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ESG Focus: Summit Calm Before The Storm

ESG Focus | May 03 2021


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:

ESG Focus: Summit Calm Before The Storm

The Climate Summit last week proved an anticlimax but with some interesting takeouts: natural gas has been granted a reprieve and indications were given on the timing of fund flows

-Summit more of an assurance than a hard hitter
-But the storm is soon to hit – or should we say flood – perhaps 2022
-Methane gains a reprieve
-Prepare for the battle of the batteries

By Sarah Mills

There was a sense of anticlimax from the Earth Day Climate Summit last week.

The summit of the world’s leaders topped off what has largely been a quiet year for ESG stocks as investors shifted from growth to value, a trend that is unlikely to show a strong reversal before the third quarter.

Investors expecting a major jolt from the summit would have been disappointed. 

Yes, there were some big announcements, but certainly nothing controversial.

Yes, US President Joe Biden announced a -50% to -52% reduction in emissions from 2005 levels by 2030, but those who were expecting a specific targeting of methane emissions would have been disappointed.

In all, the summit appeared to be more of an assurance to markets, and the world, that global commitments remain intact and that it’s all steady as she goes.

Methane gas emissions enjoy a pass-over

It is widely acknowledged that methane is a more serious greenhouse gas than coal gas, and that global greenhouse targets depend on its reduction.

But nearly every leader failed to highlight methane in their Summit speeches, with the exception of Russian President Vladmir Putin, who gave the topic lip service but no concrete commitments.

This suggests the industry may be safe from regulation for at least another year.

Given methane is critical to the US’s climate plans, Biden did give it a cursory mention, saying the US would cut non-CO2 greenhouse gases, including methane, hydroflurocarbons and “other potent short-live pollutants”.

But the mention was notably short on specifics.

The Clean Air Task Force is pushing the US to adopt specific oil and gas emission cuts to -65% below its 2012 levels by 2025, which suggest the timeframe still remains tight for the industry, despite the reprieve.

The big question: when’s the money coming?

What was interesting was Biden’s commitment to a -26% to -28% reduction in US emissions by 2025 (from baseline), which would make the remaining -24% cut in the second half of the decade look like a doddle, opening the potential for further cuts (depending on the transition’s emissions consumption). 

These commitments give investors a heads-up as to a likely acceleration of funds flowing through the market into green industries in the next few years – more on that later in the story, where we check out forecasts for green bond issuance.

With only four years of incumbency guaranteed, the Democrats no doubt want to give the transition a strong, early push.

And US Climate Envoy John Kerry has nominated the private sector as the favoured vehicle to progress this agenda.

Green and sustainable bond issuance points to 2022 and beyond

Momentum is building in the investor space with US$37trn in assets under management (AUM) committed to net zero portfolio emissions by 2050 via the Net Zero Asset Managers Initiative.

The United Nations Climate Envoy Mark Carney estimates that up to US$3.5trn will be channelled into the sustainability every year for 30 years, reports the Australian Financial Review.

“This scale of investment in energy, sustainable energy and sustainable infrastructure needs to double, every year, for the course of the next three decades – $US3.5 trillion a year, for 30 years,” Mr Carney said.

A quick scan of sustainable bond issuance forecasts for 2021 suggests that the bulk of funds are unlikely to land this year, at least not for the next six months.

According to Calvert, green bond issuance for the March quarter was US$111bn, triple that of the covid-depressed March 2020 quarter.

Average forecasts expect issuance could hit a high as US$560bn for 2021 – half a trillion dollars, but still well short of the US$3.5trn annual flows predicted by the UN (although more can come from rotation out of non-ESG investments).

Moody’s Investors Service forecasts sustainable bond issuance will hit US$650bn by year end, double that of two years ago.

Credit Suisse also forecast late last year that ESG stocks and growth stocks would take a breather for 2021 and there appears no sign of this trend reversing. 

Instead, the market focus has been on investing in transition inputs such as resources and steel making, and an uptick in value investing. 

As a quick guide to this year, Moody’s estimates 2021 issuance will be broken into US$375bn of green bonds, US$150bn of social bonds and US$125bn of sustainability.

ING reports that in 2020, use-of-proceeds bonds, which finance projects related to energy, transport, building, water and other sustainability investments, remain the most common form of green bonds issued, comprised 84% of total issuance.

Use of proceeds bonds comprised 87% of all issuance since first offered by the World Bank in 2008.

Sustainable business loans – here come the banks

Markets are particularly expecting an uptick in sustainability loans/finance this year.

At a Bloomberg webinar on sustainable finance in April, ANZ Bank Director of Sustainable Finance Tessa Dann predicted the sustainable loan market would gather pace in the second half of 2021. 

ANZ was just one of the four major banks represented at the webinar; all of which were addressing the opportunities and risks in the sustainable finance market.

Basically, the banks have their runners on and are ready to go.

How much of this largesse will flow to Australia?

BetaShares held a Climate Change Innovation webinar in April and noted that it's Climate Innovation ETF ((ERTH)) is currently invested only in international stocks. 

It has to date found no large Australian companies worthy of investment. 

This probably reflects on Australia’s resource-based economy and political climate.

Australia does have some interesting small-cap activity in the area but otherwise the pickings are slim.

But for those investing locally, Aberdeen Standard Investments (ASI) launched its Sustainable Australian Equity Fund in April.  

The fund is positioned to take advantage of forecast rises in the cost of fossil fuels and cheaper alternative energy, combined with continued investor pressure to transition.

“The Fund is ASI’s first sustainable Australian equity product, and seeks to generate strong long-term performance by investing in an all cap, concentrated portfolio of 20 to 35 financially attractive ASX-listed companies,” says the press release.

“The fund will target a weighted average carbon intensity at least 20% lower than its benchmark, the S&P/ASX200 Accumulation Index*.”

Where’s the money going?

Calvert noted that investors in green bonds in the March quarter were seeking assets that combined climate risk with environmental solutions.

BetaShares Climate Innovation webinar also shared the fund manager's views on the direction of climate funds.

Morgan Stanley’s head of wealth management Nathan Lim noted that the world is entering a multi-decade mega-trend – the road to net zero emissions.

He says that the current investment required to reach net zero is US$1trn to US$2trn a year, and suspects this figure could triple, which would align more closely with UN Mark Carney’s forecasts.

Lim expects costs for any company where the major input is carbon will rise from here; and expects ructions to begin soon in the thermal coal supply chain. 

(There were some interesting uptakes from China and India at the Climate Summit regarding coal and we will examine these in Part 2 of this series).

Lim also expects that 80% of the world’s coal reserves will stay in the ground; as will 50% of gas reserves and 33% of oil.

“These risks (stranded assets) will be particularly relevant to banks, insurers and investors,” says Lim.

On the flipside, the winners will be green energy, building efficiency, transition agriculture, electrification and conservation.

Other trends under the “sustainability” heading include sustainable products, water and waste improvements.

Lim expects a big leap in private-sector provision of social housing. 

This has been on the drawing board for decades now as part of the ideological shift from government provision of such services to the market.

Prepare for the battle of the batteries

Lim notes that bottlenecks have been identified as the main barrier to electric vehicle uptake and expects the field to be fiercely contested with lithium-ion batteries on the defensive. 

He notes that Toyota is already using solid-state batteries which go further, are safer and faster.

This dovetails with the European Union’s recent announcement that it would invest tens of billions to promote innovation in non-lithium-ion battery technology.

Lithium-ion batteries are polluting and involve poor labour practices, in violation of the UN Sustainable Development Goals (SDGs).

They also consume copper, which will be needed to fire strong demand from the computing industry in line with the rise of Big Data and the Internet of Things.

The chip industry is shaping up as a geopolitical nightmare, with Taiwan supplying 80% of the world chip market. Investors should expect considerable activity in the sector.

So investors in the lithium-ion industry will need to time their entry and exit well.

Lim also expects the number of cars on the road may decrease. 

He predicts that full automation will be a reality by 2040 if not beforehand which means households will no longer need 2 vehicles, given the car can ferry parents to work and return to take children to school, and so on.

Democratisation of climate investing in Australia

On the subject of greenwashing, Mr Lim notes that, unlike the rest of the world, it is difficult to access holding analysis in Australia, which is particularly a problem for passive investors.

But it is likely this will change in the not-too distant future. 

He also suggests investors cross-check potential investments against the UN’s SDGs given broader social and sustainability goals will be affecting the movement of capital.

Lim also forecasts a continued cumulative flow of money out of non-ESG funds.

In Part 2 of this series, we return to the Climate Summit to examine the real story behind China and India’s coal stances; Australia’s commitments and the positioning of Australian stocks; and predicted growth in the sovereign bond market in 2021.

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