Hesitations have begun to surface. After only four months from the start of the Russian invasion of Ukraine, the roar for renewables’ revival appears to be fading, if not dead already. Articles suggesting that ESG investments are now out of fashion are starting to appear. Surveys report that investors consider the Taxonomy as an hindrance to finding investment opportunities. And redemptions from ESG funds seem a real risk in the second half of the year: the darker the green, the higher the potential redemptions. Investments such as hydrogen are seen as too long-term until they become profitable, given the high costs and the lack of earnings for the next two years or more. Rising rates all but strengthen this perception.
To support this thesis, we have as well news coming from Germany, Austria, Italy, Belgium and other European countries that, to face the energy emergency, not only postpone the closure of nuclear plants but re- open the infamous coal-powered power stations.
Is this the end, then? The oil companies generous dividends are enticing for many. With sky-high oil prices and record cashflows, who wouldn’t want to invest in oil companies? Even defence stocks, since the start of the war, have prompted ESG funds to tweak their screenings, separating manufactures of generic weapons from those of prohibited non-conventional weapons.
The world of finance seems to focus more on a short-term horizon than on long-term investment returns. Driven by the need for positive performances in three, six months or one year, funds look for loopholes not to miss opportunities that could make their clients happy.
The European energy transformation will last thirty years. Maybe more, but the direction hasn’t changed. On the contrary, the targets are revised up every time there’s an external shock: from the Green Deal to Next Generation EU when the Covid-19 pandemic started, to Fit for 55 and finally Repower EU after the invasion of Ukraine. Incidental circumstances are like market trends: a bear market can last one or two years, but if one were to bet systematically on a down trending market, in the long run they would probably only lose money. Europe is firmly convinced of this structural change: as Ursula von der Leyen underlined, Europe should take the current crisis as an opportunity to push ahead, rather than going back to the dirty fossil fuels. Oil companies know that, too, and will use the huge cashflows generated by the current oil price to accelerate on a transformation that is unavoidable.
The same holds for governments that now fall back to coal-powered stations: in Germany the announcement came from Habeck, the minister for Economic Affairs and Climate Action, a member of the Green Party. A supporter of clean energy forced to such a decision by the sudden 40% reduction in Russian gas supplies, that made untenable an already difficult situation. Untenable today, that is: but what will happen when the emergency will end?
The point is that if private investments don’t go along with public incentives, certainly the energy transformation will slow down. Finance must give its own contribution during this difficult period, and the returns will come, even for those energies that are now unprofitable.
Going back to the case of hydrogen, for example, we could say that ten years ago even residential solar panels was unprofitable. In Italy it would have costed 30 thousand Euros and the energy savings alone were not enough to offset it. With public incentives, however, one would have gained almost 90 thousand Euros in 20 years.
Green hydrogen is similarly unprofitable today, given its costs, but thanks to ever more ambitious targets set by EU in terms of green electrolytes (from less than 1GW today to 6GW in the Green Deal, to 17.5GW in the RepowerEU by 2025), one can hope in considerable public incentives.
Today, residential solar panels in Italy cost around 10 thousand Euros and with current electricity prices one could save up to 1500 Euros per year. Even without considering the incentives for building renovations, it’s an investment that returns 3x in 20 years: a respectable 7.2% per year. The same will happen with hydrogen, that EU will support until it will be strong enough to become profitable per se.
Those who invest in the energy transformation, announced as the biggest revolution after the industrial one two centuries ago, cannot simply look one or two years ahead but should have more foresight and conviction that a more sustainable future is possible. Otherwise, we know already how it will end.
Nowadays they speak of sustainable or ESG investments as if they were something very different than the market as a whole. In the ESG world there’s a range of instruments, some of which are so similar to the overall market that it’s difficult to understand the difference, if any.
Let’s have a look for example at Europe, where ESG and sustainability are much more advanced: by comparing the Stoxx 600 versus the Stoxx 600 ESG in the last two years we can see no performance difference. Only 15 out of the 600 stocks of the main index are excluded by the ESG index.
The flood of investments into ESG vehicles pushed all companies to pay more attention to environmental, social and governance factors to avoid being excluded by the investors’ portfolios. As a result, what a couple of years ago was an ESG European equity fund is slowly morphing into a common European equity fund, and this can be guessed also by the number of existing vehicles that ‘change’ to ESG: one may think that their investment strategy is not changing substantially after all.
Is this what an investor would expect when we talk of sustainability? Or would he expect something about solar, wind, hydrogen energy sources, electrification, batteries, waste recycling, digitalization, building renovation, gender and diversity parity, etc? Perhaps we should make an effort to differentiate more the generalist funds that include ESG principles (so-called art. 8) from the specialist funds that aim to make an impact (so-called art. 9) according to the SFDR.
After the Russian invasion of Ukraine one of the topics was the comeback of sustainable investments; however we have seen that the Stoxx 600 ESG followed closely the Stoxx 600. Even more selective benchmarks such as the MSCI Europe ESG Leaders have behaved similarly to the generic MSCI Europe, while some difference can be seen in one of the most selective indexes, the MSCI Europe SRI. Still, these are small differences compared to those themes that will help us attain the net zero objective by 2050, such as alternative energies, well represented by the S&P Clean Energy index.
| Performance 24 Feb - 9 Mar 2022 | |
| MSCI Europe Index | -4.12% |
| MSCI Europe ESG Leaders | -3.66% |
| MSCI Europe SRI | -1.84% |
| S&P Clean Energy | 23.54% |
The alternative energies theme is the heart of the energy transformation chased by Europe, and that has become a priority with the invasion of Ukraine as it’s the only way for our continent to reach independence from the Russian oil and gas and, at the same time, reduce CO2 emissions. But it’s not the only theme. Other sectors, such as the building renovation, didn’t perform as well in the period shown in the table. On the contrary, one could say that while renewable energy has dropped on average by 50% from January 2021 to the invasion (as measured by the S&P Clean Energy), the building renovation companies has seen an extraordinary 2021 with average performances of +50% thanks to the incentives of the Next Generation EU program, which aims at trebling the renovations from 1% to 3% p.a.
Today the huge difference between MSCI Europe and S&P Clean Energy is almost halved, while building renovation dropped by 25% in 2022. The reasons are the same that are affecting all companies in these times of market turbulence: increase of commodities (energy in particular) prices, rising rates, supply chain issues and delayed projects delivery. And those multiples inflated in the wake of reform euphoria get deflated by the fear generated by all these issues.
As we highlighted more than once, art. 8 and art. 9 funds tackle the issue of energy transformation at different speed, but the former are slowing down versus a broad market more and more ESG-aware and compliant. The latter, on the other hand, continue on their path driven by specific themes, which however may rise and fall at different times.
With the new Repower EU program unveiled on May 18th, Europe keeps pushing on energy transformation: additional investments for 300 bn to step up the targets already upsized with the Fit for 55. The three main targets involve short term needs (diversification of gas sourcing), medium term goals (pushing on renewable energy) and one that will depend on the habits of European citizens and their ability to use energy more efficiently. Lacking this voluntary effort, the possibility of an energy rationing could prove a more powerful incentive.
While the short-term goal is to reduce Russian dependency by two thirds by the end of the year, the medium-term goal is to be completely independent by 2027. This will be achieved by increasing the target for renewable energy from 40% to 45%, that for green hydrogen electrolyzers to 17.5 GW by 2025 (the original Green Deal target of 6 GW looked already ambitious), and with a greater energy efficiency coming from building renovations and transports electrification (more details here).
For an art. 8 ETF that follows a generalist index is difficult to follow all these themes: hydrogen and solar pure players, for example, are small and medium sized companies not included in the Stoxx 600 ESG. There are of course ETFs that follow some of them, with the added issue of managing the volatility in the various market environments. The alternative is to invest in actively managed funds, that can be themselves art. 8 or art. 9 with different shades of green.
According to Morningstar, less than 5% of mutual funds were art. 9 at the end of 2021, while art. 8 funds represent almost 40% and some of them, as we discussed in the past, have simply “migrated” their prospectus from their pre-SFDR life.
It’s up to the investor to choose the theme(s), the vehicle(s) and the shade of green.
There are times when one has to get in the game to avoid vanishing into nothingness, come up with changes to get another chance. But the structures built over time are so deep-rooted that a remarkable thrust is needed to shake them up.
Europe has been in the shadow of US and China for some time now: growth is lacklustre, unemployment is higher than on the other side of the pond and, if we look at investments, no European company is among the world’s top ten. Why on earth a foreign investor should look at Europe? And within the continent, Italy is among the countries that have struggled in the last 20 years to keep pace even of a sluggish Europe.
With the Next Generation EU, Europe has come up with that diversion needed to increase growth, create new jobs and become again the main character among the world’s powers. It’s not a coincidence that Europe is leading the way in the green transformation, for example with the Taxonomy that Ursula von der Leyen announced as the world’s first handbook to distinguish what is green from what is not.
Italy will have a leading role in this revival, as it is the biggest beneficiary of the European Recovery and Resilience Facility with EUR 191 bn of financial support from now to 2026. Just a few days ago Ursula von der Leyen tweeted that the “first disbursement of #NextGenerationEU funds to Italy” had been made, with congratulations for the reforms implemented or approved so far. In fact this is the first payment subject to the assessment of the milestones and targets fulfilled for 2021, and it’s on top of the pre- financing of 25 bn of last August. It’s also one of the first assessment-linked disbursements at European level, after those granted to Spain (December), France (March) and Greece (April).
It's a substantial payment of 21 bn that brings the total so far to 46 bn destined to the six “missions” of the plan. If investments totalling 12 bn have been made in 2021, more than twice as much (27 bn) are targeted for 2022.
Almost a third of this, slightly less than 9 bn, are destined to the digitalisation of the public administration, national health service and companies, to the optic fibre network (the “Piano Italia 1Gbps”) and 5G infrastructure.
Almost 4 bn to improve the energy efficiency of towns and schools and to strengthen the 110% ecobonus for building renovation, while 1.5 bn will go to renewable energy, hydrogen and sustainable mobility. The investments for wind and photovoltaic projects are only 60 million euros, but those are technologies now self-sufficient and less in need of public investments. Agrivoltaic systems, more recent, will get 108 million euros. The high speed railway network will get 3 bn and research and education will get 6 bn (more details here, or in italian).
About two thirds of the total financing will be loans and one third grants. Italy is one of the few countries (along with Greece, Romania, Poland and Portugal) that have requested loans, given the economic incentive of paying less than on their own sovereign debt. The possibility of requesting loans up to 6.8% of the Gross National Income makes Italy, that used this possibility in full, the country with the most funds at its disposal: 191 bn euros, as mentioned above, which gives a clear idea of the gargantuan scale of the reforms and investments needed to modernize the country.
Should one wonder how much such reforms will contribute to the economic growth, EU studies indicate that, depending on the timing of the implementation and the productivity level, Italy’s GDP will grow by 1.5% to 2.5% by 2026 in real terms, creating about 240 thousand jobs in the process. Not a small increase for a country that had grown by 1% p.a. between 2015 and 2019.
It’s easy to imagine that companies linked to digitalisation and energy efficiency will get a lot of business in the near future, even with some caution due to bottlenecks caused by raw materials sourcing and costing, in particular for energy.
The long journey that will bring us to the final objective, being the first continent with net zero emissions by 2050, has begun. Perhaps it’s a real objective, perhaps it’s only a diversion created on purpose to boost the sluggish economic growth and reduce the unemployment too often close to double digits. Or perhaps it’s a bit of both, because both targets are commendable and they can coexist. Certainly this looks like the last chance for Europe, and for Italy, to win the trust of investors.
Man can assume different personalities, which we often simplify in two opposites: the Good and the Bad, like in the case of Dr Jekyll. When he’s inspired, Man can create timeless masterpieces such as the Gioconda, the Coliseum or the Divine Comedy; when he’s angry, he sows destruction, atrocities and terror.
As never before, these two extremes now emerge within Europe.
The war against Ukraine, while humanely terrible, has brought to the forefront in Europe two opposite needs: the Bad has called for an arms race, the Good for an alternative energies race. The latter seen as the only chance to get energy independence in the future.
In the last month we often heard talking of the NATO pact and, in particular, of the 2% of GDP guideline for defence spending by each NATO member. Today only few are at target, but after the start of the war against Ukraine many promised to reach or even exceed that threshold. Germany, among the first, three days since the start of war announced EUR 100 bn defence spending, almost twice as much as 2020. Italy approved an increase of the defence budget up to 2% of GDP and Macron included a similar increase among his re-election program: EUR 50 bn within 2025. If the single countries rush for a new arms race, EU itself approved the creation of a 5000 men army and a specific defence budget to be able to intervene in full autonomy if need be. Even before the war, on Feb 15th, EU has proposed a tax reduction on weapons produced on the continent.
One should wonder whether sustainable investments, that typically exclude arms- producing companies from their investable universe, are going in the right direction. It’s true that according to SFDR only exposure to controversial weapons is subject to disclosure, but the unripe world of ESG investments tends to neglect such subtle distinctions.
It’s the other arms race, the one of investments in renewable energies, that is going in the same direction of that ESG world and sustainability closer to the common feel.
The current war has highlighted once more Europe’s energy vulnerability due to its dependence from foreign countries, namely Russia. Additionally it showed the need to be fast and achieve energy independence as soon as possible, without further delays.
Once again, the first to move in the race was Germany, budgeting EUR 200 bn to accelerate the transition according to its Minister of Finance Christian Lindner. This, however, was after the coalition partner Greens staged protests fearing that the 100 bn defence spending would go to the detriment of the environmental budget. A thought that crossed the mind of a few investors, too.
The Bloomberg news about a second Eurobond to finance defence and energy, although later denied, prompted a rally for the companies of the two sectors. From Feb 23rd to the beginning of March renewable energy companies such as Orsted, Vestas or Nel bagged returns around 40-50% while the S&P Clean Energy index jumped by about 20%. After all, if the first Eurobond of March 2020 linked to the Next Generation EU program was followed by the best nine months for the renewable energy companies whose price grew by multiples, why there couldn’t be a second wave of repricing?
The strong rally of the first week of war, as opposed to the decline in the rest of the markets, suggest that investors wandered away from these investments despite no changes in the EU’s or world’s governments plans on the subject. Of course a few critical points emerged: the increase of commodity prices, the supply chain issues, the delay of projects and the interest rates rise that penalise growth and utility companies. However their prices may have discounted bad news too much, as if the expected growth were in jeopardy. Speaking of growth, one of the reasons why investors shied away from renewable investments last year is the increased competition in sectors such as wind and solar, but it’s easy to guess, given the need of energy from these sources, how much the demand would outstrip the supply.
If now investors don’t explicitly bet on alternative energies companies, at least they don’t ignore them anymore even though the critical points mentioned above have not disappeared. Actually the current war may only exacerbate them. The renewable investments may even overheat, and their volatility increase, if EU will actually go for a new Eurobond given the heightened sensibility of investors to this theme.
As we have always maintained, the energy transformation is often based on new technologies, sold by companies that will produce earnings only in a few years’ time because today is the moment for heavy investments. The journey will last 30 years and we’re only at the beginning: let’s keep calm and carry on.
Who hasn’t tried the paper drinking straws, with that dryness that changes the drink’s taste? You can find them at Mc Donald’s, or asking for an iced drink in a bar or even just at home, given that the old, coloured plastic straws are not anymore to be found on the supermarkets’ shelves. It’s a consequence of sustainability. Single-use plastics have been forbidden, and so we get paper plates, wooden cutleries and bamboo cotton swabs.
It's an inevitable step given that single-use plastics represent, with fishing tools, 70% of sea garbage, according to the Single-use plastics Directive that became effective the past July.
The main single-use plastics producers are once again the abused oil companies, together with chemical companies. The first twenty companies produce over half of the single-use plastics consumed in the world. The first one is Exxon Mobile, followed by the American chemical company Dow and the Chinese Sinopec. The first producing country is China, followed by the United States and India. There’s also a European company in the first twenty, and not by chance it’s the biggest European oil company: Total. That same Total that promises 7GW of solar energy per year.
Looking at the main shareholders of these companies, other than the governments owners such as China and Saudi Arabia, we find international ETF investors such as Vanguard, Blackrock and State Street. Companies push green investments but then they sell products such as ETFs which have to follow closely the world markets and perhaps they can’t invest as they wish. It’s business.
It’s not a matter of waging wars against plastic producers and those who invest in them: they have already a lot on their hands, between sale restrictions and taxes that are coming up all over Europe. We want instead to highlight those companies that have found a new impulse from this transformation.
With the digital era printed paper has declined more and more. Between 2016 and 2017 investors were wondering how the companies involved in this business would end up, as well as recycling companies, given that recycled paper was used less and less. Then the transition towards a more sustainable world – where the packaging business switches from plastic to paper, wood and other sustainable materials, and where the circular economy is a fundamental pillar – brought them back to life from a seeming extinction.
In addition to sustainability, we have seen the boom of Amazon and online commerce pushing the demand of paperboard for packaging, as well as new lifestyles from the Millennials such as takeaway food, where paper packaging is replacing more and more the plastic one.
As a result a business sector that for thirty years has grown around 3% per annum, in line with the world GDP, and that was seen on the verge of collapse, is growing today almost three times than in the past.
Along the production chain, however, there’s different businesses with very different margins.
Let’s start with the companies producing pulp, the primary raw material to make paper. In Europe it is produced mainly in the northern countries and in the past two years its price jumped by 60%. The reason is linked to the increased costs of energy and transportation and to the pandemic that in reducing the availability of workers has also reduced the production of pulp. The OCC (Old Corrugated Containers) which is used to recycle cardboards has also seen its price rise by 70%, again pushed by Covid that caused many shops to shut down thereby decreasing its supply. To keep margins at a decent level, these companies have increased the price of their products, impacting those at the end of the chain. Among the latter the producers of packages, plates, cutlery, straws etc. have seen the costs of raw materials increasing; at the same time their revenues fell because of the pandemic, as less people went to fast-food chains, made picnics or requested catering for events. As we go back to a normal situation, however, these businesses may profit from renewed demand with increased margins and profits.
There’s also shadows in this paper’s second life: publishing is one of the sectors most impacted by the increased costs of the last few years, with coated paper costing 20% more than in 2020 and even 50% more for higher quality paper and card stock, so that many small publishers had to cut production to avoid raising the price of books and reducing sales. On top of that, the increased paper consumption may lead to less trees available for its production: lacking responsible re-forestation policies such as those of northern Europe, the result would simply to move from plastic pollution to a reduced ecological sustainability.
In every change the most difficult thing is to keep the balance. Often, in trying to achieve an objective, the risk is to penalise other important resources. If we could find alternatives to plastic other than just paper, such as bioplastics that are expensive today but, like any new technology, have room to improve, we may have less distasteful straws and more choice on the bookshelves.
Consistency is a virtue of the few. For some it may be a silly thing or it could be defined as lack of imagination (O. Wilde) or mummification of thoughts, even though changing one’s vision should require much pondering over the reasons for the change. Often consistency gives way to more urgent needs, and perhaps we tell small lies, more or less plausible, to convince ourselves that we didn’t do an about-face.
Europe, too, has an urgent need: energy. And in view of a potential economic re-start, hopefully in the near future, such a need becomes ever more urgent.
As of today renewable energies are far from being able to face the gargantuan market demand. For some member states and European politicians solar panels, wind turbines and hydrogen alone won’t even be able to reach the intermediate 2030 objective set by the Fit for 55 (-55% net emissions vs 1990), let alone the final target of zero net emissions by 2050.
As a result, on the last day of 2021 the EU Commission started consultations to draft a Taxonomy Complementary Delegated Act to include gas and nuclear energy within the EU Taxonomy, effectively accepting these two energy sources. A possibility that already emerged in the COP26 as we pointed out in The long and winding road. Not a small change if we think that exactly two years ago, on Jan 15th, 2020, the European Parliament approved with a large majority the Green Deal where the two sources were considered as not sustainable. Have we discovered something new about gas and nuclear, perhaps? Macron, first to support the inclusion of nuclear in the Taxonomy, should build this year a new radioactive high-level waste (half-lives of tens or hundreds thousand years) storing facility in Bure. They say that the town welcome sign reads: “twinned with Chernobyl, Fukushima and Three Mile Island”. It’s the same Macron that at the time of the French elections promised to close 14 of the 58 nuclear reactors by 2035 in the name of energy transition and that now, for the same reason, proposes to open new plants and storage facilities.
Gas and nuclear will be considered as sources compliant with the energy transition until renewables will be sufficient. But let’s try to run some numbers: seven years are needed to build a nuclear plant and the average life of a third-generation reactor is estimated in 60- 100 years. How could this be considered a transition project, when the net zero target is set by 2050? Moreover building costs are so exorbitant that nuclear energy costs as much as three times offshore wind and as much as six times solar. One could say that the long operational life of a nuclear plant gives the time to pay back the initial investment but this too is a weak argument considering the average of a wind or solar farm and the fact that their production cost per installed kwh falls year after year. The truth is that the investments in gas and nuclear are crowding out those in green sources.
The EU Commission’s proposal brought about a dispute among member states (and not only) that support it, like France, and those that are against it, like Germany. A final decision has not been reached yet, but it’s easy to see the efforts in minimizing potential objections if we consider that the consultations have been opened on the last available day, leaving only 12 days (extended to 21 at the deadline) to the expert panel to express an opinion, and that 72% of member states are thought to be against the inclusion of gas and nuclear in the Taxonomy.
If today solar, wind and hydrogen technologies could address our energy needs, would Ursula von der Leyen include gas and nuclear among the sustainable sources?
Perhaps the answer would help us understand if the decision has been taken out of conviction or simply to face an immediate need for energy.
By the end of May we should know the final decision. Regardless, however, private investors may split between those who’ll follow the Taxonomy and those who, in line with the german minister for economic affairs and climate action Robert Habeck, will think of the inclusion of gas and nuclear as mere greenwashing. Different shades of green even within the Art. 9 funds.
Ideas are often born out of specific needs and with the best intentions. Sometimes, however, they turn out having unforeseen side effects that could prove counterproductive. Let’s think for example to plastic, invented at the end of the 19th century to replace billiard balls (produced back then with the expensive and controversial ivory) and whose development and diffusion has produced the environmental effects that we all know today.
The ETS (Emissions Trading System) is the main mechanism used by the EU to reduce the continental CO2 emissions by 2050. It is also one of the new and most important financing sources to repay the portion of Eurobonds issued with the Next Generation EU program and used to subsidise member states.
The system is relatively simple (EU ETS for more details). The EU sets a cap for the annual CO2 emissions that companies may emit in Europe, and issues one certificate for each tonne. As a result, every year the number of issued certificates will equal the emissions tonnes that companies are allowed to produce in aggregate. As CO2 emissions cannot be avoided and the EU doesn’t want to strangle its own companies, some of those certificates are allocated for free, while the others are auctioned. It should be pointed out that not all sectors are treated equally, because an IT company will definitely pollute less than a power plant and not all companies can avail of technologies to reduce their own emissions in the short- term: it’s easier for a power plant to produce energy from solar and wind sources than for an airplane or a ship to travel with electricity. That’s why the EU decides which sectors should fall within the ETS scheme and which should get a waiver (in the form of free allocation) for the time being. Every Apr 30th all companies of the sectors covered by the ETS have to calculate how many CO2 tonnes they have emitted in the previous year and hold an equivalent number of certificates to return to the EU.
To reach the carbon neutrality target by 2050, the overall number of certificates is reduced every year and the free quota is reduced, too. The faster the EU wants to reach the target, the stronger will be the annual reduction. Indeed, to implement the Fit for 55 program’s decision to increase CO2 reduction from 40% to 55% within 2030, the EU will accelerate the annual certificates reduction from 1.74% to 2.2%.
This looks like a virtuous circle, whereby companies that have emitted less CO2 will have more certificates than needed while the “bad guys” that polluted more will have to buy the missing certificates from the “good guys” or at the auction. Thus companies operating in the hydroelectric business or that produce electric cars may profit also from selling the excess certificates to the detriment of those that produce energy from fossil fuels or petrol-fuelled cars.
But… those certificates are also freely traded on the market: there’s a future contract (MO1 Comdty is the Bloomberg ticker) that tracks its price, i.e. the price of one CO2 tonne. As the EU accelerates on the certificates issuance reduction, hedge funds and other investment funds have started to bet on it, inflating its price. And it’s not only funds, as there are financial instruments that allow also retail investors to attend the party. This is entirely admissible in a world where other commodities such as oil are affected by the same behaviour, but the side effects may be controversial. Today, 80% of the energy still comes from fossil fuels. If the price of CO2 keeps rising, the companies that can’t immediately become “virtuous” will have to spend more to buy the certificates they need and may pass the cost on to their customers. About 20% of the gas price increase seen in the last few months is estimated to derive from the increase in the CO2 price, which has trebled since the start of the year.
Poland has already lamented the presence of financial speculators in the CO2 market. In addition, high gas prices make it relatively cheaper to use carbon as energy source, which in turn requires the purchase of carbon certificates and contribute to its price rise. What started as a virtuous circle risks then becoming a vicious one.
In addition to the ETS there’s also the CBAM (Carbon Border Adjustment Mechanism), a scheme by which the EU intends to “carbon tax” selected products imported from outside the Union. This is to fight the “carbon leakage”, i.e. the import of products linked to CO2 emissions from countries that have not imposed sufficient carbon restrictions. Steel, aluminium, cement, electricity imported cheaply from abroad will see an increase in prices to protect the competitiveness of companies that produce only within the EU or in countries that participate to the EU ETS, such as Norway and Switzerland.
As a result of all this, companies operating in the covered sectors will have to pass on costs to their customers or tolerate a reduction of their profit margins: eventually someone will have to pay the 9 billion EUR due for the CBAM and the 10 billion EUR for the ETS. Or more, if the CO2 price keeps rising.
Although at least a couple of years will be needed to have efficient CO2 mechanisms, its effects may be felt well before then and, in a context where many talk about temporary inflation, these could stretch even more the time needed for a return to normality.
It is plausible that an increase of CO2 prices were a conscious objective of the creators of these schemes to push ahead in the energy transformation that is so much hoped for. However such a fast rise could prove to be the unintended consequence of a double-edged sword.
The Camino de Santiago route is an 800 km long pilgrimage path. One starts walking, with only a backpack, from St Jean Pie de Port to arrive to Santiago de Compostela. Those who prepare for such an endeavour dream of arriving before even starting. They imagine the rural landscapes, the churches, the castles on their path, as much as the tiredness and the sweating, albeit sweetened by the thought of crossing the threshold of the holy city. But soon enough they realise that not all is as ideal as they imagined. The blisters are painful in the morning, the afternoon sun burns the skin and dries the throat along the Mesetas, and the destination seems never to be within reach. The despondence may turn into weeping, and the fear of failure is impending.
Also those who convened in Glasgow for the COP26 meeting are preparing for a long journey. For the first time since we heard about a Green Deal and green infrastructure plans, they met all together to draw the path towards the GHG emissions neutrality within the half of the century.
Like the well-intentioned pilgrims, the “Conference Of the Parties” has started well on the issue of deforestation, with the 137 countries that hold 90% of the Earth’s forests agreeing to stop deforestation by 2030. Already on its third day, however, the first difficulties arrived: that’s when along the path they encountered the issue of methane, a gas that is 80 times more efficient than CO2 but whose effects disappear only after two decades. Despite the agreement to reduce by 30% the methane emissions within 2030 versus the 2020 baseline being feasible with the current technologies, important countries like China, Russia, India and Australia chose to opt out.
Since governments have always maintained that public money would not be enough to reach the target, new private capitals coalitions have been formed during the conference: the Glasgow Financial Alliance for Net Zero includes the existing alliances of various financial industries such as the Net Zero Banking Alliance, the Net Zero Insurance Alliance, the Net Zero Asset Owner Alliance, etc., a dowry of 130 trillion dollars between banks, insurance companies, credit institutions, funds, financial services providers to help fight climate change. Many of these institutes, however, still hold important credits towards companies involved in gas and oil exploration, while others are not so quick in removing loans to carbon-related projects. One reason more to pay attention to the stock selection whenever sustainable funds want to invest in as varied a sector as the financial one.
Among the other initiatives mentioned all over the web by searching “COP26”, gas and nuclear are back on the table as sources necessary for the Energy Transition. Not only France, that will have one of his citizens appointed as president of the Council of the EU for the next semester, has reiterated the sustainability of nuclear energy, but also Draghi and Von der Leyen have commented that reaching the emissions target would not be possible with renewables only, as they are not yet sufficient to replace the fossil fuels.
Such comments bring about two important considerations in relation to sustainable investments: on one hand they help us understand how far we still are (thirty years at least) from an oversupply of clean energy sources such as solar, wind and hydrogen; on the other hand the possibility of having gas (as energy transition source) and nuclear within the European Taxonomy.
It’s an important recognition for these two sources, so far neglected by ESG funds, although seven European countries led by Germany have endorsed a declaration against nuclear in the Taxonomy.
In extremis, another issue has put in danger the good outcome of COP26: one word only, small but vital. Instead of a “phase-out” from carbon within 2050, the agreement settled on a “phase-down”. Thus, what should have been a GHG emissions neutrality by that date has been diluted as a target around that date. The countries responsible for such last-minute change were China and India: more and more heavyweights in the international community, their diktat has almost jeopardized the entire conference giving the opportunity for Greta Thunberg to reiterate her “blah, blah, blah” as a summary of the actions taken by world governments to fight climate change.
At least was saved that 1.5° established as upper ceiling of the global temperature increase within 2050, which implies a 45% emissions reduction by 2030 versus 2010.
Despite everything, even countries that hadn’t previously accepted CO2 as the main culprit of the global warming have now acknowledged this scientific evidence, leading some critics such as Greenpeace to recognise that the Glasgow COP26 has marked one important result: the start of fossil fuels’ decline.
As we remarked at the end of the previous issue, Two products, two gears, we are only at the beginning of a long journey, destined to last thirty years and that will see dark hours as well as days of glory. We have just got the confirmation of this.
Often, in an environment driven by excesses, only a sufficiently important event can disrupt the irrationality of the status quo. We are talking about revolutionary changes. What we’re going through today is called the greatest transformation since the industrial revolution and, as such, it created unbalances that have the power to break the excesses that we’re living in.
“Stop the Greenwashing”, “Overwhelmed by Greenwashing”, “Ecology versus Greenwashing”, “Fight the Greenwashing”: these are only a few of the headlines which populated the web in the last few weeks. As we anticipated in the previous issue (The red gold – Mining), it seems that hunting fake green is now very much in vogue, not only among investors.
Almost all articles mention the study by Influence Map, which highlights that out of 723 funds (593 generalist ESG and 130 thematical ESG), 71% of the former and 55% of the latter are not aligned with the Paris climate agreement (details here).
The problem of Greenwashing is assuming such importance that it’s been a topic in the Arcantara symposium in Venice and in mass demonstrations by many young people, which have criticised the governments’ greenwashed politics: even Greta Thunberg mimicked with “blah, blah, blah” the climate promises made by the world leaders.
The 30-years long European energy transformation might not be attuned with a youth world used to have everything immediately, but the European Union with its Fit for 55 and the intention, recently reiterated by Ms Von der Leyen, to mobilise 1 trn EUR from now to 2030 doesn’t seem poised to slow the pace. Quite the opposite.
Things, however, don’t change from one day to the next. Patience and firmness is needed. It is in fact difficult to imagine that the zero emissions objective for 2050 could be achieved simply by shutting down all the oil wells, considering that fossil fuels still contribute to generate 80% of the energy necessary to our economies and development.
In the same way it’s probably excessive to point the finger now towards those financial products that, while integrating ESG principles in their investment process, still keep a broadly neutral allocation on all sectors. Can we really achieve sustainability by avoiding the products and services provided by industries traditionally less ESG- compliant such as steel, oil, gas, cement, banks? The same Ms Von der Leyen, when the Green Deal was presented, declared that “nobody shall be left behind”.
Greenwashing is undeniably here, but it’s not enough for a product to invest in an oil company to blame it for being greenwashed. We should rather distinguish those companies that, in a polluting industry, are making efforts to transform the business to achieve the objective in thirty years’ time, from those that try to procrastinate the revolution until when it’ll be too late.
Despite the launch of SFDR (Sustainable Finance Disclosure Regulation, the EU directive on sustainable products) and the Taxonomy Regulation (the list of sustainable activities), much confusion remains around the ESG world, and clients and investment companies alike will have to engage more and more to study the companies and the products proposed.
By looking at most generalist ESG ETFs, whose tracking error versus the market is very low, we could legitimately suspect that they have been only slightly adjusted to make them appear mildly greenish. It would be difficult otherwise to understand why companies in the solar, wind, hydrogen businesses have lost 40% year-to-date while those ETFs have had double digit performances, in line with the broad market.
This doesn’t mean that there’s no room for more consistent products that prefer to invest only in the technologies of the near future.
Two products, two gears: art. 8 and art. 9, according to the SFDR classification. We should not neglect the former, only because they are less clean than the latter.
The transformation will last thirty years and to achieve a dark green we can also accept lighter hues. EU knows that and it has foreseen both kinds of products. It will be up to the investors to choose the right solution for them.
Equilibrium: we’re on a spaceship leaving for a thirty-years long journey. Let’s enjoy the ride with no hurry.
Over time, driven by our changing needs, we attributed different hues to gold. Better said, we have called “gold” commodities that have been of vital importance, borrowing the colour of such commodities. Thus cotton became “white gold” and oil “black gold”. It seems now that a new colour is emerging, and that gold is taking red hues.
EU has published two months ago its Fit for 55, a package of reforms aimed at reducing by 55% the greenhouse gases emissions by 2030, compared to 1990, as an intermediate step to ensure that the neutrality target of 2050 can be achieved.
Considering as well the programs of other countries, the quantity of copper linked to the green economy necessary to achieve the intermediate target is thought to be six times the current level. The estimate increases to nine times as the technologies involved are more and more sustainable, giving the hue a darker tone. It’s easy to see that the estimate is not unreasonable, given that copper is used everywhere: from electric cars (which use six times more copper than a conventional one) to the charging stations, from wind turbines to solar panels, from batteries to electric grids. In fact the whole world of energy and transportation that the EU foresees in the near future.
According to some research, the price of red gold is destined to almost double in the coming years, pushed by such accelerated demand that is not compensated by a similar supply increase. The reasons for a slower supply include lack of adequate technologies for a more efficient extraction process; lack of investments by mining companies, which would reduce profit margins; the two-three years’ time needed to expand an existing copper mine compared to up to eight for a new mine to be able to generate revenues.
And given the cyclicality that copper has had until now, how to blame them? The only way to convince producers is therefore an increasing price, to provide them with cashflows and a business that will be sustainable.
If copper will be the most important commodity, representing over 50% of the total of the metals needed for the green technologies revolution, the others should not be neglected: nickel, cobalt and lithium are needed for batteries, the lightness of aluminium brings down the fuel needs of cars, trucks and planes, while platinum, palladium and rhodium are needed for the catalytic converters used to reduce the emissions of diesel cars as well as the new hydrogen fuel cells.
The extraction of such commodities however has always made ESG investors uneasy, because of the CO2 emissions, the consumption of resources and for the social aspects involved. All issues that depend on many factors such as the product mix, the extraction process and the geographical location.
It is in fact more polluting to produce aluminium than iron or copper: a deeper excavation implies higher consumption of resources and higher risks for the workers, compared to surface mines. Additionally, mining in an emerging country implies higher social or political risks than mining in Canada or Australia.
If we analyse only the direct emissions (so called scope 1 and scope 2) of mining companies, we would find out that they represent only 1% of the total anthropic emissions. But the proportion increases noticeably to 7% if we consider indirect emissions, those generated by the use of the commodities produced, where the main role is played by fossil fuels.
We should consider as well the use of resources: while we have large deposits of aluminium, copper deposits are smaller considering also the increase in demand foreseen in the near future. In this case an important factor will be the recycling which will also contribute to prevent prices from skyrocketing. But the most controversial aspect linked to mining companies is the social one. Generally speaking, mines are located in emerging countries, with governments often overlooking human rights like in the known case of underage workers exploited in the Congo cobalt mines. On the other hand, the companies that operate in such countries establish a durable relationship with the local population supplying jobs, building schools, roads, bridges, providing medical assistance and support in several ways.
The Governance is another aspect to consider, one that has a greater importance for this sector given the frequent contact with governments less organised or attentive, often liable to corruption and inclined to sudden and unexpected decisions. Such an example is the law proposed by Chile last April to increase copper extraction fees up to 75% to face the Covid emergency, where local mines produce almost 30% of the world copper and thus represent a significant source of revenues for that country.
The greater weight assumed by less measurable aspects like the S and G, compared to the E, makes the mining sector liable to a wider dispersion of opinions by the rating agencies in estimating a sustainability score for any given company. This is perhaps one of the reasons why mining companies are under-represented in ESG portfolios; or it may be the result of the opinions of investors, journalists and independent analysts that could call greenwashed those products that invest in such companies. An increasing risk given that the hunt for greenwashed products is gaining traction.
The variety of critical factors affecting the mining sector definitely requires a stronger focus on the securities selection, but are we really sure that a sustainable portfolio could simply avoid investing in those commodities that are needed to achieve that sustainability?
