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How the climate change megatrend will influence investments

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OPINION: With COP26 in Glasgow wrapped up, debate will turn to whether the conference advanced the fight against climate change or was just another talkfest that failed to deliver necessary progress.

Critics will highlight that countries’ current emissions reduction pledges remain well below Paris Agreement goals. Moreover, most countries’ current policies remain well short of achieving the pledges they have made.

However, regardless of whether COP26 is deemed a success or not, we expect policies and initiatives to combat climate change will only grow in the years and decades ahead.

Emissions reduction targets will become increasingly ambitious. And pressure will grow on all countries to “pull their weight”. The climate change megatrend presents both opportunities and risks for investors.

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Navigating the opportunities and risks ahead

We expect the battle against climate change will have a dramatic influence over the global economy and financial markets for decades to come. We’ve seen estimates of the investment required range between US$50 trillion and US$90 trillion over the next couple of decades.

New assets, such as carbon units, and industries, such as electric vehicles and renewable energy, will continue to grow substantially. New technologies will emerge. Older, carbon intensive industries will shrink and may disappear.

Specific commitments made at COP26 focused on:

  1. accelerating the phase-out of coal,
  2. ending deforestation,
  3. speeding up the switch to electric vehicles (EVs),
  4. encouraging investment in renewables and clean technologies, and
  5. cutting global methane emissions.

Sales of electric vehicles have started to take off and are expected to accelerate rapidly. The United States has, to date, been a laggard in promoting EVs, but plans to rapidly catch up – President Biden’s American Job Plan proposes a US$174 billion investment to promote EVs including the rollout of 500,000 charging stations by 2030.

Unsurprisingly, investment in EV companies has boomed. While many debate whether it is rational, the market value of Tesla is now more than double the four largest auto companies – Toyota, GM, Ford and Volkswagen – combined.

David Zalubowski/AP

The market value of Tesla is now more than double that of the four largest auto companies combined.

Electrification only reduces emissions if it comes primarily from lower carbon, and, ideally, renewable sources. Also unsurprisingly, forecasts for renewable energy output continues to grow, as do the number of investors crowding into renewables companies.

Companies that rely on traditional, carbon-intensive products and processes will struggle if they don’t innovate. Here in New Zealand, gas connections to residential homes could be a thing of the past if the Government follows the Climate Change Commission’s advice to ban new gas connections by 2025.

Industrial processes, another major source of emissions, are increasingly moving away from coal. The A2 Milk Company is decommissioning the coal-fired boiler at Mataura Valley Milk and replacing it with a high-pressure electrode boiler, with electricity provided by Meridian Energy. Synlait has an operating electrode boiler and is converting a primary coal boiler to wood pellets.

Cement production is a highly carbon-intensive industry, responsible for around 8 per cent of global carbon emissions. Canadian company CarbonCure has developed a technology that increases the strength of the concrete by injecting CO2 into the mixture before it has cured.

John Hawkins/Stuff

The A2 Milk Company is decommissioning the coal-fired boiler at Mataura Valley Milk and replacing it with a high-pressure electrode boiler.

The end result is a 7 per cent reduction in cement use for similar strength concrete and CO2 that is permanently embedded.

There is also potential to reduce cement demand by changing the way we build. While concrete and steel are currently the most common structural materials used in high-rise construction, cross-laminated timber has started to become more common. Wooden alternatives emit less in production and store CO2.

In addition to considering the impact of climate change on specific sectors and companies, investors are also faced with a proliferation of “sustainable” investment funds. A growing number of these are high quality.

But in our experience, for many, what’s implied by the fund name or marketing description isn’t matched in the fine print and execution – it’s another challenge for investors to navigate.

As we enter the transition to a low carbon economy, it’s important to maintain investment disciplines. Just because a new technology might be new, exciting, and even revolutionary, it doesn’t mean it’ll be a good investment. In fact, because a technology is new and exciting, there is a heightened risk of over-exuberance leading to an investment being overpriced.

For lessons, we can look back to the 2000 dot-com crash. Yes, the internet changed the world, new leading global companies emerged, but obviously not all internet investments proved successful.

Marrying climate ambition with sound investment practices will be key.

– Matt Henry is Head of Wealth Management Research and Liam Donnelly is a Quantitative Analyst at Forsyth Barr.