Which companies are prepared for the environmental transition?

Three powerful systems changes are accelerating one of the most drastic economic transformations in modern history. These forces are reflected in every sector of the economy and will lead to widespread sustainable changes becoming entrenched. The planetary transition demands a radical rethink of how we approach global equity investment.

 

Need to know The transformation of three global systems – energy, land and oceans, and materials – is creating opportunities for our Planetary Transition strategy Within this universe, we see two opportunity sets: solution providers whose growth is driven by enabling businesses to become sustainable, and transition leaders whose products, services and business models are becoming fit for a CLIC® economy We provide two case studies:1 solution provider Tetra Tech, whose consulting, engineering and management services are key to sustainability projects in a plethora of sectors; and global auto manufacturer Stellantis, whose aggressive decarbonisation strategy make it a transition leader, in our view

 

All change

History teaches us that large-scale transitions start slowly, then happen all at once. Thirty years ago, companies were debating the importance of IT infrastructure. Now it is an unalloyed essential for businesses. Today, the amount of investment expected to be deployed into electrifying the power supply, improving energy efficiency and reducing carbon this decade is at about the same level as IT expenditure over the last few years.

Our core sustainability conviction is that the economy is transitioning to a Circular, Lean, Inclusive and Clean – or CLIC® – model. This is being driven by the transformation of three global systems and the pricing of environmental externalities, or 3+1 systems changes: 

• Energy: the energy system is being rewired by mass electrification
• Land and Oceans: the need to restore nature and harness its regenerative capacity for sustainable food value chains is changing the land and oceans system
• Materials: decoupling the production of goods from primary-resources extraction while reducing waste underpins the drive to circularity, which is overhauling the materials system

Finally, robust pricing of externalities – chiefly carbon at present – provides financial incentives for companies to pollute less or not at all.

These 3+1 systems are integral to restoring and preserving the planetary boundaries. For example, within the land and oceans system, the food industry and overall land-use changes impact five boundaries by causing:

• 24% of greenhouse gas emissions
• 90% of deforestation
• 25% of biodiversity loss
• 70% of freshwater use
• 52% of degraded soils²

We calculate that 95% of our equity investment universe will be affected, which has important implications for investors. To understand the full extent of the sustainability transition, we believe investors need to focus on all industry sectors to find companies whose products, services and business models are aligned with these shifts. Across the global economy, we define these companies as either solution providers or transition leaders.

 

Solution providers

Companies whose products and services, when applied by customers, help create sustainable outcomes. They typically harness the technologies making the transition economically favourable, and help clients prepare for regulatory and market change. In aggregate, their influence contributes to reversing the damage caused by the transgression of planetary boundaries, changing our economy to help prevent further breaches and, ultimately, restoring a margin of safety. These firms, which can count governments, corporations and consumers among their clientele, are solution providers.

• In the energy system, solution providers deliver technologies to renewables firms, transitioning energy suppliers, or carbon companies active in carbon reduction, carbon avoidance and carbon capture. The global renewables market is projected to reach USD 2 trillion by 2030, up from USD 882 billion in 2020, to drive the electrification of grids across the world. We expect the share of renewables in power generation to increase from 17% to 80% by 2050 at the expense of fossil fuel use.³
• In the land and oceans system, they enable the transformation of eating habits and food production to reduce the intense pressures of modern consumption and agriculture on the environment. For example, the chronic inefficiency of meat production is a sizable issue. To produce just one calorie of beef mince requires 54 times the volume of carbon emissions as one calorie of banana.
• In the materials system, we anticipate that dematerialisation, resource efficiency and the rise of new sustainable materials will decouple production from current levels of primary-resources dependency, while minimising waste and pollution. Embedding circularity in the materials system reduces the need for extraction of raw materials, as it enables creating of new goods through reuse, repair, and recycling of products. Leveraging the bioeconomy and its regenerative materials is essential to achieving this. For instance, wood is a sustainable building material that can be strengthened enough to replace conventional building materials in large-scale construction projects. The market for wood products is expected to grow from USD 350 bn to a USD 750 bn market by 2030.

US environmental engineering and services firm Tetra Tech is an illustrative example of a solution provider, given its work on developing water infrastructure compatible with mounting climate risks.

 

 

Transition leaders

Companies that operate in carbon-intensive industries – such as energy, steel or construction – but have credible emissions-reduction plans, are on course to adapt to a decarbonising world. Similarly, firms dependent on natural resources – like wood, soil or water – that leverage bio-based or recycled inputs, are supporting nature’s regenerative powers. Such businesses have a material impact on the progress towards a CLIC® economy, and their positive actions make them transition leaders, in our view.

Transitioning companies in sectors where emissions are hard to abate – such as steel, cement, transport, chemicals, power generation and real estate – are required for future economic growth but urgently need to decarbonise.

We look for opportunities among carbon-intensive companies that understand the need to transition and the commercial advantages in doing so. We assess their net-zero commitments and track their progress though our implied temperature rise methodology, the Lombard Odier Portfolio Temperature Alignment framework.

In the energy system, these would be companies which have set out a credible plan to exit coal power generation, for example. Global coal-fired generation reached an all-time high in 2021, and currently accounts for more than a third of global electricity generation. Coal power plants produce a fifth of global greenhouse gas emissions.

• Power companies leading the transition are demonstrating an ability to divest decisively and consistently while investing in renewables. In the US, coal-plant closures are accelerating, and coal-generation capacity is expected to fall 45% by the end of the decade from 2020 levels. New renewable generation is now expected to cover almost 90% of additional electricity demand through 2025. 
• The land and oceans system. Modern agricultural techniques rely on ploughing and tilling the land which releases carbon stored in the soils, while the fossil fuel-based fertilisers pumps more emissions into the atmosphere. The overuse of synthetic pesticides causes vast amounts of agrochemical waste which further degrades soils and pollutes water. Large-scale purchasers of produce, such as food manufacturers, can influence the transition by dealing with farmers signed up to approved sustainable agriculture programs, and tracked pesticide use. The market for bio-based fertilisers, such as microbiological, bio-organic and mineral-organic fertilisers, is expected to double by 2030, from USD 9.4 bn in 2021 to USD 19 bn in 2030.
• In the materials system, we anticipate enhanced end-of-life recovery for products, as well as recycling of materials. As much as 60% of our economy’s inputs can be derived from biological processes. Existing nature-based products may replace less sustainable industrial alternatives, with timber, for instance, capable of substituting as much as 20% of steel and concrete in construction in the European Union. Biorefineries may also process organic raw materials such as lignin and cellulose to produce bioplastics, biochemical, biomedicals, and other bio-based materials such as textiles.

With climate and nature-related solutions moving higher up regulatory and investment agendas, taking responsibility for corporate decarbonisation goals is key, both to mitigate reputational, financial and transition risks and to identify investment opportunities. Our active stewardship across the market targets such candidates and supports their development. 

Aggressive decarbonisation by Stellantis, a Dutch multinational automotive manufacturer formed in 2021 by the merger between Fiat Chrysler⁵ and PSA Group, makes it an illustrative example of a transitioning company.

 

 

Adapt now

The scale of the planetary transition is matched by the speed at which it is unfolding. This creates a limited window of opportunity for readjustment. We believe investors cannot afford to be complacent in the face of such widespread change. The risk of stranded assets will grow within a relatively short space of time, and the unprepared will find themselves stuck with the consequences, in addition to being unable to reap the benefits.

Our Planetary Transition strategy aims to identify growth opportunities, thereby capturing what we define as green alpha: companies which we believe are likely to perform better financially in an environmentally-aligned scenario.⁸