AIQ - The climate edition

An inconvenient transition

Individuals could make a massive difference if they got by with less. But will they?

Despite deafening calls for countries and companies to step up to fight the climate crisis, research suggests individuals – especially in the developed world – could also make a massive difference if they committed to getting by with less. But will they?

The world is at a crossroads. Science suggests time is running out to reduce carbon emissions and avoid reaching a tipping point for the planet. Momentum has never been so strong, from individuals around the globe demanding change, to countries committing to carbon neutrality by 2050, and investors and companies coming together to transform the economy. Yet so much still needs to be done to achieve the transition to a low-carbon economy.

Forecasts by McKinsey put fossil fuels at more than 60 per cent of the energy mix in 2050 if investment in these sources continues,1 and little progress is being made in other areas of the economy – from industry to food production, building and transport.2

Fiona Reynolds, chief executive officer of the United Nations-backed Principles for Responsible Investment (PRI), states: “A clear gap has emerged between the ambitions we set, and the actions practically required to secure the results we so greatly need. This ambitions gap presents one of the key challenges in the transition to sustainable energy. At this point, even with full implementation of existing Nationally Determined Contributions (NDCs), we now expect temperatures to rise to 3.2 degrees Celsius, according to UNEP’s annual Emissions Gap Report.”

Tackling emissions is a massive and complex challenge, with geopolitical and strategic risks to mitigate, psychological barriers to overcome, and tough economic, social and investment decisions to make. Developed countries are responsible for most of the greenhouse gases in the atmosphere today and have the financial and technological means to effect change. Yet, while struggling to curb their own emissions, they are simultaneously asking emerging markets to forgo cheap energy sources such as coal, and thereby limit their own social and economic development. Balancing historically contextual fairness with the immediacy of the action required will be no mean feat.

The difficulty of taking a long-term view

Individuals often rely on governments and institutions to put in place the legislation that will force them to change their behaviour, because it is hard for them and companies to take a long-term view. Public companies are under pressure to deliver profits on a quarterly basis, and risk being overtaken by competitors if they increase prices to fund more sustainable products. For individuals, it is psychologically difficult to embrace change on such a scale (see Apathy, anger, action: The psychology of climate change).

Countries must balance environmental decisions with economic, social and security concerns. A rapid transformation could destabilise economies and lead to job losses and social upheaval

As Paul Lacoursiere, global head of environmental, social and governance (ESG) research at Aviva Investors, puts it: “Bluntly, we’re in this mess because governments have categorically failed to sufficiently prohibit activities that harm people or the environment.”

Unfortunately, the path to solutions is not that simple. Countries must balance environmental decisions with economic, social and security concerns. A rapid transformation could destabilise economies and lead to job losses and social upheaval.

“Things like electric car subsidies tend to mainly benefit the rich, and it costs a lot to public finances,” says Antoine Dechezleprêtre, assistant associate professor at London’s Grantham Institute of Climate Change and the Environment. “There’s also the opportunity cost for politicians: Do you want to build a new hospital or do you want to put a few more electric cars on the road?”.

Figure 1: Global primary energy demand

Global primary energy demand
Source: McKinsey Energy Insights’ Global Energy Perspective, January 2019

The lobbying barrier

Another obstacle is that governments in the developed world are subject to intense lobbying against the low-carbon transition. In the US, neither major political party has taken strong action because of the influence of fossil-fuel lobbyists in Washington.3 In Europe, the game is often one of regulatory capture: companies manoeuvre so a particular climate policy will favour their sector or their firm.

Calculated, negative corporate climate lobbying is slowing political, financial and business action on climate change

“We’ve seen it in the way permits are allocated in the aviation industry, where the algorithms we use are heavily favourable to the incumbents rather than the newcomers,” explains Professor Richard Tol from the University of Sussex. As a former member of the Intergovernmental Panel on Climate Change (IPCC), he is a joint winner of the Nobel Peace Prize for contributions to knowledge on global warming.4 “easyJet and Ryanair emit much less CO2 per passenger-kilometre than [companies like] British Airways, but these companies successfully lobbied the European Commission and their governments to have an allocation boost in their favour, hurting easyJet and Ryanair.”

Although lobbying is hardly new, Tol supports the idea of simple climate policies to limit the influence lobby groups have. “The more complicated you make climate policy, the easier it is to create rents.”

Mitigating the risks of negative lobbying is in fact a priority for investor groups like the PRI and Climate Action 100+.5 “We’re facing calculated, negative corporate climate lobbying, which is working against our efforts, slowing political, financial and business action on climate change,” says Reynolds. “The effects are currently being played out in the US, where recent Securities and Exchange Commission (SEC) proposals could see the rollback of shareholder rights, creating new roadblocks for investors to signpost critical ESG issues with corporate leaders. Counteracting big corporate lobbying is a key priority for 2020 and beyond.”

Members of Climate Action 100+ have made this a key focus when engaging with companies. Getting firms to lobby in support of meaningful climate policy is as fundamental to the group’s action as getting them to commit to emissions reduction targets. As illustrated in its latest report, there is still work to be done (see Figure 2).

Figure 2: Climate Action 100+ lobbying indicators by sector

Climate Action 100+ lobbying indicators by sector
Climate Action 100+ lobbying indicators by sector

A strategic resource with geopolitical implications

Energy is deeply political in many countries because it is such a strategic resource. Economies, social stability and national security – including the armed forces, intelligence, communications and hospitals – all depend on a reliable supply. While the largest exporters of fossil fuels are mostly resisting the low-carbon transition, more than 80 per cent of the world’s population has the opportunity to put an end to their dependence on oil and gas imports and become a key driver of change.6

The new geopolitical reality that is taking shape will be fundamentally different

In turn, as the transition accelerates, it could have a profound impact on geopolitics. “It is one of the undercurrents of change that will help to redraw the geopolitical map of the 21st century,” according to the Global Commission on the Geopolitics of Energy Transformation. “The new geopolitical reality that is taking shape will be fundamentally different from the conventional map of energy geopolitics that has been dominant for more than one hundred years.”7

Change on such a scale suggests huge disruption, but even countries that stand to benefit remain cautious, continuing to prefer coal to support economic development rather than moving straight to renewables. As the Geopolitics of Renewables report states: “Renewables will also be a powerful vehicle of democratisation because they make it possible to decentralise the energy supply, empowering citizens, local communities, and cities.” Not all governments will look favourably on this possibility.

To support the transition to clean energy, many experts believe the best solution would be a global carbon tax imposed on all countries (see ‘Sticking’ it to carbon: The pros and cons of taxing emissions). Yet even this could pose a problem, as Tol explains. “Even within the EU, we have tradeable permits rather than a carbon tax because we don’t want to give up the right of taxation to the EU. It is a sovereignty issue.” Beyond that lies a simple fact: nobody wants to pay the price of emissions.

Figure 3: Comparison of per-passenger emissions on different routes with the annual carbon footprint of individuals in developing nations

Comparison of per-passenger emissions on different routes with the annual carbon footprint of individuals in developing nations
Source: Atmosfair, The Guardian, July 2019

Figure 4: Climate change considerations by European asset owners

Climate change considerations by European asset owners
Source: Mercer LLC, 2019 European Asset Allocation Survey

People don’t want to pay

For democratic governments hoping to win the next election and for autocratic states aiming to maintain social stability, imposing a carbon tax is difficult politically, because ordinary citizens ultimately have to pay.8 So far, the signs point to them not being willing to do this.

For the first time in decades, people are being asked to buy less – or to pay more for what they buy

Dieter Helm, professor of economic policy at the University of Oxford and a fellow in economics at New College, Oxford, explains the dynamics. “Many [developing] countries rely on exports for their development and we merrily buy the stuff,” he says. “The US plus Europe is basically half the world economy. And we prefer to buy their stuff because it’s cheaper to produce in carbon-intensive ways than to produce stuff from, say, British Steel, which must meet much higher standards on emissions.”

There are complex psychological reasons (which we explore in Apathy, anger, action: The psychology of climate change), but one of the key difficulties is that entire societies are built on consumerist principles. For the first time in decades, people are being asked to buy less – or to pay more for what they buy.

“That’s why this is substantive and why there is a natural political reluctance,” says Helm. “The average income in the UK is £28,000. Most people on £28,000 can’t make ends meet and resort to borrowing. And if you say to them, ‘Oh by the way you’re going to have to pay the cost of your carbon consumption on top’, you can see why most of the world’s civil unrest at the moment, outside Hong Kong, is caused by rising fuel prices. People don’t want to pay. That’s really why we’re going to end up with three degrees, because the reality of what would have to be done comes home to a very personal point: it’s you and me and what we consume.”

Figure 5: Reported low-carbon investment as a proportion of total company CAPEX (2010-Q3 2018)

Reported low-carbon investment as a proportion of total company CAPEX (2010-Q3 2018)
Source: CDP (2018), BNEF, company reports, Aviva, October 2018

Investors aren’t willing to pay either

A growing number of institutional investors and asset managers are joining the ranks of sustainable investing groups such as the PRI, Climate Action 100+ and many more initiatives, reporting their carbon footprint under the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) framework9 and engaging with investee companies to encourage them to commit to curbing their emissions. While this is positive, it is not enough.

In its 2019 European Asset Allocation Survey, Mercer found 55 per cent of pension plan respondents consider environmental, social and corporate governance (ESG) risks in their schemes – and 56 per cent of those were driven to do so by regulation. Voting at annual general meetings and engaging with investee companies came even lower, with only 28 per cent taking these activities into consideration when selecting an asset manager. On climate risk specifically, only 14 per cent declared they had considered it in 2019, and just 28 per cent would do so in 2020.10

Figure 6: Hard to decarbonise sectors

Hard to decarbonise sectors
Note: Global fossil-fuel and industry emissions by sector based on 2014 data15 (total 33.9 GtCO2). Industrial sectors that are hard to decarbonise are marked in dark blue and sectors that are easier to decarbonise in light blue. Source: S. J. Davis, et al., ‘Net-zero emissions energy systems’, Science 360.6396 (2018), Exponentialroadmap.org, September 2019

The picture is bleaker still in the US, where ShareAction found in November 2019 that US asset managers often do not use their votes to push companies to tackle carbon emissions. This is all the more concerning when you consider the 20 largest US asset managers account for around 35 per cent of global assets.11

Illustrating the short-term view of most investors in relation to the energy transition, it’s hard for those investors to really take a view into the future

“There’s a paradox,” says Darryl Murphy, managing director of infrastructure at Aviva Investors. “We talk about infrastructure as long-term investments, but maybe illustrating the short-term view of most investors in relation to the energy transition, it’s hard for those investors to really take a view into the future.”

Companies and investors are also reluctant to pay for the transition, particularly if they perceive that moving first will make them less competitive. Yet they are now having to calculate the odds of existing assets – in their companies or in their portfolios – becoming stranded. On the one hand, capital would be lost through the physical impacts of global warming if nothing changes; on the other hand, assets worth a lot of money today, such as oil, may lose all their value if people stop using them (see Stranded! When assets become liabilities).

It’s the consumer, stupid

If governments and companies are reluctant, who will eventually pay?

Some believe the only solution is millions of individuals making small changes, while others advocate a top-down approach. In reality, it will likely be a combination of both.

Heavy industry is responsible for around 22 per cent of greenhouse-gas emissions,12 and around two-thirds of energy consumption comes from buildings and transport.

Private choices really do matter and we’re not making net-zero private choices at all

“Real estate and infrastructure are at the core of the issue,” says Laurence Monnier, head of quantitative research, real assets, at Aviva Investors. “Investment in these is essential to support economic growth but also one of the main drivers for rising energy consumption. You can’t achieve the Paris targets without a radical rethink of these sectors.”

Most future growth in materials production and heavy-duty transport will happen in places such as India, southeast Asia and Africa,13 although the European Commission also recognises energy-intensive sectors like aviation and maritime can no longer be exempt from emissions rules.14

Beyond this, there is a pressing need for individual behaviours to change. “Of course, you’ve got infrastructure and all sorts of other stuff,” recognises Helm. “But our private choices really do matter and we’re not making net-zero private choices at all. Some people are trying, but even not flying for a year is very demanding.”

Another way to pose the question is to ask who should be responsible for Scope 3 emissions. These are a company’s indirect emissions, stemming from its upstream supply chains and, crucially, from the distribution and consumption of its goods and services. Should a company – or for that matter a country – be responsible for the emissions produced, or should consumers be accountable?

I’d like an economic system where the costs of pollution, the damage caused in order to make a profit, gets paid by whoever causes it, not by everybody else

Andrew Medhurst, who leads the UK National Finance Working Group at Extinction Rebellion, argues in favour of taxing production. “I’d like an economic system where the costs of pollution, the damage caused in order to make a profit, gets paid by whoever causes it, not by everybody else.”

Similarly, investor groups like Climate Action 100+ are engaging with companies to encourage them to take responsibility for their Scope 3 emissions.

Glen Peters, research director at the Center for International Climate Research (CICERO), agrees this is important. “When it comes to jurisdiction-type issues, if you are, for example, a British policymaker and you want to reduce your emissions, you can’t do very much about coal power in China. China can […] so in a sense, for production, the territorial approach is essential,” he says.

But, as the old saying goes, it takes two to tango. “You might see you’re importing a great share of emissions, so there might be policies we can implement in addition to what we do anyway to make our policies more efficient. I tend to think of consumption as ‘in addition to’ as opposed to ‘in spite of’,” adds Peters.

Lacoursiere’s stance is more unequivocal. He believes reducing emissions is a public responsibility, and “compared to producers acting within a legal environment where they happen to be domiciled, to me the consumer angle is closer to holding the governments responsible”.

This was also the stance taken by Greta Thunberg in October 2019, when she accused countries of “creative accounting” and Helm agrees. “Our consumption – which is heavily dependent upon on imports – is ultimately causing emissions in countries like China from whom we buy,” he says.16

Technical fix

Across sectors, the Global Climate Action Summit’s Exponential Climate Action Roadmap details 36 solutions capable of reducing greenhouse-gas emissions by 50 per cent between now and 2030, with a stated aim of halving them again between 2030 and 2040, and finally reaching net zero by the middle of the century.17

A number of other organisations present similar or complementary solutions, including Project Drawdown, which aims to show how to achieve net negative emissions globally,18 and the Mission Possible report by the Energy Transitions Commission,19 which focuses on demonstrating how to reach net-zero CO2 emissions from harder-to-abate sectors in heavy industry and heavy-duty transport (e.g. cement, steel, plastics, heavy road transport, shipping and aviation).

Finding and implementing solutions for energy is the most crucial step

To achieve the decarbonisation of economies, however, all these initiatives agree finding and implementing solutions for energy is the most crucial step. Whether used for buildings, transport, infrastructure or industry, it is responsible for around two thirds of global greenhouse-gas emissions.20 As such, it is the focus of intense debate.

The Exponential Roadmap report states: “Falling costs of renewable energies, battery storage and efficiency solutions, often driven by digitalisation, will increasingly make these technologies the first choice. The modularity of many of these new solutions means they can be deployed relatively easily and scale quickly compared with large power plants – giving them a substantial advantage for infrastructure investment and providing early returns. As prices tumble, by 2030 renewables hold the very real promise of abundant, almost-free energy.”

Solar and wind represent around two thirds of the emissions-reduction scenario used in the report. However, the rest stems from reduced methane emissions and other low-carbon energy. These include new nuclear capacity, hydroelectricity, wave power, geothermal and biomass.

Ed Dixon, head of ESG, real assets, at Aviva Investors, says the latter also has potential. “Investing in energy-from-waste could be a massive growth area. Although it suffers from an image problem, it’s a very financially efficient way of generating income while tackling two environmental issues: landfill and clean energy.”

Figure 7: Global CO2 emissions from fossil fuels and cement, selected countries, 2016

Global CO2 emissions from fossil fuels and cement, selected countries, 2016
Source: Global Carbon Project, World Bank, The Economist, October 2019

The Exponential Roadmap report does not mention natural gas, which has been widely used so far as a “transition fuel”, being the fossil fuel with the lowest emissions. This may be because natural gas is now being questioned, largely due to the associated methane leaks (see Stranded! When assets become liabilities).

Intriguingly, the expected share of new nuclear capacity is minimal, estimated at most to contribute 0.22 gigatonnes (Gt) of CO2-equivalent savings a year out of a total 18.5Gt forecast in 2020 for overall energy production. This highlights a persistent rift between proponents and opponents of nuclear power as a potential solution to reduce greenhouse-gas emissions (see Nuclear: From pariah to saviour?).

Innovation incentives

Renewables present other challenges, although their advocates claim these could be resolved through further research and development.21

First, some of the raw materials needed to produce solar panels and wind turbines are mined in a high-emission, highly polluting way. Second, solar and wind energy cannot be produced around the clock, and batteries capable of storing the necessary volumes of electricity for days or weeks at a time do not yet exist.

“Another issue with batteries is that the current revenue structure doesn’t provide incentives to innovate and build at scale,” says Monnier.

Finally, the transmission capacity to distribute electricity over long distances is also lacking, making it impossible to harness the regions with the best wind or solar resources. There are also social consequences of building large wind or solar farms close to possibly disgruntled communities.

The transmission capacity to distribute electricity over long distances is also lacking, making it impossible to harness the regions with the best wind or solar resources

Dechezleprêtre says incentives remain too low. “As in all areas, clean innovation is about economic incentives,” he says. “There’s a very strong correlation between the level of innovation and energy prices, and we’ve not seen carbon prices increasing enough to make up for the recent decline in renewable energy prices.”

He believes clean-energy innovation has decreased due to low energy prices, but also because governments have not been firm on policy, which has created uncertainty around the future market for renewables and other clean technologies.

“R&D support is necessary but not sufficient because, at the end of the day, it’s companies, not the state, that will develop and make clean products, and they won’t invest in R&D unless they know there is a market for their products,” he says.

Francois de Bruin, sustainable income and growth portfolio manager at Aviva Investors, also thinks incentives could enable funding to move towards clean innovation.

“If you tell insurers, ‘Your capital charge is different based on where you allocate your capital from an ESG or climate perspective,’ watch the capital flow and watch how quickly people organise themselves based on those incentives,” he says.

As an example, carbon capture and storage is an area crying out for R&D. “Every single scenario you see that suggests you can get even close to the Paris Agreement implies masses of carbon capture and storage, but there is no plan for how we get there,” says Steve Waygood, chief responsible investment officer at Aviva Investors.

Emerging markets

Emerging markets face particular challenges in the low-carbon transition. First, a number are highly dependent on fossil-fuel export revenues and could suffer significant economic damage from a drop in demand. Second, an increase in greenhouse gases is seen as a consequence of their efforts to develop their economies: building infrastructure and urbanising are high-emission activities. Third, even though they already need to budget for significant investments in adapting to the growing risks of climate change, they also face pressure – frequently from outside – to invest in low-carbon infrastructure.

Figure 8: The materiality of Scope 3 emissions to a company’s overall carbon footprint

The materiality of Scope 3 emissions to a company’s overall carbon footprint
Note: Fossil fuel producers are often seen as the main culprits, but 90 per cent of their emissions are caused by others, namely those who drive, fly and consume products imported from afar. Source: “Capital Goods report” CDP, Aviva, 2018

“Particularly (though not exclusively) in emerging markets, political instability, lack of necessary infrastructure, difficulty in attracting foreign investment and economies dependent on high-fossil sectors – such as coal mining – present significant challenges in the transition to sustainable energy,” says the PRI’s Reynolds. “Furthermore, they face the challenge of enabling a just transition – to ensure the interests of workers and communities are fully accounted for in their plans to shift to a net-zero economy.”

According to the International Monetary Fund and World Bank, the countries most affected will be those where fossil-fuel revenues typically account for more than 20 per cent of GDP and economic resilience is lacking.

To transition or not to transition?

Given the need to balance economic, social and environmental interests, how should emerging markets transition to a low-carbon world? In that respect, while a global carbon tax may prove the best answer to force the transition (see ‘Sticking’ it to carbon: The pros and cons of taxing emissions), three schools of thought conflict as to whether and how it should be applied to emerging markets.

The first contends the crisis is so grave that all states need to contribute to the transition now. This is embodied by the European Union’s proposed carbon border-adjustment tax, which aims to prevent stringent emissions rules from putting EU companies at a disadvantage with overseas competitors.22

Helm sees benefits to this solution. “The question is, do you want to be precisely wrong, and indeed encourage climate change by encouraging a switch from domestic and lower-carbon production of these things in Europe to high-carbon, high-polluting sources by shifting to places like China? Or do you want to be roughly right and also incentivise those countries to impose their own carbon taxes?”

A carbon adjustment is economically efficient – and the only way countries can address their carbon footprint properly

Although a border-adjustment tax may not affect developing markets’ domestic economies, it does bar them from developing through high-emissions exports, which has been a key pathway to development for many economies historically. Helm argues that because countries with their own carbon taxes would be exempt from the border-adjustment levy, it would encourage them to follow the EU’s example. This could be the way to achieve a global transition where the UN’s Conference of Parties (popularly known as COP) has so far failed.

“Top-down clearly hasn’t worked; most people seem to accept that it won’t meet the two-degree target, but we need something else. A carbon adjustment is economically efficient – and the only way countries can address their carbon footprint properly, because it doesn’t matter whether you buy the steel from British Steel or Chinese Steel,” he says.

The second school recognises this, but acknowledges rich countries are responsible for the majority of greenhouse gases in the atmosphere today and proposes to subsidise developing economies’ low-carbon transition. The PRI is aligned to this idea.

“Successfully achieving the transition to a low-carbon economy will rely on the efforts of all markets – emerging and developed alike,” says Reynolds. “However, as G20 countries account for 78 per cent of all emissions, they need to bear the brunt of the responsibility. They need to legislate for net zero by 2050, reducing their emissions more quickly. Currently only two of the G20 – France and the UK – even have net-zero targets, so there’s a long way to go. Developing countries then need to closely follow these actions and can already start to leapfrog to clean energy, given the current cost curves.”

Peters agrees rich countries should lead by example, by tackling the sectors where emissions are hardest to abate and by investing in solutions to the current problems of storage and distribution for renewables.

Developed countries can help cover additional costs or help support putting in the right infrastructure

“Developed countries can help cover additional costs or help support them putting in the right infrastructure as opposed to putting in coal,” he says. “There will certainly need to be some financial and technical help.”

Peters can also understand the thinking behind the third school, which believes emerging markets, and particularly the poorest countries, should be allowed to emit as much CO2 as they need to develop their economies and lift their populations out of poverty.23

He thinks the energy transition in emerging markets should be context driven. “Say you’re using a generator and you get a solar panel, then you can have a light on, or if you’re lucky you can maybe put your TV on, or if you’re lucky you can have a fridge, whereas if they build the transmission lines over you and you can connect to the grid, you can have your TV and your fridge,” he explains. “Then there’s the question of how you supply the grid. Is it with solar, wind, coal or whatever? So a lot of the grid power in, for example, India will still be from coal-powered plants, it’s a very coal-intensive grid, so that will be worse than solar, but when people plug into the electricity, they prefer 24/7 and as much electricity as they can afford.”

Michael Shellenberger, an environmental and nuclear activist, is more uncompromising in his views. As a lifelong conservationist, he is concerned about habitat destruction, but believes poor countries must be allowed to develop.

“I find myself frustrated with the narcissism of people in the rich world,” he says. “Most people are still not consuming enough energy, and we’re kicking away the ladder and lifting the drawbridge. My view is basically: If you’re burning wood and dung as your primary source of energy, you can use whatever you want, and you should not be under any climate agreement.”

Figure 9: Average unsubsidised levelised cost of energy (mean LCOE $/MWh)

Average unsubsidised levelised cost of energy (mean LCOE $/MWh)
Source: ‘Costing the earth: Renewable costs plummet’, Lazard Levelized Cost of Energy Report, November 2018

The (carbon) price of development

According to Climatescope’s 2018 Emerging Markets Outlook: “Faced with significant pressure to expand energy access (India) and keep power affordably priced (China), policymakers will be reluctant to de-commission these relatively new plants anytime soon. And no less than 81 per cent of all emerging market coal-fired capacity is located in these two nations.”24

“Those countries are developing, they need more energy consumption to lift out of poverty and so on, and therefore the energy infrastructure they build is often adding to new energy consumption,” says Peters. “For example, if you build a wind farm or solar panels, they are providing additional energy as opposed to displacing old energy.

You also have very young coal fleets in China or India, so it’s very hard for them to get quick declines.”

In the same way, urbanisation and infrastructure construction emit huge amounts of greenhouse gases. “What we’re talking about is growth and urbanisation. Every time you pick up a spade and stick it in the ground and start to build something, there’s a huge carbon cost,” says Dixon.

Figure 10: The relative preparedness of fossil-fuel producing countries for the energy transition

The relative preparedness of fossil-fuel producing countries for the energy transition
Note: Includes countries in which fossil fuel rents account for more than 5 per cent of GDP. Source: IMF World Economic Outlook database, World Bank, Global Commission on the Geopolitics of Energy Transformation, 2019

Developing resilience

Building resilience to global warming also requires robust technology most emerging nations don’t currently have access to. As such, they will need support from developed countries to finance investments in adaptative technology, such as flood-control systems, agricultural development and barriers against rising sea levels.

Building resilience to global warming requires robust technology most emerging nations don’t have access to

Shellenberger illustrates this with the case of the International Rivers Network (part of Friends of the Earth), which is campaigning against the Democratic Republic of the Congo damming the Inga river because of environmental concerns. “That’s how the DRC is going to get electricity and flood control and irrigation and all the rest, so why can’t they develop?” he asks.

 “And instead they say the DRC should use natural gas, solar panels and wind turbines. None of it makes any sense.”

Tol gives similar examples, citing the difference between the Maldives and Tuvalu, an island in the South Pacific. The former has the funds and technical means to raise its islands, and is therefore not at risk of disappearing because of rising sea levels. In contrast: “Climate change is an existential threat to Tuvalu because they are so much poorer. We forget today it is not so much that climate change is the issue or the situation of your low-lying island, but it is really a development issue.”

Minsky moment?

A Minksy moment is a sudden, major collapse of asset values marking the end of a growth cycle. American economist Hyman Minsky argued the seeds of any crisis or crash are typically sown in times of stability and calm. For the energy transition, this could be seen as a tipping point that results in a sudden acceleration of the move away from fossil fuels. In this scenario, companies whose business models still depended on fossil fuels would go out of business or see their market value crash as their growth prospects vanished (see Stranded! When assets become liabilities).

A climate Minsky moment could come from sufficient cost reductions in the technologies that can enable the transition or by governments invoking a regulation markets aren’t expecting

Waygood explains such a “climate Minsky moment” could come from two sources: sufficient cost reductions in the technologies that can enable the transition; and policy risk, “as governments tighten, either with a cap on carbon trade schemes quicker than the market is expecting, or by invoking a regulation or a standard markets aren’t expecting”.

However, as is the case in China – which prioritises coal for social and political reasons despite it being more expensive than renewables – social understanding and acceptance will be key.

An example of the impact regulation can have is the 18 countries studied by Peters et al.25 “There is no ‘silver bullet’, and every country has unique characteristics, but three elements emerge from the group: a high penetration of renewable energy in the electricity sector, a decline in energy use, and a high number of energy and climate policies in place,” say the researchers. “Interestingly, our analyses suggest there is a correlation between the number of policies to promote the uptake of renewable energy and the decline [in emissions] in the 18 countries.”

Clean-power policies are increasingly common in emerging markets, which are also responsible for most low-carbon power development

These are mainly developed nations, but the Climatescope Emerging Market Outlook 2018 report highlights clean-power policies are increasingly common in emerging markets, which are also responsible for most low-carbon power development. In 2017, clean-energy additions grew by 20.4 per cent in emerging markets, while falling by 0.4 per cent in developed countries.26

In wealthier countries, signs of a tipping point are also emerging. For instance, 2019 should post the largest fall in electricity production from coal on record, in a reduction greater than coal-generated power in Germany, Spain and the UK combined.27 Bloomberg reports that, even in the US, the “green economy” employs around four per cent of the workforce and generates $1.3 trillion in annual revenue.28

Private sector pressure

Investors and companies have a key role to play as well. “In the US there are companies driving change, more than the government,” comments Jaime Ramos-Martin, global equities fund manager at Aviva Investors. “Companies are leading the change because, at the end of the day, it’s a risk-management issue. In Europe, businesses have a voice. In the financial sector, companies are realising they need to answer and be more transparent about how they manage this risk.”

While the responsibility weighing on investors is significant, opportunities exist to increase allocations to companies leading the transition

Francoise Cespedes, equities portfolio manager at Aviva Investors, agrees change is happening at all levels. “This is linked to the fact companies are becoming much more vocal about how climate change may affect their business operations; and the fact people are also taking a closer look at how they consume. They want the products they are consuming to be more environmentally friendly.”

While the responsibility weighing on investors is significant, opportunities exist to increase allocations to companies leading the transition, those offering solutions to help people adapt to a warmer planet, and companies in traditional industries that have taken early action to rebalance their businesses.

Cespedes also sees opportunities in less obvious candidates, such as independent power producers, particularly renewable-only energy suppliers; efficient energy suppliers and buildings; and sustainable transport, railway equipment in particular.

Figure 11: Share of emerging markets using clean-power policies

Share of emerging markets using clean-power policies
Source: BloombergNEF, Climatescope, November 2018

Are you sitting comfortably?

In a recent issue on climate change, an editorial in The Economist summed up the challenge. “Reversing the 20-fold increase in emissions the 20th century set in train, and doing so at twice the speed. Replacing everything that burns gas or coal or oil to heat a home or drive a generator or turn a wheel. Rebuilding all the steelworks; refashioning the cement works; recycling or replacing the plastics; transforming farms on all continents. And doing it all while expanding the economy enough to meet the needs and desires of a population which may well be half again as large by 2100 as it is today.”29

The IPR shows that the pressure for policy action on climate will only increase and come from all angles

This will be a difficult and, for many, an inconvenient transition – one that needs to be carefully and appropriately managed. The decisions consumers make will have an impact on its direction and trajectory. But as Reynolds says: “At the government level, The Inevitable Policy Response (IPR)30 forecasts a number of key policies. [It] shows that the pressure for policy action on climate will only increase and come from all angles – environmental, social, economic – and the longer the policy response is delayed, the more forceful it’s likely to be.”

To be effective, policy will have to combine planning, research and incentives as well as regulation, particularly incentives aimed at changing behaviours.31 The Exponential Roadmap reiterates policy must include measures to mitigate the social and economic risks from the transition. It encourages policymakers to adopt comprehensive policy packages to push on all fronts at once, including removing fossil-fuel subsidies, but also stopping unsustainable infrastructure investments, promoting energy efficiency and clean energy, and supporting people whose livelihoods are disrupted.32 And for emerging markets to fully participate in the transition, the Mission Possible report notes access to capital will be essential.33

Despite the scale and complexity of the transition, it is one that is already underway and, by taking stronger action, governments can change the fundamentals in the energy mix – for investors, consumers and companies.

“The only way you’re going to change [fossil-fuel use] is to change the market fundamentals and to make it less valuable for that activity to be done, globally, for good, for all, for ever,” concludes Waygood.

Figure 12: Annual power capacity additions in emerging markets

Annual power capacity additions in emerging markets
Source: BloombergNEF, Climatescope, November 2018

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References

  1. ‘Global Energy Perspective 2019: reference case’, McKinsey & Company, January 2019
  2. Johan Falk et al., ‘Exponential climate action roadmap’, Exponentialroadmap.org and Global Climate Action Summit, September 2018
  3. Billy Nauman, ‘Moral money: What if Gore had won?’, Financial Times, December 2019
  4. ‘The Nobel Peace Prize for 2007’, NobelPrize.org, Nobel Media AB 2020, 12 October 2007
  5. ‘2019 Progress Report’, Climate Action 100+, September 2019
  6. Anatol Lieven, ‘How climate change will transform the global balance of power’, Financial Times, 5 November 2019
  7. ‘A new world: The geopolitics of the energy transformation’, Global Commission on the Geopolitics of Energy Transformation, 2019
  8. Simon Kuper, ‘The myth of green growth’, Financial Times, 24 October 2019
  9. Task-Force on Climate-related Financial Disclosures, backed by the Financial Stability Board
  10. ‘2019 European Asset Allocation Survey’, Mercer LLC, 2019
  11. Annalisa Esposito, ‘US investors failing to engage on climate change’, Morningstar, 4 November 2019
  12. See Stranded! When assets become liabilities
  13. ‘Mission possible: Reaching net-zero carbon emissions from harder-to-abate sectors by mid-century’, The Energy Transitions Commission, November 2018
  14. Sam Fleming and Jim Brunsden, ‘Brussels eyes easing bank rules to spur green lending’, Financial Times, 27 November 2019
  15. Percentages may not add up to 100 per cent due to independent rounding
  16. ‘Greta Thunberg accuses rich countries of “creative carbon accounting”’, The Economist, 17 October 2019
  17. Johan Falk et al., ‘Exponential climate action roadmap’, Exponentialroadmap.org and Global Climate Action Summit, September 2018
  18. Project Drawdown
  19. ‘Mission possible: Reaching net-zero carbon emissions from harder-to-abate sectors by mid-century’, The Energy Transitions Commission, November 2018
  20. ‘Mission possible: Reaching net-zero carbon emissions from harder-to-abate sectors by mid-century’, The Energy Transitions Commission, November 2018
  21. Billy Nauman and Anna Gross, ‘Credit rating agencies focus on rising green risks’, Financial Times, 27 November 2019
  22. Sam Fleming and Jim Brunsden, ‘Brussels eyes easing bank rules to spur green lending’, Financial Times, 27 November 2019
  23. Kenneth Rogoff, ‘The case for a world carbon bank’, Project Syndicate, 8 July 2019
  24. ‘Emerging Markets Outlook 2018’, BloombergNEF Climatescope, November 2018
  25. Pep Canadell et al., ‘Eighteen countries showing the way to carbon zero’, The Conversation, 25 February 2019
  26. ‘Emerging Markets Outlook 2018’, BloombergNEF Climatescope, November 2018
  27. Justin Rowlatt, ‘Coal: Is this the beginning of the end?’, BBC News, 25 November 2019
  28. Eric Roston, ‘America’s ‘Green Economy’ is now worth $1.3 trillion’, Bloomberg, 15 October 2019
  29. ‘The past, present and future of climate change’, The Economist, 21 September 2019
  30. ‘Preparing investors for the Inevitable Policy Response to climate change’, PRI
  31. Martin Wolf, ‘There is one way forward on climate change’, Financial Times, 5 November 2019
  32. Johan Falk et al., ‘Exponential climate action roadmap’, Exponentialroadmap.org and Global Climate Action Summit, September 2018
  33. ‘Mission possible: Reaching net-zero carbon emissions from harder-to-abate sectors by mid-century’, The Energy Transitions Commission, November 2018

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