Building back better

The call for action on the climate is timely, as the first wave of COVID lockdowns brought an unprecedented slump in global carbon dioxide (CO₂) emissions. The cleaner air and a resurgence of wildlife revealed a different world, as workplaces closed, travel was reduced, and people stayed at home.

“The immediate impact of COVID-19 was a seven to eight per cent reduction in CO₂ emissions versus 2019,” says Richard Howard, research director at the energy analytics group, Aurora Energy Research. “The challenge now is how we reboot the economy and move forward. Remember that we need to reduce emissions by around that amount each year from now on for decades if we are to stay on a trajectory to limit global warming to 1.5 degrees [the goal of the 2015 Paris Climate Agreement]. It is a very, very difficult thing to do.”

Dieter Helm, professor of energy and economics at the University of Oxford, describes it as the largest industrial undertaking attempted in peacetime; a change that will impact the way people live and every sector of the economy. Limiting emissions to cap warming above pre-industrial levels and ensuring human activity no longer adds to atmospheric carbon stock means weaning society off fossil fuels, as well as certain chemicals and plastics. It also means maintaining “a laser focus”² on carbon consumption and becoming more thoughtful custodians of the natural world.

“[Climate] mitigation is as much about stopping the damage to key parts of the natural environment which inhibit the take-up of carbon, and enhancing that through policies to increase trees, grasslands, the take-up of carbon in the soils, and the protection and enhancement of peat bogs,” Helm says.³

Ultimately, achieving net zero may also require industrial solutions, using new technologies to suck CO₂ from the ambient air (direct air capture) or compressing it and storing it underground in rock strata (carbon capture, utilisation and storage). (Read more on carbon sequestration pathways, including nature-based paths in Carbon capture: Solution or pipedream?⁴). But despite the Paris Agreement, there is no agreed route map, and no global consensus on accounting techniques to keep the score (see Shaping the agenda for COP 26 and Metrics to help navigate to net zero).

The issues are urgent, as signals from the natural world are cause for alarm. Record atmospheric CO₂⁵ levels despite COVID shutdowns, temperatures reaching 38 degrees Celsius in the Arctic in June 2020⁶ and gigantic wildfires on the US West Coast show the climate system is evolving fast.

“2020 was the year when we were supposed to see CO₂ emissions peak,” says Rick Stathers, senior environment, social and governance (ESG) analyst and climate specialist at Aviva Investors. “But it is alarming to see the responses in the natural environment. Worryingly, we may have underestimated the feedback loops, like those associated with the methane surges from melting permafrost.”

A quick glance at progress from co-ordinated climate action is not encouraging. “It is not going well,” is Professor Helm’s succinct analysis in the first line of his new book, Net Zero: How we stop causing climate change.⁷ “If the objective set in 1990 was to reduce emissions and reduce global warming, it has been an utter failure,” he says.

Aside from the reductions associated with the global financial crisis and COVID-19 lockdowns, the trajectory for global emissions has been up. And there is already enough carbon-fuelled plant in place to propel the world over the damage-limiting target agreed in Paris in 2015.

“We have not seen radical action on climate prior to now, because climate has always been trumped by what were perceived to be more acute crises,” says Jill Rutter, senior fellow at UK think tank the Institute for Government. “When I was Director of Strategy and Sustainable Development at the Department for Environment, Food and Rural Affairs, we wrote a short note comparing climate change with terrorism after the Chief Scientific Adviser suggested climate was the greater threat. But every action by government seemed to signal the reverse. Climate change only got a look in when every other policy priority had been pursued. It was ‘back of the line.’”

Climate action is no longer ‘back of the line’ on the international stage. Extreme climate events have been focusing minds, and the calls to build back better after COVID-19 have intensified. Importantly, public attitudes also seem to be shifting decisively. “Now is not the time for scoring party political points,” the first UK-wide citizens’ assembly on climate change concluded, calling for cross-party action.⁸

Initially, only Europe was heavily invested politically in emissions reduction, but momentum is accelerating elsewhere. Canada, South Korea, Mexico, Chile, Japan, South Korea and South Africa are all part of the growing club taking steps to legislate for net zero, setting out in law the ambition to balance the output of greenhouse gases with their removal from the atmosphere.

China has joined too, albeit with a 2060 target, catapulting the number of people administered under net zero regimes to over two billion. Adair Turner, chair of the global Energy Transitions Commission, believes this is a “giant step” in the fight against climate change.⁹ As the world’s largest consumer of the dirtiest fossil fuel (coal), a country experiencing rapid growth in energy demand (see Figure 1) and responsible for more than 25 per cent of CO₂ emissions worldwide, China’s commitment marks an important strategic shift. It is expected to accelerate innovation and bring dividends for those experiencing an ‘airpocalypse’.¹⁰

Figure 1: Energy demand: Slowing in the old world, growing in the new

The US is also back in the room, with Joe Biden pledging to pour up to $2 trillion of federal funds into climate action. While it may be difficult to get meaningful legislation over the line with a divided Senate,¹¹ a growing number of states are pressing ahead with their own climate targets. In California, for instance, guidance is out from Lawrence Livermore National Laboratory on how the state (equivalent to the fifth largest economy in the world) might realise its net zero ambitions by 2045.¹² Three main pathways are in the frame – restoring natural ecosystems, bioenergy with carbon capture and storage (BECCS) and direct air capture – which it hopes will deliver the goal.

Are these commitments leading or misleading, to borrow the framing used by Greta Thunberg?¹³ If they omit the carbon produced from offshoring, are they useful at all? Observers will be looking for proof of real commitment to action at COP 26 in Glasgow next year.

“The net zero target has certainly energised people,” says Rutter, who has been observing the galvanising effect of the target in the UK. (Read an analysis of policy progress in Navigating the path to net zero: An interview with Jill Rutter¹⁴). Although she sees an enormous gulf between the ambition and the practical steps being taken on the ground, she believes the feeling within government is more positive.

Why might that be the case? Could the positioning of the target be part of it? “‘Zero’ is much more powerful than nerdier climate targets like two degrees Celsius or 350 parts per million of carbon dioxide in the atmosphere,” environmental commentator David Roberts suggests. “‘Zero’ is clear and intuitive.”¹⁵

Or is it the attractive possibility of an economic ‘win-win’ that has caught attention, where tilting towards green growth could generate jobs and stimulate demand? The UK’s plan for a green industrial revolution suggests potential for 250,000 new jobs,¹⁶ with ‘shovel-ready’ projects in offshore wind, electric vehicles, hydrogen production, battery storage and geoengineering.¹⁷

Despite the urgency, many COVID-19 recovery packages around the world have been structured to support the status quo. Professor Mazzucato believes this is a missed opportunity: COVID support gives governments an opportunity to stimulate a greener recovery. She points to Austria, which tied its bailout of Austrian Airlines to a long list of conditions: lower emissions, better fuel efficiency and the goal to shift passengers off short-distance flights.¹⁸ For the first time, the airline will also be caught by an ‘anti-dumping’ clause that will prohibit it from selling tickets below cost. This action feels radical but is aligned with the ambition set out in the Paris Agreement to make financial flows consistent with climate action goals.

Future alignment means major changes need to be made by the providers of public and private capital. “Globally, around $300 trillion of investment is going to be required over the next 30 years – that’s like rebuilding the US entirely, from the bottom up, every two years for the next three decades,” says James Belmont, climate risk lead at Baringa, a consultancy. “Every bank or asset manager we talk to is keen to fund the transition, because they see a massive opportunity.”

Nevertheless, the nature of climate risk makes assessing how the land lies particularly difficult. It is only in recent years that the tools to measure what is going on have been developed. Prior to now, answers to some fundamental questions have not been clear. Accurate, timely pictures of greenhouse gas emissions have been elusive; the way physical outcomes might impact financial ones in complex feedback loops also needs to be confronted, as does a certain amount of inertia.

“Usually what happens when scenario analyses and stress tests are run is that there is a base case, and then the question is asked: ‘If something goes wrong, how much might we lose?’ But this is different, because we know that we cannot expect to keep plodding along in some kind of equilibrium,” adds Belmont. “We are either going to have a lot of transition, or we are going to have a lot of physical change; we are probably going to have some messy combination of the two. This is not a stress test away from a central case, in a way financial services firms normally conceptualise it.

“Financial institutions need to carry out detailed sensitivity analysis to understand how their investments and lending decisions might play out, because there are many possible evolutions of the world.”

Uncertainty over what the future might look like is not conducive to private sector investment in large-scale capital projects. Net zero implies a whole infrastructure revolution, but the near-term outlook is unclear.

“Investors with exposure to power rely on price forecasts from third-party consultants to assess the value of their investments,” says Laurence Monnier, Aviva Investors’ head of quantitative research in real assets. “Consultants are faced with greater uncertainty than ever on the future composition of the power system, due to its sensitivity to the regulatory changes needed to achieve net zero.”

Perhaps unsurprisingly, investors are reluctant to invest in new capacity without some mechanism for price stabilisation and more clarity from governments. (Read more about the issues in Real assets and net zero: Now for the hard part¹⁹).

“Uncertainty means people are less willing to invest, and they will demand a better return,” says Rutter. “That’s because they are not just covering the cost of change; they are covering the cost of change and the risk that the policy environment changes again too. It is not a good way to govern. For net zero, the question is how you deliver in a way that commands public consent, so you are not forced to carry out about turns, at least cost to the economy. There are lots of benefits that will come from the transition, but there is no need to make it a more expensive process than it needs to be.”

Despite the unknowns, Belmont describes asset managers as being “on the front foot”, with growing budgets being allocated to assess opportunities and risks. So far, managers of around US$5 trillion of assets have agreed to transition investment portfolios to those on net zero pathways,²⁰ and the list of corporations committing to curbing emissions continues to grow. At the executive level within major companies, the discussions are becoming increasingly involved: are formal, long-term targets admirable or “wishy washy”, as Ivan Glasenberg, CEO of mining group Glencore, suggested if they deal with timescales so far out that it is impossible to be “precise and factual?”²¹

“Net zero is becoming part of the narrative in all kinds of areas,” says Stanley Kwong, associate director, ESG for real assets at Aviva Investors. “A few years ago, the concept was nascent; it was not really understood. More people are talking about it – in government, among policymakers and companies – that’s a good thing. Of course, we need to be mindful of what is really happening on the ground and attempts at greenwashing as well.”

Significantly, the focus on decarbonisation is becoming increasingly important operationally. “It is only recently that companies outside the energy system have realised their funding costs and ability to access the resources they need will depend upon how they decarbonise, and how they communicate that externally,” Belmont says. “They are starting to see the business case and identify the transfer price for decarbonising and mitigating climate transition risks. But there is still an important piece missing from the jigsaw: the policy that will ensure the transition can be achieved.”

Policy is the hard part, because each country contemplating a net zero pathway faces its own unique challenges. The solution can never be one size fits all.

The most commonly cited action economists and analysts believe will speed the journey is to introduce coherent carbon taxes,²² to ensure polluters pay. “A neoliberal approach has not led the price of carbon and the price of climate change to be factored into markets,” says Stathers. “That needs to be addressed.”

Faith Ward, chief responsible investment officer at Brunel Pension Partnership, shares that concern. She puts “esoteric pricing and taxations that result in peculiarities” top of the list of obstacles to a net zero future.

Without effective carbon pricing, consumers fail to recognise the environmental costs of their actions, and many of the technologies that might aid the transition do not make commercial sense. Delays in developing a defined vision for new, low carbon infrastructure – public goods that should ultimately benefit everyone – also mean that path dependencies and sequencing cannot be resolved.

“I’m pleased to see that we have reached the point where government has been more prescriptive about the kind of technologies it wants to see,” says Darryl Murphy, managing director of infrastructure at Aviva Investors. (See details of the UK’s Ten Point Plan for a Green Industrial Revolution,²³ confirming commitments to offshore wind, hydrogen, nuclear power and carbon capture.)

“That’s controversial; some might say governments should not be allowed to pick winners, but we simply don’t have much time. At this point, it does not make sense to have a multitude of technologies competing among themselves. This does not just apply to electricity generation, but also to transport and energy storage, other areas that need focused attention. We need that direction at the granular level. We are not going to get there by just letting things evolve. We need much more planning, more focused effort.”

Murphy hopes the announcement of the UK’s National Infrastructure Bank will help support early stage technologies and crowd in the significant private investment that will be required.

“The question is how we are going to align different technologies with specific sources of funding to allow them to be commercialised quickly,” says Vikash Ahuja, director of energy, utilities and resources at Baringa. “We need those important phases of trialling, testing and reducing costs, and preparation for scaling up, to enable that to happen. We have already been through these stages with renewables; the same thing needs to happen with carbon capture and storage, hydrogen and other technologies.”

With innovation moving rapidly, the solution needs to be iterative. “If you had asked people in 1990 to anticipate what the world would look like in 2020, would anyone have predicted what we have now? Absolutely not,” says Howard. “The optimal solution is a concrete plan for the next ten years or so, setting out what needs to be addressed immediately, whilst also developing technology options for the later waves of decarbonisation in the 2030s and 2040s. It is near-impossible to anticipate exactly what the world will look like in 2050 – by then, we could have an entirely different equilibrium – but we need to continue to develop the options.”

An important part of any solution will also involve levelling with the public on the choices to be made. There are important social consequences of the transition to clean energy; protection may be needed for those at the hard end of ‘old economy’ deindustrialisation, or on lower incomes, who may be disproportionately impacted if the price of carbon is hiked.

“Ultimately, how will you get consumers over the line?” Rutter asks. “Will you use regulation? Will you incentivise? What is the toolset you must work with? People have limited bandwidth for change; the best indicator of what I do tomorrow is what I did today and what I did yesterday. To get people to change, you need a catalyst. This is the bit that is missing from standard economics.”

Changing the asset mix in power networks is among the low-hanging fruit for those seeking emissions reductions, and a striking amount of new capacity has already shifted towards renewables (see Figure 2). The momentum has been helped by a sharp drop in costs: photovoltaic (PV) modules have dropped 88 per cent in ten years,²⁴ for instance, and recent breakthroughs with new coatings for PV panels should boost efficiency significantly.

Figure 2: Power to renewables: Net global power capacity additions

As renewables become more prevalent, what happens next? In a market-based system, could adding further renewable capacity undermine opportunities to build out elsewhere?

“If Boris Johnson goes ahead with his plan and procures more wind capacity, to what extent will it cannibalise opportunities to build other projects through a market-based route?” asks Howard. “It’s a real state-led versus market-led argument. At the extreme, if you build enough gigawatts of renewables, there would be very little value left in the wholesale market anymore. It would still be useful for asset dispatch, but it might become less and less useful for investment decisions because the value could drop away.” Will changes in market design be needed? It’s not wholly clear.

What about the way in which potential spin-offs from renewables could be optimised? Exploring this question explains the revival of interest in hydrogen. “Is hydrogen the new wonder fuel?”, The Wall Street Journal asked in June 2020, replicating a headline that had already had a run out in the 1990s.²⁵ Hydrogen is versatile, energy-dense and clean, but it is also significantly more expensive to produce than natural gas at the moment. (Read more on hydrogen as a potential fuel source in Hydrogen: Back to the future²⁶).

There are several pathways to produce industrial hydrogen, but if electrolysers are used to break down water into its component parts – hydrogen and oxygen – the cost of production is heavily determined by the average electricity price.

With ample renewable capacity, plentiful energy can be generated when energy demand is low: hot sunshine or gusty weather can force generators to shut down capacity. In future, this excess could be put to work to produce hydrogen, (‘green hydrogen’, if the underlying energy source is 100 per cent renewable), keeping installed capacity at work. In this scenario, hydrogen is not just a fuel that could be used in cells to power hydrogen-fuelled transport, it is also an important renewable energy store.

“What happens if renewables get cheaper and cheaper?” asks Howard. “You might think it would put downward pressure on price, but there may be other forces that work in the opposite direction, to utilise the power being produced. That is the level of complexity we get to in our modelling, to try to understand these opportunities.”

Aurora Energy Research recently carried out analysis in which it added hydrogen into its forecasts for the first time. The analysis included one net zero scenario with lots of renewables and no hydrogen electrolysers, then it added the electrolysers, to compare and contrast. They increased the baseload prices by a meaningful amount and reduced renewables curtailment significantly.

“It is possible to envisage a situation where a certain amount of installed capacity combined with specific weather conditions could send the electricity price close to zero,” explains Howard. “Imagine that is the point when all the electric vehicles switch on to charge, hydrogen electrolysers switch on and other demand kicks in too. Vertical industrial farms, where crops are grown indoors using hydroponics, are another major energy user but might become viable. We would not think of building these assets now, but if electricity becomes extremely low cost at times, perhaps we might start doing things differently. There might be a new equilibrium. In scenarios like this, the demand side becomes more and more interesting and important to understand.”

Out of this come numerous possibilities – hydrogen-fuelled transport and cheaper home heating among them. But these low-carbon solutions all take time to install. Developing a new network or converting the existing gas networks to take a hydrogen fuel blend is a significant undertaking.

“To do that in one city or sub-region could take around a decade,” says Howard. “If you wanted to carry out the changes extensively, that would need at least a 20-year roadmap. We need to define what solutions we want and where, soon, to even have a chance.”

In Germany, hydrogen development is set on ‘go’, having received an important funding boost in the country’s post-COVID recovery plan. The UK is also looking to develop low-carbon hydrogen capacity in its green ten-point plan, aiming to stretch from its first hydrogen-fuelled neighbourhood to a town in a decade.²⁷

In setting the course for net zero, the management of the built environment is a critical consideration. “COVID-19 has triggered a real estate crisis, and that has sharpened minds towards addressing future risks,” says Sam Carson, director of sustainability at Carbon Intelligence, a consultancy that advises companies on how to reduce their carbon footprint. “Many buildings are not fully occupied, and we are having more discussions about net zero strategy than ever before.”

This focus is timely, as the construction, occupation and demolition of the built environment consumes around half of all raw materials produced annually. “In the UK, the construction industry generates around 45 per cent of all CO₂ emissions on its own,” says Duncan Baker-Brown, award-winning architect and lecturer at the University of Brighton.

This creates a problem that needs a holistic solution. The built environment can certainly work better, drawing in fewer resources and creating less waste; architects and designers are well placed to deliver the change. “Architects already have the ability and tools to design carbon negative or carbon neutral buildings,” adds Baker-Brown. “These buildings can be useful ‘materials banks’ for the future as well.”

Where possible, he advocates a circular approach, where valuable raw materials can be re-used. This is also being included in the net zero city plans explored by Mazzucato and her team at University College, London.

Baker-Brown’s views reflect the sentiment captured in the illustration in Figure 3. For an asset owner, not carrying out major construction works has the greatest positive carbon impact, but ‘building less’ and ‘building clever’ with lower carbon materials can be advantageous too.

Figure 3: Carbon reduction potential

“We need to be mindful that those managing the built environment have generally not been used to having constraints on the quantum of space they can build,” says Ed Dixon, head of ESG for real assets at Aviva Investors. “A skyscraper in the City of London might be knocked down and replaced with a new one, even though it is in a usable state and could be refurbished. There is nothing in current policy or regulation to prevent that; in fact, the VAT structure privileges ‘new’. 

“But we need to recognise society cannot afford this type of growth. We cannot keep demolishing 20-year-old buildings to rebuild simply because we want something different. The solution must be making better use of the assets we already have; replacing façades, freshening lobbies, improving energy performance and so on. This is the way forward,” adds Dixon.

These considerations are receiving greater attention with the arrival of carbon accounting. There is carbon embodied in every building and the materials that have created them, in addition to the operational carbon used for ongoing heating, lighting and so on.

Over a lifetime, the first category tends to be larger in scale and is harder to get a handle on. “Much of the approach to monitoring embodied carbon was developed for manufacturing, where you have a widget and you make one million of them,” Carson says. “You work out the embodied carbon in the widget and then multiply it by one million, and you are done. But every building is different, and the combination of materials that go into it varies. Each supply chain is unique, the processes are new and the people dealing with the data are disconnected. We have not yet fully resolved this; there are a lot of challenges.”

In future, the price of carbon is expected to be significantly higher; commercial property developers are unlikely to pay for carbon-heavy materials if they will not generate significant value in return. “That is what will shift the market,” says Carson, adding he expects to see ambitious plans to re-design and re-use structures in future to reduce the carbon load.

Operational carbon will need to managed better too. Meeting carbon neutral targets is likely to result in “massive retrofits”, says Baker-Brown, who reports achieving meaningful reductions in energy usage, even in hard-to-insulate constructions like 1980s warehouses.

Regulatory changes have already led to a flurry of carbon-targeting. “Nobody wants to mess up the planet,” says Carson. “But many people did not understand how to make the changes needed, even though tried-and-tested technologies exist.” He is clear those failing to address the issues swiftly enough are likely to see the value of their assets impacted.

“There is no doubt the value of properties that cannot achieve net zero without significant upgrades will fall,” says Carson. “There will be times when a potential buyer says, ‘I cannot buy that; it does not align with my science-based target.’ Ultimately, someone will buy, but they may also say: ‘You need to reduce the price significantly, because it will be costly to get the EPC up.’ There are tools to understand the risk of asset stranding due to poor energy and carbon performance. We are using them to help property owners understand that risk.”

The tone of the net zero debate often feels heavy, weighted towards industry, the asset mix in the power sector, construction and the like. But even with the best will in the world, net zero will not be achieved without careful consideration of our place in the natural world, and how to be better custodians. There is a clear choice, Helm argues, to continue to be a selfish generation, or “get cracking”.

“Meeting net zero implies a level of awareness and collectivism that we struggle to have as a society now,” Belmont admits. “But I think we are witnessing some important changes. During the coronavirus pandemic, we have had a distinctive change of views around what our economy is for. We are also seeing other changes around ideas about what work is for. It feels like a tipping point.”

For Murphy, what has changed as a result of the pandemic is attitudes towards the socialisation of costs. “There now seems to be greater commitment to the idea the current generation has a duty to pay for future generations,” he says. “In some respects, this was a constraint that held back investment in the past. COVID has tipped that view on its head. In theory, that gives a clearer way forward: it is important everyone understands these changes may be costly, but we still have a duty to invest for the future.”

Getting this right will bring many benefits. “The quality of life should be so much higher,” says Oliver Rix, partner for energy, utilities and resources at Baringa. “As professionals, we tend to talk in terms of various scenarios, and we compare the risks and costs. Those approaches are needed, but we also need to understand and talk about what it means for people. It’s about better air quality, less noise pollution, using land more sustainably, having a well-managed countryside and improving biodiversity.

“Transport will be revolutionised too, with safer roads and far fewer parked cars freeing up valuable urban space. These are all huge advantages; we need to keep them in mind,” adds Rix.