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How To Invest In Climate Change And ESG – Seeking Alpha


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Investment Thesis

Contrary to what the vast majority of Seeking Alpha readers seem to believe, climate change is real. Moreover, international policies have been set to deal with this problem – since global warming has been deemed a more important issue than investors’ greed, which tends to only look forward in time for a relatively short period compared to the scale of the issue at hand.

In short, the coming decades will see a massive energy transition to renewables combined with an electrification of processes that do not run on sustainable energy sources yet. While this will be a headwind for traditional oil, gas and coal-based companies, this transition nevertheless creates new, multi-decade opportunities.

Foreword

I certainly do not expect this to be a popular article, but it represents my tiny contribution to educating the readers of Seeking Alpha.

The reason for this is because pretty much anytime there is an article about climate change or some related topic on Seeking Alpha, the comment section tends to be full of top comments* that flat out deny climate change or something along those lines. This is objectively misinformation. Clearly, oil still reigns supreme among many investors. While Seeking Alpha is not a site about science, both public opinion and public policy should nevertheless be based on rigid science, which in turn may inform investment decisions.

(*The final straw to write this article was this one, but there have been many more.)

The Science

To understand climate change and global warming (in simple terms), one could start by considering that the Earth is actually like an object that has been placed in a giant microwave (with the microwave being the Sun in this analogy). Indeed, every square meter of Earth on average gets exposed to about 1kW of heat – as if the Earth is covered with microwaves everywhere.

So from that view, the fact that there is talk about global warming shouldn’t actually surprise anyone: just consider what would happen if you place any object in your microwave for billions of years, which is the equivalent of the Earth being exposed to the sun for billions of years.

Hence, if there was nothing that actually made the Earth cool down, it would be far too hot (and getting even warmer all the time), and hence never would any kind of complex life on Earth have been able to form, and hence no investors and companies would have formed, and hence no stocks that those investors could buy.

However, there is indeed a mechanism to cool the Earth down (not just to heat it up by exposing it to the sun). This mechanism is called radiation aka light aka electromagnetic waves (but this time coming from the Earth rather than the sun). As one could learn in physics, anything that has any temperature will radiate its heat away, cooling down as the energy leaves the object.

There is one more thing to consider. One might know that light can have different wavelengths (indeed, in the microwave analogy above, “microwave” refers to the wavelength of the light), and it turns out that the wavelengths of light that are contained in this radiation depend on the temperature of the object that is emitting the radiation: the higher the temperature, the shorter the wavelengths that are being emitted. Moreover, the shorter the wavelength, the higher the energy of the light. This is actually the key point regarding climate change, as further explained below.

So what happens is following. First, the sun, which is a few thousand degrees Celsius, emits many wavelengths of light, but for the most part in visible light, UV and infrared. This heats the Earth. However, as the Earth heats up, it will also start to radiate on its own, although with much less energy since the Earth is much cooler in temperature. Nevertheless, the amount of heat that it will radiate further increases as the temperature increases.

Hence, at some point (as the temperature rises) the amount of heat (energy) that enters Earth will be exactly offset by the amount of heat (energy) leaving Earth. In other words, an equilibrium temperature will be reached (since there will be no net change in energy anymore), and this can be represented as the average temperature of Earth.

Of course, there are some things that cause variations, such as weather, day/night cycles, seasons, etc., but the key point is that ultimately the average temperature depends on the equilibrium between heat reaching Earth from the sun and heat leaving Earth (since the Earth is radiating as well).

The significant observation here – as alluded to above – is that there is a discrepancy in the wavelengths of light reaching and leaving Earth. Since the Earth has a temperature of only a few hundred degrees Celsius, the wavelengths that it radiates are much longer, namely in the infrared part. This means energy reaches Earth as visible and UV light, but leaves Earth as infrared.

What is so significant about this, is that this provides a mechanism to change the equilibrium temperature of Earth. As anyone has who gotten some chemistry knows, certain molecules can absorb certain wavelengths of light. Hence, imagine if one could find a molecule that absorbed infrared radiation, what would happen?

Well, since the Sun mostly emits visible light, initially nothing would happen, and all radiation from the sun would continue to reach Earth unaffected (causing it to heat up). However, as the Earth then emits this radiation back into the atmosphere, since the wavelength is now much different (namely in the infrared part), those molecules I just referred to would now absorb the Earth’s radiation.

While this sounds innocent at first, at some point those molecules would radiate this energy back. However, since now it is the atmosphere (instead of Earth) uniformly emitting infrared radiation, this means that inevitably at least some (about half) of that radiation will actually hit the Earth again. But since this radiation came from the Earth in the first place, that effectively means that some part of Earth’s radiation didn’t actually escape the Earth. Hence, the atmosphere can act as an isolator, making it harder for heat to leave Earth. All while being (mostly) transparent to the radiation coming from the sun.

Put another way, less radiation/heat will be able to escape Earth due to the presence of infrared-absorbing molecules in the atmosphere. Eventually, a new equilibrium (between ingoing and outgoing energy) will eventually be reached, but at a higher temperature.

Obviously, those molecules I am referring to are known as greenhouse gasses. While there are multiple of those, the most significant one as most people know is CO2 since this is being released massively by things likes cars and electric generation plants. The more infrared-absorbing molecules such as CO2 that humans put into the atmosphere, the more that Earth’s radiation gets blocked from escaping the Earth, and the more Earth will heat up like an object that is being placed in a microwave.

As mentioned, one of the key (technical) insights is that while greenhouse gasses block Earth’s infrared radiation, the sun’s radiation (visible and UV light) remains completely unaffected.

Source: the explanation above is crudely based on the book The Physics of Climate Change by Lawrence Krauss.

Implications

Obviously, one could now ask: so what? Why does matter if the Earth heats up a few degrees. Well, in the worst case, the Earth doesn’t just heat up a few degrees, but quite a lot, which would eventually cause the oceans to evaporate. Note that H2O is also a greenhouse gas, so then Earth might become Venus 2.0. Humans will have destroyed themselves. Obviously, this would cause the value of all stocks owned by investors to go to zero.

Still, even in a less dramatic scenario, the most obvious impact/ example is that all the ice would melt, which would cause the oceans to potentially rise by many dozens of meters. This means that thousands of cities – where billions of people live – will be completely drowned. Note that this melting would take hundreds to thousands of years.

Sustainability

The last reason investors might care about climate change and ESG is something that actually has nothing to do with climate change, but simply the observation that humans are getting their energy from burning stuff that took millions of years to form in the first place. This isn’t sustainable, since those oil and other reserves will eventually become completely depleted anyway. So even if humans wanted to keep using fossil fuels and there were no climate considerations required, the current global economy simply isn’t sustainable to last.

Now, it may be understandable that investors do not care about any of this (either sustainability or climate change) since this won’t affect humans at the minuscule timescale of a single investor’s career, but that is why politics and policy should enforce sustainability, since the global environment is obviously not something that should be decided about by investors’ greed.

Solutions & Investor Opportunities

As described above, fundamentally the issue is that the world gets its energy from sources that are both finite and pollutive. The magic words for the solution are “renewables” and “electrification.”

Renewables: it is possible to generate electricity from sustainable energy sources such as wind, light and nuclear energy. In fact, wind and solar both have already become cheaper than traditional fossil sources in the last decade, so economically speaking this transition might have happened regardless of any climate considerations.

Electrification: the energy transition isn’t just about transportation or electricity, but all industries will have to transition to clean sources of energy.

The most well-known example is the electrification of ICEs to EVs. For this, I would propose NIO Inc. ADR (NIO) as an innovative EV pure play which could still have strong investor upside given its lower valuation compared to Tesla Inc. (TSLA), both due to its lower P/S multiple as well as lower sales due to being much earlier in its production ramp.

A second opportunity is the production of meat, as agriculture represents about a quarter of greenhouse gas emissions, with meat being one of the largest contributors. In recent years alternatives have been developed that are comparable in price and taste, but which have been produced based on plant protein rather than animal protein. An investor opportunity here is Beyond Meat Inc. (BYND).

Investor Takeaway

First, climate change is real and is based on valid science. Secondly, it is also agreed upon that the rise in temperature will have consequences, such as rising sea levels, that should be avoided. Therefore, in the coming decades – supposedly between now and 2050 or 2060 – there will be a massive energy transition, further fueled by a deep electrification of processes such as transport.

Since these climate plans are part of global policies, investors can be quite sure that this will happen, although the exact details may not be precisely known. This means companies that benefit from this energy transition could be strong long-term (perhaps even multi-decade) investments.

Here, I have identified NIO and Beyond Meat as two such examples, although surely there are a ton more. Beyond Meat may be more risky since there have not been policies set on meat, while this is for example already the case in Europe for the transition to EVs.

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