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Sustainability in the Spotlight
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Back on track
2010 was a challenging year for the battle against climate change, both at a policy level after the Copenhagen talks broke down and from a credibility perspective following the "Climategate" scandal at East Anglia University.
However, the recent summit at Cancun has helped put negotiations towards collective action back on track. Most importantly, it has rebuilt trust and co-operation among delegates, who have been able to agree two key policies: a monitoring and reporting framework and a climate fund managed by the World Bank to allocate up to $100bn a year by 2020 in climate aid to the poorest countries.
The monitoring and reporting framework had previously been a key barrier to China/US relations, so this should prove significant in laying the groundwork for future negotiations towards a deal on global emissions. In the UK, the government has taken the initiative on sustainability reporting, discussing the possibility of introducing mandatory reports for companies, e.g. records of their energy and water usage. There is also a suggestion that companies may wish to consider the value of "nature's subsidy" i.e. the things we get for free such as clean water and air, which under different circumstances could command a price.
As for emissions, companies in developed countries have grasped the commercial benefits of making energy efficiencies and saving money. Western governments too have understood that green jobs can help rebuild their shattered economies. But the real leaders of low-carbon infrastructure continue to be emerging countries like China, which are already incorporating sustainability principles into their building and development programmes.
Despite this forward thinking, there is no room for complacency. Divisions between countries persist, for example, on whether to continue with the Kyoto Protocol framework or start again; and no agreement was reached in Cancun over market mechanisms for protecting forestry.
Meanwhile, climate change data continues to point towards global warming. According to the World Meteorological Organisation, 2010 is almost certain to rank among the top three warmest years since 1850, when instrumental climate records began.1 Although much of Europe has been experiencing very cold weather in the last two years thanks to Arctic air, this may actually supplement the global warming picture. One recent scientific paper published in the Journal of Geophysical Research suggested a link between low levels of sea ice in the Barents-Kara Sea - consistent with a warming world - and an increased probability of harsh winters across Europe.
Among other themes likely to dominate the Environmental, Social and Governance agenda in 2011, we expect to see a particular focus on access to resources in areas most affected by environmental constraints, e.g. water scarcity. Biodiversity could also come to the fore. The United Nations General Assembly has declared 2011 the International Year of Forests to raise awareness about sustainable management, conservation and development of all types of forests.
This and the small but significant steps taken by the global deal announced at Cancun lead us to be generally positive about the future for green development. As 2011 progresses, we expect to see further action from countries and companies on implementing sustainability policies and preparing the ground for more binding agreements at the next round of climate change talks in Durban.
Governments and investors show commitment to Cancun climate negotiations
Despite wide-spread pessimism about the prospect of making progress at the latest round of UN climate talks in Cancun, agreements were reached on a number of key fronts. A compromise was struck between the largest carbon emitters - China and the US - on the previously divisive issue of international verification of emissions reduction. It was also agreed that the World Bank would act as Trustee for the Green Climate Fund, which is intended to raise and distribute US$100bn a year by 2020 to developing nations specifically to assist with low-carbon growth and climate change adaption measures.2
Of greater significance however is what lies behind the progress: a clear commitment to the climate negotiation process on the part of international government delegations. Although much more remains
to be done, the developments are a further sign of continuous progress towards a comprehensive and global framework for climate change mitigation and adaption. This draws on the policy momentum seen at a national and regional government level which is designed to avoid unmanageable risks while capitalising on commercial opportunities. Green investors can therefore look forward to future climate change negotiations.
The role for the wider investment community in facilitating the transition to a low-carbon economy was again highlighted in the run up to Cancun. A total of 259 asset owners and managers including Jupiter - collectively representing assets of over US$15 trillion - signed the Global Investor Statement on Climate Change.3 This was the largest-ever group of investors calling for government action on climate change. Citing the attractive economic benefits of shifting to low-carbon and resource-efficient economies now, the Statement makes a clear case that "private investment will only flow at the scale and pace necessary if it is supported by clear, credible, and long-term policy frameworks."
Water disclosure - a glass half full
Jupiter attended the presentation of the inaugural CDP Water Disclosure survey results where it was announced that half of the companies asked to participate had done so. The first annual water questionnaire was sent to 302 of the world's largest 500 companies in the FTSE Global Index Series, focusing on sectors that are water-intensive or particularly exposed to water-related risk.4 A key message from respondents was that water is deemed a current corporate issue, with more than half of the risks identified across all categories classified as either current or near-term (1-5 years). 39% of respondents stated they had already experienced detrimental impacts.
As one of the 137 institutional investors formally supporting the project, we see its early successes as further evidence of the collective influence of investors in driving environmental disclosure. We believe this to be highly beneficial for investors in understanding the risks and opportunities that companies face. Our recent direct engagements with investees operating in water-intensive sectors have also provided greater clarity as to the current and future impact of water-stress on financial performance. Discussion with BG Group for example, highlighted the growing significance of water use and treatment within long-term project capital budgeting. This was said to be especially true in water-stressed regions such as Australia, where regulatory policies are increasingly scrutinising large water users.
International year of Biodiversity
As the UN declared 2010 to be International year of Biodiversity, a number of initiatives have come up across the world aiming to raise awareness on the critical role of biodiversity in sustaining life and ecosystems which provide us with natural resources and vital services.
The main biodiversity event of the year was the United Nations Biodiversity summit held in Nagoya last October which invited countries to address the major ecological threat that biodiversity loss represents in ecological and economic terms. A major study was launched on this occasion called The Economics of Ecosystems & Biodiversity (TEEB), whose ambition is the economic valuing of natural capital. The leader of the study, Pavan Sukhdev, was largely inspired by the Stern report which argued back in 2006 that the cost of tackling Climate Change would be 1-2% of the global economy while the cost of doing nothing would be up to 20 times that value. Similarly TEEB aims at demonstrating that the benefits of halting biodiversity loss far outweigh the costs of not acting.
Jupiter took the opportunity to listen to Pavan Sukhdev when presenting his conclusions in London. One of the key messages he delivered was around the social impacts of biodiversity loss. As the report attempts to measure the value of ecosystems as a percentage of GDP, it highlights the astonishingly high proportion of the 'GDP of the Poor' which depends on ecosystems thus showing the dramatically high social impacts of biodiversity loss on this group.
Sukdhev emphasised the rising awareness of biodiversity among the economic world. Having engaged with Rio Tinto on this issue, Jupiter believes the companies commitment to biodiversity has helped them work towards local, social, and environmental stability which are key requirements when running efficient mining operations. Although extraction companies are directly impacted, other sector players have also identified the business risks of biodiversity loss throughout their supply chain. For example, as discussed with Unilever's management on a few occasions this year, biodiversity preservation is a key element of their sustainable sourcing and farming policies.
Jupiter has demonstrated its strong commitment to participating in the "natural capital" debate by announcing that it will part-fund the Cambridge Ecosystems and Natural Capital Programme, a leading-edge research project co-ordinated by the Cambridge Programme for Sustainability Leadership. Alongside partners that include PepsiCo and Lloyds Banking Group, the project will work with a number of international businesses to identify the risks and opportunities faced by business, investors and wider society from the depletion of the world's natural resources - biological, agricultural and mineral.
Risk formulas under the microscope at oil & gas majors
The scale of the challenges faced by the global energy sector was underlined in November when Nobuo Tanaka, Executive Director of the International Energy Agency (IEA), stated that "the energy world is facing unprecedented uncertainty." Speaking at the launch of the IEA's latest World Energy Outlook, Tanaka pointed towards the implications of efforts to decarbonise the global economy as a key test of the sector, noting the importance of the G20 agreement to phase out fossil fuel subsidies that the Agency estimates amounted to US$312bn in 2009.5
Following BP's spill in the Gulf of Mexico, 2010 might well also be remembered for a stark reminder of the potential local and regional impacts of oil & gas sector operations. Jupiter sees management of related risks beginning with the Board and executive teams. As a result, our engagement activity has remained focused on searching for evidence that appropriate board assessments are undertaken.
While recent engagements on the subject have included direct dialogue with the Chairman himself, as in the case of BP, our wider engagement programme consistently provides valuable insight. Discussion with BG Group, for example, highlighted continuing evolution in the company's approach to risk management. This includes research into the most meaningful indicators of future safety performance. Jupiter welcomes progressive and best-practice approaches to risk management, and encourages public disclosure of related metrics wherever feasible.
Brazil's biofuel future - in a nutShell
Brazil began developing sugarcane ethanol during the global energy crisis more than 30 years ago to reduce its reliance on imported oil. It has since become the world's second largest ethanol producer and its largest exporter. Almost all new cars sold in Brazil can run on any combination of petrol and ethanol.6
So when Shell announced in February 2010 that it was planning to make a strategic push into first generation biofuels through a joint venture with ethanol-producing Cosan, it was hardly a surprise that these operations would be based in Brazil.
With annual production capacity of over 2 billion litres and significant growth potential, the joint venture will be one of the world's largest ethanol producers and marks a significant step forward for Shell's sustainable transport fuels portfolio.
It is also symbolic of the growing economic importance of alternative fuels for a major oil company like Shell. According to the International Energy Agency, biofuels could account for as much as 30% of the world's road transport fuel mix by 2050.
We were pleased to be able to visit the operations of this new joint venture in November 2010 to gain an understanding of the agricultural and industrial processes and how environmental and social aspects are managed throughout the joint venture's operations.
Notably, Brazilian sugar cane ethanol can produce up to 70% lower CO2 than conventional fuels and typically has lower CO2 emissions than ethanol produced from other feedstocks.7 However, what we found particularly striking was the potential for second generation biofuel production that is being pursued by Shell.
At present, every ton of sugar cane harvested in Brazil is capable of producing an average of 90 litres of ethanol. But that is achieved using only a third of the "energy" that is on the plant. The rest (the bagasse and leaves) is either taken to the mill to be burned as fuel or is left in the field following the harvest.8
However, Shell sees potential in this "excess biomass", which is readily available and easily transportable. It believes that the eventual production of second generation ethanol from this excess has the potential to double ethanol production without the need to claim any additional arable land or major increases in logistical costs - a very positive step.
At present, the technology is not in place to harness this potential. However, through investments in Iogen Energy and a joint technology programme with Codexis, Shell is working to overcome this. Iogen Energy is a Canadian company developing the technology to enable ethanol to be made from straw using enzymes. The programme with Codexis aims to develop more powerful enzymes for faster conversion of biomass to ethanol and other fuels.
In terms of managing social impacts, Shell and Cosan support the development of international sustainability standards for the production of sugarcane. Cosan has been a leader in driving stronger industry standards in this space, including in its supply chain. Shell and Cosan are both members of the Better Sugar Cane Initiative which is looking to establish a certification mechanism for the production of sugarcane for use in ethanol and/or food.
We believe the joint venture has the potential to create a win-win event in terms of financial and environmental costs. The pursuit of second generation biofuels is not only important for investors but is important for the long term sustainability of a sector which places unique pressures on food production and fragile eco-systems.
1. Press Release: No. 904: WMO- 2010 in the top three warmest years.. Dec 3, 2010.
2. BBC: UN climate change talks in Cancun agree a deal- Dec 11, 2010.
3. Press Release: IIGCC- 259 Investors Representing over $15 Trillion.. Nov 16, 2010.
4. CDP Water Disclosure 2010- Global Report.
5. Press Release: IEA- Recent policy moves a start.. Nov 09, 2010.
6. Press Release: Reuters- Factbox: Key facts about biofuels in Brazil. Getulio Vargas, Tue Aug 24, 2010.
7. www.shell.com
8. BTG Pactual Research: Shell-Cosan Joint Venture, 21 Dec 2010.
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