Sustainable Investing weekly blog: 11th March 2022 (Issue 29)

Mar 11, 2022

Our weekly summary of the key news stories, developments, and reports that are impacting investing in the wider transition to net zero carbon and a greener/fairer society.

There are fewer topics in this week’s blog. Not because there is less to write about, but because we want to continue digging down into Europe’s plan for a more affordable, secure & sustainable energy system … “aka” how do we make ourselves “independent from Russian fossil fuels well before 2030, starting with gas”. So our main story covers the European Union’s REPowerEU proposals, and what they might mean for investment decisions over the next few years. In our Human Rights/Social section, we start to cover the proposed EU Social taxonomy and we finish with a slightly different “one last thought”. This time its a LinkedIn post from Marie-Laure Schaufelberger, the head of ESG & Stewardship at a well know Swiss asset management business. It’s entitled “a letter to my daughter” and it expresses well the need for the next decades to be “the greatest transformation in human history”.

The format of the blog is simple, first our summary of the key points of the story (click on the green link to read the original) and then what we think it means for investors. The focus is on news flow that we think should change the markets perception of the investment case of individual stocks and sub sectors. So not the place to come to for news that has already been well covered in say the FT. Our approach is unashamedly long term, so we ignore short term noise.

Top story : Europe’s plan for affordable, secure & sustainable energy

,REPowerEU – a joint European action plan (Europa )

Main points of the story as published

Earlier in the week the European Union proposed its plan to make Europe independent from Russian fossil fuels well before 2030, starting with gas, in light of Russia’s invasion of Ukraine. Commission President Ursula von der Leyen said: “We must become independent from Russian oil, coal and gas. We simply cannot rely on a supplier who explicitly threatens us. We need to act now to mitigate the impact of rising energy prices, diversify our gas supply for next winter and accelerate the clean energy transition. The quicker we switch to renewables and hydrogen, combined with more energy efficiency, the quicker we will be truly independent and master our energy system. ”
The Commission plan (REPowerEU) aims to increase the resilience of the EU-wide energy system based on two pillars: First, diversifying gas supplies, via higher Liquefied Natural Gas (LNG) and pipeline imports from non-Russian suppliers, and larger volumes of biomethane and renewable hydrogen production and imports. Second, reducing faster the use of fossil fuels in our homes, buildings, industry, and power system, by boosting energy efficiency, increasing renewables and electrification, and addressing infrastructure bottlenecks.
With the measures in the REPowerEU plan, the EU estimates that Europe could gradually remove at least 155 bcm of fossil gas use, which is equivalent to the volume imported from Russia in 2021. This seems to include the 100 bcm of reduction they estimate could come from the Fit for 55 proposals, although as always its tough to compare. The Commission claims that nearly two thirds of that reduction can be achieved within a year, ending the EU’s over dependence on a single supplier.

Our take on this

Good plan – not a realistic time scale. Regular readers will know we have covered this issue last week (blog 28) from the perspective of the IEA 10 point plan and the week before (blog 27) based on the Bruegel think tank report can Europe survive painlessly without Russian gas.
The challenges are solvable but implementation of them will take time. Our bottom line is still that the EU plan is a good idea, but its unlikely to fix the problem before next winter. We covered some of the challenges in detail last week, and you will be pleased to know we do not plan on rehashing our views on this. What we intend to focus on this week is the longer term.
While the financial markets have got very excited about the prospects for hydrogen, to quote Gerard Reid of Redefining Energy fame, “the quickest way to decarbonise is to electrify as much as possible of the energy system”. As reported in the FT and elsewhere, countries such as Germany are bringing forward the date by which they aim to fulfill all of their energy needs from renewable sources (just as an aside, we assume this doesn’t mean what it actually says as for instance the majority of cars on the road in the next decade will still be fossil fuel powered, with many analysts & journalists confusing new vehicles sold with the fleet on the road).
If Europe does push for more energy from renewable sources, and it does aim to electrify as much as possible, what needs to happen. Obviously, we would need to build a lot more renewable generation capacity, we take that as a given. But what else needs to happen. More renewable generation is not much use if the distribution and transmission system becomes unstable or if we cannot get the electricity to the user, or if the cost is just too high.
So, first up we will need a lot more battery storage. Europe is behind China and the US in this area. The European Association for Storage of Energy (EASE) together with industry analysis and research group Delta-EE, estimated that around 3,000MWh of battery storage installations will be completed in 2021, compared with c. 1,700MWH in 2000. Europe is still playing catch up in this, with Wood Mackenzie Power & Renewables estimating that the US industry brought online about 3,487MWh of new energy storage in 2020, with more growth expected this year.
What technologies will this likely to involve – its probably going to be more Li Ion than we expected. Pumped hydro etc will have a role, but it will be small. Back in February (blog 25) we highlighted reports that Li Ion batteries could be moving into the 8 hour duration market. This week another 8 hour project went Li Ion. CC Power, a Joint Powers Agency collective of Community Choice Aggregator (CCA) groups announced that it was going to enter into a contract for Goal Line, a 50MW/400MWh lithium-ion BESS project in development by Onward Energy. The eight-hour discharge duration system will be built in Escondido, California, with an expected online date in 2025.
What else do we need – interconnectors. Sticking with Europe, a recent study sponsored by Eurelectric, estimated that spending of €375-425 bn between now & 2030 is needed to make Europe’s electricity networks fit-for-purpose in an increasingly decarbonised, decentralised and digitalised power system. This spending moved a step closer when, in December 2021 EU ambassadors endorsed a provisional political agreement on the revision of the Trans-European Networks for Energy (TEN-E) Regulation, reached between the Council presidency and the European Parliament’s negotiators. This cleared the way for spending on a whole range of new projects including 67 electricity & transmission projects.
On the topic of interconnectors, regular readers will know we bash on about the importance of FERC in the US. FERC is the Federal Energy Regulatory Commission, who is tasked with ensuring economically efficient, safe, reliable & secure energy for consumers. While the States have authority over many electrification issues, FERC has massive influence over important issues such as transmission planning and cost allocation. For instance, FERC was instrumental, via its order 2222, in stimulating the growth in distributed energy resources. Plus order 841, first passed in February 2018, was instrumental in removing barriers to the participation of electric storage resource ie batteries, in the wholesale electricity markets.
Speaking recently at the CERAWeek by IHS Markit energy conference, FERC chair Richard Glick said his priorities include eliminating barriers to market participation for new technologies, supporting a build out of transmission and reining in long delays and high costs associated with interconnection queues. So watch the US as well for interconnector spending over the next 5-10 years.
One last topic – how the cost of electricity is set. This might sound geeky (ok yes it is), but its important. One system that comes in for a lot of criticism, especially with regard to how it impacts the cost of wholesale electricity, is the way prices are formed in the day-ahead market. These serve as a reference price. More specifically, it is the so called uniform pricing (also called pay-as-cleared) mechanism of the day-ahead auction that is being questioned. We intend to revisit this question, but at a high level, in European countries the price paid is set by the “merit order”, which is the ranking of the supply offered from the cheapest to the most expensive. Every supplier gets paid the same – which is the cost bid by the last producer (the highest cost) needed to match demand. There is a great chart that illustrates this here. This sounds nuts to us, but economists love it. Many argue this has to change, which could have material implications for the profitability of electricity generators at the beginning of the merit order.

Human Rights/Social: latest report on the EU Social Taxonomy

The take on this

This week our good friend Kristina Touzenis, who has many years experience in the human rights field (LinkedIn profile here), has again kindly guest written the human rights, social & legal section of the weekly. Thank you Kristina. Just a reminder, this section is not written and prepared by Sustainable Investing LLP. Quite frankly, we are not experts in this field, so we leave the topic to those that are. This week she reviews the final report on the social taxonomy, as prepared by the platform on sustainable finance advisory group. This could have material implications in the mid term for the obligations of companies in Europe.
Over to Kristina. In late February the Platform on Sustainable Finance advisory group published its Final Report on the Social Taxonomy. This draws on various documents and frameworks including the document on the European pillar of social rights and the associated action plan; the European Social Charter ; the EU Charter on Fundamental Rights ; and the European Convention on Human Rights (not an EU treaty but a treaty all EU member states have ratified).
Starting from internationally agreed documents on human rights, the objectives for a social taxonomy set out in the report have been divided according to the type of stakeholders that economic activities can affect. Stakeholders affected by business activities include an entity’s: (i) own workforce (including value-chain workers); (ii) end-users/consumers; and (iii) affected communities (directly or through the value chain). The suggestion therefore is that a future social taxonomy should be centred around these three groups of stakeholders.
The suggested structure of a social taxonomy consists of three objectives, each of which addresses a different group of stakeholders. First, decent work (including for value-chain workers), second, adequate living standards and well being for end-users & third, inclusive and sustainable communities and societies. This last one could broaden the scope of the taxonomy. There are also considerations around do no harm as well as how to advance positive social impact.
It will be interesting to see the next steps for developing a social taxonomy, which would likely include clarifying the minimum safeguards; conducting a study on the impacts of a social taxonomy considering different options for application and designs; and working out a rationale for prioritising objectives and sub-objectives. The currently available documents already provide pointers on how to prepare for more regulation – which we can be sure is coming.

One last thought

,,Letter to my daughter (Marie-Laure Schaufelberger via LinkedIn)

I thought this was both very eloquent and worth sharing. “My little one, in 2100 you will turn 80. As I write these lines, the science tells us that in your lifetime you will have witnessed millions forced from their homes due to rising oceans and extreme heatwaves. Countless species will have been driven to extinction and entire regions will have suffered from lack of water, food and critical resources. But we chose to write you a different story. A story where in your 80 precious years on this incredible planet, you will have witnessed the greatest transition in human history”. The full text is in the LinkedIn post.