Investors betting against green trades are going up against the world’s most powerful governments.
The leaders of the biggest economies have over the past week pledged massive cuts on greenhouse gas emissions, paving the way for a torrent of regulation that is set to benefit green stocks and bonds. And it’s likely to deal blows to companies not positioned for the transition to a lower-carbon economy.
During a climate summit on Thursday, U.S. President Joe Biden announced a goal to halve emissions by 2030 on 2005 levels, a vow that could mean penalizing fossil fuel use or mandating renewable power. Canada and Japan raised target cuts to 40% to 46% by 2030, while the U.K. topped that with a vow to slash 78% by 2035.
“The direction of travel is in one way only,” Mairead McGuinness, the European Union’s chief for financial services, said in an interview about new green investment rules. They form a “re-engineering of the economy and re-engineering of the financial world.”
With the world’s biggest polluter China only reiterating plans to attain net-zero status by 2060, these efforts are still not seen as enough to meet goals to limit dangerous temperature increases under the Paris Agreement. That only means more targets and rules are likely in future.
The EU is a case in point. It’s now following up goals with detailed legislation to drive money toward a sustainable future. Lawmakers reached a deal last week to make a 55% cut in emissions by 2030, compared to 1990 levels, legally binding. Its executive arm then unveiled a labeling system, or taxonomy, to classify green investment.
That’s expected to divert financing to activities on the list, starting with a third of the bloc’s $2 trillion joint budget for the next six years. In favor are producers of rechargeable batteries, energy efficiency equipment, low-emission cars, wind energy and solar plants.
“There is still much, much more to come from the global community,” said Eoin Murray, head of investment at the international business of Federated Hermes. “From an investment perspective, policy risks continue to loom large for long-term portfolios.”
European renewables are poised to be among the biggest beneficiaries of the green spending spree, after a pullback this year. A gauge of stocks in the sector rallied 7% on Thursday, though remains about 20% down from a record high in January.
The underperformance has created an attractive entry point, according to Berenberg analysts including Henry Tarr, who named wind turbine maker Vestas Wind Systems A/S and Aker Carbon Capture AS as top picks this month. Wall Street banks poured out similar research in recent days, with Citigroup Inc. liking hydrogen producer ITM Power PLC and JPMorgan Chase & Co. eyeing Siemens Gamesa Renewable Energy SA.
“The recent market correction affecting clean energy stocks, driven by short-term catalysts and what we view as unsubstantiated medium-to-long term catalysts, presents a buying opportunity,” Societe Generale SA analysts led by Rajesh Singla wrote in a note.
Among stocks expected to see gains of 20% or more, based on average analyst price targets, are ITM, Siemens Energy AG and McPhy Energy SA, according to data compiled by Bloomberg.
For those firms left out of the EU’s playbook — currently companies relying on oil and gas — there’s a risk they will find it harder or more costly to access financing.
Instead, companies are rushing into a burgeoning market for environmental and social bonds, which now make up nearly a quarter of all sales in Europe this year. They can often get cheaper borrowing costs, with a so-called greenium — a premium on bond prices.
Telefonica SA saw seven times the demand for its €1 billion of sustainable bonds, enabling it to cut pricing by a “staggering” 75 basis points, according to ABN Amro Bank NV analysts. The Spanish telecom firm’s green 2027 bond is trading about 30 basis points tighter than a similar conventional note, showing a “crystal clear pricing benefit,” the analysts said in a note.
The European Commission has also introduced more detailed and mandatory reporting requirements on sustainability, for some 50,000 companies on the continent. This is set to benefit testing and inspection companies, such as Bureau Veritas SA and Intertek Group PLC, Morgan Stanley strategists including Victoria Irving wrote in a note to clients.
The greater transparency could also give confidence to investors concerned about the potential for greenwashing, or the possibility that governments and companies are misrepresenting their environmental credentials.
Politics may become an even more decisive regional catalyst for green trades in the months ahead. The latest polls in Germany show the Greens have more than a fighting chance to participate or even lead the next government coalition.
“A Green-led government (or one with a heavy Green footprint) could more credibly build trans-Atlantic links on the green transition with the Biden administration,” said Martin Lueck, BlackRock Investment Institute’s chief investment strategist for Germany.
In any case, yet another EU legislative package will follow in June. That’s meant to reinforce carbon pricing, increase renewable energy output and boost sustainable transport. The proposals may include a carbon tax on selected products, or a carbon customs duty.
“Any meaningful change in the regulatory backdrop that drives up scrutiny on carbon-intensive industries and helps fund innovation to reduce emissions can represent an attractive catalyst,” said Luke Barrs, head of fundamental equity client portfolio management in Europe at Goldman Sachs Asset Management.
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