New mandatory climate-related disclosure rules are on the horizon. The European Commission is conducting a review of its rules on non-financial disclosure, which covers climate risk reporting.^[1] Last year, the UK said it would begin requiring certain companies to include emissions and climate risk information in annual reports by 2025, in accordance with the Task Force on Climate-Related Financial Disclosures (TCFD) framework. Both the United States (US) Securities and Exchange Commission and the Canadian Securities Administrators are also working on new reporting requirements. Currently, only high emitters of greenhouse gases in the US and Canada are required to report emission data. However, the requirement scope is expected to expand.

Recently in Japan, a new initiative from the Financial Services Agency (FSA) was announced, making it mandatory for about 4,000 companies (including those listed on the Tokyo Stock Exchange) to report their greenhouse gas emissions, and make other climate-related disclosures, effective April 2022. The FSA will require companies to make disclosures in accordance with the TCFD framework, which is structured around four thematic areas: governance, strategy, risk management, and metrics and targets.

In April 2019, Global Alpha became a supporter of the TCFD. We are committed to disclosing our approach to identifying, assessing, and managing climate-related risk in our investments on behalf of our clients. On the Global Alpha website, we published our TCFD-aligned report. There are also quarterly Climate Impact Assessment reports on our Global and International Small Cap strategies.

In previous commentaries, we have highlighted many holdings that are having a positive impact on carbon neutrality, such as Iwatani (8088 JP), Hexagon Composites (HEX NO), Clean Energy Fuels (CLNE US), Ormat (ORA IT), Biffa (BIFF LN), Aurubis (NDA GY), Primo Water (PRMW US), and Innergex Renewable Energy (INE CN), etc. This week, we are profiling Daiseki Co., Ltd., a new addition to the international small cap strategy that benefits from the upcoming new mandatory climate-related disclosure rules, as it can help industrial companies mitigate climate impact significantly.

Daiseki Co., Ltd. (9793 JP)

www.daiseki.co.jp

Business Overview

Founded in 1945, Daiseki is the largest processor of liquid industrial waste in Japan. The company mainly treats and recycles waste oil, waste water, and sludge. Its facilities are nationwide, serving about 6,500 corporate customers, and many of their customers are in the automobile, electronics, machinery, and chemicals industries.

Simple incineration of one ton of waste oil produces 2,920 kg of CO₂, but this can be reduced by 99% to 31.3 kg by recycling it as heavy oil. Through the oil-water separator and fuel conversion treatment, Daiseki reduced CO₂ by 102,000 tons in fiscal year 2021/2. Similarly, the simple incineration of one ton of waste solvent generates 1,491 kg of CO₂, but by recycling it as supplemental fuel, the emissions can be reduced by 99% to 3.7 kg. The company reduced CO₂ emissions by 437,000 tons by recycling waste solvent in fiscal year 2021/2. The total reduction of 539,000 tons of CO₂ is equivalent to emissions from 190,000 households in one year.

Target Market

• Demand for industrial waste management has been increasing due to Japan’s 2050 carbon neutral initiatives. High greenhouse gas emitters prefer recycling to incineration, and there is also a higher demand for recycled fuels to replace coal or crude oil.
• The liquid industrial waste market in Japan is very fragmented with many regional players. Daiseki is number one with a 10% market share. The number two has a 3% market share.

Competitive Advantages

• The largest liquid industrial waste treatment company in Japan and the only one with a national network.
• Superior technologies (chemical and biological) in both waste-to-energy and recycling areas.
• It has a high recycling rate of about 90%.
• High entry barriers due to license, land, and equipment requirements. Obtaining licenses can take 2-3 years or longer for specific treatment types and types of services offered. Land and equipment require capital outlays, which can be significant.
• Solid balance sheet: net cash.
• Strong relationship with customers.

Growth Strategy

• Distribution: expanding to more regions.
• Adjacent businesses: treatment of copper and nickel, soil pollution.
• New business: waste plasterboard recycling, pipe cleaning, and tank cleaning.

ESG

• Daiseki has very comprehensive ESG reporting and has identified five priority areas: environment, people, safety, communities and society, and compliance, which are in line with the United Nations Sustainable Development Goals (SDGs).
• Stable management team: Chairman Hiroyuki Ito is the son of the founder. President Hideki Hashira has been with the company since 1990. Insiders own 10% of the company.
• Regarding governance, Daiseki not only meets the requirements of the Tokyo Stock Exchange, but also meets more stringent requirements set by Global Alpha. For example, it has over one-third of board directors as independent, separate board Chair and CEO, and one female board director. Daiseki is a member of the MSCI Japan Empowering Women Index.

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[1] https://www.ft.com/content/77a8292d-2e7f-43a1-9062-2e639c1e6b2a

In last week’s commentary we discussed how green hydrogen can help reach net-zero carbon by 2050. This week, we focus on decarbonization within the aviation sector and how technological evolutions will help reduce carbon emissions.

The transportation sector is a huge contributor to carbon emissions, and is responsible for 29% of the total carbon dioxide (CO₂) emissions in the United States (US) and close to 27% in Europe. Compared to the aviation sector, the road transportation sector is far ahead on its decarbonization path.

While other sectors decarbonize quicker, the commercial aviation sector is under pressure to show greater transparency and start establishing greater initiatives in order to cut down its carbon emissions. Two weeks ago, the International Air Transport Association announced that its member airlines, which represent 82% of the world’s airlines, agreed to achieve net-zero carbon emissions by 2050.

The road map to decarbonization will essentially be driven by newer and greener technologies, and by increasing the mix of sustainable aviation fuel. Sustainable aviation fuel would certainly be part of the solutions, but that cannot be the only one. Current availability of sustainable aviation fuel represents only 0.1% of the total fuel supply needed.

Technology, which will continue to evolve, will also help reduce the sector’s carbon emissions. Pratt & Whitney designed GFT engines, which is one of the most sustainable engines in service for single-aisle planes. The GFT engine family, as an example, allows the reduction of up to 20% fuel burn and carbon emissions, while reducing the noise footprint by 75%. Today, more than 1,000 airplanes are equipped with that engine. When considering there are approximately 26,000 airplanes in service globally, the carbon footprint of this sector would be improved as older airplanes get replaced with newer and more efficient aircraft programs.

Another means of transportation for regional and urban travel could emerge in the coming years. Electrical Vertical Take-off and Landing (eVTOL) is a new type of light commercial aircraft currently under flight testing or prototyping. This new transport mode is potentially disruptive to other modes of transportation but should not be a threat to commercial airlines or the automotive sector. Conversely, it represent a sustainable alternative for inner city, short regional travels, air ambulance, and cargo transport.

Thanks to sizable investments made over the past two years, the odds of having eVTOL operating in the future has increased significantly. Since 2019, the eVTOL sector benefited from a capital inflow of approximately $10 billion.

The eVTOL market opportunity could be massive but at this time, it is hard to assess what could be an accurate figure. Lilium, one of the leading original equipment manufacturers (OEM) in that space, estimates that eVTOL could be worth $500 billion by 2040. When taking the cargo market under consideration, this market size expectation could reach $1 trillion. Other experts believe this sector could become an even bigger addressable market. It is no surprise that established aircraft manufacturers announced their own eVTOL programs, or co-investments. Last month, Airbus launched its new CityAirbus Next Gen program to address the urban air mobility market.

Joby Aviation and Volocopter are amongst the leading OEMs that could be the first to obtain their type certification between 2022 and 2024. Other interesting emerging eVTOL developers include Archer Aviation, Lilium, Vertical Aerospace, and Kitty Hawk. Note, the aforementioned companies are not part of Global Alpha’s holdings. Every manufacturer has its own design, propulsion technology, and characteristics, but all of them want to address the future of urban air mobility, focusing on a transportation range of 0-300 miles.

There are several positive advantages to support the eVOTL development over traditional transportation modes:

• Reduced travel time and the cost of congestion: Lilium anticipates a short distance trip, like JFK airport to New York City could take approximately five minutes, while a longer regional trip between NYC and Boston could take approximately 1hour and 15 minutes. Joby Aviation estimates that there are 4.6 billion hours wasted in traffic in the top 15 U.S. cities every year.
• Sustainable transportation mode: Lilium estimates that its eVTOL emission footprint would represent 18g CO₂ per passenger kilometers. That compares with 189g for commercial aircraft, 142g for gasoline cars, and 31g for electric cars. This is assuming the batteries are produced with renewable energy.
• Noise reduction: Some models of eVTOLs are expected to generate less than 70 decibels, which is comparable to the noise level of a dishwasher.
• Lower cost of operation: McKinsey estimates that the cost of operating eVTOL could drop rapidly to $2.5 per seat mile. In comparison, the cost of operating a helicopter today is around $6-$8 per seat mile.
• Simpler infrastructure needs: The urban air mobility network would require an infrastructure that would likely be much less costly than traditional transportation infrastructure, such as airports. Many of the existing infrastructure could be converted into landing/take-off pads (rooftop buildings, gas stations, parking areas). McKinsey estimates that the cost for 10 landing/take-off pads could reach up to $24 million, which includes the cost of operations.

We understand that a new ecosystem needs to be created, and with that, comes many challenges. The success of the eVTOLs will depend on several factors, such as technical challenges, regulatory approval, the pace of adoption from clients and passengers, and the infrastructure required to accommodate this new transportation mode.

In recent weeks there has been a power crisis in China, brought about by the increase in coal prices. Over the last six months, prices have more than doubled and utility companies have been unable to pass on the increase on users (consumers and industry).

In Europe, a similar crisis is unfolding with the cost of electricity reaching all-time highs, driven by a spike in natural gas prices up 400% since the spring. Earlier in the year, we saw electric grids from Texas to California suffer major outages. Those outages have been used by some commentators to blame the investments made in renewable energy.

Green hydrogen is the best and the only solution to solve many of our energy problems as well as getting to net-zero, even though producing it today is quite expensive. Green hydrogen refers to electrolysis systems in which hydrogen is produced from water using electricity provided by renewable energy. It can also be produced from waste such as biogas, municipal solid waste, and industrial waste.

Electric vehicles may help to reduce our carbon emissions, assuming the electricity to charge them comes from renewables and that the grid can handle millions of vehicles plugging in. Steel, shipping, aviation, and trucking account for 40% of our carbon footprint, to which these are industries that batteries cannot fix.

Hydrogen can serve many objectives beyond decarbonization. Its ability to substitute for natural gas would go a long way to secure a country’s energy independence, something Europe would envy given its dependence on gas imports from Russia. Hydrogen is even exportable by pipeline or ship unlike other renewables limited by electrical grids.

Within the next decade, the scaling up of electrolyzer production and the deployment of fueling infrastructure will bring costs down to a level that is lower than fossil fuels and does not have the limitations of batteries.

The legislative framework

The 2021 United Nations Climate Change Conference (COP26) will take place at the end of October. After a historic year of extreme weather, and following a grim report published in August, we can expect a real sense of urgency and more concrete and measurable commitments following the conference. Major economies have already made commitments; we highlight a few below.

In terms of the hydrogen economy, below are a few of the initiatives that have been announced in Europe:

China is widely recognized as a global leader in clean-energy technology: it controls 60% of the solar supply chain; is home to five of the top 10 wind turbine manufacturers; and leads the world in lithium-ion batteries. In September 2020, Chinese leaders pledged to reach carbon neutrality by 2060. It is no surprise that China wants to become a leader in hydrogen as well. 

Looking at the success of Tesla and the massive investments incumbent automakers are making to electrify their vehicles, we might think that adopting electric vehicles (EV) will be the solution to our problems. As we noted above, car and light trucks are only part of the emissions crisis, accounting for less than 20% of total emissions. But, staying with transportation, let us compare hydrogen with other technologies, as hydrogen is most competitive in heavy-duty motive applications.

The following chart shows the intersection of different technologies.

The addressable market for hydrogen as a transportation fuel is huge, even excluding SUVs and cars:

• 450,000 buses and intercity coaches,
• Four million medium/heavy-duty trucks,
• 8,500 Electric hybrid trains,
• 8,000 freight ships, and
• Off-highway vehicles.

However, even if we were to solve the problem of infrastructure (fueling stations), hydrogen for cars and light trucks presents many advantages:

• They are lighter;
• They can fill up in just a few minutes; and
• Their components are more easily recyclables.

A 2017 survey of 1,000 global auto executives concluded that hydrogen fuel cell technology will dominate battery-powered vehicles. More recent comments from Toyota, Honda, Hyundai, BMW, and Mercedes Benz go in the same direction.

One market that is rapidly adopting zero-emission technology is the transit bus market. Although there have been many announcements about electric buses, many studies show that Fuel Cell buses have an advantage in terms of total cost of ownership, even at current prices.

For buses, an ICT study with data collected by the California Air Resources Board (CARB) showed the advantage of hydrogen as fleet size increases:

The Foothill transit study compared the cost of deploying twenty zero-emission buses on a 42-mile roundtrip route. Due to the range limitations of electric buses, it was determined the line would require 34 battery buses versus 23 hydrogen buses.

Orange County Transportation Authority plans to transition 100% of its fleet of 500+ buses to hydrogen.

“The 100 percent FCEBs scenario showed a slightly lower overall cost than the mixed technology fleet given current vehicle, fuel, and support infrastructure pricing. FCEBs offer an extended range and better match to OCTA’s current operating parameters. In comparison, the current range of BEBs may require more vehicles and drivers to meet similar service levels.” Orange County Transportation Authority.

How does Global Alpha participate in the hydrogen economy?

Iwatani (8088 JP)
www.iwatani.com/hydrogen-fueling 

Iwatani is a Japanese company founded in 1930 and a leader in the field of energy, industrial gases and machinery, materials, agri-bio and foods. Since 1941, the company has engaged in initiatives to encourage the widespread use of hydrogen, the ultimate clean energy source as stated in the company’s mission. Iwatani is Japan’s only fully integrated supplier of hydrogen, and presently supplies its base of light and heavy-duty hydrogen-refueling stations and industrial customers via five liquid and 10 gaseous hydrogen production plants throughout the country. In addition, Iwatani is a steering member of the Hydrogen Council, a global initiative of leading energy, transportation, and industry companies, with a united vision and long-term ambitions for hydrogen to foster the energy transition. Iwatani is developing hydrogen-refueling stations with the aim of stimulating new hydrogen demand and supporting the widespread distribution of Fuel Cell Electric Vehicles (FCEV). It currently has 64 refueling stations, a number that doubled in the last three years.

Hexagon composites (HEX NO)
www.hexagongroup.com

This Norwegian company has 1100 employees across 23 global locations. Its solution enables the storage, transport, and conversion to clean energy in a wide range of mobility, industrial, and consumer applications:

From Hexagon composites website

Clean Energy Fuels (CLNE US)
www.cleanenergyfuels.com

We profiled Clean Energy Fuels in an earlier commentary, on May 6, 2021.

Although we discussed hydrogen, renewable natural gas, which can then be reformed to produce hydrogen, is the only transportation fuel today that offers a negative carbon footprint.