Sustainable Investing Through the Supply Chain: Electric Vehicles

by Salima Lamdouar, and Patrick O'Connell, CFA, AllianceBernstein

ESG in Action

The shift to electric vehicles means major changes across the supply chain and involves multiple ESG challenges. As the auto industry strives to institute sustainable practices, investors need to engage with governments and corporates to encourage and accelerate the process of change.

The IssueElectric vehicle engines need far fewer components than internal combustion engines but have much heavier and more complex batteries. These in turn use a higher proportion and greater variety of minerals—around six times more than conventional vehicles.
The Investment CaseIncreased mineral extraction and processing can damage the environment. But we see clear evidence that governments and corporates will respond to constructive investor engagement in a positive way to improve their ESG performance.
Engagement GoalsAB’s engagement program aims to create a mutually beneficial dialogue with public officials and company management to promote sustainable practices throughout the supply chain.

AuthorsSalima Lamdouar| Portfolio Manager—CreditPatrick O'Connell, CFA| Research Analyst—Corporate Credit

The automotive industry is fast transitioning to an electric vehicle (EV) future. This has huge implications for vehicle assemblers, component manufacturers, extractive industries—and responsible investors.

The shift to EVs means major changes through the supply chain. EV engines need far fewer components than internal combustion engines but have much heavier and more complex batteries. These in turn use a higher proportion and greater variety of minerals—around six times more than conventional vehicles. And extracting and refining those minerals involves multiple environmental, social and governance (ESG) challenges.

Our research and engagement programs show that it takes a holistic approach to identify companies that are managed both profitably and responsibly at each stage of the EV supply chain.

Rising EV Adoption Highlights ESG Issues

As the world’s auto manufacturers and their subcontractors execute plans for new EV products, the EV industry is transitioning rapidly from niche provider to mass producer. The demand for minerals is growing fast and the related ESG impact is rising too. But the ethical issues don’t stop with extractive industries. Across auto components manufacturing, vehicle assembly and related energy infrastructure (such as electric power utilities and charging point providers), it’s important to ensure the supply chain is managed and financed responsibly.

Mineral Extraction and Processing Are the Most Prominent Concerns…

Across the whole EV ecosystem there is likely to be a huge increase in demand for six types of mineral: copper and aluminum (for instance, to upgrade electric power networks, and for EV wiring, engines and battery cases); cobalt, lithium and nickel (EV battery constituents); and rare earth elements—a group of chemically similar metallic elements used in electric motors. This raises the risk that the environmental and social benefits of transitioning to EVs could be offset by the waste and water pollution and high emissions resulting from increased mineral extraction and processing.

That’s why responsible investors need to pay particular attention to these industries and engage not only with the producers but also with governments. After all, sovereign entities must institute the policy frameworks necessary to guide the sustainable development of the industries.

…but EVs Require a Wide Range of New Technologies Too

Mineral extraction and processing feature at the beginning of the EV value chain. Next come battery cell manufacture (the production of electric power sources with processed minerals); battery pack assembly (in which the individual cells are assembled into composite enclosures); and the manufacture of the EVs themselves (including battery integration).

Each stage requires advances in technology. Consequently, it’s important to ensure that companies at each link in the supply chain have both adequate R&D resources and a commitment to apply them responsibly. For instance, the Volkswagen Group (VW) will spend around €73 billion on electrification, hybrid powertrains and digital technology over the next five years—far more than its European peers. More recently General Motors (GM) committed US$35 billion by 2025.

EV Era Dovetails with Automotive 2.0

The transition to EVs goes hand in hand with the wider “Automotive 2.0” project for the autonomous driving era. This initiative should result in a significant cut in emissions, both through more economical usage of vehicles and through techniques like “platooning” (fuel-efficient convoys travelling smoothly at constant speeds). It should also lead to a reduction in auto accidents and fatalities.

From a technology perspective, Automotive 2.0 will require vastly increased volumes of data and data processing capability plus more sophisticated software to create the “brain” of next-generation vehicles. These new capabilities have the potential to transform the journey experience and with it the original equipment manufacturers' (OEMs') branding, monetization and customer relationships. Investors must engage with companies to ensure their management teams are ready to grasp this array of new opportunities and avoid obsolescence.

Engagement Promotes Sustainable Practices

Our research and firm-wide engagement program shows that some companies are successfully embracing responsible practices and planning for change while others are lagging. We also see clear evidence from successive meetings with management that companies will respond to constructive investor engagement in a positive way. While there is a long way to go until we can identify responsible participants in every part of the supply chain, we continue to work diligently to achieve this aim and are making good progress.

Case Studies:

• A Top-Down Approach for Chile's Sustainability

   

  Chile is the world’s largest copper producer and has set ambitious goals to limit emissions. Consequently, the country could lead the way globally in sustainable mining practices. Codelco is a Chilean state-owned mining company and by far the largest copper miner.

  As part of our engagement process, in early 2021, AB advised the Chilean government on their Nationally Determined [emissions] Contributions (NDC) target and made the case against relying on carbon sinks to achieve carbon neutrality. Instead, we encouraged other means of carbon reduction. These include accelerated phase-out of coal in the energy production mix and sustainable mining practices. We also called for top-down policies to ensure that, as copper demand increases with accelerated efforts to transition to a low-carbon economy, mining abides by high environmental and social standards. In addition, we sought to improve Chile’s green financing network and highlighted the importance of aligning any future framework with the European Union (EU) taxonomy.

  Further, over recent years we have had direct conversations with Codelco (among other large mining companies) regarding their decarbonization plans and have urged them to improve the sustainability of their operations.

  Our efforts helped drive a positive result:

   

  • In September 2020, Codelco presented their 2030 Sustainability Goals, a broad commitment to reduce pollution and carbon production as well as to address social variables
  • in third quarter 2021, the Ministry of Mining published the National Mining Policy Guidelines with a focus on sustainability

   

  We will continue to monitor progress toward Chile’s updated NDCs. We also plan further engagement on sustainable financing frameworks and other considerations around sustainability.

• SQM—Sustainable Lithium Production

   

  SQM is the second-largest producer of lithium in the world and aims to double capacity by 2025. The company has a strong reputation both for eco-friendly manufacturing and for committing to improve sustainability across its business. For instance, SQM aims to reduce water usage by 50% and to become carbon neutral in its largest business lines by 2030.

  In April 2021, our joint Fixed Income and Responsible Investing teams organized a call with SQM’s management to discuss two important topics. As a result:

   

  • SQM were able to explain why their production process is environmentally friendly and resolve any possible confusion about risks to the environment. The company produces lithium by an evaporation process from brines (salt water), meaning that over 90% of their energy needs are met by renewables—principally solar power. Their management pointed out that brines are clearly differentiated from drinking water, and in SQM’s sites the two are separated by an impermeable clay barrier. Thus any changes in the availability of scarce potable water for local communities are not related to brine extraction. SQM attempts to be as transparent as possible in its brine usage. For instance, it has a public website showing the volumes of brines used, and it contacts the environmental authorities when either brine or water levels change. SQM believes that this transparency allows stakeholders to be well-informed and limits policies that would negatively impact the company’s business.
  • We also discussed governance and management compensation issues. SQM was able to justify its remuneration and governance arrangements due to its unique shareholder structure, local circumstances and competitive position.

   

  We plan to reengage with the company’s management on both environmental and governance topics in fourth quarter 2021, as they recently published their English-language annual Sustainability Report.

• VW—A Comprehensive Plan for Sustainable EV Production

   

  VW is committed to moving to an all-EV product range. They are also investing in in-house battery production to ensure independence in this key area. This may give VW an advantage in circular product design, with planned recycling of valuable minerals creating a potential differentiator between winners and losers in the industry. In addition, their passenger auto range starts at some of the lowest price points in the industry, encouraging broad and early EV adoption.

  In June 2019 we met with VW management to discuss business strategy and ESG issues. We further engaged with the company in second quarter 2020 as they unveiled their green financing framework.

  We were able to give feedback on the framework and to explain why we would like additional ESG data disclosures—for instance, to help evaluate the risk of modern slavery occurring in the supply chain. We applauded the company management’s progress with their decarbonization strategy and their long-term strategic vision, and we urged them to set science-based targets and to give a preview of how much their activities will align with the EU taxonomy.

  Subsequently, in June 2020, VW validated its 2030 sustainability goals with reductions required to keep warming well below two degrees centigrade per the Paris climate agreement and based on the Science Based Targets initiative (SBTi).

  We intend to continue our open dialogue with the company on EV strategy and to leverage the successful outcomes from our engagement with VW as we meet with other OEMs—in particular, our collaboration on green bond frameworks.

  These case studies provide a small sample of our ongoing engagement activities. We plan many more constructive dialogues across different industries and geographies, from power grids to providers of charging points, and from developed to emerging markets, including China.

EV Transition Calls for Green Financing Structures

We also encourage responsible financing alongside responsible management. We believe green bonds and sustainability-linked bonds with robust key performance indicators (KPIs) can be effective enablers of the EV transition, especially as the criteria for these sectors have been clearly defined in the EU taxonomy.

We have already seen some exciting structures that help further the EV transition (including SQM’s recently-issued green bond to help fund the expansion of their lithium capacity), and we have been engaging with other potential issuers to encourage them to follow examples of best practice.

Further green and KPI-linked bond issuance in the sector also increases diversification in the wider green bond market and so helps investors create better-balanced investment portfolios

Increased Engagement Leads to Improved Outcomes

The automotive supply chain is huge and complex. The transition to EVs—in particular, the special requirements for battery manufacture and charging infrastructure—add further investment considerations and opportunities from an ESG perspective.

Governments and corporates are now striving to embed sustainable practices throughout the supply chain, and we can see our engagement efforts are making a positive impact. As investors worldwide increase their focus on engagement, we are confident they will accelerate improvement throughout the auto industry and across its suppliers.

About the Authors

Salima Lamdouar

Salima Lamdouar is a Vice President and Portfolio Manager on AB's portfolio-management team, focusing on thematic credit strategies. Before joining the firm in 2015, she was a generalist portfolio manager at Rogge Global Partners. Lamdouar holds a BSc (Hons) in banking and international finance from Cass Business School. Location: London

Patrick O'Connell, CFA

Patrick O'Connell is a Senior Vice President and Corporate Credit Research Analyst, focusing on emerging-market corporates in Latin American and African countries. He joined the Emerging Markets team in 2013 after working as a credit analyst covering US high yield oil and gas credits at AB. Prior to joining the firm in 2012, O'Connell was a desk analyst at UBS Investment Bank, where he helped to allocate capital on the trading desk. O'Connell holds a BS in accounting and finance from Villanova University and is a CFA charterholder. Location: New York

*****

Copyright © AllianceBernstein