced by three sectors within the European Economic Area: electricity/heat generation, energy-intensive industry, and commercial aviation.

Companies in these sectors are allocated a free emissions allowance. Those with lower emissions than their allowance can sell their “unrequired” emissions to other companies in the sector (Exhibit 1). The balance between supply and demand for emissions creates a market price.

The EU can influence supply and demand dynamics to raise the carbon price in three ways: by reducing the emissions cap; by increasing the industries subject to the scheme; and/or by reducing the allocation that is deemed free.

In its recent directive, the EU decided that the aggregate emissions cap will fall by 2.2% per year from 2021 onwards (vs. 1.74% before). The EU is still deciding whether to include new sectors, such as transportation and buildings. The percentage of free emissions allowances, which had already fallen from 80% in 2005 to 43% in 2020, is to gradually decrease to 30%.

As a result, while some of the recent surge in the carbon price may reflect strong demand for emissions allowances as firms meet rising demand, there is a structural underpinning to higher carbon prices from regulatory interventions.

The balancing act between internal drive and external competition

EU authorities are mindful of the delicate balancing act they face between meeting domestic climate ambitions while at the same time not damaging corporate profitability and competitiveness compared to international competitors that are not subject to similar regulatory standards. Encouraging international peers to keep up with the EU’s efforts is bearing some fruit: other regions are beginning to launch their own emissions trading schemes and 25% of global GHG emissions are now covered by carbon pricing initiatives compared to just 5% in 2005 (Exhibit 2). However, the carbon price in these regions is much lower than in Europe (Exhibit 3).

Coverage of global emissions trading schemes and the impact on carbon prices

Exhibit 2: Global emissions covered by carbon pricing initiatives

% of global greenhouse gas emissions

Exhibit 3: Emissions trading system prices

USD per tonnes of CO2 equivalent

Carbon prices internationally are not only lower than those in the EU, they are also below those required to meet the global climate objective of reaching net zero emissions by 2050 according to many climate scientists and policymakers. Although the estimate is wide, a range of between USD 40 and USD 80 per tCO2e is often argued as necessary to limit global warming to less than 2°C.

Carbon prices will no doubt be a key topic of conversation when global leaders convene at COP26 in November. If the EU, China and the US cannot agree on a path towards a common carbon price, the EU may need to find a short-term solution to ensure that its climate efforts do not disadvantage European businesses.

One solution that appears to be growing in appeal is a carbon border adjustment mechanism (CBAM). This import tariff would be designed to ensure that the environmental footprint of a product is priced the same whether it is manufactured locally or imported. The CBAM is one of the key measures discussed as part of the EU’s Green Deal. The proceeds of the tax would form part of the EU’s budget, which would be used to finance the EU’s recovery and green transition.

At this stage the CBAM is a threat to international peers, but the credibility of that threat has been strengthened given the legislation that would be required has been approved by the European Parliament. It is now up to the European Commission to decide whether to use it.

Investment implications

In our view regulatory interventions will increase, and these interventions will underpin carbon prices not only in Europe, but also globally. The result will be an increase in the cost base of companies in a growing number of sectors.

One of the key investment implications is that increased business costs may serve to raise consumer prices, adding to growing inflationary pressures from loose monetary and fiscal policies. If firms are unable to pass on higher costs the higher carbon prices may dent profitability.

If the CBAM is activated, companies that export a lot of their carbon-intensive products to the EU may suffer from higher carbon prices, even if their home country does fairly little in terms of carbon regulation. The price of carbon is therefore a risk that needs to be monitored.

On top of traditional financial analysis, investors may look to evaluate non-financial parameters, such as the carbon intensity of companies, as we believe that minimising the carbon intensity of a portfolio should help improve its risk/return profile over the long term. This is what we have already observed over the last couple of years when comparing the MSCI World index with the MSCI World Climate Change CTB Select, a Climate Transition Benchmark under the EU Benchmark Regulation, which reweights securities based upon the opportunities and risks associated with climate transition risks.

Indeed, the MSCI World Climate Change CTB Select Index has a Weighted Average Carbon Intensity (which represents the number of metric tonnes CO2 equivalent emissions per USD million enterprise value including cash) that is almost 40% lower than the MSCI World Index, while it has also outperformed the latter by 150 basis points since its inception in November 2013, and has a better Sharpe ratio over the last three and five years.

With global carbon prices set to increase further in the future, minimising the GHG emissions of a portfolio should not only contribute to the fight against global warming, but it should also lead to better risk-adjusted returns in the long run.

Please continue to check back for a range of blog content, from ESG focused pieces like this one to market updates and insights from a variety of the worlds’ leading investment houses.

Andrew Lloyd

01/06/2021