IR plays a critical role in the development of an environmental impact strategy, writes Charles Sunnucks
Betting against Chinese progress when it comes to commitments on climate change has been a losing strategy for some time now. You may not think of the country as ‘green’ but, from a low base, it has been hitting the gas (so to speak) in accelerating efforts forward. This was most recently demonstrated by China’s radical ambition to be carbon net-neutral by 2060.
This is important. China is the world’s largest carbon emitter and its economy fast growing in scale. In 2019, for example, carbon pollution from China accounted for 27 percent of all greenhouse gas emissions globally. That surpasses the carbon pollution of all other developed nations combined, according to the Rhodium Group, so it is in China that the real balance of power for a more sustainable future is held – and this affects us all.
Progress at a price Over the past handful of decades, due to ambitious economic reforms, China has achieved a miraculous boom in economic activity and pulled millions out of poverty. But these achievements have come at a cost. China’s progress has relied heavily on energy-intensive industry. This is in part inherited from the country’s pre-reform period, and partly due to its investment-led growth model. For example, its thirst for resources means China accounts for around half the global consumption of steel, copper, aluminum and cement.
China’s rise has also created increasing demand for energy, and this has largely been met with a carbon-intensive supply. Plentiful coal resources in China led to coal-based power generation becoming the primary means of energy supply. Even now the portion of coal in China’s energy mix is around one and a half times greater than that of the US in 1950.
The consequence is that particles from coal-powered electricity generation have created serious health concerns across some of China’s most densely populated cities, putting quality of life at risk. In Beijing, for example, even while smoking rates have declined, there has been a substantial rise in lung cancer cases over the past decade.
This combination of an energy-intensive growth model and a carbon-intensive energy supply has created a considerable carbon footprint. According to the International Energy Agency, in the last 20 years CO2 emissions in China grew six times as fast as in the rest of the world, and China accounted for almost two thirds of the growth in global CO2 emissions. By the time Covid-19 struck, China had higher per-capita CO2 emissions than the European Union (EU), albeit still well below US per-capita levels.
The rubber has already hit the road China is no shrinking violet when it comes to energy transition, however. The country has been implementing policies to manage the environmental impact of its economic development. Heavy industry has been forced to relocate far from city centers and required to meet higher environmental standards. In addition, many coal-fired power plants have been ordered to shut down entirely. In Beijing, for example, the city’s four coal-based power plants are all now closed.
China has also been pressing ahead with more sustainable means of energy production. In 2020 it built almost 100GW of windfarm capacity – almost three times the power required for all the homes across the UK – representing a 60 percent rise on the year before. That made it the greatest increase ever achieved by a country, and more than the whole world combined in 2019.
Solar has also been a key pillar in China’s sustainable expansion plans. The country already boasts the world’s largest solar power capacity, near double the installed capacity of the entire EU. Moreover, China is a key supplier of solar equipment, dominating production across the supply chain. For example, more than two thirds of polysilicon, solar cells and solar modules are produced in China.
Evolution to revolution While tremendous progress has already been made, far more needs to be done – but policymakers based in Beijing are rising to the occasion.
In a speech to the UN in late 2020, Prime Minister Xi Jinping said China would strive to be carbon-neutral by 2060, a radical undertaking considering not only the country’s existing carbon footprint but also its legacy assets. In order to meet this challenging target, China will need to aggressively pursue a two-pronged plan of attack: it will have to reduce energy intensity and further improve its energy mix.
Energy-intensity reduction gains will primarily be driven by more stringent energy-efficiency standards and a rebalancing of the economy. Less than a decade ago, China was known to most as the ‘factory of the world’, dominating production of cheap goods and acting as an export powerhouse.
Increasingly, however, it is domestic consumption that is driving economic expansion in the country. Rising disposable incomes and an increasingly educated workforce have, for instance, opened up service sector opportunities – a far less carbon-intensive source of economic growth.
Beyond energy intensity initiatives, overhauling China’s energy infrastructure mix is another key undertaking required to meet the nation’s targets. A paper by the Oxford Institute of Energy Studies notes that fossil fuels such as coal, oil and gas would need to drop from around 80 percent of China’s energy mix in 2025 to 14 percent by 2060.
This has significant implications for the allocation of capital across the domestic energy market and will likely lead to further regulatory pressure on greenhouse gas emitters.
Creating authentic corporate goals to manage risks The impact of China’s policy implementation, combined with the efforts of other nations, will likely become increasingly evident in capital market activity over time. But corporates and investors alike have been achingly slow to respond to this shift, and there are still those with their heads dug firmly into the sand. As a result, there is considerable value at risk as economies like China transition.
There is a Chinese proverb: when the winds of change blow, some people build walls and others build windmills. Firms have great scope to take positive action and show that environmental risks are not being overlooked. Apple, for instance, in 2020 committed to being carbon net-neutral across its business, manufacturing supply chain and product life cycle by 2030.
Even some companies operating in traditionally ‘grubbier’ sectors are throwing down the gauntlet when it comes to environmental impact goals. For example, energy firms Shell and BP have both committed to achieving net-zero emissions by 2050, as have American Airlines and Ford Motor.
IR plays a critical role in the development of an environmental impact strategy. Deceptive marketing around environmental outcomes – ‘greenwashing’ – has created widespread investor cynicism regarding environmental impact claims. Grand long-term targets may feel bold but, as existing management members will likely not be in post come the delivery date, they can lack any real accountability, so good disclosure and clear medium-term targets can be far more effective.
Additional weight can be added to proposals by linking progress to management remuneration, which will make senior managers not just accountable but also very much aligned – and this will not go unnoticed by investors.
Warren Buffett famously quipped, ‘Only when the tide goes out do you discover who has been swimming naked’. This will sadly be true for many companies and investors, as pressure from regulators and consumers exposes those unwilling to adapt.
This will be most evident for any companies exposed to China, where the old model of economic development is being overhauled, and business is no more ‘as usual’.
Charles Sunnucks is the former fund manager of the Jupiter Emerging & Frontier Income Trust and author of The company valuation playbook
