2021 was a climate debacle. Tied for being the 6th hottest on record, there were 20 weather/climate disaster events in the United States alone, the most events ever, with losses exceeding $1 billion. The global statistics are equally startling with radical climate events upending human lives in China, Europe, and Africa.
To avoid the worst impacts of climate change, the world needs to reach Net Zero emissions by 2050 and reduce emissions by 50% by 2030. It has been difficult to dismiss this fact. It is now impossible.
The April 4, 2022, report from the United Nations’ Intergovernmental Panel on Climate Change lays threadbare that immediate changes must be made to avert the worst consequences of the climate crisis — including the rapid phasing out of fossil fuels. Specifically, it warns that unless countries drastically accelerate efforts to slash emissions from coal, oil and natural gas over the next few years, the goal of limiting global warming to 1.5 degrees Fahrenheit will likely be out of reach by the end of this decade.
Leadership is needed and action is required. We have no other choice.
Global Climate Policy is Lacking
Despite the risks, and what some are calling an existential threat to human civilization, there continues to be a clear deficiency regarding global policies required to meet decarbonization goals. While there was much anticipation around COP26, by and large, it was a disappointment as countries did not come close to committing to the emissions cuts necessary by 2030. Regardless, it has to be acknowledged that some progress was made as countries are now required to submit revised emissions reduction targets by the end of 2022.
Perhaps the most positive, if not overlooked, result from COP26 was that the world’s governments settled on the rules for the global carbon market under the Paris Agreement’s Article 6, one of the most contentious issues in recent years. This is critical to make real progress on reducing emissions and sets the stage for the expansion of carbon markets and the widespread explicit pricing of carbon.
Investors Pressure Corporates on Emissions Reduction
Absent strong and galvanized public policy, the private sector as a whole is taking steps to decarbonize the economy with significant pressure from the demand side of energy markets. This is happening in multiple ways.
Corporations worldwide are adopting Net Zero targets to negate greenhouse gas emissions from operations and products. Such goals will both drive the development of better measurement regimes and investments in clean energy and energy efficiency at the corporate level. As an example, Italy-based ENEL S.A., the world’s largest energy utility, has moved its Net Zero goal from 2050 to 2040 citing confidence in the rate of its investment in renewables and in electrical infrastructure.
Further, the demands for greater transparency on emissions disclosures have been the impetus for the recently proposed SEC changes. Such transparency will shine a light on not just the carbon risks that corporations face, but also a company’s ESG profile. All of this will cause corporations to demand cleaner energy to run their businesses. In retail markets, Millennials and GenZ, who are benefitting from the largest wealth transfer in history, are adopting a similar strategy by requiring positive social impacts from their investments and portfolios.
Institutional investors are also applying pressure on financial institutions that continue to fund polluting industries. While in the early innings, institutions are beginning to recognize the risk to their balance sheets over time¹. Less access to capital will ultimately raise the cost of capital for polluters. And if the UN report has impact, it will shine an even brighter spotlight on the potential perils of funding additional fossil fuel infrastructure.
What are Fossil Fuel Companies doing?
The response in the fossil fuel sector to Net Zero and the changing economic environment is mixed. European companies are moving more rapidly toward better disclosures and making investments in renewable energies. U.S. companies are dragging their feet for the time being, but by doing so run a higher risk of becoming divestment targets and of experiencing further market revaluation if they do not engage in the transition and incorporate climate strategies. Activist investors are having their day in boardrooms and courtrooms to demand change, as ExxonMobil and Royal Dutch Shell can attest.
As a result, investors are looking for Net Zero Transition Data to evaluate and track how fossil fuel companies are preparing for the low-carbon economy in making timely and informed decisions on investment, engagement, and divestment. This stands to reason when investors can look at Tesla, Inc.’s market capitalization, which is approximately US $360 billion, and equal to the combined market values of ExxonMobil Corp., Chevron Corp. and ConocoPhillips Co.
Transitioning to Net Zero
Together, public policy and private industry trends support our view that the world will ultimately create the low-carbon economy needed to ensure a sustainable planet for future generations. To us, it is not a question of if, but when. As the UN report now makes abundantly clear, the world has little chance of reaching the required Net Zero milestones unless we take immediate steps to decarbonize our economy, and transition from fossil fuels to clean energy.
For example, to reach Net Zero by 2050, the world needs to invest somewhere around $3 to $5 trillion per year in clean energy². It will also need to put a price on carbon, effectively pricing the externalities associated with emissions from fossil fuel use.
There is no doubt that the technology exists today to achieve these objectives. What has been lacking is the political will to enact changes that accelerate the energy transition. Make no mistake, we must change behaviors, and governments need to step up and enact policies that force behavioral changes. The horrific Russian invasion of Ukraine may be the impetus needed.
While there is no silver lining in war, the conflict makes clear the connection between climate, energy and geopolitical conflict. Perhaps out of this dark time, governments around the world will finally find the resolve to enact policies that decarbonize our economy and reduce the risks of future conflicts.
What does all this mean for investors?
Energy markets are experiencing extreme volatility and the uncertainty regarding what the war will mean to the energy transition are top of mind for many capital allocators. We expect that the war will cause an increasing number of institutional investors and asset owners to adopt net zero targets for their portfolios. Various investor led initiatives, such as the Net Zero Asset Owner Alliance, are gaining visibility, support and membership. Coordinated efforts like this will only serve to increase the number of net zero commitments made by asset owners. They also provide frameworks that help to facilitate the implementation of Net Zero portfolios, grounded in the notion that investors should do their part to change the arc of current climate trends. While so called “best” practices are still emerging, there are two elements of most frameworks that serve as the cornerstone to these commitments – decarbonization and investing in climate solutions.
But Net Zero is also evolving into a belief among investors that a portfolio with a smaller carbon footprint should provide for better investment outcomes. To generate wider adoption of Net Zero strategies, financial advisors should help asset owners understand that virtue and long-term investment results can, and should, align.
Net Zero is not just a destination, it’s a journey. The path to get there is critical and investors can use a combination of investment, divestment, shareholder engagement and carbon offset strategies to pursue Net Zero goals.
Investing in climate solutions should generate superior returns as the world transitions to renewables. Selectively divesting from companies or industries that are not aligned with a low-carbon economy will serve as a tool that investors will increasingly utilize to align with values and manage transition risks. Engaging companies to reduce their carbon footprint should result in a lower risk exposure to carbon pricing and a higher valuation as those risks become priced into the market. And funding carbon removal projects through verified offsets provides a way to reduce the portfolio carbon footprint and impact real-world decarbonization.
It’s 2022. It’s time to do good, and do well.
1 Catherine Clifford, “These Are the World’s Largest Banks that Are Increasing and Decreasing Their Fossil Fuel Financing,” CNBC.com, April 22, 2021.
2 Seb Henbest et al., New Energy Outlook 2021, BloombergNEF, July 2021