Climate change is an unavoidable issue for everyone - governments, businesses and consumers alike - as the effects of rising temperatures and pollution levels have become increasingly apparent. The current COVID-19 pandemic is also expected to have an impact on the future trajectory of climate action. Please join Portfolio Managers Zeena Dahdaleh and Veronique Erb of the RBC Emerging Markets Equity team as they discuss the climate change theme and future of food production in emerging markets.
Watch time: 22 minutes 55 seconds
Welcome to the next webinar in our Future of Emerging Market series.
Today we’re joined by portfolio managers Zeena Dahdaleh and Veronique Erb, and they’ll be sharing with you their latest research into climate change and the future of food in emerging markets. Now we believe these two areas will create significant opportunities, but also risk, for investors in emerging markets going forward.
And with that, I will hand over to Zeena.
So climate change is an unavoidable issue for governments, corporates, and consumers alike. The World Economic Forum has recognized environmental issues as a top global risk. As you can see from this page here, extreme weather events, climate change, failure to mitigate and adaptation, in addition to natural disasters, rank as the top three global risks in terms of likelihood. This has especially been the case for the past few years and, we expect this to be the case for decades to come.
In the next few minutes I’m going to talk through with you what we believe are the key drivers behind the climate change theme, climate change with an emerging market perspective, and the impact of COVID-19 on the theme. I’m then going to hand over to Vero, who’s going to discuss the implications of this theme on a key sector, food.
So what are the key drivers behind the climate change theme, and why is it becoming more relevant? There are eight drivers that I am going to go through.
First of all, extreme weather conditions are intensifying worldwide. This is being led by a rise in global temperatures. As you can see from the chart on the left-hand side, the global average temperature continues to rise with 2019 marking the hottest day since the beginning of this record. Secondly, the health impacts are becoming more apparent. The WHO suggests that nine out of ten people breathe air that contains high level of air pollution. Furthermore, the number of deaths caused by air pollution is highest in emerging markets, as you can see from the chart on the right-hand side.
Thirdly, we have seen heightened public awareness. Climate protests in 2019 alone involved 6 million people across 140 countries.
Fourthly, climate and sustainable financing has really increased over the past decade with green bonds accounting for the majority of that financing. The other key driver is the financial implications. According to Moody’s, the cost of climate change to the global economy could range between US$54 trillion to US$69 trillion by 2100 if global temperatures exceed the target that’s been set by the UN.
As illustrated from the chart on the left-hand side, emerging markets are also projected to be impacted the most with Africa and Latin America expected to suffer the largest losses in terms of real GDP terms.
Corporates are also increasingly pushing the agenda on climate change, and although this is very much a developed market phenomenon, we do expect emerging market corporates to follow.
The seventh key driver is technology. So technology has been an important enabler. As a result, technological advancements costs have been declining for renewable energy and lithium batteries. And this is illustrated from the chart on the right-hand side where you can see the evolution of battery costs since 2010.
And then finally, governments. Governments around the world are responding to increased public concern; 195 countries have signed the Paris Climate Agreement and 187 have ratified it.
So with that in mind, what about emerging market countries? We expect emerging market countries to be disproportionately impacted by climate change, and as a result we felt it would be important to identify which countries face the biggest risks and which countries are well prepared. As a result, we developed a score card evaluating the risks facing emerging market countries and their level of preparedness. We allocated a 40 percent weighting to risk and 60 percent to the level of preparedness.
The score card incorporated 26 parameters across 24 EM countries. And you can see the results here, illustrated on this page. South Korea, Chile, and China are the highest ranks. These are the countries that came up as not only having the lowest relative risk within an emerging market context, but also being best prepared with regards to renewable energy investments. At the other end of the spectrum you can see countries such as Egypt, Qatar, and Pakistan.
The other key question we’ve recently been asking ourselves is what is the impact of COVID-19 on climate change?
Now with the onset of COVID-19, we have seen emissions reduce significantly in many parts of the world. At the time of researching this topic, CO2 emissions declined by 5.4 percent, as you can see from the chart here on this page. This is actually the largest drop we’ve seen in absolute CO2 emissions since 1975. Now, although shorter term, the pandemic has had a positive impact on emissions. The lower energy price and the need for governments to focus on global health and the economy has brought some skepticism as to whether we’ll continue to see the same momentum regarding climate action. The conclusion though, that we’ve reached, is although in the short term there may be a delay to climate change, we still believe that the longer-term goals for climate action will still be very much intact in emerging markets for four key reasons.
So the first thing to note is that when it came to the pandemic, many countries were not well prepared. As a result, the pandemic, if anything, is going to make governments focus on what are some of the longer-term risks for humanity. So climate change and the environment are key issues when that discussion comes up.
Secondly, the pandemic has led the way for fundamental change in human behavior, which we believe can have a permanent impact on the transport and food space and food sectors.
Thirdly, longer-term climate targets are unlikely to change from now, and any future fiscal stimulus could even focus more on renewable energy and the clean technology space.
And then finally, and perhaps most importantly, although we have seen lower oil prices that could impact future electric vehicle demand, we believe that the average—that the cost parity pathway for the electric vehicles is still broadly intact, and you can see that from this chart here, which look at the total cost of ownership of an internal combustion engine versus an electric vehicle.
Now agriculture and food stand as being large emitters of greenhouse gases. We think this is an important area to consider with relation to climate change.
With that, I’m going to hand over to Vero to talk about this is more detail.
Thank you, Zeena.
Indeed the food sector is facing increasingly enormous pressure as a result of climate change. In fact, in a recent study produced by the United Nations Food and Agricultural Organization in 2019, they warned of an impending food crisis that was so stark that business as usual is simply not an option going forward. Resources are already overstretched, land is becoming scarce, and it was estimated food demand will increase by over 50 percent between now and 2050. Food systems will have to undergo significant changes, given that the current methods are not sustainable.
Therefore, after Zeena completed her climate change report, I decided to deep dive into the future of food to see how we can solve these stresses on our food systems in the future, because it’s clear that the change needs to happen in order for us to live healthy and sustainably going forward. As ever, when change happens it’s because a multiple of factors collide to create the perfect storm. So the seven major issues facing the future of food and agriculture are the following.
Firstly, environmental issues such as greenhouse gas emissions and water scarcity.
Secondly, safety concerns with the recent pandemic, like COVID-19 and swine flu, even growing antibiotics resistance in humans.
Thirdly, scarcity of land.
Fourth, food security and the negative impact of globalization, because almost all countries globally are net food importers. They rely on trade. Fifth, huge and growing demand from emerging markets that at the moment cannot be met.
Number six, food waste. Up to 30 percent of all food produced globally is wasted annually.
And finally, consumer desire and availability. Consumers not only want to eat more healthily, they also want to do good to the planet. We are the conscious consumer.
These all lead to food price inflation. Although there has been cycles in food prices, the general trend for the last three decades is upwards and this has only been accelerated by COVID-19 and the anti-global sentiment, which has seen short-term supply disruptions.
For the purpose of this webinar, I will focus on the impact the food industry has on climate change. And now I’d like to focus on some of these in turn.
Firstly, as regards greenhouse gas emissions. As you can see in the left pie chart, food accounts for 26 percent of all global greenhouse gas emissions and animal products are 58 percent of that. Therefore, 15 percent of all global greenhouse gas emissions comes from the rearing of animals. This makes it the single biggest industry and single biggest greenhouse gas emitter of any industry. Bigger than transportation. Bigger than manufacturing.
But not all greenhouse gases are created equally. The five main greenhouse gases are: water vapour, CO2, methane, ozone, nitrous oxide, and chlorofluorocarbon. In fact, the most important greenhouse gases from animal rearing are methane and nitrous oxide. Methane, or CH4, mainly produced by enteric fermentation and manure, is a gas, which has an effect on global warming 28 more times higher than carbon dioxide. Nitrous oxide, arising from manure and the use of fertilizers, has a global warming potential that is 265 times higher than carbon dioxide. So in fact, whilst methane and nitrous oxide are actually more harmful, CO2 is still considered the most potent because, when you look at the top pie chart, it’s the one that’s produced the other 74 percent of the case and released more often into the atmosphere.
As a reminder, greenhouse gases trap heat within our atmosphere, making our planet hotter and causing climate change.
Indeed, as Zeena pointed out in the first slide of her presentation, extreme weather events are intensifying worldwide due to rising temperature. Further environmental pressures include land and water scarcity. Fifty percent of the world’s arable land is used for agriculture, of which the vast majority, 70 percent, is used for the rearing of livestock. And as a comparison, a mere 1 percent is used for urban spaces. The reason it’s so high is because of the feed conversion ratio, the efficiency with which the animal converts feed into output. For example, one needs 2.3 kilograms of feed to produce 1 kilogram of fish, 4.5 kilograms for 1 kilogram of chicken, 9.1 kilograms for pork, and 25 kilograms of feed are required to produce 1 kilogram of beef.
This will mean we will need significantly more land for livestock rearing if, as we expect, emerging markets’ desire for meat products continues to grow exponentially. And, as you can see in the pie chart on the right, 70 percent of fresh-water withdrawals globally is consumed by agriculture. Only 10 percent and 20 percent is used for domestic and industrial purposes. And in turn, it is livestock rearing, rather than growing fruit or vegetables that consumes by far the most water per unit produced.
When looking at global water stress levels they are only low in Canada and the Arctic. But India and China have medium to high stress levels, and that’s an understatement, as in China 70 percent of the groundwater isn’t even suitable for industrial use, let alone drinking. And the country has 20 percent of the world’s population with only 5 percent of the world’s water sources.
As people become wealthier, their diets change from being largely based on starchy staples to diets that incorporate increasing amounts of complete proteins in the forms of meat and dairy. Annual per capita consumption of meat has doubled since 1980 in emerging countries, driven by Asia as growing populations and incomes increase the demand for meat-heavy diets. In developed markets, meat demand has peaked, in part driven by vegetarianism and veganism as people become health and climate conscious. But meat demand from emerging markets will sustain growth for the global meat industry.
According to estimates from a joint study done by the United Food and Agricultural Organization and the OECD, global beer consumption will increase by 8 percent in the next decade, but growth in emerging markets will be triple that at 21 percent. And most of that will be driven by China. Though China is already the single biggest consumer of meat in absolute terms, on a per capita basis China is lower than developed markets. And, in particular, China remains lean in the consumption of high-quality animal protein such as beef, chicken, and dairy. In the coming two decades, therefore, it is believed China’s food consumption will be about improving the quality of their intake. Meanwhile, India has the lowest per capita consumption amongst major economies. As income levels in emerging markets grow, we, therefore, think per capita meat consumption levels will catch up with developed market levels. Estimates vary, but currently it’s estimated that the global meat industry’s total market size is anywhere between US$1.2 to US$1.5 trillion, and it is expected to almost double between now and 2040 as you can see on the chart on this slide.
The problem arises when we see that China will struggle to supply its rising demand. Costs in China are twice as high as peers. China’s land and labour account for 40 percent of the cost of production versus only 3 to 5 percent in Brazil and the United States. And given the multiplier effect of basic crops required to produce animal protein, this means we can expect to see China’s basic crop demand, so soy and corn, grow anywhere between 40 to 60 percent and this has to be largely met by imports. But given the current projection, it is estimated that by 2030 imports from Australia, New Zealand, the United States and Brazil combined are not even going to be meeting half the requirements.
Given what we know about the stresses on resources and consumer desire, I now want to move on to what could offer the best solutions. These are fivefold. Namely plant-based meats, lab-grown meats, insect consumption, livestock vaccines, and new farming techniques. And finally, as ever, the potential impact regulation could have, we could see these adoptions accelerate. There is talk that countries are looking at introduction a meat tax, not like a sugar tax, to try to encourage alternative protein consumption.
Now let’s look briefly at some of these in turn. Firstly, plant-based alternatives such as plant-based meats offer good solutions, especially while making use of complete proteins such as soy or peas. Many plant-based meats have come on to the market in recent years with supermarkets and restaurants serving an increasing gamut of non-meat options. In fact, 2019 was the year veganism went mainstream in developed markets. New plant-based burgers hit the markets and consumers were sold for both health and sustainability. The alternative meat market is a huge addressable market because you need to take the entire meat-based market plus the existing vegan and vegetarian markets and put them together that give you a total addressable market of over $1.5 trillion. So we can expect huge growth in plant-based segments going forward.
The second solution comes in the form of insects, which are the only complete, totally sustainable, and ethical food source. Gram for gram, they have up to twice the amount of protein as beef and they are already being eaten by 2 billion people in 80 percent of the world’s countries. So even if Western market consumers will have to get over their yuck factors, there have been huge investments into the segments. And now, for the first time ever, the European Union has provided large-scale funding and subsidies to insect farming.
Similarly, lab-based or cell-based meat has seen huge investments, mainly by technology companies globally. As you can see in the chart on the right, investments in what also is been dubbed “the clean meat movement” have quintupled in the last decade. Back in 1932, Winston Churchill was quoted as saying that we should escape the absurdity of growing a whole chicken in order to eat its breast or wing by growing these parts separately under a suitable medium. It’s as though he had a crystal ball because cell-based meat is in fact stem cells that are grown in a culture medium in a lab. This in turn saves land and water, eliminates the use of antibiotics and reduces greenhouse gas emissions. Currently they are not commercially available, but with the huge investments going in from cash-rich tech firms around the globe, as well as private equity, it’s expected that these will scale up meaningfully so as to make them a commercially viable option.
In addition, new types of farming are quickly evolving, from hydroponics to aquaponics, to vertical farming. In fact the picture on the right is of an Asian-based, already commercially operational vertical farm, which is often more efficient traditional open field farming. In addition, vertical farms offer solutions for smart cities: indoor farming in climate controlled environments, locally grown without using pesticides, and quick to market.
To conclude, our research has found that climate change and the future of food are irrevocably intertwined, but also that the themes are investible globally, relevant to both developed markets as well as emerging markets, and where we invest in those companies that are embracing change and avoid those companies that will be disrupted.
Thank you, both Vero and Zeena, for some very powerful insights there. Now we have received a couple of questions from our investors and I’ve highlighted here just a couple that have been most frequently raised.
So perhaps starting with Zeena, in terms of the country score card, what specific metrics were you looking at? Were you looking to assess climate-related risks and also country preparedness?
So when it comes to incorporating climate risk analysis at a country level, there are a large range of factors to consider. So the likelihood of extreme weather events, where countries such as the Philippines, Bangladesh, and Thailand are most at risk. The dependence on fossil fuels, where the Middle East is the most exposed. Air pollution is another factor where India and Pakistan are facing potential peril. And then with respect to preparedness, it’s really a variety of different parameters. We looked at corporate climate policies where South Africa, South Korea, and Colombia came up on top. We also looked at other metrics such as climate funding where Mexico, China, and Korea scored well.
So it’s really a variety of factors and we gave all these factors specific weightings, which resulted in the score card ranking.
Thank you. And for Vero, just a question on sustainable food. So clearly it does have potential to significantly disrupt the meat and dairy industries. But how is the team actually looking to get exposure to this theme?
Yes. I mean, as ever, when we discover a new theme, we’re conscious that new companies, disruptors if you like, will come out of nowhere and they serve a purpose, which is to disrupt and bring about change. But as is often the case, they burn through cash. They invest heavily, and as a result, we as minority shareholders have little in the way or return or dividend. And this is not the way we like to invest. We like to be able to sleep at night in the knowledge that the companies we invest in don’t have much reckless behavior, but they do embrace the change, but they won’t entirely be at the forefront of it.
So as regards plant-based and cell-based meat, we would not be investing in these companies that are currently burning through cash, but we do realize that, for example, food ingredients, enzyme companies, flavouring companies are set to benefit enormously and they’ve been around for the last many decades. And also we’ve also seen many of the incumbent meat and dairy companies are also embracing change and adjusting their product lineup. So we’ve invested, for example, in a soy-based dairy company that has been around since just before the Second World War, with a very, very strong brand and really poised to benefit from the demand of plant-based milk out of China.
Thank you, both Zeena and Vero. And thank you very much for joining our webinar today. Please reach out to your local RBC representative for any further information.