What ESG Issues will Investors Face as the Electric Vehicle Market Gears up?

On 2 July 2017, Elon Musk tweeted that the first Model 3 would be delivered by the end of the month and that Tesla plans to ramp up production to 20,000 units by December. The announcement is a strong indication that the electric vehicles (EVs) revolution may be approaching faster than expected, driven by a favorable combination of political, technological and market trends. This is certainly a positive development, however, even in the world of clean tech, environmental, social and governance (ESG) issues abound. Companies and investors alike will need to manage related risks carefully.

ESG issues related to lithium-ion battery production

While we recognize the indisputable benefits of EVs, we remain wary of the environmental and social impact related to the production of lithium batteries – see The Electric Vehicle Boom: Towards Supply Chain Transparency (gated content, you will be asked to complete a form to download the report). While this topic has received comparatively little attention in the media, we believe it will become a key issue as the market continues to grow.

A June 2017 Bloomberg Intelligence report revealed Chinese plans to dramatically increase lithium batteries output in a push to secure an advantage in the surging battery market. According to the report, global battery production will increase almost three-fold by 2021. This growth will stimulate a demand for commodities such as lithium, nickel and cobalt.
From the extraction of raw materials to the disposal and/or recycling of spent batteries, there are several social and environmental factors to consider throughout the supply chain.

In addition to energy use, water use and pollution, and ecological toxicity, investors also need to consider potential labor and human rights issues affecting the mining sector. More than half of the global lithium reserves are found in countries like Bolivia, Chile and Argentina that have comparatively weak social and environmental standards. Cobalt is concentrated in the Democratic Republic of Congo and its extraction and refining pose unique risks in terms of human rights and conflict minerals trade. In 2016, Amnesty International reported that major automakers were sourcing minerals from mines in the DRC that have been linked to human rights abuses.

Our research shows that leaders in the EV market, such as Tesla, trail the more traditional carmakers when it comes to their approach to monitoring and managing ESG-related risks in their supply chains:

On the opposite side of the life cycle, the recycling and disposal of batteries will need particular attention. A recent Financial Times article notes that less than five percent of lithium-ion batteries are currently being recycled. In the coming years, increasing recycling rates will be crucial to offset the negative environmental impact of these batteries while ensuring the availability of a sufficient supply of raw materials. However, the piece adds that recycling capacity may fall short of the first significant wave of EV batteries reaching the end of their lifecycle around 2025.

Strong market growth will compound ESG risks

The most compelling growth driver for EVs is simple economics. A recent report by Bloomberg New Energy Finance showed that the cost of lithium-ion cells has already declined by 73% since 2010. It is expected to fall by an additional 60% over the next eight years. While EVs still constitute a fairly small percentage of the major manufacturers’ revenues, tightening emission standards and testing mechanisms are creating additional pressure to invest in cleaner technologies. Simultaneously, politicians are creating incentives to stimulate the market and setting ambitious targets to clean up road transport. France, Norway, Germany, India and the Netherlands have all announced plans to phase out the sale of petrol and diesel cars with target dates ranging for 2025 to 2040.

The report also forecasts that electric vehicles will outsell internal combustion engines within two decades, accounting for one-third of the global auto fleet by 2038. The current rapid growth in the EV market is therefore only the beginning and the corresponding ESG risks will increase exponentially as the market takes off. Companies like Tesla are well positioned to benefit from this growth, but may be less prepared to manage the associated ESG risks. Traditional car manufacturers may be better equipped to manage their supply chain exposure, but the value chains of EVs look very different from those of internal combustion engines. Companies like Volvo, which recently announced ambitious plans to place electric motors in all their cars by 2019, may therefore be equally exposed.

Implications for investors

Together with autonomous vehicles, EVs represent one of the biggest opportunities in the auto industry. As EVs inch towards mass adoption, companies need to carefully manage emerging ESG risks within their supply chains. Responsible sourcing of raw materials is critical to uphold the sustainability credentials of EVs. There is also a need for greater transparency driven by investor demand and legislation such as the US Dodd-Frank Act, the UK Modern Slavery Act, the California Transparency in Supply Chains Act, and the EU’s conflict mineral disclosure requirements. Finally, companies will benefit from strengthening programs that drive continuous environmental and social improvements at suppliers as well as expanding their monitoring and engagement activities beyond their first-tier suppliers.

As investors align their strategies to the new realities of a low-carbon economy it will be crucial to remain vigilant in their efforts to understand and proactively manage emerging ESG issues.