Co2 intensive company support for transformation

Investors can significantly lower their portfolio issues by just avoiding a few companies. (Image: Photograghy)

CO2-intensive polluters are often replaced by investors with cleaner, greener alternatives in a knee-jerk reaction. However, this may be the wrong approach, according to Thomas Leys of Aberdeen Standard Investments.

The need for rapid decarbonization and limiting the potentially devastating consequences of global warming has moved higher and higher on the agenda of governments, businesses and investors. Reducing a portfolio's carbon footprint by excluding high-emitting companies may seem reasonable at first glance. However, according to Thomas Leys, investment manager at Aberdeen Standard Investments, this does not take into account the real reduction in emissions that is so urgently needed to achieve the goal of "net zero by 2050".

In addition, he believes this will cut off capital inflows from those sectors most in need of them, namely polluters who want and need to reduce their CO2 emissions. "So forward-looking investors looking to support the transition to a zero-emissions economy should instead focus on how to spot the leaders in decarbonization from the highest-emitting sectors," says the Aberdeen Standard Investments expert.

Share of total CO2 emissions (Scope 1+2+3) by sector* (%)

The emissions rankings of the broader stock or corporate bond indices are typically always led by the following five sectors: Energy, Basic Materials, Automotive, Utilities and Capital Goods. At a global level, these sectors account for more than three-quarters of emissions, but only one-fifth of market capitalization, according to the expert. Looking at Climate Action 100+, a global investor engagement group, this concentration of emissions becomes even clearer, he said. For example, the 167 companies tracked by the group are responsible for over 80% of greenhouse gas emissions in the industrial sector. Accordingly, investors can significantly reduce their portfolio emissions by avoiding just a few companies.

"But how will these companies make progress without sufficient capital? How utilities should make the transition from fossil fuels to renewables in power generation? How should automakers transition production from internal combustion engine vehicles to electric cars? How should industrial companies invest in the electrification of their processes?", are just some of the questions that Thomas Leys asks himself. The green future requires substantial investment, and investors should select companies from these sectors that have ambitious and equally credible plans to decarbonize, in his view. In return, they should be prepared to accept a currently high level of emissions if they are convinced of the downward emissions trend of the companies.

Better than its reputation

There are numerous examples of companies with high emissions pursuing solid improvement plans, including global building materials giant LaFarge Holcim, he said. The group records CO2 emissions of over 148,000,000 tons (scopes 1, 2 and 3) in 2019. In contrast, the average CO2 emissions for the MSCI All Countries World Index were 241,000 metric tons, so LaFarge Holcim in terms of emissions in 98. index percentile lay. A simple strategy focused on low CO2 emissions would avoid this company. However, LaFarge Holcim stands out as having one of the most aggressive decarbonization plans within the sector.

For example, the company aims to produce cement with the lowest CO2 intensity compared to its peers, reducing its Scope 1 and Scope 2 emissions per ton of cement by 17.5% and 17.5%, respectively, by 2030. Reduce 65% (starting from the levels recorded in 2018). Group investments underpin these goals: The first net-zero cement production plant is about to open, and more than half of research and development spending is on greener alternatives. CO2-conscious investors should support these plans, regardless of the current high emissions.

Another good example is Energias de Portugal (EDP). Until recently, it was one of Europe's most CO2-intensive utilities, due to old coal-fired plants. However, the group is successfully repositioning itself as an energy producer of low-carbon electricity. By closing coal-fired power plants and investing heavily in renewable energy, the company aims to reduce its emissions from its own operations by 90% between 2015 and 2030. In addition, EDP is setting its sights even higher, and in February shortened its coal phase-out deadline by five years to 2025, and is now allowing only 2% of its capital expenditures to go to fossil fuels (for maintenance purposes only). EDF has an impressive issuance record.

Supporting the transformation

"Unfortunately, investors can't simply pick the companies with the most ambitious decarbonization targets, either," says the expert. According to the International Energy Agency, around 40% of companies with a net zero target have not yet announced any details on implementation. The goal of "net zero by 2050" was quickly formulated, but as always, the devil is in the details. An analysis of companies' commitments from carbon-intensive sectors by the Transition Pathway Initiative also found that few decarbonization targets were ambitious enough. Only if investors can understand the credibility of the targets, as well as the plans for implementing them, will they be able to identify high-emissions companies that are on the right track, he said.

"To build investment portfolios that support the net zero target, investors need to look beyond current corporate issues," says Leys. Emissions development is what matters. By removing the highest-emitting companies from a portfolio, a rapid improvement is achieved, but some sectors are cut off from much-needed finance and real emissions reductions are not taken into account, it said.

Using analysis of companies' decarbonization plans to identify credible efforts in support of the energy transition, investors can fund fundamental action to combat climate change. At the same time, this gives them exposure to companies that are taking a leading role in their sectors in the transition to a zero-emissions economy.