Essex Global Environmental Opportunities Strategy (GEOS) April 2023 Update
Spring is emerging here in Boston, well ahead of itself given a temperate winter. As we exit from a tumultuous winter from so many perspectives, we welcome spring – a season of new growth and green shoots. While our winter was warm, news flow was dark, from extreme weather events to an economy still suffering stresses from inflation and resultant Federal Reserve action to control it. After the bleak winter, we believe with spring will come renewal for the equity market.
The Intergovernmental Panel on Climate Change (IPCC) released the AR6 Synthesis Report in March, summarizing the main findings of the previous six reports in this IPCC cycle. The IPCC reiterated that society needs to rapidly reduce global emissions to avoid breaching 1.5- or 2-degrees Celsius warming. Immediate action on climate mitigation also has important implications for the effectiveness of adaptation. Adaptation is critical to help society manage the impacts of climate change, but it is more effective at lower levels of temperature warming. Finally, the IPCC explained that even if society were to overshoot 1.5 degrees or 2 degrees Celsius of warming, sustaining net negative global emissions for an extended period could return warming to below 1.5- or 2-degrees C. This would require a rapid scale up of carbon dioxide removal technology in addition to the deployment of existing low carbon technologies.
While the final IPCC report from the Sixth Assessment cycle is a sobering portrayal of the reality of climate change, we believe it showcases the benefits of near-term action using the commercial low carbon technologies available today. The time value of carbon states that emissions abated now are more valuable than emissions abated in the future since temperature warming and other negative climate impacts will continue as long as global emissions are net positive. Therefore, near term decarbonization is most valuable. Thankfully, most of the technologies needed to reach net-zero emissions are cost competitive and viable today, but for a select few technologies needed to decarbonize hard to abate sectors, such as heavy industry and long-haul transportation, and facilitate carbon dioxide removal. Rapid deployment of solar, onshore and offshore wind, battery storage, smart grid technology, electric vehicles, heat pumps, and other existing commercial low carbon technologies can catalyze society’s path to net-zero emissions starting today. GEOS recognizes the urgency of the situation and invests in existing commercially viable technologies that can be scaled today to enable a net-zero world.
The GEOS team recently engaged with Zurn Elkay Water Solutions to discuss their ESG progress. Zurn is a leading provider of water management solutions and has significant growth opportunities associated with clean drinking water products. After closing the acquisition of Elkay Manufacturing that brought more drinking water filtration products into their portfolio, the company made all employees shareholders and eligible for an annual bonus to boost engagement and retention. Zurn’s management has also held several town hall meetings to gain feedback from employees and boost employee satisfaction. Moving forward, we plan to track Zurn’s product roadmap around PFAS filtration given the need to ensure drinking water is free from harmful contaminants.
Despite the fits and starts of clean technology stock performance over the past year, the fundamentals of the companies behind those stocks – the businesses are progressing. Certainly there are hurdles, from continued labor and supply chain stresses to higher capital costs. We have emphasized the importance of financial discipline and look to a firm’s returns on investment. A company which is struggling to scale may have to constantly find capital in the form of loans or equity offerings which dilute shareholders. Ineffective capital discipline could cause excessive cash “burn”, which, when coupled with a technology which is struggling to scale commercially will cause an excessive debt burden and leverage. Effective discipline leads to optimal allocations of capital – a balance between investing for growth, such as research and development, or hiring, versus capital retention for periods of uncertainty, such as longer sales cycles. Discipline can take the form of capital and financial discipline, but also strong operational governance – knowing how to bring a new offering to the right market is key and avoids expensive missteps. Discipline is all important at this time of tight capital.
Despite the many headwinds for our economy, our philosophy is well intact – certainly given all the commitments to net zero, SDGs, and water conservation, players need solutions. The chart below speaks to a continued strong clean energy investing pace, growing unconstructed by geopolitics or economic volatility:
And, speaking of politics, renewables growth in the U.S. is apolitical – states are scaling renewables because of the economic vitality – costs are cheaper for green electrons versus fossil fuels, with less risks and greater functionality. By 2027, we believe Texas could surpass California for net new utility scale solar, and Texas is already the top state for wind production. Subsidies are catalysts for some industries within our GEOS themes, but our primary criterium for GEOS is commercial and financial viability before we consider any incentives – that is gravy.
This commentary is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. The opinions and analyses expressed in this commentary are based on Essex Investment Management LLC’s (“Essex”) research and professional experience and are expressed as of the date of its release. Certain information expressed represents an assessment at a specific point in time and is not intended to be a forecast or guarantee of future results, nor is intended to speak to any future periods. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties.
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