The Sage ESG Top 5 – Week of November 21 – ETF Trends

By Andrew Poreda, Vice President & Senior Research Analyst 
What it means: The FTX saga has been one of the most intriguing and shocking events of 2022. In a very short time span, the often-revered crypto exchange with a supposedly visionary CEO came unraveled, and the fallout has been enormous. FTX, a previously $32 billion company led by 30-year-old Sam Bankman-Fried (known by many as just SBF), is now bankrupt, and it doesn’t have the funds to pay back its millions of customers. How did this happen? While the details are still playing out, the first sign of trouble to the public happened last week when FTX’s sister site Alameda Research had gone offline, and the SEC announced it was investigating whether FTX mishandled customer funds. Rival exchange Binance then backed off on its acquisition of FTX (having previously dumped all its FTX-backed FTT token, which crashed that coin’s market value), and then the wheels came off the bus. It appears FTX funneled customers’ money (approximately $10 billion) to Alameda Research for some risky investments, and there isn’t any money to pay them back. An FTT token that was worth $26 at beginning of November is now hovering around $1.602. Due to client calls for funds, FTX also blocked anyone outside of the Bahamas from redeeming their accounts. SBF resigned as the company’s CEO but is still desperately seeking investors for funds to pay back customers. That’s unlikely to happen. Expect SBF to be under a great deal of legal scrutiny, and don’t anticipate him to be allowed to venture too far from his Bahamas resort headquarters.
Sage’s View: This is such a huge debacle, reminiscent of Bernie Madoff’s Ponzi scheme, Elizabeth Holmes’ Theranos fabrications, and Kenneth Lay’s Enron accounting fraud. And for those that still aren’t convinced how malicious this whole scandal is, just looking at his text conversations with a Vox reporter should allay any doubts3. Powerful politicians and investors were hoodwinked by a bunch of aspirational nonsense, and for those involved there were plenty of warning signs. Respectable firms like Sequoia Capital invested $210 million and Softbank another $100 million, even though the terms were essentially that of the “take it or leave it” variety and gave FTX a blank check with no expectations of transparency in return4. Many celebrities had also lined up out the door to invest, as we now know that Tom Brady, Steph Curry, and Shark Tank’s Kevin O’Leary are among the many victims.
From an ESG perspective, the big lesson that repeats itself time after time is how important the topic of good governance is to the long-term success of a company. While it is easier to look back in history and notice the warning signs, an objective observer should have been able to pick them up. If we looked at FTX through Sage’s “5 Cs of Good Governance” (compensation, composition, competency, clarity, and consistency)5 there are so many questionable elements. Whether it be the inexperience of anyone on the team running a multi-billion-dollar business (basically a bunch of roommates figuring things out as they go while hanging out in the Bahamas), a board of directors with only two seats and one of them also being the CEO, the ill-defined and likely illegal ties between other businesses (FTX being a bank account for Alameda), or the lack of communication and divulging of financial information (no transparency) – there were more than enough problems to give pause. Clearly customers and investors became enamored with a false profit, the “white knight” of crypto, in an industry that often promises infinite returns with little risk. But this drama will rightfully set back the industry for decades to come, and many will hopefully start being a little more dubious of the get-rich-quick schemes that crypto advocates offer. Crypto backers have largely failed to coherently communicate how crypto is needed and will fit into a future society, so maybe now they will spend a little more time convincing stakeholders on the use case instead of stirring fears of FOMO. It was also interesting to note that SBF sounds like he is trying to blame “ESG” for his misdeeds after reviewing texts with Vox (which will be worthy of a bigger discussion), but really, he only has himself to blame.
At a minimum, politicians across the aisle and around the globe will have to up their regulation game. SBF appeared to be in the back pocket of many politicians, as he was a top-10 donor for this election cycle6. “Pro-crypto” politicians that have thwarted regulation and taken his money, like Kirsten Gillibrand, are probably going to have to change their tune on enforcement to save face7. With the number of ordinary investors that lost their hard-earned savings, it would be criminal not to enhance the regulation and legislation covering the industry. The Securities and Exchange Commission (SEC) clearly has its work cut out regardless of how Congress tries to steer the discussion, and we are looking forward to seeing what proposals surface to rein in the industry.
The final question Sage has is, from a fiduciary perspective, what will the sentiment be now toward crypto-related investments? Fidelity’s Digital Asset Survey showed that 74% of institutional investors planned to add digital assets to their portfolio in the future8. Fidelity planned to capitalize on this interest with the launch of its crypto-trading platform (launch date TBD). Will interest remain that high once the dust settles on this catastrophe? Time will tell, but with even the flagship Bitcoin down nearly 75% in the last 12 months, hopefully all investors are now re-evaluating those plans and proceeding with caution.
What it means: Many climate advocates anxiously awaited some sort of big news to come out of COP27 in Egypt that could put a dent on global warming. The US tried to capture headlines with the unveiling of its Energy Transition Accelerator. While light on details, US Special Climate Envoy John Kerry explained the accelerator was a carbon offset plan that would encourage US corporations to purchase offsets from developing nations, which would then use the revenue to help foster renewable power and shutdown fossil fuel-based power sources like coal. Partnering the US government with the Bezos Earth Fund and Rockefeller Foundation, the program will operate through 2030 at a minimum. Countries including Nigeria and Chile have expressed interest, as have influential companies, such as Bank of America, Microsoft, and Pepsi. The UN Secretary General had his doubts on the initiative and expressed that carbon offsets should be used sparingly and not get in the way of broader Net Zero initiatives.
Sage’s View:  While Jeff Bezos may be struggling with the difficulty of trying to give all his money away to goodwill10, many US corporations aren’t in that same position. And when the US carbon market is expected to remain voluntary for years to come, purchasing offsets might as well be a charitable contribution. The only reasonable rationale for a company to purchase them would be a calculated risk that buying these offsets would increase brand value through appeasing customers and employees. Unfortunately, rewarding companies for purchasing carbon offsets has many flaws in general, and for energy projects, the first one that comes to mind is the concept of additionality. Would some of these projects still take place even in absence of the offset? We’d argue the answer is likely yes.
What will happen is these offsets will increase demand for renewable energy projects, and since supply chains are so strained with little aid in sight, prices will go up. And unfortunately, we are likely to have no extra renewable power to show for it. Areas like mining, mineral processing, and manufacturing are where the real work needs to be done, and many of those projects take years to get online. We all would love to shut down every coal power plant for the sake of the environment, but it is not feasible without the building blocks in place to force that dream into a reality. With all the limitations, one solar or wind project built in Africa means one less built in the United States or elsewhere. And since global warming doesn’t care where emissions come from, this type of initiative will have no environmental impact in the near-term. Corruption and misallocation of funds would also be of paramount concern, as we can’t even seem to properly manage government funds here in the United States, whether it be the fraud associated with the Paycheck Protection Program (PPP) or jobless claims in states like New York.
Instead of focusing on trying to force other countries to wean off fossil fuels, why aren’t US leaders trying to concentrate on what we can do to ensure our own clean energy future? At this point, it appears we are content with putting our energy future in the hands of China, which makes one wonder why another country would follow our lead. America’s efforts need to focus on building domestic clean energy supply chains, from mining to manufacturing. We need to foster innovation, which has driven the US economy for the past one hundred years. And finally, we need to collaborate with our strongest allies in shoring up our areas of weakness. Stop wasting time trying to control the developing world and look in the mirror.
What it means: In an era where automobile manufacturers are bending over backwards to showcase their commitment to the electric vehicle (EV) movement, some companies are pumping the brakes on that trend. Renault is one of those companies, seeing the internal combustion engine (ICE) playing a pivotal role in its business for years. Last week, the company announced a partnership with the Chinese firm Geely to develop, produce, and supply hybrid power trains and efficient ICE vehicles. The rationale for the move: “In our view, and according to all the studies that we’ve got, there is no scenario where ICE and hybrid engines represent less than 40% of the market with a horizon of 2040. So it’s actually … a market that’s going to continue to grow,” according to Renault Chief Financial Officer Thierry Pieton. Renault is, however, planning to create an EV spin-off Ampere. Analysts think the move could pay off, as margins on ICE vehicles exceed those from EVs. But certain markets will provide headwinds to ICE manufacturers, such as California, which banned the sale of new gasoline-powered vehicles by 2035, or European Union members who have also set similarly ambitious goals. The industry is hopeful that leaders will take a more practical look at the EV transition and acknowledge some of the challenges. Stellantis’ CEO summed that sentiment up with a great quote, arguing European leaders needed to be “more pragmatic and less dogmatic.”
Sage View: Everyone should be skeptical of political leaders’ expectations for the pace of the EV transition. The transportation sector accounted for 37% of global emissions in 202112, and the electrification of passenger cars would make a huge dent in that figure. But there are many shortcomings that should temper our expectations for the tempo of the shift. The first one is infrastructure. Here in the US, charging stations are still limited in number, and we haven’t reached a consensus on what is the best charging strategy (e.g., should we have lots of cheap and slow Level 2 chargers or a smaller number of more expensive yet fast level 3 chargers?). We must also smartly think about how utilities will have the resources to effectively pick up the increase in demand by shifting transportation off fossil fuels onto the power grids. But the biggest concern may be the supply chain constraints. Battery manufacturing is a huge challenge, and weaknesses exist for both cathode manufacturing resources (lithium, nickel, and cobalt), as well as anode resources (natural and synthetic graphite). Toyota, a pioneer in offering clean vehicle options, shares a similar sentiment to Renault and Stellantis, and hints that it is going to double down on a “pragmatic” vehicle transition (while also offering other technology options)13. These companies are in the business of making money, and taking into account consumer sentiment, tempered ambitions of global leaders to combat climate change, the prohibitive cost of electric vehicles and their materials, and undeveloped infrastructures, the reality is that ICE vehicles will be in demand globally for decades to come.
What it means: Many people think of blackouts as the result of an extreme winter storm or a hurricane wreaking havoc on a power grid, but a larger underlying issue is also to blame. Traditional power grids are all about getting energy to customers immediately after it is produced, which means there often is no reserve to pick up demand spikes. Experts argue that needs to change, especially as we try to combat climate change and shift toward renewable energy options like wind and solar. Historically, fossil fuel power plants are on standby, but now the hope is energy storage can accomplish the same mission. Many people immediately think of large-scale lithium-ion battery storage as a major solution, but this technology is currently prohibitively expensive, and more intriguing options might exist. One of those options is pumped hydro, which utilizes two reservoirs at different altitudes, forcing water to the higher one to reap the benefits of potential energy when needed. Pumped hydro is not new and gained popularity in the 1970s as an option to capture unused energy from nuclear power plants running around the clock. Reservoir pairs could be either man-made or natural bodies of water, but geographical limitations limit the scalability.
Another option? Create a multi-armed crane that employs renewable energy to lift 35 concrete blocks to store energy. Energy Vault hopes to use gravity to store excess energy and is hopeful that it can bring costs down to compete with lithium-ion battery technology. The last interesting non-battery option resembles creating a giant thermos. By using excess energy to heat up some sort of material like a molten salt, the heat is then trapped with thick insulation, allowing stored thermal energy to create steam that will power a turbine for energy production. The nice part about this strategy is that current coal and natural gas power plant turbines could be utilized. The biggest problem with the thermos option is that it is far less efficient at storing energy than the previous two concepts.
Lithium-ion batteries may have limitations as a chemical battery, but one other type of chemical reaction may offer a pragmatic solution: rust. Iron-air batteries use iron and oxygen to cause oxidation of the iron, which pushes electrons out of the battery. And to charge the battery, the process is reversed, and the electrons are used to essentially polish the iron. Form Energy has partnered with Georgia Power for a proof-of-concept project to provide 100 hours of energy storage. Iron-air batteries are not very efficient at energy storage but hold the potential to ultimately be the cheapest option.
Sage View: The ability to continue to add wind and solar power to grids will be limited by either supply chains or energy storage. For storage, the current projects usually tend to be very expensive and limited to 8 hours of storage maximum (often taking advantage of excess power output during peak capacity). But we are going to need affordable longer-term storage options to deal with unforeseen weather patterns (think of a time with multiple weeks in a row with heavy clouds or calm winds). A difficult task for sure, but without it there is going to be the need for a substantial amount of standby fossil fuel power, which will likely get utilized frequently and is expensive to keep around. Balancing demand and power output is already an arduous task and will only become more difficult with every gigawatt of renewable energy added. The US government recently unlocked $350 million for long-range energy storage innovation (projects with 10 to 24 hours of storage capability)15, but this figure seems small considering the magnitude of the problem and the White House’s goals for clean energy implementation. Places like Germany and California have seen their energy rates skyrocket with the deployment of wind and solar, and one of the key culprits is the lack of affordable energy storage. So, if we want to truly benefit from how “cheap” renewable power sources have become, this must be a universal area of focus. All these listed options above certainly show potential, and it is likely they will all play a role and are worth investing in. Or we could just gamble our future on nuclear fusion with the possibility for a huge payout and have no need for energy storage16.
What it means: A leading US sanitation company just got caught employing children as young as 13 to work “graveyard” shifts in dangerous conditions at three meatpacking plants. Packers Sanitation Services (PSSI) was issued a temporary restraining order and injunction by a federal court at the request of the Department of Labor over alleged crimes. Over 30 children all under the age of 18 were tasked with cleaning dangerous equipment, including a 190-pound saw used to split cow carcasses. One even suffered chemical burns, according to a federal lawsuit. Upon the launch of the investigation, stemming from an allegation from a credible source, PSSI supervisors attempted to thwart the investigation at every turn. PSSI denies all charges, insinuating that identity fraud could be a possible reason for the transgressions.
Sage’s View: When we think of child labor controversies, the United States is unlikely the first country to come to mind. But with the story of Hyundai and Kia suppliers in Alabama utilizing child labor fresh in our memory18, is this an alarming trend that is happening more often than we think? This is also not the first time PSSI has been in hot water. Since 2018, three adult three workers have died on the clock, including one who was decapitated cleaning a chicken chiller19. And since reports are out that a PSSI manager solicited fake IDs for plants in Minnesota, we have some individuals that are directly responsible20. However, there are some others that need to be held to task as well. PSSI is owned by Blackstone, one of the largest and most influential private equity firms in the world. Ultimately one would have hoped there would have been some more thorough oversight, especially considering the subpar historical safety record since they took over in 201819. But Blackstone isn’t the only one worthy of some criticism. JBS USA, a subsidiary of the largest meat processing company in the world, was the one that contracted PSSI to clean their facilities (where the alleged crimes occurred). As these PSSI employees were working on their property, one would anticipate there would be some supervision since they had to check in nightly via a facial recognition time clock21. From an ESG perspective, supply chain management is a common area of weakness for companies. Companies are ultimately responsible for their choice of suppliers and contractors, and while there may not necessarily be any legal liabilities to JBS, there is certainly reputational risk. Since similar investigations are going on at Tyson (which also employs PSSI), this may not be the end of the story. And finally, we believe the end client, some big-box grocery retailers, should also have some accountability. Ideally, these companies should have robust supplier codes of conduct and are thorough in their on-site due diligence visits. If they aren’t, they will likely face the ire of investors and the public.
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Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.
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