The investment case for transitioning to a carbon-neutral economy is strong. Mark Dunne looks at how investors can help governments achieve their net-zero targets.
You cannot see, smell, taste or touch it, but carbon dioxide (CO₂) is all around us. Rising temperatures, bushfires, floods, droughts and an increasing number of asthma suffers are proof that the gas not only exists but that there is an abundance of it.
Carbon is released during some industrial processes, such as making cement, and from burning fossil fuels. It then lingers in the air for years, stopping the sun’s rays from escaping back into space, a process known as the greenhouse effect. It is accelerated among others by deforestation as trees remove carbon from the atmosphere.
Human activity such as burning oil and cutting down trees has dramatically accelerated this effect, experts now warn that without a dramatic reduction of CO₂ emissions, large parts of the world will become uninhabitable over the coming decades thanks to higher average temperatures and rising sea levels.
Wearing a surgical mask to protect yourself from Covid is bad enough but imagine having to cover your whole body every time you step outside to protect against the sun’s harmful rays. It is a possibility if temperatures rise too steeply. This, understandably, is scaring people around the world. Campaigns to push for change have been launched in response, which have resulted in many companies promoting their products as climate friendly.
More importantly, these campaigners have succeeded in getting governments to take responsibility for dealing with the growing threat to our future. The leaders of some of the world’s richest countries have not only pledged to make their economy net-zero carbon by 2050 they have enshrined the target into law. But transitioning to a cleaner world is an easy goal to set, but harder to achieve in less than 30 years.
It means producing less carbon and removing more of it from the atmosphere. This is a big task. If we stop burning oil today then we may not be able to generate all the electricity we need, while the world’s much-needed infrastructure upgrade cannot happen without tonnes of cement. Perfecting the technologies and infrastructure to change this could take years and huge sums of capital.
Indeed, the International Energy Agency estimates that $10.5trn (£7.6trn) needs to be invested globally in low-carbon energy and efficiency technologies by 2030 to keep temperature rises below 2 degrees Celsius, the level the United Nations believes will see us avoid a catastrophic climate change scenario. Governments cannot do this alone. Consumers and corporates have to play their part, as do investors. Private capital is “critical” if the world’s leaders are serious about creating a net zero carbon economy, says Lucian Peppelenbos, a climate strategist at Robeco. “The Paris Agreement cannot be achieved without private capital.”
We can work it out
A low carbon strategy is not just about making a return or building good relations with governments. It is in long-term investors interests to consider climate risks in their decision making as extreme weather events caused by climate damage could erode the value of their investments. But here is the issue. Investors and fund managers who have a policy of banning companies with large carbon footprints from their portfolios are not helping to solve the problem.
The way to remove this threat to our future is through working with companies in the traditional energy sector as well as miners, property managers and transport businesses to lower the levels of harmful gases that they emit. “Encouraging companies to transition through engagement and through investment strategy is critical to achieving the net zero targets,” Peppelenbos says.
Working with companies to change is the goal here, but if the message is not getting through and a portfolio company’s board are not being responsive to shareholder requests to clean up its operations, then they will have to implement the ultimate threat.
Robeco is one such asset manager that agrees with divestment if there is no positive engagement outlook. This means cutting off a company’s access to funding. If enough investors adopt low carbon strategies, and more and more institutional investors are judging by the flurry of announcements on the topic in recent years, then corporates may have to rethink their attitudes towards climate change. Mark Lewis, BNP Paribas Asset Management’s chief sustainability strategist, says: “If you cannot finance an activity, the activity will not be around for long. “All businesses need capital and, unless it is nationalised, that capital comes from the private sector,” he adds.
Building new markets
Reducing the level of pollution in a portfolio is only half the battle in the transition to a low carbon world. “We need to rebuild the economy, which means capital flows need to be re-allocated from carbon intensive to green activities,” Peppelenbos says. This means new technologies need to be developed, such as cleaner energy sources contributing more power to the national grid like wind and solar parks as well as developing more electrically powered cars, trucks and buses. Then there is the important issue of reversing the damage caused by previous generations by removing carbon from the atmosphere and storing it. All this needs investment. “Entire new industries will have to be built around carbon removal technologies,” Peppelenbos says. “All this needs to be built with private capital.”
This is about creating the technologies and infrastructure that are needed to reduce our reliance on oil and gas. “We have to clean up the power industry,” Lewis says. “This means more renewables and energy storage as well as some green hydrogen. Green hydrogen is a form of renewable energy that is not made from greenhouse gas-producing methane like its more mainstream version, which is known as grey hydrogen. “Green hydrogen is key. It is where we are going to see huge development over the next decade,” Lewis says.
Political will behind green hydrogen is strong, especially in the European Union (EU). “It is a major industrial policy target for the EU,” Lewis says. “They are setting up processes and a framework to incentivise the roll out of green hydrogen.”
Not just saving the world
The good news is that saving the world does not necessarily mean having to make a lower financial return anymore. The cost of building solar and wind parks is falling as renewables take over a larger share of the national grid. “With every day that passes, the economics of renewable energy compared to conventional fossil fuel energy improves,” Lewis says.
“We have reached the tipping point where renewable energy can stand on its own feet without the need for subsidies. That is a game changer. It means that private sector investment will start flowing, not only because it is the right thing to do but because it makes sense from an economic perspective.” For Lewis this is a game changer for achieving government carbon targets. “The augment has been won and the transition is just a question of time,” Lewis says.
“You cannot dispute that with way the economics are going, that the whole world is gravitating towards renewable energy,” Lewis says. Indeed, global demand for energy generated by the weather grew by more than 100% in 2020, a year when overall demand for power fell. “The rest of the world went backwards but solar and wind went forwards,” Lewis adds.
Yet falling costs, a growing share of the national grid and increasing regulation on oil and gas does not mean that our economies are no longer reliant on fossil fuels. Lewis still expects fossil fuel demand to rise in the next few years before peaking for good in around 2025, which could come earlier given the impact of Covid.
Green dividend
The Covid pandemic has indeed provided a boost to those wishing to eradicate our reliance on carbon-generating processes. With fewer people travelling the full beauty of the Himalayas can now be seen from the ground, while you can now see your face clearly staring back at you when looking into Venice’s canals. This “green shine” appears to have increased peoples’ drive to act on these issues and make a change. Other positive signs in the fight against climate change in 2020 were commitments made by China, Japan and Korea as well as Joe Biden re-joining the Paris Agreement.
“If all of that is delivered then 63% of global emissions are committed to net zero. That would translate into 2.1 degree warming,” Peppelenbos says. “But this is based on an assumption that all of it will be delivered. And that is a huge assumption to make,” Peppelenbos says. These targets provide some reassurance and identifying the industries that need investors support is a good starting point.
But can anyone really know if we are on the right track? “Nobody knows how this is going to work exactly,” Peppelenbos says. “It is the same as when the Americans wanted to put a man on the moon. They did not know how to do it, but they did it. “This is the same. We want net zero by 2050 but nobody has a crystal ball. We need to set concrete targets and make ourselves accountable along the way,” Peppelenbos says.
He believes that the next 30 years will be interesting as the world tries to avoid an environmental catastrophe. “We know little about climate change going forward because it is unprecedented, but one thing we know for sure is that change is not linear. It is disruptive and exponential. “As momentum builds, innovation can spur and these goals are attainable as long as we act upon them,” Peppelenbos says.
BNP Paribas AM’s Lewis is confident that change is achievable within the time horizons set. “In the same way we have seen coal pushed off the grid, we will see more carbon intensive industrial processes pushed out of the mix,” Lewis says. He adds that the events of last year will help to harden peoples drive to facilitate change. “2020 will be viewed as a trailer for the feature film about the energy transition, which will be showing in cinemas worldwide over the next decade,” Lewis says.
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