In conversation with Ben McEwen
As companies attempt their transition to a net-zero world, we sat down with Ben McEwen, Climate Analyst at Sarasin & Partners, to understand more about what the high-carbon transition means for investors and how we assess the credibility of companies’ climate claims.
What we are looking for in our high-carbon transition sub-theme is to protect our clients’ capital and generate durable returns over the medium to long term.
Companies that aren’t addressing significant transition risks, principally adaptation to climate change or mitigation of emissions, will be less likely to sustain their returns over the medium to long term.
We often hear it’s essential for all sectors of the economy to decarbonise rapidly, but why is high-carbon transition so important?
We’re all increasingly cognisant of the rates of warming that we’re seeing globally. As of last year, the world has experienced 1.1°C of global warming relative to the pre-Industrial Age. On land masses, that’s actually about 1.6°C of warming, already above the Paris Agreement, which called for well below two degrees of warming, with a target of 1.5°C.
Current policies take us towards 3°C of warming by the end of the century. That will have profound socio-economic consequences, due to rises in sea levels, loss of biodiversity and more frequent extreme weather events. In the US, for example, climate and weather-induced damages were in the order of $165 billion in 2022. For context: the annual average was approximately $30 billion in the 1990s, increasing to about $58 billion in the 2000s. In short, we already see a significant increase in climate-induced damage.
Analysis from bodies such as the Network for Greening the Financial System2 shows that scenarios with the worst macroeconomic damage are those in which we have unabated climate change. It’s clearly in all stakeholders’ interests to abate emissions as quickly as possible.
Some indispensable industries – such as steel, chemicals and cement – will struggle to transition. What is the incentive for companies to change?
There are really two forces that drive change: regulation and increasingly attractive economic incentives for change. On the one hand, regulatory and legislative incentives drive companies to decarbonise. This already has an effect in Europe, where the price of carbon recently reached €100 per tonne for the first time in history.
Coupled with this, are the economics of transition. The cost of offshore wind energy fell by approximately 60% between 2010 and 2021. Over the same period, the cost of solar energy has fallen by 83% and the cost of producing electric batteries is down 89%.3 This means companies have an increasingly compelling economic rationale to expedite the change to net zero. However, we do have to bear in mind the significant differences between industries in terms of their ability to change – and nuances within specific industries.
Given these differences, how do you go about finding companies that are likely to perform well over the coming years as we transition to net zero?
We can’t expect industries to decarbonise at a linear pace that will take us all to net zero. The steel industry will decarbonise at a different pace to the cement industry, and the chemical industry will have its own path to follow. We also have to consider the individual firms within those sectors, as well as the core competencies and attributes that could enable them to make the transition.
Essentially, what we’re looking for in our high-carbon transition sub-theme – as we do in all of our themes – is to protect our clients’ capital and generate durable returns over the medium to long term. Companies that aren’t addressing significant transition risks, principally adaptation to climate change or mitigation of emissions, will be less likely to sustain their returns over the medium to long term. We have to consider whether our clients’ capital would be put at risk by investing in those companies.
How does Sarasin assess the credibility of a company’s transition targets?
We draw on a variety of sources, including our own Sustainability Impact Matrix (the SIM), in an attempt to standardise the type of information we seek from every company. The SIM presents over 160 questions on a range of environmental, social and governance (ESG) metrics to help us pin down where a company might be vulnerable to ESG- related risks. We also use some external data providers to help us think about companies’ physical risks and the viability of their transition pathways.
Importantly, we bring internal and external ESG and transition metrics together with our fundamental analysis. A company might score highly in terms of its alignment with climate targets but still, in our fundamental analysis, be unattractive in terms of its ability to generate cashflows.
Do you hold any companies in hard-to- abate industries in the portfolios?
Two interesting examples are Rio Tinto and Air Liquide. Rio is one of the largest mining companies in the world and it faces interesting challenges and opportunities in its decarbonisation journey. It has significant exposure to copper and lithium – both of which will be in high demand during and after the energy transition. By some estimates, production of global lithium will need to increase about 42-fold over the next 30 years to keep pace with battery demand, while copper is crucial in electrification and building smarter power grids.
It faces a great set of opportunities, but it also has significant exposure to iron ore, which has high scope 3 emissions. These are outside of Rio’s control, as they are caused by activities elsewhere in the value chain. The question is: How does Rio go about capitalising on higher demand for copper and lithium, whilst also decarbonising its business and reducing reliance on cash flows from iron ore, for which there is likely to be lower demand over time?
Another interesting company in terms of the high-carbon transition is Air Liquide, a global leader in industrial gases. Today it has a high emissions footprint due to the energy intensity of its products, but it also has two interesting energy transition opportunities. The first is carbon capture storage, which has some controversial aspects, but will be needed in some form. The second is hydrogen production. Hydrogen’s multipurpose potential has been much-hyped, but the industrial sector will increasingly need hydrogen. Air Liquide is a global leader in producing hydrogen and has good potential to generate enduring cash flows from that value chain.
Does this process lead to avoiding companies in hard-to-abate sectors?
We don’t rule out any specific industries. We aim to protect capital by looking at the world in terms of the themes that are shaping society. Given these forces, we seek to identify companies that are most likely to benefit as a result.
There are companies in hard-to-abate sectors that won’t protect our clients’ capital. But these may also be companies that we can engage with and apply very specific targets for change. Shifting those companies towards a more responsible path can lead to capital protection and more durable cash flows.
So yes, we can and will invest in high-carbon companies – if they meet our ESG requirements or can be shifted towards a responsible path. It remains an investment decision. If our research shows that a company’s returns will be challenged, then we’ll look for better opportunities elsewhere.
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