Climate has everyone's attention this summer. Elevated temperatures across the globe over the past two months are making us sweat and consider the implications of extreme weather beyond just physical discomfort, especially if such occurrences are indeed here to stay, as research suggests. A changing climate has the potential to disrupt numerous industries and will have important implications for long-term investors, both in terms of assessing risk and finding opportunities.
First, is the extreme weather just our imagination?
It isn't. June 2019 was the hottest June ever globally, at nearly 1.7 °F warmer than the 20th century average of 59.9 °F, according to the National Oceanic and Atmospheric Administration, which has tracked temperatures for the past 140 years. And July 2019 appears on track to achieve similar distinction, with all-time country temperature records set on July 25th in the UK (38.7 °C / 101.7 °F), Germany (42.6 °C / 108.7 °F), Belgium (41.8 °C / 107.2 °F), and the Netherlands (40.7 °C / 105.3 °F), among others. The body of research and evidence that extreme weather events are more likely now and that they can be attributed to human generated emissions, continues to grow. A recent collaborative study conducted by eight European research organizations concluded that human-induced climate change is likely to have added 1.5-3 °C to Europe's July heatwave.
What does this mean for investors?
From an investor's perspective, climate change presents numerous risks that warrant consideration, including physical risks – the damage to various assets resulting from more frequent and extreme climate events – and transition risks – the various impacts on economies, sectors and business models of shifting toward a less carbon intensive world. As part of this transition, we are seeing increased focus from policymakers and investors on the economic and financial implications of climate change. These forces are raising the stakes for companies and those that are slow to adapt could be at risk of being overlooked by investors and be subject to regulatory and reputational risk in the years to come.
In theory, investors have a variety of options to position portfolios for climate change, including focusing on companies with already low emissions or those actively reducing carbon intensity, engaging with high carbon intensity companies to encourage change, and investing in transformational areas that seek to solve these issues. But investors need better information from companies to take action on these options. The June 2019 status report from the Task Force on Climate Related Financial Disclosure (TCFD) makes clear that while companies are making progress overall on evaluation and disclosure of climate risk and resilience, more action is required. Indeed, actual progress on limiting temperature increase to 1.5° per the Paris Agreement will likely require disruptive, moonshot-like change more so than gradual, incremental change.
Some sectors where we are seeing examples of rapid disruption in response to climate-related issues include energy, transportation, and food. We focus on these industries in more detail below, but this is by no means an exhaustive list. In our view, companies that successfully navigate these industry transformations– whether they're new entrants or incumbents – represent attractive opportunities for investors.
Rise of Renewables
Renewable energy's rise as a viable and scalable energy source is sustainable disruption taking place before our eyes. For the past two centuries, fossil fuels generated the power that fueled economies across the world. Yet they are finite resources and the emissions resulting from their use have immeasurable environmental and social consequences – the UN reports that combustible fuels are responsible for approximately 60% of climate change-inducing global greenhouse gas emissions (GHGs), and as recently as 2012, caused 4.3 million indoor air pollution deaths. Though rising energy demand will require the world to rely on traditional energy sources as part of its energy mix for the foreseeable future, renewable energy is gaining in share and its growth in demand will far exceed that of fossil fuels going forward.
In response to the rising demand for cleaner energy and changing emissions standards, many energy companies are undertaking efforts to reduce their environmental impact and making investments in renewables. Some companies have set aggressive goals to change their power generation mix. US-based Xcel Energy recently committed to a full transition to carbon-free electricity by 2050, with a pledge to reduce carbon emission by 80% by 2030. In Europe, Spanish utility provider Iberdola made a similar commitment but with concrete incentive to meet its targets, taking out a USD 1.7bn loan with conditions directly linked to its ability to increase renewables' share of its total energy mix. And these aren't overly optimistic, isolated commitments; according to IEA forecasts, the global share of renewables used in electricity generation will approach 35% by 2040, up from 20-25% today. We expect this growth to accelerate as renewable power generation gets cheaper and becomes more cost effective. Already, solar and onshore wind power projects are cheaper for companies to build and operate than all other bulk generation sources in most countries, according to Bloomberg.
Non-energy companies are also transitioning toward renewable power, citing financial reasons and further catalyzing the transition. Some companies are far along in this process – as of the end of 2018, two of Disney's four Orlando theme parks were wholly powered by solar energy, with the company acknowledging that climate change has negative implications for tourism. Further, in June, US retailer Target pledged to source 100% of their electricity from renewable sources.
These are just a few examples of the many companies adjusting their long term strategy as the competitive landscape shifts due to the increasing financial relevance of climate issues. Investors can potentially capitalize on these trends and drive positive change by looking at investments that recognize the rise of renewable energy. For more information about renewable energy, please read the CIO report Longer Term Investments: Renewables.
Transformation in Transportation
Sustainable disruption in the automotive industry is already underway, driven by stricter emissions regulations and by innovative technologies, as well as by urbanization trends in emerging markets. Transportation is one of the largest contributing sectors to carbon emissions, accounting for 23% of energy-related emissions. Megacities in particular are plagued with heavy traffic, negatively impacting air quality and contributing to the disproportionate environmental footprint of urban areas. Increasing vehicle electrification can help address the issue. We estimate that by 2025, around 25% of new vehicles sold globally could be electrified. In late July, major auto manufacturers Ford, Honda, BMW of North America and Volkswagen reached an agreement with California regulators under which their vehicle fleets would average 51 miles per gallon fuel economy by 2026. Cities are also increasingly moving towards electric or hybrid bus fleets in an effort to reduce their carbon footprint. While it varies by region, electric buses should become a larger percentage of the global fleet over time, estimated to surpass 50% share around 2031, according to Bloomberg.
Beyond electrification, another transformation underway in the transportation sector is the development of autonomous driving capabilities. Autonomous features could reduce traffic related deaths and potentially reduce traffic jams, eventually flowing through to improved fuel efficiency per mile traveled. Companies spanning across industries from automotive to technology are investing in autonomous vehicle inputs in an attempt to gain share in a transforming market.
Our definition of smart mobility is a combination of smart powertrains, smart technology, and smart car use such as ride hailing services. Similar to renewables, disruption in the transportation industry presents an inherent investment opportunity as smart mobility solutions gain traction. We see opportunities in electronics and electric components related to electrification and autonomous driving, and believe the smart mobility market more broadly will grow to around USD 400bn by 2025, 8-9 times today's size. For more information about smart mobility, please read the CIO report Longer Term Investments: Smart Mobility.
The Future of Food
The agriculture industry is facing a two-pronged challenge– the need to increase efficiency to meet the nutrition demands of a growing population, while at the same time finding ways to overcome environmental challenges stemming from desertification and other extreme weather events. Agriculture makes up approximately one-quarter of global GHG emissions, and this is could increase over time without efficiency gains and the transition to more sustainable food sources.
One potential solution is a shift to plant-based, rather than animal-based protein. Estimates of resource efficiency and carbon emissions for animal based diets relative to plant-based can vary depending on the assumed substitutes and other input variables, but in a report from the World Resources Institute, it's estimated that meat from ruminants (beef, sheep, and goats), requires over 20 times more land and generates over 20 times more GHG emissions per gram of protein relative to pulses.1
Companies – both new and mature – are recognizing the opportunity in alternative proteins, especially with the recent consumer enthusiasm for plant-based options. With Beyond Meat's IPO garnering attention from investors, and Impossible Foods's expansion to over 5,000 outlets in the US, including Burger King and White Castle locations, existing industry giants like Tyson Foods are crafting plant-based products in response. Tyson Food's plant-based pipeline includes red-meat alternatives for many of their popular products, from burgers to meatballs. It's not just meat either, companies are responding to demand for plant-based beverages as well. Both private companies and existing beverage producers, such as Oatly and Pepsi respectively, are offering oat-based beverage products that allow consumers to avoid dairy.
Future industry disruption could also stem from lab-grown meat, which is another technique being explored to produce more sustainable protein alternatives. Using stem cells from living animals, cultured meat can be grown in a lab, using fewer animals per pound of protein and in turn, reducing the amount of emissions associated with raising cattle. Regulatory hurdles, price barriers, and consumer adoption rates could pose challenges for labgrown meat in the years to come, but over a longer time horizon labgrown meat could be another potential disrupter in the agriculture space. In our view, the transitions underway in the agriculture industry are likely to continue over time as demographic and environmental pressures mount. For more information, please read the CIO reports Longer Term Investments: Agricultural Yield and The food revolution: the future of food and the challenges we face.
An urgency remains…
Our summer encounter with more extreme weather may just be a passing memory once cooler autumn temperatures arrive, but the need for companies to address climate change and other sustainability challenges with greater urgency will remain. As the examples above illustrate, these issues are driving rapid disruption of established sectors and business models and elevating innovation from "nice-to-have" to business priority for startups and incumbents alike. Furthermore, many companies increasingly recognize that the implications of what were once seen as long-term secular trends and risks must now be evaluated, addressed and disclosed in a much shorter timeframe. As policymakers and investors sharpen their focus on the economic and financial implications of climate and other issues, markets will likely reward those companies that are proactive and innovative in establishing their role in a rapidly evolving world. Investors who are ahead of the curve in identifying the winners and losers of these "long-term" changes will benefit too.
Andrew Lee, Head Sustainable & Impact Investing Americas, UBS Financial Services Inc. (UBS FS); Laura Kane, CFA, CPA, Head Thematic Research Americas, UBS Financial Services Inc. (UBS FS); Michelle Laliberte, CFA, Thematic Investment Associate, UBS Financial Services Inc. (UBS FS); Andrew Little, Sustainable and Thematic Investing Associate, UBS Financial Services Inc. (UBS FS)
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