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ESG

ESG Newsletter published on April 1, 2021

Changed Power Structure in DC May Support Environmental Initiatives

The arrival of new leadership in the White House and Senate in Washington DC increases the likely elevation of the debate—and perhaps legislation and regulation—related to key environmental interests. Breckinridge investment team members shared their insights about these topics. Participants included Senior Research Analysts Alriona Costigan, Josh Stein and Chris Woodward along with Senior Investment Strategist Cara Early; Director, Municipal Research, Andrew Teras; and Director, ESG Research, Rob Fernandez. Their comments follow.

Rob Fernandez: President Biden signed almost 30 directives in the first couple of weeks after taking office that cover a range of issues. Environmental and climate-risk advocates were enthusiastic. These and other issues he focuses on are integral to our work.

Andrew Teras: As noteworthy and as far-reaching as the executive actions were, I think the appointments in key departments across the government suggest potential regulatory changes for climate policy, as well as social reforms and corporate governance, that may prove even more consequential.

Cara Early: Right. Start with Janet Yellen at Treasury. Leading Treasury and the Financial Stability Oversight Council positions her to have a pervasive policy influence. She seldom misses a chance to talk about the financial and economic risks of climate change and has endorsed a carbon tax. She also is considering a new senior advisor on climate change. Her chief of staff is Didem Niscani, who was global head of public policy at Bloomberg.

Interior Secretary nominee Deb Haaland would be the first Native American cabinet member if confirmed. The Interior Department oversees natural resources, public lands and Indian affairs. Haaland is viewed as a consensus builder.

Gary Gensler is nominated to lead the SEC, which may bode well for regulatory reform of corporate disclosures that are important to our security analysis on topics like greenhouse gas emissions, racial equity, executive pay and other ESG factors.

AT: The Securities and Exchange Commission created a new position and appointed Satyam Khanna to advise on ESG matters and advance related new initiatives across its offices and divisions. Also, the SEC’s new acting director for the Division of Corporate Finance, John Coates, believes the agency has a role to play in creating an ESG reporting framework for corporations.

CE: Yes. The point is that the latitude to effect change through policy and regulation can often be more expeditious and focused than might be achieved through the legislative process where the Democrat majority is thin, and some members are aligned with their state’s fossil fuel interests.

RF: I’d add Marty Walsh, confirmed to lead the Labor Department. Walsh led the bipartisan Climate Mayors network of city leaders who believe economic growth and environmental stewardship go hand in hand. There is also hope that he will help roll back a 2020 rule that hemmed in pension fund decision-making on funds managed to climate change, racial justice and other ESG risk factors. And, the Fed has noted that the economy and financial system are already being affected by climate change and is ramping up work to ensure the financial system can deal with the risks. Importantly, the Fed said that its interest in shoring up the financial system against climate change risks is not in conflict with its legal mandate of promoting job growth.

Alriona Costigan: Climate certainly is centermost for the administration. In November, Biden introduced John Kerry as his special envoy for the climate crisis and added him to the National Security Council, which raises the profile of climate issues. Kerry’s comments clearly show he believes climate change and its consequences are immediate and catastrophic concerns.

Chris Woodward: It has been interesting to track John Kerry’s evolving position on nuclear power. During the 1990s, he did not believe nuclear was a viable solution. More recently, he has been supportive of advances in nuclear power generation given the challenge of climate change. His position may open opportunities for greater consensus building in efforts to address climate risk through emissions reductions.

AC: True. And, in January, Biden recommitted to U.S. participation in the Paris Climate Accords. He also cited a goal to transition the U.S. away from fossil fuels during the campaign. Climate Coordinator Gina McCarthy and National Economic Council Director Brian Deese lead an interagency working group to help communities transition away from coal and other fossil fuels. They emphasize that these efforts also are intended to create good jobs in the clean energy industry.

There is a moratorium on all new oil and gas leasing on federal lands and waters. Josh follows the utilities and energy on our corporate team and can speak to the implications for bond issuers in those sectors?

Josh Stein: The government is adding to stakeholder pressure for the energy sector to respond to physical and transitional climate risks.

For energy, the drilling moratorium is a concern but, it’s a 60-day limit. The moratorium does not halt existing operations, there currently is a large backlog of permits that have already been filed as well as a massive inventory of drilled but uncompleted wells. That should support production in the near term. However, a longer-term moratorium would be a challenge for the industry as federal lands and waters account for more than 20 percent of U.S. oil production and more than 10 percent of U.S. natural gas supply. Reduced production would challenge exploration and production companies, as well as midstream operators, and would likely lead to higher oil and gas prices, and shift energy leadership outside of the U.S. again.

We also will be watching longer-term initiatives related to taxing carbon or mandates for sectors of the economy to decarbonize.

Biden’s plans would de-carbonize electricity generation by 2035 by transitioning to renewables. That encourages investments in renewable technologies, which can be a credit positive. Regulated utilities can recover capital expenditures, which could benefit earnings. In addition, tax credits for wind and solar investments sunset in 2025. If they can be extended before that time, also a credit positive.

Most utilities are currently targeting 2050 as their goal for decarbonization, so Biden’s proposed accelerated timeline is aggressive considering the limitations and costs of existing technologies. Renewables and energy storage costs would need to come down considerably to meet that goal, as well as new technologies such as carbon capture or using hydrogen as a fuel source.

CW: I would play devil’s advocate and consider the room sectors such as transportation and utilities might have under an administration that supports markets. The one it replaced began with import tariffs on washing machines and solar panels. It went on to restrict nuclear research, in China, withheld permits for offshore wind, and stewarded lower global oil production. The end of Trump’s term mostly ended these market-steering policies, as will Biden’s end, unless the Administration fosters where the market is already going.

Carbon dioxide does not yet have a clear federal price signal, but it is safe to say its cost is being treated more positively. Helping it stay there might also redefine what we mean by energy leadership.

The Biden Administration’s four, maybe eight, years mean efforts for 2035-2050 carbon goals must be strategic. Cara and Andrew touched on climate related issues with ESG investing, that the SEC and Fed can address.

There’s also the Department of Energy’s new $40 billion loan program. Notorious for leaving behind half a billion in Solyndra losses, its previous iteration, the “ARRA”, also helped launch Tesla toward half a trillion dollars in market value. Clean industries already offering consumers lower overall costs, can take advantage of such leverage and scale up a delivery of lower the up-front costs. Ones which could otherwise remain an obstacle to lowering CO2.

AC: To Chris’s point, DOE efforts may go a long way to make lower cost energy and power generation more accessible.

Over the longer-term, there is a transportation infrastructure dimension to hasten a clean energy transition. The Transportation Department’s $889 million Infrastructure for Rebuilding America program will carve funding for projects addressing climate change and environmental justice, like reconstruction, rehabilitation, acquisition of property and environmental mitigation.

Projects could include modernizing roads, bridges, rail, ports and airports to better withstand the effects of climate change. These initiatives in the public sectors that I watch could lead to a better, more equitable and sustainable transportation system in the future.

I understand the administration is talking about facilitating climate-friendly transportation modalities by reintroducing tax credits for electric-vehicle purchases, installing charging stations, and pursuing and advancing high-speed rail. Supporting the most serious polluters as they transition to greener operations also will be necessary. These are substantial investments.

JS: Electrifying transportation and infrastructure could drive electricity demand. Again, that would boost revenues and earnings for utilities. Biden plans measures that will phase out fuel-based cars in favor of electric vehicles (EVs) and converting the fleet of federal vehicles from fossil-fuel-powered to EVs.

CW: Transportation is challenged by manufacturers, who don’t walk the talk. More do, but for example, GM said it aspires to eliminate tailpipe emissions and sell only zero-emission light-duty vehicles by 2035. Such a goal has to reconcile with its mission to be profitable. Right now, GM, its dealers and other auto companies are tooled to service dirtier vehicles. Consumer selection, the environment, are secondary.

My point is: The market’s will to change can be impeded before a consumer gets the chance to weigh their own costs, or values. And that market is not really free if your government, car company or utility excessively controls selection. Many businesses embracing carbon-neutral and net-zero fit this profile. The distinction versus carbon-free, in my view, is critical.

How much will the Biden Administration give a nod to technologies that have not been developed, like taking carbon dioxide from the air or putting it back into the earth at scale? The pressure to do so maintains a larger investible universe, but it also raises moral hazard. Climate change has already gotten to a point at which becoming more resilient competes for the same resources needed to stop it. The importance of market accommodation, with a government that can help facilitate practical solutions, is paramount.

 

DISCLAIMER: The opinions and views expressed are those of Breckinridge Capital Advisors, Inc. They are current as of the date(s) indicated but are subject to change without notice. Any estimates, targets, and projections are based on Breckinridge research, analysis and assumptions. No assurances can be made that any such estimate, target or projection will be accurate; actual results may differ substantially.

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While Breckinridge believes the assessment of ESG criteria can improve overall credit risk analysis, there is no guarantee that integrating ESG analysis will provide improved risk-adjusted returns over any specific time period.

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