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The energy transition is too important to get wrong

Please see the below article from Jupiter Asset Management:

The global climate change train to limit the rise in average temperatures to ‘well below 2 degrees Celsius and preferably to no more than 1.5 degrees by the end of the century’ is heading firmly down a single-line track. Even the Americans who temporarily jumped off under Trump are aboard again with Biden. But while its accelerating momentum is inexorable, as it approaches a major junction there seems to be confusion, indeed disagreement, about the ultimate destination.

For some, particularly hard-line climate change activists and carbon nihilists, the aim of absolutely zero carbon emissions at all is the only acceptable terminus and for whom the arrival date of 2050 is years too late; for others it is the Paris Climate Accord target of net-zero emissions by 2050 which is the destination even if there is further to go beyond that. Using the analogy of Orwell’s Animal Farm, the danger is that in an immensely complex and sensitive environment, for many the debate is no more sophisticated than “four legs good, two legs bad”: “green good, brown bad”.

What does not help is the casual interchangeability of nomenclature, sometimes deliberate, sometimes merely the sloppy use of language, between the terms “zero carbon” and “net-zero carbon”. Whichever, the effect is insidious. They are very, very different. The key is that word ‘net’.

Zero emissions assumes the total elimination of all fossil-based or fossil-consuming processes; not only would this include traditional coal, oil and gas extraction, and oil refining with all its implications for energy production and transport fuels, it would also mean that significant outputs of the petrochemicals industry would have to be replaced including all plastics. Net-zero on the other hand says yes, CO2 emissions must be reduced but allowance is made for those CO2 emissions which remain unavoidable: an equivalent tonnage must be offset or ‘removed’ elsewhere (carbon credits, carbon capture, tree-planting etc). But the fundamental presumption is that a zero-carbon cliff-edge is neither feasible nor compatible with the demands of 21st century economic, political and social systems.

Ahead of COP26, the global climate policy forum in Glasgow this autumn with the UK in the chair, expectations for further change are rising. President Biden’s new climate envoy, John Kerry, has already labelled it “the last chance to save the planet”. It is notable just how much faith is being placed in this summit to deliver (bearing in mind its forerunner, COP25 in 2019 was dominated by the phenomenal political effect of Greta Thunberg); the spotlight has particularly been thrown on Glasgow thanks to many western governments explicitly linking Covid economic recovery packages to the acceleration of green infrastructure plans. The green project has been turbocharged.

From an investment standpoint, the green revolution presents significant opportunities. But every revolution has its casualties. The most obvious so far has been the coal industry. Now oil is firmly in the crosshairs. While the global oil companies and the oil ‘majors’ in particular (otherwise known as the ‘integrated’ companies, their activities stretch all the way from up-stream exploration and extraction, to mid-stream refining, moving downstream to wholesale distribution and service station retail, they include such names as EXXON, Chevron, BP, Shell, Total and others) have been some of the biggest, most successful and most enduring companies in history, the most reliable payers of dividends, they are now under concerted threat.

Investors have always been free to invest according to their principles and consciences, regardless of under what badge such investing has taken place over the years (ethical; SRI; ESG etc). But the deep politicisation of the climate change debate adds new dimensions. Just in the US in the past two weeks, President Biden in addition to re-committing the US to the Paris Climate Accord, has issued Executive Orders for the abandonment of the half-complete US/Canadian oil pipeline and declared that there will be no new drilling licences issued for Federal-owned land or waters. In the UK, a group of 50 MPs has written to the Bank of England demanding that the green bond element of its QE programme should specifically exclude any benefit to oil companies.

Going further back, warning about the risks posed by climate change to the banking and insurance sectors, the then Governor, Mark Carney, highlighted the risks to lenders and insurers of oil companies’ ‘stranded assets’  and the potential vulnerability of their balance sheets should those oil reserves prove significantly less than stated, or even worthless (while highlighting the risks for the right reasons, Carney’s motives were called in to question when, after leaving the Bank, he was immediately appointed the United Nations Climate Change Ambassador). The UK Pensions Regulator has issued warnings to pension fund trustees about their over-reliance on oil companies as significant sources of dividend income; it is a brave trustee who takes a different view, however considered. In Europe Christine Lagarde has also raised climate change policy to the top of the ECB’s strategic agenda, explicitly aligning it with the Paris Accord and the European Green Deal with the emphasis on facilitating the finance of green projects through green bonds while particularly highlighting the risks to banks of lending to legacy industries. This is all leaving aside institutions such as colleges and trust-and-grant charities being persuaded or leaned upon to abandon investing in certain companies and sectors, including oil.

The travails of the industry itself aside, since 2014 when the oil price hit its all-time high before two significant bouts of volatility, first due to slackening Chinese demand and more recently Covid, the longer-term effect of the factors described above is pernicious. As many investors drift away, filing oil in the ‘too difficult’ bucket, remaining capital providers and lenders need a higher rate of return (a risk premium) on their investment to compensate. The International Energy Agency (IEA) estimates oil demand to peak in about 2030 after which it will be downhill. But will it be a managed decline, or chaotic? Reality will be determined by a combination of political and populist pressure balanced by the extent to which new energy, motive and materials technologies can be successfully developed to replace those provided by fossil-based materials now, all the while keeping people and goods supplied and moving at a reasonable cost. While electric technology is already provenly viable for road vehicles (even if the infrastructure is not currently there to support it as a workable mass-transportation system) fully switching from petrol/diesel will take at least a decade beyond the date that the sale of new combustion-engine vehicles is banned (2030 in the UK, one of the earliest); in the absence of workable solutions, air and maritime transport will continue to rely on oil-based fuels for the foreseeable future.

In context, world crude consumption is currently 100m barrels per day, forecast by the IEA and others to reach 110mbpd in 2030; even if all the world’s hydro-carbon fuelled passenger vehicles and trucks were removed, global oil demand would still be in the range of 70-80mbpd. The danger is that if the oil companies’ cost of capital is pushed up excessively by the risk premium, over and above the sustainable returns companies are able to make, long-term decline and eventual extinction are virtually assured even if future needs are not able to be met.

Then there are the geopolitical effects. For a century, national ownership of oil reserves has conferred political power and leverage (or conversely posed a national threat from those who have designs on your assets!); undeniably in some cases it has fostered widespread corruption. Even if not wholly dependent on oil revenues and many have already frittered away the economic benefits, the fortunes of some are highly sensitive to the industry’s prospects: Russia, Nigeria, Algeria, Libya, Venezuela, Iran and Iraq, a number of the Gulf states to name but a few could potentially see their prospects alter with significant consequences.

No company or industry has a God-given right to survive. However, swap the word ‘energy’ for ‘oil’ and the possibilities for the oil sector take on a different perspective. Surely these global oil companies should be part of the solution to future energy and fuel needs rather than purely perceived as the problem. The managements of the big oil companies recognise the existential threat to their businesses; if they haven’t already (and many including BP have), most are turning their investment attentions towards renewable, sustainable energy development and are committing significant capital. Critics point to the sums as miserly compared to the capital invested in their current ‘legacy’ technology and assets. But in nominal terms they add up to significant amounts: BP alone, for example, is budgeting $5bn pa investment to achieve an installed renewable capacity base of 50 gigawatts (gw) by 2030; ENI (Italian) plans 55gw by 2050, Total (France) 30gw by 2025; there are many others. These figures are meaningless without context: Drax, the UK’s largest power station, has a generating capacity of 3.9gw;  marginal capacity added to the entire UK renewable energy fleet (encompassing all renewable sources) in 2020 totalled 1.2 gw. Far from being stigmatised and demonised, arguably such companies should be positively encouraged, incentivised even, to help the transition. It is too important to get wrong!

Sustainable/ renewable energy is something that we have mentioned before when talking about ESG. Sustainable energy is energy produced and used in such a way that it “meets the needs of the present without compromising the ability of future generations to meet their own needs.”

The global economy is slowly but surely switching power sources toward cleaner and renewable alternatives. These green energy sources include wind, solar, hydro, geothermal and biomass.

Since the start of the pandemic, climate change has become a common topic for discussion and investment managers are all now being forced to look at their propositions to either build in ESG processes or develop new ESG or ethical investment solutions.

Renewable energy is growing very fast. The International Energy Agency (IEA) have said that this type of energy reached 30% of global electricity generation in 2020, and they forecast that renewable energy is on track to overtake coal to become the largest source of electricity generation worldwide by 2025, supplying one-third of the world’s power.

The growth in this sector provides investment opportunities for investors as nobody expects this growth to slow down any time soon.

Please keep an eye out for more ESG related content from us, along with our usual market update content.

Andrew Lloyd


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Janus Henderson ESG Thought Pieces and Our Thoughts

Investment Management House Janus Henderson recently published some thought pieces on ESG and Socially Responsible Investing. Please see the key takeaways from these pieces below:

Sustainable equities: the future is green and digital

  • The pandemic has accelerated investment into digitalisation, which we consider to be a key enabler of sustainability.
  • We expect support for sustainable development to gain momentum as countries embrace the need to be low carbon and as Joe Biden takes his seat in the White House.
  • Investment into electric vehicles is expected to surge in 2021 as innovators ‘race’ to the top.

Sustainable design in consumer products

  • The apparel sector is well known for its detrimental effects on the environment. However, as consumers become more aware of their own environmental footprints, there has been a surge in demand for sustainable goods.
  • A circular economy is based on the principles of designing out waste and pollution, keeping products and materials in use, and regenerating natural systems.
  • Companies including Nike, Adidas and DS Smith have incorporated a circular approach to the design and production of their goods, creating durable and long-lasting products with a reduced environmental footprint.

Investing in Diversity: analysing the investment risks and opportunities

  • Companies are increasingly being held accountable by consumers who reward brands aligned with their values.
  • For many global businesses, matters of diversity and inclusion go beyond the workplace, and efforts are made to address discrimination in the countries in which they operate.
  • Investors should be wary of companies that fail to futureproof themselves in terms of diversity. Socially conscious brands that make inclusivity a central part of their business strategy and brand ethos are more likely to succeed.
  • What gets measured, gets improved. Investors should focus on company disclosure, diversity-related targets, and meaningful initiatives in place. A list of suggested investor questions can be found at the end of this paper.

Janus Henderson are ahead of the game with ESG policies and started factoring this in back in 1991 shortly following the 1987 United Nations Report, ‘Our Common Future’ which I mentioned recently in an ESG blog. Their philosophy is below;

‘We believe there is a strong link between sustainable development, innovation and long term compounding growth.

Our investment framework seeks to invest in companies that have a positive impact on the environment and society, while at the same time helping us stay on the right side of disruption.

We believe this approach will provide clients with a persistent return source, deliver future compound growth and help mitigate downside risk.’

As I wrote about in our blog, as a firm we undertake regular due diligence with regards to the investments we recommend to our clients. This an ongoing process and we are constantly monitoring the market, and this year ESG has become a key factor in what we look for in the due diligence process.

Of course, many businesses may have a broad and generic ESG statement, but having a strong and well defined ESG process embedded into a businesses culture and investment process is definitely one of our key determining factors in the companies we choose to recommend.

We start off with an investment houses ESG statement, but then we dig deeper, to make sure these investments do exactly what they say they do, in terms of ESG, then factor this into the rest of our research i.e. investment returns, track records, cost etc.

It’s good to see so many investment houses now openly talking about and promoting ESG and demonstrating their views and philosophies.

Now could be a great time to invest whilst asset prices are still generally low, all whilst taking a responsible approach to investing!

As always, keep checking back for a variety of blog content from a wide range of investment houses, fund managers and our own original pieces.

Andrew Lloyd


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ESG… the ‘new normal?’

Firstly, yes, this blog is called ‘the new normal’ and yes, I know you may be fed up of this phrase (believe me, I am too!), but dare I say it? Is ESG ‘the new normal’ when it comes to investing?

You may have seen some of our posts over this past year on ESG and sustainable investing.

We posted a 3 part series over the summer called ‘What is ESG? – An Introduction’, this was written by us to help our clients really understand what ESG is, and it’s a good thing we did… a recent study was undertaken in this industry and it was found that the majority of clients didn’t understand what ESG was, in fact it was found that people thought it stood for ‘ethically sourced goods’.

Google searches also show an increase of 216% in the term ‘ESG’ since 2018. This shows if people don’t know what it is, they want to learn.

Over the summer we wrote;

What does ESG stand for?

ESG stands for Environmental, Social and Governance

But what is it?

Investopedia definition for ESG is;

‘Environmental, social and governance (ESG) criteria are a set of standards for a company’s operations that socially conscious investors use to screen potential investments.’

ESG is more of a theme or a set of principles to follow rather than a single set principle.’

In case you missed it, please revisit this blog series using the following links: What is ESG? – An Introduction – Blog Series – Part 1, Part 2 and Part 3.

One Planet, One Society, One Economy

ESG is a set of principles throughout not just investing, but throughout the world.

Climate change is a factor within ESG principles, but why is it important to focus on climate change?

Well we are one planet. We are one society and one economy. Yes, I am aware that sounds very ‘tree hugger-ish’… but look at how issues caused by climate change can affect society and the economy.

You will have seen hurricanes, floods, the wildfires in California and Australia on the news over the past few years. These are all driven by global warming. Since 1980, the cost of weather related catastrophises has been over $4,200Billion.

Boris Johnson recently announced that the aim is for the UK to have no sales of new fossil fuel cars by 2030.

Climate change is not an abstract future concept anymore and ESG isn’t just the latest trend, it is a future state of being, it’s an input into the outcomes of the future and it’s about companies embracing opportunities and making changes now to invest in the future.

The concept of ‘ESG’ or ‘ethical’, ‘socially responsible’ isn’t new.

Over 30 years ago, in 1987, there was a study by the Brundtland Commission called ‘Our Common Future’ which said that;

‘Sustainable development meets the needs of the present without compromising the ability of future generations to meet their own needs, guaranteeing the balance between economic growth, care for the environment and social well-being’

ESG has been gaining momentum for a while now as climate change and other social issues presented themselves but then of course, the pandemic hit.

Many investors probably assumed that the ESG focus would fade however it was only strengthened, with people looking at how everybody working from home would reduce carbon emissions, international travel was halted which again contributed to the drop in carbon emissions and early on in the pandemic when companies had to send employees off to work at home or on furlough and their mental and physical wellbeing became a focus.

Sustainable investments were once few and far between and usually meant sacrificing returns in order to stand by your beliefs, but these days, you would be hard pressed to find a company or an investment that doesn’t have some form of ESG policy or statement. Of course some may just be doing this to ‘tick the boxes’ but some will be actively involved in ‘doing the right thing’.

ESG has momentum now, we no longer think you have to sacrifice returns either!

As we have said before, ESG is not a tangible ‘thing’ that you can see or hold, it is in fact a complex interconnected system of ideas and processes.

Think of it as a journey, rather than a destination.

Andrew Lloyd