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Most investment managers are familiar with the attractions of the world-leading chip company TSMC. Responsible Global Equity Income remains excited about the opportunity offered by this powerhouse of advanced semiconductor innovation.
But, as long-term investors, we also must consider and assess potential obstacles to the company’s continued ability to generate stellar compound growth. Some of these are bound up with Taiwan’s challenges on the road to net zero. The subject has featured recently in our discussions, and in our dialogue with TSMC management.
The net zero challenge comes from Taiwan’s heavy reliance on imported fossil fuels. In 2021, almost 98 per cent of energy came from abroad. For electricity, imported coal, oil and natural gas provided over 83 per cent of the island’s generation, while renewables generated just under 6 per cent. The lion’s share of the rest, approximately 9.5 per cent, was generated by nuclear power.
This reliance on imports is uncomfortable – particularly when energy markets are volatile. From an environmental, social and governance (ESG) perspective, however, TSMC needs to stay closely engaged in Taiwan’s decarbonisation challenge.
© Taiwan Semiconductor Manufacturing Co., Ltd.
Energy policy
Energy policy is politically sensitive in Taiwan and nuclear power is a partisan issue. The ruling Democratic Progressive Party (DPP) has been anti-nuclear since it was founded in 1986, only months after the Chernobyl disaster. In 2017, the year after it won office, the DDP amended the island’s Electricity Act, directing it towards a nuclear-free future by 2025. The catalyst was the Fukushima disaster, but the decision was linked to long-standing anti-nuclear sentiment in Taiwan.
The main opposition party, the Kuomintang, has called for a repeal of the 2025 target. A 2018 referendum reamended the Act, allowing retention of nuclear beyond 2025. Nonetheless, the DPP retains that goal. A further referendum, in late 2021, on whether to restart a mothballed fourth power plant went against that proposal. The politicisation of these matters, and numerous referenda, have introduced uncertainties in policymaking. The fact that the two main parties have switched positions on some issues complicates things even further.
Towards decarbonisation
The revised 2017 Electricity Act also set Taiwan's 2025 ambitions for:
• increases in renewables - 20 per cent up from 5.4 per cent in 2020;
• increases in imported liquefied natural gas (LNG) - 50 per cent, up from 35.7 per cent;
• reduced reliance on coal - 30 per cent, down from 45 per cent;
• and the aforementioned phaseout of nuclear - down from 11.2 per cent.
However, progress on renewables has been anaemic. To illustrate: 2021’s 6 per cent contribution from renewables to electricity generation is only a marginal increase from 4.8 per cent in 2016.
There are several reasons for the slow progress towards greener energy. Solar power installation is challenged by a lack of available land for large-scale arrays: Taiwan is densely populated, with two-thirds of its land rendered undevelopable by mountains. Wind farm development has been hindered by pandemic-related supply chain delays and, offshore, by environmental concerns. Last year, the Taiwanese Ministry of Economic Affairs revised its 2025 goal for renewable electricity generation down from 20 per cent to 15 per cent. LNG expansion has been stymied by a debate about the environmental impact of a proposed offshore terminal, necessary (according to the DPP) to increase LNG’s contribution to Taiwan's energy mix.
Even if Taiwan were to reach its new 2025 goal of 15 per cent renewables and zero per cent nuclear, estimates suggest this will represent a net increase in thermal electricity generation to its grid, although LNG increases might lower grid carbon intensity.
LNG tanker
Implications for our holdings
Taiwan's limited progress on its clean energy transition represents a significant challenge to TSMC's decarbonisation ambitions. The Responsible Global Equity Income team see this as an increasingly material threat to the company’s long-term success.
TSMC is by far the largest user of Taiwan’s electricity, consuming approximately 6 per cent of the entire grid. This percentage can be expected to increase significantly as the company adopts extreme ultraviolet lithography, a more energy-intensive technology for the production of more advanced semiconductor chips, and expands its manufacturing base on the island. Approximately 62 per cent of TSMC’s reported carbon emissions come from its electricity use. If the company is to decarbonise, much depends on Taiwan’s progress more generally. We believe TSMC recognises this challenge and takes it seriously. We believe this to be appropriate as we do not consider TSMC’s decarbonisation drive to be solely an environmental or moral imperative.
Many of TSMCs customers have ambitions to reduce their own carbon footprint beyond their immediate operations – the wider ‘scope 3’ emissions covering all upstream and downstream activities and connections. These ambitions are driven by their perceptions of ongoing shifts in regulation, cost and customer expectations.
The company’s task, therefore, will be to align its technological leadership with an understanding of market developments around the net zero transition.
It is in our interest as long-term shareholders to understand the specific challenges the company faces and patiently encourage it to pull every available lever. Fundamentally, the pace of innovation in renewable generation technologies suggests that over time wind and solar sources will enable TSMC to access power at lower cost and lower price volatility.
The evidence tells us it’s trying hard. The company recently improved its target, aiming to derive 40 per cent of its electricity consumption from renewable sources by 2030. It signed the world’s largest power purchase agreement with Ørsted and, although our estimates suggest that even accounting for this contribution still makes its 2030 goal challenging, there are other examples of TSMC ambitiously pursuing renewable purchasing. For instance, it has been buying almost 99 per cent of available renewable energy credits in Taiwan, is installing renewables on new fabrication plants and supporting suppliers to purchase renewable power.
Supporting our companies
Taiwan has a profound decarbonisation challenge. Electricity demand is forecast to rise significantly and this is set against constrained supply, policy obstacles, a highly politicised energy landscape, geopolitical tensions, an ongoing reliance on imports, a fragile grid, a lack of energy storage and more.
As long-term, supportive investors we need to stay aware of these issues and the various bottlenecks in Taiwan’s decarbonisation process. Engaging with experts from numerous Taiwan-based energy-focused think tanks, who have studied these issues for years, has helped further. Through doing this, we believe we can arrive at a better-informed position from which we can engage with our holdings with operations in Taiwan, leading to better outcomes for Responsible Global Equity Income’s investors.
Responsible Global Equity Income team members have discussed what we have learned with TSMC, to convey our understanding of the situation and to encourage the company to continue doing what it can to support the roll-out of renewable power in Taiwan. We encouraged the company in its ambitions to get ahead of the curve on these issues, expressing our full support as long-term shareholders for the company incurring the short-term costs needed to ensure the future sustainability of its electricity supply.
The ESG issues many companies face are deeply complex and embedded in local as well as global circumstances. We believe that investing our time to understand the nuance, rather than being satisfied by a tick-box approach to the data, is likely to lead to better long-term relationships, more effective engagement and better outcomes.
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The views expressed should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.
This communication was produced and approved in July 2023 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.
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