InvestmentsOct 6 2014

Industries benefit from tighter rules

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Mitigating and adapting to climate change continues to form a growing concern for policymakers, and government bodies are having a marked impact on a host of industries through more aggressive regulation.

When it comes to government directives on climate change, there are several industries likely to benefit. Most notable is the automotive industry, which has been forced to build more fuel-efficient cars as emissions standards tighten globally over the next 10 years.

Investment opportunities borne of such global policy change can be accessed through automotive suppliers such as US company BorgWarner, which manufactures turbochargers and emissions systems. These systems not only help to limit carbon dioxide emissions, but also allow manufacturers to adapt to ever-smaller engine sizes – another outcome of tightening global emissions and fuel economy standards.

In large part because of this increased global regulation, revenue growth in well-placed businesses such as BorgWarner should accelerate meaningfully in the coming years.

Car manufacturers, including BMW and Nissan, are also well-positioned to meet these new, lower emissions requirements. BMW is building cars with smaller engines and both firms are investing heavily in electrical variants – the BMW i3 and i8 and the Nissan Leaf. While the cost of meeting the 2020 standards is significant, both BMW and Nissan should be able to rise to this challenge, given their strong track record of production efficiency.

Building construction is another area affected by rising global efficiency standards, both current and anticipated. The Leadership in Energy & Environmental Design (Leed) green building certification programme, for example, has been active in the US for several years. Interestingly, many Chinese contractors have chosen this standard over a less-strict domestic equivalent called 3-Star, as they anticipate tougher government policy ahead.

Building services providers such as United Technologies could benefit from adoption of the Leed standards. The company recently combined its heating, ventilation and air conditioning (HVAC) business with its lift business to operate under one umbrella division. Its intention is to offer more of a turnkey service to customers through a simultaneously diversified and specialised global business.

The refrigerant industry – which produces products used in refrigerators and cooling systems – is also undergoing significant regulatory scrutiny. Over the next few years, the entire crop of refrigerants currently used will be phased out – a direct response to their harmful impact on the Earth’s ozone layer.

Emerson Electric is one company that has demonstrated long-sightedness in the face of change in this instance. This global manufacturing and technology company has significantly increased research and development in its HVAC business in anticipation of forthcoming refrigerant changes, which should place it well ahead of the competition over the coming years.

In addition, some companies are positioned to benefit from the unintended consequences of government policy. Under the auspices of energy self-sufficiency, the US outlawed the export of unrefined crude oil after the energy crisis of 1974.

Recent advances in drilling (fracking), however, have nearly doubled oil production in the US over the past 10 years, leaving a glut of unrefined oil in a nation that sorely lacks refining capacity to handle the increased output. One company likely to benefit from this disparity is Valero, a US refiner uniquely positioned to take advantage of the resulting spread between the glut-depressed crude price and the global price for refined product.

Policy ripple effects are being felt across other industries, too. While the energy efficiency of rail haulage has been helping to shift cargo from lorries to rails, railways are now also benefiting from increased regulation of the trucking industry in the US. The US Department of Transportation has imposed tougher work rules for truck drivers (shorter hours, more rest breaks) and has tightened up on driver qualifications, causing a severe driver shortage. This is likely to lead to increased lorry operator costs, and hence pricing.

As the world becomes increasingly globalised, policy mandates will become more broad-brushed and impactful. There is growing evidence that this trend is expanding from the global automotive industry into other areas. Energy efficiency has been a common thread, but investors should look beyond the more obvious angles, aiming to capture more, as yet unrecognised, opportunities.

Max Burns is global equity research analyst at Sarasin & Partners