NAB Morning Call

Weekend Edition: Investing on the Road to Net Zero – Why Aren’t We Leading?

Friday 19th July 2024

Please note this communication is not a research report and has not been prepared by NAB Research analysts. Read the full disclaimer here.

Much of the world is on the road to achieving to net zero by 2050, a target which gets more challenging as each year passes. Australia is on the right path, but it isn’t leading the pack. Why Not? Phil puts the question to Rochel Hoffman, who leads Deloitte Australia’s ESG M&A practice. Despite having many rare earth mineral resources, vast quantities of land, a wealthy society, political stability and a sunny climate, Australia has been slower than most to invest in NetZero projects. The Climate Action Tracker, which is an independent scientific group that rates each country’s progress on the targets set in Paris, rates our climate finance as ‘critically insufficient’. That will change, says Rochel. We’re working through a series of constraints that have impacted the speed of the transformation. Our history with fossil fuels has been a part of the problem. Now, green technology provides a wealth of investment opportunities for a range of risk categories.

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Duration:: 23m
Broadcast on:: 19 Jul 2024
Audio Format:: mp3

"The world is on the road to reduce carbon emissions getting down to net zero by 2050, which is getting more challenging as every year passes, but for Australia don't we have the money, resources and space to be ahead of the pack, but we're not. Why is that?" "The Morning Call from NAB with Phil Dobby." "The weekend edition." So you'd assume that Australia was leading the way when it comes to investment in reaching net zero targets for a start as a sizeable exporter of fossil fuels historically, then we've got a lot of ground to make up, so you'd think we'd be moving quickly on it. Secondly, we have a lot of renewable resources, the minerals for batteries, for example. We've got lots of sunshine, we've got a long coastline, we've got lots of space. Thirdly, we've got a relatively stable political situation. I think that counts a lot these days. We've got no coups, no wars to distract us from the task at hand. We can just get on with it. Finally, we've got lots of money, we've got lots of money in super funds, for example, looking for strong returns, but lots of other ways of raising finance. Yet, I'm looking at the climate action tracker, which is an independent scientific group that tracks government action and measures that are set to reach the target set in Paris. It rates our climate finance as critically insufficient. That puts us on a par with the United States compared to the EU, for example, which is only insufficient. We're critically insufficient. I don't think anyone is doing well on this, by the way, but critically insufficient is where we are. Let's look at where we are in all of this and where the opportunities are for investors, in particular, super funds, but also private equity. We have more pet capital in super funds than just about any country in the world, I think. Raquel Hoffman leads Deloitte Australia's ESG M&A practice. Raquel, welcome. Australia has played streets net zero by 2050, but if you look at the nationally determined contributions as they call the NDC targets, we're falling behind. Is that simply because there's just enough investment happening? It's a good question. I think that a useful way to think about the problem is really to be thinking about it in terms of what are the key sectors that contribute to Australia's current carbon footprint, which cumulatively all of them need to effectively get to net zero by that 2050 goal. When I think about that, the three top ones are everything in relation to electricity and energy generation, then transportation and that sector, followed by industrial slash also the resources sector. I guess in relation to the electricity and energy generation sector, I guess some of the key things, as you've rightly pointed out, we definitely have an enviable amount of sunshine and land to be able to host things like solar and wind, but we can only phase out certain assets, particularly in the coal and over time, and obviously there's going to be a longer tail in relation to gas, as much as we're able to actually get renewables up and running. But what we've been seeing is just a series of constraints, which I would say are slowly being worked through, but still have had a major impact on the speed of which we've been able to really change the composition of our energy generation sector. Some of those key ones, everything from supply chain constraints, financing constraints, approval costs and also approval timeframes and also labour constraints. I think, beautifully, those have been some of the main factors which have been impacting the speed of change in that sector. Then you compound that with our transportation sector, which of late, we've been seeing some major developments coming through in relation to particularly road transportation and what's going on there in relation to electrification. But then we've still got a number of other parts of our transportation sector, rail being a good example of that, where you've got challenges in relation to asset replacement timeframes, as well as still waiting on those key technological breakthroughs, everything from hydrogen-fueled cells and across the spectrum of technologies there. Then you overlay that again with our industrial sector, which has more of those hard to abate the sub-sectors and industries, and then I guess the compound effect of that is still a really challenging set of dynamics to really work through to get us on the pathway to actually being able to achieve that net zero by 2050 ultimate. So on the hand of all of that, I can see in the transport space, I can see why that would be difficult for Australia, more than most countries, because it's got long distances, so it's difficult to have electric vehicles, for example, if you're going to drive a long way, you've got to have a lot of charging points with a relatively sparse population covering large distances. But if you look at electricity generation, so the Energy Institute, they say Australia's share of electricity from low carbon sources is 36% compared to 41%, and of course, you know, might have different figures, but just as a general order of things, 36% compared to 41% for the United States, 54% for Germany, 60% for the UK, 80% for Canada, why are we so far behind? And I guess what it does show is there's a lot that can be done. So presumably this creates a big investment opportunity, but, you know, why are we where we are? It's sort of been that the curse in a way of being in a country which has an abundance of fossil fuel commodities where historically our reliance on coal-fired generation has been the easiest and most commercially viable option for us. Then you add on top of that the fact that we also have access to gas, and that has gone into the gas-fired power stations. And then you add on to that up until recently our policy environment and just the rhetoric around decarbonisation, particularly the energy sector, has been, I guess, communicated in a way which has been quite unusual to a lot of investment actually coming through into this space. I think it's fair to say that it's a lot clearer now in terms of the policy setting environment and sort of the direction that we're going in. But of course it takes time to move through development into operation and allising a lot of these assets. And then you add on to that the actual needs for investment in everything in relation to transmission and distribution. And then you recognise, I think, or we collectively recognise that it's not a case of just switching on the green switch and switching off the fossil fuel switch, it is actually going to take time. So the transition is going to take time, but is it becoming now more viable alternative to invest in green, are those green initiatives, if you're looking at it and without any sense of what's important for the planet, if you look at those green initiatives now in Australia, would you be saying, well, okay, that's where the money is, this is what's going to give us the best returns. I mean, it's no doubt that for certain types of investors with certain risk profiles and return profiles, that investment in everything that will facilitate the greening of the energy system poses a huge amount of investment opportunity. And that's in the actual development, and then ultimately the operation of the actual generating assets themselves, be it the solar, the wind, the hydro, etcetera. But it's also in all the auxiliary technology, which is actually going to, you know, enable behind the metre solar, all the, you know, at home energy needs both ways in households. Obviously, you know, producing potentially more than actually consuming at various times in relation to renewable energy and all the related infrastructure. So absolutely the energy system, huge opportunities for investors across, you know, all different spaces, including, of course, super funds in certain spaces directly and indirectly. And I think more broadly, the energy transition is giving rise to, you know, huge spades of opportunity. And it's the way I like to frame it is, it's both the investment opportunities in the actual green investments as well, actually, as the continuing role and opportunities for investors in actually taking assets which today might be playing or still servicing industries which are carbon intensive and playing in a role in moving them from being quote brown assets to olive assets to ultimately actually being assets facing into the tailwinds associated with the energy transition. So some good examples of that, everything from our big ports, which today may still be providing the thoroughfare to export a lot of our fossil fuels and rethinking their roles in the future, i.e. green hydrogen and other things like that, as well as thinking about the roles of, you know, airports, you know, what will be their continuing opportunity to face into tailwinds as sustainable aviation fuels, et cetera, become really commercially available. So I think there's just really a very wide range of opportunities for investors facing into the energy transition. But some of those, I imagine, will be a much safer bet than others. So for example, if the government was to say, look, we want to build big hydroelectricity plants. We want to build big dams, in other words, you know, we're going to put a bit of government money behind that. But largely, we want it to come from the public sector. That's a fairly safe bet, isn't it, and you know, it's going to be, you know, it's going to be completed, you know, it's going to provide a return, whereas other stuff is a bit more experimental, like carbon capture, for example, might be less secure and therefore for a bigger risk. So how do we direct money to make sure that we're still getting that, you know, the combination of both the infrastructure and the innovation? I think that's kind of the different sorts of investors out there. I mean, that's where this space gets so interesting, you know, it's no, it's, it's really spans something for everyone. You know, you've got your more venture capitalist firms, or even, you know, existing large incumbent companies, which have got now innovation hubs with hubs and investment going there, where they're, you know, really, you know, really at the edge of cutting, you know, potentially cutting edge technology, and have got appetite to be investing in things where they are still unproven, then you kind of move into the private equity space where I guess risk profile is lower, but, you know, still willing to and have a desire to do what they've always done well, which is to see growth opportunity and to really get behind some of these companies and help them further grow and ultimately making them in some cases, either, you know, potential target, take over targets for some of our large listed organizations, which are looking for ways to continue to grow and transform as a result of the energy transition right through to other asset classes, which, you know, which will have the potential to generate steady, long term yields with high barriers to entry, which, you know, arguably a more in the, in the appetite of more traditional financial investors, and increasingly, in some cases, within the appetite for super funds when they come to direct investing as well. But why wouldn't super funds, for example, be looking at lithium extraction, given that, you know, there's such a demand for a globally, we, you know, supposedly have so much of it, I would have thought to be, they'd be top hat heavy with lithium extraction. Well, it's a question of time and probably also a question of them, the getting the mature, those, those opportunities to a level of maturity that then become, I guess, directly within the risk appetite and investment appetites of super funds, insane that, of course, there's a number of different ways that super funds can be backing emerging industries coming, coming through, you know, particularly in their role, often as the, the investor sitting behind, for example, private equity and other investors, particularly in their non, their nonlisted equities space. But I think the challenge for Australia in getting a lot of these industries up and running is effectively been getting, is actually getting to a point where they can actually make the equation make sense. And what I mean by that is that, you know, you look at, for example, what's been going on in relation to not just solar panel manufacturing, but everything in relation to wind turbines and batteries, et cetera, some jurisdictions elsewhere, particularly in our region have had specific advantages, particularly as they have related to, to labor and material costs. So, you know, that comes back to the, the conversation around, you know, the grants and incentives frameworks, and that playing a really critical role in effectively de-risking some of these emerging opportunities and to effectively make the manufacturing on shore in Australia actually financially attractive. But, you know, there, there's this to the school processing space, and then, you know, our ability to manufacture things like solar panels, which obviously Australia is, we all know that we're, we've, we've got the blessing of the sun abundance. It's really the question of, actually, can we, how can we actually further that opportunity and deepen that opportunity for the Australian economy? Which are questions, aren't they? Which, to which the answer is, well, why not already? You know, it's, why are we not further down the track? What's the, but I think you've sort of partially answered it, and we've had a change in government where perhaps the, you know, there's more, there's more focus on this now, whereas perhaps there wasn't, previously. But then that, you know, raises the question of politics comes into this, and we're looking for security of investment. What does it mean if we've got a Trump 2.0 world? And, you know, for example, you're saying, well, you know, if we could qualify for the do the inflation reduction act, I mean, that could all go by the wayside in the years time, couldn't it? And we, and yet you could have invested heavily. So politics is a big problem in all of this. There's always going to be degree of politics. You know, I think wherever there's the climate change conversation, but I think what has really, you know, changed over recent years is the recognition that this is such a significant investment opportunity. And that countries that get behind this and economies that get behind this have huge opportunities. I think the cost of not, of not doing anything because of politics doesn't really hold water anymore. And so I definitely understand that the skepticism, you know, potentially with the change of government in countries like the US, but I do think at the end of the day, the economic equation here will mean that it's going to be very difficult for the US just to, you know, cut key policy frameworks like the inflation reduction act, which has actually led to such a significant pivot in capital that is actually seeing the US as a really attractive destination to actually commercialize and bring to life so many of these key opportunities in industries that are required for the energy transition. Right. But our adoption of those technologies is slow, isn't it? And I guess the problem is the closer you get towards net zero, the closer you get to that deadline, those technologies older resources, all the manpower, whatever it is you need to make that transition, it's all going to get more expensive if there's sort of like a bit of a last minute rush and everyone is fighting for those same resources. So the best place for investors to be is getting in there early, getting in now and avoiding the rush, isn't it? Correct. But to your point as well, there's, there are some, I guess, existing sectors and industries where there is, you know, some definitely short to medium term, high returns to be made, but making sure that at the same time that you are, you know, really getting onto this, you know, new set of investments as early as possible. And then just keeping an eye on the industries and the sectors, which ultimately are going to phase out and making sure that the way in which you're thinking about the end value there is consistent with ultimately what will be, I guess, the likely scenario under, under a net zero world. And then, yeah, I mean, placing, you know, to some degree, some bets in, in terms to some of the spaces, you know, some will be winners, some will be not, but that's just sort of the way investing goes. And for individual companies as well, I mean, it's not just those people involved directly in this space. I mean, every company is going to have a net zero strategy, haven't they? Really? Everyone's got to play their part. And I wonder whether it's just going to become more risky to be a company that's not doing that because you may find that your customers, well, I mean, we're already seeing that saying, well, what is your net zero strategy? Because we're not going to, we're not going to buy from or invest in or work with companies that don't have an effective net zero strategy. So companies have got to get up to speed with that. But that's a problem of, it's a space that you know nothing about and, you know, you make yourself susceptible to greenwashing. And if there's a whole load of, you know, different strategies and different companies providing all sorts of difficult solutions, how do companies really navigate that? It's a bit of a mind for you. Yes, it is. So I guess, increasingly what I would say is that the net zero strategy of a given company in a sector, such as electricity and energy generation, industrials and transportation, and net zero is no longer just something which sits on the side. It actually is core to the overall risk and growth opportunities that that business is facing or looking to pursue. It is core to the products and services. They're changing customer expectations, the regulatory environment. I guess where I'm going with that is that thinking about net zero for companies, for example, operating in the everything from the road transportation space through the transmission distribution, obviously everything in relation to all of the low emission fuels coming through, etc. It's actually just so quarter to their business strategy. And if you don't have a convincing and compelling narrative around how the business is actually facing into these tailwinds, I think that is just a fundamental issue which I would expect investors would be identifying and questioning as part of just, you know, just standard practice. I think what gets tricky is in situations where, for example, when hard to abate sectors where, for example, the rail sector where the actual timeframe and the exact technology which at the end of the day is going to be the winner actually enable that sector to decarbonise is still unknown. And so in that case actually the ability to get to net zero and knowing the exact pathway in which you're going to get there is really difficult. And so I guess in that case, like what ultimately we want to, I think we all particularly as a student investors would want to be understanding is the way in which that particular company in that sector is thinking about the variety of options where they're placing their bets, where they're choosing to allocate their capital to and ensuring that they're continuing to stay across and monitor key signals coming through so they can vary and pivot their strategies as required to, you know, ensure that they're not ending up with with stranded assets and ensuring they are, I guess, agile and able to take advantage of technology breakthroughs when they come through. So I guess point here is that net zero strategies and the connection through to growth and the management of core business risk really does depend on, you know, which sector you're in and what is the clarity that one has on what the tail winds are and what the overall decarbonisation pathway is for that business. I do wonder how we ensure that, you know, this collected effort, which is going to be a bit all over the place because it is a complex map. I wonder how we can ensure that that actually achieves that target, you know, that we reach net zero or, you know, do we fall short of it because we just haven't got away of collating all of these individual activities. But I also sense, I mean, it sounds like, you know, we're a bit behind the eight ball, but this year is going to be a year where things take off perhaps. Definitely. And I think particularly when we're staring down the barrel of the short to medium term goals set for 2030, particularly for Australia, 42% reduction on the 2005 emissions levels is if I'm correct. I think that 2030 is getting closer and closer. And I think the reality of what it might mean to not meet that and then actually being able to take stock in terms of what's going to happen out to 2040 and then what that really means for 2050, I think it's going to be a very interesting one for us to watch and see what happens. Whether it all happens fast enough. That's the question, isn't it? Meanwhile, on electric cars, just get one because they're fantastic to drive. Most of us just drive around town. You're not doing a long journey. So just get one. Raquel, thank you very much for that. Excellent to talk to you next week. It's all about Japan, inflation, the Bank of Japan, structural weakness, that aging population, the value of the end, the impact of Trump 2.0. Loads of questions about where Japan is right now and where it's headed. Barry Oshihara, who's a macro strategist contractor for Maco Bond and Japan exchange group, he joins me next week on the weekend edition. And I am back on Monday morning with the week edition of the morning call as well. I'm Phil Dobby for Knapp. Thanks for listening. The Weeknd Edition.