Engaging with the agriculture supply chain

In September 2024, we bought shares in seven companies operating in the agriculture sector. This basket of equities offered the portfolio attractive attributes, given the macroeconomic backdrop and relative risk premiums.

Allocating capital to this basket led to an increase in the portfolio’s greenhouse gas (GHG) emissions. But it also gave exposure to a collection of assets and capabilities that are critical to improving the way food and other primary products are produced – for human health, amongst other reasons.

Mindful of this complex assortment of climate-related risks and opportunities, we developed an engagement framework outlined in our position paper Climate Strategy and Competitive Advantage. Our aim was to help sharpen companies’ transition plans and to explore the technologies progress depends on. During the fourth quarter, we engaged with all seven of the basket constituents, explaining what we see as best practices, flagging areas of potential improvement and encouraging companies to work towards closing gaps.

Agriculture, forestry and land use together account for nearly 18.5% of global GHG emissions, according to Our World in Data. Project Drawdown, a non-governmental organisation aiming to support science-based climate solutions, promotes an array of possible actions ranging from coastal wetland protection to a system to increase rice yields, to lower the sector’s GHG emissions in absolute terms or per unit of output. According to its calculations, reducing food waste and adopting plant rich diets would be the major factors in reducing agricultural emissions.

ARCHER-DANIELS-MIDLAND

produces oilseeds, corn, wheat, cocoa and other agricultural commodities

CF INDUSTRIES manufactures and distributes nitrogen fertilisers

CORTEVA provides seed and crop protection solutions (pesticides, fungicides and herbicides)

DEERE & COMPANY

manufactures and distributes equipment (mainly tractors) for agriculture, construction, forestry and turf care

MOSAIC

produces and markets concentrated phosphate and potash crop nutrients (fertilisers)

NUTRIEN

produces and distributes crop nutrient products for agricultural, industrial and feed customers

YARA

produces, distributes and sells fertilisers

The seven companies in the agriculture basket are largely not consumer facing and therefore may not be positioned to pull these two high-impact levers directly – for that, we should perhaps turn to other portfolio companies, like Tesco. But they should be able to contribute in other spaces, such as the use of green hydrogen when producing fertilisers, regenerative farming techniques, conservation agriculture and nutrient management.

Take Deere. Its Task Force on Climate-related Financial Disclosures (TCFD) Report states its products could ‘support regenerative agriculture practices such as cover cropping, hasten outdated equipment through performance upgrades or retirement, and supply soil carbon measurement products (similar to nitrogen sensing product lines).’ It also highlights opportunities relating to low carbon fuels, hybridisation and electrification, as well as the company’s considerable strengths in precision agriculture technologies.

We note several encouraging snippets of disclosure from other companies in the basket, suggesting they already contribute towards climate solutions – indicating an awareness that such capabilities may determine their future competitiveness.

For example, Yara’s EU taxonomy disclosure shows that around 30% of its capital and operating expenditure is taxonomy-eligible, with a few percentage points already taxonomy-aligned.

CF Industries is working on green ammonia as an input into fertilisers. Corteva is expanding its biologicals business; its line of biocontrol products uses naturally occurring materials to control pests. Nutrien is developing advanced nutrition products, including nitrogen inhibitors and stabilisers, and naturally derived biocatalyst technologies. In their TCFD disclosures, Mosaic and Archer-Daniels-Midland acknowledge customers are increasingly looking for solutions to help reduce the impact of agricultural activities on the environment (such as employing the 4 Rs of nutrient management: right source, right rate, right place and right time) whilst increasing farm productivity through higher yields with lower inputs. So capital needs to be directed that way.

Many of these capabilities and business lines are in their early stages of development. But they are growing quickly, given the confluence of computing (artificial intelligence), robotics and automation, genome sequencing and remote sensing. Companies must continue to strike a balance between harvesting and distributing to shareholders cash from established businesses whilst reducing their environmental footprint; and reinvesting cash in potentially lucrative but uncertain solutions to growing demand for nutritious and healthy food with lower carbon emissions.

Lack of clarity on the regulatory landscape and uncertainty about customer preferences can sap investors’ confidence and derail even the best-intentioned strategies. So our engagement approach has a dual focus: first, we must encourage these companies to reduce emissions across Scopes 1, 2 and 3 through strategies that create economic value; second, if management can articulate how its strategy creates shareholder value whilst reducing carbon and environmental footprint, shareholders need to support their plans to invest in developing capabilities that can serve climate-conscious customers, at scale, in ways that are not fully recognised within GHG protocol-aligned carbon accounting.

We have designed a five point alignment framework to structure our engagement, facilitate benchmarking and advance our commitment to the Net Zero Asset Managers initiative whilst striving to protect our clients’ capital. This framework is a natural extension of our research process, which emphasises the pillars of ambition, credibility and scope for value creation when appraising companies’ transition plans.

In summary, we are looking for the following

  • a comprehensive, precise, third party-assured GHG footprint that allows us to judge operational quality
  • GHG reduction targets that are ambitious but calibrated based on dependencies and bottlenecks
  • key performance indicators and incentives that cascade through the organisation to coherently drive GHG reduction and financial performance
  • an internal carbon price that seeks to make projects more resilient in the face of climate uncertainty (transition risk and physical risk)
  • a marginal abatement cost curve (MACC) that shows the range of value-accretive GHG reduction projects available to the company and indicates its capabilities.

We complement analysis of all these factors with a quantitative assessment of companies’ economic profit track record, resource productivity and financial flexibility.

FIVE POINT ALIGNMENT FRAMEWORK

FOOTPRINT

Comprehensive (no significant exclusions), third party assured GHG footprint across Scopes 1, 2, 3 (limited assurance to start with and a plan to move to reasonable assurance), presented in a way that facilitates trend analysis. Initiatives in place to increase the proportion of high quality primary data (granular product-level and supplier-specific data). Efforts made to attribute changes in emissions to various drivers, preferably quantitatively.

TARGETS

Paris-aligned, science-based targets out to 2050, with periodic milestones, covering Scopes 1, 2 and 3. Targets might be contingent, ie ‘We will reduce GHG by x% by 20xx if a certain technology becomes available at an affordable cost…’

INCENTIVES

Clear governance pathways and accountability for GHG reduction. Significant % of C-suite remuneration tied to achieving GHG reduction (across Scopes 1, 2, 3). Coherence between financial KPIs and GHG KPIs. Consistent KPIs cascading through the company to promote ‘decentralised innovation’.

INTERNAL CARBON PRICE

Defensible internal carbon price (shadow price, internal fee or equivalent approach to internalising the GHG externality) that drives capital allocation decisions (capex, opex, R&D), and perhaps shapes the view on offsetting/insetting/beyond value chain mitigation. The internal carbon price should drive capital allocation decisions that might have an impact on Scopes 1, 2, 3.

ENHANCED MARGINAL ABATEMENT COST CURVE (MACC)

(plus an assessment of historical RUPI* and lock-in risk†)

Well-specified MACC covering Scopes 1, 2 and 3 – with efforts to extend the MACC each year – highlighting assumptions (eg asset life, discount rate), dependencies, bottlenecks (eg resource availability) and constraints (eg technology readiness levels). The MACC should help us assess the current and potential viability of abatement levers underpinning the transition plan: does the positive net present value (NPV) portion of the MACC cover the demands of the GHG reduction target? If so, is the company allocating capital to execute on the MACC? If not, how will the company reconcile its climate targets with the pressures of shareholder value maximisation?

In our engagements so far with companies in the basket, we have covered these five dimensions, outlining our requirements, flagging what we see as gaps and tabling our expectations for future enhancements. Some common challenges arose in our discussions. Here, we describe two of them and how we plan to track companies’ progress over time.

* Resource usage and productivity indicator (RUPI) – this is our quantitative assessment of whether a company has been able to decouple economic profit from resource consumption and externalities.

† Lock-in risk: a state of inertia arising from a combination of psychological resistance, technological constraints, financial inflexibility and incentives to maintain the status quo.

ACCURATE EMISSIONS DATA

It’s hard to compile a precise GHG footprint, particularly for Scope 3 emissions. For companies to use their purchasing power – should they be in a position to do so – to encourage a reduction in suppliers’ carbon footprint, they must have access to supplier-specific data. If, for example, a large proportion of Scope 3 Category 1 (purchased goods and services) data is based on industry average emission factors, then it is difficult for companies to track the potential benefits and costs of supplier engagement.

In our view, requesting supplier-specific data where substitutes exist can have a positive ripple effect through the value chain as suppliers respond to customers’ intensifying scrutiny. But several companies said some suppliers are still either unwilling to disclose emission intensity (for reasons related to competitiveness or commercially confidential information) or unable to disclose emission intensity (because GHG measurement, reporting and verification is an immature field or simply not economic).

That said, companies are working on this problem in some form and are aiming to increase the proportion of supplier-specific data on Scope 3 in the coming years. One company supported our view that the implementation of the EU’s Carbon Border Adjustment Mechanism (CBAM) will force companies to start dealing with supplier-specific data.

MACCs

None of the companies in the basket has yet published a full marginal abatement cost curve (MACC), though some have disclosed project details and capital allocation frameworks that can be seen as early foundations of a MACC.

We explained our rationale for wanting to see MACC disclosure: a MACC shows us whether a company is likely to meet its GHG reduction targets whilst creating value. The availability of positive net present value (NPV) projects – owing to corporate capabilities, supportive regulation or the judicious use of an internal carbon price – can signal the credibility of a transition plan and alleviate investors’ concerns that GHG reduction may compromise economic value creation.

Some companies in our basket use MACCs internally to direct capital. Whilst respecting their concerns about competitiveness, we urged them to disclose their MACCs for all to see. Other companies are considering the NPV of projects more informally, factoring in the benefits associated with current regulations (such as the US Inflation Reduction Act and the EU’s Emissions Trading System) and stress-testing project economics using a shadow carbon price. Again, we pushed them for comprehensive MACC disclosure that builds on current internal capital allocation frameworks.

We will continue to monitor the evolution towards MACC disclosure. Once MACCs are disclosed, we will watch how they expand and contract over time to reflect shifts in the policy landscape and the technology backdrop, as well as companies’ investment in their own capabilities and supply chain relationships.

Heavy emitters in the portfolio need to have transition plans that are ambitious and credible, with a clear path to creating economic value. However, for various reasons, these may not be physically, technically or economically possible. As we state in Climate Strategy and Competitive Advantage, we believe the companies best placed to tackle climate risk are innovators which emphasise productivity and flexibility; those with influence and bargaining power over customers, suppliers and even policymakers; and those whose robust processes help them respond to calls for greater transparency.

Our five point alignment framework helps us monitor whether companies are developing the capabilities to remain competitive in the face of climate challenges, in terms of both their own GHG footprints and their broader climate contribution.