Positioning your ethical energy portfolio

Monitoring climate policies and considering stocks beyond renewables are keys to maximising clean energy investment portfolios.

While it might be evident to some that wind and solar power are considered ethical investment choices, technologies that enable the transition to a completely sustainable energy cycle are equally qualified.

In making investments with a focus on ethical outcomes my company – Australian Ethical Investment – needs to consider how energy is produced, transported, consumed and regulated in determining the best investment opportunities for our investors.

So, while we hold 16 per cent of our funds in renewable energy, the balance of the portfolio is invested in companies that own critical energy infrastructure, enable waste recycling, ensure efficient capital allocation by pricing climate change into their products, and promote products and or services that reduce energy usage.

This approach means we are continuously tracking numerous issues and opportunities throughout the energy market.

At this time, we believe there are five primary issues that influence portfolio positioning over the next 12 months:

1. Negotiations over the EU’s 2030 climate and energy goals

While the European Union Commission has expanded the EU’s emission reduction target from 20 per cent to 40 per cent, it is now calling for a non-binding renewable energy target of 27 per cent and has yet to disclose what its plans are for energy efficiency.

This softening in the EU’s broader energy policy towards renewable energy is part of a larger societal and political pushback by member countries that are trying to better balance climate protection and affordability. Germany probably best demonstrates this new attitude towards renewable energy because while subsidies are being scaled back, they are not being done in such a destructive or haphazard approach as seen in Spain, for example.

We get the sense that the EU is moving towards a more technology agnostic approach to emission reductions versus government-prescribed solutions. The seeds for such a change can be seen in vehicle emission reduction targets that prescribe targeted levels of emissions that need to be achieved by a certain time but which automobile manufacturers are free to comply in whatever method they propose. This is a decidedly more market-based approach to tackling emissions, which would also be consistent with the EU Emission Trading Scheme.

2. Japan’s progress transitioning away from nuclear to natural gas, coal and renewable energy

Post the Fukushima disaster, Japan is struggling to build the new capacity to replace its nuclear reactors that might never be restarted. This is no small task as nuclear power contributed to more than 25 per cent of the nation’s electricity generation before the disaster which is 1.2-times more electricity than Australia consumes annually. So far Japan has approved over 20 gigawatts of new solar capacity, which in a world that only installed 31 gigawatts in 2012 indicates renewable energy will have a good position.

3. Increasing American domestic oil and gas production

Increasing American unconventional oil and gas production has profound global ramifications too numerous to be quickly surmised. One specific area we are focused on is the increased substitution of natural gas for diesel for both trucking and train haulage. The immediate fuel savings, lowered maintenance expense, lowered emissions and similar performance are resulting in meaningful take-up by US logistics companies.

4. US Environmental Protection Agency’s carbon pollution regulations

The US Supreme Court is currently hearing arguments in regard to the Environmental Protection Authority’s authority to regulate carbon pollution. While the current challenge is focusing just on the EPA’s permitting process, a ruling against the agency would put the Obama administration’s plans to tackle climate change in flux. A positive ruling would be supportive for the natural gas and energy efficiency sectors while a negative ruling would be supportive for the coal industry primarily. This legal overhang has plagued the EPA for some years and it is hoped that its authority to regulate carbon pollution will be reaffirmed when the Supreme Court makes its ruling around July.

5. Increasingly national versus supranational efforts towards the decarbonisation of the economy (which will likely not include Australia)

With the end of the latest United Nations climate talks in Warsaw, we note the growing discord between nations in addressing emission reductions. Though a global treaty on emissions to replace the Kyoto Protocol would be the best outcome, we note that in its absence nations continue to decarbonise their respective economies with sensible local policies that have dual benefits. Two notable examples:

– Many developed nations have specific fuel economy mandates that will see dramatic improvements by 2020. These mandates improve fuel economy and reduce the CO2 emissions from vehicles.

– Many developed nations (admittedly some do so only at a state level) have some way of pricing carbon as they recognise it as an unpriced externality. Said differently, they recognise it as an invisible cost on society and put a price on it so people see it. By pricing carbon there is pressure to reduce this cost which inevitably leads to either increasing lower emission energy production or outright energy use reduction, either of which is the right national outcome.

Unfortunately, Australia does not have a fuel economy policy and would appear to be only encouraging a token price for carbon, which puts us decidedly out of step with much of the world. In this global period of uncertainty, being efficient and minimising costs resonates with both corporations and households, which portends to an extended period of opportunity for investors. Particularly taking a holistic approach to the energy market that inherently focuses on energy efficiency will provide growing opportunities.

Nathan Lim is international equities portfolio manager at Australian Ethical Investment. He manages the $128 million International Equities Trust, which is themed around global smart energy. All of Australian Ethical’s investments are made in-line with their Ethical Charter.