Une reprise plus verte
We are consistently seeing technological progress towards the goal of de-carbonising our economies. Alternative energy is becoming cheaper and more and more activities have the opportunity to shift towards a lower carbon footprint. But there is a huge amount still to do. Meeting the Paris Agreement goal requires investors, governments, businesses and consumers to do more. Hopefully, the coronavirus has set us on a path to more rapid progress. The goal of a cleaner, greener future should encourage us all to minimise the risks and exploit the opportunities provided by choosing that over the catastrophic alternative. Investment can and needs to play a vital role.
Fill ‘er up, guv!
Do you know that a hydrogen fuelled car is able to run for about 400 miles on one “re-fill”? At least that’s the claim in a review I read of one of the three hydrogen fuelled cars currently available on the UK market. Do you also know that there are currently only thirteen hydrogen refuelling stations in the UK? Hydrogen is the cleanest alternative to petrol and diesel, emitting only water and created using alternative energy sources. The entire process of producing the energy and running the vehicles has the potential to massively reduce CO2 emissions relative to conventionally fuelled vehicles. Not only that, it has broader energy uses. One of the leading manufacturers of electrolysers is based in the UK and supplies hydrogen technology for use in vehicles, as an input into the production of other chemicals and as a source of energy in powering electricity grids. Hydrogen is clean and efficient. Yet, today, we aren’t using it enough.
The big threat
Yes, I know I normally write about the Fed or credit spreads or equity earnings forecasts. Recently, the investment outlook has been dominated by the pandemic and efforts to bring it under control and return economic activity to “normal” levels. The pandemic remains a serious threat and the challenge for investors is in assessing whether current market valuations truly reflect the impact of the pandemic on the global economy. However, climate change is arguably an even bigger existential threat. This week there have been reports of abnormally high temperatures in the Arctic Circle, potentially related to global warming. I attended a webinar about the net-zero ambition with panellists from an oil major and from a well-known activist NGO. As you would expect there was a certain amount of polarity between them but there was one message that was shared. Governments are not doing enough to accelerate the carbon transition. The urgency of the need to do more was noted and shared by all participants There should be more investment in the alternatives infrastructure and more done to speed up the shift in demand away from fossil fuels. This should be THE investment theme for the ages.
Building on 2020?
It has already been acknowledged that global CO2 emissions have fallen this year due to the collapse in global economic activity at the end of Q1. According to the International Energy Agency, full-year 2020 emissions could be as much as 8% lower than in 2019. Yet the risk is that once the COVID-19 crisis is over (herd immunity reached, vaccine or anti-viral drugs produced or there is a settlement between social distancing and business as usual), emissions will start to climb again. Meeting the Paris Agreement goal of restricting the rise in global temperature to below 2 degrees relative to pre-industrial times and meeting the net-zero carbon emissions target by 2050 remain super ambitious. Yet there is renewed hope as a result of the global reset that has happened in recent months. Consumer and business activities have changed and some of those changes will be permanent and beneficial. Policy makers have been brave with monetary and fiscal policy and have responded actively to the health crisis. Can they now be brave in accelerating the carbon transition policies?
What can Brussels offer?
This weekend’s European Summit is important in this respect. Bond investors have been encouraged by the apparent progress towards greater fiscal mutualisation with the proposed Recovery Fund. The funding of that will create a new risk-fee asset in Europe, helping reduce systemic risk and reducing borrowing costs for the most economically challenged member states. The Euro has already benefitted in the foreign exchange markets (up 7.5% against the dollar since the March low) and the EuroStoxx 50 index has outperformed (in local currency terms) the S&P500 over the last three months. The political significance of what is happening in Europe is important but from an environmental point of view what the money from the fund is actually spent on is more important. The European Commission’s proposal for the fund is littered with references to green and digital and ambitions to improve the resilience of Europe’s health and environment. The devil, as always, will be in the details.
Reducing externalities through investment
From the investment community side there is a huge potential to mobilise private savings even more towards environmental and social goals. It is clear to me, as a practitioner in asset management, that the pandemic has given new vigour to responsible investment. In fact I think we have shifted to a position where mainstream investment is responsible at its core now. Of course it should be. We invest to achieve greater utility in the future. That utility is not just about the wealth we will have amassed through saving and investing, but about what condition the world will be in when we, or future generations, get around to consuming it. Left unchecked, the negative externalities generated by economic activity will reduce that future utility (gross inequalities, recurrent epidemics, extreme weather, disruptions to supply and so on). Investment has to play a role in reducing these so that the future is better. Investment strategies are being shaped to minimise the exposure to risks – which may be monetised – associated with economic activities that negatively impact on society, the legal framework and the environment. At the same time, strategies are being shaped to maximise exposure to those companies that have fewer risks. More than that, investors can seek out the opportunities for growth as society confronts the challenges of the carbon transition, of sustainable agriculture, of more digitalisation and of recognising the benefits of diversity in all walks of life.
Risks and opportunities
I could probably spend every remaining working day of my career engulfed in researching, investing in activities related to, and lobbying around, climate change. As asset managers we are consistently incorporating techniques and data sources to allow us to more accurately align portfolios with sustainable goals. This means trying to assess metrics like carbon intensity and the “temperature” of the invested assets. We are also searching for the opportunities in new technologies and companies that are changing their business models to become more sustainable, or indeed disrupting established practices. Hydrogen is just one example. I have also been reading about carbon capture, one variant of which is to extract carbon from the air and either store it underground or use it in the production of sustainable fuels and other materials. COVID-19 has also led to a huge amount of brainstorming amongst investors about how people’s lives will change – less leisure and business travel, changes in food consumption, more digitalisation, changes to the way healthcare is provided – and many more. It’s a scary and, at the same time, exciting time to be alive.
There is no question that we need to accelerate the move away from a reliance on fossil fuels. One way of doing that is to increasingly monetise the cost of externalities. That means charging for carbon usage (emissions) across broader sectors of the economy. Appropriately priced, demand for carbon would decline more quickly and would increase for alternatives or for carbon reducing activities. It is complex and radical because there would be winners and losers from essentially massively increasing the price of traditional energy sources. Energy companies would face losing assets and low-income consumers would be hit until alternative energy became cheaper and more widely available. Yet governments would raise money to finance income redistribution and fund new technology. Meeting the Paris Agreement goal requires huge levels of investment – some of that has to come from extracting the “cost” of carbon emissions. Yes, carbon pricing does exist today but its role is fairly limited. A more transparent, global price for carbon would also help us value companies more effectively – adjusting their cost for their carbon intensity to reflect whether their credit spreads or price-earnings ratios were a true, sustainable, value measure.
After the 2008 crisis, governments responded by tightening the regulatory framework around the financial sector. It changed the economics of banking and asset management. Of course, the sector responded and changed. It remains profitable but it is much more responsible. Today, governments have a role to help further change the economics of energy. I look forward to hydrogen re-fuelling stations and electronic vehicle charging points being more numerous and accessible as petrol stations are today. Let’s hope “green recoveries” can deliver.
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