Martin Lefebvre
Hi everyone. Welcome and thank you for tuning into this NBI podcast. I'm your host, Martin Lefebvre, Chief Investment Officer at National Bank Investments. Our topic of discussion today will be around net zero goals and their impact on the economy. To do so, I'm joined by Stephen M. Liberatore, Portfolio Manager at Nuveen Asset Management. Stephen, thank you for being with us.
Stephen M. Liberatore
Martin, thank you for having me. And thank you for speaking English. I speak a little French, but it's very bad.
Martin Lefebvre
Excellent, we'll do it in English. Stephen, perhaps to begin, can you just explain the concept of net-zero emissions and why it's crucial for everybody?
Stephen M. Liberatore
Net zero can mean a couple of different things, but the general concept around is, it's not about necessarily eliminating the emissions that someone has. It's about offsetting that through other factors or other processes that effectively make you an operation or you as an entity or as a person, not impacting the environment in any way. Whatever you do admit, you actually recover or reduce in another way so that your existence doesn't have any new to any material impact on the state of the environment.
Martin Lefebvre
That seems pretty logic to me. What's the lay of the land? What's the biggest challenge and opportunities in achieving net-zero emissions by 2050?
Stephen M. Liberatore
The biggest challenge really is, one, measurement. You know, you will hear things when you think about net zero, you'll hear different concepts, you'll hear scope 1, scope 2, scope 3, or different types of emissions that are out there that can be measured. Scopes 1 and 2 are straightforward in that they're your own emissions and the emissions of your direct suppliers, if you're a manufacturing company, for example, or if you're a service provider, the people that you're working with that are providing you goods and services, what are their emissions? The real challenge comes down with scope 3, which is more of a measurement of going all the way down the chain of the impact of emissions from the coffee bean that you purchase from a supplier to make coffee in your offices, for instance. And it can be very difficult to get that granular level of detail.
And there's also a great risk in the fact of double counting or even maybe triple counting emissions because you're not exactly sure who and which it applies to within the chain and in the supply chain. The biggest issue is how do you measure and how do you account for it? And then I would say the next second set, the biggest challenge there is finding ways in which to offset your own emissions. Are there viable, high quality, measurable ways in which you can effectively cut emissions or reduce emissions or remove emissions from the environment. You really kind of have a dual-edged problem of correct calculation of the emissions being generated currently, but then also access to quantifiably verifiable projects or assets that allow you to be certain that you're either reducing or removing emissions on the other side.
Martin Lefebvre
Does that difficulty in measuring make it sort of a utopia or is this just a challenge that we've got to work around? And a follow-up question to that is that why banks moved out of that net zero emissions by 2050 or was it 2035? And there's two important dates here, I think, we need to discuss.
Stephen M. Liberatore
2035 was for banking and for financing. 2050 has been more the general overarching United Nations-driven emissions goal. I think that the real challenge is making sure that everyone is doing what they can do best. And I think everyone's approach is a little bit different. That's one of the things, you always say it's a challenge, but it's simultaneously an opportunity, it’s what we're talking about in a lot of ways can be subjective, right? What you may consider to be positive for the environment may not be what others consider positive for the environment. The real issue is how do you produce, in our case, investment opportunities that really showcase the ability to effectively reduce emissions.
We do a variety of different projects, whether it's debt-for-nature swaps, where the underlying capital is being used for projects that are environmentally beneficial that also tie back into environmental opportunities. We've done some things around reforestation and more accurate and sustainable maintenance of forests, for example. The real key is being able to find those opportunities that have a financial benefit associated with them. Therefore, you really can have an investment case for it, an investment thesis, but also produces those high-quality outcomes that you can feel comfortable with.
I think of a transaction we've done recently where we provided financing for what's called the Amazon reforestation project. And this particular case capital was provided to an operating company in Brazil called Mombak to acquire deforested Amazonian property or work with the legal owner, do the appropriate analysis, scientific analysis, topographical analysis, and basically find the appropriate mixture of flora and fauna that would rewild that property back to its original state. And it was more than just say, we're going to put up a bunch, we're going to buy some land and we're going to put up a bunch of eucalyptus trees because those grow the fastest. But they die after five years because they're not native.
This was a really thoughtful integrated approach to really rewilding. And after roughly three years, you can start then verifying, auditing, true removal carbon credits that are then being taken off in this case by Microsoft. That's an opportunity to show real carbon reduction by effectively creating a carbon sink that creates these removal carbon credits that are extremely high quality because they've been audited. They're on the Verra website [a global nonprofit organization setting standards for climate action and sustainable development] and they're being off taken by an entity like Microsoft who's a long commitment to the carbon credit market, for example.
Martin Lefebvre
You talk about carbon, why didn't the carbon tax work? Canada is talking about axing that. What's your thought on that?
Stephen M. Liberatore
It's a great question. And it kind of goes back to one of those basic economic theories, that you're supposed to tax the things you don't want to occur and not tax the things that you want to encourage to happen. And I do think that the carbon tax is difficult because it is a relatively complex calculation. And I think because there's so many externalities associated with what is the appropriate level of a carbon tax. If it's not a clear and concise explanation, I think people have less ability to understand it and therefore are less supportive of it because it's not a direct understanding of why I am being taxed X amount because you can't really understand the basis for X. There's a general negative connotation anywhere of an additional tax or any taxation. And I think if it can't be cleanly and simplistically laid out as to why am I paying this tax on this particular item, good or service, I think that generates less support from citizens.
Martin Lefebvre
In terms of traction or degree of adoption, can you give us a few case studies where countries or companies have made significant progress towards net zero?
Stephen M. Liberatore
I think what you'll see is there's a variety of different types of ways to do it. You'll see it primarily when you start looking at utilities, and this would include both developed and emerging markets. You've seen a portfolio generation shift to renewables, and those renewables tend to be wind, solar, hydro, although you're seeing an increasing amount of geothermal, in some places also nuclear power. And you're starting to see that shift away from pure fossil fuel utilization in a country's entire electric grid to including more and more capacity that's renewable and therefore beneficial to overall emissions.
You've also seen certain sectors – technology, for example, has been a big one, data centers are another one – where their growth and their operations have tended to try to make carbon neutral by powering them all with purchase power agreements for only renewable energy, for example. That's another area where you've seen material improvement as far as overall composition of myths of power.
Pretty much every sector in the global economy is looking at ways to becoming more energy efficient and less reliant on power as a whole but also trying to look at more renewable energy. And I would like to sit here and tell you, Martin, that that's because everyone has identified the fact that global warming and climate change are huge issues for us as a species, but that's not really it. It's because it's cheaper to use renewable energy, especially at utility scale. And depending upon where you are in the world and what your topography and environment is, it could be solar, it could be wind, but those are two technologies. There are no fuel costs.
There's the same concept that applies to semiconductor improvement, Moore's law. And I apologize to the scientists that came up with this because I can never remember his name, but you think about solar panels, the efficiency that is driven in every single generation for a solar panel only increases over time. It only becomes cheaper to operate, it generates cheaper power because again, there's no fuel. Same with wind in that those technologies become more adept, they become more efficient over time. You see a declining cost of maintenance, a declining cost of investment.
That's why we look at things the way we do as an asset manager. All of this ties back into stability of free cashflow generation. On the debt side, that's how we get repaid is we want to make sure that an issuer is able to repay us. If we can focus on projects, assets, strategies that generate more stable free cashflow over time. That's only a benefit for us as a bond investor where it's an asymmetric payoff. We receive par back, par in a coupon. If we're able to find those issuers, where over time they become more stable free cashflow generators, that means their risk has been reduced, which means we're being compensated at trade date for a riskier entity than what it ends up being over time, which is how you generate excess return.
Martin Lefebvre
Country-wise, who's the champion in all of this? We often hear the European countries being leaders in that role?
Stephen M. Liberatore
Yes. It's, it's been pretty much in Europe. They have been far more focused on transition away from fossil fuel. They also have more national defense potential issues there considering, and national security issues, given that the majority of their fossil fuel comes from Russia and natural gas there. I think that they've been focused on how they transition themselves away from the use of fossil fuels, not only from an environmental cost, but also a national security issue.
Martin Lefebvre
One last question. You've mentioned investments. So how do you see investors and advisors supporting the transition to an end to your economy?
Stephen M. Liberatore
I think one of the things that we have seen really rapid growth in has been – and I can speak to the fixed income side – is the AUM going into sustainable fixed income strategies continues to grow rapidly. We continue to grow at a faster pace than the non-sustainable strategies within fixed income. Investors are looking for these opportunities because one of the real key direct measures of performance for fixed income is again tied to this concept of stability of free cash flow. If you're using impact considerations or environmental, social and governance considerations, what you're looking for are operations and management teams that are incorporating more sustainable strategies over time because they become more cost effective and they become more free cash flow generative. I think that that direct correlation between sustainability and free cashflow generation really plays itself out well in fixed income and has attracted more and more investors into the space. Again, if you're doing it well.
Martin Lefebvre
That’s all the time we had today. It was a quick dive in the world of zero emissions. And I think that your comments were very enlightening. Thank you very much for your participation in this podcast, Stephen.
Stephen M. Liberatore
Thanks for having me, Martin, I appreciate it.
Martin Lefebvre
