Taking the temperature on climate change – an investment perspective

December 2020 marked the fifth anniversary of the Paris Climate Agreement. For all the promises made during the talks, countries have already fallen woefully behind on their commitments to limit global warming. But could the narrative be shifting? We take a close look.

As asset managers, we have a responsibility to consider how climate change will impact the value of our clients’ investments. We take that responsibility seriously. Over the coming weeks, we will share with you a number of articles looking at this most vital topic. These include the shift in oil majors’ approach to climate change, ‘greenwashing’ and the investment opportunities available as we tackle climate change. To start, we set the scene.

The Paris Agreement – five years on

December 2020 marked the fifth anniversary of the Paris Climate Agreement. Its goal is to “hold the increase in the global average temperature to well below 2°C above pre-industrial levels and pursue efforts to limit the temperature increase to 1.5°C”. But for all the promises made during the talks, countries are woefully behind on their commitments to limit global warming. The world needs to halve emissions by 2030 for a chance to limit warming to 1.5°C.

So, what is holding back progress? What are the remedies? And what does this mean for investors?

The problem

The Paris Climate Agreement has singularly failed to live up to its promise. According to the UN’s 2020 Emissions Gap Report, without drastic action, temperatures could rise in excess of 3°C this century. Such an increase would leave large swathes of the planet uninhabitable, cause mass extinctions and spur large-scale migrations. As it stands, our own research supports the conclusion that we are currently on track for a 2.5°C warming world.

The fault lies at many doors. In particular, financial flows are falling short. The International Energy Agency estimates that the world needs to immediately allocate around US$3.5 trillion a year to finance the decarbonisation of the global energy system at the speed and scale implied by the Paris Agreement. Currently, the world is allocating only around half that. This shortfall is largely the result of the failure of global government policies and commitments to align with the stated objectives of the Paris Agreement.

Reasons for optimism

But even against this gloomy backdrop, the narrative around climate change is shifting. Following Trump’s withdrawal, new US President Biden will re-join the Paris Agreement. China’s commitment to be net zero by 2060 surprised many and could signal positive change. Europe’s intentions are especially encouraging, notably around its €1 trillion Green Deal.

Indeed, according to the UN’s Gap report, the most “significant” development of 2020 was the growing number of companies, cities, investors, universities and other players undertaking commitments to become carbon neutral by 2050. We should not underestimate the scale of this. Together, those committed to net zero represent over 50% of global GDP and 25% of emissions.

Most importantly, an energy transition is underway. Private sector innovation has started driving down renewable energy prices, such as solar power. A diverse range of companies, including some oil majors, are sitting up and taking notice.

Assessing the impact of different climate pathways

From oil & gas to construction, retail and utilities, detailed climate scenario analysis is increasingly important in measuring and assessing how different sectors approach the energy transition. It is also essential in helping identify the leaders from the laggards within these sectors.

Climate scenario analysis is therefore a vital part of our investment activity. It allows us to assess the financial impact on assets today of different climate pathways, ranging from 1.5°C to 4°C. This provides the important, forward-looking insight we need in order to robustly incorporate climate change risks and opportunities into our investment decision-making.

It is also a key input to developing resilient, market-leading climate-driven products for our clients. Such analysis helps us understand the impact of Paris-aligned climate pathways and identify companies that could benefit from the energy transition.

We will be publishing our climate scenario analysis white paper in February 2021 and will discuss the key results at our second Global climate series event.

Investment opportunities

Client demand for Paris-aligned investment solutions is growing rapidly. For example, the UN Net Zero Asset Owner Alliance consists of investors with combined assets of more than US$5 trillion (and growing). Each investor has committed to net-zero portfolios by 2050 and verifiable intermediate targets, albeit some stipulate caveats related to the evolution of global policy.

As with energy transition, commitments on net-zero emissions will likely produce winners and losers, as some companies meet their targets while others lag. To separate the two, such pledges require scrutiny on what a company means by a 2050 net-zero commitment or setting other ESG-related targets.

For example, is a company's commitment already reflected in shorter-term capital expenditure plans? Is it limited to its own emissions or does it include those of its suppliers? We believe there are multiple pathways that criss-cross the road to sustainability, and investors need to be aware of the implications. We take an in-depth look at this issue here: Net zero – idle promises?

Our role as asset managers

At ASI, we strongly support the objectives of the Paris Agreement. We are committed to playing a constructive role in the decarbonisation of the global economy and serving the long-term interests of our clients. As investors, we have a critical role to play in making the energy transition happen and focus on three areas.

First, to fully integrate climate change risks and opportunities in all our investment decisions. Second, to continually develop our capabilities and products to enable our clients to achieve their net-zero goals. Third, to work with investee companies, industry initiatives and clients to have a real-world impact on the energy transition. As part of this, we actively engage with companies from across the corporate world – challenging them and offering advice as they journey towards net zero.

Final thoughts …

Lastly, a call to action. In November 2021, the UK will host the 26th United Nations Climate Change conference. For many – ourselves included – this must be the year of climate action and implementation, not just pledges and promises. We believe the foundations for bold initiatives are in place. The cost of further delay will be great.