Companies that help prevent CO2 emissions play a crucial role in the transition to a low-carbon economy. They unfairly remain under the radar of investors, argues Raj Shant, managing director at Jennison Associates, in an interview with Investment Officer.
The active equity manager recently launched the PGIM Jennison Carbon Solutions Equity Fund. This fund includes Scope 4 emissions in its investment strategy, unlike most strategies within this theme. Scope 4 are avoided carbon emissions. A big difference from existing sustainability funds that focus only on realised emissions. Companies’ emissions are calculated in different ways.
Shant gives the example of an oil company that extracts oil at sea. “Scope 1 includes all emissions caused by the company when pumping and processing oil. Scope 2 measures all the emissions associated with all the steel and concrete needed to build the rigs and perhaps distribute their products. But that only gives you a fraction of the CO2 emissions they contribute to the world, because most of it is Scope 3. When the petrol and diesel is eventually used in cars, trucks and buses, the carbon emissions from their operations really hit the planet hard.”
Underexposed emissions
Scope 3 is much larger than 1 and 2, but like oil companies, it is sometimes difficult to measure. Moreover, there is little data as companies are not required to map their emissions under Scope 3. ESG data providers and investment strategies therefore do not take it into account, says Shant. Scope 4, he says, is even more important. “Suppose a consultancy firm advises a company some energy-saving measures for its office building. Fitting light sensors and insulating window coverings can reduce energy consumption. Thanks to the advice, the company has avoided emissions,” Shant explains.
That requires estimating emissions before the advice and after all energy-saving measures have been installed. The difference can be considered avoided emissions and falls under Scope 4. Because it is difficult to map, companies are not required to estimate or report avoided emissions. “Therefore, it is completely ignored by regulators, policymaker and investors. They are thereby missing opportunities because avoiding carbon emissions is very important to meet climate goals,” says Shant.
ESG data providers, he says, are not starting to collect Scope 4 data because they are used to top-down analysis. There are thousands of companies in the MSCI World Index making it an impossible task to assess how many emissions were avoided in a given year. Estimates also need to consider the proper context for each company. There is also the risk of double counting.
“Will the avoided emissions be credited to the consultancy firm or to the client? We take a different approach and make a bottom-up analysis of the number of emissions avoided for a much smaller group of companies.”
‘Good approximation’
“Our estimate may not always be completely accurate, but it gives a good approximation. Where possible, we use hard data for this. At Tesla, for example, we look at car sales by country. China still uses many coal-fired power plants to generate energy, so each Tesla sold in the country prevents fewer emissions than, for example, in Scandinavia, where renewable energy already has a large share in the energy mix. This data is quite easy to retrieve.”
Besides Tesla, the fund invests, for example, in LNG producer Cheniere Energy. “This is somewhat sensitive, but natural gas is relatively clean and often replaces highly polluting coal in the energy mix. LNG can therefore make a big contribution to reducing CO2 emissions, even if you ship it around the world,” says Shant.
New megatrend
By including avoided emissions in the strategy, the investment universe is much larger than in mainstream funds responding to the energy transition and the concentration risk is lower. A huge, new growth market is emerging. According to researchers at Princeton University, the transition to a low-carbon economy will require an investment of $2,500 billion by 2030. A more recent McKinsey study shows that India alone needs this amount to get on track, Shant said.
“This is one of the strongest megatrends in the world and companies that capitalise on it can benefit for decades to come. Our fund offers investors a much broader exposure to this theme than traditional SRI.”