Sector Scan: A hot day in Paris

November 12, 2018 Mark Fairbairn

          

Why climate change risk is now on your power company's agenda

Three years after the world found a common cause to cut carbon emissions in the Paris Agreement, climate change is a hot topic for investors.

I heard this loud and clear across Europe in mid-October while travelling for due diligence meetings and an investment conference. I heard many speakers, including senior managers of large multinational corporations, talk about the impacts of climate change. They viewed climate change as a real business risk—and opportunity—and are making decisions accordingly.

More fuel for discussion during my trip: Paris was in a heat wave. Temperatures soared 10° C above normal the day I met with the portfolio management team at Comgest Asset Management International. It was hard not to note that with some irony as we talked about the MD Fossil Fuel Free Equity Fund, of which they are a sub-advisor.

The heat is turning up to reduce carbon emissions, but I think there's a lot to be encouraged about in how key industries, such as power companies, are responding.

Keeping the lights on: changing economics for energy utilities

One industry being rapidly transformed as a result of climate change conversations is the energy utilities sector whose primary business is to deliver energy, whatever the source of power. Much of the world's energy still comes from burning fossil fuels, but this need not always be the case.

As alternative sources of primary energy become more efficient and less expensive, as with solar, utilities will naturally shift away from fossil fuels—or risk being priced out of their markets by others who do.

Economics are also driving a move away from coal-generated power: it has less to do with politics. Natural gas is twice as efficient, and emits half the carbon for the amount of energy produced—it's seen as at least a stop-gap solution to limit growth of carbon emissions.

U.S. power companies are on track to shutter more coal-fired capacityin 2018 than in any other previous year. For the first time, natural gas has surpassed coal as that nation's largest source of electricity.

The next growth opportunity: expect to see more solar, wind and other renewables move onto the grid and closer to customers as price and performance meets, or exceeds, conventional sources.

A growing preference for renewable energy

Canada is blessed with an abundance of flowing water which allows us to draw much of our power from renewable, hydroelectric sources. In Ontario and Quebec, we even refer to utilities companies as “hydro."

A few companies in our portfolio are bringing this renewable energy to the world.

Our holdings in this sector include Ontario-based Algonquin Power & Utilities Corp., a company that actively invests in hydroelectric, wind, and solar power facilities, as well as utility businesses. About 95% of its revenue comes from the U.S., with growth primarily by acquisition.

We also hold a position in Brookfield Renewable Partners, which owns one of the largest renewable power portfolios in the world. It has more than 875 generating facilities in North America, South America, Europe and Asia, about of which are 75% hydroelectric.

Brookfield is pushing ahead with other renewable power sources, locating them closer to its customers. It is capturing a fragmented, but fast growing, market for distributed power generation—where electricity is produced on site, via solar rooftops and canopies.

Elsewhere in the world, fossil fuels are still required to produce energy, but even traditional power utility companies are reducing carbon emissions and investing in the post-carbon economy. One company in our MDPIM International Equity Pool is Iberdrola SA, a Spanish-based multinational with a 170-year history that is now a leader in clean energy in wind farms, solar and other renewables. Its business modelaims to replace polluting sources of energy with clean ones–67% of its current capacity creates zero emissions. Italian utility company, Enel also expects 40% of its power to come from renewables by 2040, up from 14% today. A subsidiary company, Enel X, is building out a countrywide network of charging stations for electric cars.

Saving the planet: It's now a business thing

This really isn't just a story about power generation and utilities. One thing that hit home during my travels is the extent to which industry and the private sector can act and innovate faster than countries. While the impacts of climate change are concerning, I'm encouraged by the human ingenuity being brought to bear in solving the issue.

Even just a quick glance across some of MD's major holdings highlights companies across all sectors addressing climate change.

MD Financial Management Inc. is a signatory to the United Nations-supported Principles for Responsible Investment (PRI), an organization that promotes responsible investment to enhance returns and better manage risks. One of these principles is to ensure that corporate governance mechanisms support the ambitions of the Paris Agreement and do not create barriers.

Closer to home, our own head office at MD is in a LEED (Leadership in Energy and Environmental Design) Gold certified building, a rating system that rewards green building design.

A few steps in my own carbon footprint

For the first leg of my trip home from Paris, I flew on Lufthansa to Frankfurt to catch an Air Canada flight back to Ottawa. As I waited for take-off, I leafed through the in-flight magazine.

Inside was a letter from the Lufthansa CEO about the growth of air travel, its impact on the environment and what the airline is doing to mitigate these risks. There was also an article on the potential of electric planes in the future of aviation.

The plane I was on was a new Airbus A320 NEO with next-generation jet engines that improve fuel efficiency by 15% and a 1:1 reduction in carbon emissions. Lufthansa clearly knows this resonates with travellers, and has proudly emblazoned these facts on the side of the plane in large font.

As consumers, we're getting used to seeing these kinds of measures as we try to make choices that contribute less to climate change.

Similarly, as investors, we incorporate a company's sustainability reports and environmental, social and governance (ESG) scores as a normal part of our due diligence and decision-making process. This is true across MD funds and portfolios, and is exemplified in our MD Fossil Fuel Free Equity Fund.

I think that ESG as a niche investment style will become a thing of the past. One day, sustainability will be table stakes to conduct any kind of business, in any sector.

I hope you can share our optimism as we seek to profit from the businesses that address these challenges, build great companies, and aim to be at the forefront of creating a post-carbon economy.

Oh, and maybe turn the heat down a notch?

 

1 Institute for Energy Economics and Financial Analysis, October 2018.

About the Author

Mark Fairbairn

Mark Fairbairn, CFA, B.Eng., is an Assistant Vice President with the Investment Management and Strategy team at MD Financial Management. He is responsible for the non-North American equity funds and pools as well as the currency overlay program within the equity funds.

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