Are Investors Adequately Pricing The Risk Of Plastics?

Investors are failing to adequately price the social and environmental externalities associated with the plastic value chain, according to new research. A report published by the non-profit think tank Planet Tracker has investigated the financial risks priced into major businesses working in the plastic sector by analysing their equity risk premia (ERP). Stark findings from the investigation note that social costs associated with plastics triggered between 2022 and 2030 could surpass $100 billion globally, each year.

Despite increased awareness at a policy and citizen level, the global volume of plastic waste is projected to triple by 2060. The United Nations Environment Programme (UNEP) claims that from the estimated seven billion tonnes of plastic waste generated globally so far, less than 10% has been recycled.

This trajectory, paired with low rates of recovery and recycling, has far-reaching implications for biodiversity, rising greenhouse gas emissions and waste management challenges. The material risks are furthered by the effects of associated chemicals on human health with evidence of microplastics now being found in human blood and drinking water as well as the links between exposure to plastic chemicals like PFAS and cancer being raised.

In spite of sobering health implications and the emergence of global policies like the UN Treaty on Plastic Pollution and the EU Packaging and Packaging Waste Directive (PPWD), this roster of risks may not be adequately accounted for and priced by the investment community.

To understand the risk premium associated with the industry, Planet Tracker reviewed 145 corporates dispersed both up and downstream by analysing the ERP, as a measure to examine the amount of risk investors require to invest in equities at a risk-free rate. The data revealed that the ERP traded on an average of 7.5%, peaking in September 2021 at 9.1%, but has since decreased to 5.8% at the end of March 2023. This suggests that perceived risks are steadily decreasing and were found to be lower than in other sectors, including metals and mining.

The research evaluated single-use plastic producers (SUPs) who are mostly fossil fuel-based manufacturers. This segment typically carries the highest risk premium and includes companies like Reliance Industries and Chevron. Planet Tracker estimates this part of the market is responsible for $40 billion annually in externalities. The analysis also included midstream players involved in container and packaging converter production and downstream organisations such as P&G and Nestlé who are reliant on plastic to sell consumer-facing products.

The research does provide balance, noting that measurement through ERP can be impacted by the considerable rise in interest rates. Additionally, it is suggested that investors are aware of the risk but remain confident about the growth prospects of the sector which could remedy and fund any regulatory and litigation costs down the line.

However, low EPR rate recorded for perhaps one of the most pervasive and environmentally damaging industries suggests that long-term physical, transitional and legal risks are not being considered in full. Arthur van Mansvelt is a Senior Engagement Specialist at Achmea Investment Management, the firm has been an active member of the Business Coalition for a Global Plastics Treaty. Van Mansvelt shares that “As investors, we see that the externalities of plastics used are not priced in, resulting in plastic pollution costs to society of $100 billion a year.” Planet Tracker’s report also details that in the U.S. alone, the sector’s legal costs could amount to over $20 billion by 2030.

But pricing these costs is not straightforward. “The risk most difficult to predict and could catch capital markets by surprise is litigation penalties,” says Planet Tracker’s Senior Investment Analyst Thalia Bofilou. Liability cases linked to plastic pollution have already started. Bofilou points to the current 3M Co case to indicate how significant the social costs can be. The corporate faces numerous lawsuits over PFA contamination of water and has recently reached a settlement of an eye-watering $10.3 billion with U.S. public water systems to solve disputes related to water pollution claims.

“Reputational and legal risks are the most prominent short-term risks investors should assess and address with their investee companies,” comments van Mansvelt, citing the influencing of upcoming EU regulation and enhanced rules in other jurisdictions. He relays the acute awareness firms like Achmea Investment Management have of the risks of plastic packaging for human health. This has in part driven their calls to address toxicity in plastic value chains and is included in the investor statement initiated by VBDO which Achmea Investment Management supported. The statement’s opening line begins with ‘the whole plastics lifecycle poses a serious and growing threat to the environment, climate, biodiversity, human rights and public health.’

Beyond legal liabilities, transition risks will present additional costs for the plastic sector. Bofilou from Planet Tracker warns, “The transition costs have already started. For instance, the Plastic Packaging Tax came into force in the U.K. on 1 April 2022 and it applies a rate of £210.82 per tonne on plastic packaging that contains less than 30% recycled plastic, manufactured or imported into the country.”

Rachel Whittaker, Head of Sustainable Investing Research at asset management firm Robeco states her personal view, “I believe transition risks could be most significant in the short term, including regulatory changes and demand shifts to alternative materials.” Both Whittaker and Planet Tracker reference the influence of the Extended Producer Responsibility (EPR) legislation and how this will significantly increase costs for companies with global footprints. “This could make business models that rely on low-cost disposable materials to be unworkable from a financial perspective,” Whittaker adds.

How can the investment community and corporates account for and remedy these risks? Bofilou recommends that each plastic company’s risk register should include exposure to carbon dioxide (CO2) emissions, harmful toxic discharges, visible and invisible plastic pollution for land, sea and air as well as chemical additives exposure and the rising harm to people and nature.

The impact of plastic policy development

Between 2012 and 2022, over 700 plastic pollution policies have been introduced across the world. Notably, this includes the UN Treaty on Plastic Pollution, set to be negotiated by the end of 2024 where 175 nations hope to agree on a legally binding agreement on plastic pollution, plastic use and disposal as well as mitigate the emissions from its production. It is estimated the ratification of the treaty could reduce plastic pollution by 80% by 2040 if combined with existing technology and major policy reform. “The Treaty would likely trigger a landslide of regulation and change for governments,” says Planet Tracker’s Bofilou.

Elsewhere, the PPWD, as a tenet of the EU Circular Economy Action Plan has set requirements for packaging waste, reuse, recycling and recovery. Van Mansvelt from Achmea Investment Management asserts that “Effective regulation like the EU’s PPWD has the chance to create strong financial incentives for sustainable packaging solutions and a solid business case for waste collection and recycling systems.”

But despite positive development, the Planet Tracker report states ‘It would appear that investors are viewing these policies and regulations as too marginal to impact the finances of these plastic companies.’, meaning that investor returns will be unaffected.

Robeco’s Whittaker sees the rapid change in the regulatory environment for plastics as difficult to keep track of for investors and expects the effects to be gradual, especially when being reflected in measures such as ERP. “The industry will need time to adapt by finding alternative materials, processes and business models. So, the impact on companies and their valuations will not suddenly become clear,” she comments.

The responsibility of investors to help turn the tide on plastic

The modest ERP rates identified by Planet Tracker suggest investors are still attracted by the growth prospects of plastic. Bofilou shares “There is a very high correlation between plastic consumption and GDP per capita.”

And herein, lies the problem – the obsession with growth at the expense of planetary and human health. Active ownership from investors can encourage companies to act responsibly in the plastic sector – what does that look like in practice? Through its work with the Business Coalition for a Global Plastics Treaty, Achmea Investment Management has set out to reduce waste and work towards a circular economy. “We do this because as long-term, responsible investors, we are very aware that if we do not act now, costs to mitigate the risks will only increase,” comments van Mansvelt.

Similarly, Robeco is working with its engagement specialists and sustainable investing researchers to become a positive force. The firm is involved with the Investor Initiative on Hazardous Chemicals (IIHC), an investor-led collaborative engagement initiative with over $11 trillion in assets under management. The initiative aims to reduce impacts on human health and on the environment from the manufacturing of hazardous chemicals and to reduce the financial risks to investors from litigation, regulation and threats against the licence to operate. Whittaker states that “These large initiatives help to show companies that investors are aligned on the need for change.”

Plastic as Big Oil’s Plan B – The implications

But, for all of this, perhaps one of the report’s most poignant findings is the marked decline in the risks associated with single-use plastic producers which has been driven by the popularity of oil producers as an investment.

Under the pressure to forego fossil fuels for renewable energy sources, leading oil companies have placed their bets on petrochemicals to generate oil demand and profits, delaying progress on incentives to reduce plastic pollution. The IEA has estimated that petrochemicals including plastic, are set to drive over a third of oil demand growth between now and 2050 and that policy is a blind spot when it comes to this. This may present obstacles for stakeholder groups fighting against plastic pollution and working to prevent lobbying efforts that could derail effective legislation. U.S. shareholder advocacy group As You Sow have filed shareholder resolutions to raise important questions on this issue.

As Planet Tracker reiterates plastic should be priced beyond the market price. Calculating the social costs should consider greenhouse emissions, health implications, waste management, unmanaged waste and other externalities. Together, policymakers, investors, shareholders and corporates have the opportunity to advocate for and instil regulation that champions this.

Read the full article here