May 30, 2019
No longer simply a risk, climate change and global warming are now realities that continue to reshape the corporate and investment landscape. As countries institute policy actions to improve on environmental and social criteria, institutional investors and asset managers are asking key questions about integrating environmental, social and governance (ESG) drivers into their investment process.
“2018-2019 will be remembered as watershed years for climate change awareness as weather-and environment-related events have convinced the public and policymakers that global warming is not a risk, but a reality, with intensifying political activism evident through movements such as the Green New Deal and the recent global youth climate strikes,” said Gregory Elders, the Senior ESG Index Analyst for J.P. Morgan. “Uncertainties remain in projecting both the extent of global warming and its economic impact, but macro and global financial stability risks are becoming more skewed.”
In this report , J.P. Morgan Research explores some of the latest developments with policy responses and in ESG investing.
Around the world, governments have turned to carbon pricing as a markets-based approach to curbing greenhouse gas emissions. Among the policy tools available for dealing with harmful over-consumption of hydrocarbons is a so-called “carbon tax,” which involves the introduction of a fee to energy consumers (both households and industrial users).
The dual intent of the tax is to signal the “true” cost of their energy usage and dissuade consumers from choosing energy products that contribute a disproportionate share to global warming and harmful air pollution. Somewhat similar to a direct tax on carbon are emissions trading programs, often referred to as “cap and trade,” which fix the quantity of emissions via issuing ‘carbon units’ and allow firms to trade these units among themselves.
Some 25 nations have implemented or are scheduled to implement some form of a carbon tax this year according to the World Bank; in some cases in conjunction with other programs such as cap-and-trade. These nations are primarily concentrated in Western Europe and the Americas (Japan and South Africa are the exceptions) and many have undertaken these efforts following the Paris Climate Agreement.
“Carbon taxation has traditionally faced steep political opposition, to the extent where even governments with ambitious intentions instead opt for the (arguably less efficient) cap-and-trade approach. Critics point out that assessing fees based on the impact to GDP can have substantial drag and distortionary effects on a nation’s economic health and competitiveness,” said Munier Salem, U.S. Fixed Income Strategist at J.P. Morgan.
Beyond nations, several Canadian provinces have implemented programs more stringent than the national policies. While in the U.S., no state has implemented a carbon tax, several have piloted cap-and-trade programs, which have also been the favored policy tool in China, Australia and New Zealand.
“Investors should prepare for carbon pricing and other actions encouraging a shift to low-carbon solutions to become increasingly prevalent. Climate change is already reshaping the corporate landscape, as companies are reducing their carbon footprints and preparing new technologies to deliver a lower-carbon world,” added Salem.
The global energy consumption landscape has changed dramatically in the last two decades, as the share of oil and coal has declined and natural gas and renewables have risen. The growth in demand for oil is now a hot topic of debate as alternate energy sources and the rise of electric vehicles pose a threat to the demand for the commodity in the future.
Total oil products demand has risen by 1.2 million barrels per day (mbd) each year on average between 1990 and 2018, rising to 1.3 mbd a year between 2010 and 2018. But with the advent of EVs and technological efficiencies, the demand for gasoline is expected to drop by 2.6 mbd between 2018 and 2040 according to the International Energy Agency’s New Policies Scenario (IEA NPS).
As the EV market expands, electricity consumption for transportation is expected to grow at a compound annual growth rate (CAGR) of 7.2% between 2017 and 2040 compared to oil, at a CAGR of 0.6%.
“Today there are around 1.1 billion cars on the road globally, nearly all fueled by oil. Electric cars account for just 1% of current annual car sales. Under the IEA’s NPS, the global car fleet expands by 80% by 2040. Yet global oil demand for passenger cars barely changes, from 21.4 mbd today to just over 23 mbd in the late 2020s and ending just above today’s level by 2040,” said Abhishek Deshpande, Head of Oil Market Research and Strategy at J.P. Morgan.
* IEA NPS
Currently most Environmental, Social and Governance (ESG) and climate change investors are underweighting or completely avoiding investments in oil and coal. But given the lack of investment in the energy sector and demand for oil being driven predominantly by non-OECD economies where population growth is on the rise, oil as an asset class should still end up providing positive returns, according to J.P. Morgan Research.
“Geopolitics will always be core to oil at least in the next decade. The same may not be true for coal due to the abundance of natural gas and renewables to replace coal in the power sector,” said Deshpande.
While sustainability has been both a topic of public debate and an increasingly important consideration for investors for some time, there has been a significant increase in the public discourse around the need to cut down plastic pollution in the last 18 months or so. Factors such as the BBC TV series "Blue Planet II," which aired towards the end of 2017, helped raise awareness, particularly in Europe, after the report estimated as much as 12 million tons of plastic ends in the sea each year, with more than 80% of marine litter coming from plastic. The documentary brought greater attention to what many see as the excessive use of plastic as a packaging material and the need to improve how this material is managed, post-consumer use. Since then, governments around the world have responded with new legislation and guidelines to encourage recycling and address litter. The EU is set to ban 10 single-use plastic products such as cutlery, straws, plates and cotton buds by 2021. Major global corporations including Unilever, Procter & Gamble, Nestle and PepsiCo have all proposed major waste reduction initiatives. Many retailers around the world such as Ikea have pledged to phase out single-use plastics completely and supermarkets in the U.K. and the Netherlands have started introducing 'plastic free' aisles. Consumer preferences have also shifted dramatically, with increasing demand for reusable plastic products and more sustainable packaging solutions.
"Consumer sentiment has undergone what appears to be a permanent shift in its attitude towards the use and disposal of packaging. The particular focus on plastic, especially single-use plastic that is thrown away shortly after purchase, will see some of these products become almost unviable," said J.P. Morgan Head of European Business Services and U.K. Small & Midcaps Research, Alexander Mees.
"In general it is likely that consumer goods companies will seek to reduce plastic as much as they can, provided they can continue to ensure proper shelf life and protection of the product in transit," Mees added.
Public aversion to single-use plastics and excessive plastic packaging appears to be changing the behavior of Fast-Moving Consumer Goods (FMCG) companies and supermarkets. Many have committed to the greater use of recycled and recyclable plastics or, in some cases, to the replacement of plastic with other forms of packaging material such as compostable alternatives. Some of the largest plastic and chemical producers in the world, including Dow Chemical, have also signed up to organizations committed to developing large-scale solutions to tackle plastic waste.
Increased demand for corrugated cardboard packaging in the U.S.
This shift in public sentiment towards plastic waste has not gone unnoticed by investors. Some investors have been expecting and have priced in a reduction in demand for plastic packaging or increased costs of delivery, according to J.P. Morgan Research.
"This has yet to be seen in the numbers, but many packaging companies have taken pre-emptive measures to demonstrate how they can address the new reality. This includes increased investment in recycling capabilities and the use of biodegradable plastics," said Mees.
Meanwhile, non-plastic packaging companies have stepped up to demonstrate the opportunity the change in public sentiment might create. One particular material, corrugated cardboard, is set to see considerable growth as a result of the departure from single-use plastic packaging. Corrugated businesses are developing new products to act as alternatives to plastic packaging, with examples including fruit packaging and paper straws. London-based packaging company DS Smith has estimated the shift away from plastic packaging will create an extra $700 million in demand for corrugated cardboard in Europe and the U.S. between 2018 and 2022, equal to 0.4% per annum of incremental growth.
"The overall message from non-plastic packaging companies is that the tide is turning and while it may take some time, it is likely that the use of plastic will decline and other packaging materials will step into the gap it leaves. Plastic packaging companies have generally given the message that they expect to use more recycled and recyclable plastic in their products, but that the benefits of plastic (flexibility, weight, ability to hold liquids) will continue to underpin robust demand," said Mees.
Beyond the sustainability debate, demand for cardboard-based packaging has trended steadily over the past few years, largely fueled by e-commerce. Almost everything sold online comes in a box and so the rise of e-commerce is an important structural change underpinning the recent turn in demand for corrugated packaging. Highly customizable and versatile, corrugated is an ideal material for online retailers big and small.
"The use of corrugated cardboard as a packaging material is likely to grow faster than other materials regardless of the sustainability debate as it is best suited for e-commerce, which is the fastest growing retail sub-sector. However, corrugated is easier to recycle than plastic so this will also likely help drive volumes," said Mees.
E-commerce vs. global packaging market share
Government legislation is forcing the packaging industry to change and adapt too. Last year, China announced it would no longer buy the world's discarded plastics. Up until relatively recently, China was importing 45% of the world's plastic waste imports2 so the move created major disruption for the recycling industry. Plastic packaging companies in Europe and the U.S. in particular have a huge opportunity to increase and improve both their recycling facilities and the volume of recycled materials in their own products. In Europe, the U.K. government has indicated higher taxes will apply to plastic packaging that does not use at least 30% recycled material. The European Commission has suggested it may even look to introduce "producer pays" regulations that require the companies that use plastic packaging to help pay for the cost of cleaning up beaches and building out recycling capacity. Taking action now is expected to avoid environmental damages costing the equivalent of €22 billion ($24.8 billion) by 2030 and save consumers a projected €6.5 billion3.
"These measures are just the start and there may even be greater incentivization for the recycling industry — this is a long-term dynamic. We are at the start of a long journey towards better environmental stewardship," added Mees.
JPMorgan Chase has a long-standing commitment to promoting sustainable business practices and advancing sustainable solutions for clients all over the world. Here are some of our firmwide sustainability initiatives.
2National Geographic, 2018
3European Commission, 2018
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