ESG Focus: Decarbonisation Demand Drives Ethical Investing

ESG Focus | Apr 13 2022

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ESG Focus: Decarbonisation Demand Drives Ethical Investing

The European Union prepares to reduce its reliance on Russian-supplied gas, net zero emissions goals set and forget until 2030, and the market demands better ESG commitments from companies, with those failing to act missing out on competitive advantages.

-Green hydrogen gets the green light as European Union boycotts Russian gas
-Global government net zero commitments leave a heavy burden after 2030
-Elevated CEO turnover appears encouraged by ESG-related resignations
-Early decarbonisation adoption offers opportunity in the construction industry
-Competitive advantage to be gained for those who act ahead of Modern Slavery review

By Danielle Austin

Cutting ties with Russia could boost green hydrogen energy

In the face of threats by Russia to cut gas supplies to Europe, the European Union plans to reduce its reliance on Russian gas by two thirds by the end of this year and eliminate dependence on Russian gas supplies by 2027. The plan involves diversification of suppliers, as well as ramping up the production of green hydrogen.

With fossil-fuel linked hydrogen costs rising more than 70% since the start of the Russia-Ukraine conflict, analysts at Macquarie note green hydrogen is becoming an increasingly competitive and affordable energy source.

The Macquarie experts anticipate a step change away from Russian gas supplies will only further incentivise investment into green hydrogen projects, as the European Union looks to replace its exposure to 155bn cubic metres of Russian gas annually.

Heavy lifting ahead on the road to net zero emissions

There remain vast differences between the commitments of individual nations to achieving net zero carbon emissions, leaving a heavy burden on the two decades following 2030, observes JP Morgan.

While the United Kingdom is targeting a -60% emissions reduction on benchmark levels by 2030, China has promised only that its emissions will peak before 2030 despite being the world’s largest carbon emitter and demonstrating emissions growth of 3.3% annually since 2005.

JP Morgan analysts predicts global emissions will decline at a steady -1% annually through to 2030, or a total -8.4% by the end of the decade. Based on this assumption, the broker anticipates emissions will need to decline a further -13.5% annually between 2031 and 2050, or -1,300m tonnes annually, to achieve a net zero result.

This equates to three times the carbon emissions produced by Australia being removed each year.

Closer to home, while Australia has finally set a net zero emissions target, the path to achieving it lacks some clarity. The nation has committed to a -26-28% emissions reduction by 2030, but the broker notes faster action on coal could see this exceeded.

Importantly for shareholders, the market appears to be rewarding those companies with a proven commitment to not only emissions reductions, but to environment, social and governance (ESG) issues generally.

Movement in management driven by ESG measures

Those in top management roles are being held to higher standards than ever it appears, with a notable increase in CEO resignations related to ESG issues.

CEO turnover increased 54% year-on-year in 2021 and Macquarie analysts note the trend appears to be continuing into the current year. Almost a quarter of resignations were ESG-related, including issues such as poor corporate disclosure, corporate governance issues, Royal Commission enquiries and issues relating to diversity and inclusion.

Typically, Macquarie research revealed stocks underperformed the market in the year following an ESG-related CEO resignation. The research highlighted the action taken by a company following the resignation appeared to be crucial to its share price performance.

According to data collected by the broker, filling the CEO role with an external hire was more likely to improve performance, probably reflecting that investors look to a change in strategy and approach following the emergence of ESG issues.

Decarbonisation and the construction and building industry

Embodied carbon in our built environment is likely to come further into focus as decarbonisation efforts continue, according to Morgan Stanley. Embodied carbon largely refers to the emissions that occur before a building or structure becomes operational – that is, the emissions generated through the manufacture of materials, transport and construction.

While the majority of emissions from buildings, which are assumed to account for 38% of global carbon emissions, are operational, low-carbon construction technology offers a more holistic approach to carbon emission reductions within construction.

Developments in low carbon concrete, involving the use of alternative fuels to heat kilns and increasing the ratio of supplementary cementitious material, could provide an easy win for construction companies looking to improve embodied carbon levels in the present, Morgan Stanley points out.

Looking ahead, new technology that will allow heating processes to be separated from products, allowing emissions to be fully captured, allows for the possibility of net zero concrete products in the future.

The broker expects decarbonisation will become of increasing importance to the construction industry as developers and contractors increasingly seek out more sustainable practices. Morgan Stanley experts did note that while there is limited evidence that a greener building can command higher rental pricing, choosing not to implement sustainable practices could encourage increased vacancy.

Market listed emitters benefit from a commitment to change

Relative share price movements in recent years suggest carbon reductions remain important for investors, with companies that have improved their emissions profiles in the past three years outperforming peers who haven’t.

Listed companies in Australia continue to account for 48% of the nation’s scope I and II emissions, with AGL Energy ((AGL)), Rio Tinto ((RIO)) and South 32 ((S32)) named as the three largest contributors to emissions, but with the market rewarding those companies acting on sustainable issues many continue to implement emissions targets.

Among companies announcing climate targets through to 2030 is Santos ((STO)), which has committed to increased capital expenditure for new energies of up to -US$5bn by 2030.

Analysts at Macquarie observe the company has stepped up its emissions reduction target to -30% of absolute emissions, and a -40% reduction in emissions intensity, by 2030. New energies capital expenditure, focused on carbon capture storage and hydrogen and ammonia hubs, could represent up to 30% of Santos’ total capital expenditure by 2030.

The company has four potential carbon capture storage projects in the works, with a final investment decision made on its Moomba project and three additional projects in the pipeline.

Qantas ((QAN)) has also recently announced a new 2030 emissions target, aiming to cut emissions by -25%. The airline is committed to establishing a sustainable aviation fuel industry in Australia, providing a $50m investment for its formation and targeting the inclusion of 10% sustainable aviation fuel in its fuel mix by 2030, and 60% by 2050.

Qantas noted sustainable aviation fuel can reduce emissions by -80%. The company targets a fuel efficiency improvement of 1.5% annually through to the end of the decade and is considering different flight patterns to improve fuel usage.

With offsetting intended to account for 60% of the company’s emissions reductions by the end of the decade, Qantas has launched a carbon offset project in Western Australia. The major carbon farming project in the wheatbelt region with see farming land will be replaced with sustainable and drought-resistant native plants.

Industry fails to acknowledge extent of modern slavery reliance

As mandatory reporting under the Modern Slavery Act continues, published statements have highlighted the importance for companies to engage with suppliers, as well as a number of gaps in the current approach to regulating modern slavery risks.

Among these gaps, broker Jarden notes a strategic, blanket approach was often employed in audits, focusing first on largest suppliers rather than the highest risk points of a supply chain. Additionally, statements revealed a lack of evidence in responsible sourcing practices and poor engagement with employees and unions to adequately address grievances and remediation.

The highest risk sectors for modern slavery are financial services, mining, construction and property, food, beverages and agriculture, healthcare and apparel. Within these sectors, garments from China, rubber gloves from Malaysia, seafood from Thailand, and fresh produce from Australia remain the areas of highest concern, with sugar in Latin America and the wider agricultural industry emerging as additional pressure points.

Analysts at Jarden note there are real benefits to a reliable, quality supply chain, including lessening exposure to supply constraints, price fluctuations, fines, penalties and regulatory breeches. A review of the Modern Slavery Act is expected later this year, and Jarden experts expect the review to recommend mandatory reporting and harsh penalties for non-complying companies.

The broker notes there could be a competitive advantage for companies who prepare now for stricter regulation.

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:

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