Natural capital and biodiversity | Seeking alpha
The world faces two enormous, interconnected challenges. One stems from our changing climate, the other stems from distressed nature and the realm of biodiversity. While the world remains short of the path required to reach the network Zero co2 emissions by 2050, they simultaneously face the realistic possibility that more than 1.2 million species of plants and animals will be threatened with extinction. Resolving these two crises will not be a simple task, and this task will only be exacerbated by the need to feed a global population that is expected to reach 10 billion people by 2050. From an investor perspective, these critical challenges will create risks for some companies and companies. Offering opportunities to those who can provide solutions to address them. This article provides perspectives on how investors can deal with this complex situation by selecting companies Which will benefit structurally and which will be challenged.
Why should investors care about biodiversity and the nature crisis?
Although in recent years biodiversity has become a top concern for many regulatory bodies and investors alike, this concept lacks clarity for most market participants. One reason for this is that unlike climate change, there is no single metric that sums up the challenge. Instead, protecting biodiversity and nature is a complex task that takes a different form whether you are on farmland in most developed countries or in the rainforests of the Amazon.
From an investor’s perspective, what remains clear is that most global economic activities depend on nature and functioning ecosystems. Although estimates vary, the World Economic Forum estimates that nearly half of global GDP depends moderately or heavily on nature or biodiversity, amounting to $44 trillion in economic value. Examples of dependency include farmers’ need for thriving ecosystems to grow crops, as well as the construction industry that remains dependent on readily available natural materials. Until recently, companies were largely able to rely on an abundance of resources that were readily available for extraction. However, at current levels, the world is consuming resources that require a biological capacity equal to 1.75 Earths. This number is expected to reach two Earths by 2030. This means that companies with business models that rely on readily available natural resources are likely to face a future of greater scarcity and disruption. For investors, this is a risk that must be taken into account when investing in companies that rely moderately or heavily on nature, as this could lead to higher operating costs or disruptions to supply chains.
Food producing companies are at the heart of this dependence. In recent decades, global food systems have become more complex and interconnected. Today, more than 80% of the world’s population depends on food imports. The globalization of food production has helped reduce global food prices, but at the same time it has created dependencies and fragility that have led to rampant food inflation following a combination of the Covid pandemic, ongoing regional droughts, and the war in Ukraine. Looking to the future, where NASA expects growing conditions and ecosystems to come under increasing stress with climate change, this fragility likely won’t go away anytime soon. In this regard, food producing companies need to future-proof their businesses to reduce these risks. Diversification may be one way, but a more impactful approach is to work with suppliers to ensure a greater degree of flexibility in their supply chains. This increased flexibility can come by introducing best practices through technology or farming techniques, such as regenerative agriculture that can help improve soil conditions and production yields. From an investor’s perspective, this can help mitigate material risks in favor of long-term value generation.
Will resolving the crisis create value?
In the past year, an increasing number of companies have launched biodiversity strategies. While this increased focus and disclosure is welcome, questions about validity, measurability, and linkage to financial significance remain. For some companies, the biodiversity and nature crisis will either create material risks to profits or opportunities to grow by helping to resolve it. To capitalize on a structural opportunity, it will be important for investors to be able to distinguish between when a crisis turns into a material risk, an opportunity, and when investors focus their attention elsewhere.
We noted in the previous section that the agricultural and food industry remains one of the most vulnerable to biodiversity and nature. Growing crops is inherently dependent on properly functioning ecosystems, and historical improvements in agricultural activities have meant that farmers have been able to feed 3.7 times as many people over the past 100 years, while expanding farmland by only 40%. This is an amazing achievement, but it has had some negative impacts on biodiversity. What remains clear is that the historical path of increasing food production cannot be applied to feed the expected ten billion people by 2050 without having a harmful impact on the environment. For this reason, agriculture is on the one hand at risk, while it is also one of the industries that can make a big difference. At this complex intersection of the social issue of feeding a growing global population cost-efficiently, while leaving environmental considerations intact, one of the most promising avenues for improvement comes from the adoption of technology. Historically, agriculture has been one of the least digitized industries. However, this has changed in developed markets in recent decades.
An example is precision agriculture, where data and vision technology, including cameras and sensors, enables fields to no longer be treated uniformly, but instead rely on an optimized or customized solution to their specific needs. From a biodiversity perspective, this means that herbicides can be applied with a high degree of precision on weeds only, rather than uniformly across the entire field. In addition, this approach makes it possible to apply fertilizers in optimal amounts when needed. These practices can significantly reduce use and leakage into nature, with material benefits to local ecosystems. This results in improvements in material cost efficiencies for farmers, leading to significant value generation potential for companies offering such solutions.
In addition to the agricultural industry, the durable goods and construction industries remain highly dependent on nature. For these two industries, this dependence stems from the extraction of resources and materials from nature that are used to manufacture and build physical products. Over the past century, this extractive relationship with nature has expanded continuously as population and income have grown, taking advantage of readily available resources that can be obtained at relatively low marginal costs. This has resulted in material benefits for the world’s population, but it also means, as mentioned earlier, that resource consumption is unsustainable and is heading towards weakening the biocapacity of the planet. From an investor’s perspective, this means that companies that rely on these readily available resources are likely to face additional risks in the future. If the equation is to be balanced, the world must separate economic growth from environmental degradation. Achieving this will require a large number of solutions, ranging from increased recycling, improved production, and the use of renewable materials. To this end, innovative companies must play a key role by innovating and scaling solutions that can increase the efficiency of how resources are produced and consumed. In this regard, industrial and technological companies are likely to be at the heart of achieving this. For industrial companies, the key will be to automate and increase efficiency in production to reduce waste, as well as bringing in new technologies to digitize production and supply chains. Technology companies will also help improve operations across industries, including construction, as buildings can be designed to use fewer resources and waste. Such improvements will be important for reducing the resource intensity of economic growth, while also likely to lead to opportunities for value creation through increased efficiency and lower costs.
Where do we go from here?
Providing solutions to address the biodiversity and nature crisis can lead to opportunities for some companies. However, many companies are also likely to face material risks in the future. These risks can take the form of increased regulation that limits business activities or dependencies, leading to disruptions to inflexible systems. The threat of regulation is not new to most companies, but as the world becomes increasingly focused on the biodiversity and nature crisis, it may become even greater in the future. This has been demonstrated in the EU Biodiversity Strategy 2030 as well as in initiatives launched by the United Nations Biodiversity Conference. To date, regulation has mainly focused on setting minimum standards for environmental protection or limiting harmful activities, although this is likely to change in the coming years.
Human activities and changes in climate actively threaten biodiversity. From a growing population to increasing resource use and emissions, the world is entering a critical period of transition. These challenges will create risks for some companies and will provide opportunities for companies that can provide solutions to address them. Thus, we look for companies that are becoming better and taking into account the evolving world that will drive the upside of earnings growth over the long term.
Risk considerations
Past performance is no guarantee of future results. Investing involves risks, including possible loss of capital. Stock markets are subject to many factors, including economic conditions, government regulations, market sentiment, domestic and international political events, environmental and technological issues, which may affect returns and volatility. International investment involves greater risks such as currency fluctuations, political and social instability, and different accounting standards.
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Editor’s note: The summary points for this article were selected by Seeking Alpha editors.