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Buying dirty for clean energy

22 July 2022 Stock Stories, Sector Insights, Investment Styles, How to Invest Stephanie Spicer, Head of Content, Quill PR

If you want to put some energy into your investment portfolio, look no further than how Alliance Trust and it Stock Pickers have dont it for you

So you’d think any investor or fund manager wanting to demonstrate their ESG credentials would be disinvesting pretty sharpish.

Well, no, not necessarily – for there is the school of thought that if as a planet we are going to achieve zero carbon emissions, we need to work with the worst offenders to help them get there, which invariably means energy and mining.

The argument goes that investing in higher-carbon emitters, such as more traditional fossil fuel-based energyproducing companies, should not be ruled out, as excluding such stocks is counterproductive to achieving future zero carbon emission gains.

Alliance Trust for example, is committed to a target of net zero greenhouse gas emissions by 2050 and to halving them by 2030, but believes that it is wrong to punish industries or countries facing the biggest hurdles in moving to a low-carbon world.

Mark Atkinson, Head of Marketing and Investor Relations at Alliance Trust, says, “Starving such companies of funding at a time when they most need it, may be more harmful to a successful shift to a low-carbon economy.”

“Avoiding investing in certain industries and companies entirely or selling out of existing investments in companies whose activities harm the climate, are options. But this may not bring us closer to a more resilient economy or benefit wider society, so we use those options sparingly.”

“Although their carbon footprint might be significant now, we believe many of these companies are also part of the solution, not only because they have plans to align their carbon reduction trajectory with the Paris Agreement, but also through researching and investing in alternative energy sources and carbon capture technology.”

Alliance Trust Portfolio fossil fuel-based investments include, among others, BP in the UK, Exxon Mobil in the US and Petróleo Brasileiro in Brazil, as well as Reliance Industries and PetroChina. The company disinvested Gazprom, Rosneft and Lukoil earlier in the year.

Jupiter Asset Management, in its Stewardship Report writes, “We continue to believe that if mining companies have high-quality management teams, the sector can be investable for ESG-conscious investors, and that these companies will play a crucial role in the global economy and in energy transition for many years to come.”1

PROVIDING SOLUTIONS

The climate change transition also offers opportunities for investors through companies that are addressing climate resilience, and some of these are traditionally ‘dirty’ sectors but are working on developing more energy-efficient alternatives. And there are innovative companies providing new technology and/or solutions to other companies helping the economy to reduce climate-related risks, in a range of sectors, not just energy, including agriculture, industrial and building solutions among many others. Positive solution stocks include Bureau Veritas, Schneider Electric, Kubota Corporation and ANDRITZ.

Bureau Veritas is a global leader in the provision of carbon and energy consultancy, verification and certification services. Its team of experts support the development of bespoke energy and carbon management strategies to set objectives, targets and management plans, helping companies in their decarbonisation journey.

Schneider Electric SE is a French multinational company, providing energy and automation digital solutions for efficiency and sustainability. It addresses homes, buildings, data centres, infrastructure, and industries, by combining energy technologies, real-time automation, software and services. It was ranked the world’s most sustainable corporation by Corporate Knights, the media, financial information and research company, in 2021. It helps customers reduce their carbon footprints via products and software tools that optimise energy management and industrial processes.

Kubota Corporation is a Japanese multinational corporation, focused on the manufacturing of a wide range of products and technologies to provide solutions in the areas of food, water and the environment. This includes agricultural machinery, construction equipment, engines, pumps and equipment for water purification, sewage treatment and air conditioning. The company offers smart agriculture products, to enhance crop yield, as well as water solutions including water treatment systems, from water purification, sewage purification and wastewater treatment.

Finally, ANDRITZ is an international technology group providing plants, systems, equipment and services for various industries. ANDRITZ Hydro is a global supplier of electromechanical systems and services (‘from water-to-wire’) for hydropower plants, and one of the leaders in the world market for hydraulic power generation. ANDRITZ offers technologies for producing steam and electricity from renewable fuels, as well as the efficient use of traditional fossil fuels.

Simon Denison-Smith, Co-founder and Portfolio Manager at Metropolis Capital, holds ANDRITZ. “Within its Hydro division, the climate agenda is driving renewed interest, particularly in pumped storage hydroelectricity, where hydro plants are effectively used as batteries to store energy generated by wind and solar, which is not always generated synchronously with demand,” he says. “ANDRITZ has 40% of this market. Furthermore, the existing installed base of hydroelectric power plants is ageing, and ANDRITZ is well positioned to take a share of the longterm need to upgrade and replace these old stations.”

Denison-Smith adds, “We do not invest in companies with serious ESG issues. A key part of our investment analysis is to look at the disruption threats that every business faces from changes in the world around them. These disruption threats include changes in technology, changes in competitive intensity and changes in demand.

“One of the biggest areas that we focus on is the threat of increased regulation. Thinking about a business from the point of view of regulation (which includes all government action and taxation policies) enables us to pinpoint potential issues which could compromise its cash generation over future decades.”

“This approach led us to specifically exclude certain industries such as thermal coal and tobacco. More generally, it has ensured that our portfolio has very good social and environmental characteristics with very low carbon and fossil fuel risk.”

FOLLOW THE RESEARCH

If you are determined to invest in companies with good ESG credentials, look to see how they have engaged to gain those credentials themselves, or have engaged with companies that can advise them. A study – ESG shareholder engagement and downside risk – which uses engagement data from responsible investment fund manager EOS at Federated Hermes (formerly Hermes EOS), reveals that companies that are successfully engaged by EOS exhibit a lower risk profile, particularly when environmental issues are tackled.2

Dr Michael Viehs, former Head of ESG Integration, Hermes Investment Management, says,

“Companies with better ESG credentials have on average a lower chance of going bankrupt, more stable cash flows, and are more resilient to external ESG shocks, such as tightened regulation on pollution and climate change."

While zero targets are one essential measure, they are not everything, and while working from within is key, there are still cases for exclusion. These for Alliance Trust are firms making a significant amount of money from activities likely to be phased out in the net zero world, for example thermal coal and tar sands are major sources of greenhouse gas emissions, and highly pollutive and environmentally damaging.

BEWARE IMITATIONS!

Investors need to be alert to comp anies paying ‘lip service’ to ESG targets, virtue signalling and ‘greenwashing’, i.e., claiming to be more ESG legitimate than they are. Even the most earnest may be missing the mark.

In its report ‘Absolute Impact: Why oil and gas companies need credible plans to meet climate targets’, Carbon Tracker, the think tank that focuses on energy transition and investment in carbonintensive fossil fuels, warns that net zero targets are not enough for companies to be aligned with the Paris Agreement – they need absolute limits on future emissions and significant interim targets.3

Mike Coffin, Head of oil, gas and mining at Carbon Tracker and report co-author, says, “Financial institutions must scrutinise companies’ emissions targets, and whether their plans to achieve them are practical and credible, in order to assess alignment with global climate goals. This is particularly so for companies which seek to ‘create space’ for further fossil investment. The best way for companies to reduce both their climate impact and transition risk exposure for investors, is to allow their existing production to decline without investing in new assets.”

Maeve O’Connor, Analyst at Carbon Tracker and co-report author, adds, “Oil and gas companies are gambling on emissions mitigation technologies that pose a huge risk to both investors and the climate.

Most of these technologies are still at an early stage of development, with few large projects working at anything like the scale required by company goals, while solutions that involve tree planting require huge areas of land. It remains to be seen whether these technologies will be technically feasible or economically viable, given the huge costs involved.”

The process is, however, naturally a changing one. “Our sense of what business activities we must exclude, will evolve,” says Mark Atkinson. “However, we generally prefer engagement over exclusions. Having candid but productive discussions with companies on their climate impact is likely to be more effective in decarbonising the global economy than exclusions.”

CASE STUDY – BP

Ben Whitmore, Co-portfolio Manager, Jupiter Asset Management, says it remains a long-term, engaged shareholder in BP. “We believe the oil and gas sector faces a profound challenge in adapting to the energy transition, and that BP is better placed than others to manage the transition effectively, due to the greater operational flexibility it developed in the years following the Macondo crisis.”

“Following shareholder engagement, BP unveiled a radical new climate strategy to achieve net zero emissions by 2050, including emissions generated by the use of its products. As an interim measure, BP aims to reduce oil and gas production by 40% by 2030. We believe BP has an ambitious and credible decarbonisation strategy, and is taking steps to align its business model with net zero. Our engagement objective, aligned with CA100+, is for the company to show yearon-year progress towards its long-term objectives and lay out a roadmap to net zero, with further detail on how this will be achieved.”

1. Jupiter Asset Management, Stewardship Report, April 2022. https://www.jupiteram.com/uk/en/individual/about-jupiter/esg-and-stewardship/
2. https://www.hermes-investment.com/eos-insight/eos/shareholderengagementresearch/
3. https://carbontracker.org/reports/absolute-impact-2022/

This information is for informational purposes only and should not be considered investment advice. Past performance is not a reliable indicator of future returns. The views expressed are the opinion of the Manager and are not intended as a forecast, a guarantee of future results, investment recommendations or an offer to buy or sell any securities. The views expressed were current as at June 2022 and are subject to change. Past performance is not indicative of future results. A company’s fundamentals or earnings growth is no guarantee that its share price will increase. You should not assume that any investment is or will be profitable. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. TWIM is the appointed Alternative Investment Fund Manager of Alliance Trust plc. Alliance Trust plc is a listed UK investment trust and is not authorised and regulated by the Financial Conduct Authority.

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