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Citi

Investing in an ESG World

Key Takeaways

 

  • Investments in companies with high environmental, social and governance (ESG) standards may receive additional attention.
  • Market forces, rather than government mandates alone, are now powering the switch from fossil fuels to renewables and Citi analysts believe the investment case for renewables just became even more compelling.
  • In 2020, electricity from renewable energy became cheaper than that from key fossil fuels for the first time ever. This could hasten the greening of energy use over the coming years. Citi analysts see potential arising from further technological advances, electrification and an energy efficiency drive.

 

The rise of sustainable and responsible investing

The COVID-19 pandemic has highlighted the inextricable link between the current societal and environmental crisis, emerging communicable disease and the quality of social systems such as health systems in many countries. Interest in ESG investing has grown as threats from sustainability issues have become more pronounced.

Many sustainable or purpose-driven companies are likely to emerge with stronger risk mitigation efforts and clearer board oversight as well as understanding of ESG issues and opportunities. Citi analysts believe this is an important inflection point as ESG considerations reshape the investment management industry.

ESG investing offers the financial sector a unique opportunity to play a pivotal role by directing capital flows towards the solutions.

Between the global pandemic, China’s commitment to the net zero target and President-elect Biden’s plans, ESG momentum looks set to continue on an upward trajectory. President-elect Biden has put a range of climate targets back on the agenda for the US, including decarbonizing the power sector by 2035, re-joining the Paris Agreement and a US$2 trillion stimulus plan targeted at clean energy, infrastructure and clean manufacturing.

By embracing net zero ambitions, recent commitments from China, South Korea and Japan, as well as the EU Green deal, reveal the direction of global policy, highlighting a low-carbon transition tipping point. With the US soon to follow, Citi analysts estimate we could soon have 62% of global CO2 emissions and nearly three-quarters of GDP under a carbon-neutral goal. The race to zero suddenly seems within reach and rather exciting.

2020 has seen a sharp growth in demand for ESG investment opportunities and the rise in capital flows to sustainable investing investment strategies, funds and bonds. The Global Sustainable Investment Alliance (GSIA) study in 2020 estimates that investment in ESG funds is now over US$40 trillion, increasing by approximately US$10 trillion every 2 years, with a growth trajectory that looks unlikely to slow (chart 1).

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Climate Change - United Behind the Science

Global warming is linked to absolute concentrations of greenhouse gases in the atmosphere. Greenhouse gas concentrations are occurring ten times faster than any sustained rise in CO2 during the past 800,000 years and as a result, climate change is moving rapidly.

The current period of warming has resulted in more frequent and extreme weather events that have impacted supply chains, infrastructure and local communities among others. Scientists forewarned about climate change and are now cautioning against the impact of environmental degradation and biodiversity loss on the functioning of ecosystems that support human health, wellbeing and food production.

With the development of new, low-carbon technology and greater effort towards portfolio decarbonization, investors have an essential role to play in the transition to a low-carbon economy by directing capital flows towards future, low-carbon solutions.

Citi analysts believe that there are three complementary energy shifts that are occurring simultaneously. As well as technology innovation and roll out of new sources of energy, electrification and a great efficiency drive are also underway. Together these three forces form part of a much bigger unstoppable trend – “greening the world” – a multi-faceted transition to a more sustainable world.

 

Renewables Accelerate

Renewable energy is now the cheapest new source of power in most of the world’s major economies (chart 2). For example, solar is the least expensive new source in the US, China and India. In nations with less abundant sunlight like the UK and Germany, wind is the least expensive new source.

The main winners from the transition to renewable energy sources are likely to be energy consumers, both households and companies. The biggest losers could be within traditional fossil fuel industries. Citi analysts also see potential winners among energy producers.

 

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An Electrifying Trend

As the price of electricity falls, end-users of energy could find it more attractive to use electricity instead of traditional fuels. This transition could require new technologies in areas as diverse as vehicles, heating and large-scale manufacturing.

It is the innovators of these new techniques who are most likely to thrive in our greener energy future, as firms that cling to traditional methods find themselves facing a shrinking market and an unsustainable cost curve.

In transportation for example, battery-powered electric car sales are rapidly ramping up. New industries, like charging station vendors have arisen. For industrial applications, electrification could find a mix of solutions with heat pumps, electric motors and existing hydrogen turbines powered by green sources of hydrogen. While governments around the world may pass laws and green energy targets, falling prices could ultimate driven the mass electrification of industry, as producers can otherwise relocate to avoid higher taxes and tougher regulations. 

Likely beneficiaries of electrification include electric carmakers, battery makers and eventually, heavy industry innovators.

 

Energy Efficiency

Battery technology remains a relatively expensive link within the electrification chain. As more appliances and vehicles undergo electrification, energy efficiency could become increasingly important. This means getting the most out of batteries and helping utilities manage dramatically higher usage.

Emerging technologies in residential and commercial buildings have enabled two-way communication between grids and appliances, enabling some appliances to be “turned off” when they are not needed. In addition, tightly regulated heat pumps and other heating, ventilation and air conditioning systems could make for more comfortable and attractive residential, commercial and industrial spaces.

Likely beneficiaries of the efficiency drive include suppliers and installers of residential and commercial infrastructure, as well as battery makers, “smart” appliance manufacturers, and select REITs.

 

Conclusion

There is growing consensus that the world needs to find new and better ways of doing things once the COVID-19 pandemic is defeated. Switching to cleaner and more sustainable sources of energy is an example of how we can do this. At the same time, there is a belief that many governments may borrow and spend more to stimulate growth in coming years. Capital investment in renewable energy and related infrastructure is likely to play a prominent role in such initiatives.

There are many ways that investors can build exposure to “greening” of the world in portfolios. Citi analysts prefer firms at the cutting edge of new energy development, electrification, or energy efficiency that can offer exposure to this unstoppable trend. At the same time, shifting out of fossil fuel assets could avoid the negative impact from the most obvious losers of the transition. Finally, while there are many areas that the green revolution is only beginning to touch, Citi analysts favor companies with a strong focus on cost and quality.

 

 

 

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