Vues d’Iggo

Everything’s going green

The world is probably not on track yet to preventing global temperatures rising by more than 1.5oC above pre-industrial levels. Despite all the pledges made at COP26 we are likely going to be faced with more frequent extreme weather events and their consequences for businesses and communities. So, pressure will remain on policy makers to do more. For investors, the good news is that we are mobilising finance to help the transition and companies are developing more sustainable technologies. We are definitely moving towards a greener economy and that brings with it tremendous investment opportunities. 

Blah, blah or hurrah, hurrah?  

Judging the success or otherwise of COP26 depends on the answer to one simple question: will it contribute to humanity successfully reducing net carbon emissions to zero and stopping the global atmospheric temperature rising by more than 1.5oC by 2050? Clearly we can’t answer that today so we have to rely on judgement and scientific analysis to decide whether we think that a) pledges made by world leaders in Glasgow are sufficient and will be implemented and b) whether what has been pledged and what will be implemented will result in that 2050 target.

Small degrees

On the optimistic side some research suggests that the global temperatures will peak at 1.9o C this century. A report by Climate Resource cites University of Melbourne research based on pledges made by countries immediately ahead of COP26. Assuming pledges are implemented (including those updated Nationally Determined Contributions from India and China) then there is a 50% chance of us coming in below 2o C. This compares with the estimate of 2.7o C estimated by the UN Environment Programme based on pledges made up to a few weeks ago. Potentially some good news then. 

Eyes on the big four

Optimists would also take heart from the agreements reached on deforestation, plans to reduce methane emissions and commitments to phase out coal. Towards the end of COP26 it was announced that the US and China would work together to reduce greenhouse gas emissions. They need to. Those two countries are the biggest emitters, followed by India and Russia. Indeed, the gloss may be taken off any optimism by the realisation that none of the big four have committed to net zero by 2050 nor have signed the agreement to phase out coal. We can only hope that intermediate targets and co-operation will result in significant declines in emissions in the short term and over the whole period to the second half of the century. As yet though, the intermediate targets are not convincing and more formal commitments to reducing emissions this decade have yet to be agreed on.

Political constraints can’t be ignored

On the whole, I would say there has been modest progress but not enough to be confident about meeting the Paris targets. It’s easy to see why activists are sceptical about official pledges and there is a sense that leaders of the biggest countries lack ambition and are hindered by domestic political considerations, powerful vested interests, and geo-security concerns. Can we really be sure that the current political leadership in Brazil will stop deforestation of the Amazon given the importance of cattle rearing and soya production to the Brazilian economy? Can we be sure that the US will reverse on its commitments should there be another significant political swing at the 2024 election? If we are to focus on one thing, there has not been enough concrete action to reduce coal usage in the biggest consumers of that fuel source.

Good things

I attended the World Climate Summit (Investment COP) in Glasgow with some of my colleagues. One thing we can be sure of is that the private sector is doing a lot. Under pressure from their investors and their customers, companies across a range of sectors are developing new technologies and shifting their operating models to be on a pathway to net zero. There were discussions about the falling costs of offshore wind. I saw a company present technology that used recycled textiles and wood pulp to manufacture new textiles for the clothing industry (apparently only 1% of textiles are recycled currently – most end up in landfill or on stalls at Camden Market!). Technology is advancing everywhere and that means lower carbon production is becoming cheaper.

Opportunities

The private sector can’t do it all and there is far to go. There were consistent calls for clearer policies and regulations, for governments to use taxes and subsidies more effectively and for joined up plans and financing to deliver the infrastructure necessary to rapidly shift to a low carbon economy. The mobilisation of green finance will be important in all of this and there are increasingly larger amounts of capital controlled by asset owners, asset managers and banks that are looking to be invested in a net zero way. As I’ve written many times, this means huge investment opportunities in climate leaders that are developing the technological solutions to climate change and those companies that are leading the transition to a lower carbon business model. Some of that means exposure to the regime changing technologies – electric vehicles, batteries, renewable energy, hydrogen and so on. But it also means using ESG techniques to identify companies that are making changes to what they do today to reduce their carbon footprint. A footwear manufacturer said it changed the size of its shoe boxes to optimise the space that shipments would take in containers. Using less space means losing less CO2. Things like that will be (or should be) picked up in an ESG assessment, allowing companies to attract capital from investors focussed on sustainability.

What price carbon?

There have been widespread calls from the private sector for world leaders to agree on a system of carbon pricing. I heard many at the WCS and I watched online a COP associated session on innovation focussing on hydrogen where all the speakers called for a carbon price. At the time of writing there was no agreement. It is crucial there is though. Carbon pricing – in the form of taxes on carbon emissions or delivered through a cap-and-trade emissions trading system –internalises the external costs from emitting CO2. That means a fossil fuel using power generator would need to incorporate the cost of carbon to its cost base. It would suffer lower profit margins or pass on the cost to its customers – either way making the business less attractive. Higher costs for fossil fuels through the incorporation of carbon pricing would shift the relative cost comparison in favour of more renewable alternatives. This is true not just in energy but in range of sectors. However, overtime it would be most impactful in the hardest to abate areas like steel production and long-distance transportation. As fossil-fuel based processes rise in price, technology is driving down the cost of alternatives and this will contribute massively to decarbonisation in the real economy.

Costly transition

Another thing that was clear from the discussions is that the transition is costly in terms of the amount of investment needed. It could also be costly in that it leads to higher prices for some goods and services, especially if policy actions are taken to shift relative pricing before competitive markets have evolved sufficiently on the renewable or low carbon side. I received a piece of research this week that made the link between capital being channelled away from high emitters, forcing up the cost of capital and contributing to lower replacement capital spending. That means capacity gets constrained in those sectors and the current problems with energy might be a clear example of that. Politics has not even started to address the cost on low income households and countries – electric cars, domestic heating, basic transport and housing needs in emerging countries. There is a huge social cost to be addressed and it needs to be unless we are willing to countenance the much bigger economic and human costs of rising above 2oC.

Inflation

Markets are concerned about inflation and rightly so in the wake of the 6.2% year over year gain in US consumer prices for October. In the last almost 40 years, US inflation has only been above 5% on three occasions, including now. After the previous two it fell back sharply, and I’m not convinced that our economies have reverted to the institutional structure that sustained higher rates of inflation before the early 1980s. Yet supply problems, base effects and strong demand could be compounded by price effects related to the structural shifts towards low carbon. Needless to say, markets will keep pushing this narrative until central banks start raising interest rates and that looks increasingly like being the key focus in 2022.

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