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12 August, 2022 / Comment

What is the circular economy?

By Yohann Terry, portfolio manager, Man GLG

And how can investors consider it in their portfolios?

What is the circular economy?

Responsible investing is heavy with buzzwords and acronyms: ESG, SDGs and more. Another to add to the pile is the circular economy. What does this mean and why is it important for investors?

In short, the circular economy is an attempt to close the linear consumption model of resource extraction, use, and then waste.

Take, for instance, paper. In a linear economy, a tree grows, is cut down and then is pulped to make paper, which is then used. Once used, the paper is binned, completing a linear journey from seedling to landfill.

However, in a circular economy, the used paper would be recycled up to seven times before finally being sent to a waste-energy plant – ‘circulating’ many times around the economy to maximise the uses of a single item, with the overarching aim of reducing mankind’s impact on the planet. Instead of being confined to a single product, the circular economy tries to apply this principle to as many products and commodities as is practically feasible.

By working to make the global economy as circular as possible to reduce waste and minimise extraction, companies and investors can minimise their impact on the environment and safeguard the planet for future generations.

Linear versus circular economy

How does this work in practice?

The circular economy is defined by the four ‘Rs’: reduce, reuse, recycle and replace.

In terms of reducing the amount of material needed to satisfy the world’s consumption demands, there has already been great progress – even if more is required. The mining industry is a clear example of how applying circular economy principles can aid the cause of water conservation.

A standout area has been the growing use of dry separation techniques in mining to reduce freshwater consumption. These range from dry comminution, where ore is crushed and ground down to particle size without water being added, to non-aqueous processing techniques using polymers instead of water to separate ore particles from waste rock.

Tailings, the often-toxic detritus left over after mineral has been fully separated from waste rock, are usually mixed with water and contained by a dam.

However, by introducing course particle flotation techniques and dry stacking, miners are able to remove the water from residual waste, producing dry, stackable tailings. This provides safety benefits – lax safety precautions led to the collapse of a tailings dam in Brazil in 2019, which left 259 dead and 11 unaccounted for – by drastically reducing the amount of water needed for tailings storage. Water usage can be further reduced by introducing water treatment facilities, aiming for a ‘closed loop’ system in which water usage is reduced, and the remainder is cleaned before being reused.

Reusing material is also a key principle of the circular economy. If a broader range of materials can be reused and brought within the purview of the circular economy, pressure on the environment can be reduced.

A prime example is cement production, which is responsible for an estimated 8% of global carbon emissions, with the final product often used to create concrete. It is possible to reuse waste concrete, with some 60-70% of the material reused, often as crushed hardcore in road building. However, new techniques have enabled concrete to be recycled fully, by mixing carbon dioxide with chemical additives to break down the concrete into its constituent elements. These can then be used to create new concrete, saving major environmental damage from new resource extraction.

See also: – Podcast: Materials can drive the circular economy

Increasing the use of recycled materials within the production cycle is a similar, though equally important, part of the green transition.

Steel production accounts for around 7% of global CO2 emissions and aluminium represents around 3%3. However, scrap-based steel can be made with up to 79% lower emissions intensity per ton, using an electric arc furnace compared with a traditional blast furnace process.

Blast furnaces currently account for more than 70% of furnaces in use globally, and use entirely virgin iron ore to produce steel, leaving a great deal of room for improvement. Using recycled metal instead of virgin ores reduces water pollution by 76% and water use by 40%.

As well as recycling as many materials as possible, replacing those materials that are worst for water conservation and the wider environment is a key pillar in a fully circular economy. This will not be practicable for every material, but the fact remains that there are multiple instances where direct substitutes exist for everyday pollutants.

An example that relates to water would be plastic packaging. According to the United Nations, more than 14 million tons of plastic end up in the ocean every year and just under 15% of plastics are currently recycled.

One solution would be to adopt the principles of the circular economy by replacing non-biodegradable plastics with carton packaging. This would not only mean a higher percentage of the packaging could be recycled – as stated above, carton and paper-based products can be pulped and recycled many times – but it also would mean a reduced carbon footprint. Compared to HDPE or PET type plastic bottles, carton-based packaging requires 34% and 45% less carbon emissions to produce, respectively, as well as diverting a considerable amount of plastic from ending up in the ocean.

Portfolio perspective

How can discretionary managers best engage with the growing attention being paid to the circular economy, and do so in a way which enhances their portfolio?

The key thing is to buy the solution providers. Most listed firms are already under pressure to reduce their environmental footprint, publishing climate targets as well as changing their energy providers and component sourcing to comply with the scrutiny of a more environmentally conscious consumer.

However, this cannot happen overnight, and many companies lack the expertise and technical ability both to monitor their environmental impacts, and to address them. In addition, while many firms will wish to use recycled materials to meet environmental targets, most of them will have no desire to bring the recycling process in house.

We therefore see alpha in three key areas. First, we are positive on waste disposal and recycling firms themselves. Within this, firms with strong R&D capabilities are ones to monitor.

Second, there is likely to be concurrent earnings growth for firms that provide consultancy and information services regarding product design, recycling and water and waste management. As the old saying goes, if you can’t measure it, you can’t manage it.

Third, we see particular value in specialist solutions companies exposed to highly polluting industries – firms that are able to solve technical, industry-specific environmental problems.

Part of the Bonhill Group.