Mike Disabato:                  What's up everyone, and welcome to the weekly edition of ESG Now, where we cover how the environment, our society, and corporate governance effects and are affected by our economy. I'm your host, Mike Disabato. And this week we have two stories for you. The first is we're going to talk about the economic damage caused by river evaporation that is plaguing a good portion of our globe. And then we discuss this Semiconductor Act that the US just passed, which it hopes to develop its domestic semiconductor manufacturing industry with. Thanks as always for joining us. Stay tuned.

                                                Images of dry riverbeds and warnings of historic droughts are combining with sweltering heat waves to make me really anxious. Oh right, and it's also getting harder for countries to run vital infrastructure. Let me give you two quick examples of that. Not two quick examples of my anxiety, don't worry. I mean, two quick examples of issues with vital infrastructure, which maybe goes hand-to-hand with my anxiety. Anyway, the French energy supplier, EDF is temporarily reducing output at its nuclear plant stations on the Rhine and the Garonne Rivers, as heat waves have pushed up river temperatures and restricted EDF's ability to use river water to cool its nuclear plants.

                                                And then also, record high temperatures and severe drought in West Central China have crippled hydropower generation and prompted the shutdown of many factories in the region. And that's partially due to low river flow in the Yangtze River, due to a failure of summer rains this year, coupled with daytime highs that have regularly approached or exceeded a 100 degrees Fahrenheit. The evaporation of rivers is seen by climate scientists as an example of a catastrophic tipping point caused by climate change.

                                                You may have heard that term before, catastrophic tipping point. Well, this is one of them, and for the markets it spells trouble for an already troubled economy in regions like the EU, China, and the American West. It's a physical risk problem that we can use as a hot take for this week's episode. And when I say physical risk, I mean the risk that climate change poses to company's asset, like a building. There are two types of risks due to climate change that we predominantly look at, there are physical risks and transition risks. Physical risks are risks that wildfires pose, for example, to company's infrastructure. A transition risk is the risk that climate policy will impact a coal company's ability to run for example. So to talk more about physical risk, I called up my colleague, Gillian Mollod, who looks at physical risk for us, and I asked her what these droughts might do to European companies that sit along European rivers.

Gillian Mollod:                   So a good example is the Rhine river in Germany, which is really a linchpin of Europe's network of inland waterways and does a good job of showcasing the effects of river low flow from climate change since it's really central to the region's economy. And clearly, there are a number of industries that may be impacted from poor river flow if you think about it anecdotally, transportation, agriculture, and the power sector. So what does this look like? Inland shipping is a major part of the European economy and transportation on the Rhine is huge, right? There's a lot of traffic on the Rhine, so if the water gets too low, these ships have to cut their load by a certain percentage. It really depends on how low the water gets.

                                                Agriculture on the other hand is sort of obvious, right? You have less water, that equals less irrigation and then you get lower crop yields. For example, in Italy's Po Valley, which is home to 30% of the country's agriculture production, the river there fell to its lowest in 70 years, so that's quite significant. And then there's the utility sector, which is what we model in our fiscal risk model. We look specifically at hydropower plants, which are of course totally reliant on water flow. But we also look at thermal power plants because these cannot operate without water systems near them to cool down their systems. So they're also very reliant on water. So we look at any thermal power plants that are 10 kilometers from a river.

Mike Disabato:                  But just to quickly say there are problems that low rivers can cause to the energy industry as a whole because inland rivers in Europe especially constitute a vital supply route. Take the Danube River and that runs east across Germany to the Black Sea and is connected to the Rhine via a canal. The Danube River is a vital supply route for utilities as barges bring coal to feed generators when output from hydro facilities suffers. But what Gillian was talking about was specifically what can happen to energy utilities that sit along rivers when those rivers evaporate, as they're doing now. To look at that, we use what was called the two degrees Celsius river low flow company climate value at risk, which is a mouthful. But to not be so wonky, what that does is it looks at power utilities' upside or downside risk, so it could go up to its market value if rivers continue to behave as they are now, based on an assumption that we will keep warming below two degrees Celsius from its pre-industrial levels.

Gillian Mollod:                   So what we did today was to pull up any asset that generates power using the EU river systems. And we found 18 companies with a total of about 350 assets that sit along Europe's rivers. And one company that stood out in particular was Uniper, which is a German-based energy company that has 79 assets along Europe's rivers. And when we looked at its impact to its overall company value, so when we looked at the physical risk, value at risk, we see it's almost 40% is due to river low flow, so that's quite significant.

Mike Disabato:                  This bear is repeating that 40% number that Gillian just said that represents the market value at risk. And remember market value is outstanding shares times price. But Uniper also plans to be carbon neutral in all of its Europe-based operations by 2035. That means no more coal and more wind in solar. And you don't need water to run wind and solar plants, or you don't need to ship fuel to them also. Still, at the moment in our model, Uniper is sort of this special case because it has so many assets along rivers in Europe, and it has a possibly large value at risk due to low flow rivers so far.

                                                But there are other companies with a less pronounced European presence that are probably looking at these low-flow rivers with a bit of an alarm. And I'm just saying that because Uniper is not the only player here. This is on the mind of everyone, that's kind of along these rivers. According to Bloomberg News, between the German towns of Sankt Goar and Budenheim, the Rhine's depth will be increased by 20 centimeters in a project that's going to be completed in the early 2030s. But as Bloomberg rightly notes by 2030, it could be too late for many businesses that depend on Europe's rivers.

                                                Semiconductors are in everything they're in medical equipment, they're in automobiles, they're in industrial machinery, they're in consumer electronics, they're in environmental systems. And of course, they're in defense and weaponry. For being so vital you would think that every country would produce its own supply of semiconductors because let's say one government is angry at another, as so often happens you wouldn't want such a vital supply route to be compromised. Well, if we use the US as an example, you'd be wrong. Nearly four-fifths of global semiconductor fabrication capacity was in Asia. South Korea hit 28%. Taiwan was at 22%. Japan was at 16% and China was at 12%. US companies do dominate some parts of the semiconductor supply chain such as chip design. But when it actually comes to making the things, the US predominantly relies on other countries. And the US government is worried about this. And so they're trying to change it by passing what was called the Creating Helpful Incentives to produce semiconductors for America or CHIPS Act that was signed into law in early August.

                                                It's a big opportunity for a vital industry to grow in the US, but it comes with a lot of issues that are inherent when you try to reverse a decades-long shift to overseas production. And so to talk about what the CHIP Act means in a short term, I called up Siyu Liu, my colleague who helps cover the semiconductor industry. And I asked her to put an ESG lens on and tell me about how she thinks the CHIPS Act is going to affect the semiconductor industry in the short term. And she said that the problem the industry is going to face is the shortage of labor needed to fabricate these semiconductors.

Siyu Liu:                                The industry itself just has a really long payback period. It does require very heavy upfront investment, fixed cost, including the plants. But also the training of the skilled technicians and engineers that have been lost for over a few decades, that training to fill the gap, it's going to take some time. The Act itself does include a grant of 200 million in other training programs to facilitate acceleration of that process. The companies that are bringing the manufacturing capacity back to US, does voice concerns about the immediate recruiting challenges.

Mike Disabato:                  Yeah. There's not a lot of people that can manufacture semiconductors when you spent three decades moving away from the manufacturer fabrication of semiconductors in the US. And the CHIPS and Science Act, which is what the US calls it in its press release tries to spur the industry along by providing 52.7 billion US dollars for American semiconductor research, development, manufacturing, and workforce development. That includes 39 billion in manufacturing incentives, 7 billion for legacy chips used in automobiles and defense systems, 13.2 billion in research and development and workforce development, and 500 million to provide for international information communications technology security and semiconductor supply chain activities. Which likely will be eagerly accepted all of that if possible, by companies already in the semiconductor game like Intel.

Siyu Liu:                                But also for other foreign companies, such as TSMC, Taiwan Semiconductor Manufacturing Company, and Samsung, for example, if they want to build a factory in US states they are also technically eligible for the grant under this Act.

Mike Disabato:                  In addition to Intel, Taiwan Semiconductor Manufacturing Company, and Samsung, there's also Micron Technology, Broadcom, Qualcomm, Texas Instruments, and VITA. Many of these companies don't have their own manufacturing facilities, even though they're already in the US. They just rely on overseas suppliers. And many want to shore up their supply chains because of all the complications that happened for example because of COVID-19. But semiconductor manufacturers in the US, to which right now there are about 185,000 workers, they garner a good wage. According to the Congressional Research Service, semiconductor manufacturing workforce earned on average around 166,400 US dollars in 2019, that's more than twice the average for all US manufacturing workers, which is around $69,000 USD.

                                                Now, those numbers are great for increasing a labor force that isn't there at the moment. But it also could spell trouble for US manufacturers when they're competing with what have anecdotally and historically been lower-wage paying companies in Asia and Southeast Asia. So I want to know from Siyu, that even though there's demand by the US government for more domestic manufacturing, how would these US semiconductor manufacturing companies compete with the lower wages abroad? And she told me that, well the Act is dealing with that.

Siyu Liu:                                Another component of this Act is to provide a 25% tax credit to help support the longer-term development of the industry. So it's not just 39 billion up-front but also sustained support through the tax credits. Supposedly the intention is to help improve the competitiveness of the chips produced on the US soil with the US labor.

Mike Disabato:                  That US labor part is a very important part of this bill. It's focused on developing manufacturing capacity, yes. But it's doing so using a pretty prominent ESG theme in workforce development because it's a politically savvy move. Basically in the Act, it says companies need to demonstrate significant worker and community investments, ensuring semiconductor incentive support equitable economic growth and development. Now that's kind of broad, but it is a look into the labor-management part of this bill. And that is one of the main ESG thrusts of it. But to tie this to another ESG factor and to the drought discussion we had earlier, manufacturing comes with environmental questions and for semiconductor fabricators, there are a lot of questions around water availability.

Siyu Liu:                                For example, one of the plants that Intel is building and the other one that TSMC is building, they're both in Arizona. And I think Samsung is building one potentially in Texas, where both of them are experiencing elevated water risks.

Mike Disabato:                  Intel TSMC, which is Taiwan Semiconductor Manufacturing Company, as Siyu just said they're building facilities in Arizona and Samsung is building a facility in Texas. Texas is a bit better. Around 97% of Texas is under drought right now, sure. But last year around this time it was 94% drought-free. So there's hope there. But Arizona, Arizona is currently in the 27th year of a long-term drought. And that's going to be really difficult for the semiconductor industry because it's manufacturing facilities can take in between 2 to 4 million gallons of water to cool down its equipment and to clean its silicon wafers. And for those silicon wafers, the water needs to be what is called ultra pure water that is treated to remove contaminants, minerals, microorganisms, and trace organic and non-organic chemicals, or it can destroy the semiconductor itself.

                                                And so water's a huge deal for this industry. And you might have thought we moved away from water. You might have breathed a sigh of relief and thought, "Well, this seems good for labor management. We're making the supply chain more global. That'll probably help out some things, right?" But that can only happen if we are able to deal with the water constraints, that's an economy that we are now facing. And the only way that can happen is if companies start to understand the physical risks that they might be facing in the future, especially those risks that water scarcity and droughts can cause.

                                                And that's it for the week. I wanted to thank Gillian and Siyu for talking to me about the news with an ESG twist. A special shout out to David Booker who helped with some of the data for this episode. And I want to thank you so much for listening. I really appreciate it. If you like what you heard, don't forget to rate and review us, that helps push us up in podcast lists. And that helps me in general. And if you want to listen to us each week, don't forget to subscribe. Thanks again. And talk to you soon.

Speaker 4:                           The MSCI ESG Research podcast is provided by MSCI Inc. subsidiary, MSCI ESG Research LLC, a Registered Investment Adviser under the Investment Advisers Act of 1940. And this recording and data mentioned herein has not been submitted to nor received approval from the United States Securities and Exchange Commission or any other Regulatory Body. The analysis discussed should not be taken as an indication or guarantee of any future performance, analysis, forecast, or prediction. The information contained in this recording is not for reproduction in whole or in part without prior written permission from MSCI ESG Research. None of the discussion or analysis put forth in this recording constitutes an offer to buy or sell or promotional recommendation of any security, financial instrument, or product, or trading strategy. Further, none of the information is intended to constitute investment advice or recommendation to make or refrain from making any kind of investment decision and may not be relied on as such. The information provided here is as is. And the use of the information assumes the entire risk of any use it may make or permit to be made of the information. Thank you.