Chinese equities continued to be volatile over the last quarter - a small rebound before news about Evergrande’s debt crisis and a widespread power shortage weighed on investor sentiment. More than half of China’s provincial-level jurisdictions faced power rationing, triggering blackouts and forcing factories to temporarily curtail production. The shortage is caused by insufficient coal due to energy conservation and emission restrictions, coupled with lower electricity supply from alternative energy sources amid adverse weather conditions. The Chinese government responded by increasing coal supply and liberalising electricity pricing: a case of necessity trumping over the environment?
As we reflect on COP26, the carbon footprint of China and emerging markets remains in focus. These countries operate as the factories of the world – delivering raw materials or supplying components and finished goods that are essential to our lives. Even as we move towards “net zero”, mines must still deliver copper and cobalt for our electric vehicles, and steelworks and aluminium smelters deliver components for our buildings and bridges.
In addition to a significant skew to high emission sectors, emerging markets are well behind developed peers regarding emissions within each sector. At the same time global asset owners are under pressure to demonstrate action towards net zero and undoubtedly there is more regulation to come. In the quest for reducing emissions, investors must ensure they don’t forget the manufacturers of essential goods in emerging markets. Simply put, we need these companies. They need sufficient capital to ensure they can meet global demand for their products and also make the necessary investments to clean up production. Reductions in their emissions can have a dramatic impact on global emissions – some large companies in China, Brazil and Russia could each reduce emissions over the next 5-10 years by more than the total emissions of smaller European countries.
Take Gazprom, the large Russian state-owned gas company. Most of Europe, including the UK, is reliant on gas supplies from Russia and hence from Gazprom. It has a very poor ESG rating. However, what may be surprising is the initiatives it is taking to reduce emissions. Thanks to the hard work of a number of local asset managers the company has improved its governance over recent years and committed to significantly reducing carbon emissions. It reduced these by 8m tonnes CO2 equivalent over the last year just by making small efficiency improvements. This equates to roughly 13% of Sweden’s total emissions. Furthermore, it has committed to a further 22.6m tonne reduction by 2031. One Russian investment manager told us that their portfolio companies have announced combined annual emissions reductions equivalent to 130% of Sweden’s annual greenhouse gas emissions. Gazprom’s share price has also doubled over the last year. This example demonstrates that it is possible to deliver both returns and reduce emissions. However, it requires exceptional investment managers that are willing to engage with companies (and even the Kremlin in this specific example).
We strongly believe it is possible to achieve similar results by investing in Chinese companies. Anhui Conch, a cement company, enjoyed strong returns as it took market share from competitors that were unable to meet ever-increasing environmental regulations. Most recently, CNOOC, the state-owned oil and gas company, announced a carbon neutrality plan and established a Carbon Neutral Institute.
Almost every investment manager, bank or economist that focuses on China tells us that the government is very serious about achieving carbon neutrality by 2060. Individual cities have even more ambitious targets. Shenzhen, a city of 15m with a GDP of $423bn, plans to reach net zero by 2030. It is the first major city to fully electrify its bus fleet (16,000 vehicles). Companies are following a similar path. In order to be globally competitive, Sany Heavy Industries, the Chinese maker of construction machinery equivalent to Caterpillar or Komatsu, needs to offer products with comparable energy efficiency. Its ESG reports reveal how it has been working to increase the energy efficiency and reduce pollution in mining and industrial processes such as welding and spray painting. The company has also launched mixer trucks, dump trucks and tractors that are either fully electric or powered by hydrogen fuel cells.
Whilst it is exciting to see the world taking action on emissions, the transition needs to be managed carefully. Gas shortages in Europe or coal shortages in China remind us of the fine balance between making the transition but not going so fast that the economic consequences become counterproductive. The green economy transition provides abundant investment opportunities in China, which is the global leader in renewable energy, electric vehicles and their supply chains.
ESG reporting has historically been poor in China but is rapidly improving. The Hong Kong SFC has proposed climate risk disclosure requirements that are consistent with the TCFD and no doubt the onshore regulators will follow in due course. According to CDP, an NGO focused on environment-related global disclosures, TCFD reporting of Chinese companies has increased sharply over the last three years. In 2016 they only had one company that achieved their highest rating and now there are more than 12 that have A or B ratings. No doubt there is still lots of room for improvement, but the trend is in the right direction
Lars Hagenbuch, Consultant, RisCura
