You think that because you understand “one” that you must therefore understand “two” because one and one make two. But you forget that you must also understand “and.”

— Donella Meadows, Thinking in Systems, 1990

Think in systems

Allspring’s Climate Change Working Group (CCWG) has two mandates:

  • Provide thought leadership on how climate change affects the value of companies
  • Create investment strategies that help investors achieve climate and financial goals

To do these, it’s imperative that we constantly improve our understanding of climate’s role in Earth systems—where climate interacts with other biospheric threats. We’re now evaluating and adapting basic Earth system models[1] to enhance our perspective. Climate change and biospheric integrity (including biodiversity) are at the core. Seven other existential air-, land-, and water-related subsystems interconnect, as shown in Figure 1.

Each of these subsystems involves a physical limit—or planetary boundary[2]—which, if transgressed, can compromise human life. We believe activities that drive us closer to (or through) these limits are likely to attract disruption by regulators, technology innovators, investors, and others. Figure 1 uses colors to emphasize that many of these limits have been breached or may be breached in the foreseeable future. Firms can be major beneficiaries or casualties of the breaches, as we’ve seen with coal’s decline, renewables’ rise, and changes in other industries highly exposed to climate change.

Farm to table

Food and agriculture are the CCWG’s top industry priorities right now. These account for about one-third of annual global greenhouse gas emissions and could eventually challenge all nine boundaries identified above. Two striking examples include tilling practices and fertilizer use:

  • Modern tilling emits huge amounts of greenhouse gas. One-third of the atmosphere’s post-industrial CO2 emissions result from soil degradation. Organic carbon has fallen from 4% to 1%‒2% due to mechanized agriculture. Today, soils store about 2.5 trillion tons of carbon—three times more than the atmosphere does. But soils have lost about 130 billion tons of carbon since mechanized farming emerged in the 19th century.[3] Ploughing churns up the soil, exposes it to air, and accelerates decomposition of organic material. This activity impairs soil’s ability to feed the microbiome and, by extension, impedes uptake of nutrients. Ploughing also obstructs carbon’s benefits for soils’ structure, such as preventing desiccation. Achieving decarbonization goals depends on minimizing soil carbon losses.[4]
  • Fertilizers put most or all planetary boundaries in play. Fertilizers’ primary components—reactive nitrogen and phosphorus—contribute to climate change, freshwater and ocean eutrophication, air pollution, soil degradation, biodiversity loss, and growth in stratospheric ozone. These effects interact with and can exacerbate each other. Since the 1960s, there’s been a nine-fold increase of synthetic nitrogen fertilizer use. Emerging market‒driven demand may increase this another 50% over the next 40 years. Emerging economies’ dietary trends favor red meat, an exceptionally damaging food ecologically. Fertilizers’ annual damage to fisheries alone (ignoring other ecosystem services) runs about $170 billion annually.[5]

These challenges may become more complicated as climate change becomes more extreme. Vulnerability to climate change depends on geographic as well as social and economic characteristics. Agriculture-dependent economies, including India’s, have populations that depend on subsistence farming and may be particularly vulnerable.

Chickens come home to roost

U.S. Environmental Protection Agency scientists have recommended nitrogen control for decades with scant success. State governments dominate agriculture regulation. Almost all states make suggestions and ask for voluntary cooperation rather than set hard requirements. Congress exempted large-animal farms from greenhouse gas reporting requirements in a spending bill rider signed by former President Trump in 2018. Especially with Ukraine war‒driven food supply disruptions, stricter federal regulations look unlikely in the near term. But the risk remains. Filings by CF Industries Holdings, Inc. (the largest nitrogen fertilizer producer in the U.S.), identify environmental regulations as significant business risks. The Mosaic Company, another big producer, points to similar risks.

Certain European and Asian nations show more concern via the Global Programme of Action for the Protection of the Marine Environment from Land-Based Activities (GPA). GPA is also taking the lead in developing land-based pollution policies through the Global Partnership on Nutrient Management. In 2018, more than 200 scientists signed an open letter asking world leaders to reduce nitrogen pollution. Letter author Mark Sutton, former chair of the International Nitrogen Initiative, suggested Paris Agreement goals can’t be met without addressing nitrogen. To date, the nations that have been most successful in reducing nitrogen pollution—Denmark and the Netherlands—have done so with clear and enforceable rules.

Conservation agriculture innovations can also help. Cover crops and crop rotation add nutrients to soil, which greatly reduces fertilizer needs. Growth in conservation agriculture could take share from the (roughly) 186-million-ton-per-year fertilizer market. Today, nitrogen- and fertilizer-based products compose about 80% of this market.

Conservation agriculture can also advance the energy transition. Out of today’s roughly 40 billion tons of annual CO2 emissions, fertilizer production contributes about 1%, or 0.5 million tons per year, with three tons of full-cycle emissions per ton of ammonia production. What’s more, positive feedback loops though oceans, fresh water, and other airborne emissions that behave like greenhouse gases can add to the benefits.

Conservation agriculture’s economics show potential to be exceptionally positive with scale. Thunder Said Energy estimates that crop yields can increase 10%‒30%, especially in dry years as water retention doubles in soil with 4% carbon. Fertilizer cost is lowered by 50%‒100%. Diesel cost is lowered by 30%‒80%. Agricultural profitability is thus restored from marginal to $190‒$470/acre.[6]

Food for thought: Forthcoming research

Key agri-food corporate strategy and valuation risks we’re evaluating (among others) include:

  • Fertilizer producers’ valuations appear to reflect little if any disruption risk, at least in the U.S. This is understandable given today’s Russian invasion-induced hunger crisis. However, as we (hopefully) develop new food-supply chains, opportunities may emerge to transform systems in sustainable directions. Today’s fertilizers stand to suffer shrinking markets and lower margins, barring rapid growth in emerging economies. Nitrogen-fixing bacteria may offer an attractive alternative to fertilizer and potentially a good diversification strategy for fertilizer producers.
  • Beef and dairy farmers could suffer, particularly in developed markets where we can envision consumers likely shifting to alternatives over time. About one-third of crops globally are used to feed animals, and there are more than about 1 billion cows globally. To combat climate change and many other planetary challenges, shifting diets further away from beef would help. We can imagine—at least, with respect to specific cow-derived ingredients (if not mainstream meats)—synthetic alternatives could grow much more quickly.
  • Farmers of marginal croplands could choose to return them to forests. Timber economics and avoided climate, water, and biodiversity stress can deliver attractive economics.

Stay tuned—there’s more to come: The CCWG is reviewing each of these ideas and their investment implications. We’ll share our insights in future articles.

Tom Lyons and Nashat Moin are members of Allspring’s Climate Change Working Group.

 

[1]. Randers (2009), Rockstrom (2018), and Steffen (2015)

[2]. Rockstrom (2009)

[3]. Thunder Said Energy: Conservation agriculture, farming carbon into soils, May 1, 2020

[4]. Thunder Said Energy: Conservation agriculture, farming carbon into soils, May 1, 2020

[5]. Global Partnership on Nutrient Management in collaboration with the International Nitrogen Initiative: Our Nutrient World, The Challenge to Produce More Food and Energy with Less Pollution

[6]. Thunder Said Energy: Conservation agriculture, farming carbon into soils, May 1, 2020

 

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