Welcome back everybody, my name is Freddie Fuller and I’m the product specialist on the RBC European Equity Team and after a tumultuous few months in both markets and geopolitics, we’re going to explore some of the impacts of these events on the broader sustainability movement within Europe. Especially with what we see as a need for Europe and the West to look at the implications of their sustainability transition in a global context. To discuss this, I’m joined again by Elma de Kuiper, Portfolio Manager on the desk.
Elma, I thought it might be an apt place to start with how the war in Ukraine has really served to lift the curtain on many of the inherent contradictions in Western energy policy and how this feeds into broader sustainability and carbonization trends. Perhaps, the most obvious position to pick out first might be that of Germany. Now we will always seek to extricate ourselves from the broader moral questions of paying regimes that a Western centric point of view may deem questionable, but the more interesting point is one you recently made regarding the way that Germany has handled its broader energy policy in the face of the need to decarbonize.
Yeah, Germany is a great one to discuss simply because there’s been such a change. Until 2011 Germany obtained a quarter of their electricity from nuclear energy, and they had 17 reactors. But then Fukushima happened and that spurred the decision to fully faze this out this year, 2022, a mere 11 years later which is very fast. Now that’s interesting because popular opinion had been trending against nuclear as an energy source since long before that, the 1970s, and all of this is very well intentioned in terms of its motivations in safeguarding citizens and protecting the environment. I guess because this transition was so fast it’s left Germany more reliant on coal and gas to meet their energy needs and there’s some worrying statistics associated with that. The National Bureau of Economics has found that Germany’s decision to switch off their nuclear reactors causes an additional 1100 deaths per year due to additional air pollution and that’s because carbon dioxide emissions have increased by around 36 million tonnes. Now that’s not ideal, half of Germany’s electricity supply today comes from non-renewable sources, including 35% from coal and lignite. You know it’s true, Germany definitely is prioritizing the decarbonization of their economy, but the fact remains that they still import vast amounts of coal and gas for their own use. You mentioned Ukraine, well 40% of Germany’s natural gas today is imported from Russia specifically and that does leave them in a sticky situation. Unfortunately it doesn’t solve the emissions problem, especially given that Germany doesn’t plan to end their reliance on coal until 2038.
Yes, I think that this issue can be fairly extrapolated out to a number of Western countries, not just Germany and, you know, demonstrates quite how reliant we are on fossil fuels for the energy transition. Just look at the recent political debate in the U.K. around the pressure on oil and gas companies to increase fossil fuel capex being case in point. Now, there are questions around how much the transition may be stalled by the recent crisis. I’m not sure that’s for us to comment on. Instead, much of this comes back to the point we make a lot which is needing to approach these things with a skeptical mindset. It’s all well and good developed nations promising targets but then proceeding to offshore their dirtiest activities. The point being that you must always, always examine the counter-factual and this is just talking about energy for power generation and we haven’t even scratched the surface of energy for product manufacturing.
Yeah sure, take the position of Iceland actually. Proportionally Iceland is the world’s biggest energy producer by a wide margin. They produce around 55 kilowatt hours per person which is four times more than the U.S. and well over double that of Norway which is in second place. You know, that shouldn’t be a concern in itself because nearly 100% of their electricity is derived from renewables – hydro and geothermal so the heating literally comes from the warmth of the Earth. But, still some would point the finger at the fact that the majority of this clean energy is used for heavy industry and most notably the production of aluminium and, to a lesser extent, silicon and other metals. Iceland produces more of these metals than any other European country apart from Norway. That is a fair point because of course that is emissions intensive but this critique fails to take into account that arguably is a positive because by producing these important metals with 100% renewable electricity in Iceland, it causes 10 times less CO2 emissions than if those activities were to be moved to energy intensive China.
Which has been a trend for many number of years now but, you say that the more that is produced with this renewable energy supply, not to mention the safer and less contentious labour practices, you would say arguably better for the planet. The point also here being is that public policy is probably behind the curve in taking this into account.
Yeah, absolutely. I mean both the Icelandic government and the EU target reduction in CO2 emissions but that’s on a local level rather than looking at the broader picture on a global scale. It is actually a fascinating fact that if the next aluminium smelter were to be built in Iceland rather than in China, globally that would more than make up for all of Iceland’s current CO2 emissions which is a huge win. Of course, that same logic applied to any energy intensive industry that could make use of renewable energy in the West rather than say coal in a faraway country.
Effectively what we’re saying here is that if the ultimate aim is to decarbonize our global activities then that is what it must be. It’s a pointless exercise to look at these things in autarky, even in Europe where regulation just about remains ahead of the curve there remain issues. You know, you talk about the ability to build out renewable infrastructure. There’s a huge amount of concrete and steel, amongst many other things, required for this so will the EU only use that produced within the EU using cleaner energy, how far will this raise the capital required for the break-even point for renewables in the future? Does this suggest that support for the oil and gas industry from an ESG investment point of view is actually a necessity because it’s a necessary facilitator of the build out of renewables? This is a point that has, perhaps, been muddied in the last few years but they are very complicated questions. Ultimately, much of this comes through the complexity of a heavily interlaced and globalized world, going through a potential transition to a more regional or national self-determination in regard to energy supply and policy with the recent geopolitical events serving as a catalyst.
It’s an interesting question and, you know Freddie, it’s not just limited to countries actually. As an investor from an investment standpoint, it’s become increasingly important to engage with businesses far beyond their own reduction targets. Those companies that look best through an ESG are often those that completely outsource production because then their carbon footprint looks nice and low, and their core business can be considered clean. You can think of lots of different examples but just to name a few; electric vehicles that use lithium ion batteries manufactured by very carbon intensive factories in China not to mention the raw materials and where those are mined; solar panels where the raw materials are sourced from mines using slave labour in Xinjiang. These companies are effectively rewarded for their capacity reporting on these more nebulous parts of their supply chain. Perhaps that’s because being perceived by investors to be green, they trade on a much higher valuation.
Yeah and, you know it’s interesting to note that shareholders in those businesses do in a way share this perverse incentive because they would have made pretty good money themselves as a result and given that management teams themselves are rewarded in company shares, typically rooted in total shareholder return targets, they too benefit directly from the spoils of being deemed an ESG business. Perhaps it’s worth going into an example here of some of the inherent conflicts that companies display. I know that you’ve been looking into shipping on this basis recently.
Yes, take Maersk, one of the biggest shipping companies in the world and how they handle the disposal of their ships once they’ve reached the end of their lifespan. So, Maersk is a Danish business, and they have several standards around ship disposal that, as a result, would naturally apply. Firstly, there is some standards around hazardous waste but also, very specifically, there’s an EU law that came into effect in 2018 called the ship recycling regulation and that requires companies to scrap ships registered in the EU in EU approved facilities that maintain environmentally sound operations and ensure worker safety. That’s the goal behind that particular piece of regulation. There’s several examples of Maersk having sailed ships to unusual ports and then selling their ships or changing the flag which then allows them to use shipyards for disposal that are not subject to EU rules. This is a practice that is entirely legal, it should be said, and it’s definitely not limited to Maersk. 90% of ships globally are disposed of in this way but I do think it represents just how widespread, and it’s so emblematic of our globalized economy and how it contrasts with these localized regulations and, in the case of shipping, bypassing them is very easy. It’s made possible because of the use of something called flags of convenience. You can choose where to register your ship and, you know, these are often countries that allow ship owners to pay a fee to register with them and often they’ll fail to police international maritime law or regulations to the same extent. Now if you look at Maersk ESG report, and they report extensively on matters, they do note their approach to responsible ship recycling, but they make no mention of either the OEC or the EU rules when they discuss the shipyard they utilize in the relevant location of Alang in India. Therefore, it’s interesting for the company to cite sustainable ship recycling as a core priority, especially when contrasted with earlier comments made by their Head of CSR in 2016 who actually said that flying an EU flag would hinder Maersk’s ability to use the shipyards in Alang, then they would consider changing the flag and they have subsequently been shown to have done that which is very interesting and kind of makes the point. I will say that Maersk’s publishing of yearly sustainability reports is laudable and, indeed, they’ve committed to reducing the emissions generated from their operations and they’ve actually championed improved recycling schemes for many years but it does just highlight the need for new ones when, as an investor, you’re analyzing these corporate sustainability targets or reports.
While Maersk and the wider shipping industry may eventually make progress on sustainable business practices, you’re suggesting that as long as things such as flags of convenience and last voyage flags prevail, the EU’s attempts to regulate will never really have the desired impact. Is that what you’re saying?
Really that just points again to the need for as broad a coalition as possible when it comes to policy and regulation at both a corporate and regional basis to ensure that the correct course is set on sustainable practices. Unfortunately, that is all we have time for so thank you very much Elma for joining us and to all of our listeners for tuning in.