Climate Change Responsible Investing (ESG) Fixed Income Article

Investing Lessons from Climate School, Class of 2021

May 27, 2021
16 min read

ESG in Action

Climate change is likely to have significant impact on financial and economic outcomes in the future. AllianceBernstein has developed, with our partners at Columbia University’s Earth Institute, the Climate Change and Investment Academy. This educational forum is designed to help our clients and partners learn more about the multifaceted science of climate change and the potential impact on investment decisions.

The Issue
Asset owners face growing commercial, economic and regulatory pressure to more proactively address the complex issues arising from climate change.
The Initiative
The Climate Change and Investment Academy was developed to fill a gap in financial markets that lack training or education about climate science.
Program Objectives
To support client and partner efforts to better discern, analyze and integrate climate change considerations into their investment and capital allocation decisions.

As the world embraces ambitious goals to fight climate change, cutting down carbon emissions will force companies and governments to abandon polluting practices and adopt new environmentally friendly business models. Investors of every background will need to deepen their climate knowledge to prepare for the impact of the changes on economies and companies across sectors.

To help investors navigate the changes, AllianceBernstein (AB) embarked on a first-of-its-kind partnership with Columbia University’s Earth Institute. Through that partnership, we established the Climate Change and Investment Academy, a six-week course of study that draws on the expertise of climate scholars and investment professionals to integrate scientific and academic analysis of how climate change can affect investment risks and opportunities.

More than 1,000 asset owners and investment consultants from around the world participated in the first Climate Academy course during the first quarter of 2021. Here’s a sampling of the questions they asked and the insights that were discussed.

Extreme Events: The Impact of Climate Mitigation Efforts and Measuring Risks to Real Assets 

Q. If changes are made to meet long-term climate goals, how much would that reduce the risk of extreme weather events? Would there be an observable impact, or are we stuck with the extremes?

A: Radley Horton, Associate Research Professor at the Lamont-Doherty Earth Observatory, Columbia University’s Earth Institute: Even if we take the necessary steps to dramatically reduce greenhouse gas emissions, it will still take a while to see the rewards, unfortunately. Actions we take today to reduce emissions will have an enormous effect on how severe future heat waves and flooding are going to be, but it's going to take two to three decades to see those benefits.

There are other benefits we can see right away, like improvements in air quality and fewer lives lost due to air pollution. Depending on the adaptation strategy, some can have very quick benefits, certainly on time scales shorter than two or three decades.

Radley Horton

 

Q. Given the extreme impacts of sea level rise and other extreme climate risks, how should a REIT or a real estate manager conduct climate risk analysis? Is there a standard model to follow? 

A: Marco Tedesco, Lamont Research Professor at the Lamont-Doherty Earth Observatory, Columbia University’s Earth Institute and Adjunct Scientist at the NASA Goddard Institute of Space Studies: REITs are a very interesting case because the geographic distribution of properties is scattered over a given territory. It could be within the same country, but they are exposed to different levels of risk—even at small distances. For example, residential property values can be impacted significantly by developments in the mortgage market. The loan-to-value ratio might change. That, in turn, might change the dynamic of the real estate market.

Furthermore, one of the biggest problems from a scientific point of view is that a lot of the data necessary to run these models needs to be purchased. The datasets look at variables like assessor data and transactions data. They’ve been made public by companies which are compiling them, but they're selling them for hundreds of thousands of dollars. And there are many restrictions and limitations on their usage and potential application.

Marco Tedesco

 

China: Balancing Growth with Decarbonization

Q. Will it take an economic slowdown for China to actually start cutting emissions, given that its massive carbon output is largely driven by its economic growth and expansion? 

A: David Sandalow, Co-Director Energy and Environment Concentration at the Columbia University School of International and Public Affairs: My answer is an emphatic “no.” There are many strategies that the Chinese government and Chinese companies can take to cut emissions without an economic slowdown, and we've already seen evidence of that potential. In the past decade, emissions in China have barely grown while the economy has skyrocketed, growing at an average rate of 6%.

I think that opportunity is very much there in the future to reduce emissions. The Chinese government has committed to reaching maximum emissions by 2030 and reducing them afterward. And there's no way that the Chinese government envisions that economic growth will peak after 2030. One important point is that the Chinese economy is shifting from a manufacturing-based economy to more of a service-based economy. That alone drives a reduction in emissions because the service sector is so much less emissions-intensive than manufacturing.

The transition from traditional fossil fuel energy to renewable energy will also drive the drop in emissions. Solar power and wind power costs are dropping dramatically and can take over many of the functions of traditional fossil fuels. The shift to natural gas and to nuclear power will do the same. Transitions in the transport sector will make a big difference as well. China leads the world in electric vehicles by far, and that spells emissions reductions.

The Role of Nuclear Power in a Paris-Aligned World

Q. Do you see nuclear power as a future keystone within the field of renewable energy?

A: Arthur Lerner-Lam, Deputy Director of the Lamont-Doherty Earth Observatory, Columbia University’s Earth Institute: We cannot meet some of the objectives of decarbonization without going to nuclear power, in addition to a huge expansion in solar, wind and renewables. Investment in the development of new, safer nuclear reactors will be an important part of that. Of course, the politics of nuclear power plant construction are another matter.

David Sandalow

 

A: David Sandalow: Firstly, for the sake of clarification, nuclear power is not renewable power. Nuclear power depends upon uranium, which is mined from the earth. It's not renewable in the same sense that solar power or wind power is. 

But it is essentially zero carbon, and from that standpoint, it is potentially a very important part of the solution to climate change. It can produce massive amounts of electric power with baseline power. That means that it's not intermittent in the same way that solar power and wind power are. So, just having this type of steady source of massive electric generation in zero carbon could make a huge difference in fighting global warming.

There are two principal constraints on the nuclear power sector today that will be very difficult to overcome. The first constraint is cost. Nuclear power today is extremely expensive in relation to other power sources—particularly solar and wind. It's not entirely an apples-to-apples comparison because solar power and wind power are variables. But particularly with battery costs coming down, solar and wind combined with batteries are easily going to be cost competitive. The business case for nuclear power is extremely questionable.

Constraint number two is public acceptance; around the world, we find publics deeply resistant to nuclear power.

COVID-19: Cultural Nuances and Implications for Responding to the Climate Crisis

Q. Does the way in which society has adapted so quickly to lockdowns demonstrate how quickly we could act against climate change? Are there studies on the behavior element of how societies handle shocks?

A: Jeffrey Schlegelmilch, Director for the National Center for Disaster Preparedness, Columbia University’s Earth Institute: The answer is “yes,” but it might not be the kind of “yes” we would hope for. We've seen in some areas a lot of adaptation to COVID and a lot of behavioral changes. But we've also seen extraordinary resistance to it.

This intersects with behavioral science, and particularly individual behavior, where the use of fear as a motivator tends to be effective only if there's an alternative to the way you're currently behaving. If there's no alternative, it tends to lead to more pushback.

Jeffrey Schlegelmilch

 

The cultural context matters. In more collectivistic cultures, individuals are more willing to make sacrifices for community benefit. In contrast, cultures that are more individualistic are less willing to make these sorts of sacrifices for the communal good. We can see this across the world.

For example, in parts of Asia, mask mandates and social distancing are much more widely accepted. And in very individualistic countries like the US, giving up freedom is a very profound thing that’s not easily done.

This tells us two things: first, we do have a better sense about how these sorts of changes will play out, but they're also not going to play out consistently. The strategies that may work in one sector may not be as effective in another sector.

Second, it's important to recognize that the one-size-fits-all approach still eludes us. If you want to speak to a more individualistic society, you can't use the same tools with the same degree of efficacy as those you would use in more community-based places.

Q. Are any countries leading the way to climate resiliency or climate infrastructure? Any companies leading the edge here?

A: Ryan Oden, AllianceBernstein Research Analyst for Equities, focused on integrating ESG factors: COVID provided us with a test case for resiliency, both on climate and on culture. The questions regarding nation-states are questions that we, as investors, ask of sectors and individual companies. We try to benchmark quality [company] cultures and try to quantify them. And that includes a culture of climate resiliency.

Companies that had strong supply-chain sustainability programs often had very deep relationships with their suppliers, while companies that didn't have those relationships often did not demonstrate a similar level of consistency of supply chain—nor a consistency of labor and worker conditions as well.

Ryan Oden

 

We had sectors of companies that routinely ran things like wage stress testing—not only for their direct employees, but also for their supply chain employees. And some companies ran geographic stress testing for the suppliers to understand if they could pivot in a moment of inflection. We saw several companies outperform, both culturally and physically, in a moment of inflection.

Putting culture and climate risk together has created a bucket of companies that were good at this previously. There's another bucket of companies that developed this muscle during COVID. And there's another bucket of companies that need to get with the program. The ability to separate cultural and climate resiliency is getting more difficult to do because they're so intertwined. COVID really was a lab for that.

Innovation: The Transportation Sector and Carbon Capture and Storage

Q. Are synthetic fuels better than electric vehicles for the transport sector, given the massive need for batteries?

A: Julio Friedmann, Senior Research Scholar, Center on Global Energy Policy at the School of International and Public Affairs at Columbia University: For cars, it’s more likely that batteries are going to win. You can buy a car and it runs a whole 200 miles or something like that. The battery costs about $5,000 and you can charge it in 20 to 30 minutes. For light-duty vehicles, and even lighter-duty vehicles, like two- or three-wheelers in developing Asian economies, batteries look like a pretty good fit.

That’s not the case with a ship. You cannot charge a battery in the middle of the Pacific. If you try to build an electric ship, the batteries would consume the entire volume of cargo hold. The same thing holds true for trucks and trains and other heavy-duty vehicles. For garbage trucks or mining equipment, it makes more sense to use a synthetic fuel. That’s because it would cost $60,000 to $90,000 for the battery. It would eat up 40% of the cargo hold and it would take 20 hours to charge. 

Julio Friedmann

 

Q. How can hydrogen be used as a green source of fuel for vehicles?

A: Julio Friedmann: Hydrogen is the Swiss army knife of decarbonization. You can use it to make heat in heavy industry and you can use it as a chemical reductant. You can use it as a feedstock or to run a car as a fuel. There are all kinds of things you can do. You can use hydrogen to make ammonia, which is a perfectly good fuel. And there’s no carbon in it. If it's used as a fuel in a fuel cell, or if it's burned, it doesn’t generate any greenhouse gas emissions. One of the nice things about ammonia is you can use it today in existing engines. For heavy-duty transportation vehicles—like ships, trucks or trains—synthetic fuels like ammonia or liquified hydrogen are possibilities, whereas electric batteries are not practical.

Q. Can you explain the idea behind carbon capture, and how it’s done? By putting it back into the ground, aren’t we just kicking the can down the road?

A: Arthur Lerner-Lam: Capturing and sequestering CO2 is a critical technology that will have to be part of the solution as we move to low-carbon alternatives, but deploying at scale will take a significant amount of time.

There are a variety of scenarios that allow us to move in that direction. They vary in their requirements for infrastructure, financing and their impacts on social equity. Not least of these is the mode of sequestration. Geological storage can be safe and secure, but practicality needs to be demonstrated. 

Arthur Lerner-Lam

 

Direct air capture is a tool that draws CO2 from the atmosphere or smokestack. It can partially compensate for the total emissions output and provide a bit more time for low- or no-carbon sources to be deployed, but its overall contribution to total emissions reduction will need to be supplemented by other actions in parallel. Relying on direct air capture alone to go cold turkey won’t work.

A: Julio Friedmann: There are processes, like steel production, where we don’t have a path to zero-carbon emissions. Carbon capture is a way to manage that.

We can either continue emitting now and hope we can solve the problem later, or we can take stewardship for the problem now. The idea is, if you take carbon out of the ground, you have to put it back. You’re not allowed to just keep pumping it out. Part of that is to not continue removing it from the ground in the first place. If you use carbon anywhere in the economy, you should manage it. Acknowledging that principle is what things like carbon management and carbon capture are all about.

The Time Horizon Mismatch Between Climate and Investing Outcomes

Q. Investors usually have a short investment horizon, while climate impact is only realized over the long term. How do you persuade investors and managers to prioritize long-term growth over short-term profit?

A: Michelle Dunstan, Global Head—Responsible Investing; Portfolio Manager—Global ESG Improvers Strategy, AllianceBernstein: Yes, the shorter the duration your investments are, the more challenging it is to fully realize or fully incorporate the effects of climate change.

But there still are many short-term impacts. A lot of the physical risks we see—the slow increase in temperature—are going to play out over the long term.

However, there are physical impacts that are happening today. For example, we're seeing an increasing number of extreme weather events that are having a very short-term impact. Not considering those is a risk to investments over the short term.

The transition impacts, including those on cash flows and valuation, are playing out now—over the short term. We are seeing regulatory change—even looking at what has happened in the US since the election in terms of capital allocation, in terms of stock prices or bond prices moving around based on the assumptions of what the new administration is going to do.

So, whether it's implementing carbon taxes, changing regulations requiring your plants to upgrade their equipment or customers changing their preferences for what kind of products they're going to buy, those actually do play out over a very short term. Those all impact cash flows.

Q. Do you see exclusion or engagement as the most important tool for addressing climate in the investment context?

A: Lisa Sachs, Adjunct Assistant Professor of International and Public Affairs; Director, Columbia Center on Sustainable Investment at the School of International and Public Affairs at Columbia University: ESG investment means so many different things that each ESG product has a different strategy. Exclusion portfolios make sense for investors who just simply don't want to be exposed to certain types of assets for moral reasons, or because they think that they are just long-term bad stocks. Others are just integrating ESG as a risk factor, so they’re just accounting for exposure to these ESG risks. But it doesn’t mean that they’re doing anything different in terms of what they’re including or not including, or in terms of their engagement strategy.

Lisa Sachs

 

Engagement is the most important way for investors to actually change the practices of the companies they're holding, and from a strategic perspective for asset owners and asset managers. Our goal is for companies to align with value creation and to align with the interests of society, and to minimize their exposure to related risks. Unfortunately, those trends don't happen on their own. Market forces don't push in that direction. Many companies really need to be pushed. And they're attentive to the interest of their investors. Investors hold a lot of power in that respect and have a lot of opportunity to actually shift management.

Urbanization Trends

Q. How will migration to the cities and greater demand for consumer goods impact climate goals? 

Michael Burger

 

A: Michael Burger, Executive Director of The Sabin Center for Climate Change Law at Columbia Law School: The policy frameworks for coping with the current and future crisis of human migration as a result of climate change are just really under development now at the global, national and local levels. We’re seeing cities and cohorts, and networks of cities, trying to get out ahead of the vested set of issues that will arise as more and more people move into cities. It causes greater demand for services within cities, based on the demand for infrastructure, and the issues around where people are going to live, overcrowding and how to deal with the increased poverty that, along with the increased opportunities for wealth, also goes along with urbanization in the modern world.

Cities, internationally, are just beginning to develop policy frameworks for addressing urbanization as a result of climate migration. It's a relatively early stage; they are trying to figure out just how many people are going to move and where they're going to move and one of the policy scenarios under which that movement might transpire. We're at the early stages of trying to figure out what's going to happen. 

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to revision over time.