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David Kimberley
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Updated 21 Oct 2022
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Disclaimer

This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. This material should be considered as general market commentary.

If you spend too much time on the internet, like I do, you may have seen the following interaction play out in some shape or form.

Leftie: Wow, we emit so much carbon in the West. We should stop doing this. Also isn’t Greta just the best?

Neo-con capitalist running dog: Yes leftie, but did you know China and India emit a lot more carbon than we do? Haha, I bet you never thought of that now did you?

Easy as it is to poke fun at those on the left in this situation, the arguments favoured by those on the right aren’t completely sound either.

Part of the reason developing countries like China emit so much carbon is because Western companies decided to relocate a large chunk of their manufacturing there. So not only did we outsource a huge proportion of our industrial production, we also exported all the carbon emissions that come with it.

Now we are seeing signs that companies may be changing tack. Covid-19 showed how fragile supply chains are and the dangers of relying on hostile countries for critical supplies. Russia’s invasion of Ukraine also seems to have awoken some (but certainly not all) to the dangers of doing business in an autocratic nation.

Growing talk of ‘onshoring’ manufacturing is the result, with more companies purportedly seeking to move production back home or to more friendly third-party countries. It would be easy to write these claims off as idle words, but it does appear to be happening.

A survey by UBS in September of last year found that 90% of US companies were weighing up moving production out of China or were already doing it. Mid Wynd International (MWY) chairman and economic historian Russell Napier recently said this process will result in a massive boom in capex, as western countries invest large sums of money to ‘reindustrialise’.

Some readers are sure to be thrilled about this and will be counting down the days until they get to have a copper smelting plant next to their house. But if reshoring does happen then it could pose something of a problem to our ‘decarbonisation’ efforts.

Companies and governments alike have been chomping at the bit to say when they’ll be carbon neutral. For instance, Joe Biden wants the US to be 40% below its 1990 levels of carbon emissions by 2030. This would be hard enough as it is. Now imagine large amounts of manufacturing being brought back to the US and the task seems even more daunting.

To be fair, there are claims that technology in the US and other western countries would be ‘greener’ than it is abroad. For example, new developments in hydrogen technology could make steel production much less polluting than it is now. Having production closer to home also means shortening supply chains, which are themselves responsible for a large proportion of total emissions. Nonetheless, it is hard to envisage large scale industrial plants not being major greenhouse gas emitters for the foreseeable future.

The result may be more price pressure on the market for carbon credits. For those not familiar with them, carbon credits are issued to companies that engage in activities that either remove greenhouse gases from the atmosphere or prevent their use. Each credit is equal to one metric ton of carbon.

There are already signs that there will be upward pressure on the price of carbon credits in the years ahead. More than 80% of FTSE 100 firms, for example, have said they’ll aim to be carbon neutral by 2050.

For companies that can’t reduce their emissions, carbon credits are an alternative way of hitting these sorts of targets. In simple terms, you look at how much carbon you’ve emitted and then buy the requisite number of carbon credits to offset that amount.

The trouble is that there is likely to be growing demand for carbon credits but not a commensurate increase in their supply. According to Richard Kelly, a manager of Foresight Sustainable Forestry (FSF), there has been a 17x increase in pledges to reduce emissions over the past three years but only a doubling in the number of carbon credits used for offsetting.

What that implies is there could be an impending shortage of carbon credits as companies scramble to hit their net zero targets. And remember this is before we factor in the potential for countries to begin a process of ‘reindustrialisation’, which it’s hard to imagine wouldn’t compound the problem.

FSF’s portfolio is one of a small number of trusts on the London Stock Exchange today that looks capable of producing carbon credits. These can be kept on the balance sheet or distributed to shareholders as a dividend. The trust invests in forestry and looks capable of generating returns via timber sales, as well as any increases in the value of the land it acquires.

Carbon credits may act as an additional source of returns in the years ahead. The market for them is still a nascent one and so it’s hard to make any concrete predictions as to what will happen. But current trends suggest that, at a minimum, investors should keep an eye on carbon credits as climate change policies mean they are likely to grow in importance.

Past performance is not a reliable indicator of future results

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