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A once-in-a-generation opportunity

Livewire Exclusive

Livewire Markets

The world faces two huge challenges right now: one short term (COVID-19), and one long term (climate change). But could the former offer an opportunity to deal with the latter? Danielle Welsh-Rose, ESG Investment Director Asia-Pacific at Aberdeen Standard Investments believes this is a once-in-a-generation opportunity for investors to re-tool economies. To achieve this, we must ensure that stimulus is not provided to high-carbon, high polluting industries.

“Climate change potentially poses an even greater threat to the global economy than COVID-19. Heavy investment in traditional fixed assets could derail efforts to restrict temperature rises to 2°C. Not meeting this goal could lead to infrastructure damage; diminishing harvests; more expensive assets; and greater operational risks in supply chains.”

In this Q&A, Danielle discusses the sectors most at risk from rising temperatures and shares four companies set to benefit from rising ESG investment.

Some governments are putting in place initiatives to support a green economic recovery. Can you tell us what you are seeing and what it means for investors?

As economies reopen after Covid-19 shutdowns, policymakers and investors face a stark choice: redeploy the same old strategies to boost growth in the short term, or recognise this pandemic as a once-in-a-generation opportunity to re-tool economies so that younger generations have a future. Investors have a crucial role to play in influencing governments, businesses and the public to maintain a longer-term focus to ensure that climate change and environmental goals are not sacrificed in planning for a rapid economic recovery.

The pandemic has proved devastating for people and economies the world over, and its effects will be felt for a long time to come. 

But financial stimuli to support businesses and save jobs must not be allowed to flow into high-carbon, polluting industries as happened after the global financial crisis. Climate change potentially poses an even greater threat to the health of the global economy and people over the long term than the pandemic. Heavy investment in ‘traditional’ fixed assets could derail efforts to restrict temperature rises to within 2°C from pre-industrial levels – a target established by more than 180 countries at the UN climate change conference in Paris in 2015. Not meeting this goal could lead to infrastructure damage; diminishing harvests; more expensive assets and commodities; migration of climate-change refugees; and greater operational risks in supply chains. By contrast, green stimulus policies would help to develop cleaner renewable energy sources; retrofit buildings to enhance energy efficiency; create better energy storage and management systems; and build more efficient power transmission networks.

So far, the responses of policymakers have been mixed. Germany assigned almost one-third of its €130 billion (A$211 billion) stimulus programme to climate-related investments and set aside nothing to help the traditional auto industry. At the other end of the spectrum, the United States pulled out of the 2015 agreement to limit temperature gains to within 2°C, while US President Donald Trump wants to bail out the US oil and gas industry.

Asian countries occupy various points in-between. South Korea unveiled its Green New Deal, which seeks to phase out coal as an energy source, focus on renewable energy investment and implement a carbon tax. New Zealand set aside the equivalent of US$600 million of its recovery budget to create ‘nature-based’ jobs in segments such as conservation. Meanwhile, China – one of the world’s biggest polluters – has not said how much of its US$430 billion-equivalent stimulus programme will go to green investments.

The shift towards more sustainable models of development has been underway for some time and won’t be stopped by this pandemic. However, the way that coronavirus-linked stimuli are deployed will dictate the pace of change and determine whether we can achieve urgent climate-change goals.

If the world does move towards a green economic recovery, and more emphasis is placed on accelerating action on climate change, then investors will need to grasp how these changes may affect them. Some business models will become unviable during the transition to a low-carbon world. Carbon prices will impact profitability as businesses that fail to reduce emissions are punished. Stranded assets – fossil fuel reserves, coal plants, gas infrastructure – may suddenly lose value as demand evaporates. Corporate reputations will be damaged amid changes in public opinion – affecting consumer behaviour as well as companies’ access to capital. There are also physical risks in the form of short-term disruption and one-off costs. Gradual climate change will also require adaptation to a ‘new normal’ of higher sea levels and further environmental degradation. Adaptation costs – investing in infrastructure to protect against physical damage and rising insurance premiums – are longer-term considerations.

On the other hand, there are investment opportunities to mitigate or prevent damage. These include developing new technologies, as well as areas such as electrification amid transportation’s shift away from the internal combustion engine. Investments may be needed into infrastructure to protect coastal cities from rising sea levels; water and soil management to stabilise falling crop yields and assist water-dependent sectors in water-stressed regions; and technology to make life in high temperatures more bearable.

The pressure to let climate change priorities slide in these unprecedented times is immense.

However, this is something that can’t be brushed under the carpet, not least because we are the last generation that can do something about it.

Can you summarise how key sectors would be impacted by a warming climate?

Australia as a nation is vulnerable to extreme weather events, and climate change will continue to exacerbate their frequency and severity. It will also likely lead to more ‘compound events’, where extreme weather events combine to generate impacts far worse than any individual event. Australia experienced it in January this year, when prolonged drought combined with heatwaves to produce the most significant bushfires the country has seen.

Climate change also presents systemic economic risks, impacting all sectors of the economy. But these impacts are unlikely to be distributed evenly, as climate change and the transition to a low-carbon economy poses different challenges across sectors. Investors need to understand the potential physical impact of climate change and the implications of the low-carbon energy transition on sectors. This process will change the risk profile for assets and companies that investors invest in.

Physical risk from climate change will affect sectors differently, depending on the nature of the business and its location. Those that are heavily reliant on water – in segments such as agriculture, energy and cement, for example – will be impacted by water scarcity. Real estate is at increasing risk from damage caused by floods, storms and fires. This can affect any business with real estate in vulnerable locations such as coastal regions, as well as investors in real-estate assets. The insurance sector is already adjusting to having to price in the increased frequency and severity of weather events. Businesses reliant on agricultural commodities will also be at high risk from climate change-driven physical impacts. Droughts and floods reduce the productivity of harvests and increase commodity prices. Businesses reliant on agricultural commodities for their operations will be affected by supply shortages, higher prices and the longer-term trends affecting food production.

Turning to the low-carbon transition, those companies and industries with high levels of CO2 emissions (considering the whole supply chain) generally face the highest levels of energy transition-related risks as well as opportunities. The most exposed companies operate in the following sectors:

  1. Utilities. Utility companies generating power from fossil fuels face high transition risks, such as increasing costs from carbon prices and reputational pressures.
  2. Heavy industry. Production of cement, steel and iron are particularly carbon intensive and difficult to decarbonise. These industries are at risk of losing competitiveness where carbon prices are in place because of ‘carbon leakage’. This means materials can be imported from regions without carbon prices at lower cost.
  3. Energy. While the direct emissions of fossil fuel energy companies are lower compared to the industries mentioned above, their downstream emissions related to the consumption of fossil fuel products are significant. Fossil fuel producers also face the risk of stranded fossil fuel-related assets.

Simply avoiding investing in high-emitting companies is not necessarily the best way to ensure a swift shift to a low-carbon future. Channelling capital towards high-emitting companies that have ambitions to transform their businesses and align themselves with the Paris goals is critical for enabling the energy transition.

Three sectors most at risk from climate change

Fossil fuel industry

There has been a demonstrable shift to renewable energy as prices have continued to decline, in many instances becoming cheaper than fossil fuel power. We believe the writing is on the wall for the fossil fuel industry, most prominently the thermal coal value chain. Although there are instances and/or geographies where price parity has still not been met, in many cases it has. Solar and wind power now provide very viable alternatives when part of a smart energy grid system.

Insurance sector

The insurance sector is having to price in the increased frequency and severity of weather events. Rising sea levels continue to encroach on conurbations, most notably for coastal towns that sit roughly at sea level. There is a threat not only to housing, but also to industry, including business infrastructure, as well as roads and rail. All of this has implications for insurance liability risk.

Financial sector

Investors need to understand climate change and its impact on all parts of the economy, yet many are still not including these risks in their analysis. This is no longer a niche issue. There is a clear need to think about climate change risk mitigation within a portfolio and prepare for the world missing its carbon emissions targets. The financial sector, in particular, needs to think hard about issues regarding stranded assets, and industries that will change completely due to climate change.

Can you provide an overview of some companies that look set to prosper from rising ESG investment, and three sectors that look most at risk?

Four companies in line to benefit from rising ESG investment

Korea – Samsung SDI
A global leader in the development of lithium-ion battery technology to power electric vehicles and largescale Energy Storage Systems (ESS) as part of its energy solutions business. This segment generates about three quarters of the company’s revenue, with other electrical equipment accounting for the remaining quarter. Samsung SDI has continued to innovate through research and development. In 2018 it launched a new ESS product with substantially increased energy density, enabling it to produce more energy using fewer materials. Its sale of electric vehicles as a proportion of total vehicle sales is expected to grow rapidly in coming decades, which will go hand in hand with growth in demand for batteries.

China – China Conch Venture
The nation’s biggest cement maker – it owns Anhui Conch Cement – is well placed to benefit from sector consolidation. But what is underappreciated is its transformation into an environmental business. Through subsidiaries, China Conch Venture provides energy preservation and environmental protection solutions and offers environmentally friendly building materials. It also has expertise in environmentally sound treatment and co-processing of hazardous waste, for which there is strong demand given increasingly strict guidelines in China. Its core business is the construction of waste incineration systems to retrofit cement kilns. Its proprietary incineration technology and cement production process helps to improve carbon efficiency and reduce heavy metal emissions such as dioxin.

Indonesia – Medikaloka Hermina
As Indonesia’s second largest private hospital chain, Hermina plays a key role in helping the government to achieve its goal of universal health care. Historically, access to health care in Indonesia has been limited, with more than a third of the population estimated to have had no form of health coverage as recently as 2012. A large part of Hermina’s business is providing treatment covered by state health-care programmes known as Jaminan Kesehatan Nasional (JKN), which were introduced in 2014. All Hermina’s facilities accept JKN patients; they have proved adept at managing the provision of these services, emerging as an industry leader in this segment. The company is now well positioned to scale up coverage of JKN-related health care.

Australia – Cleanaway Waste Management (ASX:CWY)
As Australia’s largest waste management company, we expect Cleanaway to play a critical role in the nation’s transition to a more sustainable, circular economy. Cleanaway faces numerous investment opportunities to convert the waste it collects from customers into valuable commodities. The company recently announced a joint venture with Asahi and Pact Group, which will leverage off prior investment in waste-sorting facilities to convert recyclable bottles into high-value plastic pellets. Additionally, Cleanaway is in the process of gaining approval to build an energy from waste facility in Western Sydney, which would divert 500,000 tonnes of waste from landfill each year, provide a renewable source of energy to the grid and, according to the company, reduce carbon dioxide emissions by more than 450,00 tonnes per annum.

Invest today. Change tomorrow.

ESG considerations underpin all investment activities at Aberdeen Standard. Their goal is to make a difference – for clients, society and the wider world. ESG investment is about doing the right thing, while aiming to achieve investors long-term financial goals. For further insights from Aberdeen Standard, please visit their website 

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