Climate change: The potential and risks for investors

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The day before I met Tim Holme at his headquarters in San Jose last December, he had just become Silicon Valley’s latest startup billionaire.

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Shares in his next-generation battery company, QuantumScape, were surging in the wake of its recent public listing — one of many clean-tech stocks that had caught the imagination of investors across the U.S. and beyond, amid a growing focus on the market implications of climate change.

Holme, a former Stanford physicist who co-founded QuantumScape in 2010, gave me a tour of the company’s experimental assembly lines, in a brightly lit room with moisture levels 2,000 times lower than the air outside. He claimed that the cells being developed in this controlled environment could revolutionize the rapidly-growing electric car market, with performance far better than current batteries.

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“All of a sudden, you’re not talking about a nice high-end toy for rich people,” Holme told me. “You can really get into the mass market, which is what you need to tackle climate change.”

Stock market investors eager to grab a piece from the global clean tech bonanza proved to be an open audience for this message. Within a few weeks, QuantumScape — still years away from commercial production — would hit a market capitalization of US$48 billion, comfortably exceeding that of the century-old Ford Motor Company.

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Holme was one of many entrepreneurs and business leaders I encountered during two years of research for a book exploring how the climate crisis — and the response to it — is reshaping the modern world. It’s a subject that has surged to the top of the agenda of the largest asset managers and is no less critical for individual investors.

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Climate-related questions that investors have to answer are complex and dizzyingly numerous. What new energy systems will be available and what technologies will be the most successful? What big companies are most at risk from financial risks due to the energy transition and extreme weather? How can investors ensure that their portfolios are able to ride the economic waves created by the climate crisis?

QuantumScape is one of many high-profile clean-tech firms that went public through a special-purpose acquisition company (SPAC) in the last few years. This route requires far less disclosure than a conventional initial public offer.

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Retail investors can now buy stock in clean-tech companies at an early stage of their development due to the increasing use of SPACs. It’s also becoming increasingly controversial, as small investors in some companies have been left sitting on hefty losses from bets on high-profile SPAC-linked businesses. If you bought QuantumScape stock at its feverish peak last December and held it, you’re now sitting on a loss of nearly 80 per cent.

Some believe that the sector’s overheating and subsequent sharp corrections in share prices are cause for concern.

‘Haters and doubters’

When I caught up with Holme this month, he said that amid the whiplash fluctuations in QuantumScape’s share price — which now leave the startup valued at US$10 billion, a third lower than on the day it went public — it has made faster than expected technical progress towards rolling out a commercial product for Volkswagen, its major investor, by 2024.

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“There will always be the haters and the doubters,” he says. He maintains that the larger case for investing in electric cars is unarguable. “Very soon,” Holme told me, “there will be a tipping point where a combustion car is no longer superior in any way to a battery vehicle.”

Equity investors looking to gain exposure to the clean-tech revolution can choose from a fast-growing set of public companies not just in the big western markets but notably in China, where renewable energy and electric transport are an increasingly important part of the country’s vast manufacturing sector.

I travelled through China just before its borders closed amid the coronavirus pandemic, visiting some of the country’s prominent new energy companies. I visited Xpeng Motors in Guangzhou to speak with its chief executive He Xiaopeng on the rapid development of his industry.

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The Chinese government has sought to encourage green tech for years through lavish subsidies. However, these subsidies have been cut in recent years.

Some analysts saw this as a sign of wavering commitment by Xi Jinping’s government to its vaunted green agenda. He Xiaopeng argued, however, that technological advances have allowed leading companies in this area to compete with state support. As that support was scaled back, weaker companies dropped out of the market — a welcome development for the stronger ones, he said, who were gunning to make an impact not just on the huge domestic market, but globally.

A few months after my visit, Xpeng, which is building higher-end electric cars intended to compete with Tesla, went public in a high-profile New York flotation that valued it at US$20 billion — a market capitalization that has since doubled.

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It is one of many listed Chinese clean-tech companies that have proven popular with foreign equity investors. Other examples include fellow electric car startups Nio or Li Auto. Another is BYD, a group with a market valuation of US$125 billion that is China’s biggest electric-car maker as well as a major producer of batteries and solar panels, whose vast 40,000-worker campus I toured in Shenzhen.

Soon, a combustion car will no longer be superior to a battery-powered vehicle.

Tim Holme

All the Chinese clean-tech entrepreneurs I met — not least He Xiaopeng, who previously made billions in the Chinese internet industry — seemed convinced that the Xi administration’s long-term strategic focus on green growth put their sector in line for phenomenal growth. For foreign retail investors who want a piece of their profits, there are obvious risks.

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As in the west, China’s energy transition strategy faces resistance from conservative voices worried about the impact on long-term growth. Rising tensions with the west are a headwind for Chinese clean-tech companies — witness the U.S. tariffs slapped on solar panel exports from the likes of BYD.

Even after the declining state subsidies thinned the crowd of Chinese companies in this space, they remain numerous and the competition between them intense — making a big bet on any single group a risky prospect. Even though companies like Xpeng or Nio have floated to New York, they are still not easily accessible to western retail investors. However, the Chinese government is increasingly scrutinizing foreign listings.

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A miner breaks new ground

When it comes to climate-related risks, no company in the world is exempt — and for some of the biggest businesses in the world, the climate crisis has created an environment of unprecedented disruption and uncertainty.

While in Australia I visited the Melbourne headquarters of BHP, the world’s biggest mineral resources company, with annual carbon emissions greater — when the use of its products is factored in — than those of the U.K.

“When BHP moves, the whole sector moves,” Fiona Wild, the company’s sustainability head, told me. “It’s not just about sitting here thinking how to manage risks and minimize impacts for BHP. It’s about how to galvanize really significant change — and I honestly can’t think of a better place to do it than here.”

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Wild added that the company is breaking new ground by promising to set reduction targets for its Scope 3 carbon emissions — meaning it would take responsibility for emissions from the use of its products and in its supply chain, as well as those from its own operations.

In recent months, however, the company — listed in Sydney and London — has come under heavy pressure from investors and external critics who argue that it is moving too slowly. Seventeen percent of shareholders protested against its climate action plans last month. Proxy adviser Glass Lewis had recommended that they reject it. He said it was unclear if the plan aligned with Paris.

Yet when BHP has taken serious action to “decarbonize” its business, the stock market response has been less than wholly encouraging. In August, the company announced that it was selling its oil and gas operations to Australia’s Woodside Petroleum for shares to be distributed to BHP shareholders.

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BHP’s share price fell sharply, and is now down about a quarter from its level on the eve of the announcement, as analysts warned about an unhealthy reliance on the volatile market for iron ore, now overwhelmingly BHP’s biggest business. BHP has not stopped its gradual withdrawal from fossil fuels. Last month, BHP announced a major divestment of coal assets in Australia.

The resources sector is also facing a similar dilemma. Shell and BP, both London-listed oil companies, have faced shareholder revolts over their climate plans. Rio Tinto, a mining company, responded to investor pressure in October by increasing its emission reduction goals. In the U.S., ExxonMobil — the world’s biggest non-state oil company — was hit by a remarkable shareholder intervention this year, when the little-known hedge fund Engine Number 1 succeeded in gaining three seats on its board to drive faster climate action.

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Weather threat

Investors cannot simply ignore companies that are directly involved in fossil fuel production to protect themselves from climate-related disruption. In the financial sector, for example, the biggest groups are forced to reckon with the effects on their portfolios of the global energy transition — and of increasingly severe destructive weather events.

Munich Re, a global reinsurance firm, was where I visited. It was half a century ago that they began seriously analyzing climate change risks. That part of the business is now led by Ernst Rauch, who started researching natural disaster risks for Munich Re in the late 1980s, using the company’s second-ever computer. Today, he is the leader of a team of analysts spread around the globe. They use voluminous information and high-tech modelling software in order to plan a path for this huge insurer in an age when climate change is rampant.

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Early in Rauch’s career, 16 insurance companies went bankrupt in the wake of 1992’s Hurricane Andrew, which caused US$25 billion of damage mainly in southern Florida. Today, Rauch told me, his team’s analysis leaves no room for doubt that the strongest storms are becoming increasingly destructive, along with disastrous forest fires in places such as California. The insurance industry was hit hard by natural disasters in 2017 and 2018. Its payouts totaled US$215 billion. The threat grew with record-breaking 30 storms in the North Atlantic last year.

However, there are no high-profile bankruptcies of insurance companies. Munich Re has been solidly profitable and its share price has steadily climbed through the superstorms, now at 38% more than at the beginning of 2017. While storms, fires and floods are all expected to grow in severity, another Andrew-style rush of insolvencies is now hugely unlikely, Rauch told me, citing insurers’ far stronger loss reserves and careful use of climate data. He said that climate change concerns were likely to increase demand for property insurance over the next decades.

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He stated that pricing is the real danger. In much of the world — cities on storm-hit coastlines, for example — insurers will be forced to increase their premiums to levels that could become unacceptable to many. “The question here is affordability,” Rauch told me. “And that should be a concern for our industry, because it can undermine and erode our business model in the long run.”

A new age of disruption

Throughout my travels, big companies were facing a climate-driven era. In Brazil, I met executives at JBS — the world’s biggest meat producer with US$50 billion in turnover — to hear about the blockchain-based verification system they hope will tackle growing investor unease about the company’s alleged links with illegal cattle ranchers, and the implications for its long-term prospects.

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At the Dhahran headquarters of Saudi Aramco — by far the world’s biggest listed energy company since its 2019 flotation — chief technical officer Ahmad Al-Khowaiter told me how it was racing to future-proof its business by building new businesses in sectors such as hydrogen, even as he predicted its low-cost production would make it the “last man standing” in a slowly dwindling oil industry.

In Chile, I spoke to the chief winemaker at Santiago-listed wine giant Viña Concha y Toro, who explained the company’s fast-growing investment in research to help its vineyards adapt to rising temperatures and shifting rainfall patterns.

While the climate crisis is a time of disruption for many businesses, others are seeing unprecedented opportunities in the powerful environmental changes that are occurring.

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In the far north of Greenland I witnessed how the gradual disappearance Arctic ice threatens the centuries old traditions of Inughuit dogsled hunter. But a short distance south from their main settlement of Qaanaaq lies one of the world’s most lucrative titanium ore deposits, being developed by London-listed Bluejay Mining, a small-cap company backed by the likes of Prudential and M&G.

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Bluejay chief executive Rod McIllree said that the Arctic sea-ice season has always left only a short window for ships to reach the titanium site. It made mining uneconomical. He told me this when we met at his Mayfair offices. This is just one of many new Arctic projects that show the region’s growing economic potential as a result of global warming. “There are projects being contemplated now that would never have got off the drawing board 10 or 15 years ago,” McIllree told me. “I mean, it’s just accelerated out of the box.”

Investors looking to build a climate-smart portfolio, in short, will find opportunities — and grounds for concern — in every corner of every stock market. Those seeking growth would do well to consider increased exposure to a clean energy sector set for enormous long-term expansion — while remaining conscious of the huge swings in valuation that are bound to continue among companies jostling for leadership in the space and the uncertainty as to which will emerge on top.

Income-focused investors should not ignore the new set of serious financial risks that have emerged for the most dependable blue-chip companies — most obviously in the energy industry, but across every sector to some extent. In the face of the increasing global impact of the climate crisis, there is one certainty: this will be a major issue that investors will need to address for many decades.

Simon Mundy’s book  is out now (William Collins, £20 / US$28.99 / C$34.99).

© 2021 The Financial Times Ltd