Last month, the European Commission released its “Fit for 55” proposals. These set out how the European Union should reach its legally-binding target to cut net greenhouse gas (GHG) emissions to 55% below 1990 levels by 2030. That target will be an important milestone on the road to reach net zero emissions by 2050.
The urgency of cutting emissions has been underlined by the recent United Nations Intergovernmental Panel on Climate Change.
The EU has already made some progress, with data last year showing a 24% reduction in GHG emissions compared to 1990. However, there is still a long way to go.
The “Fit for 55” proposals are wide-ranging but some of the key points are:
- Expand the EU Emissions Trading System (ETS) to cover shipping, buildings and road transport;
- Strengthen the existing ETS, reducing the free allowances for aviation;
- Introduce a border tax on high carbon imports (Carbon Border Adjustment Mechanism, or CBAM);
- Higher targets for renewable energy (40% of overall mix by 2030), and for energy efficiency;
- End exemption of shipping and aviation from energy taxation;
- Cut road transport emissions by 55% by 2030;
- Include land use and forestry in EU targets, and boost tree planting.
The proposals will be subject to much debate and negotiations are expected to last around two years.
Anastasia Petraki, Head of Policy Research, said: “Most of the EU regulatory effort in the last couple of years has gone into promoting sustainable finance and trying to channel more private funding towards greener activities in the real economy. Fit for 55 is the next step in the implementation of the EU Green Deal and addresses the real economy itself.
“The hallmark across the entire spectrum of the proposed changes is making carbon more expensive, the intention being to accelerate the shift from carbon-intensive to carbon-free activities. We see this with the proposals to extend the ETS to include emissions from combustion fuels used in road transport and heating, amend the Energy Tax Directive to penalise energy sources with a high carbon footprint, and introduce the CBAM.”
The proposals would amount to a reshaping of Europe’s economy. They could have a significant impact on European companies and demand for the products and services they provide. However, the biggest beneficiaries may not be the ones you might expect.
We asked our investment experts which industries and companies they think could stand to gain most from these proposals, if implemented.
Suppliers vs OEMs in wind and solar
European Equities Fund Manager Martin Skanberg said: “Given the target of increasing the share of renewable energy to 40%, you might naturally assume that firms like wind turbine manufacturers would be big winners. In fact though, they may struggle to prosper financially.
“This is because of twin pressures on profitability: firstly, the price declines needed to drive renewable adoption; and secondly, rising commodity price pressures (mostly steel) which are pushing costs higher. Careful selection is needed to find the true sustainable winners in equity markets.”
Instead, it may be that the winning companies are the suppliers to the clean energy industry, rather than the original equipment manufacturers (OEMs). Europe is home to numerous “green tech” firms who supply the wind and solar industries.
Martin Skanberg said: “Chemicals companies are an important part of the supply chain that enables green energy. One example is Germany company Wacker Chemie which is a leading supplier of the polysilicon needed for solar cells. In wind power, an example could be Sweden’s SKF which makes the heavy duty ball bearings needed for wind turbines, as well as for many other applications.
“Such companies may not be immediately front of mind when it comes to renewable energy, but their components have an important role to play.”
The “Fit for 55” proposals do not only concentrate on generating and distributing renewable energy but also on using that energy more efficiently. One important aspect of this is in buildings. Buildings account for 40% of energy consumed and 36% of energy related GHG emissions, according to the Commission.
A focus on energy efficiency will therefore be needed both at the construction stage for new buildings and for retrofitting existing buildings.
A company with products used across the construction industry is the Swiss firm Sika.
European Equities fund manager Paul Griffin said: “Sika is innovating with a range of so-called water-reducing admixtures that can provide greater strength and significantly reduce the amount of water used every year in concrete production.
“Then there’s their ‘building envelope systems’ – the roof membranes, sealants and mortars used to construct a building’s outer shell. Introducing effective insulation, sealant and glazing systems can achieve a significant reduction in the energy required to heat the building.”
The European Commission’s proposals for road transport include a 55% cut to the CO2 emissions of new cars and vans by 2030, escalating to 100% in 2035. That allows a 15-year period for the last petrol and diesel vehicles to be phased out in time for the 2050 net zero target.
“Consumer and regulatory demand for electric vehicles (EVs) is there and Europe has car companies able to meet that demand”, said Scott MacLennan, European Equities fund manager.
“For many people, Tesla is still the company most associated with EVs, but in Europe Volkswagen has transformed itself into an EV leader and is also investing in battery technology.
“The pace of change in the sector is extremely rapid. Yet there is still sometimes a perception that the legacy carmakers can’t become EV leaders. Such outdated perceptions can lead to stocks becoming mispriced, and other investors can take advantage of that.”
- Read more: Chasing Tesla: How traditional carmakers are revving up their electric vehicle production
Again, it is not only the carmakers themselves but some of the suppliers that could see increased demand for their products as the regulatory push for cleaner mobility intensifies.
Nicholette MacDonald-Brown, Head of European Blend, said: “Johnson Matthey has several different exposures to the green transport push. Its catalysts can be fitted to existing petrol, diesel or hybrid vehicles to reduce polluting emissions. It also makes catalyst coated membranes which are part of a hydrogen fuel cell.
“Johnson Matthey is active in battery materials too”, Nicholette said. “It is developing nickel-rich cathode materials that can give batteries high energy density while reducing the levels of cobalt needed. This is important as cobalt is both expensive and largely mined in countries where there are concerns over labour exploitation.”
Hydrogen and batteries aren’t the only fuels that could help the EU achieve the “Fit for 55” proposals. Biofuels also have a role to play.
Scott MacLennan said: “Biofuels companies such as Finland’s Neste offer a solution for the diesel vehicles that remain on our roads. Neste has a renewable diesel product which can be used instead of conventional diesel. It has also developed a sustainable aviation fuel (SAF) which is already being used by some airlines.”
Sustainable aviation fuel is currently only used in small quantities. However, demand looks set to rise rapidly as the EC’s proposals include a requirement to increase the amount of SAF blended into the jet fuel mix from 2% in 2025 to 5% in 2030 and 63% in 2050.
As with batteries though, there is still work to be done on ensuring that biofuels are produced as sustainably as possible. The EC’s proposals include measures to ensure that demand for biofuels does not impinge on land better suited for food production. Neste’s advanced biofuels are produced using 83% wastes and residues. The company continues to innovate and develop new potential feedstocks for its biofuels.
Return to rail
Decarbonising transport will need new fuels and technologies, but an older technology – rail – is already one of the most environmentally-friendly options. Paul Griffin said: “Significant investments are already earmarked for rail networks across the continent. These plans include new high-speed corridors and also the modernisation of regional and metropolitan lines.
“Again, there are some less obvious companies which could prove interesting investments in this environment. Knorr Bremse, the leading brake manufacturer for trains and trucks, is one and online booking platform Trainline is another.”
Carbon border tax
The “Fit for 55” proposals as they stand will have a profound effect on the products and services companies in Europe offer. But they also include measures to ensure the sustainable efforts made by Europe’s companies are not undone by cheaper offerings from polluting overseas competitors.
Martin Skanberg said: “By erecting carbon border taxes and driving a higher carbon price, Europe can promote the use of lower carbon commodities. This includes indirectly supporting domestic EU suppliers from unfair foreign competition. For example, Europe’s three stainless steel companies (Outokumpu, Aperam and Acerinox) all make low carbon steel and could now see greater protection and a much higher profitability as a result.”
The “Fit for 55” proposals also state that, by 2035, the EU should aim to reach climate neutrality in the land use, forestry and agriculture sectors. This includes agricultural non-CO2 emissions, such as those from fertiliser use and livestock.
Again, there are companies with innovations that can help make this a reality, while maintaining a reliable food supply. Methane is an important gas to tackle here, as it has around 20 times the heat-trapping potential of carbon dioxide.
Paul Griffin said: “Much of the methane generated by agriculture has been emitted from the burping cows being bred for meat and dairy consumption. DSM, a supplier of both human and animal nutrition products, has developed a feed additive to address these methane emissions from cattle. It safely suppresses the enzyme that triggers methane production in the cow’s stomach, with tests showing it consistently reduces enteric methane emission by almost a third.
“Should the product reach a commercial stage, it could be a significant step towards making livestock farming more sustainable.”
Impact will reach beyond financial markets
The “Fit for 55” proposals will now be negotiated by EU member states. The effects of the plan will be felt in EU citizens’ daily lives, potentially leading to some tough negotiations.
“While increasing carbon prices is necessary, there could be both political and social backlash as this will translate to higher energy bills and more expensive transport for EU households”, Anastasia Petraki said. “Theoretically, this should not be an issue as long as low-carbon alternatives become cheaper or subsidised. But the proposed changes are more about setting stricter targets and less about making renewable energy cheaper. So the finances of poorer households could face a substantial dent.
“The EU has planned for a new Climate Social Fund, which will draw from EU public money and ETS revenues, to support these households. It remains to be seen whether this will really end up helping the people who need it most.”
“Some political backlash could also be expected around the proposed changes to the Energy Tax Directive. EU member states will not disagree with the principle of it but rather with the actual tool as it is about taxes and, historically, member states have guarded sovereignty over fiscal policy very jealously.”
But while member states may wrangle over the details, the impact of these proposals on financial markets looks likely to be profound. Given the urgency of reducing emissions, as highlighted by the recent IPCC report, investors may want to consider how they are positioned for the enormous period of change that lies ahead.
“The Fit for 55 proposals represent a major opportunity for Europe to transform its economy for a low carbon future and this will have significant implications for shares”, said Nicholette MacDonald-Brown. “As investors who integrate sustainability into our fundamental analysis, we think the best returns will be achieved by looking beyond the headlines and the most obvious winners.
“Instead, we favour a more nuanced approach: looking at suppliers as well as OEMs for example, and companies who are innovating. It’s also crucial to consider factors like cost and competitive pressures, strength of business model, and of course, valuation.”
This article was published in August 2021. Any company references are for illustrative purposes only and are not a recommendation to buy and/or sell, or an opinion as to the value of that company’s shares. The article is not intended to provide, and should not be relied on, for investment advice or research. If you are unsure as to the suitability of any investment, please speak to an independent financial adviser.
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