As a founding member of the Net Zero Asset Managers initiative, Arisaig Partners is committed to, among other things, working in partnership with our asset owner clients on decarbonisation goals. In late June, we hosted a small gathering of institutional investors to discuss investment in climate change solutions in emerging markets.
There is still a stark geographical disconnect between where most climate change portfolio investment is directed (the US and Europe), and the main source of incremental emissions (Asia), as well as the location of the population most impacted by climate change (emerging markets). BloombergNEF found that in 2020, developed countries had 12 times more investment per MtCO2e emissions from the energy sector than emerging markets. Furthermore, this gap has been widening since 2015.[1] As we discussed in our meeting, there are considerable challenges to identifying targeted, financially attractive, high impact solutions to climate change transition and adaptation.
But there is surely no more financially and socially significant theme over the coming decades than this. The scale of economic transformation required to adapt to climate change brings with it the potential for vast rewards. And the societal imperative to identify transition and adaptation solutions makes this arguably the most high-impact destination for capital deployment in modern human history. It is likely that hundreds of millions of lives, and the quality of life of billions more, depend on capitalism’s ability to evolve towards a net zero emissions world. And we suspect that homegrown solutions are imperative to this transition in developing countries, since it is unlikely that a reliance on ‘technological aid’ drifting towards the Global South can trigger change with anything like sufficient urgency.
We began our meeting by defining a starting point for filtering such a vast possible universe of investments. With ‘impact at scale’ in mind, it makes logical sense to focus on the greatest sectoral contributors to global emissions, namely energy generation (for industry and buildings), mobility, and agriculture & food. Roughly 90% of global emissions can be grouped into these three buckets, with some overlap between mobility and energy generation, given the dependence of emissions-free mobility on electrification and a decarbonised grid. The remaining ~10% of the global emissions pie covers significant, but less immediately transformative, sources of greenhouse gases such as cement, chemicals and landfill[2].
Within our three simple categories of emissions, the agriculture & food sector also brings us into climate change adaptation territory, and the need for global food systems to develop resilience to increasingly drought-prone, volatile climates, as well as the growing threat of food insecurity among import-dependent nations. In constructing an investment universe, we find a fourth category of companies, in the water industry, which are hugely significant to climate change adaptation, if not (to any major extent) the transition to net zero.
Our screens suggest there a few hundred public equities in emerging markets which align to our four principal climate change solutions categories. This excludes diversified conglomerates which do not provide distilled exposure, as well as disputed activities such as biofuels, which we discount given negative externalities around land use and food security. We exclude natural gas, which we discount given their continued contribution to greenhouse gas emissions. There are also very few listed equity opportunities in nuclear power, which typically requires state support given the lengthy payback period on vast amounts of upfront investment.
In our first main category, energy generation, the good news is that solar and wind power already make obvious economic sense in the emerging world’s major population centres. Put simply, the sun shines plentifully and predictably near where most of the world lives, and solar panel production costs have fallen enough to make harnessing that energy economically worthwhile.
The most recent International Energy Agency (IEA) data on levelized cost of electricity suggests that solar energy and onshore wind remain the most cost-efficient sources of incremental electricity generation capacity in China and India[3]. This remains the case despite increased financing costs, as well as cost pressure on key inputs like polysilicon. It is worth reiterating that, unlike fossil fuel electricity generation, renewables require little in the way of ongoing inputs and are thus not subject to fluctuating commodity costs on a continuous basis. Solar panels, once installed, simply require sunshine and infrequent maintenance in order to function for the duration of their c.20-year lifecycle.
Emerging markets are, in fact, home to substantially all of the upstream solar energy industry (the global wind turbines manufacturing footprint is somewhat more Westernised). It is not a great stretch to say that if you invest in developed market solar power, you must be investing ‘downstream’ – i.e. in the utility-style, asset-owning, end-of-the-chain energy generation business, and financing thereof. China, on the other hand, actually produces the panels and components which make this expansion of solar energy capacity possible on a global scale. This is an industry which carries ESG risk (principally in labour rights and use of coal power) but which is high-growth, fundamental to global climate change transition, and consolidating around a few increasingly stable, established pioneers who are able to reinvest the proceeds of their scale in eking out additional production efficiencies and solar panel effectiveness.
Within the ‘mobility’ category, the market has thus far overwhelmingly focused on the cluster of electric vehicle manufacturers which has appeared in China. In most developing countries, electric vehicles do not represent a meaningful climate change solution. Most of the Indian population, for example, do not own petrol-fuelled cars nor hold a realistic short-term chance of buying one. The development of road infrastructure in India which could support mass car ownership would itself be highly carbon intensive. In all countries, developed and emerging, the most effective climate change mobility solution is dense population centres built around a system of walking, cycling and public transportation.
Nonetheless, China does have a developed road infrastructure already in place, and as the world’s largest car market in terms of annual sales, there is the opportunity for significant carbon displacement through the mass adoption of EVs. From an investment perspective, the greatest challenge we face is that massive amounts of capital have already chased this opportunity, such that the Chinese electric vehicle industry appears to have developed vast overcapacity. Even those car brands lucky enough to win sufficient market share to absorb their manufacturing capacity may be forced into irrational pricing in the coming years. And it is unlikely, in a deglobalizing world, that exports can compensate, particularly with numerous national governments and legacy car companies also heavily focused on meeting the burgeoning demand for EVs.
Whilst the battery industry comes with broader sustainability challenges that need to be well managed, we view the industry as a crucial component of the EV supply chain, as potentially a more reliable, brand-agnostic route into facilitating and harnessing the surge in EV demand. Elsewhere in emerging markets, there are encouraging developments in electrified transportation solutions which are tailored to an urban EM environment, such as affordable electric scooters and ‘swappable’ batteries negating the need for home charging points.
Of all climate change investment opportunities in EMs, we are perhaps most energised by the potential for transformative solutions in the agriculture space. Developing countries face the challenge of enhancing their own food security such that they are not vulnerable to future ‘black swan’ events such as the Russian invasion of Ukraine. They also face an inevitable structural decline in yields as a result of the changing climate. India and China, for example, are estimated to face a 5-10% decline in maize yields by 2050 because of changing temperatures. In parts of Africa, the Middle East and Southeast Asia, the decline is estimated to fall between 10 and 20%.
There is therefore immense potential for biotechnology to play a role in protecting developing countries against the damaging effects of climate change, and to therefore lessen their future reliance on the goodwill of food-exporting nations. More efficient agriculture also brings with it a reduction in the resource footprint of existing producers. One business we own offers both targeted, biological alternatives to the conventional blanketing of fields with fertilizer and insecticide chemicals; as well as drought-tolerant GMO variants of core staple crops.
We expect significant further listing activity in this space in China and India. Both are agricultural superpowers on a global scale, with over a billion mouths to feed domestically. Yet both face clear food productivity challenges as climate change takes hold.
There are many further industries which need to change – too many to list here – creating opportunities for investment in the innovators driving this progress towards a more sustainable future. Climate change in emerging markets is, simply put, where the world’s biggest problem meets the world’s largest populations. We have little doubt that companies and investors which provide genuine, scalable, and sustainable solutions will be amply rewarded. Despite the challenges, it is firmly worth the effort to continue searching for these solutions.
[1] BloombergNEF, Climatescope 2021 (December 2021)
[2] https://ourworldindata.org/emissions-by-sector, accessed August 2022
[3] World Energy Investment 2022, IEA
