Circular economy: unearthing investment treasures in the trash

Following on from our food sustainability article, the second instalment of our thematic sustainability blog series will discuss what a circular economy is. We’ll look into what’s required for it to be successful, and how it can generate unique investment opportunities for us to exploit.

Our unsustainable consumption

Just like the food sector, today’s consumption of goods is unsustainable. The sheer scale of basic resources we consume means we’re heading towards a reserve depletion of many minerals. This is very topical on World Earth Day.

A lot of minerals that we consume end up in landfill as waste. The waste we produce holds the potential to become valuable feedstocks (inputs for manufacturing processes) for something else. 

The benefits of a more circular economy

Either we change what we consume (the world’s richest 10% produce roughly half of global emissions) or how we produce it. The latter is an easier option for policy makers. One solution is to make supply chains more circular. The heavy reliance on linear supply chains rather than circular is one of the reasons our level of consumption is unsustainable.

Creating circular supply chains is not just about reducing the negative externalities of manufacturing goods – stopping microplastics entering the sea or reducing potentially hazardous waste to landfill – it’s about using waste to create feedstocks for future products and saving the associated emissions linked to the extraction or production of virgin feedstocks (a previously unused raw material). There is a growing need for substituting virgin feedstock where possible to help mitigate climate change. Maternal Economics estimates that circular practices could reduce the carbon footprint of cement, steel, aluminium and plastics, by 60% in the EU. 

Can the circular economy be successful?

This will require suppliers to ramp up the production of recycled feedstocks and increase the number of buyers of these products. Regulation such as carbon credits can be used to help align the virgin and recycled feedstocks prices, but, importantly, we already have the underlying ingredients for growing supply and demand of circular feedstocks. 

• Increasing supply of recycled feedstocks: Supply will benefit from the amount of capital flowing into this area. With the increased importance of ESG in investment and growth of Sustainability funds’ AuM, capital markets have the means to fund investment into the circular economy.  In addition, initiatives such as the European Green Deal offer centralised funding.
• Increasing demand for recycled feedstocks: Consumer and corporate behaviour is already changing. Consumers are increasingly favouring products manufactured from circular supply chains.  Initiatives such as Taxonomy and the growing focus on Scope 3¹ emissions will encourage corporates to consume recycled feedstocks where possible.

Furthermore, we are not starting from scratch. The private sector has already built circular supply chains where the economics make sense. For example, EU recovery rates for demolition waste is close to 90%, more than half of steel scrap is used in steel production and over 75% of boxes in Europe are made from recycled paper. 

Higher commodity prices are facilitating this switch

The task of promoting the circular economy is being made easier by today’s high commodity prices. Reaching parity between recycled and virgin feedstocks is easier when the latter have already increased. The tight supply and demand dynamics across the commodity space makes us confident that commodity prices will remain elevated for a long period of time. Circular supply chains also help reduce dependency on regions where mineral deposits are located. This is an important factor in a world of growing geopolitical tension. 

Stocks which are exposed to the circular economy

There are only a handful of ways to get exposure to the circular economy in Europe. The multi-year outlook for these companies will be strengthened by any consumer, corporate or policy driven demand boost for recycled feedstocks. We have identified several companies that in our view are likely to be beneficiaries of this and have built exposure to them through our various European equity strategies. We separate them into two types of circular economy-linked business models: feedstock creators and circular economy capex plays.

They are all large beneficiaries of more investment into the circular economy. Again, the demand levers here are multi-fold. The amount of waste we produce is growing, the recycle rate of this waste needs to grow and the recycling complexity of this waste is increasing due to miniaturization and the use of metal alloys within products. These three factors create the need for more capex in waste management and recycling networks.

We believe the market is underappreciating the potential high returns of the circular business models. Where companies can build competitive advantages, they will have the ability to generate excess returns. Neste is still growing its biofuel capacity group, but its current biofuel projects earn a 30-40% return on investment. This compares to a mid-single digit ROI at their traditional oil refinery.

To us, it’s clear that Europe will take a leadership role, and that the circular economy is set to grow significantly from here. This has allowed us to find investment opportunities in the trash, and we’re happy to have a meaningful exposure to this area.

It’s worth noting that whist the circular economy will play a key role in decarbonising global supply chains, this will need to be done in conjunction with creating carbon-free virgin feedstocks too. In the final instalment of this thematic sustainability series we will discuss the impacts of ramping up carbon-free virgin feedstocks.