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Climate change could cause consumer confidence and consumption to contract

Dec 19, 2015
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19/12/2015

I was in Delhi, India recently. Delhi was dirty. The streets were dirty and the air was dirty. I didn’t leave the hotel unless I had to. I had no desire to visit museums or shopping malls. I wanted to buy presents for family and ended up not spending.

My son recently came back from Beijing, China after an exchange program. The smog, he told us, made it impossible to go jogging. Even in the gym, the air was dirty. “I wouldn’t go back to work in China. People try not to go out unless they need to” he told us. “How can they deliberately poison their own people like that?” I asked.

In 2006 I created a series of ABN AMRO Climate Change Indices. The concepts were simple. In one Index I looked at all the environmentally friendly sectors, Solar, Wind, Geothermal, Hydro, Energy Storage, Waste Management, Water etc. and measured the market capitalisation of each sector. The Index gave exposure to the most liquid and largest constituents in proportion to the economic weights of each sector and then revised those weights based on how each sector faired.

Even then we were talking about a price for Carbon and believed that the global community will get together and impose (develop) a carbon market. That didn’t happen. Carbon capture was also a big theme. That didn’t happen either. We started to measure the carbon impact of different sectors and companies and developed another index which invested in low carbon footprint companies. We showed that responsible corporations in a wider sense appeared to perform marginally better compared with polluting and irresponsible companies, but there was very little linkage to carbon emissions; which in any case used imperfect methods and estimates. Responsibility in a wider sense implied equal opportunity for women and minorities, employee engagement, genuine corporate responsibility and engagement with communities and managing the business with prudence, meaning sustainable levels of debt and low leverage. Something the banks didn’t do then and the miners haven’t done since!

Those low carbon indices we created at ABN AMRO on the whole didn’t work. Long before the price of oil collapsed, solar, wind, nuclear were in rapid decline.

There are industries that appear clean on the surface, but have hugely negative implications for the environment. Accurate measures on polluting companies are difficult, if not impossible to determine. One can measure the carbon imprint of producing consumer goods, but it is not so easy to measure the carbon imprint of a Google or Microsoft or a company that manufactures pharmaceuticals. Software applications, playing games, watching TV, data storage, and consuming an aspirin all have carbon impact. It is a long path from crude oil to aspirin or other more complex drugs, but who should pay for the carbon impact once Shell has pumped the hydrocarbons and sold them in drums?

Bashing the fossil fuel companies is disingenuous when we all want to drive nice cars and live in centrally heated homes and consume until the fat is oozing out of us. The focus needs to be on consumption. For us to have real impact on global warming, overall consumption as well as consumption patterns have to change. Energy efficiency is part of that equation.

Index providers look at short term sell off in fossil fuel producers and miners and jump to the conclusion that investing in low carbon (S&P 500 or FTSE minus Energy and Mining) companies produces better investment results. They deliberately do the test over short periods over which a massive sell off has taken place. It is easy to come up with a back test that shows merit retrospectively. They conveniently forget about highlighting the collapse in the renewable energy, banks and emerging markets as a whole, where even in China per capita carbon footprint remains one third of the United States. The causes of sell off are not related to carbon footprint. Blaming companies with a high carbon footprint for climate change is narrow minded because all other sectors would come to a grinding halt if the lights went out!

For robust methods in investing and managing market risks, please look elsewhere on our site (www.algoam.com). Carbon emissions are not a very powerful measure and it is questionable if steering investments based on carbon impact in diverse sectors leads to any meaningful improvement in performance over the medium to long term. With energy prices at multi-year lows, this may very well be the time to buy beaten down stocks.

Except for coal, which gets burnt as is it (it has no derivatives, except polluting gases) index providers and institutional investors are not measuring rationally or accurately the contribution to carbon emissions. What exactly is the share of carbon emissions between a crude oil company that just pumps and the car manufacturer and the driver? Or a company such as Monsanto that produces a pesticide, the farmer who produces the corn to feed the cows and the beef eater? Or a mining company, the computer manufacturer and the internet service providers and the consumer at home or in an office using the devices?

Only when a carbon tax is imposed on consumption, on the end product, will consumers start to appreciate the impact they are directly having on our climate. They will then start to comprehend the dire situation that humanity finds itself and will then, perhaps, start to respond by both reducing consumption and possibly shifting to low carbon products.

My personal view is that left to citizens’ humanity is unlikely to see progress. Human beings cannot postpone gratifications. Our leaders certainly cannot. The survival of the species is not all that important to us at the individual level. In this context Darwin may very well have been wrong. Survival of the self and the pleasure of the self is what drive us. Survival of the species is only tested in extreme situations.

Consumer confidence will start to shift only when people are impacted at the personal level. We can either wait for the impact through natural disasters or it needs to be felt on the wallet. Climate solutions need to be imposed by governments and overseen by regulators. The consumption tax needs to be based on scientific methods. For a start, we need to stop blaming China for carbon emissions on the things we consume that are manufactured in China.

There are very few short cuts to a low carbon future. Renewable and nuclear energy are part of the solution. Short of a scientific breakthrough which fixes the carbon problem for humanity, consuming less and changing consumer habits is the solution. Misleading the investment community by coming up with gimmick alternative indices is dangerous and doesn’t really solve the carbon or the investment conundrum.

The signing of the climate accord signed in Paris by most nations including China and India gives us some hope. Like all great challenges, humanity as whole needs to come together. Both individual and collective actions are necessary. There are huge risks. If we don’t solve the climate crisis, life on earth may become unsustainable for very large numbers.

The process of reducing consumptions (which should include a planned reduction in global population) is going to be a real challenge for the global markets as we know them. We have an obsession with growth and ever larger numbers. Small is not only beautiful, it is also safer!

Of course on a bright note; addressing the climate change challenge will result in huge opportunities also. The relative fortunes of companies and countries will shift. The important thing is not to second guess, but to monitor, measure and manage those opportunities and risks.

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