Industry is essential to society and the economy, and real decarbonisation throughout its various forms - from steel and cement to automobile and appliances manufacturing - is vital to the net-zero transition.
How can emissions from these hard-to-abate sectors be reduced? In this Q&A, Thomas Höhne-Sparborth, Head of Sustainability Research at Lombard Odier Investment Managers, discusses the potential for industries to harness technology and adjust business models to meaningfully decarbonise.
Q) What makes a sector ‘hard to abate' and how do we approach these areas differently?
A) A sector like IT is one we would consider to be easy to decarbonise, or abate emissions, because this would largely involve investment in renewable bioenergy and greater energy efficiency. But sectors such as cement and steel generate vast amounts of emissions, but only some of which are related to the energy they use. Much of their issues are related to the fact that they involve high-temperature processes, where fossil fuels are often still needed to support them.
We need alternative and more technologically sophisticated solutions in these sectors. These can include technologies such as carbon capture and storage, a transition to the hydrogen economy and phasing out fossil fuels in favour of biofuels and others. However, in all of these cases, these technologies are often not yet commercially viable, at least not necessarily at the costs where we would like to support the large scale of these kinds of solutions.
These hard-to-abate industries face a big challenge. They clearly need to decarbonise, as they account for such a large share of emissions in the economy, but it is not exactly clear how they will be able to do so in the near term. As such, we expect some of these sectors to decarbonise at a slightly slower or delayed rate than some of the easier to abate industries, such as a power utility or technology company.
Q) What is the significance of scope 1, 2 and 3 emissions for the industrial sector?
A) Scope 1 emissions are linked to a company's own assets, facilities and vehicles. Scope 2 emissions relate to its power supply and external steam and heating. Scope 3 emissions link to the upstream supply chain of a company as well as the downstream lifecycle of products and emissions generated during their use.
For a car manufacturer, emissions become more significant when you look at their upstream and downstream supply chains. This captures the emissions that are generated in the making of aluminium, steel and all of the parts that go into making these vehicles. And scope 3 downstream emissions are the most significant for a car manufacturer, as these emissions are linked to the use of vehicles - like when we are on the road, driving and burning fossil fuels. These scope 3 downstream emissions involve all of the emissions incurred after the product leaves the factory gate.
As investors, we need to make a comprehensive assessment of all scopes of emissions to understand where companies need to focus their efforts and, specifically where the most significant financial and transitional risks are situated within a company's product lifestyle.
Q) When analysing hard-to-abate sectors, how does LOIM distinguish between those companies that have a viable path to decarbonisation and those who do not?
A) Today, many investors are still tempted to look at the overall carbon footprint of a company. They may see that a steel company has a higher carbon footprint than a media company, so they prefer to allocate their capital to the media company, without comparing the decarbonisation trajectories of each business.
When we look at the steel industry and make a forward-looking assessment to understand which companies are transitioning to lower carbon business models and which ones are not, it starts to allow us to distinguish who the leaders and laggards are. We believe that high-emitting sectors, like the steel industry, are still very much going to remain a vital part of the economy. These sectors need to decarbonise and can decarbonise.
Not only do we think they are better insulated from some of these transitional risks we have been speaking about, but we also believe it is a tremendous commercial opportunity if some of these companies can 'crack the code' and can begin to supply carbon neutral steel for instance, which we believe will be in significant demand as the economy as a whole begins to decarbonise.
For example, you can build a bridge using a variety of different grades of steel. When you move to higher strength grades of steel, you tend to pay a bit of a premium but you also need less of that material. This is can create increased opportunities. From a climate perspective, when you look at the overall lifecycle footprint of key infrastructure, you can bring some of that footprint down by transitioning into premium forms of steel. From the steel company's perspective, that might mean you might produce fewer tonnes of steel, but steel that is ultimately much more valuable, more prone to recycling and has a longer lifetime.
Q) What are some of the predominant developments in this area that investors should be paying close attention to?
A) Investors should be on the lookout for the ability to assess which companies have the ability to genuinely decarbonise and which ones do not. To do that well, it is important to focus on the next generation of climate analytics.
Financial markets as a whole are still looking at carbon footprints, but at LOIM, we have developed more forward-looking investment capabilities. We analyse scope 1, 2 and 3 emissions and assess the decarbonisation targets and commitments companies are setting to form a forward-looking perspective of their future emissions trajectories.
We do not believe that these targets are all created equal, though. Some are independently verified, subject to regular interim reporting and backed up by a clear financing strategy. Those commitments are the ones that we believe are most credible and ultimately most investable.
This is an extract from CLIC™ Conversations, our podcast on sustainability and investment. The full episode can be heard here.
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