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Climate Assets monthly update: Perfect is the enemy of good

Date: 12 October 2022

In less than a month, the largest annual gathering on climate action will convene in Sharm el-Sheikh, Egypt’s main coastal tourist attraction, for the 27th Conference of the Parties to the United Nations Framework Convention on Climate Change - COP27 for short.

Faced with a worldwide energy crisis and increasing extreme weather events, policy makers and climate champions will look to build on the outcomes of COP26. Energy remains critical to tackling the climate crisis with fossil fuels, renewable energy, and net zero sure to remain front and centre of this year’s discussions.

Drawing comparisons among events is rarely helpful, but I find it difficult to ignore the fact that Sharm el-Sheikh is quite a lot hotter than Glasgow, which may be a climate change statement in its own right. Aside from temperature, there are also several remarkable differences for this year’s event.

Take sponsorships for example.

Last year the UK government banned fossil fuel companies from sponsoring COP26, underpinning the climate talks with a clear message. In contrast, this year’s sponsor of the event is Coca-Cola, one of the major plastic polluters. The soft drinks industry produces more than 470 billion bottles a year and Coca-Cola sells about a quarter of those, the equivalent of three million tons of plastic packaging a year. The company has commitments to a ‘world without plastic’ (collect and recycle every bottle it produces) by 2030, but limited progress has been shown so far, as was widely reported by the BBC last year, BBC Panorama|Coca-Cola’s 100 Billion Bottle Problem.

One may argue that choosing a sponsor for an event like this is an extremely challenging job, as no company is perfect. Furthermore, in Coca-Cola’s defence, it is truly a worldwide brand with an incredible marketing reach, undoubtedly appealing characteristics for an event sponsor. However, this is not just any event. This is ‘the’ event of the year for tackling the climate crisis. In addition to the growing awareness that plastic is polluting our oceans and rivers, nearly all plastic is produced from fossil fuels. Far from a perfect choice, if you ask me.

When it comes to event participants, climate activists have traditionally been a vocal and visible presence in climate talks and one may argue, a much-needed presence. However, this year may be different. Over the past decade, Egypt has banned protest and cracked down on independent civil society action. This underpins scepticism among international and local NGOs about whether they will be able to participate in discussions, let alone meaningfully influence any negotiations or outcomes.

There is also increasing pressure for COP events to support the funding needed to remediate loss and damage caused by extreme weather events, like the devasting flood in Pakistan earlier in the year. Poorer countries want a new fund to be created that would pay for the ‘loss and damage’ from extreme events that they are unable to adapt to.

Last year the pandemic brought a sense of unity and common purpose, fostering a co-operative spirit among participants. In contrast, this year there is a widespread sense of independence, in part because of heightened concerns around the security of essential supplies, such as energy and food. The geopolitical situation is very different. Food and energy shocks resulting from the Ukraine/Russia conflict and rising inflation have caused countries to turn inwards, to go back to natural gas and protect grain stocks.

The buzz and excitement that we all had last year around Glasgow and COP26 has been diluted and there is currently little clarity regarding what to expect this time around on emission reduction goals and broader targets. To replace Russian gas, European politicians are considering a significant infrastructure expansion to handle LNG (liquid natural gas), imported from the US and other places. I am cautious on this, in the knowledge that the infrastructure needed to import gas takes years to build and represents a significant investment, an investment that could soon be left redundant as the energy transition progresses. Perhaps Europe should focus on progressing energy efficiency technologies, and green hydrogen production, instead.

In the US, President Joe Biden’s Inflation Reduction Act (IRA) includes US$369bn for climate and energy funding. There is a potential multiplier effect here and we believe this could ultimately unlock more than US$1tn in combined climate-related investments. The IRA has positioned the US at the forefront of the race to become world leader in green energy production. The legislation is not perfect in every detail, but it has given investors an energy roadmap and the renewables transition a much-needed boost.

In general, the energy crisis has accelerated the need for renewables as it has clearly revealed the level of reliance on Russian imports and demonstrated how precarious energy security is for many countries. The rapid rise in power prices, so far in 2022, shows the level of vulnerability and we believe that renewables offer the most attractive opportunity to reduce this reliance. Yet the same power price rise has also temporarily put a cloud over listed UK renewables companies as we wait to learn the price they will receive for the electricity they generate. While the government’s Energy Prices Bill, announced this week, will sever the link to the high wholesale gas price, consultation is still ongoing about what will replace it. This heightened uncertainty and the possibility of receiving lower prices going forward is a far from ideal scenario for investors.

Waiting for everything to be perfect before tackling the energy crisis and climate change is a fool’s errand. Scaling up green energy production and developing low carbon technologies would no doubt provide an attractive business case for those investors who understand that not only is change taking place, but that going forward the pace of change is likely to only increase.

Take the Climate Assets strategy for example, we continue to favour companies that are well placed to be beneficiaries of the energy transition, such as EDP Renovaveis (EDPR), a long standing holding among our renewable exposure. EDPR is a leading renewable energy producer operating offshore, onshore and solar wind farms across the globe and stands well placed to benefit from the energy transition as the renewable rollout is accelerated.

The current environment is especially challenging for new and innovative businesses, as central banks rapidly raise interest rates in a bid to tackle persistently high inflation. This raises the cost of capital and adversely impacts the valuations of these companies, which have a larger share of their profits projected to occur further into the future. Still, we maintain our strong belief that this is a challenge which the best companies will overcome. Waiting for a more favourable environment for these firms risks missing the bus on what, in our opinion, is the investment opportunity of our generation. While painful for many in the near-term, this year’s events, and the associated moves in energy and power markets, can hopefully serve as a catalyst to accelerate the energy transition. The current high-rate backdrop may not be perfectly conducive for this, but then again, perfect is the enemy of good.

Please note: any mention of a specific security should not be interpreted as a solicitation to buy or sell a security.

Author

Claudia Quiroz

Head of Sustainable Investment

I lead the sustainable investment team at Quilter Cheviot, dedicated to serve clients who would like to invest in companies offering solutions to the economic and environmental problems of urbanisation, climate change and resource scarcity.

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