Investment Matters

Environmental, social, and governance (ESG): Progress in the "E"

Climate change has been a pressing factor over the last decade, as it has shifted from an inconvenient truth to a sober reality.

Corporate Australia has become much more pro-active in the past few years in making sustainability a focus, as it has increasingly being assessed based on a triple bottom line (social, environmental, as well as financial).

Your investment team has seen this accelerate post-COVID, with the unique circumstances of 2020 shifting the collective focus towards broader social and environmental issues.

We have subsequently seen a greater emphasis on environmental concerns, with many companies committing to sourcing 100% of their electricity from renewable sources in the next few years.

This has coincided with the successful deployment of renewable sources of energy. Australia is now a world leader in solar and wind energy, with 29.8% of our electricity coming from renewable energy sources compared to 15.6% just four years ago (Source: OpenNEM).

The impact of a combination of solar and wind power has reached a scale that is enabling an excess of supply of electricity at many parts of the day across large parts of the country.

We continue to be fascinated by the rapid pace at which components of our future energy supply are evolving and future challenges are being rapidly solved.

As a result, we view the environmental impact of our portfolio with an eye to the future, while providing clients with the option of tailoring their portfolio to reflect their preferences.

Murra Warra Wind Farm: a recent example

We recently had the opportunity to visit the Murra Warra Wind Farm (pictured below). Local history suggests the Wotjobaluk tribe gave the name to the area meaning "place of no water".

The Murra Warra Wind Farm project is located in North Western Victoria, 25km north of Horsham. Upon completion, the Wind Farm will be home to 99 turbines.

We were incredibly impressed by the size and scale of the project (rotor diameter in Stage 1 144m and Stage 2 158m), which will produce enough power for more than 400,000 households. Not being an anemologist (wind scientist), your CIO has driven the breadth of the Wimmera and is confident of an enormous supply of similar looking paddocks ripe for increased supply to Melbourne homes and businesses.

Energy produced by the farm is contracted to be supplied to some of Australia’s leading corporates, including Telstra, ANZ, Coca-Cola Amatil and Monash University.

This provides one of many examples where corporate Australia has teamed up with the government and private sector to accelerate the transition towards a renewable future.

Windmills

Source: First Samuel

The missing link in rebuilding our energy production, and making the most of renewables, was the supply of batteries that allow energy created at one point of the day to be deployed at a later time. Famously kickstarted by the Elon Musk solution for South Australia, Energy Storage News reported in Dec 2020 that planned grid scale battery projects “will play multiple roles in the country’s energy systems and around 900MW are in “committed and significantly progressed” stages to be completed and online by 2024.

Renewables as an investment

An interesting question raised by the stunning growth in renewable energy projects is: are they a good investment (especially considering the high levels of government support)?

At this stage, based on current long-term contracts and the costs of construction, the returns are quite small (less than 5% p.a). But such returns, and the long-term cashflows associated with them are attractive to global pension funds faced with even lower returns (and arguably more risk) in government bonds.

Australia, armed with government support, is very effectively making the most from low bond yields globally by letting the rest of the world fund the switch to renewable generation. Such a scenario has been witnessed at many points in Australia's history.

While there are still challenges, such as electricity grid design, market structure (Australia has a National Electricity Market (NEM) that controls every aspect of generation and distribution) and wavering energy policy, considerable progress continues to be made.

Measuring your portfolio’s footprint


Our approach to incorporating ESG into our investment framework concentrates on risk factors and emerging trends. Especially important are macro trends that suggest markets for various products are likely to be discouraged by changes in social and environmental values. Our decision to sell our coal investments is an example.

The establishment of frameworks such as the National Greenhouse and Energy Reporting Scheme have greatly enhanced the level of transparency we have as to the energy production, consumption, and greenhouse gas emissions of Australian corporates.

Participants in the scheme are required to report their Scope 1 and Scope 2 emissions* and energy production and consumption data to the Clean Energy Regulator.

While the scheme is voluntary, a large proportion of Australian corporates have registered, which now gives us insight into corporate Australia’s efforts to reduce their environmental impact.

Using this data, we have looked at the emissions produced by the model First Samuel Australian Equities portfolio. Our analysis shows that the total emissions (Scope 1 and 2) produced by client portfolios is in line with the broader market (ASX300).

However, excluding Origin, the approximate emissions produced by the average client equity portfolio is less than half of the broader market. Most of the Origin emissions come from a single large black coal generation asset called Eraring. The disproportionate impact of Origin reflects that the raw numbers do not always tell the full story.

 Company

 Contributions to Portfolio Emissions
(Scope 1 and 2)

 Origin Energy (ex Eraring)
- Eraring

 15.9%
 37.1%

 Incitec Pivot

 9%

 Viva Energy

 8%

 Boral

 6%

 Aurelia Metals

 4%

 Source: First Samuel, Reuters

*Above: Share of portfolio emissions based on company ownership and Estimated CO2 Equivalents Emission Total in Tonnes.

In Origins case, we note the company has made a strong commitment to transitioning away from Eraring as a source of electricity (its lone coal fired generator) and is looking to install one of Australia’s largest commercial batteries at the site as it transitions away from coal fired power. It has already significantly reduced electricity output from Eraring and is targeting a reduction in Scope 1 and 2 emissions by 50% by 2032 (Source: Origin) which could be brought forward by an earlier closure.

Another vital factor in Origin’s favour remains its position as “short” electricity, that is it produces less electricity than it sells, purchasing the remainder in the open market. That shortfall is increasingly provided by renewable sources. Therefore, along with reduced output and final closure of Eraring, Origin will continue to benefit from the rollout of new renewable energy.

Under the current regime Origin is attributable for 100% of the emissions produced in the generation of electricity (Scope 1 and 2). This effectively sees Origin attributed with approximately 30% of emissions from all the household electricity used in Australia.

However, a fuel producer such as Ampol is not attributed with fuel used by its customers when looking at Scope 1 and 2 (which in this case, are classified as Scope 3). This difference in treatment has a large impact on reported numbers.

Ambiguity as to who is attributable for what emissions along the value chain therefore represents a challenge in assessing a portfolio’s overall carbon footprint and in avoiding “double counting.” This is complicated by the fact that current data (self-reported by companies) is by no means complete or comprehensive.

Measuring with an eye to the future: supermarkets leading the shift

Another important consideration is that these numbers represent a “point in time” measure. They do not give us an indication of the progress a company has made or may make in the future in reducing its emissions, or their ability to adapt. This ignores a lot of the progress being made that we have discussed above.

The transition supermarkets are making provides another example of where current reported numbers do not tell the full story.

As one of Australia’s 20 largest companies, Woolworths uses around one per cent of Australia’s national electricity.
While the company currently has a large carbon footprint, it will tread much lighter in the near future. The company has set a target of powering its entire operations with renewable electricity by 2025.

This will involve installing solar panels on the rooves of stores and distribution centers, signing power purchase agreements with renewable energy providers as well as co-investing to build new renewable energy projects (Source: Australian Financial Review).

 

Woolworths: driving change

Woolies

Source: Woolworths

And while this may seem ambitious, some of its peers are well on their way to achieving this goal.

For example, ALDI recently committed to purchasing 6% of the output of the Dundonnell Wind Farm project (DDWF), a windfarm constructed in 2018 with the backing of the Victorian State Government.

This will complement other initiatives such as the installation of over 100,000 rooftop panels across its stores and distribution centers in what is one of Australia’s largest commercial roll outs of solar. These measures have seen ALDI reduce its emissions by 40% from a 2012 baseline.

Integrating the “E” in ESG

Remarkable progress has been made in decarbonizing our economy and progressing towards a cleaner, greener future.

The National Greenhouse and Energy Reporting Scheme has resulted in significant progress in emission reporting and accountability. However, these measures do not always tell the full story.

While client portfolios today have a relatively modest carbon footprint under these measures, we like overlaying this with a common-sense approach.

This is one that incorporates the complexity involved in assessing a company’s environmental footprint: taking a view of not only their impact today, but the remarkable progress that many are making in shaping their footprints in the future.

Given the complexity and judgements involved, we also strongly believe investors should have the ability to express their own preferences. This extends beyond environmental issues to broader issues such as social and corporate governance.

Our structure enables our clients to tailor their investment portfolio according to their wishes. We are happy to tailor client portfolios according to their views and judgements.

 

*For more information on the definition of Scope 1, 2 and 3 emissions, please access the following resource: https://app.plana.earth/academy/what-are-scope-1-2-3-emissions/