Weekly round up 3
What caught our eye this week
Here are three stories that we found particularly interesting this week and why. We also give our lateral thought on each one.
Are investors using the wrong models?
Do indices actually contribute to decarbonisation?
The chicken and egg of green steel.
Are investors using the wrong models?
What mid term scenario about our environment do you use in thinking about your investments? If you are like most investors, you use one of the available economic models. Are they really consistent with the science? What if they are massively under estimating the risks to your investment portfolios?
Recent research from the University of Exeter and the Institute and Faculty of Actuaries suggests that many investors are using models that are totally inconsistent with the known (and agreed) science. So, what is the problem?
Some economists have predicted that damages from global warming will be as low as 2% of global economic production for a 3°C rise in global average surface temperature. Such low estimates of economic damages – combined with assumptions that human economic productivity will be an order of magnitude higher than today – contrast strongly with predictions made by scientists of significantly reduced human habitability from climate change.
How can we have such a massive difference?
The answer is ‘easy’. Economists seem to argue that the future will look like the past, which leads them to what is known as a quadratic relationship - greater warming leads to more economic damage, but at a steady non-accelerating relationship. This is the lower yellow line in the chart below:
By contrast, most scientists think of a world of accelerating damage and tipping points. This gives the exponential or logistic plot in the chart.
The difference between the two approaches might seem small when the temperature increase is small, but these differences become massive as the world warms up. When you add in the fact that most economic models only look at temperature, not rainfall etc, you can see why there is such a big difference.
If you were looking after the assets of a pension fund, which scenario would you find most likely?
One of the bigger UK pension funds, the £90bn (€104bn) USS fund is working with academics at the University of Exeter to establish an “approach to climate scenario analysis that integrates a deep understanding of climate science with its interaction with macroeconomic and financial markets outcomes over different time horizons,”
In other words, the very question we posed. If the science says that climate change etc will cause material damage to our environment, then how can economists argue that the impact on our economy will be small? Someone must be wrong, and it’s probably the economists.
Do indices actually contribute to decarbonisation?
Lots of investors (allocating billions of dollars of capital) use sustainable financial indices, either via passive ETF-type products, or as benchmarks for more active products. They do this because they believe that investing 'in these indices' will actually advance decarbonisation (or any other of the sustainability aims such as biodiversity).
Do the indices actually contribute to decarbonisation and the transition to net zero, or do they just encourage the perception of change, while not really making much difference on the ground?
This video was a panel discussion at the recent Oxford Sustainable Finance Summit 2023. The topic of sustainable indices might sound arcane and boring, but it's really important. The key question is ... does the capital allocated against these indices actually make a difference?
Panellist Ellen Quigley is, in our view, one of the best thinkers on this topic. She expounds on the important difference between the impact of equity vs debt really well (starting at around 30 minutes in). If you invest using a sustainable equity index, and you don't actively engage and vote (and most passive investors do not), then you are probably not making much real difference on the ground. Why? Largely because public equity is mostly a secondary market. We buy and sell shares among other investors. Most companies don't raise new equity. So while they care about their share price for other reasons, it has little impact on their real world financing decisions.
However, they do frequently raise debt and refinance existing debt, which means that they need easy access to the debt markets. So, if you exclude companies who are carrying out unsustainable activities from your debt index, then you are reducing the pool of available capital. There is some evidence that this makes the cost of debt for the excluded companies higher. Which makes them, at the margin, less likely to fund 'dirty' projects, and more likely to fund 'green' projects.
In an age when the use of passives and indices is increasing, we need to think more deeply about what this means for our efforts to make the sustainability transitions actually happen. If you use passive equity, you have to make sure your asset manager is engaging and voting in a manner that is aligned with your views, and if you use debt then exclude funding activities you do not support. These are decisions you should not outsource.
One final point from Ellen (around 40 mins in) is really valid: decarbonising investment portfolios is unlikely to decarbonise the real world.
We discuss the concept of 'universal owners' in a Sunday Brunch. Universal owners are savers (i.e. investors) who hold broadly diversified portfolios. Describing this in financial terms, they are unable to avoid/diversify away these external costs on society, and so regardless of how good their asset managers might be at beating the index, their long term financial returns are diminished. Universal owners need to think about their investments differently, in a way that is alien to how most asset managers currently work. Change is coming.
Click on the image below to read our recent blog on the Universal owner concept.
Link to blog 👇🏾
The chicken and egg of green steel.
'Chicken and egg' is a popular analogy in sustainability transitions. How do you get companies to invest in new ways of doing things, when the end demand doesn’t exist yet? How do you get companies to buy new products, when no one is making them yet?
Green steel is a great example of this. It’s currently more expensive to produce than traditional steel, for what is the same product, just with lower carbon emissions. What breaks this log jam?
The RMI believe they have found the key. US companies which purchase steel are sending a strong, clear demand signal for near-zero emissions steel, which can now be competitively met with US supply due to the federal incentives kick-starting a new low-emission marketplace.
US annual demand for near-zero emissions steel is anticipated to reach 6.7 million tons (Mt) by 2030. To put this in context, the United States produced approximately 82 Mt of steel in 2022, with a typical steel plant producing 2 million tons per year. Since not one ton of US steel currently produced is near-zero emissions, American steelmakers are at a critical investment juncture: build near-zero emissions steel plants now or miss the boat by forcing US companies to import to meet their near-zero emissions steel needs.
Who wants to buy this green steel? One big customer group is automotive, at roughly half of the expected 2030 demand. Then it’s buildings, followed by machinery and appliances.
Is this finally an industry at the tipping point, where the chicken and egg debate is resolved?
Not only is green steel an important sector from a GHG emissions perspective, it could be the trail blazer for a number of other important transitions. Here is a Deep Dive on that.
Link to blog 👇🏾
Not only is green steel an important sector from a GHG emissions perspective, it could be the trail blazer for a number of other important transitions.
Bridging the gap - a round up of this week’s blogs
In this week's blogs we look at how the specific focus on agricultural productivity can actually lead to system inefficiency, AND why Human Rights is as much a value and investing issue as it is about ethics.
Here is a selection of recently published Deep Dives, Perspectives and Quick Insights that our subscribers get to read in full.
When a focus on productivity leads to system inefficiency (Agriculture / Natural Capital)
Human rights is not just a values issue (Transitions / Human rights)
Plus a few from the archives:
Green cement - there are solutions (Greener Energy Applications)
Reducing electricity demand and still staying cool (Built Environment / Wellness, Greener Energy Applications)
Choking hazard - the link between air pollution and health (Built Environment / Wellness)
What subscribers are reading this week
When a focus on productivity leads to system inefficiency
"We simply pay too much to the wrong people, to grow the wrong foods the wrong way, in the wrong places"
(Earl Blumenauer, US rep. Oregan's 3rd congressional district)
Has a focus on farm productivity led to system inefficiency?
Historically, investment in agriculture has been focused on increasing yields or increasing farm productivity - from research into pesticides and fertilisers through to agtech designed to irrigate, cultivate and process more efficiently.
That focus on 'yields per unit input' has led to a massive growth in agricultural produce supply and subsequent declines in prices. It has also led to production becoming specialised on a small number of highly productive crops creating a dependency risk. The top 5 exporters of wheat and rice represented 59.4% and 72.95% of global exports by value respectively. That 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 (which now exceeds the prevalence of underweight) and the associated health and economic issues.
So could it be that a focus on farm productivity actually promotes system inefficiency?
We discuss a proposal from Chatham House that suggests a shift in focus from yields per unit input or ‘Total Farm Productivity’ to the number of people that can be fed healthily and sustainably per unit input or ‘‘Total Resource Productivity’.
Link to blog 👇🏾
Human rights is not just a values issue
For many people human rights is a values and ethics issue. There are company behaviours and actions that are just plain wrong. People don't want their capital, their money, invested in companies with poor human rights records and practices. For many years, that was as far as it went. Human rights, with a few major exceptions, was a moral issue.
Then the world started to change. Society's views on human rights became more enshrined in the law. In many ways this should have been expected. Public opinion leads, and the politicians follow. Over time the penalties move from ineffective sanctions, through fines, to actions that have material impacts on companies.
Now, it is increasingly understood that human rights is no longer just a values and ethics question. It's also very much an investing issue, one that can have a very direct impact on a company's long term value creation. Companies that do not prepare for this new world will lose competitive positioning; it's not just about paying fines anymore. Companies increasingly bear responsibility for what happens in their supply chains, and they face legal action in their home country for acts elsewhere.
This does not make the ethics aspect of human rights any less important to investors. But, what it does add is a double hit for companies (and investors) that pay lip service to human rights, those who see it as a box ticking exercise. First, people are much more willing to call out greenwashing. Second, not properly taking human rights into account in investment decision making can have material implications for financial value.
Link to blog 👇🏾
From the archives
Green cement - there are solutions
MIT engineers have created a carbon-cement supercapacitor that could potentially store large amounts of energy. Could it allow structures to become large batteries? Too early to tell.
The production of cement is a big contributor to global GHG emissions - almost as much as the global airline and shipping industries combined. Unlike passenger cars, where we have a financially and technically viable alternative (electric vehicles or EVs), the current low carbon alternatives to traditional cement are niche products, and they look hard to scale. We will need a lot of work, and investment, over the coming decade or more if we are to get close to decarbonising this important industry. We need to start now.
The so-called hard to decarbonise sectors, steel, cement, chemicals, and some forms of transport, are currently massive contributors to GHG emissions and environmental (and social) harm. Yes, we need to focus on green electricity, and EVs, but we also need to start tackling the harder challenges - which means investment and financial support. We wrote about this back in May.
Link to blog 👇🏾
Reducing electricity demand and still staying cool
(Built Environment / Wellness, Greener Energy Applications, Professional)
Spain is sweltering in another heatwave that meteorologists warn could be the most extreme of the summer. Extreme heat has hit countries around the world causing discomfort and devastation.
These extreme conditions have been exacerbated by the effects of El Nino but underlying temperatures are going up. As the world continues to warm, and as those in the Global South become more affluent, this is going to become an increasingly important contributor to electricity demand. The good news is that there are solutions - among which demand management is potentially one of the most powerful and (technically) easily implemented. This is something we wrote about in a blog back in April.
Recent attention has been focused on the need to strengthen our electricity grids to accommodate variable sources of generation, such as renewables. But there are also ways of helping the electricity supply we have go further. This can postpone the need for extra spending AND reduce some of the transition risks.
When most people think about the security of electricity supply they tend to start from "making sure we have enough supply to meet demand". But what if we turn the question around. Instead of thinking about electricity demand as being fixed, why not start with "what demand can we shift into periods of surplus or cheaper supply". Welcome to the world of demand management - probably the least known, but potentially most important tool we have for decarbonising our electricity systems.
Link to blog 👇🏾
Choking hazard - the link between air pollution and health
(Built Environment / Wellness, Professional)
ER visits for heart problems plummeted after Pittsburgh coal processor shut down recently. "Levels of one highly-toxic pollutant fell 90% & ER visits for heart problems decreased 42% immediately after shutdown"
There is a link between air pollution and our health. There are both direct and indirect impacts on health and our bodies are affected in ways that we are beginning to understand. We discussed how it impacts our skin, eyes, respiratory disease, lung cancer, cardiac incidence, dementia, breast cancer, fertility and childbirth in a Deep Dive back in June.
Global excess mortality from all ambient air pollution was between 7.11 and 10.41 million per year. In addition it was estimated to lower life expectancy by between 2.3 and 3.5 years - more than from smoking tobacco.
Link to blog 👇🏾
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