Four ways investors can benefit from the JSE’s transition to net zero

What does ‘net zero’ mean and why is it important?

Fifty-one billion tons of greenhouse gases are released into the atmosphere each year, according to the Intergovernmental Panel on Climate Change (IPCC). It’s widely accepted that the world needs to reduce this number dramatically, and soon, to avoid a worldwide climate catastrophe.  

Ideally, authorities want the world to reach ‘net zero emissions’ by 2050. This is achieved when the amount of carbon dioxide absorbed by the planet each year is equal to what is emitted into it.

Emissions are classified into Scope 1,2 and 3. Scope 1 are the emissions stemming directly from production, Scope 2 are indirect emissions from inputs to the production process (like bought electricity) and Scope 3 are indirect emissions generated from downstream activities (for example the emissions relating to the transportation of a finished product).
 

Source: EPA.gov, 27 April 2023

Reaching net zero on a global scale is a central part of efforts to prevent global warming exceeding the 1.5^OC climate target set at COP 21 in Paris in December 2015. Many countries have made net zero commitments, including South Africa, where the goal is to get to net zero by 2050. 

Where are the investment opportunities?

There are two overarching approaches to managing climate change: adaptation and mitigation.

Adaptation relates to the process of adjusting to the current and future effects of climate change. This can be done by diversifying energy supply and improving access and stability of these supplies, making crop-land management, undertaking greener urban planning and infrastructure building, and putting disaster risk management measures in place in societies.

Mitigation relates to preventing or reducing carbon emissions. This can be done by finding alternate, more renewable energy supplies, lowering methane emissions in agriculture, transitioning to electric vehicles, efficient lighting, and appliances, and making more use of public transport while also recycling, undertaking carbon capture and increasing energy efficiency.

We believe there are four key investment themes that underpin the mitigation approach to carbon emissions in South Africa. Each of these is discussed in detail below. 

1. Green metals

We recognise that there’s going to be significant demand for green metals as we transition to a lower carbon world. Copper and lithium are particularly well known for their applicability to several renewable energy solutions.

In our view, Glencore provides investors with exposure to the best basket of green metals, followed by the likes of Anglo American, BHP and Rio Tinto. It’s important to note that the latter three expose investors to iron ore, which is not a green metal given its reliance on coking coal in the reduction process. Nevertheless, steel is crucial for many renewable energy propositions. These companies need to encourage downstream green steel production using hydrogen reduction instead. 
 

Source: Company financials, Bloomberg, 27 April 2023

Looking at the Scope 1, 2 and 3 emissions of these producers, Anglo American performs particularly well given the company targets a transition to net zero Scope 1 and 2 emissions by 2040, whereas the others target 2050.  
 

Source: Company financials, Bloomberg, 27 April 2023

Looking at the Scope 1, 2 and 3 emissions of these producers, Anglo American performs particularly well given the company targets a transition to net zero Scope 1 and 2 emissions by 2040, whereas the others target 2050.  

2. Renewable energy 

Renewable energy has become increasingly affordable. In many cases solar and wind are cheaper than some traditional fossil fuels even after adjusting for intermittency and subsidies. Others like Hydrogen are expected to come down in cost rapidly and benefit from significant subsidies, for example almost half the cost of hydrogen will be subsidized through the US Inflation Reduction Act.

While there are no companies listed on the JSE that offer direct exposure to solar, wind or hydrogen theme today, there are several listed industrial companies that offer an indirect and growing exposure, including, but not limited to, the companies pictured below. 
 

Source: Investec Wealth & Investment

We favour Reunert in this space because we believe it is not only well positioned from a renewables and battery solution point of view, but that it also stands to benefit from the extensive investment in grid infrastructure and cabling that needs to take place in this country. 

3. Transition opportunities

Here Sasol stands out as a potential beneficiary. It emits the most carbon into the atmosphere in the southern hemisphere, but we see this as an opportunity rather than a threat. The Fischer-Tropsch technology it uses is setting it up to be a major player in the transition to a more hydrogen-based economy. The Fischer-Tropsch process essentially converts a mixture of carbon monoxide and hydrogen into carbon-neutral liquid hydrocarbons.

Global oil majors are currently trading at low price-to-earnings ratios. This is due to the expectation of increasing carbon taxes, growing regulatory risks as well as the rising possibility of future climate litigation. We think these risks will reduce as these companies transition their portfolios. Take Orsted, for example. Orsted started life as Denmark’s state-owned oil and gas company and it was once the most coal-intensive company in Europe, responsible for one-third of Denmark’s emissions. Its share price has re-rated significantly since it began its transition journey.
 

Source: Bloomberg, 27 April 2023

We believe we can have the greatest impact by investing in companies like Sasol, PPC, Arcelor Mittal and certain coal miners, and actively engage with them to help them transition their businesses toward a more sustainable future.

4. Financing the transition

It’s important to recognise that most banks in South Africa have committed to net zero emissions, including across their loan portfolios. This means that over time, they have to move from financing high emitting businesses to those that are more energy efficient, based on renewables and are not destroying the environment. It’s going to become increasingly difficult for companies with no regard to the environment and sustainable business practices, to find financing from SA’s banks.

The below table compares the exposure of the country’s top five banks to fossil fuels as a percentage of their loans and advances. Standard Bank has significant exposure to fossil fuels and very little to renewables in terms of their loans and advances. At the very least we need to be encouraging Standard Bank to do more in terms of lending to renewables-related companies and less financing of fossil fuel-related companies.

Absa, FirstRand and Investec are doing well in terms of lending to renewables companies but a lot more work needs to be done because their exposure could be significantly greater.

In terms of the banks’ own ESG risk, Investec leads the pack. Investec was on of the first banks in the country to measure its Scope 3 emissions and they are highly rated by most of the ratings agencies for their management of environmental, social and governance risks. 
 

Source: Company TCFD discolsures, Bloomberg & estimates (there are inconsistencies in disclosures), 28 April 2023

We believe we can have the greatest impact by investing in companies like Sasol, PPC, Arcelor Mittal and certain coal miners, and actively engage with them to help them transition their businesses toward a more sustainable future.
 

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