The impact of Climate Change on investment strategy is as profound as the impact on the world’s growing population. The global response to Climate Change is irreversibly changing the investment landscape, creating both threats and opportunities for investors.
Today’s investment decisions must be made in the context of how the world intends to mitigate and adapt to the risks (and opportunities) brought about by Climate Change. Governments around the world are actively pursuing a coordinated and far-reaching economic transition to a carbon-neutral economy, that is essential to address the negative impacts of Climate Change. The timing and means by which this economic transition can be effected is fundamentally re-shaping investment strategy, in order to optimise future investment returns.
There is much scientific research that indicates affirmative climate action is essential for sustainable world economic and population growth, and the maintenance of living standards. It is widely accepted that the world must achieve net-zero global emissions by 2050, to support sustainable economic growth and development. Against this background, with an estimated population of 8.3 billion people by 2030, the world will need 50 percent more energy, 40 percent more water and 35 percent more food, than it has today.
This is the conundrum confronting the world – in a low carbon environment, how do we feed and house this growing population, while transitioning away from a reliance on high-carbon industries dependent on fossil fuels like oil and coal?
As the world transitions away from fossil fuels and carbon-intensive industries, there will be investment winners and investment losers.
The losers are likely to be businesses that are dependent on or aligned with carbon-intensive activities for their income or business growth. There is a risk that anti-carbon emissions legislation or consumer boycott behaviour may strand the assets of fossil fuel aligned companies, or permanently diminish their profit-generating capacity. This may include energy and transport companies, and businesses heavily dependent on energy and transport input costs.
According to the USA-based Environmental Protection Agency, the transportation sector generated 27 percent of 2020 greenhouse gas emissions and electricity production, using fossil fuels, produced 24 percent of greenhouse gas emissions, in 2020. Direct greenhouse emissions from commercial and residential real estate accounted for 13 percent of total greenhouse gas emissions in the USA in 2020. These greenhouse emitters and businesses may also be penalised with a higher long-term cost of risk-capital by lenders, or a carbon border tax imposed by foreign governments, as a penalty for engaging in carbon intensive manufacturing activities. The other investment-related issue for these companies is that ethically minded investors simply will not own shares in these companies. This reduces investor demand for companies that are sensitive to climate change, which in turn leads to share price weakness, as there are more sellers than buyers of these companies.
A carbon border tax imposed on Chinese manufactured goods by the US on Chinese imports, for example, would have an immediate negative impact on our bulk commodity producers like BHP, Rio Tinto, and Fortescue. The heightened level of political tension between the US and China suggests that the prospect for such action should not be overlooked. Similarly, our second largest trading partner, Japan, has announced its intention to reduce the share of LNG consumption in its power mix from 37 percent in 2019 to 20 percent by 2030. Japan has also announced that it intends to reduce coal consumption from 32 percent of its energy mix in 2019 to 19 percent by 2030. Japan is the world’s largest importer of LNG and the world’s third largest importer of thermal coal. This decision has long term implications for LNG producers like Woodside Petroleum and Santos. Interestingly, Rio Tinto, the world’s second largest mining company, sold its coal interests in 2018 and today is coal-free.
The winners in this transition to clean or ‘green’ energy are the industries that can provide new technologies such as electric vehicles, and energy-efficient homes or offices using intelligent heating and cooling systems. Investors are also being drawn to companies that invest in waste reduction, or have a recycling, and pollution control focus and are working toward reducing emission of greenhouse gases like carbon dioxide, methane, and nitrous oxide. Renewable energy aligned investments, like wind and solar and hydrogen power businesses that can scale these technologies, are also finding investor appeal. The advent of environmental, social and governance (ESG) investing, with a focus on positive social benefits brought about by investment decisions, is supporting investments of this nature.
However, the world cannot immediately abandon fossil fuel energy sources and investors must factor this transition period into their investment strategy.
In summary, investor awareness of climate-change risk is shaping investment decisions, especially long-term investment decisions. Investment funds-flow out of carbon-intensive companies is beginning to have a measurable financial impact on investee companies, driven by selling pressure and a rising cost of capital.
This is the nature of Responsible Investing, which supports technologies or companies that are essential to a world transitioning itself away from fossil fuels and carbon-intensive industries. The flip side to Responsible Investing is that companies aligned with fossil-fuel and carbon-intensive activities, are being avoided by investors.
The cornerstone of every investment strategy should be an awareness of Climate Change and its irreversible and profound impact on the world’s population and economic growth.