The Sustainable Investor weekly (issue 41)

23rd September 2022

Topics - Changes to animal feed could help “feed 1bn people, ag productivity promotes food system inefficiency, green steel in MENA, the “death of the German auto industry”, why do philanthropists not give more to fixing the environment, and why ESG investing is just investing.

The Sustainable Investor - our weekly summary of the key news stories, developments, and reports that are impacting investing in sustainability, the wider climate related transitions, and a greener/fairer society. The important word in this sentence is investing - it’s perfectly possible to use our capital to support sustainability, and still earn a fair financial return.

Before we head into the news, in a couple of days we are launching the first of our long blogs, deeper analysis of some of the important issues that we believe will drive sustainable investing over the coming years. So, taking a longer-term view, something we don’t think other sources of sustainable investing research do very well. Our first topic might seem an odd one, what we can learn from old and already proven technologies and practices. But it highlights an important point - in our desire to find and roll out investible solutions, do we tend to look too much toward new technologies, and ignore what we know already works. This overlaps somewhat with the global vs local solution debate. Look out for it.

If you want to be helped to think more deeply about the issues being faced by sustainable investors, please subscribe and support our work or even better subscribe and share (see the button at the end of the blog).

This week’s blog has a bit of an Ag theme. We don’t think this topic gets the attention it really deserves, so this is our little bit to bring it more into the mainstream. Our top story looks at how changes to how animals are fed could free up food for up to 1 billion humans. We then move to how we need to shift our ag focus from just increasing yield, to improving the total system efficiency. We then examine why the MENA region could be important for green steel, and we revisit the augments around the “death of the German automotive industry”, and why the wrong question is being asked. Before quickly covering a report on low levels of philanthropic investment in fixing the environment. We finish on an excellent Alex Edmans working paper on why ESG factors are the same as other intangibles (for investors).

Agrifoods : New menu for animals; feed a billion people

Changes to animal feed supply could feed one billion people (Aalto University)

In a nutshell - what does the story say

• Researchers from Aalto University in Finland, led by associate professor Matti Kummu examined how food and feed flows through the global food production system. They concluded that replacing livestock and aquaculture feed with food system by-products and residues could free up enough food to feed an additional one billion people. The changes proposed could redirect between 10-26% of total cereal production and approximately 11% of current seafood supply to human use. This would represent as much as 15% of current food supply protein content and up to 13% of caloric content.

Our take on this

Why is this important ?

• There is less interest from investors in the whole agriculture and natural capital space than its importance deserves. Yes, it’s a big topic in the private space, but not in public equities. Some of this is due to an absence of quoted investments with an obvious exposure to the theme, and many of the companies that do exist are smaller, local and less liquid. But, if you think about it a bit more deeply, many larger investible companies rely on our agricultural supply chains (think food producers and supermarkets for instance), so it’s a big long-term issue all investors should be considering. Maybe recent food supply disruption and price inflation will bring it more to the fore.

• The United Nations Food and Agriculture Organisation (FAO) currently estimates that almost 690 million people (just under 9 percent of the global population) are hungry. UN SDG 2: Zero hunger, aims to eliminate hunger and ensure access by all people to safe, nutritious and sufficient food all year round by 2030. The UN believes that under current assumptions that goal will not be reached, with more than 840 million people still suffering from hunger by 2030.

• Currently almost 40 percent of arable land and more than 30% of cereal crop production is used for animal feeds, whilst 23% of all captured fish are used for fish and livestock feeds and other non-food uses. According to data from the FAO Global Livestock Environmental Assessment Model (GLEAM), 86 percent of the 6 billion tonnes of dry feed matter consumed by livestock annually is made of resources not edible by humans, with the bulk made up of grass and leaves (almost half). Crop residues and by-products already make up a proportion of livestock feed (almost one-quarter).

• However, whilst accurate, the “86 percent” figure could be misleading. A 2017 study found that “producing 1 kg of boneless meat requires an average of 2.8 kg human-edible feed in ruminant systems and 3.2 kg in monogastric systems. While livestock is estimated to use 2.5 billion ha of land, modest improvements in feed use efficiency can reduce further expansion.”

• Climate change continues to be the major macro factor impacting the availability of sufficient food for the global population. Indeed, if GHG emissions were allowed to grow unabated, then by the end of the century more than 33 percent of current global food production would be “out of safe climatic space.” Food systems themselves are responsible for 37 percent of GHG emissions. 

• An earlier study from Kummu’s team found that “...reducing food loss and waste by half would increase the food supply by about 12%. Combined with using by-products as feed, that would be about one-quarter more food.”

What other issues does this raise you need to be aware of ?

• Historically, investment in agriculture has been focused on increasing yields - from research into pesticides and fertilisers through to agtech designed to irrigate, cultivate and process more efficiently. There have also been innovations looking at reducing feed requirements, it’s just these generally get less attention.

• Insects, as well as being a potential alternative source of protein for humans (being commonly consumed in Asia, Africa and South America already) could also be substitutes for fishing and pet foods. Mycoprotein made from fermenting fungus is another partial substitute to reduce overall livestock requirement.

• Acquaculture has bred (no pun intended) a number of feed initiatives from fish food substitutes including those made from microalgae to creating symbiotic relationships such as cultivating sea cucumbers alongside marine fish farms feeding on the waste from those farms. Finally, lab grown or cell-cultivated protein offers another solution with companies such as BlueNalu focusing their cultivation on overfished and difficult to farm species such as Bluefin Tuna. 

• On overhaul of the entire food production system may also be required. We discuss this further in the next article.

Agrifoods : productivity promotes system inefficiency

The paradox of productivity: focus produces food system inefficiency ( Global Sustainability)

In a nutshell - what does the story say

• This interesting hypothesis is put forward by Tim Benton and Rob Bailey from the Energy, Environment and Resources Department at the Royal Institute of International Affairs, Chatham House. They propose shifting the current policy focus for food from yields per unit input or ‘Total Farm Productivity’ to the number of people that can be fed healthily and sustainable per unit input or ‘‘Total Resource Productivity’. This would, in their view, increase the efficiency of the overall food system. 

• The focus on ‘yields per unit input’ has led to a massive growth in agricultural produce supply and subsequent declines in price. However, the availability of increasingly cheaper calories has led to a vicious circle of increasing demand for cheaper production, driving damage to the environment, increasing waste, and higher levels of obesity (now exceeding the prevalence of underweight).

• Measured as the amount of food grown that is eaten by humans, the current inefficiency in the global food system is a result of the drive for efficiency at the farm level - the “paradox of productivity.” Production has become specialised on a small number of highly productive crops crowding out traditionally grown varieties and creating a dependency risk on certain areas of the world (e.g. the so called ‘breadbasket’ areas). More than 50% of the world’s crop calories as of 2014 came from just 3 things: wheat, rice and maize. More than three-quarters of all crop calories came from those three plus sugar, barley, soy, palm and potato. 

Our take on this

Why is this important ?

• Although this paper was published in April 2019 (how did we miss it then ?) it is still very much relevant today - hence why we are repeating it. And it links neatly into much of the way that thinking has developed over the last couple of years, as illustrated by the Finnish story above. We have already mentioned the hunger issue and the fact that under the current trends the “no hunger” target for 2030 is not achievable. As mentioned in the previous article, most agricultural innovation historically has been focused on improving yields. However, there have also been a number of rather obvious yield improving measures that have been ignored.

• These include wasted fruit and vegetables at the point of harvesting for not being the right shape, through to surplus fresh food thrown away at the point of sale or in our homes. In the UK for example it is estimated that 3 million tonnes of good, edible surplus food is thrown away each year. UN Sustainable Development Goal 12.3 aims to halve food waste at the retail and consumer level and to reduce food loss across supply chains.

• There is also a climate change imperative. Food waste itself generates a large amount of GHG emissions. It is estimated that if food waste were a country, it would be the third largest emitting country in the world (between 8 percent and 10 percent of global GHG emissions).

• The authors put forward a number of individual policy measures to achieve their aim including cross-disciplinary, cross-sectoral framings of the issues, incorporating social and environmental costs into food prices (balancing the implied regressiveness with improving intergenerational equity), greater contribution from governments on the debate, rebalancing of subsidies to agriculture, reducing waste throughout the chain, new technologies and new norms (such as veganism, vegetarianism and flexitarianism).

What other issues does this raise you need to be aware of ?

• The yield improvement focus has led to a reduction in the variety of crops providing calories with a focus on a small number of crops. The creation of hardier strains of wheat through cross-breeding, for example, has produced strains that contain novel proteins that are hard for many to digest. A return to a broader set of crops can not only potentially help reduce inflammation but also there is an important social aspect in encouraging the growth of local and indigenous communities, increasing subsistence and rejuvenating local areas. From a risk management point of view, it can also potentially stabilise food prices - the Ukraine conflict drove the FAO Food Price Index up 12.6% in March month on month.

• From an investment perspective, there are a number of interesting areas for development. The removal of expiry dates and the marketing of so-called “wonky fruit and vegetables” reduces waste at supermarkets and can have a financial benefit too. When Morrisons brought in their wonky produce line, it boosted its own-label sales by 18%. Vertical farming could be a low footprint way of producing all manner of produce and it can even reduce stocking times and transport costs and emissions by locating within retail stores. Taking the previous bullet point further, the relocation and dispersion of food production to be closer to the point of consumption will also have implications for associated infrastructure such as cold chain logistics (freezing food at point of harvest is a way of reducing waste too), employment migration and seasonal consumption. 

Industry : green steel opportunity in MENA

Green steel opportunity in the Middle East and North Africa (IEEFA)

In a nutshell - what does the report say

• The report, from the Institute for Energy Economics and Financial Analysis, identifies the opportunity for the Middle East & North Africa region to become, over time, a powerhouse in green steel production. This is driven largely by the continuing industry shift from the old-style blast furnace-basic oxygen furnace (BF-BOF) technology, that uses coal to make iron, to the direct reduced iron-electric arc furnace (DRI-EAF) route. This second technology removes oxygen from the ore without melting, using a mixture of carbon monoxide and hydrogen. This currently comes from natural gas.

• The MENA region produced just 3% of global crude steel in 2021 but it accounted for nearly 46% (55 Mt) of the world’s DRI production. Furthermore, some of the largest iron ore pelletising plants in the world are in MENA and hence the supply of DR-grade pellets is not a hurdle. Initially, it would be possible to replace 30% of natural gas with hydrogen in the incumbent fleet of DR plants without any major equipment modifications. The region could then gradually move towards 100% green hydrogen to produce carbon-free

  steel.

Our take on this

Why is this important ?

• Regular readers will know that we frequently consider how, over the long term, the production of many industrial materials could be relocated, as companies switch from the use of fossil fuels to renewable based inputs. Historically, the decision as to where to site large production plants was based on easy access to key raw materials. In the case of aluminum for instance, the key input is cheap and abundant electricity, which is why you find most plants in regions with hydro electricity generation.

• In the case of steel, the main raw materials are currently iron ore and coal. The most widespread method of production is BF-BOF, in which iron oxide is reduced to iron inside a blast furnace with coke (derived from coking coal) as a reducing agent. The resulting pig iron is then processed into steel in a basic oxygen furnace, where oxygen is blown through the molten, carbon-rich pig iron to reduce its carbon content. In 2021, 71% of global crude steel production was made via the BF-BOF process.

• You have probably guessed by now the problem with this - its CO2 emissions. It is estimated that the steel industry is responsible for 7% of total CO2 emissions. If global steel production were a country, it would be the third-biggest emitter in the world after China and the U.S. The likely game changer is using green hydrogen in steelmaking, a subject at the top of all recent steel decarbonisation studies.

• The key raw materials could therefore change dramatically if the industry shifts to green steel. As the report highlights, this can be produced by applying green hydrogen in the direct reduced iron (DRI) production process, then using electric arc furnaces (EAF)—powered by renewable energies—to melt it. Some of the large end users of steel, such as automotive OEM’s, have plans to eliminate carbon emissions completely from their entire value chains (including their suppliers). For this to happen they need green steel to be available at scale and at an affordable cost. Which means cheaper renewable electricity.

• In terms of future cost, the MENA region is “blessed” with excellent solar resources, with for instance IHS Markit forecasting that by 2050 the region will have added c. 334GW of solar capacity. This can potentially power both the production of green hydrogen via electrolysis, and the electric arc furnaces. And as the report highlights, the MENA is already the leading source of DR grade iron ore. So, potentially, all of the key inputs come together.

• The problem is currently cost, green steel is still more expensive. How much more expensive is hard to know for sure. Many people quote a recent Time article, that refers to climate think tank RMI saying its 25% more expensive. But following the source, in a 2020 article RMI stated that “with power prices at $25 per megawatt-hour, and hydrogen electrolyzer costs of $450 per kilowatt, zero-carbon primary steel without coking coal can reach a fully loaded production cost of $400/ton. This is competitive with many existing steel mills today.” The bottom line is that for cheaper green steel to be available at scale, we need cheaper renewable electricity, which is probably solar.

• If that happens, we could see green steel production moving at scale to the MENA. That could be interesting politically.

Industry : the death of Das Auto ?

Can German cars survive the end of the engine (Politico)

In a nutshell - what does the article say

• Since the dawn of the automobile, Germany’s prowess in producing the combustion engine set German-made cars apart from the competition; in recent decades, the engine has also been one of the only major components still produced inside the country. But as the industry goes electric, that leadership position becomes as irrelevant as the skills of an Italian master tailor in the face of fast fashion mass-produced in overseas factories. In the modern age of mobility, it’s the battery and software that offers the added value, not the engine.

• The race to lead the electric revolution isn’t over, but it’s already far from clear if the likes of Mercedes, Volkswagen, BMW, Bosch — or indeed Porsche — will be able to keep pace. For the first time in the industry’s history, the prospect of Germany’s most storied brands suffering the fate of faded American powerhouses like Pontiac or Oldsmobile no longer seems like an impossibility. German carmakers are racing to adapt, with Mercedes, BMW and Volkswagen all committing to rapid electrification programs and multi-billion battery investment deals. But their ability to manage the transition is far from a sure thing.

Our take on this

Why is this important ?

• We thought twice before including this article. It’s hardly unbiased, being written by SQM, the lithium company. And it’s hardly new, it’s a topic that we remember discussing at various points over the last two or maybe even three decades. Despite this, the reason that it’s in this weekly is - it’s actually a good question, but only partly for the reasons the article sets out.

• In this blog, we can only really scratch the surface of this complex topic, so it’s a topic we want to come back to in a long blog. But we can make one, important point. It’s mostly about the context of the question. Instead of thinking about the individual companies in the German automotive industry as being the same as any other competitive industry, we perhaps should actually think about the entire system as being a product of the society in which it thrived, and maybe can thrive again. This is an idea that we first saw in a fairly complete form in a report from the Friedrich-Ebert-Stiftung (FES) foundation. And when you think about it that way, it’s not that different from the Chinese or Japanese or Korean automotive industries.

• The concept is simple. The success of the German automotive sector is as much about the political and social environment in which it operates, as it is about the products they make. The industry benefits from the combined efforts and co-operation of the Federal government, the Lander, the unions and wider society. To put it simply, there is a very strong social contract. To adapt to the changing environment, which includes new mobility requirements, the growing importance of software over hardware, and competition from China and California, Germany needs a new pact for the future that unites private enterprise, trade unions, politicians, and consumers. In the absence of such a framework, the efforts by individual German automotive companies to restructure and reposition are probably not going to be sufficient.

• Can we see progress in this direction, yes, but its slow and rather disjointed. Which doesn’t bode well as time is running out.

Climate change : still low on philanthropic action.

Much alarm, less action (Centre for Effective Philanthropy)

In a nutshell - what does the article say

• Total philanthropic giving by individuals and foundations focused on climate change mitigation represented less than two percent of total global philanthropic giving in 2019.  

• CEP conducted a survey of US-based foundations and nonprofits in 1Q2022 (with responses from 188 foundation leaders and 120 nonprofit leaders) to understand how the philanthropy sector views climate change and their approach, whether engaged in climate change efforts or not.

• 60 percent of both Foundation and Nonprofit leaders felt that climate change was an extremely urgent problem. More than 70 percent of Foundation leaders felt that climate change would negatively affect the issues that their foundations focus on and their ability to achieve their goals. However, less than 15 percent have had board discussions about how climate change affects the foundation’s ability to deliver. Respondents felt that the public sector, private industry, foundations and nonprofits could all do more.

• Foundation efforts to address climate change are relatively limited with more than 70 percent of climate foundation leaders having less than 20 percent of their total grant dollars for the current fiscal year dedicated to climate funding. Foundation and nonprofit leaders both felt engagement could be more effective but only 11 percent of foundation leaders rating their own foundation’s efforts as very effective.

• Most non-climate funders tend to see the issue of climate change as outside the scope of their mission despite having concerns about climate change. 47 percent of those surveyed do not plan to consider funding efforts in the area.

Our take on this

Why is this important ?

• The key point that jumped out of the survey was that climate change is a macro factor that will likely prevent foundations from achieving their aims regardless of whether those aims are directly aimed at addressing climate change. For example, a provider of microfinancing to those facing poverty in developing countries may be impeded should there be extreme weather events or if climate change forces migration.

What other issues does this raise you need to be aware of

• There are a large number of projects where the environmental and social benefits are interlinked. And where the financial involvement of a normally socially focused foundation can “make things happen”. By helping solve the environmental issue they can make solving the social one easier or even possible. For example, providing electrification in isolated rural areas can improve job prospects, education and health. The challenge for the private sector is that such projects might not be financially viable without some sort of foundation support. And so, progress is often slower than it needs to be.

• The Bill & Melinda Gates Foundation is one example of a foundation that “funds entrepreneurs [and] companies… creating incentives that harness the power of private enterprise to create change for those that need it most.” The foundation recently announced (during United Nations General Assembly week - for maximum impact) a further US$1.27bn in commitments, focused on delivery of the UN SDG’s. Their sixth annual GateKeepers report, highlighted “opportunities to accelerate progress by investing in long-term solutions and innovative approaches to entrenched issues, including poverty, inequality, and climate change.”

• It’s not clear to us what is needed to change this dynamic, it might be foundation education ? Answers on the back of a postcard please - this is a situation we need to change.

Sustainable finance : the end of ESG

The end of ESG or ESG is extremely important, but it's not (Alex Edmans SSRN)

In a nutshell - what does the working paper say

• ESG is both extremely important and nothing special. It's extremely important because it's critical to long-term value, and thus any practitioner or academic should take it seriously, not just those with "ESG" in their job title or list of research interests. Thus, ESG doesn't need a specialised term, as that implies it's niche. But, at the same time, it’s nothing special since it's no better or worse than other intangible assets that drive long-term value and create positive externalities for wider society, such as management quality, corporate culture, and innovative capability.

• Practitioners shouldn’t rush to do something special for ESG factors that they wouldn’t for other drivers of value, such as demand that every company tie executive pay to them, force a firm to report them even if not relevant for its particular business, or reduce complex intangibles to simple quantitative metrics. Many of the controversies surrounding ESG become moot when we view it as a set of long-term value factors. It’s no surprise that ESG ratings aren’t perfectly correlated, because it’s legitimate to have different views on the quality of a company’s intangibles. We don’t need to get into angry fights between ESG believers and deniers, nor politicize the issues, because reasonable people can disagree on how relevant a characteristic is for a company’s long-term success.

Our take on this

Why is this important ?

• Let’s get something out of the way first, about how words are used. ESG investing, at least as far as the asset management and investing world are concerned, reflects how ESG factors impact the long-term financial performance of companies. Done well, it will include likely future changes, so carbon pricing, social preferences, regulation, changes in supply chains, biodiversity, human rights, and even the preferences of the underlying providers of capital, the asset owners. Even if the investing objective is sustainable investing ie using capital to make a positive difference to the multiple transitions we need to make, it’s really important to also understand the impact on the value of a company. Why - because it helps to quantify the tradeoff that is being made with an investment, how much financial return is being forgone to help deliver sustainability objectives. This ties back into concepts such as Universal Ownership and Blended Finance - topics for another blog.

• If you work in any way in managing or investing in a company, please read this paper. This includes everyone in companies who have to set strategy and communicate it to investors and stakeholders. This deserves to be read well outside the ESG and sustainability set. Many of you will know that we like the work of Alex Edmans, we think he normally talks sense. In this case we really like what he has to say, probably because it aligns with what we have been saying for some time.

• Single materiality ESG (ie how ESG factors impact a company) should be treated no differently in our investment cases than any other intangible factor, and they face similar issues. Our examples are slightly different from Alex’s, we often quote brand value and innovation. We cannot measure their impact precisely, but we know when they are important, and we know that companies that do them better, normally perform better, and trade on higher valuation multiples. Yes, we would like more data, but its absence doesn’t stop us making investment judgements.

• What this article also does is tie in the analysis of people like Aswath Damodaran (from NY Stern) that ESG is confused about doing good or sounding good (the title of his 2020 paper with Bradford Cornell.

• We know that many of you will disagree. There are arguments that say for instance, the impact of emissions is not an intangible, it’s very real and can be costed, and the same applies to human rights or biodiversity or social issues. We understand your point. But, from the perspective of valuing an individual company, which is what investors need to do every day, these factors are not hard numbers.

• Maybe the system should be different. But if we are to mobilise the vast amount of private sector finance needed to achieve our transition objectives, we need to make clear the distinction between those problems that the private sector can help to solve (which means earning a fair financial return), and those that need government action. We are happy to debate this, it’s an issue that came up time and time again at the excellent Chatham House Sustainability Accelerator Un-conference, held on the 16th September. Its only through respectful and honest discussion can we find common ground and make progress.

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