In this issue, we highlight the challenge of reducing carbon and hitting Paris climate targets. We review how banks are making slow progress, the small number of companies responsible for most greenhouse gas emissions, the energy requirements and climate implications of AI, and the Science-Based Targets initiative’s (SBTi) controversial recent statements about carbon offsets. We also take a look at recent government policy changes that have watered down their own transition commitments. Together, these topics highlight the need for innovative and efficient financing solutions for transitioning the real economy.

1. Net zero banks don't seem to finance less carbon A recent Columbia business school study on net zero commitments made by banks made discouraging reading. 138 banks, representing over 40% of global banking assets, have set net zero targets under the Net Zero Banking Alliance (NZBA) – yet the study finds that these commitments have not led to meaningful change in bank behavior. Specifically, NZBA banks have not divested from financing high-carbon sectors nor accelerated their engagement in a net zero future. The report finds that “net zero banks do not differentially divest from targeted sectors relative to banks without a net zero commitment.” Despite this, the ESG ratings of these banks tends to improve after making a net zero commitment. This leads us to believe that over the next 12-24 months, the banks making the most progress will be rewarded, while the “greenwashers” will be exposed and the ESG-related reputational benefits they have so far enjoyed will reverse.

2. 57 companies contribute 80% of emissions A recent article from the Carbon Majors database highlights how the carbon intensity is concentrated in the oil, gas, coal and cement industries. Roughly 57 companies are estimated to be responsible for 80% of the emissions produced since the Paris Accord in 2015. One of the features of this analysis is that it includes not just scope 1 and 2, but also scope 3 emissions, which includes the downstream use (e.g., the use of cement in a building project) of their products. In this sense, solutions that can help reduce scope 3 emissions (e.g., mechanisms that can accelerate adoption of green cement or other transition-aligned technologies) are key near-term drivers for progress, as consumption of oil, gas, coal and cement are not falling quickly enough to hit Paris targets.

3. AI’s energy needs are growing fast Over the past year, AI has captured society’s imagination. What is receiving less attention is the enormous energy and carbon cost of improving the technology. The power usage of a typical AI querry is roughly 10x that of a typical google search query.  The head of semiconductor company ARM indicated that at current trajectories, AI will US drive data center power demand from 4% today to 25% by 2030.  For as long as most grids are still partially fossil powered, AI may be a substantial net driver of emissions over the next few years.

4. The SBTi seemed to wobble this month The SBTi surprised many observers last week when it announced that it was permissible for companies to use environmental attribute certificates (EACs) to offset emissions from their supply chains (i.e., their Scope 3 emissions) to meet their science-based targets. It’s easier to buy offsets than it is to actually transition your company’s supply chain, and some companies may have pushed SBTi to make life easier for them.  In addition to being a rather stunning statement from a group that has largely focused on changing systems, it proved to be equally stunning for the organization itself. The staff of SBTi indicated that it was the sole decision of the board and CEO, with limited-to-no consultation from staff or industry experts. The staff, threatening mass resignation, called for the resignation of the CEO and any board members that supported this announcement. The board has since backtracked and indicated its policy on offsets has not changed, and any amendments to that policy will be announced in July after consultation internally and externally with scientific experts.

5. Governments are also bowing to pressure to water down commitments – Here’s a list from recent work by Bloomberg (here’s the extended executive summary of BloombergNEF’s  G-20 Net Zero Carbon Policy Scoreboard, published in early April). We quote directly – but the point is that governments are finding it hard to stick to commitments too, increasing uncertainty across the board.
 
“The weakening climate ambitions of the world’s biggest economies is increasing uncertainty among consumers, industry and investors — a subject that will likely set the tone for many discussions at BNEF’s summit in New York this week.

“There are a number of reasons top ranked G-20 members lost points on BNEF’s ranking. In some cases, governments scrapped low-carbon programs with little warning. For example, in December 2023, Germany announced unexpectedly that it would accept no further applications to the electric vehicle purchase subsidy program, which had been due to end in 2024. As a result EV sales dipped 16% in 2023 compared with a 14% increase across the EU as a whole.

“The last year has also seen European policymakers weaken or backtrack on low-carbon regulations. EU lawmakers reached a provisional deal at the end of 2023 to allow an exemption to the rules on mechanisms to ensure sufficient electricity generation capacity. This would effectively mean that national governments can continue to subsidize coal-fired power plants until at least 2028. The bloc and its member states also lost points for weakening measures to promote low-carbon farming and proposing to change the green conditions imposed on agriculture subsidies into a voluntary system.
In addition, these countries pushed back key policy dates: France delayed its coal phase-out by three years to 2027. Meanwhile the UK deferred its bans on sales of new vehicles with an internal combustion engine and on fossil-fuel boilers. It also postponed the start of the Clean Heat Market Mechanism, which will set a quota for heat-pump sales for a certain number of fossil-fuel boilers. The US lost points for the delays to the rules regarding the Inflation Reduction Act incentives, causing low-carbon project developers to put final investment decisions on hold.

 “Governments justified these moves by pointing to factors like stretched public budgets. UK Prime Minister Rishi Sunak called it a “new approach to net zero” in September 2023. While these rollbacks may give some companies short-term relief, they also increase uncertainty among industry players and consumers, hinder planning and investment and call into question policymakers’ overall commitment to climate action.”

Conclusion
Taken together, these developments highlight that addressing scope 3 emissions is hard. Proving claims is hard, but progress is being made on that front. Many large companies, with large supply chains, have made science-based commitments. They are now grappling with how their buying power can the transition faster in partnership with their suppliers. Market-based solutions, which (crucially) help to drive transition in the real economy are a space to watch.

In this edition we’ll look at the latest projections of how the Inflation Reduction Act (IRA) will impact US carbon emissions, as well as its political durability. We’ll also look at how in Europe carbon prices are falling, while the Chinese EV industry is making inroads based on their low cost advantage. Finally, the climate data isn't improving, with oceans proving the latest example of accelerating change.

Future impact of the IRA – The National Bureau for Economic Research (NBER) published its most recent analysis of the IRA under several different scenarios post 2024 election. These include extremes from completely rolling it back, to complimenting it with carbon taxes/carbon price. The range of outcomes is wide, but under any scenario, the US emissions profile is most encouraging with the IRA in place. The most impactful option would be to add a carbon tax, with a particular focus on fossil fuel exports. Although no scenario is seen to hit the Biden administrations 2030 targets, the more aggressive scenarios are only a few years off target.

Political durability of the IRA – One of the key rationales for the NBER study is to look at what might happen under different administrations after the 2024 election. As one pathway involved the repeal of the IRA, that has prompted speculation that a Trump administration would look to completely undo the IRA. We find that highly unlikely, as the majority of the spending is going to heavily republican geographies, by design. Indeed, GOP Representative Garret Graves told Asios news that a full IRA repeal “realistically isn’t happening.” It remains to be seen if certain specific programs would be pared, but we take comfort knowing that most of the policy is likely to be in place regardless of the political outcomes. 

Is European carbon price collapse a condemnation of cap and trade? – Over the past several months, the price of carbon on the European ETS has fallen dramatically, from roughly 100 euro to less than 60 euro. The key drivers are multiple: record wind, solar and nuclear power production, higher natural gas price (Russia/Ukraine) reducing consumption, relatively warm winter, etc. What we find most consequential is that the growth in low or zero carbon power is causing utility sector emissions to fall faster than the regulated requirements that would support higher carbon prices. Our takeaway from this is that if the US does add a carbon tax or cap and trade system, the flexibility to adjust as the power sector responds will be key to getting the most out of the system. 

Will your next car be Chinese? A core component of the IRA is support for EV adoption. Most recently, European car manufacturers have been asking parts suppliers to reduce their prices to enable them to compete with lower cost Chinese EVs. Given the scale of production and learning curve experience that many of the Chinese EV makers now have, their prices are systematically lower than comparable vehicles from European manufacturers. With the US as the second largest car market in the world, the only factor that would prevent Chinese companies from flooding the US market with more affordable EVs is political push back(tarrifs, etc.). If the Democrats retain control of the presidency, it will be interesting to see how they balance the desire to electrify our transit system for carbon reduction vs. the geopolitical economic competition with China. 

Enjoy swimming in the warm ocean this year - The New York Times recent article on latest trends in ocean temperature highlights how extraordinarily warm the ocean has been by almost any standard, especially in the North Atlantic. This continues the recent trend of climate data being more dire than expected. One knock on effect is a potentially devistating hurricane season as warm water fuels larger hurricanes. The other concerning trend is the impact on sea ice, as warmer waters reduce sea ice formation, which in turn changes broader ocean circulation. This negatively reinforcing cycle is what many scientists are most concerned about. Although it's looking like a great year to vacation at the beach, we look forward to having a colder ocean back. 

In this newsletter, we'll look at how the politicization of ESG and sustainability writ large over the last 18 months has created a stark difference between US and European approaches. This is both in support for ESG initiatives at companies, as well as the political and community support for solar and wind solutions. Despite this backsliding, the climate reality was significantly outside the bounds of normal for 2023, making the political headwinds even harder to understand. The lack of political will for support of ESG initiatives and permitting for projects is a larger barrier to mitigating climate change than capital.  

Big asset managers backtracking on ESG/metrics – A recent report from Morningstar tracks the proxy voting of US and European equity managers on ESG topics. Unsurprisingly, Europe continues to lead the way in ESG, with of its 15 largest managers approving 98% of key ESG resolutions. By contrast, the largest 20 US managers have approved a declining percentage of ESG resolutions over the last three years. They supported 67% in 2021 and only 50% in 2023. 

There are exceptions, however, which the charts below illustrate. Morgan Stanley Asset Management looks more like European managers than its US peers, and its support for ESG resolutions is the highest of all 20 US managers included in the study. Goldman Sachs Asset Management by contrast, has retreated from supporting ESG resolutions. The decline in the firm’s support is among the steepest of all managers in this study.

A company suing its shareholders? - In another example of how the politicization of ESG has weakened US resolve on these issues, ExxonMobil has taken the unusual step of suing its shareholders over an environmental proposal that was submitted for consideration at the annual meeting. Arjuna Capital has proposed that Exxon identify Scope 3 emissions reduction targets, something the four Western oil supermajors (Shell, Chevron, BP, and TotalEnergies) have already done. Given weakening support for environmental resolutions from US asset managers, it’s unclear why Exxon felt it necessary to sue to have the item blocked from a vote. It could simply have allowed it to be put to investors, where similar proposals have failed in previous years. Perhaps European asset managers have been buying Exxon stock lately?

Money isn’t the biggest constraint to addressing climate change - A UN report released at the end of 2023 compared the volume of financial flows into Nature-based Solutions (NbS) with those that have “direct negative impacts on nature.” The conclusion? The “nature-negative” flows amounted to nearly $7 trillion, and the “nature-postiive” to $200bn: an imbalance of 35:1 It is tempting to draw from this that the capital markets are skewed to the status quo over sustainability, but the reality might be more worrying still: In 2022, fossil fuels subsidies to consumers doubled from the year prior. If half of the fossil fuel subsidies were to be directed toward nature-based solutions, the ratio would drop to ~9:1 ($6.2tn to $700bn), and the funding would be sufficient to track with Paris Accord targets. 

Constraints on wind and solar are zoning permits NIMBY – Lawrence Berkeley National Labs released their latest research on the factors that limit wind and solar development. The top three reasons are: 1) local zoning; 2) grid interconnection; and 3) community opposition. The project-specific items of access to finance or having a power off-taker are rarely a top concern. The permitting/NIMBY challenges led 4 out of 5 developers to be moderately concerned that community opposition will get in the way of decarbonization goals. 

Meanwhile, the earth is burning – While the political winds shift against ESG and sustainability, the climate data is in direct contrast, with 2023 being the hottest year on record. The Economist had several charts and articles on this over the last week, highlighting that it’s been 47 years since a year has been colder than average. For those considering 2023 as a one-time outlier, the current predictions are for 2024 to be equally hot. Here’s hoping the political will and support will shift as the facts outweigh the backlash to ESG and sustainability. 

In this month’s newsletter, we look at potential progress associated with COP 28 that is wrapping up as we write, 2023’s record-breaking emissions, as well as asset owner allocation trends, and data from Pitchbook on impact fund performance.  

COP review – With COP 28 winding down, we’re broadly skeptical about the outcomes of the meeting. Although it’s encouraging that the words “fossil fuel” were used for the first time in COP language, we are skeptical it will amount to much if it doesn’t specifically call for phasing out fossil fuels. And the second draft, released on Wednesday Dubai time, has no explicit commitment to “phase down” (let alone “phase out”) fossil fuels.  Four geographies matter: If the US, China, Europe and India don’t start to at least “phase down” fossil fuels, the outlook for meeting Paris Accord targets becomes bleak. For every year that passes without accelerated progress, the measures needed become even more challenging. If anything, the progress on the Loss and Damage fund announced at the beginning of this COP (which we discussed in our newsletter about last year’s COP) potentially implies resignation about exceeding the Paris targets and focusing on adaptation in lieu of mitigation. The draft language could change from here however, so stay tuned. 

What level are emissions actually at? The context for COP28 is (perhaps) under-reported, in that global carbon emissions are still rising: in 2023, they will reach a record high. This report, published this month by Stanford’s Doerr School of Sustainability and Exeter University, notes that on the current path, global temperatures will surpass 1.5 degrees above pre-industrial levels by 2030, and 1.7 degrees soon after that (today, we are about 1.1 degrees above 1850’s levels). The U.S. has managed to trim emissions by 3% relative to 2022, but global carbon dioxide-equivalent emissions will exceed 40 billion metric tons this year, including ~36 billion tons from fossil fuels (the other ~4 billion tons come from land use changes, like deforestation). Globally, that’s an increase of 1.1% from 2022.  

Continued mainstreaming of impact investing - In addition to increasing their focus on ESG, more institutional investors are incorporating impact investing in their portfolios. Earlier this year, Schroders published results of its annual institutional investor survey (which covers 770 institutions, including corporate and public pension plans, official institutions, endowments and foundations collectively representing ~$35tn in assets). Two-thirds of respondents said decarbonization would drive innovation and create investment opportunity, and a similar proportion indicated interest in green hydrogen, nature-based solutions and similar new sectors for increased portfolio diversification. Furthermore, private assets are the preferred approach to accessing these impact opportunities. “54%” Schroders writes, “are seeking to proactively allocate to harness the investment opportunities presented by the energy transition and technological revolution though a greater exposure to private assets.” These figures extend a trend toward impact documented in the 2020, 2021, and 2022 editions of the survey.  The difference between ESG and impact? ESG is about how you run your business, while impact investing is about the positive social and environmental benefits your business’s product delivers. 

Impact strategies and asset classes The chart below highlights Pitchbook’s latest tally of the AUM of impact strategies at large asset managers:

What leaps off the page is the role of real assets as the principal approach asset owners are using to access impact themes. This largely makes sense given the lower volatility and regulatory momentum behind clean energy infrastructure, in addition to the need for vast amounts of capital. Indeed, real assets represent a disproportionate amount of capital in impact portfolios relative to non-impact portfolios. 

Impact vs. non-impact funds: Don’t forget about risk – One complaint about impact investing is that investors may need to sacrifice returns for impact. The biggest challenge in quantitatively answering this question is that there are far fewer impact funds than non-impact ones. So with a smaller sample size, a few outliers can skew the interpretation. What is more relevant for this context is that the dispersion of the quartiles tends to be much tighter with impact funds. The returns data from Pitchbook (below) is challenging as it’s all private market investments and doesn’t distinguish by asset class. But given the high representation of real assets, it’s not terribly surprising that there could be lower volatility in impact funds. This means that even though the highest performing decile of funds predominantly comprises non-impact funds, the volatility of non-impact fund performance is also higher. Indeed, in some years the lowest quartile of impact funds performs better than the lowest quartile of non-impact funds, meaning “returns-only” investors underperform impact investors. With more institutional investors allocating to impact, in a few more years sample sizes will be large enough to allow deeper analysis of impact-related risk-adjusted returns. In the interim, the takeaway from Pitchbook’s data is that there’s weak evidence that risk-adjusted returns suffer, on average, by focusing on impact. Our view is that this is similar to ESG – if investors focus on impact or ESG factors that are material to the business, competitive returns can result. 

We wish everyone a wonderful holiday season.

In this month’s newsletter, we look at trends in climate investing and progress ahead of COP 28 in Dubai at the end of the month. We also find a few green shoots among some depressing trends in climate change mitigation efforts that have been politicized and lost momentum in certain geographies.

Is there a ‘COP’ out ahead? – The next UN climate change conference takes place at the end of November, and our expectations for significant progress are low. Oil companies and politicians have recently backtracked on their commitments, which perhaps seems fitting for a conference held in major oil-producing country (Dubai) and chaired by the head of the Abu Dhabi oil company. 

Loss and damage progress ahead of schedule – One item that has made progress ahead of expectations is related to a loss and damage fund intended to compensate the countries severely affected by climate change, but which haven't materially contributed to the problem. With the US, China, India and Europe as the major emitters, and China and India relatively recent additions to that list, the US and Europe have made pledges in the past they have not fully funded. The breakthrough in establishing a more formal mechanism came when the smaller countries agreed to start the funding vehicle within the World Bank as opposed to a new entity, which had been their preferred pathway. Given the US and European influence at the World Bank we’ll be watching to see how well this new funding mechanism operates.

Climate tech venture is plummeting, but reality is a bit more nuanced – Adding to the rather grim climate trends over the past few months, PwC’s latest state of climate technology report finds that climate tech VC funding has declined significantly in 2023. 

A key driver of this is the decline in investments for sustainable mobility. All sectors saw an absolute decrease in funding, except for carbon capture and sequestration, and financial services, two rather small sectors by absolute dollars. Against an overall backdrop of lower funding amounts, the percentage of capital going toward industrial efficiency is growing, because it declined far less than mobility. This aligns better with the actual magnitude of emissions. We are fans of electric mobility, but when mobility and energy are 27% of emissions but 75% of funding, the market is not efficiently (at least from the climate’s perspective) allocating resources.

Good news (mostly) on cost to address climate change – The Inflation Recovery Act (IRA) has been one of the bright spots. Goldman Sachs’ Carbonomics report  tracks the technology and finance trends associated with climate change mitigation. Some solutions are highly capital intensive, and the rise in interest rates made them more expensive. (Offshore wind is an example.) The good news is that on balance many solutions are getting less expensive, reducing the estimated requirement to hit 1.5^· from $5.7 trillion/yr in 2019’s report to $3.1 trillion/year in 2022. If the total cost of the IRA over many years is well over $1 trillion, as Goldman estimates, we would argue it’s money well spent, as the difference between 1.5 degrees and 2.0 degrees of warming is projected to be more than $1.5 trillion per year from flood impacts of sea level rise alone.  

As a final positive note, CalPERS has announced it plans to commit $100 billion toward climate solutions by 2030. As climate change is a systemic risk that can’t be diversified away, we believe this is a good investment for achieving the objective of paying for future employee retirement benefits. Given CalPERS’ leadership within the public pension space, we wouldn’t be surprised if this provides a nudge for other public pension plans to make similar (albeit smaller) commitments.

We wish everyone a wonderful fall.

In this issue, we look at how the proliferation of climate frameworks is an opportunity for AI to harmonize analysis. Even with the best climate frameworks, there's the question of whether accounting for carbon as opposed to reporting it will drive better outcomes. We'll also look at how governance is (again) often taken for granted and ends up hindering otherwise promising organizations. Finally, we'll look at how water remains an issue (and potential investment opportunity) in different ways in different areas.

One climate framework to rule them all?  - Over the past few years, the number of climate frameworks has proliferated tremendously. The list below captures most of the frameworks for context (from the report - Net Zero Transition Plans: Red Flag Indicators to Assess Inconsistencies and Greenwashing)

Obvious challenges this presents include the decision of which framework to use, and, as an investor or asset allocator, how to compare different companies or assets if they use different frameworks. WWF, in partnership with the Universities of Oxford and Zurich, is piloting an AI tool to try to collect the common factors among the different frameworks to enable better comparability. While this pilot is expected to be up and running by the end of the year, we'd also refer back to last month's newsletter where we highlight highlight 15 Rock as an AI solution for climate analysis that is up and running today, albeit not one that is focused on analyzing framework-overlap. 

Is reporting missing the point because accounting is the core need? – Reporting of climate data is, then, characterized by a range of approaches, with Scope 1,2, and 3 emissions almost the only the metric common to them all. Some observers wonder whether merely reporting the data is sufficient to drive behavior change. A team from Stanford University has proposed a different solution, which isn't measuring and reporting carbon, but accounting for it, much as one accounts for financial performance. If carbon were to be added to a balance sheet (either as an asset or liability depending on the company), that provides a concrete way to tie emissions to financial performance. This would motivate companies to "only emit greenhouse gases if the value created exceeds the cost of reversing the emissions".

Best of intentions waylaid by the 'G' in ESG  – The focus on the 'S dramatically increased after the George Floyd murder in 2020, while the 'E' has received tremendous focus ever since the Paris Agreement in 2015. What has sometimes been assumed to be well in hand is the 'G' of governance. As we pointed out in a prior newsletter, the 'governance gap' between large-cap companies with best practices and smaller companies that often lack best-in-class governance practices remains a challenge. With the dramatic downsizing of the Center for Anti-Racist Research, the application of best practice oversight is sometimes lacking in smaller social sector organizations as well. For investors, or even individuals that also provide philanthropic capital, the lesson seems to be that the 'G' should be assumed to be lacking, until proven otherwise.

Water water everywhere, and (sometimes) nary a drop to drink - New York and New Orleans are reflecting two different ends of the spectrum of water impacts. In the case of New Orleans, the lack of rainfall has caused the salt water from the Gulf of Mexico to move further upstream, potentially affecting the city's drinking water supply as early as the third week of October. By contrast, NYC experienced a rare bout of flooding over the weekend. The volatility in rainfall and geographic dispersion of this impact is likely to continue to create these dislocations as a byproduct of climate change. Astute investors are likely to see this as an opportunity to invest in ways that will have growth potential and significant environmental and social benefit.

A final thought on Climate Week, credibility, and accountability We were fortunate to attend a range of high-quality events during Climate Week 2023. These discussions, which were hosted by NGOs, private sector and public sector institutions, all touched on the same theme of credibility of commitments. The Science-Based Targets initiative (SBTi) seeks to address this question, and has grown rapidly since launch in 2015. Around ~5,750 companies and 240 financial institutions have committed to setting SBTs, and ~3,450 have SBTs in place (i.e., their plans have been checked and validated). In 2022, 87% more companies had their targets validated than in 2021. As is often the case, private markets firms appear to be lagging their public counterparts. Over 20% of the Fortune 500 have committed, while one large asset owner – widely regarded as a sustainability leader – we spoke to reports ~10% of its stable of PE GPs had SBTi commitments.

Hello from Impact Delta.

In this issue, we review:

• How a Canadian company is using AI to assess the credibility of climate commitments; 
• Why the European Central Bank is worried about damaged ecosystems;
• How climate change is changing European tourism; and
• The large jump in the northern hemisphere’s atmospheric carbon concentration this year.

The credibility of climate commitments, and a powerful approach to check them - Many asset owners find that asset managers are more willing to report sustainability performance than ever before. British Columbia Investment Management Corporation (BCI) reported this, for example, in the private equity section of its most recent ESG report:  

But how could an asset owner like BCI check (for example) the decarbonization plans of those portfolio companies? A Toronto-based firm, 15Rock, has developed an AI-based approach to address this question (disclosure: we are exploring a partnership). The core idea is to run two contrasting models to test the credibility of claims. One model collects evidence that the portfolio company could be right, using data from the company itself (or from similar companies as a proxy), while the other looks for evidence that the company is wrong. The models then iteratively learn from each other’s points and evidence, to land on an overall assessment. This is the kind of work a team of human consultants/researchers could do, but at higher cost, and lower speed.

Ecosystem services: the ECB is worried - In a post written last month, Frank Elderson, a Dutch member of the ECB’s Executive Board, noted that the bank has started to look at how 4.2 million companies (representing $4.2tn in borrowing) depend on natural capital for their operations. Biodiversity (see last issue) continues to rise on the sustainability agenda, and professionals in the space welcomed the news that a mainstream bank regulator is now evaluating nature-related risks. The ECB’s initial work found that three-quarters of companies in the euro area depend heavily enough on ecosystem services (think of nature’s provision of clean air, protection against natural disasters, carbon uptake and storage, erosion control, and drinking water) that continued impairment of those services would lead to riskier credit portfolios in the banking system. And, through disrupted supply chains, further natural capital degradation could create inflationary risks too. What are the services on which European companies most depend? The ECB is most worried about erosion control, water supply, flood protection, and carbon uptake and storage. Of note, differences between countries in the euro area are quite modest:

The future of European tourism - As wildfires swept across Greece and tens of thousands of holiday-makers were forced to evacuate Corfu and Rhodes, hospitality industry observers asked longer-term questions about the viability of tourism in southern Europe as a whole. The Acropolis had to be closed early, and tourists in Sardinia were confined indoors as temperatures reached 45 degrees. Searches for northern European destinations were up 1,000 percent, according to travel website eDreams, and the hippo at Rome’s Biparco Zoo was fed frozen watermelon to keep it cool. Concerns about “over-tourism” in Greece, which surfaced in late 2022 after visitors outnumbered citizens by 3:1, may be premature. Tourism accounts for around 15% of Greece’s GDP, and 8-10% of Italy’s and Spain’s. The winter corollary for increasing latitude in tourism preferences, is increasing altitude instead. This past winter, amid mass early closures of resorts in France, skiers found 1,700m was the elevation generally required to enjoy snow. If snow counts as an ecosystem service, then the ECB is already right: lenders to many European hotels have riskier credit portfolios.

Atmospheric CO2 concentration: a large jump - Pop quiz: In which month every year does atmospheric CO2 concentration peak in the northern hemisphere? It’s in May, just before growing season. This past May, NOAA data collected at its Mauna Loa monitoring station showed CO2 reaching 424.0 ppm, or 3.0 ppm higher than last year’s figure. This year-on-year jump is the fourth-highest on record. Last year, when carbon dioxide hit 421 ppm, a different – and no less sobering – milestone was passed, which is that our atmosphere was officially 50% richer in CO2 than the 280 ppm the planet enjoyed in 1750. The chart below is known as the Keeling curve, after Charles David Keeling, the scientist who first started measuring atmospheric carbon dioxide’s seasonal and annual variations in the 1950s.

Hello from Impact Delta.

In this issue, we look at how EV adoption is going in the leading country, Norway. We'll also look at how reading/education solutions require more than just curriculum for greatest impact, how the proxy season is going for carbon proposals, and how biodiversity credits are rapidly developing along the lines that carbon credits did 15 years ago. 

Norway as the EV canary in the coal mine - The growth of electric vehicles is undeniable, and a trend that is only likely to continue. Skeptics have pointed to challenges with consumer range anxiety, changing driving habits, and stress on the electric grid from a dramatic increase in EV penetration. The clearest answer to concerns comes from Norway, where progressive policies have shifted 80% of new car sales to EV compared to the US target of 50% of new car sales being EV by 2030. The benefits have been substantial, with dramatically lower NOX pollution (a leading cause and aggravator of asthma) among other environmental benefits. Additionally, the power grid has not been negatively affected, and the employment at gas stations has not collapsed, as many now offer EV chargers. The presence of charging infrastructure has been less of a challenge than making sure the chargers are working, as off-line chargers are the largest complaint to date. This may partly explain why Ford has been willing to consider Tesla’s charging standard given the reliability of its charging network against other systems (Electrify America, ChargePoint, etc.).

Mississippi reading – The recent focus on reading proficiency (or lack thereof) in the US highlights interesting systemic solutions. Although much of the progress has been attributed to leveraging scientific evidence that phonic based teaching methods are far superior to the standard that has been widely adopted over the last two decades, the dramatic growth in Mississippi reading performance includes a more holistic approach. Of note, one approach has been holding back students instead of passing them on if they aren’t meeting proficiency. This approach has often been criticized as leading to an increase in absenteeism and increased dropout rates, however, the latest results indicate no such adverse effects if applied the way Mississippi has done. If anything, this model may become more prevalent as research and trends highlight the challenges boys are currently facing, given the comparatively slower cognitive development relative to girls in school. 


Climate proxy season, what a difference two years makes – Chevron and Exxon held their annual meetings on Wednesday May 31, and substantively all of the climate related shareholder proposals were defeated. Beyond this, Total has just announced it is selling its venture arm, which was investing in many energy transition opportunities. This is in marked contrast to the momentum over the prior two years. In Exxon’s 2021 meeting, three dissident board members were elected to the board by Engine no 1 and its institutional supporters like CalSTRS among others. With the oil price currently in the mid-$70s, it seems to be harder to push oil companies to focus on climate and emissions than when prices were higher. Additionally, any climate proposal that is not supported by one of the larger institutional investors does not seem to be making traction. We’ll be watching to see how this evolves if profits rebound and the current focus on short term performance returns to focusing on longer term risk. 

Carbon market growing pains – With that slowdown in corporate actions at fossil fuel companies addressing climate risk, the carbon markets become more relevant to drive capital to mitigate emissions. However, the application and claims of the carbon markets are under increasing scrutiny as users are increasingly concerned about greenwashing. Delta airlines is currently being sued by customers for its claims of carbon reduction and carbon neutrality. The complaint is that the airline’s claims are not backed up by actual reductions in emissions, but instead reflect credits it purchased. These credits in turn are not proven to have additionality or sufficient quality or duration to be a true reduction in emissions. Companies that anticipate reaching ‘net zero’ by purchasing credits instead of focusing on absolute emissions reductions are likely to remain (rightly so) accused of greenwashing.    

Nature is just as important as carbon – Despite the controversy over whether the credits actually deliver climate benefits, this market has been around in some form for nearly two decades. By contrast, the concept of biodiversity credits is even more nascent and unproven. However, a recent study has focused on the gap between current spending of $150 billion for conservation efforts against the best estimate of $1 trillion of annual spending necessary to address biodiversity impacts on ecosystem services humans need for survival. With the development of the Biodiversity Credit Alliance working with the UN, this is a sector that is resembles carbon markets 15 years ago. The complexity of ecosystems makes the data to verify biodiversity benefits more challenging than carbon. However, as more long-term investors are expressing concerns about the impact of biodiversity loss on future portfolio returns, innovation in data and validation would help this market become a useful tool to address what is otherwise a difficult investment factor to incorporate in portfolio construction. The companies that can address this data and verification challenge will be the key to unlocking this potential. 

Hello from Impact Delta.
 
In this issue, we look at how governance is sometimes taken for granted when it's not under a microscope. We'll also look at BlackRock's recent DEI report, as well as Microsoft's 2021 environmental report, in advance of their upcoming 2022 release. Finally, we'll look at whether carbon prices have an impact on share prices of companies that have regulatory exposure to the Emissions Trading System (referred to as “ETS system”) in Europe (spoiler alert, they do). 

Good governance is most prevalent in the sunlight - Most investors that focus on ESG spend most of their time enhancing 'E' and 'S' efforts, with the view that 'G' is very well in hand. Indeed, the research on the benefits of diverse boards (and management teams) is clear that this approach leads to better performance and returns. However, the application of best practices and what is considered good governance is not as widespread as is often assumed. A recent report in the Yale Law Journal highlights how the governance practices vary between Fortune 500 companies and their smaller counterparts. The “governance gap” is material and in "smaller, less-scrutinized corporations, the adoption of governance arrangements is less systematic and often significantly departs from the norms set by larger companies." This likely reflects that companies do not default to best practices for governance absent additional regulatory or investor pressure, which is more pronounced for larger companies. 

DEI is a challenging issue to hold on to - We give BlackRock full credit for having time bound and quantifiable objectives for its DEI work. As impressive is their use of an independent third party (Covington) to hold them accountable. BlackRock recently released its diversity report, with findings that highlight the challenges in building a diverse financial services company. The data highlighted that the challenge for diversifying their workforce is less of a candidate pipeline issue, than it is a retention and promotion issue (a common refrain, discussed in our January Newsletter). The chart below highlights this challenge as well as the report's findings that "In 2022, attrition rates of Black senior leaders nearly offset increases in Black senior leader hiring and led to senior Black representation staying nearly flat for the year. Attrition has also had a significant impact on overall Latinx representation which, combined with Latinx recruiting, has resulted in an overall increase in Latinx representation of just 0.5 percentage points during the same time period."

It ain't easy being green (and growing rapidly) – Companies in tech sector have, in general, done far better than those in other industries in seeking to identify and address their environmental footprints. Among the tech crowd, Microsoft has impressed us with their efforts around climate and the environment, seeking to be net zero by 2030 and to have offset all the carbon the company has ever generated by 2050. As part of this work, they have been at the forefront of improving carbon markets and offset solutions. However, the results that were published in the 2021 report outline some of the challenges in driving absolute reductions while experiencing growth. With the 2022 report likely to be released in the coming weeks, we'll be looking to see if they have found more ways to reduce their environmental footprint, while continuing to support the growth of their businesses. As AI, the 'cloud', and other digital tools continue to expand, it will be increasingly challenging to reduce emissions in absolute terms, and Microsoft will need to rely more heavily than expected on offsets to achieve net zero. 

Carbon influences stock prices – at least in Europe - With Microsoft investing significant capital to get to net zero, the question becomes: is it's actually worth it? A recent study of European securities tried to parse out the impact of the carbon price on share prices. The study just focused on regulated entities that had carbon emissions allowances through the EU ETS market. This is a “cap-and-trade scheme, in which participants face limits on total emissions and are simultaneously offered allowances (either for free or through an auction process). Companies that reduce emissions well below their caps can sell their allowances in the market; those that need additional allowances must buy them. This as the effect of creating a price for carbon. The most recent phase of the ETS (“Phase 3” from 2013-2020) saw carbon prices rise from EUR5 per metric ton, to over EUR30.

As intuition would suggest, the research found that those companies that had an excess of carbon allowances saw their shares prices increase when carbon prices increase, while those companies that were short of allowances saw share prices decrease when the carbon price increased. Indeed the "study indicates a high level of informational efficiency of financial markets, with stock traders responding in real time to changes in carbon prices, taking account of disclosed information on carbon permit coverage." In less happy news, the paper also studied total corporate emissions, whether they are regulated by the EU ETS or not. Here (and also as intuition might suggest) companies “with a significant shortfall in emissions permits do lower their emissions in the EU [but] they do not lower their emissions globally.” Hence, the EU rules have likely had the effect of lowering corporate carbon emissions, but this effect has been only regional.

Hello from Impact Delta.
 
At the CERAWeek annual oil and gas/energy conference last week, Jigar Shah (head of the U.S. Department of Energy’s clean tech loan program) said, "I do think that today we view ourselves as one energy industry, not a clean energy industry and a dirty energy industry," which raises the question: Is oil and gas really committed to decarbonizing? Also in this newsletter, we look at the recent SVB collapse and potential collateral damage, as well as the start to the 2023 proxy voting season.

CERAWeek - The annual CERAWeek conference convenes the CEOs of the largest oil companies around the world, and increasingly includes some of the leading lenders and operating companies driving the transition to clean energy. However, the commitment to energy transition seemed to be losing, rather than gathering, strength. Discussions focused on new gas development as the next stage for the industry. Indeed BP's comment last month that it aiming to reduce oil production in 2030 by 25% rather than 40% is consistent with the tone of modest progress evident throughout the event. Jigar Shah's comment likely reflects the political constraints of the Biden administration, which needs to be seen to keep oil prices/energy costs low while still promoting a shift to clean energy. 

Oil and gas leasing developments in Alaska - On the topic of the administration keeping oil prices low, a key topic at the conference was the decision about the Willow Oil project in Alaska. Environmentalists oppose the project, as it both sets back progress to achieve Paris climate accord targets, and affects a previously undisturbed wilderness in Alaska. This week, the Biden administration did move forward to approve this project, albeit with a narrower scope than ConocoPhillips requested (3 drilling sites instead of 5). The political demands of keeping inflation low, and shielding consumers from higher energy prices are proving strong enough to offset some of the federal subsidies and policy support for clean energy found in the Inflation Reduction Act (IRA).

Capital, labor, or regulations as the bottleneck? – Even with the decarbonization of energy underperforming near-term expectations, the hundreds of billions of support in the Inflation Reduction Act for clean technology deployment are still expected to accelerate the transition. However, even with the influx of capital, it remains unclear if the IRA’s potential can be realized if regulations or labor constraints are not addressed. Anyone who has tried to install solar panels at home will appreciate that local building, fire, and zoning codes can substantially delay construction. Indeed, the Biden administration is seeking to streamline the permitting process, although it can only go so far without local support. Even if these barriers are overcome, the labor for scaling the infrastructure remains in in short supply: the industry currently is struggling to add the roughly 500,000 workers annually that are needed to meet the administration's targets. 

SVB - The failure of Silicon Valley Bank has dominated the headlines over the past week. Although it now appears that a systemwide banking crisis has been averted, there are two potential implications we will be watching closely. First, SVB's demise may have negative impacts on the climate tech industry. As the chart below (from SVB no less) shows, climate tech VC funding has increased dramatically over the past four years. It now accounts for roughly 20% of all VC funding. Not only that, the use of venture debt is slightly higher in climate tech, as it often requires more capital than other venture-backed sectors. SVB was a substantial supplier of venture debt, so its bankruptcy many slow the growth of the climate tech ecosystem. 

The second knock-on effect we will be watching is employment. If the banking industry seeks to address the volatility of the SVB fallout by reducing costs, we could see significant job losses (see chart below from the Bureau of Labor Statistics). With tech (labeled “information”) and “financial” typically having above average compensation, layoffs in these sectors could reduce demand in other sectors (e.g. hospitality and leisure), leading to a significantly cooler labor market overall. We’ll be watching whether this leads to a soft landing or reduces inflationary pressure.

It's time for another proxy season - As the 2023 proxy season gets underway, we are likely to see more shareholder resolutions and, thanks to pending SEC rule changes, more shakeups in board composition. Beyond this governance impact, we also expect to see more “E” and “S” shareholder proposals. The percentage of these proposals that will be approved is likely to decline (as has been the case over the last few years), but the absolute number that are approved may go up. So, we will be watching to see the extent to which incumbent board members are held to task, as well as which E and S themes investors deem to be the most material and worth supporting.

The Impact Delta Team
contact@impactdelta.com

About Impact Delta
A secular shift towards a more responsible capitalism is underway. Impact Delta is a specialist consultancy founded to help investment firms capitalize on this shift. We believe good environmental and social thinking helps investment firms raise capital and earn better returns. More about us here.