What is ESG? Investors are increasingly concerned with environmental, social, and governance (ESG) factors. These factors influence everything from a firm’s operations to its long-term strategy and even who sits on its board of directors. The “E” in ESG has been around since the beginning and without it humanity will not survive. However, what we mean by it today is evolving, but it is most often referred to as sustainability. How can we change our business practices to repair the devastation that we have created over the last century and yet still be profitable. The environmental component of ESG assesses a firm’s performance as a caretaker of the natural world.
What Does Environmental Part of ESG Mean?
Today, when when we talk about the environment in accordance with ESG principles we mean the physical environment – the natural world that we live in and depend on for our survival. The environment can be broken into three broad categories: climate change, resource depletion (especially fresh water), and pollution (both air and water). Oftentimes these factors work together to compound their effects. For example, floods are becoming more common and affecting greater numbers of communities. Other environmental effects are more direct and observable, such as the proliferation of oil slicks in water or smog hanging in the air.
Table of Contents
What Does Environmental Part of ESG Mean?
- Environmental Issues vs Environmental Impacts
- Food Shortages
- What is Sustainable Land Use to Investors?
- Water Scarcity
- Agricultural Pollution
- Plastics and ESG Investment
- The Breakdown
- ESG, Shareholders and Water
- Worldwide Competition for Water Resources
- Sustainable Water Risk Management
- Fracking, Methane and ESG Investing
- The Climate Action Initiative
- ESG Risks and Biodiversity Investment
- Define Biodiversity in ESG Factors
- Natural Capital and Overpopulation
- The Importance of E in ESG
- Supply Chain Security
- Caveats and Disclaimers
Environmental Issues vs Environmental Impacts
To understand which companies fall into the environmental category we need to make a distinction between what ESG calls “environmental issues” and “environmental impacts.” An environmental issue is anything that relates directly to the environment. Overpopulation is one the top 10 environmental concerns of today.
The environmental impact of overpopulation has a variety of environmental and social consequences, including pollution, hunger, cramped living circumstances, and inadequate medical care. This makes for poor communities which are more vulnerable to infectious diseases. It also creates an increased demand for resources like food, water and shelter, with fewer resources to provide them.
An environmental impact is the result of an environmental issue. Food shortages are a problem in some countries due to overpopulation, something that could have negative impacts on the environment because there will be fewer resources available for everyone. Famine can lead to deforestation. When more people are looking for firewood to burn, or fields to farm, the environment loses its ability to absorb carbon.
What is Sustainable Land Use to Investors?
Sustainable land use is the practice of using land in a way that can provide for current demands while maintaining its ability to produce similar amounts in the future.
Water scarcity is becoming more of an issue worldwide, which will have direct impacts on both nature and humans. Water shortages are likely to increase poverty levels, mass migration, heighten regional pressures on natural resources and increased deforestation. Biodiversity loss and climate change are two of the most serious sustainability concerns for investors, with deforestation being the most apparent and pressing aspect of these twin dangers.
Agriculture is the world’s largest polluter, accounting for 23% of global greenhouse gases and 71% of deforestation. Forests are not only a source of food for 22 percent of the world’s population, but they also absorb 40 percent of global carbon emissions. Carbon emissions have been directly attributed to much of the climate change that we are now witnessing. This includes the frequency of more Category 4 and 5 storms, massive forest fires and flash floods in urban communities.
Plastics and ESG Investment
The consequences of plastic production, usage, and disposal on the environment are far-reaching. Plastic has been used for many years but became a worldwide obsession in the 1960’s. It was discovered to be lightweight, cost less than other materials, and could be molded into virtually any shape. Since then, global production and consumption of plastic have increased exponentially.
Not only does plastic production, use, and disposal contribute to significant greenhouse gas emissions, but so do its manufacture and decomposition. mission (sGHG). The primary GHG is carbon dioxide (CO2), but plastics emit other gases as well, such as methane and ethylene. Methane is a greenhouse gas 28 times more powerful than CO2. It also takes much longer to break down in the environment, which means that even small amounts of methane have significant global warming impacts.
In addition to greenhouse gas emissions, plastics pose a threat to wildlife and waterways as they break down into small pieces. These particles are consumed by animals and enter the food chain, which can be harmful to human health as well. The performance of plastic in landfills is another concern: methane is collected under plastic liners and collected for energy. Design, repurpose, repair, and recycling are all possible solutions at each stage of the circular economy. Some or all of these can be worked into the Environmental part of your company ESG strategy.
ESG, Shareholders and Water
As a result of both increasing demand and strains on supply, particularly those linked to climate change, fresh water supplies have become increasingly vulnerable. Agriculture, the world’s largest consumer of water, is affected by climate change and competition for water. But it is also contributing to the degradation of the substrate which reduces the lands ability to trap and retain water. As a result, agriculture-related businesses with direct operations and supply chains are at risk of suffering from water scarcity.
Worldwide Competition for Water Resources
Competition for water is increasing as climate change has a negative effect on precipitation and soil moisture. In fact, since 1950, gross domestic product (GDP) is positively correlated with total water withdrawal. The more GDP/capita increases, the more water is withdrawn from rivers and groundwater aquifers. This poses a problem because agriculture is a water intense activity which represents the largest consumer of water. As a consequence, companies that depend on agriculture and also use water (directly or indirectly) need to monitor this variable in order to adequately anticipate and mitigate the risks associated with water scarcity.
Sustainable Water Risk Management
The need for rigorous risk management is even greater when studying agricultural companies because climate change, competition for land and other factors directly affect sustainability. Soil erosion is also also exacerbated by an excess of water due to climate change. In addition, water scarcity can even be a limiting factor to crop yield, as was experienced during the recent droughts in North America and Australia.
Furthermore, water is a vital component of agricultural commodities producing processes for companies such as Monsanto, Pioneer Hi-Bred and other seed distributors. Water grows crops that are used directly or indirectly in products that are used by 10’s of millions of people every day around the globe. If water is in your supply chain, you may want to analyze and quantify its use and demand.
Fracking, Methane and ESG Investing
Another topic that has been a growing focus for ESG investors is hydraulic fracturing, or fracking. Fracking is a process of extracting fossil fuels from shale rock formations by injecting water and various chemicals at high pressure to create cracks in the rocks and release natural gas and oil trapped within them. The rapid increase in the number of wells drilled using fracking has rapidly increased carbon release on a grand scale. Methane accounts for over 75% of the emissions associated with natural gas production. The rate of methane leakage throughout fracking is responsible for 25% of our global warming over the last 20 years. Methane is a climate pollutant 84 times more harmful than carbon dioxide. And yet we are still completely dependant on companies involved in shale gas extraction and the related infrastructure.
The Climate Action Initiative
Investors managing more than $6 trillion in assets have now signed on to the Climate Action 100+ initiative, which calls for greater disclosure of climate risks. The need to address methane leakage is one of the critical issues they seek to highlight to companies in their portfolio. On the other hand, Methane has a relatively short life cycle (about 12 years) before it becomes CO2, but during that short period methane is very efficient in trapping heat. So perhaps it’s not surprising that many investors are absorbing the issue of methane leakage into their existing engagement on climate change. Once you’ve identified that there are issues with methane emissions associated with your investments, then you need to actually quantify the scale and scope.
ESG Risks and Biodiversity Investment
When you look at your supply chain, you may want to consider biodiversity because of the potential risks from oil – palm, soy, beef and other commodities. Then there are also risks from common global agricultural inputs such as fertilizers and pesticides. Of course these products will be used for both food and non-food purposes – i.e. biofuels – so you need to do your homework. According to the UNPRI paper Investor Action on Biodiversity, biodiversity loss threatens our very existence as we have come to know it over millennia.
Define Biodiversity in ESG Factors
The term “biodiversity” is defined in the paper as the variety of living components of nature. It contributes to natural capital assets’ resilience and safeguarding them for the future. Land use change, climate change, exploitation, and pollution, on the other hand, are driving biodiversity and ecosystem decline. This decrease poses risks as well as possibilities for investors and investment.
For example, Aviva Investors published a report on deforestation in the food and beverage sector. Titled ” From Conflict to Opportunity “, it shows why supply risks pose challenges for investors while also laying out opportunities that can help protect business value.
Natural Capital and Overpopulation
Although economic activity has increased twofold over the past 50 years, population growth has more than quadrupled. Natural capital is important to business because it is the source of many products and services we use every day.
For example, natural capital is found in food and beverage markets, on which 7 billion people depend for their survival. The biggest challenge to the availability of such goods and services is over-exploitation of these natural systems, brought about by human activities such as deforestation, pollution and disregard for the importance of biodiversity.
The Importance of E in ESG
The E in ESG stands for Environment and is a critical component of any sustainable business model. The sustainability of water conservation is threatened by plastic pollution, fracking & methane production reduction strategies
Supply Chain Security
There’s plenty of opportunity to protect the environment and make money, but it takes effort to find those opportunities. As a company, it is equally important to define analyze and quantify the Environmental factors which affect your supply chain. This will help with investment, consumer confidence, employee confidence and provide supply chain security.
If you want help, download our free report on what makes up ESG Frameworks. The document will walk through all aspects of ESG that can be used to improve your ESG Score. In turn, this will generate interest from investors. Why wait and see when you can increase profit margins while protecting the things we need every day like clean air and biodiversity!
Caveats and Disclaimers
We have covered many topics in this article and want to be clear that any reference to, or mention of investing, responsible, criteria, sustainable investing, investment funds, considerations, investment strategies, financial performance, mutual funds, funds, corporate governance, risks, investments, institutional investors, investment process, evaluate companies, climate change, criteria, waste management, brokerage firms, socially conscious, portfolios, capital markets, esg research, strategy vs compensation, energy efficiency and analysis of integration factors, the global economy, non-financial considerations and accounting transparency, ethical investing in indexes by professionals on environmental concerns, metrics vs processes, supply chain investment decision making process for your own consumer protection in regards to mission related investing, central factors for how to screen investments, a framework for documentation, how employee relations affect a company’s carbon footprint on green issues, socially responsible, social criteria vs governance issues in local communities, millennial investors, scores or cfa institute in the content of this article is purely for informational purposes and not to be misconstrued with investment advice or personal opinion. Thank you for reading.