S&P/ASX 200 Index (ASX: XJO) shares are under increasing pressure to reduce their emissions to help mitigate global warming.
ASX 200 shares that are seen to be high emitters tend to be left off the investment lists of environmental, social, and corporate governance (ESG) focused retail investors and funds.
But this year Russia's invasion of Ukraine, and the resulting boycotts of Russian oil, gas and coal, have demonstrated how reliant the world still is on fossil fuels.
While European nations have led the global charge in championing renewable energy, many are finding it could take several years to wean themselves off Russia's fossil fuels.
Meanwhile, here in Australia, the newly elected Labor government has more ambitious emissions reduction targets than the outgoing Coalition, putting additional pressure on ASX 200 shares to do more on the environmental front.
A big opportunity for ASX 200 shares
Addressing the Labor government's more ambitious 2030 emissions targets, David Gilmour, portfolio analyst & ESG specialist at Yarra Capital Management, said that this presents "the largest opportunity on our pathway to net zero emissions: making dirty cleaner".
"For too long, sustainability investment has centred on future facing industries, like renewables, and blatantly ignored the dirtiest industries," he said. "The focus has been on the cure to emissions, with no consideration to prevention. Divestment has been the weapon of choice."
With the electricity sector in the United States only accounting for about a third of emissions, Goldman Sachs believes the biggest cuts by 2030 will be delivered by oil and gas producers, diversified metals and mining, and aluminium, where you'll find few ESG investors holding shares.
According to Gilmour:
Domestically it's a similar story. Like the US, Australia's electricity sector only accounts for around 30% of total emissions. Labor's new target for a 43% reduction on emissions to 2030 (based on 2005 levels) will require substantive efforts from industry and transport.
He added that "the electricity sector is already stretched to its limit with a forecast 49% reduction by 2030 from today's levels."
Without additional cuts from the electricity sector, Labor will need to achieve a 22% reduction in emissions from other sources to achieve its target. That compares to the Coalition's former forecast for a 1% increase.
The case for investing in these 'dirty' shares
Which brings us to 3 'dirty' ASX 200 shares Yarra holds positions in.
Noting that Yarra supports Labor's proposal to strengthen the existing Safeguard Mechanism, Gilmour said, "Investors must also play an important role. We believe strongly in company engagement over exclusion; the former can lead to outperformance, while the latter shifts ownership to parts of the market with less oversight and deprives companies of capital when they need it most."
He said this was the reason Yarra was invested in ASX 200 shares unlikely to top the list of ESG investors, like Alumina Limited (ASX: AWC) and Worley Ltd (ASX: WOR).
According to Gilmour:
That's why we are shareholders in high emitters such as Alumina, a company with a harder pathway to net zero but has the capability to benefit from the transition. AWC is already among the lowest emitters among major alumina producers, is pursuing early-stage technologies and is a clear beneficiary of green capex given the expected growth in demand for aluminium (39% demand growth to 2030).
We are also overweight on Worley, which is well positioned to capture higher structural demand from energy transition work over and above its traditional work for the oil & gas industry.
The recently rebranded ASX 200 energy share, Woodside Energy Group Ltd (ASX: WDS), also makes the cut.
"Early this year we established a position in Woodside Petroleum (WPL), a company which predominantly produces gas and has a new strategy to invest $US5bn in new energy opportunities by 2030," Gilmour said.
"Our focus remains on working with management to strengthen its 2030 interim target and lower its reliance on offsets," he added.
Some food for thought for ESG investors running their slide rules across potential ASX 200 shares.
