Climate investing – Opportunity
From bushfires to retreating glaciers – climate change sometimes feels overwhelming. But out of adversity comes opportunity. We can invest in the companies that are part of the solution, from renewables to smart technology.
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66%
of investors globally say they will focus their decarbonization process on global equities. Domestic equities, corporate debt and private markets are also expected to be a focus for decarbonization in the next one to two years. -
57%
of investors see real assets as a focus for decarbonization. This makes sense, as the generation of energy to power lighting, heating and cooling for buildings in the latter sector (in)directly produces carbon emissions.
Equities and real assets to be the focus for decarbonization in the next 1-2 years
funds
equities
'There will be clear winners and losers, which is good for active managers'
The winners and losers in the low-carbon transition
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Meeting net zero carbon goals by 2050 requires decarbonization on a global scale. Its scope will range from switching from coal-fired power stations to wind farms, to electrifying vehicles, insulating every building and making agriculture more efficient.
This will produce many winners, particularly among those companies that form part of the many technological solutions to climate change. These can be found in arenas such as renewable energy infrastructure, carbon capture systems and recycling techniques.
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Ultimately it means moving to a circular economy to reduce the manufacturing processes that generate carbon in the first place.
And there will also be losers – those companies that are too slow to adapt to the need to move to lower-carbon business models over the coming decade. As regulation gets tougher and consumer tastes change in favor of more climate-friendly products, these companies will eventually be the ones still selling horses when the railroad has arrived.
Decarbonizing as the yardstick
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Separating the wheat from the chaff is the job of any asset manager who is serious about performance. One way in which this is done is by measuring how well a company is doing in decarbonizing its business model, using metrics that measure greenhouse gas emissions, energy used for heating and waste produced during the production process.
For example, many car manufacturers have already announced plans to have an all-electric model range by 2030, to avoid their businesses becoming obsolete when governments eventually ban petrol and diesel vehicles from the roads. These will be the winners, while auto makers still offering internal combustion engines in a decade’s time are likely to be shunned by investors.
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Airlines offer a different example. Battery-powered aircraft are currently not possible, since the weight of the battery needed to generate the power for take-off would be three times the weight of a modern jetliner. Instead, they are switching from four-engine aircraft to more fuel-efficient twin-engine planes, and many have announced plans to ditch their fleets of the iconic four-engine Boeing 747 jumbo jets.
For energy companies, it is a different story again, since the world will remain reliant on oil and gas for many years to come. This means the winners in this industry are increasingly viewed as those whose business models are transitioning towards wind and solar power, for when the oil and gas either runs out, or can no longer be sold.
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China: charting the course to carbon neutrality
China’s pledge to become carbon neutral by 2060 has left many observers both excited and perplexed. Making the world’s largest CO2 emitter carbon neutral within the next 40 years is no mean feat, and will have far-reaching consequences. But the formidable challenges associated with the transition also come with many investment opportunities.
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Download our whitepaper ‘China: charting the course to carbon neutrality’
China is by far the largest carbon emitter in the world. The country currently accounts for close to 30% of global CO2 emissions, according to the International Energy Agency (IEA), versus 15% for the US and 9% for the European Union.1
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Colossal investments will be required to help the transition, especially in areas such as renewables, the electrification of transport and nuclear power generation.
Figure 1: China’s rising share of global CO2 emissions
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The rapid pace at which CO2 emissions re-embarked on their upward path last year, in spite of all the havoc caused by the Covid-19 pandemic, is a testament to the disruption needed only to put our economies on the necessary trajectory. So, while current trends in CO2 emissions may not be comforting, the recent change of tune at the highest level clearly warrants close attention.
Net zero carbon emissions will require combined efforts in three directions. Firstly, a shift in the country’s gross domestic product (GDP) mix, away from carbon-intensive industries such as manufacturing and construction, towards more carbon-light activities such as services. In fact, China’s gradual move away from industrial activities started over a decade ago.
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Secondly, a change in the country’s energy mix, away from coal and oil towards renewables. Despite sizable investments in areas such as hydro, wind and solar power over the past decade, China’s economy remains heavily dependent on fossil fuels. In particular, China is extremely reliant on coal, which is arguably the most problematic energy source in terms of carbon emissions.
Finally, carbon compensation plans will also play a key role. Even with the most radical measures, full decarbonization is unlikely to be achieved without compensation initiatives. From this perspective, carbon capture, utilization and storage (CCUS) techniques, as well as forestation and reforestation, will likely become an indispensable part of the government’s toolbox.
Implications by sector
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Around 90% of China’s CO2 emissions come from electricity and heat production, industry, and transport, with electricity and heat production representing half of all emissions.2
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Logically, these three areas will be affected most by the transition, with electricity and heat production at the forefront.
Figure 2: China’s historical carbon emissions
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Yet there are also important differences across sectors. For instance, while industry emissions already peaked almost a decade ago, emissions from electricity and heat production, as well as from transport sectors, have yet to. But there are signs that the tide is slowly turning. For one, investments in coal-fired power generation have been slowing sharply over the past few years.
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Meanwhile, moving towards a more sustainable transport sector will also require drastic changes, as well as sizable investments. These include a greater use of public transport infrastructures, an accelerated increase in the use of electric vehicles, and a further improvement in the efficiency of conventional oil-powered vehicles.
Seizing investment opportunities
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Given the changes needed in most sectors to achieve carbon neutrality, the key issue for investors is to identify any major risks they might be exposed to, and to find the most attractive opportunities. Arguably, the most exposed companies are fossil fuel producers and in particular oil majors. Their core business is fundamentally at odds with decarbonization.
But many other industries also stand to suffer from a badly-handled transition, including petrochemicals, steel and cement. Conversely, companies able to support the transition are poised to benefit from the decarbonization trend. In some cases, the likely impact of decarbonization is already well known, but in others, the consequences remain difficult to fully grasp.
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For now, we see opportunities in three major areas. Renewables are expected to retain the lion’s share of investments. But electric vehicles are also expected to be among the big winners. Finally, upgrades in power networks and energy storage technologies, as well as the hydrogen industry are likely to capture a significant portion of total investments too.
Recent official announcements suggest there will be an ambitious ramping up of clean power over the coming decade, with the share of non-fossil fuels in primary energy now expected to reach 25% by 2030, compared to an earlier target of 20%.3 Given the gradual exhaustion of hydropower potential and slowing nuclear power additions, this targets implies a rapid step-up of wind and solar.
China is leading the NEV pack
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Beijing has also made it clear that it wants to continue leading the way in new energy vehicles (NEVs), with a recently approved plan for the industry. According to the plan, NEV sales are expected to reach 20% of overall new car sales by 2025, up from 5.4% last year.4 This target for 2025 is lower than the previously stated target of 25%, as it takes into account the rough patch of 2019 and 2020.
Finally, while renewables will play the most critical role in the transition toward carbon neutrality, additional storage technologies will be also needed to address intraday and seasonal variability issues inherent to wind and solar energy, and to decarbonize all parts of the economy – including the most carbon intensive ones, such as steel and cement production.
From this perspective, two complementary technologies – batteries and hydrogen – are likely to play a key role given their ability to convert electricity into chemical energy and vice versa. China is already the world leader in terms of battery manufacturing, accounting for around 70% of global capacity.5 Despite the air pocket experienced early in 2020, production recovered rather quickly.
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From this perspective, two complementary technologies – batteries and hydrogen – are likely to play a key role given their ability to convert electricity into chemical energy and vice versa. China is already the world leader in terms of battery manufacturing, accounting for around 70% of global capacity.5 Despite the air pocket experienced early in 2020, production recovered rather quickly.
Meanwhile, developments in hydrogen are also set to accelerate over the coming decades. The China Hydrogen Alliance, a trade group representing the sector at large, estimates hydrogen could account for up to 10% of China's total energy mix in 2050, compared with less than 1% today.6
1 Source: IEA. Based on CO2 emissions from fuel combustion for 2019.
2 Source: IEA. Based on CO2 emissions from fuel combustion for 2019.
3 Myllyvirta, L., 15 December 2020, “Analysis: China’s new 2030 targets promise more low-carbon power than meets the eye”, Carbon Brief article.
4 Yu, C., 4 November 2020, “High-quality growth of new energy vehicle sector prioritized”, China Daily article.
5 Gül, T., Fernandez Pales, A. and Paoli L., May 2020, “Batteries and hydrogen technology: keys for a clean energy future”, IEA.
6 China Hydrogen Alliance, 2018, ‘White Paper on China Hydrogen and Fuel Cell Industry’, white paper.
Hydrogen – an element loaded with hope, hues, and hurdles
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Great expectations
Download our whitepaper ‘Hydrogen power – between hype and hope’After promising starts and prolonged stalls spanning at least a century, hydrogen’s star is once more on the rise. Hydrogen holds the promise to fuel the energy needs of the global economy without generating excess pollution in the process.
Along with renewable energy production and electrification trends, clean (green) hydrogen will be part of an essential strategy for decarbonizing energy markets and industrial sectors, reducing global warming and combatting climate change.
Investments made now into hydrogen technologies and infrastructure are critical for accelerating the energy transition to reach net zero targets by 2050. Attractive opportunities exist along the entire hydrogen supply chain that will reduce production costs, increase production scales, and accelerate hydrogen’s deployment and adoption within sectors and across the wider economy.
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Industry applications
Though it is still niche, hydrogen production is expected to grow and will be a game changer, especially for lowering the carbon footprints of many heavy-carbon emitting industries (e.g. steel, glass, fertilizers and semiconductors) where electrification is not feasible. Moreover, its capacity as an energy carrier means it can store and deliver surplus renewable energy for later use on the electrical grid or to any number of energy-hungry sectors. It can be used for building heat (to replace natural gas for heating residential and commercial buildings) or as a building block (to replace fossil fuels as feedstock in industrial productions of chemicals and biofuels).
Within transportation, hydrogen fuel cell technologies are seen as an effective means of decarbonizing long-haul freight fleets including heavy-duty trucks, trains, container shipping, and even some types of aviation.
Hydrogen applications across the economy
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Accelerating investments
Hydrogen’s versatility explains why enthusiasm from the public and private sectors has reached fever pitch. Worldwide big industrialized economies like Japan, South Korea, China, the EU, and Australia, have outlined hydrogen strategies as part of their decarbonization agendas. Meanwhile, eager to seize early mover advantages, giga-scale production projects have even been announced in less industrialized regions like Chile and the Middle East.
Along with big government, big industry is also putting skin in the game, launching more than 200 pilot projects that span the entire hydrogen supply chain. All totaled, announced private investments stand at USD 300 billion by 2030 and that figure excludes public financing and incentives to further catalyze development1. As part of its Green Deal and Covid recovery plans, the EU is set to spend around USD 560 billion on transitioning its economies to hydrogen energy through 2050.
Energy incumbents are also joining the fray. Big oil is hedging bets on the peak of big oil in part by bankrolling hydrogen projects. Saudi Arabia recently announced its intention to build a USD 5 billion hydrogen plant powered by plentiful desert sun and desert winds2. Other petrol producers like Royal Dutch Shell, Equinor and PetroChina are also shifting future strategies and investments on the assumption that a hydrogen-based economy will shortly materialize3. This comes as no surprise, given the addressable market globally could reach in the trillions by 20504.
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Hydrogen hues
Hydrogen is the most abundant element in the universe, and so supply is virtually endless. It is a molecule found in water as well as fossil fuels. Although hydrogen is abundant in nature, that does not make it easily available.
In the environment, it is usually combined with another compound from which it must be extracted. If extracted from a fossil fuel, it is called grey hydrogen. The process is cheap and efficient (partly due to historically low natural gas prices) but also emits CO2 as a by-product. Grey hydrogen is by far the most common form of hydrogen currently produced.
Blue hydrogen is produced in the same way as grey varieties. However, the CO2 emissions are captured and sequestered. As a result, overall emissions are reduced.
Green hydrogen, in contrast, is produced without fossil fuels as input and without emissions as output. Instead, hydrogen is extracted from water (H2O) within an electrolyzer that uses an electrical current to split hydrogen (H2) from oxygen (O) molecules. If the current is from renewable sources like wind and solar, then the hydrogen created is entirely carbon free.
Important hues of hydrogen
Hydrogen (H2) can be extracted from water (H2O) via electrolysis to make carbon-free, green hydrogen. The most dominant form in industry at present is grey, made from extracting it from natural gases like methane (CH4).
Source: Resources for the Future Report, December 2020
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Hurdles
Green hydrogen is a beautiful concept but its production is expensive. Production volumes have therefore remained low – less than 4% of all hydrogen produced is green. More renewable energy and more electrolyzers are needed to increase green hydrogen’s supply and bring down its price. Conservative estimates suggest it will take another five to ten years before green hydrogen reaches cost parity with grey. In some regions where renewables are cheap, parity could be reached in just two to three years.
In recent decades, hydrogen fuel cell vehicles have been widely publicized as a cleaner alternative to fossil fuels in passenger and freight transportation. Japan and South Korea’s governments and auto manufacturers in particular have invested heavily in fuel cell R&D and infrastructure. But for fuel cells to truly be a zero carbon mode of transport, green hydrogen must replace grey on the grid as well as in the gas tank. Otherwise, lifetime emissions from hydrogen fuel cell vehicles are not much better (and sometimes worse) than petrol-powered cars.
Hydrogen also poses other challenges. It is complicated to store, transport and distribute both as a gas and as a liquid. Current gas pipelines could be used but require heavy modifications to accommodate hydrogen’s unique properties. Concentration to a liquid is also a possibility but this too is energy intensive, inefficient and costly.
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Certain future, uncertain timeframes
Technical challenges, high production costs and economic uncertainties currently obstruct green hydrogen’s supply and uptake. Given these aspects, there is still considerable variations in timelines for hydrogen’s deployment. For some applications where infrastructure already partially exists, adoption may take just a few years. For others, it might take more than a decade.
Current estimates are predicated on fixed assumptions. But as is common to many technologies, breakthroughs can dramatically alter variables and development trajectories. Moreover, with hydrogen, it is much less a story of technological breakthroughs as political will and investment momentum. As regulatory pressures increase, market incentives intensify, and economies of scale expand, hydrogen’s development and predicted timelines will accelerate.
Hydrogen will ultimately reveal another feature common to many technologies – challenges are overcome and development timelines reduced when innovation and ingenuity meet the right incentives.
1 “Hydrogen Insights: a perspective on hydrogen investment, market development, and cost competitiveness.” (February 2021). Hydrogen Council and McKinsey & Company.
2Ratcliffe. V. “Saudi Arabia’s Bold Plan to Rule the USD 700 billion Hydrogen Market.” Bloomberg News. (7 March 2021).
3Fickling, D. “Big oil seeks redemption in the hydrogen revolution.” Bloomberg News. (4 December 2020).
4Goldman Sachs Equity Research Report. ( September 2020). “Green Hydrogen: The next transformational driver of the Utilities industry.”
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Pioneers: from green certificates to climate bonds
As a pioneer of sustainable investing, Robeco has been at the forefront of providing sustainability solutions since the mid-1990s, when the environmental movement first started to gain ground. Our dedication to creating investment products that can bring about change continues to this day.
Here we take a trip down memory lane to highlight the many firsts that Robeco has notched up:
- In 1994, Robeco launched the world’s first sustainable investment product, the ‘Groencertificaten’ (Green Certificates), for Dutch retail investors.
- Five years later, we launched Europe’s first dedicated SI equity strategy, in 1999.
- The use of engagement began in 2005 with the creation of a bespoke Active Ownership team dedicated to voting at shareholder meetings and talking to companies about improving their ESG credentials.
- Routinely integrating ESG factors into the investment decision-making process started in 2010; we are now the only mainstream asset manager in the world to use sustainability principles across the entire range of fundamental equity, fixed income and quant strategies.
- Further innovation with the launch of impact investing strategies came along in the 2010s, targeting, among other things, renewable energy and the Sustainable Development Goals, including SDG 13 on climate action.
- In 2020, Robeco launched the world’s first climate change fixed income strategies, investing in companies that make a direct contribution to tackling global warming. Our Climate Global Credits strategy invests in corporate bonds, while the Climate Global Bonds strategy invests in both credits and government bonds.
All of these developments have been backed by firm policies that are based on a commitment to help combat climate change. In line with the launch of the climate strategies, Robeco also committed to achieving net zero greenhouse gas emissions across all its assets under management by 2050.
As for the future, we will continue to innovate, particularly in the areas of climate change, green bonds and the SDGs.
Due precisely to these storage and transport issues, most grey hydrogen used by utilities and industries used existing natural gas pipelines to deliver the gases needed to produce grey hydrogen at stationary plants on site. Graphic source, Inside EVs, https://insideevs.com/news/326333/hydrogen-versus-electric-cars-video
Investing in bonds and striving to keep the global temperature rise well below 2°C.
How regulation promotes sustainable investing
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A raft of new measures contained in the EU’s Sustainable Finance Action Plan (SFAP) seeks to promote sustainable investment across the 27-nation bloc. In particular, it aims to meet the climate goals of the Paris Agreement and the European Green Deal.
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Part of the plan will be embodied in new rules such as the Sustainable Finance Disclosure Regulation (SFDR), which clarifies what constitutes sustainable investment funds, and the Taxonomy Regulation, under which asset managers must disclose the impact (positive and negative) they are making.
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Three main objectives
The SFAP has three main objectives. The first is to reorient capital flows towards sustainable investment and away from sectors contributing to global warming such as fossil fuels. The second objective is to mainstream sustainability into risk management. Finally, it seeks to foster transparency and long-termism in financial and economic activity.
The SFDR aims to make the sustainability profile of funds more comparable and better understood by end investors, using predefined metrics for ESG characteristics used in the investment process. As its name suggests, much more emphasis will be placed on disclosure, including new rules that must identify any harmful impact made by the investee companies.
Robeco has committed a dedicated project team of over 40 people to embed all aspects of the SFAP, which will come into effect in phases. The first important deadline of 10 March 2021 for the categorization of funds and disclosures required in fund prospectuses and on websites passed without a hitch.
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Landmark agreements
The SFAP was first laid out by the European Commission in March 2018 in response to the landmark signing of the Paris Agreement in December 2015, and to the United Nations 2030 Agenda for Sustainable Development earlier in 2015, which created the Sustainable Development Goals. It is also aligned with the European Green Deal, which aims to see the EU carbon neutral by 2050.
The scope of the regulation is broad and applies to asset managers, pension funds, EU banks and insurers, among others. A very visible and impactful element in the new regulation is the classification of funds and mandates into three categories, as described in Articles 6, 8 and 9 of the SFDR.
Levels of fund sustainability
- Article 6 funds are those which do not integrate any kind of sustainability into the investment process.
- Article 8 applies “… where a financial product promotes, among other characteristics, environmental or social characteristics, or a combination of those characteristics, provided that the companies in which the investments are made follow good governance practices.”
- Article 9 covers products targeting bespoke sustainable investments and applies “… where a financial product has sustainable investment as its objective and an index has been designated as a reference benchmark.”
Some 95% of Robeco’s funds are classified as either Article 8 (83%) or Article 9 (12%) and just 5% as Article 6. Article 8 funds encompass the Sustainability Inside and Sustainability Focused ranges of strategies. Article 9 funds are the Impact Investing range and are labelled as RobecoSAM. Only a small handful of funds such as those using derivatives or cash accounts do not integrate ESG.
Source: Robeco, March 2021
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Prioritizing adverse impacts
The SFDR will also require asset managers to make ‘adverse impact statements’ describing how they takes the principal impacts of investee companies into account when making investment decisions. They must also describe the actions they are taking to mitigate these adverse impacts.
This will be monitored using a system of 64 adverse impact indicators, of which 18 will be mandatory to report, and 46 will be voluntary. While detailed requirements have only recently become available, Robeco has dedicated efforts to make sure it is prepared, for example by creating prototype adverse impact tooling to assess the impact of the regulation.
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EU taxonomy
Another impactful element of the SFAP is the proposed EU Taxonomy Regulation, which aims to create a harmonized understanding of what actually constitutes ‘green activities’. The EU has defined minimum criteria that economic activities should comply with in order to be considered environmentally sustainable.
In short, such activities should contribute substantially to one or more of the following six environmental objectives: climate change mitigation, climate change adaption, protecting marine and water resources, transitioning to a circular economy, preventing pollution, and protecting or restoring biodiversity and ecosystems.
European utilities: a showcase for the climate change investment opportunity
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The utilities sector is at the forefront of a global challenge to provide affordable, low-carbon and reliable power to a growing population as well as tackle climate change by decarbonizing its generation fleet. It is also primed to capitalize on the evolution of renewable technologies which in recent years have enabled a rapid decline of the Levelized Cost of Energy for solar and wind. Abundant flows of financial capital, progressive policies and the advancement of technologies made environmental progress possible in 2019, most notably in Europe. Yet much remains to be done across the globe to combat climate change.
The European Green Deal and the 2030 Climate Target Plan represented a step change in EU climate ambitions in 2019 and 2020. The Covid-19 crisis has accelerated this agenda even further, as the decarbonization efforts will be used to support economic recovery. By summer 2021, the European Commission will revise all of the EU’s climate and energy legislation to align it with the new plan.
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The European utilities sector is the second-most emissions-intensive sector – measured as emissions per capital – contributing to 32% of Scope 1 industrial emissions. This is according to Robeco’s analysis of 424 European companies across eleven sectors. The utilities sector emits 1kg of greenhouse gas for every EUR 1 in revenue, and for every EUR 1.6 of enterprise value. Can European utilities help reduce emissions, grow revenues and profitability, and improve valuations for the coming decade, all while continuing to champion the global energy transition and without losing to Big Oil?
According to the International Energy Agency, under the policies adopted in mid-2020, by 2030 the EU27 would see its emissions fall by 30% relative to 1990 levels, while its global share would more than halve to 5.7%. The EU’s recently announced decarbonization target is ambitious, aiming to reduce its greenhouse gas emissions by 55% by 2030 and to become net zero by 2050. This is a major increase compared to the former target of an “at least 40%” reduction in the same time frame.
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A steep path towards decarbonization
To achieve this target, the EU will be using a variety of means, such as increasing the amount of renewable energy, promoting energy efficiency, and supporting and broadening carbon pricing. This new proposal is in line with the Paris Agreement objective to keep the global temperature increase to well below 2°C above pre-industrial levels. The power segment, mostly represented by utility companies, faces by far the steepest path to decarbonization.
The European utility sector fared relatively well in 2020, having recovered some of the power demand lost from steep declines in the spring. Going into 2021, the sector’s balance sheets are healthy, liquidity is sufficient, credit ratings are steady and earnings are recovering. This is especially true for companies with high shares of renewables and networks, and strong pipelines of investment opportunities for 2021 to 2023.
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Decarbonization pathway across sectors
Utility companies in the power sector face the steepest decarbonization path between 2020 and 2030 (1990=100).
Source: The European Commission 'Stepping up Europe’s 2030 climate ambition' plan, Sep 2020; Robeco's annotations.
What we look for in utility credits
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We are positive about utility companies that are improving the quality of their assets and reducing their cost structure while actively and effectively working towards diversification. This involves not only moving away from fossil-based and nuclear energy generation activities towards renewable energy sources, namely wind and solar, but also investing in networks, energy efficiency strategies in supply activities, Scope 1, 2 and 3 emissions disclosure with credible emissions reduction targets, and geographical diversification to emerging markets.
We are constructive on the credit quality of the sector. Leading utility companies have upgraded their capex programs to prioritize renewables and networks, with leverage net debt/EBITDA projections considered to be manageable.
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Regarding contributions to the SDGs more specifically, we focus on utility issuers whose activities reflect a positive contribution to the SDG 7 (affordable and clean energy) and SDG 13 (climate action) by screening for certain positive and negative KPIs. These include renewables/nuclear generation in the energy mix, sales to emerging markets, nuclear/coal expansion plans, and carbon intensity of operations. We believe companies with these positive characteristics will have a more reliable and stable financial performance in the long run.
