This year will likely see a continuation of one of the defining investment trends we have identified in the past few years: the energy transition. There is no doubt about the intent of advanced-country governments to switch power generation from fossil fuels to renewables. They also share a desire to decarbonise many industrial processes and transport. But the pace and magnitude of the energy transition is still very much to be defined.
Last November’s COP26 climate conference in Glasgow made some progress towards these green goals. The ‘Glasgow Climate Pact’ set the global climate agenda for the next decade and there were new pledges made by various countries to cut emissions. Significant progress was also made on curbing methane emissions and halting and reversing the forestry loss. However, the two week meeting was seen as a critical moment to limit global temperatures rising to “well below” 2°C above pre-industrial levels as set out by the Paris Agreement. In this sense COP fell short. New pledges to cut emissions lead to a best estimate of 2.4°C warming.
There was an explicit reference to coal and fossil fuels with the Glasgow agreement calling upon nations to accelerate efforts to “phasedown unabated (i.e., without carbon capture and storage or similar technology) coal power and phase out inefficient subsidies for fossil fuels”. This was a significant moment in COP history, although it is clear that countries most reliant on coal remain reluctant to make more ambitious commitments, for instance India setting 2070 as its target to reach net zero. Moreover, as China currently accounts for more than 30% of the world total output of carbon dioxide, Chinese insistence on carrying on increasing its output this decade makes achieving the 2030 targets extremely difficult.
An uncertain trajectory
Warming of 2.4°C is a long way from the 1.5°C that the scientific community generally deems acceptably safe. A gulf therefore exists between countries long-term net zero goals and actual plans to deliver emissions cuts. To attempt to bridge this gap, the Glasgow Climate Pact requests countries publish updated plans ahead of COP27 in Egypt next year in line with what is needed to achieve 1.5°C.
There is significant uncertainty on countries’ ability to deliver and implement these pledges in full and in time, particularly in the context of the current energy crisis. How quickly will governments want to close coal mines and oilfields with citizens’ energy cost rising, and how high they will be willing to push the carbon price and the cost of fossil fuel taxes? Given the world still relies on fossil fuels for over 80% of its energy, and with global energy demand projected to increase by 50% over the next 30 years, a multitude of new technologies need to be developed rapidly if there is any chance of meeting net zero targets of 2030 that much of the developed world aspires to.
The investment theme of backing the green future and gradually closing down the carbon past will continue, but at an uneven pace. Most forecasters expect at least maintained demand for oil this decade, as the developing countries still plan to increase their use of coal, oil and gas. The world will be split between the richer countries aiming to speed towards the transition and lower-income countries wanting to use fossil fuels to protect and expand jobs and incomes.
Alongside China, the world’s largest CO2 emitter with targets of peaking carbon emissions before 2030 and achieving carbon neutrality by 2060, India will become increasingly important to global climate discussions. It has low per capita emissions today – roughly a tenth of that of the US and a quarter of that of China – but its high growth trajectory and heavy reliance on coal means that is set to rise rapidly. Significant advances in solar and wind are planned but it may well fall short of its goal of 175 GW capacity of renewables by end of this year.
The pace of change in the developed world cannot be taken for granted either. President Biden’s $1.7B ‘Build Back Better’ bill faces opposition and may require slimming down to pass through the US Senate. The climate provisions of the bill are geared toward providing incentives to develop domestic supply chains in solar and wind industries and offering tax credits to those who invest in solar rooftops and electric vehicles. However, even with some compromises it stands to be the largest ever public investment program on climate in US history.
Meanwhile, in the EU there is greater political consensus around a much greener future, though as we mentioned in this article 'Germany will help shape the EU green drive' the acceptance of gas as a transition fuel may be required to keep industry competitive and consumer prices in check.
There is significant uncertainty on countries’ ability to deliver and implement these pledges in full and in time, particularly in the context of the current energy crisis.
The continuing commitment of the EU, the US and other leading advanced countries means there will be much more work on greening economies and further stimulus to a range of new technologies and products in industry, transport, farming, heating and much else. Pressure for transition will continue to build through the regular reviews of countries’ net zero plans and from the tightening regulation that results from the increasing pace of the agenda.
There’s a groundswell of investor movement on the issue too. Increasing numbers of investors have been selling out of high polluting or other controversial areas to align themselves with a fairer, greener and more sustainable world. Confining portfolios to better corporate citizens diverts capital out of unsustainable investments by making it harder for companies not tackling the issue seriously to access capital.
These actions are part of the formula that can help guide the world to a net zero pathway – but they are not a silver bullet. If an investor disposes of an asset, another party is on the other side of the deal – and they may not be sympathetic to emissions targets, or any other ESG issues for that matter.
A more holistic and thoughtful approach is going to necessary from some quarters. Shunning fossil fuel companies altogether or driving ‘bad’ assets out of businesses might make investors feel better but it won’t necessarily lead to a better environmental outcome – the assets still exist but in someone else’s hands. Less responsible owners could be left to run ‘problem assets’ outside the line of sight of regulators within the opaque world of private investments and or in clandestine jurisdictions.
While some investors choose the divestment route and impact a company’s cost of capital, others can have a powerful impact by remaining shareholders by demanding material progress on carbon emissions and clear transition roadmaps. 2022 will be a year for these techniques to be further developed in support of the green transition with shareholder engagement ramped up. It will also be necessary for global investors to increasingly fund climate mitigation and adaptation investments in lower income countries, the key battlegrounds in terms of curbing emissions, in order for net zero goals to be realised.
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