Help! Corporate Options for a Climate Centric World

Products Mentioned:
Carbon, Hydrogen, LNG, Water, Polyester, PET

Companies Mentioned:
GameStop, ExxonMobil, Chevron, BP, Total, Shell, CP Chemicals, Olin, Danimer Scientific, Gevo, Tesla, Dow, LyondellBasell, GM, Fulcrum Bioenergy, Blackrock, Eastman, Suez, Darling Ingredients, Amazon, Refinitiv

Subjects Covered:
Recycling, Renewables, Carbon Capture, Emissions, New Energy, The Hydrogen Economy, ESG Investing

C-MACC Weekly “CRETER” (Climate etc.)

Help! Corporate Options for a Climate Centric World

Despite ever louder calls for uniform metrics and consistent reporting, large elements of the ESG investing process remain clouded in inaccuracy and inconsistency – and consequently ripe for abuse or misuse.
The flow of money into ESG focused investment vehicles continues unabated, driving the increase in challenging valuations and increasing the incentive to “greenwash” for both companies and investors looking to deploy cash. The need for better structure and clearer definitions becomes more imperative each day.
We take a look at the battery/hydrogen debate and conclude that hydrogen in passenger transport applications will be a side show without blue hydrogen now.

See PDF below for all charts

First this week we are going to focus on the power of the people (Including Larry Fink).

While unrelated to ESG, we saw last week with GameStop how social media-based chat rooms and hype can take almost complete control of a story and an investment, creating significant waves. Every corporation or industry with an ESG challenge should be concerned that they could be targeted, especially if it is felt that policy is not doing enough to drive climate change goals. See Exxon commentary below.

Exhibit 1: There is no rocket science in this chart as it simply extrapolates the growth since 2018 – it is likely a low case, but it adds just under $100 billion this year.

The forecast funds flow in Exhibit 1, is likely to be far too conservative, given the current momentum and even more so with some policy changes. If the Biden administration is hamstrung in terms of policy because of congressional impasse (for example, if it proves impossible to pass a carbon tax in some form), the administration could choose to help the ESG investment community do the job instead. Removing the recent DOL restrictions would be one step, but actively encouraging ESG components within public pension portfolios would be another. While the battle for supremacy wages in the standardization of ESG metrics, some valuation anomalies are likely and could be exploited or amplified by retail investor groups or other activists.

In the meantime, there are an increasing number of stories, backed by opinion more than data, around “greenwashing” – the idea that companies can produce data (selectively) to appear better than they really are when a more standard yardstick is employed. Because there is no agreed standard yardstick, the ability to show only the brighter side of a business remains. Some money managers may be equally tempted, to increase the pool of available assets as cash inflows grow.

Smarter activists and possibly internet driven groupthink could see through some of these ESG definition stretches and exploit them. Back in the “good old days” when the quality of sell-side research and buy-side collaboration with the sell-side (and aggregate industry experience was higher), I would occasionally be asked by relatively new Investor Relations executives and the odd CEO and CFO how a certain person could be in a role (because of their age and inexperience) and whether that would result in them making poor stock decisions. I was always quick to point out that at that time they were not dealing with an individual, but with a collective. Everyone talked to enough people such that the better ideas and views were quickly filtered from the rest. Maybe these internet-based stock chat groups should be thought of the same way – individually not that impressive, but collectively potentially unstoppable – even if Robinhood flounders, something else will pop up.

No-one in the materials space and in many of the industrial sectors has immunity. If an environmentally active investment group decides they can profit and drive ESG change at the same time, they could pick on anyone. We could list an itch to scratch with every company we cover and have covered in the past, but we are choosing not to, as we do not want to provide a catalyst for any troublemaker or profiteer.

Plus, we must talk about Larry Fink and his CEO letter. I have always had a bit of issue with someone who primarily profits from index funds pushing CEOs around, as for the most part he has nothing to lose. That said, BlackRock still has active funds and slamming a company held in one of those funds would hurt fees. So, some of Mr. Fink’s platform is on more sound footing, but much less than 50% in our view. This year, however, we are in complete agreement with one of his comments – companies need to stop talking in generalities about what they “plan” to do with respect to ESG goals and they need to start acting – making investments where necessary and showing progress. We would add – fewer charts that look good but have no scales, please.

Back to ExxonMobil. While the company has this week announced a low carbon strategy/investment, committing $3bn to low carbon solutions, including CCS, we want to focus on the other news this week, that ExxonMobil and Chevron discussed a merger in 2020. Faced with extreme laggard positions on emissions and climate change, versus their European counterparts, and an investor backdrop that is likely to become less supportive over time, a merger could solve many problems for both companies.

It could be sold as a change in direction for both companies – “the larger game plan all along” – creating a platform that can deal with, and benefit from the changing energy landscape – “we weren’t ignoring it; we were planning something bigger and better.” The stock would have greater relevance.
If your PE ratio is falling and oil is weak you need other ways to create E. The synergies would be enormous – as would be the efficiencies that could be gained from the combined know-how. Lower cost and lower carbon footprint crude and natural gas – another competitive edge
If the combination proposed to take the synergy savings and plow some of the money back into clean energy, the combined company would have a story to rival bp, Shell and Total.
The combination of CP Chemicals and ExxonMobil Chemicals would create a clear industry leader, with significant synergy opportunities.

So, aside from our recommendation for ExxonMobil, what do other companies do here? How do you limit the risk of being a target? Data is a two-edged sword; if you do not provide it you can be targeted for being evasive – especially with climate related data such as CO2 (and equivalent) emissions – look at what has happened to ExxonMobil over the last few months with activists. If you do produce data, then you give activists something empirical to work with – and you need to be prepared to deal with that. We have shown the chart in Exhibit 2 before, but we have now added ExxonMobil. We have also divided the KG CO2 per share by the share price to show KG of CO2 per dollar of equity. On that basis the Industrial Gas companies do not look as bad and the Dow and LyondellBasell positions reverse.

Exhibit 2: The chart shows how important CCS could be for some of the chemical companies, but also shows that ExxonMobil needs a carbon plan – either the announced initiative, or a game changer with Chevron

Source: Bloomberg, Corporate Reports and C-MACC Analysis

A carbon tax would provide direct data on the potential impact for each company and the value of avoiding the CO2 and equivalent emissions. Without a tax, and with the risk that investors focus on this metric, there is potentially a lot at stake for several companies. We would argue that the valuation risk is largest for the Industrial Gas Companies as they are already getting an ESG kick because of their hydrogen exposure and their multiples are high.

Is there an advantage in being pro-active? We now have a test case, as Olin led the field this week with two pages of EGS metrics in its quarterly release – copied below. This could work in Olin’s favor if the company can show progress on the metrics that require progress, but having produced this once, the company is now likely obligated to produce it every quarter, and it will be a struggle to show progress in all metrics in each quarter. While the intent might be to produce this data annually, in conjunction with the publication of sustainability reports – we would not be surprised to see this type of analysis insisted on by ESG investors and lobbyists for all companies and for each quarter – which will mean that the data will have to reported more real-time than in the tables below.

Olin may be dragging industry towards a new reporting standard but should not take blame for this as we believe that it was inevitable anyway. The structure and metrics that Olin has chosen is likely a first step in what will be an iterative process which will see the reporting requirements refined over a year or two. It is also important to note that by making this change, Olin gets a seat at the table in terms of dictating what should be measured – others should follow.

Exhibit 3: While other companies will point to the availability of most of this data in sustainability reports – presenting it in an easy form and focusing on what you believe is important to the ESG contingent within the investment community can only work in your favor in our view.

No company wants to have to meet additional reporting standards and requirements. With the increased importance of corporate access, the seismic change in the sell-side, and the lower budgets for internal research on the buy-side, because of fee compression, almost all public companies have seen their Investor Relations costs rise over the last 15 years – this will be an additional cost, but our recommendation would be that to resist it would not be in the best interest of any stakeholders.

Separately, but while we are addressing ESG, in one of the headlines in the ESG section below the question is asked of whether Tesla was a driver of ESG performance in 2020. Maybe the question should be whether ESG inflows were the driver of Tesla’s performance in 2020? There is a supply and demand squeeze in the ESG world in that there is far more cash chasing the pool of investment contenders, than there are contenders to chase. This seems to be accelerating in 2021, based on news flow.

This squeeze is in part linked to the increasing call for more and more consistent disclosure as well as metrics and rankings. Fund managers need clear and more consistent metrics so that they can stretch the ESG definitions in order to find enough equities to include in funds to meet demand, and to avoid the perilous gap between the multiples of the few stocks and sectors that clearly meet ESG standards and those that do not. There is likely to be a cleaning out of the ESG provider ranks this year and Refinitiv’s decision to make its company ESG scores free is a smart move, as level of use and inclusion will be a key determinant of who is left standing with respect to credible providers of ESG metrics.

Note: we are already helping some clients on a bespoke basis as they iterate to what should be their strategy with respect to ESG – please contact us directly for more details

Second topic of the week – the Battery vs Hydrogen Battle

While some (Elon Musk comment below) have very strong opinions on electric versus hydrogen fuel cell vehicles, we are unconvinced that the debate is that complex or contentious – each technology will have a role, and in specific applications and perhaps certain geographies one will likely dominate over another. However, the battery/EV segment has a major lead on the hydrogen wannabees, and this could end up being more important than which technology is ultimately the lower cost in many of the small vehicle applications.

Neither is a carbon free solution on its own, when you consider the life-cycle of the vehicle and the carbon footprint of the materials and the fuel. The battery industry will need to focus on its environmental footprint from the lithium and other materials through the effective recycling of batteries at the end of their life, and the hydrogen advocates not only need green hydrogen, transported without a carbon footprint, but the lifecycle of the fuel cell also needs consideration.

Batteries likely have more of hill to climb from the life-cycle perspective than fuels cells and hydrogen, but at the same time batteries have a 10-year head start on hydrogen and more limited refueling (charging) infrastructure challenges. Hydrogen will have to offer a lot more to take share from the automotive battery EV evolution, which is probably unlikely. Using renewable power to make hydrogen to then move a vehicle will always appear one step more than just using the electricity – Exhibit 4.

Hydrogen will have significant value where electric power does not solve the problem – hydrogen or ammonia are more obvious fuels for heavy transport, trucks, ships and perhaps aircraft, but in each of these applications bio-based fuels with a zero or negative lifecycle carbon footprint will put up a challenge. We see hydrogen with two more obvious applications:

Fleet transport – especially “hub and spoke”, such as municipal buses, trash collection, school busses etc., where the vehicles come back to a central hub and can refuel there.

Exhibit 4. This VW derived schematic does a good job of showing the logistic challenges that hydrogen faces for passenger vehicles.

Heat intense processes where electric heating simply cannot achieve what is required – so mostly industrial applications:
- While many ethylene producers sell their by-product hydrogen to third party users because of the higher value achievable, or they use it in integrated refining units. Those without that option have been using the hydrogen as furnace fuel, mixed with natural gas, for decades. These furnaces have a lower carbon footprint than those just using natural gas, and likely are more efficient as you are not wasting as much energy heating up the unwanted nitrogen and CO2.
- For the moment, using hydrogen as a furnace fuel is uneconomic in almost every case (where you have access to a hydrogen market), but as hydrogen costs fall and carbon penalties rise it is a possible option for the chemical industry and other heat intensive processes.

The challenges with hydrogen as a fuel for passenger vehicles is the need to build a refueling infrastructure – although if there are country or state-based decision to build the infrastructure for trucks it will be much less costly to add fuel cell-based passenger vehicles to the mix.

The other potential in the passenger market would come with autonomous transport and taxi fleets – again because of the “return to base” model.

Exhibit 5: Taken from a Visual Capitalist Article from May 2019 the chart shows some of the transport opportunities for hydrogen that we discuss above – the case for hydrogen in passenger vehicle hinges on full life-cycle emissions (hydrogen wins on weight of vehicle and cost of disposal/recycling) and the idea that while hydrogen infrastructure is expensive – overall costs will be lower by the time you pass 10 million vehicles – see link. We like to be balanced!

Timing is the other major challenge. If the hydrogen lobby wants to wait until they can get competitively priced green hydrogen to make their case – battery and renewable fuel-based transport will be so widely accepted and adopted that hydrogen will become only niche in the transport world, while still important in industrial applications. In our view, the proponents of hydrogen, who want a seat at the table now, need to plot a course through blue hydrogen and blue ammonia as soon as they can. In the meantime, Batteries Are King and almost all large volume vehicle plans (see GM announcement) are EV based.

Note that our concerns on lithium are not focused on demand – which will almost certainly grow very quickly over the next 8-10 years. Our concerns are on supply, initially from too many projects and eventually from the addition of recycled batteries.

There are an increasing number of hydrogen announcements in the Renewable Fuels, Power, Hydrogen segment below, but these are mostly “pet projects” and lack the broad infrastructure connectivity that would be needed to drive the next leg of investment and innovation that would encourage more fuel cell vehicle design and production plans. The battery EV makers are pushing into the truck business and Amazon is already using battery-based delivery vehicles in some locations. By the time hydrogen catches up, the switching costs may be too high for many of the hydrogen transport opportunities to be more than just distractions, without major government intervention/subsidies.

Recycling/ Renewables

The Eastman polyester recycling project is significant in size, but we would question how far afield the company needs to look to get the used material, which has always been one of the major limiting factors with recycling. However, for perspective, the global polyester (fiber plus PET) market is already more than 80 million tons and the Eastman project is hoping to make 200,000 tons – which is 0.25% of global demand. Many more facilities will be needed to make a meaningful difference, but Eastman is banking on customers being willing to pay more for recycled content and consequently the company would not want to flood the market. Like the LyondellBasell/Suez polyolefin ventures in Europe, the limiting step here is going to be finding enough locations that have sufficient feedstock within a reasonable radius.

We note another “plastic road” headline below, aiming to use waste plastic, and we have also been looking at some of the “pyrolysis” technologies – targeting the idea of chemical recycling. While these technologies can make a synthetic naphtha – or naphtha like stream – they may find more margin in low sulfur renewable/recyclable fuel oil for marine transport. Both ideas may be economic uses for waste plastic, but both take the polymer out of the reuse recycle loop and will add to the challenges that consumer products and other companies will have meeting stated recycled or renewable content goals. We see an almost inevitable move towards renewable based polymers (and some chemicals) as an alternate. Ultimately this is probably good news for companies like Danimer Scientific if the biodegradable products can be segregated post use. It is also likely to be good for the fermentation based and bacteria-based liquids manufacturers, as well as the bio-fuel companies – so Gevo, Darling Ingredients, and maybe even the waste-based players like Fulcrum Bioenergy, as their outputs can also be chemical and polymer inputs if the economics make sense.

The highlighted headline towards the end of this section is an indication of what is at stake. In the same way that battery technology may maintain dominance over hydrogen longer-term, simply because of the lead it has today – chemical recycling, which does not put the material back into the plastics loop, and/or use of recycled polymers in new, lower grade, opportunities, WILL limit mechanical recycling and the availability of recycled polymers. The inefficiency of the recycling system and the unwillingness of potential beneficiaries to pay based on cost rather than virgin polymer price markers only makes this a more likely trend. Renewables will have to play a larger role.

The chart at the end of this section is likely to be grossly wrong in our opinion because of what we discuss above – the temptation to use recycled polymers in new applications. We think the gap will likely be filled with bio-based polymers, but it is also likely that the growth rate is too high given what is likely to be an increased focus on conservation in use.

We also believe that the analysis in the chart fails to consider degradation, something Eastman talks about in its quarterly release and comments on its own recycling plans. Mechanically recycled polymers degrade over each use and need increasing levels of virgin polymer in the mix, or eventually have to be land-filled or included in a chemical recycling process. This will be a main topic of next week’s report.

Exhibit 6: This chart comes from the report titled Carbon dioxide on the rise in feedstock evolution. We use it as an example of emerging trends in renewable feedstocks for polymers and mounting expectations toward their use. We also highlight the report from last week from the non-Institute titled Carbon Dioxide (CO2) as Chemical Feedstock for Polymers – already nearly 1 million tonnes of production capacity installed!

Source: nova-Institute, Plasticsinpackaging.com, C-MACC, February 2021

Carbon Capture and Emissions

So, the big news is the ExxonMobil news. Whether the goal is to lower the carbon footprint of the company’s current platform, or to diversify into a new business line, part of which would be solving its own problems, is unclear. ExxonMobil already claims to have a lower cost carbon capture technology and the company could make a lot of changes to its Gulf Coast CO2 footprint with $3bn. Alternatively, the idea might involve partnership with or the acquisition of someone who already has a developed CCS business. The only real option here, in our view, would be Equinor, but given that lack of real geographic overlap, while it might make for good headline it would not really make any more of a difference than ExxonMobil cold achieve alone. We like the Chevron merger idea discussed above – the synergies from such a combination as well as the lower combined capital budget would provide ample funding for a CCS and other clean energy initiatives on a very large scale.

Exhibit 7: When Will Carbon Capture Tech Become Economically Viable? This chart comes from The Emissions Gap Report in 2017 shows the many paths to capture CO2. We also highlight an article discussing a recent Elon Musk US$100m proposed donation for best carbon capture technology to show that it also considers many paths and is focused on the outcome. Note that none of the pathways below include CCS from existing industrial carbon dioxide streams.

Source: The Emissions Gap Report, Nanalyze.com, January 2021

Renewable Fuels, Power, Hydrogen

We have discussed at some length the battery versus hydrogen debate above, although not with Mr. Musk’s eloquence. However, to put the hydrogen fueling stations comment below into context, 584 stations in 33 countries is an average of 18 per country: there are 1240 gasoline (petrol) stations in Houston and 168,000 in the US. Hydrogen has an uphill battle for passenger cars. Despite this, we expect to see increasing activity in both blue and green hydrogen in 2021 as public transport goals, especially in Europe need some action to back the rhetoric – back to the only part of the Larry Fink letter that we found important – it is time for action rather than words.

ESG Investing

We have covered ESG sufficiently above this week, but note the increased activity, especially around definition and around any role the SEC might take – either to ensure that what is advertised as ESG really is so – or to promote more active use of ESG in all investment decisions (perhaps one follows the other). As we have stated above, if the Biden administration faces too many hurdles passing legislation, an alternative would be to empower the ESG investment community to drive the same outcomes. At a very minimum limit constraints on ESG strategies that favor the outcomes that the Paris Agreement requires. The equity and debt markets may be able to impose a virtual carbon tax more efficiently that the government can with a real one.

Lastly – if Iron Man is in, then it must be good.

Exhibit 8: ESG’s Turning Point: Four Trends Could Accelerate Flows in 2021. We included this chart in today’s Daily and the inflows in 2020 give us confidence that the projections for 2021 in Exhibit 1 are conservative – especially as we see regions outside the US and Europe stepping up.

Source: Morningstar, ETFtrends.com, C-MACC, February 2021

Others Relevant News

It is becoming clear that there are polarized positions with respect to climate change; at one extreme there is the fear that a pull back from fossil fuels will costs jobs, create inflation and economic pain, while at the other end of the scale it is seen as a huge opportunity for investment and a potential boost economic growth and employment. In our opinion both views are valid, with the optimists looking at the big picture and the pessimists more parochially looking at their fossil fuel dependent constituents or in some cases entire economies.

The big picture is likely the correct one, but it papers over what will likely be some uncomfortable local transitions. In our view, the Energy lobby should be resigned to what is likely to be an inevitable path – either driven through regulation or consumer preferences, or both – and embrace all the transitionary moves that are likely needed between now and at least 2040 and ensure that those investments benefit their constituents/economies. We see this already with regional competition for battery giga-factories. ExxonMobil’s CCS initiatives may create jobs (or save them) and may prove to be a profitable move for the company, especially if it can extend the useful life of oil, gas, refining and chemical assets. The low carbon assets will be the last ones standing – or may survive.

Finally, if you want a depressing weekend but with an uplifting tone, read the two pieces directly below in sequence – we would recommend reading the abbreviated version of the first review. It is a comprehensive review of how capital and personal value and worth have benefited for decades as the expense of nature and while it is somewhat connected to climate change it focuses on other critical damage that is being done to nature as well. Then read my old colleague Stephen King’s excellent piece which looks at the roaring 20s and asks whether we are in the same place 100 years later. It is a great read for those with interest in politics and economics, but it will likely drive you to the same conclusion that it did me – which is that there is not enough political harmony in the World today to tackle the problems of the first article – with climate change alone very much a stretch goal.