Implications, investment opportunities and the role of sustainability factors
15 May 2023
According to the Saltus Wealth Index, of investors who currently do not invest according to Environmental, Social and Governance (“ESG”) considerations, 87% either plan to or are considering it.
Interest in sustainable investing has grown rapidly in recent years, and it’s an important part of the Saltus investment approach. We seek to identify and invest alongside the world’s leading managers across asset classes. Before any investment, we assess each manager’s capabilities on multiple criteria, including their sustainability factors.
We believe sustainability awareness is beneficial as a means of mitigating downside risk, as well as generating returns, and therefore should be embedded into our investment process.
By doing this we think we can contribute to our clients’ peace of mind, as their portfolios are managed not only to maximise risk adjusted returns, but to do so in a manner which hopefully contributes to sustainable benefits for the economy, the environment and society.
Our policy is based on constructive engagement with our underlying managers on overall sustainability and related issues. We do not seek to use exclusionary techniques as we wish to use our influence as a positive force for change.
Decarbonisation refers to the process of reducing and eventually eliminating carbon dioxide emissions from various sectors of the economy, such as transportation, energy production, and general industry. The primary goal is to mitigate the harmful effects of climate change caused by the accumulation of greenhouse gases in the atmosphere, including carbon dioxide.
Decarbonisation can involve a range of strategies and technologies, including transitioning to renewable energy sources such as wind and solar power, increasing energy efficiency, electrifying transportation and heating systems, and implementing carbon capture and storage technologies to remove carbon dioxide emissions from the atmosphere.
Decarbonisation is a critical step towards achieving global climate goals.
One critical part of environmental issues relates to decarbonisation. In this article we discuss what decarbonisation is and we consider some of the investment considerations as well as some potential impacts, such as on inflation.
What is the “2 degrees” target?
The “2 degrees” target refers to the goal of limiting global warming to 2 degrees Celsius above pre-industrial levels. The target was agreed upon by the international community in the Paris Agreement on climate change, which was signed in 2015 and has been ratified by 191 countries.
The target of limiting global warming to 2 degrees Celsius is based on scientific research indicating that, beyond this threshold, the risks of climate change become significantly greater and could result in more frequent and severe heat waves, droughts, floods, and other extreme weather events, as well as rising sea levels, ocean acidification, and loss of biodiversity. The Paris Agreement also calls for increased efforts to pursue limiting warming to 1.5 degrees Celsius, recognising that this would further reduce the risks of climate change impacts.
To achieve the 2 degrees target, global greenhouse gas emissions must be reduced significantly, with many countries committing to reaching net-zero emissions by 2050 or earlier. This will require a transformation of the global energy system, including a shift away from fossil fuels and toward renewable energy sources, as well as significant improvements in energy efficiency, changes in land use, and other measures.
How does ESG fit in?
ESG (Environmental, Social, and Governance) factors are closely related to decarbonisation efforts. ESG factors are a set of non-financial criteria that investors use to evaluate the sustainability and ethical impact of a company’s operations. Environmental factors, in particular, are highly relevant as they involve assessing a company’s impact on the environment and its ability to reduce greenhouse gas emissions.
Decarbonisation is a critical part of addressing environmental concerns, and investors are increasingly using ESG factors to identify companies that are well-positioned to succeed in a low-carbon economy. ESG considerations may include:
- Climate-related risks: Investors may evaluate a company’s exposure to climate-related risks, such as extreme weather events, changes in regulations, and physical risks to its operations.
- Carbon footprint: Investors may assess a company’s carbon footprint and its progress in reducing greenhouse gas emissions, including setting targets for emissions reductions.
- Renewable energy: Investors may look for companies that are transitioning to renewable energy sources, such as wind or solar power.
- Energy efficiency: Investors may evaluate a company’s efforts to improve energy efficiency in its operations, such as through the use of energy-efficient technologies or sustainable building practices.
- Environmental management: Investors may evaluate a company’s overall environmental management practices, including its policies and procedures for managing environmental risks.
In short, ESG factors provide investors with a framework for assessing a company’s ability to navigate the transition to a low-carbon economy and its potential for long-term sustainability. By considering ESG factors in investment decisions, investors can support companies that are making a positive impact on the environment and promoting decarbonisation efforts.
There are several investment implications of decarbonisation, as businesses and industries adapt to the changing economic and regulatory landscape. Here are some examples:
- Increased investment in renewable energy: A shift away from fossil fuels and towards renewable energy sources such as wind, solar, and hydro power. This creates opportunities for investment in renewable energy infrastructure and technologies, such as solar panels and wind turbines.
- Growth in electric vehicles: Decarbonisation also involves a transition to low-emission transportation, which is expected to drive growth in the electric vehicle (EV) market. Investors may consider investing in companies that manufacture EVs or provide charging infrastructure for them.
- Increased demand for energy efficiency technologies: focusing on improving energy efficiency in buildings and industrial processes, which creates opportunities for investment in energy-efficient technologies and services.
- Stranded asset risks: As efforts accelerate, companies in industries that rely heavily on fossil fuels may face risks of stranded assets, or assets that become prematurely obsolete or economically unviable due to changes in regulation or consumer preferences. Investors should consider the potential risks of stranded assets when making investment decisions.
- Regulatory risks and opportunities: As governments around the world implement policies and regulations to reduce carbon emissions, investors should be aware of the potential risks and opportunities associated with these changes. For example, companies that are well-positioned to comply with emissions regulations may be more attractive to investors.
Impact on inflation?
The impact of decarbonisation on inflation is complex and can depend on a range of factors. In general, policies such as carbon pricing and emissions regulations are likely to increase costs for companies, particularly those that rely heavily on fossil fuels. This could lead to higher prices for goods and services, which could contribute to inflation.
However, there are also several factors that could offset the inflationary impact of decarbonisation. For example:
- Increased energy efficiency: Decarbonisation efforts often focus on improving energy efficiency, which can reduce energy costs for households and businesses, potentially offsetting any price increases due to policies.
- Technological innovation: Decarbonisation efforts can drive technological innovation, which can lead to lower costs for renewable energy and other low-carbon technologies over time, potentially reducing costs for businesses and consumers.
- Consumer demand: As consumer awareness of climate change increases, there may be greater demand for sustainable and low-carbon products and services, which could encourage companies to innovate and compete on price.
- Policy measures: Governments may implement policy measures such as subsidies or tax breaks for low-carbon technologies or energy-efficient products, which could help to offset any inflationary impact of decarbonisation policies. You can see this in the United States with their “Inflation Reduction Act” which is a combination of policies (some that may reduce inflation) with $391 billion allocated towards climate change and energy security.
In summary, while there may be some short-term inflationary pressure from decarbonisation policies, there are also factors that could offset this impact over the longer term. Ultimately, the net impact on inflation will depend on a range of factors and will vary depending on the specific circumstances of each economy.
Decarbonisation can have a significant impact on commodity markets, as the shift to a low-carbon economy is likely to change patterns of demand and production for a range of commodities. Some potential impacts of decarbonisation on commodities include:
- Reduced demand for fossil fuels: The transition to a low-carbon economy is likely to result in reduced demand for fossil fuels such as coal, oil, and gas. This could lead to lower prices for these commodities and could impact the profitability of companies that rely on fossil fuel production.
- Increased demand for metals and minerals: The production of low-carbon technologies such as solar panels, wind turbines, and electric vehicles requires a range of metals and minerals, including copper, lithium, cobalt, and rare earth elements. The increased demand for these commodities could lead to higher prices and increased competition for supply.
- Changes in agricultural production: Decarbonisation efforts could impact patterns of agricultural production, as changes in climate and weather patterns require farmers to adapt to new conditions. Additionally, the increasing focus on sustainable agriculture practices could lead to changes in the types of crops grown and the demand for inputs such as fertilizers and pesticides.
- Increased demand for energy storage: The transition to renewable energy sources such as wind and solar power requires effective energy storage solutions to ensure a consistent supply of electricity. This could lead to increased demand for batteries and other energy storage technologies, which require metals such as lithium and cobalt.
Overall, decarbonisation is likely to result in significant changes in commodity markets as patterns of demand and production shift in response to changing energy needs and climate conditions. As such, investors and companies will need to carefully evaluate the impact on commodity markets when making investment and business decisions.
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Oil companies have varying levels of alignment with decarbonisation. While some oil companies have publicly committed to reducing their carbon emissions and transitioning to low-carbon energy sources, others have been slower to adopt measures and continue to focus primarily on fossil fuel production.
Many oil companies have recognized the need to address climate change and have made commitments to reduce their carbon emissions, such as setting targets to achieve net-zero emissions by a certain date or investing in renewable energy technologies. However, the pace and ambition of these commitments vary widely among companies, and some critics have argued that many oil companies are not doing enough to address their carbon footprint.
In addition to reducing their own carbon emissions, oil companies can also play a role in decarbonisation by investing in and developing low-carbon technologies, such as carbon capture and storage, and by transitioning their businesses to focus on renewable energy production. Some oil companies have already made significant investments in renewable energy, while others have been slower to make this transition.
Overall, while some oil companies are taking steps to align with decarbonisation efforts, there is still a significant gap between current emissions trajectories and the level of emissions reductions required to limit global warming to below 2 degrees Celsius.
Decarbonisation is a fascinating topic, spanning almost all countries and companies, and its implications for investments is something we are watching closely. Reducing carbon emissions and transitioning to a low-carbon economy has significant implications for businesses, investors, and commodity markets. Decarbonisation efforts can impact commodity markets, including reduced demand for fossil fuels, increased demand for metals and minerals, and changes in agricultural production. The target of limiting global warming to 2 degrees Celsius above pre-industrial levels is a key driver, and achieving this goal will require significant changes in the global energy system. Overall, it presents both challenges and opportunities for businesses and investors, and it will be important for stakeholders to carefully evaluate the implications on their operations and investment strategies.
All authors have considerable industry expertise and specific knowledge on any given topic. All pieces are reviewed by an additional qualified financial specialist to ensure objectivity and accuracy to the best of our ability. All reviewer’s qualifications are from leading industry bodies. Where possible we use primary sources to support our work. These can include white papers, government sources and data, original reports and interviews or articles from other industry experts. We also reference research from other reputable financial planning and investment management firms where appropriate.
The views expressed in this article are those of the Saltus Asset Management team. These typically relate to the core Saltus portfolios. We aim to implement our views across all Saltus strategies, but we must work within each portfolio’s specific objectives and restrictions. This means our views can be implemented more comprehensively in some mandates than others. If your funds are not within a Saltus portfolio and you would like more information, please get in touch with your adviser. Saltus Asset Management is a trading name of Saltus Partners LLP which is authorised and regulated by the Financial Conduct Authority. Information is correct to the best of our understanding as at the date of publication. Nothing within this content is intended as, or can be relied upon, as financial advice. Capital is at risk. You may get back less than you invested. Tax rules may change and the value of tax reliefs depends on your individual circumstances.
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