Environmental Investing

A greener orient will bring new opportunities to investors

MF TANG & CHRIS TANG, LLOYD GEORGE MANAGEMENT
Originally published in the May 2008 issue

The economic development in Asia, particularly in China and India will bring with it an increasing amount of environmental and social issues. Air and water pollution, land degradation, deforestation, energy security, and social inequality will continue to make daily headlines. As community awareness increases, the public are demanding their governments and corporations take a more active stance. In China this is all set against a backdrop of international pressure prior to the Beijing Olympics this summer. This increasing concern will bring huge investment opportunities across the Asia Pacific region as corporations attempt to tackle these critical issues in the face of stricter regulations from the government. New types of products and services will be developed in order to mitigate or solve these issues. Companies that are proactive in factoring in the environmental and social costs to their bottom line will be ahead of their peers and be better at adapting to the imminent changes in the regulatory environment in the region.

In Asia, the environment regulations and emission trading are still largely undeveloped. However, governments around the region appear to be moving in the right direction. In China, the State Environmental Protection Administration (SEPA) has been elevated and given a ministry status. This will give the new ministry greater powers in monitoring and penalising offending companies. In Australia, the newly elected federal government has rectified the Kyoto agreement and thereby by 2012 is likely to establish a carbon trading scheme.

Green technology

Already a key global manufacturing hub, Asia will greatly benefit from the surge in demand for energy efficient/emission reduction products and services. For example, in the manufacturing of carbon fibre composite materials, Asia is already a dominant player with Japanese manufacturers such as Toray Industries leading the way. The company already dominates the global market share of carbon fibre material production and has exclusive long term arrangements with Boeing on its new 787 aircrafts. Its advance polymer chemical technology and its large scale operations in Japan, Europe and the United States are set to benefit from the increasing demand from the aviation and automobile industries for lightweight, high strength composite materials.

Another example is energy-saving lighting technology. Demand for LED (light-emitting diode) products is taking the spotlight as consumers push for low energy intensity products. The expanding range of LED application from laptop screen to street lighting and outdoor advertisement is benefiting the Taiwanese and Japanese manufacturers, including Epistar and Toyoda Gosei. Patented technology, economies of scale, competitive pricing, and design flexibility are some of the critical criteria to look for when investing in this industry.

Green energy

Energy security in Asia is a key concern as most nations in Asia are importing their oil requirement. Hence, the search for alterative sources of energy as their economies grow is of increasing importance, especially in the face of record oil prices. In fact, China is set to become the largest renewable energy market in the world as it plans to invest at least US$179 billion in renewable energy until 2020. Currently, 78% of the country's total energy supply is from fossil fuel with 69% from coal, compared to the US at 24%. Therefore, the search for alternative sources of fuel becomes critical in reducing emissions.

Asia has a wide array of potential alternative energy sources, including biodiesel, wind, solar, geothermal, coal seam methane. However, they are all at different stages of development and more investments are required. Nevertheless, it presents once again excellent investment opportunities around the region.

An important source of alternative energy is in solar energy. Continuous improvement in photovoltaic technology is lowering the cost per watt to become increasingly closer to the cost of energy from the power grid. China is already a dominant manufacturer of solar cells and modules. The recent increase in solar cell production has caused a major shortage in polysilicon, a key ingredient for solar cells and has therefore pushed the prices to record highs. An important element we look for in a solar cell manufacturer is the extent of their upstream integration into polysilicon production or the ability to secure long term supplies at prices below the current record high prices.

In terms of biofuels, palm oil is a key feedstock for biodiesel in Asia. Malaysia and Indonesia dominate the palm oil industry. There are fantastic investment opportunities within this industry as governments in the region (including Thailand, Malaysia, and Philippines) are proposing a mandatory switch to biofuel blends in the next several years. The key characteristics we look out for are the company's operational efficiency in terms of the yields from and maturity of its plantations and its production growth going forward.

Food prices around the world have experienced exponential increase in the recent months as a result of weather disruption and farmer's preference for growing biofuels. In addition, the population is growing while the amount of arable land is not.

Consequently, agricultural yield from arable land will need to improve. This in turn creates significant opportunities for the agricultural fertiliser and chemical companies around Asia. With fertiliser input prices also rapidly increasing, well integrated fertiliser companies like Incitec Pivot will benefit from their relatively low cost of production compared to the high marginal cost producers.

Promoting green practices

Clearly it will not only be alternative energy producers, energy efficient product manufacturers and agricultural related companies that will benefit from increasing environmental concerns. In fact, effects will be felt across a wide array of sectors, with almost all companies being impacted either positively or negatively by the increased focus on environmental and social issues. Companies who are able to integrate successfully the range of sustainability issues into their daily business operation and overall strategy will be able to maintain or enhance their competitive advantage against its peers. For example, most companies in the Asia Pacific region have yet to consider factoring the cost of carbon into their financial analysis and their environmental legislations are still in their infancy. However, the cost of greenhouse gas emission will inevitably hit their bottom line with the eventual introduction of carbon trading schemes around the region. Therefore, companies that have proactively calculated their carbon footprint will be better placed to understand the financial implications in the future and plan now and act accordingly.

For example, Australian power companies have begun looking into the fuel mix of their generation capacity due to the Australian federal government's rectification of the Kyoto protocol. Companies who stay ahead of the curve in managing and improving their mix of generation to renewable sources, such as hydro, wind, geothermal and solar, will clearly benefit from the unavoidable carbon trading scheme that will be established in due course.

LG Asian Green Fund

Five years ago, we asked 'What does China need?' One of the clear answers was Natural Resources. As a result we established the LG Asian Natural Resources fund which has successfully compounded returns in excess of 37%pa since inception to Dec 2007. Lloyd George Management is establishing, subject to regulatory approval, an LG Asian Green Fund, which is based on the strong performance of its sister fund, the LG Asian Natural Resources Fund. The Fund will focus on the three distinct areas described above – Green Energy, Technology and Practices.