Investors and regulators are asking investment managers to tell them how portfolios are managed in a world that places new emphasis on environmental, social and governmental (ESG) issues. At Charles Stanley, we have been keen to analyse portfolios and keep those interested informed of how the investments are placed when it comes to assisting the journey to “net zero”, improving terms and conditions for employees, ensuring honest management and the other good outcomes planned from the ESG focus.
The scrutiny of how companies and governments tread the road to a carbon-free future poses some challenges on how you assess company and individual actions – and where you attribute the carbon dioxide generated. The main system worldwide is based on countries reporting the amount of carbon dioxide produced within their territories by individuals and business activity.
This means that if a country runs down its own fossil-fuel-using processes to import the products affected, that country will look better on the global carbon dioxide table, whilst the country exporting to them will look worse. For this reason, some argue we also need to look at the carbon dioxide generated by products consumed but not made in any given country – and maybe give the exporting country a reduction for the exports. Others do not wish exporters to be let off having to meet ever-tougher standards.
Complex assessment for individuals
Individuals are typically advised by governments to switch the diesel car to an all-electric vehicle, and to scrap the gas boiler for a heat pump replacement. This may be a way of reducing carbon-dioxide emissions, but a successful outcome depends on use patterns and the time period over which these are accounted for.
Electricity is a secondary fuel. If it comes from burning fossil fuels... this must be accounted for.
Clearly, using an electric vehicle (EV) once you have acquired it should generate less carbon dioxide in use than the diesel equivalent. The equation is better for the EV if all the power used to recharge the battery comes from renewable sources, worse if the grid is being supplied mainly by gas, coal and oil fuelled power stations.
Electricity is a secondary fuel. If it comes from burning fossil fuels, with plenty of loss in converting the fossil-fuel energy into electrical energy, and further loss in transmission to customers, this must be accounted for. The amount of carbon dioxide produced when the vehicle is built is also a major factor that needs examining.
If you buy a new EV and send your old diesel to scrap, the two vehicle changes produce a lot of carbon dioxide. You then need to do substantial miles per year or run the EV for a good few years to offset the extra carbon dioxide generated by its production, compared to running on your old diesel for some more years. The sums are variable and complex depending on size of engine, usage patterns and the method of original manufacture.
Chart 1: US electricity production by source and its associated thermal efficiency
The heat pump has so far proved less popular than the electric car. They tend to be expensive and are best in highly-insulated new homes. Adapting an older property with more heat loss through walls, windows and roof requires a lot of work on insulation as well as on extracting the heat from air or ground. As with the car there needs to be an account of the carbon-dioxide cost of the products used in the installation, and consideration of any back up space and water heating people might want to protect them against possible lower temperatures for water and air from the heat pump. Where electricity is used for heating, as for travel, it needs to come from renewable sources to secure the emissions benefits.
Judgement calls required
Attributing carbon dioxide to a company is also a matter of judgement. When considering an oil or gas company, does the investor need to include all the carbon dioxide that will be generated from users of the fuel they sell, or just consider the carbon dioxide they generate in their own business? If you take the wider definition, does that mean you should not invest, or do you give credit to an oil or gas company that is itself in transition to a greener future with pledges to gradually switch as its customers switch to renewable power away from fossil fuel?
The world is working on new accounting standards that will incorporate views of the costs and benefits of transition to net zero.
If you decide not to invest in oil and gas companies at all, you will still be investing in companies that use their products as there are few companies in this fossil-fuel dominated world that is truly fossil-fuel free. The very sinews of the electrical revolution – wind turbines, towers and blades – need fossil fuel for their fashioning. Many businesses have gas heating and processes and rely on electricity that in part comes from fossil fuels.
The world is working on new accounting standards that will incorporate views of the costs and benefits of transition to net zero for every business into the published figures. There is a wish by some to make companies assess the possible losses on stranded assets, the fossil-fuel reserves and fossil-fuel processes that will be retired early.
There is a wish to capture some of the external costs imposed by emissions of carbon dioxide. The European Union is proposing a Directive on Corporate Sustainability reporting and the US has a similar plan. The international bodies are out to improve definitions and requirements for company accounts.
When introduced, these new figures may affect relative valuations of companies. They increase the dangers for business of greenwashing, taking actions for effect that do not solve the underlying problem. They also leave open the possibility that a company may wish to present itself favourably under green standards and will go too far in its interpretation or accounting system, getting into difficulties as some diesel engine car makers did with other emissions reporting.
The electrical revolution imposes strains on some of the Earth’s resources. It needs large quantities of copper, cobalt, nickel, lithium and rare earths. All these need to be mined and processed for battery manufacture or renewable power equipment.
Investors can be a force for the good, but they need to be honest about the complexities. There is no single number that can show any given individual or company has achieved the right answer or which sums up the true position with clarity. We need to look back and forwards over many years of use of many of these products and need to understand the compromises made to get the new green products to consumers.
Chart 2: Global reserve distribution of select materials needed for green transition
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