Transcript: In Conversation with Deirdre Cooper | The Future of Energy in a Net Zero World

Air Date: October 24, 2022 | 12:00 PM, EDT

Caroline Cakebread: Good afternoon, everyone, and thanks for joining us. I’d like to welcome you to this week’s Monday Minute Live Chat hosted by the Canadian Leadership Congress. Today, we’re addressing the future of energy in a net zero world. Here to address this topic for us is Deirdre Cooper, global head of sustainable equity and co- portfolio manager of the decarbonization strategy for global environment for Ninety One. Welcome, Deirdre.

Deirdre Cooper: Thank you so much, Caroline. It’s a pleasure.

Caroline: Excellent. Look, my first question is on policy. We can’t really get around that when it comes to net zero and decarbonization. I’d like your take on how effective governments have been at actually encouraging companies to reduce carbon emissions, and how this is working from your perspective. We get a lot of criticism that companies are focused a little bit more on PR than actual impact through some of these carbon emission strategies. What are your thoughts?

Deirdre: The first thing I’d say is, you’re absolutely right. Policy matters. It’s not the only thing that matters, but it matters. When we think about the drivers of decarbonization...and we do a lot of work on what are the things that are going to move us from the, say, ff the current pathway that we’re on, which might imply three or four degrees of warming down closer to the much-wanted one-and-a-half-degree scenario. We think about regulatory change; we think about technological change. Don’t discount human ingenuity. We also think about just individual behavioural change.

There are areas where meat, for example, how we eat, is a really good example of an area where we don’t expect policy, but we do see really different behaviour from younger generations versus older. Having said that, let’s go back to policy matters. No one really believes that we’re going to make it to net zero without government action, sadly. In a way, that’s the bad news because we don’t like being reliant on policy to meet our goals. That’s the bad news.

The good news, however, is that, at the moment, policy is pretty constructive. If you think about the big economies in the world and we go one by one—let’s talk about the U.S., let’s talk about Europe, and let’s talk about China. In the U.S., I’m sure you’ve seen Congress recently passed the inflation reduction rate. In spite of the title, the Inflation Reduction Act from a climate perspective is pretty much everything that the industry wanted from Build Back Better.

Build Back Better was the original stimulus bill that was really going to focus on climate in the U.S. and that didn’t make it through the Senate. It made it through Congress but really fell apart in the Senate because of some of the more moderate Democrats really not liking, not necessarily the climate policy, but some of the social measures. It was reinvented by Senator Joe Manchin as the Inflation Reduction Act. It has 10 years of visibility on tax credits for renewable energies.

It has an incredibly generous tax credit for making green hydrogen—hydrogen made from renewable energy rather than from natural gas—more economic than natural gas. It makes wind and solar energy more economic; now it makes them multiple times more economic than fossil fuel. It has incentives for electric cars; it has incentives for energy efficiency. It really is a step change in policy in the U.S. In Europe, post the Russian invasion of Ukraine, you’ve had another step-up in energy policy in Europe to focus on decarbonization.

In the short term, emissions in Europe will go up. The EU acknowledges that. We’re going to use less gas, more coal. But, of course, in the medium term, that just means the case for investing in renewable energy and energy efficiency in all of those areas has massively improved. In China, broadly speaking, you’re seeing more stimulus; you’re seeing monetary loosening, not monetary tightening. All of those things are supportive for the transition, and, more specifically, if you look at where stimulus is likely to go, and China’s well behind on its growth targets.

I think nobody thinks China is going to make its 5.5% stated growth target this year. It simply can’t only be property anymore; it needs to be somewhere else. Energy infrastructure, renewable infrastructure, electric cars—those are all very, very natural places to go. The regulatory environment, almost done usually at this point in time, looks pretty good. It’s never perfect in every sector at every time, but we’re in quite a nice place.

Caroline: That’s a good point. Let’s look at that a little bit because you’ve got a stronger regulatory impetus, and you’ve got these net zero targets. But standing back a little bit, how optimistic are you that countries, say, like Canada, [with] fairly aggressive net zero targets, can actually comply within the stated time frame?

Deirdre: Look, I think that the story is different in every region, and the regions that have the hardest journey are not actually the heavy emitters. And you mentioned Canada, Australia, for example, would be good examples of countries that have big energy industries that have high emissions, but are also countries that are in very different economic positions.

For example, some of the global sets, and those are the areas that we think will have the hardest time making their journey to one and a half degrees. Ninety One, as a business, was born in one of those emerging markets. We were founded in South Africa in 1991. That’s where our name comes from. Those are the countries that really have the hardest time. These are countries with north of 20% unemployment.

The employment that is really dominated in those areas. People don’t necessarily have the education and training that Canadians have to allow them to move into other industries to upscale, and that’s where we feel very strongly [that] support is required, and that support, of course, includes government to government, and some of my colleagues worked very closely with the South African leadership on the packages that were announced at the COP last November.

I think that was a really important deal, and those discussions obviously continue. But also institutional investors, I think, need to make sure that when you think about allocating to net zero, you don’t take money away from those regions of the world where that capital is going to make the biggest difference, and that tends to be in the global sector.

Caroline: What advice would you have for asset owners and countries like Canada, for example, where the energy sector is such a prominent part of the economy? We’re not alone. You mentioned South Africa, there’s also Australia—very resource- driven economies. As an asset owner, pension investor, et cetera, what should they be doing?

Deirdre: Our view as a firm, it is based on two high-level principles. We want to engage, and we want to invest. We don’t think that there’s a huge benefit to divestment. We certainly run money for certain clients that won’t invest in certain sectors, and for our sustainable equity group, we tend not to invest in energy, not for ethical reasons, but simply because, as we see that transition, as we see that carbon externality being priced, we see less value in the energy sector.

Particularly now once higher prices are discounted. It isn’t a sector we want to own for 10 years because we see such uncertainty around demand for regulatory, the technology reasons I talked about earlier, but if you want to invest towards net zero, you really need to do two things. First of all, you need to decarbonize your portfolio, but it’s really important that you don’t do that through divestment. The way that you can have an impact on real-world emissions, not portfolio emissions, is, of course, through engagement, and that’s exactly what we do.

As a firm, our target is that 50% of our emissions will be in companies that will have externally reviewed science-based targets by 2030, and 50% of our emissions is a much harder target than 50%. So what you’ll find as you look through—and this will be the case for almost every large asset owner—your emissions will be concentrated in a very small number of companies. That’s where you need to focus your engagement. It’s very easy for assets like tech companies to set net zero plans because they don’t have a lot of emissions; [it’s] really hard for energy companies.

You want to focus your efforts on the emissions; you want to focus your efforts on real-world change. For us, if we had 25 companies account for 50% of our emissions, but they make up only a single-digit percentage of our..., so we could come out and say we want 50% of our ... to science-based targets. We wouldn’t really have to do anything. Those companies are going to set their targets.

The target that we’ve set ourselves means we’re going to have to spend an enormous amount of time engaging with companies. And then equally important on the other side, you need to invest. So you need to invest in climate solutions, companies, strategies like the global environment strategy that are investing in companies that are the solution providers for climate change, that are really helping to move the world to net zero.

The world invested about $700 billion this year in climate finance; that number needs to be somewhere between $4 and $5 trillion. Then, of course, coming back to our last conversation, it’s even more impactful if you can do that in emerging markets. So some of my colleagues here run something called the Emerging Africa Infrastructure Fund. They invest in those projects, but only on the African continent. That’s [a] long-term project finance-backed by development banks really having an impact.

We think there’s a huge role for lending to corporates and emerging markets to help them to transition. That’s something we spend a lot of time focusing on and advocating for. What we really worry about, what we think you shouldn’t do, is set a non-discriminatory carbon emissions target across your portfolio. The right way to decarbonize is not to say I want my Scope 1 and 2 emissions.

We are direct emissions and the emissions from your purchased electricity as a percentage of market cap or as a percentage of revenue to be 30% lower than the market and to decrease that significant percentage every year because, realistically, the only way you do that is by selling companies with emissions and buying companies with low emissions. That’s going to make your portfolio look nice, but it’s not going to have an impact on real-world emissions. That we feel really strongly about is what we, as asset managers and asset owners, need to do.

Caroline: That’s a really good point because it’s very easy to reduce the carbon footprint of your portfolio by packing on tech companies, but you’re taking on a lot of risk in the process. Which brings me to my next question, which is around data and whether or not how reliable it is for investors. How should they be assessing the data around some of these investments?

Deirdre: The good news is that the carbon data is so much better than it was 10 years ago, five years ago, even two years ago. I’ve been working in sustainable climate finance for almost two decades and it’s been fantastic to see the pace of improvement. I wish the pace of improvement on other ESG data was as good as it is on carbon data, and a lot of that is regulatory-focused.

Most companies now will be reporting some emissions, but we’re nowhere near that improvement journey. We talked about how asset owners that set targets typically only look at so-called Scope 1 and 2 emissions—really, your direct emissions and your purchased electricity. What this misses are all the emissions from your supply chain and the emissions from your products once they’re used.

For example, in an energy company, 95% of your emissions will often sit in your Scope 3. Taking the oil out of the ground isn’t the problem. It’s when you burn it; you don’t own it when it’s burnt. You really need to take into account those Scope 3 emissions. That’s an area where I would ask anyone who’s listening to engage on Scope 3 disclosure where Scope 3 is a big category, and then the next step is to set a transition plan and to disclose your transition plan.

You talked at the beginning about companies overpromising, and it’s all PR, the ones that have a transition plan that has a big 2050 number and absolutely no journey to get there. So we want companies that have really detailed transition plans, that have short-term targets, medium-term and long-term targets, that tell us how much capital that they need to invest, that tell us who’s responsible, and that updates you regularly on their journey.

It’s also something that we, in the industry, need to do and that I really believe is not done enough in investment teams, is hold those companies to account. Ideally, your asset managers should be as familiar with a company’s carbon footprint as they are with its net income, that they should be able to tell you, well, the footprint last year was, maybe the carbon intensity was 1,500, and we think it’s going to go down to a thousand for a heavy emitter, or it was eight and it’s going to go down.

The differences between carbon intensity numbers for utilities versus tech companies are that big. You need to have a good idea how that looks, and you need to be holding them to account to deliver on their plans, just like you hold them to account to deliver on their financials. I don’t think the industry is there. We at Ninety One over the last couple of years have put our entire investment team through climate training.

Everyone across the teams has spent about 30 hours being trained by academics at Imperial College in London so that they really understand climate science and they really understand transition plans and they can then hold companies properly to account to deliver on those plans.

Caroline: I think that’s a great point. Maybe it’s just me, but over the last few years, I feel as if the feeling that policy-makers can really effect change has diminished somewhat and it’s easy to be cynical about policy and its ability to have an impact. Biden’s Inflation Reduction Act is, as hard one as it was, is focused on fighting inflation. You’ve argued that there are some game-changing developments in it that are related to energy and climate change. I’d like you to tell me a bit more about that.

Deirdre: Absolutely. There is no question that this is a game-changer for the U.S. in the field of renewable energy, in the field of green hydrogen, in electric cars, and also in energy efficiency. I think if you look through each one of those sectors, what you see on renewable energy is that renewable energy in the U.S. is incentivized through a tax credit.

Typically, that tax credit has a couple of years to run, and then it sunsets, which leads to these huge spikes, across the industry, which makes it really hard for companies to invest. We now have 10 years of visibility. On the hydrogen sector, we have the most generous hydrogen incentive scheme in the world. All of those companies that were looking to sell electrolyzers to make brain hydrogen are moving their business from Europe to the U.S.

The nice thing about this is, then you get a little bit of positive regulatory competition. We’re hearing European countries in the EU talking about where we need to do a bit more because we’re going to lose the hydrogen industry to the United States, so we’re going to have to figure something out, and that’s exactly what we want if we need to transition.

If you look at EVs, the U.S. is miles behind in terms of percentage of cars that are electric. In China, to give you an idea, last month, about 35% in new cars sold for electric, in New York, depending on the country, are somewhere between 18 and 20. In the U.S., you’re still in the 4% or 5%, but the Inflation Reduction Act has a significant extension of EV tax credits. It has investments in charging; it has incentives to build battery manufacturing.

That’s probably, in our view, the single most important point. That will reduce the cost of batteries and therefore make EVs cheaper for American consumers. It’s been great to see GM and Ford really get behind investment in electric cars, and they’re launching both of them a whole number of models over the coming years.

That, we think, gives us reason to be quite optimistic on electric car uptake in North America. On the energy efficiency side, there’s, again, a number of different incentive programs that we think will accelerate investment in energy efficiency, which, of course, is also accelerating because of high energy prices. There’s nothing like high prices to encourage investments in efficiency.

Caroline: Great. That’s excellent context. Thank you. As a portfolio manager, the environment around sustainable investing, the energy transition has shifted so much in the last few years. How has your decision-making process changed or your approach to making decisions changed in the last few years?

Deirdre: We as a group in the sustainable equity group at Ninety One invest on an investment philosophy where we all really believe that we are moving to a world that is increasingly going to price and value negative externals. That those companies that think not just about their financial shareholders, but about all their stakeholders.

Those companies that think about the environment and natural capital, that think about their employees and human capital, that are truly conscious of the role in society, the benefits of their products. Social capital, those are the companies that will thrive and generate performance in the future. They’re also the companies that are having a positive impact on those stakeholders. That’s a really exciting way to invest. The reason it’s so exciting is because we’re right at the very beginning of it.

The pace of evolution—in whether it’s data, whether it’s frameworks that we’re developing to understand those stakeholders better—is really, really fast because we are at the beginning of that. We talked about how much carbon data’s improved. We’re just at the beginning of biodiversity data where we’re working together with another small group of investors to develop now the TNFD, the nature and biodiversity equivalent of the TCFD.

That will be important. We’re working with companies on water and waste disclosure. We’ve been working with a professor at London Business School, led by my colleague Stephanie Niven, who runs our global sustainable fund, to understand company culture benefit. We’ve developed a framework with Alex Edmans—he’s the professor at London Business School—to assess company culture, not just on the buzzwords, what do the companies say the culture is, but rather to ask them really detailed questions about workplace practices.

We look for trust, recognition, support, and ownership mindset, and we have a specific list of questions to find those things. We think the companies that outperform on all of those are the companies that are great places to work and will thrive because they’re going to attract and retain the best and the brightest, and in the really long term, that probably is the ultimate sustainable competitive advantage.

Then led by Juliana Hansveden, who’s my colleague who runs our emerging market sustainable fund, we’ve been really thinking about social capital. That’s, of course, somewhere where you can have an even bigger impact as an emerging market investor. She’s thinking about financial inclusion, about the digital divide, about healthcare, and how companies can benefit their stakeholders, particularly in regions where consumers are genuinely underserved in those areas, and developing frameworks to assess that.

It’s evolved a huge amount in the last five years. I would expect it to evolve equally quickly in the next five years. We look forward to working broadly across the industry and with all our clients to develop those metrics together, because we do really believe in working collaboratively as a group to move capital to the right companies and the right places.

Caroline: Yes, and those are really good points. It raises a question. We talked about sustainable investing. We talked about ESG. As this area of investing has evolved, is there a distinction between safe, sustainable investing and ESG? If so, what is it?

Deirdre: The thing about many of these monikers is they mean different things to different people. To some people, ESG means a score that comes from an MSCI or a Sustainalytics or pick your favourite data provider. Our view is, we wouldn’t sum up a management team in a one to 10 metric; it’s even more difficult to sum up a company in a one to 10 metric. How do you offset a social benefit versus an environmental negative? How do you give a mark to company culture, even though you can very systematically rate it? Of course, we know this, that there’s very low levels of correlation between ESG scores. And we all know that there will be companies that have huge controversies that get big scores.

If that’s what you mean by ESG, I think that’s the past, not the future. A mark out of 10 is not the right way to invest in companies that are benefiting all of their stakeholders. I think when we talk about sustainable investment, again, it means very different things to different people. I have just explained how our sustainable investment philosophy works; it’s allocating to those companies that are working for all their stakeholders, that will thrive in a world that prices and externalities.

The one other point worth making—because it is a big source of confusion, I think, when we talk about either sustainable or impact-driven ESG—is it is important, I think, to divide between investment impact and company impact. When I’m talking about allocating to companies that are doing a great job for all their stakeholders, that’s company impact. We’re investing in listed equities; those companies existed before we invested, [and] they will exist again.

Our investment impact is really about signalling that impact matters, working as part of the community that we discussed, it’s about engagement. We spend a lot of time with companies, whether it’s on transition plans, it’s on disclosure, lots of different sustainable topics. And then there’s another piece of impact, which is capital in markets that wouldn’t have happened without it.

The Emerging Africa Infrastructure Fund that my colleagues run that I talked about is a great example of that. The projects they fund in Africa probably wouldn’t have happened without that capital. Our listed equities fund is not that kind of capital. That kind of capital tends to be concessionary, either in terms of tenure or risk profile relative to return.

I think it is important to separate those things and not to overclaim, not to claim investment impact, not to say our companies can’t use carbon, but we would never tell our clients you couldn’t use that carbon to offset your own footprint, because, of course, those are two very different things, but it is important to measure the impact the companies are having. It’s not that it’s not an impact, it’s just it’s a company impact. It’s not an impact of your investment.

Caroline: Yes. I guess one of the big questions that we hear around all of these funds and these approaches as performance is, [is] there a necessary acceptance of a lower performance that comes with making an impact with some of these investments? Or how do you see the performance of some of these approaches?

Deirdre: If you look at our sustainable equity group, and again, we’re saying we’re investing in companies that have an impact, we’re not claiming that our capital is going places where investment wouldn’t have happened without it. We absolutely believe that those companies will not just match, those companies will outperform. That comes back to this point that we think the world we live in is going to have to value those externalities more in the future than it’s done in the past. We are starting to price...carbon regulation is moving that way—it’s ups and downs and fits and starts, but the trend is unquestionable.

Human capital is more important; we’ve seen the Great Resignation. Interestingly, the data really...interesting study from MIT and Glassdoor that said, “If you looked at the companies [that] think people are leaving for salary, if you actually interview the employees that are leaving, it’s about culture.” Being a great place to work and having great human capital will allow you to create value.

We see signs of those externalities being priced, and, actually, if you look across our capability, you see the sustainable funds and inception—some are older, some are more recent—are outperforming the benchmarks. We have the data behind us to prove that. We think as we look forward for our performance as the speed of externalities pricing increases, that opportunity as well increases.

Caroline: Yes. I guess my final question is really around the stickiness of some of these companies and some of their initiatives. Are there impact strategies or sustainable strategies that you see that work at companies, and are there ones that maybe need a little bit more time or that you avoid?

Deirdre: Do you mean in the companies that we invest in, rather than across the investment management industry? Absolutely. There’s a whole range of things. We talked about assessing transition plans, but, of course, sustainability is much broader than just carbon. If we move into the human capital sphere, we always think a lot about diversity and inclusion. Our view is that you want to do inclusion first, and diversity is the output; it shouldn’t be the input. If we need the company to be a place where everyone across every spectrum, gender, ethnicity, et cetera would want to work.

That will lead to diversity, and that’s what we want our companies to do. That’s why we did all the work to develop our culture assessment to try to find those companies that really will have great and inclusive cultures. As we start to move deeper into fields like biodiversity, it becomes really complex, and you really need to avoid companies that are overclaiming.

Generally, you want to see people taking baby steps, not rushing in. You want to look at where the person responsible for sustainability strategy sits. Do they sit in the PR department? That’s not ideal. Or do they have real clout over operations? We hold a semiconductor company in Germany where the head of sustainability has a person who reports to him in every factory.

There’s a particularly toxic greenhouse gas called SF6, and if you want to use SF6 in the factory, you need to have approval from the head of sustainability and you can override the factory manager. Those are the kind of things that we look for to find those companies that are really taking this seriously and are not just making announcements to keep their shareholders or their customers happy.

Caroline: Is biodiversity the next big thing?

Deirdre: It’s certainly really important. I think we would say that it’s very challenging from a company perspective because it’s very hard to know. If your company refuses to buy palm oil from a certain place, does it just go to the other buyer? How do you deal with the additionality? It’s certainly an area where we think company engagement is important, but it needs to be done in a lot of detail.

It’s an area where sovereign engagement can be really important because then you don’t have that, you engage with a country to make sure it collects, it protects its forests, and you have less of that problem of moving things between bottles and sending one lot to the right customers and the other lot to the wrong customers.

Caroline: Great. Excellent. Look, thanks very much for your comments today, Deirdre, and I’m sure they’re going to be helpful for everyone who’s signed on today. That wraps this week’s Monday Minute. Don’t forget to send us your questions and we’ll get right back to you with our speaker’s response. We’ve got a lot of exciting content and great interviews lined up this year that you won’t want to miss. Be sure to hit Like and Subscribe on the buttons below and visit us at leadershipcongress.ca to get more information about our CLC newsletter. It’s great and you’ll enjoy it. Thanks very much, Deirdre.

Deirdre: It’s a pleasure. Thank you so much.

Caroline: Thanks, everyone, for joining. See you next time.