ESG Focus | Apr 03 2020
FNArena's dedicated ESG Focus news section zooms in on matters Environmental, Social & Governance (ESG) that are increasingly guiding investors preferences and decisions globally. For more news updates, past and future:
https://www.fnarena.com/index.php/financial-news/daily-financial-news/category/esg-focus/
Part One was published on 25 March 2020:
https://www.fnarena.com/index.php/2020/03/25/esg-focus-plastic-recycling-lay-of-the-land-part-1/
-Obstacles to recycling an opportunity for disruptors and investors
-ESG investors to rally around recycling theme
-IPOs and mergers and acquisitions to dominate
ESG Focus: Plastic Recycling – Lay of the Land, Part 2
By Sarah Mills
Plastic recycling is easier said than done. There are many obstacles that recyclers have to overcome to produce a competitive alternative to virgin plastic. Solutions to these problems will be a key investment theme over the next five years as ESG impact investors, not-for-profits and governments allocate funds to this market.
The many challenges associated with recycled plastic
Traditionally, plastic recycling has encountered many problems: poor recycling habits and weak protocols around cost-effective waste collection; cost of transport and labour; the comparative cheapness of virgin plastic; the fact that gyrations in the oil price can make a massive difference to returns; problems with mixed plastic streams (not all plastics can be recycled and high purity waste streams have higher value); the degradation of plastic with each recycle until it is no longer fit for purpose (meaning it all reaches landfill eventually); and the lack of downstream markets.
New technology and processes are resolving many of the more controllable problems such as plastic collection and sorting, which, in turn, are the key areas of investment focus.
For example, multi-film packaging, black and coloured plastic, and plastic with advanced functionality such as electronics usually cannot be recycled with other plastics.
Bioplastics generally cannot be recycled with petrochemical plastics, stymieing the shift to renewable plastics.
Sorting plastics into appropriate disposal streams is laborious and expensive and a large amount of plastic is unrecyclable and destined for landfill or incineration – both of which are environmentally unfriendly.
This has severely hindered the plastic recycling industry, but it is all about to change.
The ABC of plastic recycling
There are two recycling streams for plastic: chemical recycling and mechanical recycling.
Chemical recycling typically offers two choices: fuel pyrolysis and depolymerisation or monomer recycling.
In pyrolysis, plastics are subjected to a chemical reaction to create fuel. Commercial pyrolysis has had its drawbacks because the type of plastics that can be subject to pyrolysis are limited.
For example, PET plastic used in items such as soft drink bottles cannot be included because they contain too much oxygen. Bioplastics and plastic film are often excluded.
New technologies, such as Licella’s (mentioned in Part 1), appear set to change this. Certainly, it can handle a wider range of polymers than other methods. It is also more competitive when oil prices fall (at above US$50 a barrel) than other recycling modes and is the best candidate to deal with end-of-life plastic that has degraded through other recycling processes.
On the downside, chemical recycling is capital intensive, requiring heavy investment in steam crackers. It is less circular, and has more emissions issues.
Another form of chemical recycling is depolymerisation, or monomer recycling, in which chemicals and heat are used to break polymers down into their original components, and the plastic is re-used to create new plastics.
Typically the plastic degrades in this process. It can only recycle a couple of types of plastic, PET plastic being one, and is often used for making PET plastic bottles.
This process requires less capital than fuel pyrolysis, nor does it require plants to produce the PET polymers; and according to McKinsey it therefore has the potential to produce some of the most profitable recycling levels, along with mechanical recycling.
Mechanical recycling involves grinding, washing, separating, drying, re-granulating and compounding waste plastic at which point the resulting material is generally extruded into any number of products such as decking, bollards, fencing, crash barriers, rail sleepers, furniture, picnic tables, gardening products, shark fencing, noise walls and roads.
This process is used to generate new plastic bottles from old ones by recycling plastic into pellets and into their original formats, and it is this route that most of the consumer goods companies are opting for as they build closed loops for their products. The major problem with mechanical recycling is that the quality of the plastic degrades through each recycle.
Mechanical recycling requires less capital than chemical recycling, given its access to relatively cheap equipment and raw material, making it more competitive. It has lower barriers to entry. McKinsey estimates that mechanical recycling is likely to generate the largest profits out to 2030. However, it is less competitive when oil prices fall below US$75 a barrel.
Solutions are within spitting distance
Solutions for some of these problems are very close. On the production and process front: vertical integration can solve plastic transport issues; regulation and incentives can help combat cheap virgin plastic prices; new technology is making plastic sorting less laborious, reducing the amount of sorting, removing degradation, reducing costs and enhancing competitiveness; governments and industry are collaborating on residential recycling habits; and protocols and standards for plastics, including legislation banning the production of unrecyclable plastic, are under way.
On the product design front: new plastic products are being designed to be recyclable in existing waste streams. For example, a self-funded company Great Wrap launched a DIN CERTCO certified compostable and degradable stretch wrap in March from plant-base products to replace the wrapping around the billions of pallets transported each year, removing an annual one million tonnes of plastic from the environment.
It is compostable and leaves no trace of residue or microplastics in the environment and will break down within 180 days. This innovation, while still requiring industrial composting which is not yet well catered for in waste collections, removes a major contaminant from recycling streams. Should the wrap make its way into collections, then it should at least be useable in modern pyrolysis plants, the likes of Licella, which can compost both bioplastics and chemical polymers in the one stream.
As an example of how innovators are building relationships in the not-for-profit and government sectors, Great Wrap will be partnering with Plastic Bank to remove plastic from coastal ecosystems. For every box of Great Wrap sold, 761 bottles or 15kg will be removed.
Plastic Bank is a plastics recycling exchange, funded by an external currency. It allows the trade of plastic items for money via Blockchain; secured digital tokens.
The downstream market front represents the last major hurdle for the industry, and the main barrier to entry for disruptors.
Government procurement can create a difference, but more will be required in terms of regulations upon the amount of recycled plastic content required in plastics.
If virgin plastic continues to be produced at the present pace, unmatched by recycling demand, then complete bans may be required for virgin plastic in single-use plastics.
Developing downstream markets is likely to be a focus for ESG impact investors, not-for-profits, and governments. Plastic roads, cars, building frames and single-use plastics are all new potential repositories for recycled plastic.
Consumer marketing and product design will play crucial roles in building these markets.
For example, consumers may be prepared to pay a premium for recycled plastic products, and this price may vary according to the source of the plastic. Ocean plastic for example, is likely to attract the highest premium.
Developments with ocean plastic
Last October, teenage inventor Boyan Slat’s ocean garbage collection machine finally retrieved its first catch from the Pacific Garbage Patch, an island of rubbish three times the size of France, opening the premium market for reclaimed ocean plastic.
While there is a still a long road to hoe between here and commercialisation, Slat says the success gives his organisation Ocean Clean-up and its backers sufficient confidence to continue with the project.
The plastic will be brought to shore for recycling and Slat hopes the cost of operations will be covered by the sale of harvested plastic.
The project is scaling up to become more durable and could well be the recipient of grants and government subsidies, and should find support from blue (see below) ESG investors.
Ocean Clean-up now plans on building a full-scale system that endures, collects and retains the plastic for up to a year prior to its redeployment to recycling. The organisation aims to collect 50% of the Great Pacific Garbage Patch within five years and 90% of it by 2040.
If successful, this one project should prove an area of massive investment from governments, not-for-profits, ESG impact investors, and ocean-dependent industries given it is considered one of the most urgent environmental issues of our time.
What is interesting is that it provides petroleum-based polymer recyclers an alternative, potentially higher yielding source of raw material– reducing dependency on virgin plastic petrochemical production and cushioning it against bans on petrochemical content in single-use plastic.
If successful, it may even find support from the packaging and consumer goods companies, seeking to improve the green profile of their products, and cushion them against potential bans on virgin plastic content in single-use plastics.
Recycling of retrieved waste from the ocean patch would become a priority – and the most innovative and efficient technological developments and operators are likely to be recruited to the solution – both onshore and at sea.
Ocean plastic could spawn its own industry of recyclers, designers, producers, wholesalers and retailers.
ESG and the plastic theme
ESG now accounts for one third of the world’s total investing at roughly $30trn.
Firstlinks (prior Cuffelinks) identifies plastic as one of the top-10 global ESG issues and MSCI identified plastic waste as one of five key ESG themes for 2019 and beyond.
A coalition of 25 major institutional investors, boasting combined assets valued at US$1trn, have joined the Plastic Solutions Investor Alliance, according to Sustainalytics. It is not unreasonable to expect that government, industry and not-for-profit funds could equal this.
Plastic has both an environmental and social component given the potential human health issues and solutions, which will attract the eyes of different investors to a broad array of solutions.
To improve transparency for ESG investors and facilitate more efficient flows of capital to effective and better performing assets, the Plastic Disclosure Project, a Clinton Foundation Initiative, encourages measurement and disclosure to improve corporate, community and individual accountability on plastic manufacture, use and disposal.
Blue investing: The main ESG plastic thematic is “blue investing” reflecting the impact of plastic waste on the ocean. Many ESG analysts and funds have aligned themselves specifically with this thematic.
Plastic pollution in the world’s oceans costs the marine economy US$19bn a year according to Deloitte Research, and a study published in the Marine Pollution Bulletin says it costs society up to US$2.5trn a year when taking into account broader impacts.
Green investing: Plastic recycling may also be the beneficiary of the much larger pool of ‘green’ funds (the carbon emissions thematic).
While the green investing dollar remains heavily focused on coal, the aggressive acceleration of the petrochemical industry into plastic is turning heads.
Plastic requires roughly the same amount of energy to process it, as it does to make it and recycling plastic is roughly equivalent to removing 1m cars from the road a year.
The potential annual energy savings that could be achieved from recycling all global plastic waste is estimated to equate to roughly 3.5bn barrels of oil per year. That will rise as sharply as the market for virgin plastic rises to 40% by 2030.
Stranded assets
MSCI last August warned that given the recent acceleration in production, plastic could become the next stranded asset after coal.
“A growing legal and consumer backlash against plastics pollution may threaten the economics of further petrochemical and O&G developments,” MSCI said.
If this trend continues, petroleum assets envisioned as plastic inputs could end up as stranded as those intended for combustion,” MSCI said.
Mounting an emissions-based defence, petrochemical producers are touting plastic for its emissions-reducing properties. For example, they note using plastic cuts the costs of transport by preserving food shelf life.
So the green investment markets will needs to offer investors clear direction as to the weighting of these two evils in their investment choices.
This seems unlikely within the next few years, given the high level of forecast demand on plastic from 4IR. It would also require revolutionary innovation in the bioplastic market, which would take years to roll out and commercialise.
Also, US President Trump has squarely backed the petrochemical plastic industry, subsidising plants to the tune of billions of dollars.
Best in class and impact investing
The impact-investing dollar will most likely be confined to high impact, transformative concepts, preferably with both a green (low emissions) and blue (removal of plastic from the environment) focus; and bioplastics (not biodegradable/biocomposites) where feasible will be favoured over petroleum/gas based plastics.
It is also possible that on a portfolio weighting and ESG best-in-class basis, waste-management companies that have shown a clear directional commitment to plastic recycling could attract both green and blue funds in the near term.
A more specific ESG market for methods that avoid or overcome contamination, upcycling, closed loop, energy from waste pyrolysis, integration of technologies should also develop.
Consumer goods companies closing their loops are also aiming to attract a best-in-class ESG dollar. They too are looking at vertically integrating operations.
Vertical integration a key theme for the best in class ESG dollar
Highly vertically integrated companies appear to dominate the list of top-10 recycling companies by investment level in the US, suggesting there have been opportunities throughout the supply chain to create value in plastic recycling. The cost of transport significantly increases the costs of recycled feedstock.
Also, the separation of waste onsite can result in higher streams of purity. It also increases a company’s attractiveness as both a blue and green ESG best-in-class investment. However, a clearly defined strategy that addresses emissions and efficiency will be critical to gaining investor favour.
IPOs and Mergers and Acquisitions
The high upfront investment required for vertically integrated operations suggests the plastic recycling and waste-management industries are candidates for large IPOs and mergers and acquisitions, which could also be supported by ESG dollars.
According to global research from CSIRO, the recycling and waste management sectors have been very active, a sign of strong growth, but plastic recycling supply chain clusters seem to have the highest value exit and acquisition events.
Given the advantages of vertical integration, the core plastic recycling industry is, at least for now, capital intensive, which creates a barrier for new entrants once vertical integration is established.
CSIRO expects a compound average growth rate for recycled plastic of between 5% and 6.80% out to 2026.
“Strong positive growth is expected in plastic recycling markets,” says CSIRO.
“Increases in demand will spur growth in packaging, construction and automotive industries. In addition, environmental concerns and regulations are expected to be strong positive drivers for growth in this industry.
“Business opportunities for research and development exist because technological barriers are limiting recycling rates, efficiency and safety in the industry.
“Business opportunities also exist in redefining business models, to increase penetration and off more value-added services (especially across the value chain).
“Investment trends appear to favour companies that are highly vertically integrated within the plastic recycling supply chain, providing significant competitive advantage against other rivals.”
There have been several large waste start-ups around the world. Waste Connections Inc raised more than US$1.3bn, more than 40 times its closest rival ECO2 Plastics Inc, and is highly vertically integrated.
Australia does not have the same manufacturing base to easily support this kind of integration in the near term, but that will change. In the meantime, any step entailing a level of integration is a step in the right direction. We examine how Australian companies are fairing on this front in a separate article.
FNArena's dedicated ESG Focus news section zooms in on matters Environmental, Social & Governance (ESG) that are increasingly guiding investors preferences and decisions globally. For more news updates, past and future:
https://www.fnarena.com/index.php/financial-news/daily-financial-news/category/esg-focus/
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