1. Executives Are Backing Away From ESG As Recession Risks Mount
What it means: KPMG’s recently released 2022 CEO Outlook gave some intriguing insights into the minds of corporate leaders, who mostly agree (86%) that a recession will occur in the next 12 months. The KPMG study also found that 45% of corporate leaders believe ESG programs improved financial performance, while 69% believe the demand for increased reporting and transparency in ESG disclosures will increase. Unfortunately, due to the recession, many companies (50%) are planning to pause their ESG efforts, including some that have done so already. It is also important to note some of the criticisms CEOs have of ESG, the top 5 being:
- Other pressing business/economic matters that shift focus away from ESG (17%)
- Increased or frequently changing regulations (16%)
- Lack of budget to invest in ESG transformation (15%)
- Lack of technology to effectively measure and track ESG initiatives (14%)
- Challenges identifying and measuring standard metrics (14%)
Sage’s View: While we certainly appreciate both recessionary concerns and the perceived challenges to adopting ESG initiatives, these responses are problematic for a multitude of reasons. ESG initiatives are meant to be long-term value drivers for a company, not some optional feel-good endeavor. No company can afford to ignore workplace safety (a social issue) because of recession worries, nor can one afford to stop enhancing cyber security (a social/governance issue) efforts. At its core, ESG analysis is meant to manage risks and enhance performance, so the idea is that companies that ignore financially material issues relevant to their operations will pay the price at some point. “Short-termism” is not in the best interest of shareholders or other stakeholders, so hopefully, there will be some pushback if companies are, in fact, thwarting ESG progress. From a more cynical perspective, the current sentiment on ESG may be due more to the culture war in which ESG has become embroiled in. Rather than seeing the positives that ESG brings to a company, many leaders may be systematically lumping it into the “woke” discussion, hence the willingness to ditch the efforts. But ESG is more than just virtue signaling and marketing, so we too would agree that if the chief sustainability officer (or whoever oversees ESG) is not part of the firm’s overall business strategy, then cuts makes sense. We are cautiously optimistic, however, that executives will realize ESG efforts are critical to their long-term success.
2. GE Will Cut 20% of US Onshore Wind Workforce
What it means: No industry is safe from the effects of inflation. While many people think of renewable power as an area of endless growth, General Electric (GE) had to make the difficult decision to lay off 20% of its workforce in its renewable energy operations. The cuts primarily impact US onshore wind turbine workers, but overseas staff may also see cuts in the future. GE lost $419 million in the second quarter, with competitors Siemens and Vestas also in the red. With inflation as high as it is now, contracts just aren’t making sense, though many are hopeful that the Inflation Reduction Act changes the dynamics of the market and adds some stability going forward.
Sage’s View: The inflation story is playing out across the entire clean energy landscape and should be a wake-up call for bigger problems to follow. For those who were optimistic that we would see renewable costs come down while simultaneously ramping up capacity, it’s not going to happen any time soon. Europe is facing similar problems, with 35 GW of solar manufacturing projects at risk of being mothballed due to a weak supply chain. As an example, Maxeon Solar Technologies is shutting down a solar module manufacturing plant due to costs. While we applaud actions in Europe and the US that seemingly support the development of clean energy supply chains, the reality is that the efforts in this space are woefully inadequate to make a difference. When a Chinese-fueled supply chain can produce a solar panel for much less than developed nations (35% less than European nations, for example), we are going to need more than just a few little trinkets of support to put companies on equal footing. So, is anyone else concerned that measures like the Inflation Reduction Act will only increase demand (along with prices) for end-state products while doing very little to help develop the rest of the domestic supply chain? While not the aim of the bill, it might put Chinese-led companies at a greater advantage. We dread the influence that the OPEC+ cartel has on our energy prices, but we seem hell-bent on creating an even stronger clean energy cartel. When the current administration chose to waive tariffs for solar panels imported from Southeastern Asia (coming by way of Chinese companies and Chinese materials), it was clear that the US solar industry was going to be primarily the US solar panel installation industry. But at least we can point to all the announcements for US battery assembly projects as progress toward Net Zero (unfortunately, most of the materials needed to make the batteries are still under Chinese control).
3. Alice: A Major Moment In Sustainable Aviation
What it means: Electric airplanes are not a new phenomenon, but the challenge has always been how to create an aircraft that can carry multiple passengers or large volumes of cargo. Alice, whose name was inspired by “Alice in Wonderland” and Jefferson Airplane’s song “White Rabbit,” is the world’s first all-electric commuter aircraft, capable of carrying nine passengers with a range of nearly 250 nautical miles. Eviation Aircraft, based out of Washington State, thinks that electric planes may have a niche in short-range flights under 500 nautical miles. As jet fuel is 19 times more energy dense than a battery, Alice requires a huge battery for even a short range (the battery is half the weight of the plane). But the hope is that over the long run, there can be both cost and emissions savings. Eviation wants Alice to hit the skies by 2027 and already has orders from companies like DHL.
Sage’s View: With aviation’s share of emissions representing 2.5% of the world’s annual total, this is a needed focus area. But what should the future look like? While the prospect of electric aviation is intriguing, the size and weight of the battery seem to make it a non-starter or at least a less desirable option for most situations. Current planes benefit from using a highly dense energy source (jet fuel) and have the advantage of becoming more energy efficient as the flight goes on (getting lighter by burning fuel). Any electric aircraft will sacrifice range, speed, and payload. If we can improve battery storage to hold more energy on a pound-for-pound basis, then perhaps there is a rational path forward. QuantumScape’s solid state forever battery is a technology that we are following closely. The other future areas to look at are hydrogen and sustainable fuels. American Airlines is betting on hydrogen by investing in both hydrogen infrastructure and hydrogen-electric engine development. While getting passengers and crew on board with supporting a floating Hindenburg traveling at the speed of sound, a hydrogen-fueled aviation industry would result in a less radical transformation (e.g., similar airplane designs, ranges, and logistical infrastructure). Same goes for pushing for sustainable fuels, which would be the simplest solution (literally swap out jet fuel). Unfortunately, once-promising options such as algae-based biofuel (very land and energy efficient) have yet to pan out, but some companies like TotalEnergies still remain hopeful that they can scale production. One good aspect of this discussion is that the work done in the aviation world will help shape the path of maritime shipping and long-haul trucking. These industries have similarly uncertain futures, but progress in one area will certainly pay dividends for the others. And for a wild card option, is anyone willing to get onboard a nuclear-powered plane that can go from New York to London in 80 minutes?
4. Auditors Fall Down On Climate Risk As Corporate Polluters Fail Basic Tests, Study Shows
What it means: Auditors dropped the ball on climate change disclosures. An annual review by the non-profit group Carbon Tracker revealed that carbon-intensive companies were not sufficiently disclosing the effects of climate-related risks and details of their Net Zero emissions plans, robbing investors of key financially material information. Of the corporations that are responsible for 80% of corporate global emissions, all 134 failed. In the eyes of Carbon Tracker: “Auditors do not appear to comprehensively consider the effects of material climate-related matters in their risk assessments and audit testing. The stark differences between audit report information across the same global firm further suggests a lack of network policies to address climate matters.” The Big Four all joined the Net Zero Financial Service Providers Alliance last year to align their product offerings to a “Net Zero by 2050” world, but according to Carbon Tracker, they are not on a path toward doing so.
Sage’s View: When interest in ESG investing took off, the Big Four accounting firms seemed onboard. PWC made a pledge to hire 100,000 sustainability workers over a 5-year period, and Deloitte, KPMG, and Ernst & Young all pushed initiatives in ESG-related education and training for all their employees. But where has the leadership been in shaping the complex and somewhat contentious discussions on sustainability disclosure? When the Securities and Exchange Commission (SEC) Climate Disclosure Rule came out, we were hoping accounting firms would speak up and provide some perspective on how difficult and costly it would be for firms to follow the rule as is. Instead of giving much-needed insight on challenges, like a lack of agreed-upon methodologies for calculating and collecting Scopes 1, 2, and 3 emissions data, and giving estimates on what reasonable or limited assurance of the data would cost, they were largely silent. What about thoughts on disclosure and assurance on other non-emissions-related sustainability metrics? Perhaps it was in their best interest to just say yes with no questions asked, as mandatory reporting, in general, will be a huge windfall for all of them. As the International Financial Reporting Standards (IFRS) and the work of the International Sustainability Standards Board (ISSB) push to integrate sustainability reporting into traditional financial reporting, the leadership of these companies is critical and cannot be understated. Trying to balance the desires of investors, companies, and regulators is an immensely challenging task, which is why we would love to see them have more of a vision, as they are stakeholders stuck in the middle of it all.
5. Future Returns: Investing in Food Security Solutions
What it means: Food security has become a critical global issue. Scarcity due to droughts, geopolitical tensions, and pandemic-strained prices have sent food prices spiking, and with global needs expected to be 60% greater by 2050, the problem may only get worse. Investors have noticed, and now there is a network of private sector solutions, encompassing seed technology and irrigation, supply chain, and food storage solutions. Many try to focus on the end-state products coming from farms, but UBS thinks necessary areas like cold storage facilities could be interesting plays. And for those trying to invest through an ESG lens, many investments will have clearly identifiable sustainable characteristics. And for those options that don’t appear sustainable at first glance, such as cold storage, there may be some clear benefits when looking beyond the surface. Since older versions of storage have prohibitively high energy consumption, new technology may bring immediate emissions reductions and cost savings. Plant-based protein is another area of focus for UBS, while not necessarily looking at consumer brands but again targeting the infrastructure angle. Costs must come down for many of the consumer products to become competitive, so production is the missing link. One overall piece of advice to highlight for those interested in investing in this space is to be patient and focus on long-term outcomes.
Sage’s View: A variety of problems are only going to increase the importance of tackling global food scarcity. Climate change is leading to more droughts with greater uncertainty, geopolitical tensions are further straining supply chains, and the population is expected to grow to 9.7 billion by 2050. Concerted efforts between public companies, private companies, and governments will be needed. Following the wheat supply fiasco fueled by the Russian-Ukraine War, everyone should have learned their lesson that these types of problems will pop up in the future. From an investment standpoint, Sage strongly believes in the future growth potential of agribusiness and has made it a cornerstone of our New Frontiers ETF Strategy. Another area that is closely tied into the food scarcity story is water scarcity, which will also be a long-term investing opportunity. With all the thematic plays in the investing world that are coming to market, there are now more ways than ever to target specific issues that will be vital to the global economy’s future.
Source List
1) Marsh, Alastair. Executives Are Backing Away From ESG As Recession Risks Mount. Bloomberg. October 3, 2022.
2) KPMG 2022 CEO Outlook. KPMG. October 2022.
3) Proctor, Darrell. GE Will Cut 20% Of U.S. Onshore Wind Workforce. Power Magazine. October 7, 2022.
4) Scully, Jules. European Solar PV Manufacturing At Risk From Soaring Power Prices – Rystad. PVTECH. October 6, 2022.
5) Scully, Jules. Maxeon Closes French Solar Module Manufacturing Plant. PVTECH. October 7, 2022.
6) Badalian, Vartan. Alice: A Major Moment In Sustainable Aviation. GreenBiz. October 11, 2022.
7) Overton, Jeff. Issue Brief | The Growth in Greenhouse Gas Emissions from Commercial Aviation (2019, revised 2022). EESI. June 9, 2022.
8) Rosevear, John. QuantumScape Promised A Revolutionary EV Battery. Here’s Why Investors Are Still Waiting. CNBC. June 11, 2022.
9) American Airlines Invests in Firm Aiming to Supply Hydrogen to Planes. NBC DFW Via AP. October 11, 2022.
10) American Airlines Announces Investment in Hydrogen-Electric Engine Developer ZeroAvia. American Airlines. August 3, 2022.
11) Jain, Rahul. Will Algae Biofuels Become Viable? DownToEarth. September 23, 2022.
12) Reilly, Patrick. Supersonic Jet Would Fly From NYC To London In Just 80 Minutes. New York Post. September 30, 2022.
13) Hodgson, Camilla. Auditors Fall Down On Climate Risk As Corporate Polluters Fail Basic Tests, Study Shows. Financial Times. October 7, 2022.
14) Boudreau, Catherine. The Big Four Accounting Firms Need Sustainability Experts — And Are Investing Big In Training In Order To Get Them. Business Insider. June 13, 2022.
15) Csernyik, Rob. Future Returns: Investing in Food Security Solutions. Barron’s. October 11, 2022.
16) Global Issues-Population. United Nations. 2022.
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