The necessity of pursuing environmental improvements in hard-to-abate industries

investment viewpoints

The necessity of pursuing environmental improvements in hard-to-abate industries

Christopher Kaminker, PhD - Head of Sustainable Investment Research & Strategy

Christopher Kaminker, PhD

Head of Sustainable Investment Research & Strategy
Thomas Höhne-Sparborth, PhD - Senior Sustainability Analyst

Thomas Höhne-Sparborth, PhD

Senior Sustainability Analyst
Kristina Church - Head of CLIC™ (Sustainable) Solutions

Kristina Church

Head of CLIC™ (Sustainable) Solutions

Emissions are deeply entangled with every sector of the economy. The modern day industrial and economic model is entirely built on the convenience and energy density of fossil fuels. Due to the complex nature of the flow of global emissions, and the need to understand the entire emissions value chain, it is vital to focus on decarbonisation across all industries. At Lombard Odier, we believe simplistic carbon-footprinting risks overlooking the urgency of the net-zero transition across all industries and the huge investment opportunity this presents.

In the pursuit of a cleaner, climate-neutral economy, it may be tempting to favour those stocks characterised by a low carbon footprint. Given the growing interest in such stocks, carbon footprinting has become a growing business among information and data providers, and is a common metric against which funds and indices are compared. These footprints can offer a useful benchmark for comparing companies within the same industry, or for tracking the progress of environmental improvements within a single company. However, they act as a potential pitfall when used indiscriminately.

Firstly, a simplistic focus on carbon footprints quickly leads to the exclusion of sectors that are at heart of the problem, but must – owing to their economic importance – also form part of the solution. In the EU, for instance, the five highest-carbon industries – including chemicals, cement, and steel - account for around 40% of total turnover, but for 93% of emissions. Excluding these sectors results in a radical improvement in the carbon footprint of a hypothetical portfolio, and might be marketed as offering an opportunity to invest in best-in-class industrials, at least from a carbon footprint perspective.

In the EU, the five highest-carbon industries – including chemicals, cement, and steel - account for around 40% of the total turnover, but for 93% of the emissions.

Secondly, owing to limited data availability and transparency, many providers of carbon footprints fail to take into account the complete lifecycle of a company’s products. Whereas so-called Scope 1 emissions refer to emissions generated on-site by a company’s own manufacturing processes and activities and Scope 2 activities take into account the emissions related to the company’s energy requirements, Scope 3 activities relate to the upstream emissions accounted for by the company’s supply chain and the downstream emissions resulting from a product’s use. On average, emissions in a company’s supply chain outweigh those of its own operations by a factor of four, but data providers often omit these latter Scope 3 emissions, or estimate them from broad sectoral models.

 

Direct and supply chain greenhouse emissions by sector (% of total emissions)

 

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Source: Adapted from McKinsey & Company (2016), based on Carnegie Mellon University, CDP, GreenBiz. McKinsey & Company (2016). Starting at the Source: Sustainability in Supply Chains. Bove, A-T and Swartz, S. Accessed at https://www.mckinsey.com/business-functions/sustainability/our-insights/starting-at-the-source-sustainability-in-supply-chains

 

Thirdly, additional complications arise when a product’s use serves to avoid emissions that might otherwise have occurred. Whereas the manufacture, distribution, installation and use of a wind turbine – to cite an intuitive example – incurs a substantial carbon footprint, this is more than offset by the emissions that are avoided by substituting wind energy for electricity derived from fossil fuels. This type of additionality (the added value of the product or service compared to a baseline scenario) requires more in-depth analysis, but is essential to understand the true carbon footprint of a company.

Given these various pitfalls, a more holistic approach to tracking the path of global emissions is required, one that goes beyond carbon footprinting. A simple low-carbon strategy that only cherry-picks investment among industries with a low environmental impact ignores the simple fact that even in a net-zero emissions economy, paper, chemicals, basic metals, cement, glass and other non-metallic minerals will all still be required. The simple exclusion of these sectors, therefore, fails to capture the necessity of pursuing environmental improvements in these hard-to-abate industries.

An effective strategy does not exclude such industries and, instead, aims to identify companies that either offer specific solutions or are positioned within transitioning industries, where decarbonisation is both an environmental necessity and a source of competitive advantage.

We therefore seek to include solution providers as well as transitioning industries, including key sectors where action on climate change is a necessary step on the pathway to the net-zero economy. It seeks out the existing solutions and strategies that can form the basis for effective climate action, focusing on those actions that also offer competitive advantages to companies that adopt them.

 

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