Mike Appleby

Good COP or bad COP – energy transition will still power on

Mike Appleby

With the recent report from the UN's Intergovernmental Panel on Climate Change (IPCC) heralded as a code red for humanity, there is rapidly increasing anticipation about and expectation for November’s COP26 Conference in Glasgow.

As sustainable investors for more than 20 years, we clearly want the Climate Change Conference of the Parties to be a great success and achieve its broad goal of galvanising the global effort towards reducing emissions. We have seen many such events experience varying degrees of success in the past – 25 previous COPs for a start – and however COP26 ultimately plays out, we will continue to see huge disruption as the world grapples with the energy transition.

COP26 has four key goals:

1. Secure global net zero by 2050 and keep 1.5 degrees within reach. To deliver on these targets, countries will need to:

  • Accelerate the phase-out of coal
  • Curtail deforestation
  • Speed up the switch to electric vehicles
  • Encourage investment in renewables

2. Adapt to protect communities and natural habitats

3. Mobilise finance

4. Work together to deliver

The IPCC’s latest report was very clear on the science behind the energy transition: we need to reduce emissions from human activity materially within the next decade (approximately halving them) to limit the global average temperature rise to a rate that does not seriously limit our future quality of life.

Familiar anxieties about the financial implications of doing this fail to consider the fact that not taking action to halve emissions by 2030 will cost orders of magnitude more in limiting growth and development – and for more on this, see the Stern Review on the Economics of Climate Change from 2006.

We continue to believe materially reducing emissions will impact the whole economy, including our energy system and how we heat and cool buildings as well as driving transformations in transport, industrial processes, agriculture and land use.

This move to an ultra-low carbon economy will have a massive impact on investment returns, and our Sustainable Future (SF) funds have been built with this in mind since launch in 2001. Companies contributing to this shift should prosper while those on the wrong side of the energy transition, or simply not confronting its ramifications, are at risk of secular decline and underperformance over the next decade and beyond.

Some of this has already been happening, with the European utilities market being a good example. The losers over the last 20 years have been those companies with high carbon-generating assets while the winners have been investing in renewables and the grids supporting them. To stay on the right side of this trend, we have avoided areas such as fossil fuel extraction and production and, more broadly, internal combustion engine car manufacturers, airlines and energy-intensive businesses not positioning themselves for a lower-carbon world.

On average, our funds have 28% invested in companies improving resource efficiency and reducing emissions across areas such as energy waste, smarter water management and increasing recycled material. Our funds also emit 68% less (in terms of companies held) than the markets in which they invest. Our favoured stocks have less carbon costs to pass on to customers, which means their margins will be more resilient to inevitably tightening emission regulations – on which COP26 may potentially shed further light.

Our Increasing electricity generation from renewable sources theme, for example, is focused on companies involved in substituting coal-intensive fossil fuel electricity generation with renewable power sources, reducing carbon emissions and providing a cost-effective means to connect people to cheaper, more reliable power sources.

A holding in this area is US Solar Fund PLC, a London-listed renewable electricity generation company that builds new and operates existing solar farms in the US. Solar is becoming an increasingly cheap source of electricity generation, which can now outcompete natural gas derived from fracking on an economic basis.

For our Improving the efficiency of energy use theme, we see several ways of making energy cheaper by reducing waste while also curbing emissions through better use. This cuts across many areas of the economy and includes building insulation, efficient lighting, energy-efficient climate control, travel and industrial processes. Companies that provide services or equipment, particularly in upgrading the power grid network to deal with changing production and consumption patterns of electricity, play an important part in achieving affordable clean energy.

One of our holdings is SDCL Energy Efficiency Income Trust PLC which invests in projects or assets that reduce the amount of energy wasted, thereby cutting energy bills for users and emissions. The projects owned cover a broad range of technologies globally, such as providing efficient heat and backup power to a London hospital, cogeneration of heat and power in olive processing using olive wastes, and recycling waste gas technologies used in steel smelting in the US to make it more efficient.

The energy transition is also seen in the following three themes:

  • Building better cities: We recently initiated a position in US homebuilder NVR, with 100% of its homes built in 2020 verified by an external party to be 40% more energy efficient than the average home constructed that year.
  • Making transportation more efficient: We own companies such as National Express in the UK as we see safe, efficient mass transport as the best way to reduce congestion and emissions in our cities. The company has committed to never buying another diesel bus in the UK, pledging to invest in battery and hydrogen over the coming years and potentially linking up with fuel cell producer Ceres Power, which we also hold.
  • Improving the management of water: We own Ecolab, which is the global leader in technology that allows people to save key resources, particularly water and energy, in the industrial and hospitality sectors. From restaurants to steel mills, Ecolab’s products and technologies significantly reduce water and usage and save customers money, driving cost savings and efficiencies.

We are also challenging all the companies held across our SF funds to decarbonise their business at a rate consistent with the science as we think this will give them a competitive advantage in an increasingly carbon-constrained world. We launched this 1.5 Degree Transition Challenge last year and will be reporting our findings over the next few weeks.

For a comprehensive list of common financial words and terms, see our glossary here.

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Wednesday, October 13, 2021, 9:12 AM