ESG-Warakirri

HARVESTING SUSTAINABLE VALUE Australian agriculture is uniquely exposed to the risks of climate change while contributing hard-to-abate emissions, and the rise of natural capital and carbon and biodiversity offsets present intriguing opportunities for new market developments.

Rachel Alembakis reports.

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Feature | Investment

www.fssustainability.com.au October | 2022

01: Richard Eckard

02: Adrian Goonan

03: Leilani Weier

professor of sustainable agriculture University of Melbourne

head of cropping and diversified agriculture Warakirri Asset Management

head of ESG and responsible investment and sustainability Rest

T

he Australian agriculture sector presents opportunities for non-correlated risk-adjusted return seen to bring diversification benefits as well as potential opportunities in sustainable development and exposure to the emerging natural capital markets.

However, Australian agriculture is also uniquely exposed to the transition and physical aspects of climate change, and investors in agriculture also emphasise that due diligence, care and active management needs to be paid to the social aspects of farms and farming communities.

“On the positive side, Australia can grow everything from tropical fruits all the way to cherries in Tasmania,” says Richard Eckard01, professor of sustainable agriculture at the University of Melbourne and director of the Primary Industries Climate Challenges Centre.

“Very few countries that can manage that.

Australia is the only developed country in the world with true tropical agriculture.

“It is a fairly safe, politically stable and therefore reliable investment country that can do the range of temperature from Mediterranean to monsoonal.”

There are risks and challenges to Australian agriculture as well.

“Australia’s rainfall is 23% more variable than any other economy, so we have a challenge in climate variability, but we also have a long history of dealing with that climate variability,” Eckard says.

“The major risk is drought and climate variability and climate change itself, but having said that if we’re smart about adaptation, that risk is quite manageable.”

Diversification, sustainability benefits “Investing in agricultural farmland is a defensive alternative that behaves differently from other asset classes,” says Warakirri Asset Management head of cropping and diversified agriculture Adrian Goonan02 .

“We saw this materially through the global financial crisis in 2008/09, the recent COVID economic stress and now in the current inflationary and higher interest rate environment.”

Rest has allocations to agriculture through Warakirri, and its agricultural investments are part of its alternatives asset class, explains Rest head of responsible investment and sustainability Leilani Weier03 .

She cites the uncorrelated sources of return and diversification benefits as well as the hedge against inflation that agricultural income can provide, while also citing the exposure to positive environmental factors.

“Agricultural assets can have attractive risk and return and are natural capital style assets which help to fulfil Rest’s ambitions in sustainability,” she says.

“There’s an obvious link. If you have good quality land, you’re going to have a good output over the seasons in what you’re producing and the management of one risk can help the other.”

The Clean Energy Finance Corporation (CEFC), Australia’s green bank, invests in Australian agribusiness as part of its wider mandate to catalysing the Australian economy’s transition to net zero.

CEFC head of natural capital investments Heechung Sung04 notes that agricultural investments also suit institutional investors’ longer term time horizon.

“Institutional private capital, the large pension funds and insurance funds in Australia and internationally, are long term investors,” Sung says.

“Their investment horizon is decades, and you need a long-term outlook in this asset class.

“The technologies that are deployed on the ground require some time to see the benefits.

This is not a private equity play – this is a longterm asset preservation play. You need that capital there to back the strategies.”

Sung also points out that the agricultural sector is an important driver of economic activity.

“Australia is a net exporter of agricultural products, so it’s extremely important to the economy, and the megatrends and tailwinds supporting the transition are enormous,” she says.

At the forefront of climate impacts Australian agriculture is both uniquely exposed to the impacts of physical and transition risks of climate change and is also a significant contributor to Australia’s greenhouse gas emissions.

In a 2021 report, Towards net zero: Practical policies to reduce agricultural emissions, the Grattan Institute noted that the agriculture sector was responsible for 15% of Australia’s greenhouse gas emissions in 2019, emitting 76.5 million tonnes. Cattle and sheep account for 75% of emissions in the sector.

On the flip side, the Grattan Institute report found that changes in rainfall patterns over the past 20 years have cut profits across the agriculture sector by 23%. It is also one of the most difficult sectors in which to cut emissions.

The Australian government recently legislated its target to cut greenhouse gas emissions by 43% by 2030, and for the first time, agricultural emissions were included in government legislation.

“In previous times, when governments introduced carbon targets, they struggled with or excluded agriculture,” says Grattan Institute energy and climate change program director Tony Wood 05 .

“Broadly speaking, that’s still true today, but the agricultural sector is very keen to be part of the solution, not part of the problem.”

The government will have to set policies to achieve the target, including for the agricultural sector, Wood says.

Australia can grow everything from tropical fruits all the way to cherries in Tasmania ...

Very few countries that can manage that.

Richard Eckard

In its 2021 report, the Grattan Institute made policy recommendations, including encouraging deployment of lower emissions technology and practices through the Emissions Reduction Fund by expanding methods related to agricultural practices.

The federal government should also invest in a multi-decade program advising farmers to reduce emissions and secure resilient income streams and should consider alternative financing mechanisms like income-contingent loans to finance lower-emissions practices.

The Grattan Institute also recommends that the funding remit of the Australian Renewable Energy Agency (ARENA) be expanded to support early-stage development of low-emissions agricultural technologies that are not energy-related.

Further, Grattan says that existing state and territory land clearing laws should not be weakened and should aim to keep existing stocks of nature-based carbon at or above current levels.

“The trick with the legislation is having set a target, it’s a bit like having a dartboard without darts,” Wood says.

“How are we going to achieve it? You need to set policies.”

These risks are part of the financial analysis of assets, says Goonan of Warakirri.

“We’ve gone through a climate change action plan aligned to the TCFD framework for all of our investments, to understand the risks and opportunities of climate change, in terms of both physical and transitional risk,” Goonan says.

“We have always applied a rigorous assessment analysis in our investment decisions.”

Building geographically diverse portfolios can help mitigate those risks, Goonan adds.

“We spend a lot of time thinking about building geographically diverse portfolios that behave differently to each other, are considered in the potential impacts of climate change scenarios in those regions and also, and most critically, consider what are the current and potential future management practices which can abate or mitigate those climate change risks, because some environments and regions in Australia are able to, with smart science and best in class management, mitigate those risks,” he says.

QIC head of agriculture and regional investment Tom Murphy06 corroborates this view.

QIC holds an 80% stake in the North Australian Pastoral Company (NAPCo), which consists of six million hectares of land across Queensland and the Northern Territory and 200,000 cattle.

“Every asset is unique, with unique ecosystems and their own ESG challenges, but their own opportunities as well,” Murphy says.

“I think it’s very much how you screen every asset from an origination perspective to determine how it fits into the overall portfolio from

Investment | Feature

www.fssustainability.com.au October | 2022

04: Heechung Sung

05: Tony Wood

06: Tom Murphy

head of natural capital investments Clean Energy Finance Corporation

energy and climate change program director Grattan Institute

head of agriculture and regional investment QIC

a commercial and environmental perspective, what are the challenges we might face in balancing these perspectives, and what are the opportunities that we could develop from a sustainability point of view in terms of improving the bio-condition of the asset we are investing in.”

Because Rest is an active owner and allocates to external managers for its agricultural impacts, it engages with manages on questions of ESG risk and opportunity and how their managers take those risks into consideration, Weier explains.

“Rest’s exposure is in the dryland cropping industry and we don’t have any direct exposure to livestock, so what we’d look at is the crops they’re growing, the crop rotations, soil erosion, soil quality, how any biodiversity on the farms is being protected, how chemicals are being used, how water is being used across the farms, and climate scenario impacts,” she says.

The value of resilient farming communities Social considerations were central to the investment in and stewardship of agricultural assets.

“The social pillar is a really significant focus for us, starting with the health and wellbeing of our people, advisors and contractors who work on our portfolios nationally” Goonan says.

Warakirri sponsors career development programs stemming from work experience, gap year programs for school-leavers and a two-year graduate program as well career development pathway work and targets to improve diversity in what has traditionally been a male-dominated sector Goonan notes.

Rest also monitors its external managers on key risks like occupational health and safety and modern slavery as part of its due diligence, Weier notes.

“We also look at labour standards and health and safety risks,” she adds.

“The broad agriculture sector is one of the highest risk sectors in Australia, so we are looking at how health and safety is managed on farms.”

Cultural heritage protections are also part of the questions that Rest will ask, as well as general governance questions.

The rise of natural capital considerations Given the role that carbon and biodiversity offset credits will most likely play in achieving Australia’s net zero ambitions, the agricultural sector is a central area for development of this nascent market.

Warakirri is watching the development of agriculture-related biodiversity offsets and carbon offsets, Goonan says.

“The biodiversity discussion at the moment is principally a revenue debate in terms of stacking them with carbon offsets,” he says.

“We’re cautiously observing because there’s a long way to go in terms of clear rules of engagement. On the medium-term horizon, we’re likely to position our funds to benefit from the emergence of carbon and biodiversity markets, but sustainability is more holistic for us – it’s about our people and communities, sustainable farming systems and being strong environmental stewards, that’s where enhancing biodiversity in our systems and playing our part in reducing emissions comes into our strategies.”

The challenge of most carbon credit activities that apply to the agriculture sector is that the income stream is still marginal for working assets, which means the lack of scale is a barrier for family-owned and smaller holdings, Eckard explains.

“Carbon farming is a good example of this,” Eckard says.

“Very few family farms are involved in that because an average dairy farmer, for example, would generate less than 1% of their annual turnover from a carbon method. It’s not worth the effort.

“If you go to a large corporate farm and apply the correct methodology, it may be $20 million of income. That’s still only 1% of turnover, but you can employ a full-time ESG manager to manage your carbon portfolio.

Family farms don’t have the incentives. So, we do need to find ways in which family farms can engage and benefit.”

Eckard notes that the lack of scale and extra time required to gather the data on car-

On the mediumterm horizon, we’re likely to develop strategies around offsets, but biodiversity for us is a bit more holistic – how we enhance biodiversity in systems.

Adrian Goonan

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bon sequestration in soil, for example, can be a disqualifying burden and recommends that existing reporting platforms can be augmented to allow for capture of the information that is more efficient for smaller farmers. He notes, for example, that DairyBase, an online tool enabling dairy farmers a to measure and compare farm business performance over time, includes a full carbon audit using existing data.

Natural capital has become an important investment consideration, says Murphy of QIC. “What we’ve seen over that management period the rise of importance of the natural capital,” Murphy says.

“We have the potential to declare up to a million hectares of a nature refuge within that. But also clearly, there’s the potential now to participate in carbon markets through different methodologies - soil sequestration and human-induced regeneration, for example.”

To take advantage of this nascent market, QIC recognises the need to bring in external specialists at this stage, particularly around environmental auditing, and analysis, while augmenting its internal capabilities.

“It will be a partnership between internal capability and external expertise,” Murphy says.

“With a lot of the ecological/biological ecosystems work, it’s technical and complex. For example, soil testing which should reside within specialist consultants, but a lot of reporting and on-the-ground practice will be done by the actual operator/farm manager.”

CEFC also sees nature-based offsets as a nascent market and is keeping a “watchful eye” on developments, Sung notes.

“We invest to make a positive return for taxpayers and to increase private sector investment.

So, when we consider opportunities in natural capital, we look at it through an economic lens because of our investment mandate,” Sung says.

“We focus on investing in ways that utilise the assets of nature – farms, forestry, and adjacent asset classes – carbon, water management and co-benefits such as biodiversity. We see our primary role to help the Australian economy transition to a low emissions future, agriculture is a key part of that.” fs