03 Aug 2021
Jon Wallace, Fund Manager, Environmental Solutions
The European Union’s ‘Fit for 55’ climate strategy announced this month shows how all-encompassing and unprecedented the effort to curb climate change will be. Targeting a 55% reduction in annual carbon emissions by the end of the decade compared with 1990, this implies the strategy aims to cut emissions by around a third by the end of the decade.
It is important to remember that this represents the minimum required to avoid dangerous levels of climate change that would undermine global development on all fronts. It will be almost impossible to tackle poverty, inequality or to improve standards of healthcare provision and education if we do not also make rapid progress to avoid further damage to the environment on which we all depend.
This underpins a growing consensus – consumers, voters, politicians, regulators and some executives – for action. In terms of scale, the proportion of global GDP covered by national-level net-zero targets amounts to two-thirds of global GDP, including commitments from China, the US, Japan and South Korea. It also covers over 61% of global emissions and 56% of the world’s population.
This unprecedented challenge also represents a compelling investment opportunity – providing capital to the companies that can enable the transition to net-zero carbon emissions. These are companies focused on providing the critical products and services to help businesses deliver on their emissions targets. We believe these environmental solutions companies over time will offer long-term outperformance as their markets expand rapidly.
A growing seam of opportunity for these companies stems from ever-more sophisticated corporate net zero ambitions. Just over a fifth of the Forbes Global 2000, or 417 companies, generating annual sales of about $14 trillion, have made a commitment to net zero emissions, most before 2050.
Companies aiming to meet net zero targets will require a whole ‘lifecycle’ approach, including tackling upstream emissions (from suppliers) as well as downstream emissions that capture the all-important emissions from a product’s ‘use phase’. What is encouraging is that these ‘Scope 3’ emissions are recognised by initiatives such as the UN’s ‘Race to Zero’ as a necessary rather than a desirable element of corporate net zero ambitions. Research from the University of Oxford and the Energy and Climate Intelligence Unit found that over a quarter of the sales of companies within the Forbes Global 2000 that have a net zero target already to cover this level of detail.
In our view, this is already beginning to send powerful signals through value chains, providing opportunities for those companies with enabling technologies to reduce the climate intensity of supply chains towards net zero. Furthermore, many of these opportunities are in industries that have so far seen limited progress when compared to those that are already making strides, such as the energy and automotive sectors.
This will take time. Supply chain decarbonization is picking up pace but is not commonplace and is distinctly challenging. While a manufacturer can calculate the greenhouse gas emissions from its own operations with a relatively high degree of confidence, getting a view on Scope 3 emissions is very complex, especially for companies with thousands or even tens of thousands of products and suppliers.
Many emission-reduction measures are also expensive and difficult for companies operating in relatively commoditised spaces with slim margins and few opportunities for differentiation.
Nevertheless, we are starting to see a steady stream of opportunities emerge. This can be in pockets of the market where a small increase in raw material prices is manageable, such as when a fast-moving consumer goods company can substitute carbon-intensive ingredients. This provides potential opportunities for ingredients companies in the chemical sector, which can dramatically benefit from margin uplift if they have a differentiating product that can help in the transition to net zero.
There is a Norwegian company that produces synthetic vanilla flavouring from sustainable wood-based materials as an alternative to petroleum-based vanilla flavourings that is the food industry norm. The wood-based product offers carbon reduction on a life-cycle basis of about 90% versus the oil-based ingredient. This category is growing well over 10% a year compared to the 1% per year growth of oil-based synthetic vanilla.
In summary, net zero carbon ambitions will absolutely require environmental solutions, and we will need more solutions spread widely across sectors. Companies that make or have exposure to these products and services will have a heightened profile, reflecting the urgency of climate mitigation plans. We believe these are long-term opportunities, and they are not just limited to higher profile solutions such as electric vehicles or clean energy.
We expect to see environmental solutions with a wider array of potential exposures, including markets and sectors that are very under penetrated. We also expect to see continued growth in the depth and diversity of the opportunity set, and this will provide a very healthy stock picking environment into the long term.
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