Felix Odey, Global Resource Equities Portfolio Manager at Schroders, discusses the threat that climate change poses to our food sources and what this means from an investor standpoint.
With nearly eight billion people to feed and climate change wreaking havoc across the globe, producing enough food sustainably while meeting climate targets poses a significant challenge. Meeting the challenge will require rethinking how we produce and consume our food and the pressure it places on other utilities, particularly water. In turn, it will redefine where we invest.
A perfect storm for disaster
Food production is currently responsible for a quarter of the world’s greenhouse gas emissions and is the largest driver of deforestation, as well as accounting for 70% of global freshwater use.
The United Nations (UN) estimates that the global population will reach 11 billion people by 2050, which would involve an approximately 50% increase in the amount of food produced today. This means that more food production will be required in the next 30 years than we have produced over the entire course of human history.
According to the Worldwide Fund for Nature (WWF), the annual economic value of water and freshwater ecosystems is estimated to be around $58 trillion, or 60% of global GDP. Yet the world’s freshwater ecosystems are in a downward spiral due to climate change, posing an ever-growing risk to these economic values.
We’re also seeing more extreme weather, which is starting to have a very real impact on food production. For example, even in a 1.5 degrees variance scenario, the yield of produce such as corn and wheat is expected to decline by between 12 – 14%. Weather variability is also having an impact on our ability to predict what food production levels are going to be.
Policymakers awaken to the challenge that lies ahead
At its current rate, the world’s food system is set to devour the globe’s entire 1.5 – 2 degree carbon budget – a threshold target that was established in the 2015 Paris Agreement. The challenge of feeding the world sustainably and meeting climate targets has dawned on policymakers. At last year’s COP28, heads of state and governments signed a declaration that recognised the grave threat climate change poses to our ability to produce sufficient food.
What this means for investors
The crux of the investment case for sustainable food and water is that demand will continue to grow, land usage will become more competitive (with sustainable fuels, renewable development, and urbanisation) and food production will become increasingly challenged, by desertification, declining soil quality, and increased weather volatility.
This means that food inflation lo-g term is likely to be higher than it has been in the past, and we need to materially change the way we produce, distribute, and consume food and water in the coming decades to keep food inflation at manageable levels. This creates challenges for investors, as it has implications for long-term interest rates.
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However, it also creates investment opportunities. We believe there are structural growth opportunities for the companies involved in alternative proteins, sustainable packaging, smarter irrigation and water management solutions, sustainable aquaculture, precision farming equipment, and lower carbon fertilisers. Like any other change in history, the adoption of these technologies will be driven by the relative cost, consumer demand, and supportive policy.
Over the last few years companies in this space have been contending with cyclical pressures and macro headwinds. Farmer incomes have fallen from record highs in 2022, consumer spending has been challenged by price inflation outpacing wage inflation, and higher interest rates have resulted in higher costs of capital for companies globally. This exacerbated weakness in consumer exposed subsectors, as companies of all sizes sought to preserve capital by destocking their inventories.
The good news is that valuations have reset materially in the food and water space, and we do not believe they reflect their longer-term growth potential, or the nearer term demand recovery we expect as real wage inflation recovers, and interest rates start to normalise. The sustainable food and water universe has not looked this cheap relative to the wider market for over 10 years. Moreover, the destocking across the agricultural inputs, food and beverage packaging, food technology ingredients and vitamin space, could result in some restocking volume recovery in 2024.
Having exposure to this theme allows investors to mitigate some of the risks around food inflation and be positioned for the growth opportunities that will arise from the structural changes the food and water system needs to undergo. This exposure also offers diversification to the wider market given its value characteristics at this point in time.
Where could investors focus?
Historically the widespread adoption of new technologies has created winners and losers. Investors would be well served to look for companies that are adapting their own operations and end products to meet both consumer demands and the growing environmental imperatives. Many of the technologies needed to reduce GHG intensity, water usage, and waste already exist in the market today and are cost competitive.
Recently, there have been a couple of key shifts across the food industry. We’re seeing the adoption of technologies that make the system more resource-efficient, increasingly plant-based global diets and a rising consciousness around the need to reduce food waste. Consider that the amount of food produced each year should easily be enough to feed the world; however, one-third of food produced for human consumption is lost or wasted globally, according to the World Food Programme data in 2020.
Technology will play a significant role, and regenerative farming and sustainable farming will have a place as well, given that we are beginning to see ecosystems collapse because of monocultures that have developed around the world. However, it is equally critical to consider the potential yield collapse from stopping the use of fertilisers. It may be better to lower the carbon intensity of fertilisers and make sure they’re being applied appropriately, through technologies like precision agriculture and equipment, rather than trying to just get rid of all this overnight.
If we’re going to bridge the calorie gap that we see emerging out to 2050, we will need these technologies and the investment to fund them.