Morningstar panel lays out challenges, opportunities of net-zero goals

The transition to a greener economy is filled with challenges and opportunities, and most industries are still in the early stages of reducing carbon emissions.

Net zero is a target to balance the world's greenhouse gas emissions to zero by 2050, both by reducing the gross carbon emissions humans currently produce while negating any remaining emissions. Slightly more than half of the 2,000 largest companies have net-zero or emissions-reduction targets, said Adam Fleck, director of equity research for ESG at Morningstar Research Services.

But one of the hardest parts of achieving net zero is getting people to agree on how the world is going to get there and what needs to be done, Fleck said, speaking on a panel about net-zero commitments and the implications for investors at the Morningstar Investment Conference in Chicago Tuesday.

As the world gets more serious about tackling carbon emissions, it’s important people understand the different types of emissions, known as Scope 1, Scope 2 and Scope 3 emissions, and how they're produced, he said. Scope 1 emissions refer to any emissions that are directly produced by a company. Scope 2 emissions are produced when a company purchases electricity or energy for its operations, and Scope 3 emissions are the indirect emissions created both upstream and downstream, which can be everything from business travel to consumers using the company's products.

[More: BlackRock to clients: Net zero is coming]

A VIEW OF TWO SECTORS

Reducing the energy sector’s total greenhouse gas emissions will go a long way toward achieving net zero since 80% of carbon emissions come from this sector, said Travis Miller, equity strategist at Morningstar Research Services, who also spoke on the panel.

The solution is to move all power generation to electricity, Miller said, but the challenge is getting there. Currently there isn’t enough wind and solar power to move to 100% electricity generation, nor are there reliable, wide-scale storage solutions for when the wind isn’t blowing or the sun isn’t shining. While Morningstar is bullish on electric vehicles, electric versions for transportation such as aviation and shipping aren’t available, he said.

“If we can solve the electricity problem, we can get to net zero," Miller said. "If we don't find a way to make electricity our primary energy source, we will never get to net zero.”

There are good opportunities for investors in this sector. Miller cited utilities such as NiSource (NI) an Indiana electric utility with a large gas distribution system, which gets 60% of its earnings from gas-powered electricity and 40% from renewable energy. California-based utility Edison International (EIX) is another favorite play.

There are also opportunities on the consumer products side, said Erin Lash, director of consumer equity research at Morningstar Research Services and another speaker on the panel.

The key challenge on the consumer products side is how companies invest to reduce their emissions, since 85% to 90% of their emissions are Scope 3. That means collaborating with partners throughout the supply chain, in addition to retailers and consumers.

One concern is that companies' investment in reducing emissions will come at the expense of money spent to support their competitive position in the marketplace, but Lash said there are also opportunities. Consumers have a penchant for environmentally friendly fare, although that may be tested in an era of rising inflation. Companies may save money if they can optimize delivery routes, use fewer resources and minimize waste.

Lash pointed to Unilever (UL) as a company that focused on net-zero commitments at the expense of sales and profitability. As a result, its valuation suffered and its stock price performance lagged its peers'.

General Mills (GIS) is a company that Lash said is balancing both goals well. The cereal maker does a “great job” of holding its executives accountable on achieving the targets that they've laid out, pushing their farming partners on reducing emissions, and taking other actions for a more sustainable firm, she said.

“That hasn't come at the expense of improving sales and profitability [or] investments behind their brands, which we view as key,” Lash said.

[More: ‘Net zero’ oil firms are selling their dirty assets to private market]

Debbie Carlson writes about investing, personal finance and retirement.