Climate Change - June 2023 Update
The rate of temperature rise in the last half century is the highest in 2,000 years. Concentrations of CO2 are at their highest in at least 2 million years. The climate time-bomb is ticking. The 1.5°C limit is achievable, but it will take a quantum leap in climate action. In short, our world needs climate action on all fronts – everything, everywhere, all at once.
António Guterres, UN Secretary-General, March 2023
An update on megatrend #6, Climate Change, isn’t due until later this year, but something ‘untoward’ has popped up on my radar screen which warrants a few comments, hence this early update. That “something” is the return of El Niño, one of the most powerful and influential weather phenomena known to mankind. El Niño was actually discussed in some detail in the June Absolute Return Letter. If you haven’t read that letter yet, I suggest you do so.
El Niño is not manmade. Both El Niño and La Niña – El Niño’s cooling opposite that has been with us since 2020 – are natural weather phenomena, resulting from variations in ocean temperatures in the Equatorial Pacific. In the following, I will explain what the implications are weather-wise when El Niño takes over from La Niña, and what investors should do.
The return of El Niño
Nearly everyone thinks the last few years have been characterised by exceptionally warm weather, but the truth is more nuanced than that. Average temperatures have actually been held down by an unusually long La Niña. Had it not been for her, 2020-2022 would have been much warmer. That said, La Niña is now being replaced by El Niño. You could actually argue it has already happened. The change from La Niña to El Niño spells much warmer weather the next couple of years. The extreme temperatures in the Mediterranean in April were only the first sign of what we can expect (see the story here).
As El Niño is not manmade, some climate sceptics have argued that the extraordinary few days in the Mediterranean in April were a result of a natural weather phenomenon, and that one shouldn’t overreact. The problem with that argument is that El Niño also existed in pre-industrial times; however, temperatures of 40°C+ in the Mediterranean in the month of April happened less than once every 40,000 years back then (such things can be accurately measured). Furthermore, in the last 2-3 years, La Niña has cooled down the entire planet; yet, it has been extraordinarily warm pretty much everywhere. For those reasons, you will struggle to convince me that we should ignore what happened in the Mediterranean in April.
Several greenhouse gases contribute to global warming with the biggest culprit being CO2 (Exhibit 1). As the most significant source of CO2 is fossil fuels, it is fair to say that the problem will not be properly addressed until fossil fuels have been completely fazed out, and that is still (most likely) decades away. Having said that, CO2, and the use of fossil fuels, is far from the only problem. Take for example CO4 (methane). It is a biproduct of agricultural activities, waste management and energy use, particularly biomass burning. Or take N2O (nitrous oxide) which is also, first and foremost, the result of agricultural activities, e.g. fertilizer use (source: EPA).
Sector-wise, the agricultural industry (including forestry and other land use) is one of the biggest emitters of greenhouse gases worldwide (Exhibit 2), i.e. you won’t entirely fix the problem by phasing out fossil fuels. This must not be used as an excuse to continue to burn fossil fuels, though. They are a very clear number one on the list of offenders.
Emissions by country
Geographically, the worst CO2 offender worldwide is China, accounting for nearly one-third of all emissions (Exhibit 3). The problem is that greenhouse gases don’t acknowledge geographical borders. When the Chinese burn fossil fuels, it affects the weather everywhere.
Whereas the use of coal (the most polluting of the three fossil fuels) is declining in many countries, it is rapidly expanding in China. Permits, construction starts and new project announcements on coal-fired power plants all accelerated dramatically in China last year with new permits reaching the highest level since 2015. Construction starts on coal-fired power plants in 2022 were six times larger in China than in the rest of the world put together.
Indeed, the Chinese started the construction of 50 GW of coal power capacity last year, a more than 50% increase vs. the year before. Many of the new projects had their permits fast-tracked and moved to construction in a matter of months. A total of 106 GW of new coal power projects were permitted – the equivalent of two large coal-fired power plants every week (source: Centre for Research on Energy and Clean Air).
In the last few years, the Chinese have made a big issue out of coal power plant retirements, arguing that this is an integrated part of plan to become greener. However, that can only be classified as greenwashing of the worst kind. In 2022, Chinese coal power plant retirements totalled 4.1 GW, down from 5.2 GW in 2021. Those numbers should be compared to 106 GW of new permissions issued last year.
I won’t spend much time on the rest of the world, as it largely complies with the UN’s guidelines. Only India should probably get a mention, as the industrial revolution there is a few years behind that of China. Political leaders in India, like in China, have declined to join European and North American commitments to go net zero by 2050, arguing that such a policy would unreasonably constrain the country from raising living standards.
Mostly for that reason, I think the climate crisis will get a great deal worse, before it stands any chance of easing. It may not yet be too late to save the planet from the apocalypse projected by many, but it is a very close call. If the Chinese and, after them, the Indians continue to use fossil fuels in large quantities, by the time they realise they shouldn’t have done so, it will almost certainly be too late for everyone.
That said, it is worth pointing out that China and India are not the main culprits of the current climate crisis. Rather, they are the straw about to break the camel’s back. Europe and North America, more than anyone, have emitted vast amounts of CO2 since the early days of the industrial revolution, i.e. for more than 250 years, and current climate problems are the result of cumulative CO2 emissions since then – not the result of what China and India are up to right now.
What to expect this year and next
With the arrival of El Niño, certain things are likely to happen (source: Leeds University). First and foremost, the +1.5°C degree cap set by the UN could be exceeded for the very first time. We are already 1.2-1.3°C above pre-industrial temperature levels, and the average El Niño raises the mean temperature on Earth by 0.2°C. If this El Niño turns out to be above average in strength (all El Niños are not equally powerful), the average temperature could rise by 0.3°C or 0.4°C, in which case we will exceed +1.5°C for the first time ever.
This will most likely create a great deal of panic in the political corridors around the world, which could drive various political leaders to gear up their combat against climate change. Stocks positively exposed to the green transition will probably respond in kind but more on that below.
Australia is likely to be greatly affected by El Niño, as it always is. Australia has ‘enjoyed’ three years of La Niña conditions. That brought plenty of rain and severe flooding to many parts of the country. With El Niño returning, the rain and floods will be replaced by drought, excessive heat and increased fire risk.
Another problem in El Niño years is that the Amazon rainforest becomes drier; thus, the vegetation growth slows. This has the effect of reducing the uptake of CO2 all over South America, which will send the alarm bells ringing around the world. Europe will also be affected. El Niño almost always lead to drier and colder winters in Northern Europe, while the winters in Southern Europe tend to be warmer but wetter.
How it could all pan out
Not all El Niño years are identical, but the overall picture is pretty clear. After a few years of benefitting from the cooling effect of La Niña, we are now in for a few years of above-average temperatures caused by the arrival of El Niño. Precisely how much we can expect the temperature to rise is difficult to say, though.
That said, the combined effect of El Niño and rising CO2 levels will probably lead to an uncomfortable temperature rise and an unpleasant increase in the number of natural disasters. This could again turn all the red warning lights on in the political corridors. Politicians don’t always understand the finer details, and neither is it always their job to do so. This implies that we could be in for a massive overreaction later this year and/or next year if things develop as I predict.
Petrol and diesel cars could be banned altogether. It could also be outlawed to heat your home with oil. And the biggest offender of them all – coal-fired power plants – could be facing early retirement. Who knows? I can think of half a million different ways politicians may choose to tackle the rising CO2 problem. It is not that simple, though. The EU and North America account for only one-quarter of global CO2 emissions from fossil fuels (see Exhibit 3 again), so it is critical to get the rest of the world to back up the net zero programme if we want it to stand any chance of success.
Whatever action our political leaders choose to take, the primary objective must be a significant reduction in CO2 emissions. Even if the Americans and European struggle to get the whole world to back up the net zero programme, I very much doubt that this will be used as an argument to do nothing. In today’s climate conscious society, such an approach will be akin to committing political suicide. And, for that reason, your portfolio should be heavy on climate crisis solutions. In our megatrend portfolio, we currently allocate almost 50% to climate change-exposed equities and commodities.
Longer term, one of the biggest winners investment-wise is probably going to be carbon allowance trading. Today, the EU has the most ambitious carbon permit programme in place (you can read more about it here). In simple terms, the way it works is that heavy emitters (airlines, heavy industries, power plants, etc.) are allocated a certain amount of CO2 every year that they can emit without any further ado. If they emit more than that, they must buy additional carbon credits on the carbon exchange to cover the shortfall, typically from those that emit less than permitted who can sell those excess carbon permits. We are increasingly active in this market, as we believe governments will tighten the screw further, and that is likely to drive up the price on carbon permits.
Other likely winners would include lithium, graphite, copper, nickel, aluminium, uranium and water, all of which have been discussed extensively in other research papers, so I shall not go into much more detail here. The only exception is water which deserves some clarification. Most investors, when investing in water, buy water utility companies, but we don’t think that is the best approach in a world increasingly suffering from lack of freshwater. When we invest in water, we focus on companies providing solutions, as we believe a rising use of various water technologies will be the way forward to solve the problem. Take for example the antiquated water pipe infrastructure many countries are suffering from. Vast amounts of freshwater are lost every day through leakages, but that problem could relatively easily be fixed, provided the money to fix it is made available.
Another new water technology is the smart water meter, which not only helps to reduce the overall consumption of water. It also assists users in determining when it is optimal to use water. The technology is similar to the technology increasingly used by households to determine when to use electric appliances like dishwashers and washing machines.
Niels C. Jensen
30 June 2023