Investors must push companies to play their part in tackling the climate crisis by adopting science-based targets, argues Rick Stathers.
Read this to understand:
- The scale of emissions reductions needed this decade
- Why companies have more confidence setting near-term science-based targets (SBTs) than longer-term net-zero objectives
- How SBTs focus on real-world reductions in emissions in the value chain, excluding offsetting and other carbon dioxide removal mechanisms
Time is running out to prevent the most damaging impacts of global warming. To have a 50 per cent chance of keeping heating within 1.5oC above pre-industrial temperatures, humanity must reduce greenhouse gases to net zero by 2050 at the latest. Emissions need to fall around 50 per cent each decade from 2020 to 2050, roughly seven per cent annually.
But progress has been disappointing. Figure 1 shows the gulf between current policies and action and the radical change required to achieve 1.5 degrees. Even an optimistic scenario falls short of what needs to happen.
Figure 1: Global GHG emissions reduction – ambition and reality (GtCO2e/yr)
Source: Climate Action Tracker, November 10, 20221
More action is needed fast because warming gases emitted today will stay in the atmosphere for years. As the half-lives of gases like carbon dioxide and nitrous oxides are over one hundred years (it takes more than a century for half of the molecules in a sample to break down), major cuts in emissions must happen sooner rather than later.2
This will require asset owners to hold investee companies accountable, pushing them towards a rigorous, time-bound approach to transitioning their businesses. Since climate change is the largest long-term systemic risk in portfolios today, there is a financial imperative to do so, as extreme weather events such as droughts, heatwaves and floods are already affecting corporate activity in every corner of the globe.
Setting decarbonisation pathways using SBTs
It is encouraging to see more companies setting targets (see Figure 2). More than 4,500 have committed or set near-term targets grounded in climate science. Yet few have longer-term SBTs in place. It is also striking that while 1,833 companies have announced their intention to reach net zero, few have target dates. This reflects the tendency to acknowledge the ambition without knowing how to achieve it – hence our support for the practical orientation of near-term SBTs.3
There are significant differences between SBTs and net-zero targets
There are significant differences between SBTs and net-zero targets. The latter acknowledge SBTs might only deliver 90 per cent of emissions reductions and allow residual emissions to be neutralised through carbon dioxide removal (CDR) mechanisms, like carbon offset schemes.
CDRs can be used as a “fix” to align an emissions pathway with the desired net-zero outcome, but there are growing concerns about whether there will be enough capacity to deliver genuine carbon reductions, either though natural sequestration (forestry, soil carbon) or emerging technological solutions. SBTs do not allow abatement targets to be met through CDRs in any timeframe.
Figure 2: Companies setting or committed to setting SBTs and net-zero targets
Notes: Targets are considered “science-based” if they align with what climate science deems necessary to meet the goals of the Paris Agreement – to limit global warming to well-below two degrees Celsius above pre-industrial levels while attempting to contain warming to 1.5 degrees (1.5°C).
Near-term SBTs cover commitments to reduce emissions throughout the value chain five to ten years after a target is set. Long-term objectives capture ambitions ten years or more after a target is set. Companies can commit to a near-term SBT, then in theory have two years from that point to firm up plans in a formal target.
Source: Science Based Target downloads, February 2023, March 2022, October 2021, October 2020
Achieving real-world carbon reductions
Existing members of the Science-Based Targets initiative (SBTi) achieved a 29 per cent reduction in Scope 1 and Scope 2 emissions (direct emissions and indirect emissions from electricity and other types of power) between 2015 and 2020.4
In the longer term, SBTs should help concentrate minds on Scope 3 emissions
In the longer term, SBTs should help concentrate minds on Scope 3 emissions (all indirect emissions not included in Scope 2 from upstream and downstream value chains, as illustrated in Figure 3).
Many companies reporting carbon data omit Scope 3 entirely, a significant issue because in many industries Scope 3 emissions are larger than Scope 1 and 2 combined. Within the SBTi framework, firms are required to include Scope 3 emissions in their calculations where they account for more than 40 per cent of total emissions.
Figure 3: Greenhouse gas emissions through a company’s value chain
Source: Aviva Investors, GHG Protocol, 2021
Virtuous circle: Pressuring value chains through SBTs
By setting SBTs, companies signal they are aligning their businesses with a 1.5°C future, taking an active, forward-looking view. Those including Scope 3 emissions will encourage suppliers and users of their products to curb their own carbon footprints. Eventually, suppliers that fail to act may struggle to retain customers.
In this sense, SBTs are superior to other measures used to show climate alignment. From a portfolio management perspective, cumulative emissions data offer little insight. Normalised carbon footprints (which measure emissions in tonnes of carbon dioxide per million dollars/euros invested, adjusted for equity ownership) or carbon intensity (measuring total carbon emissions relative to revenue) have their own challenges. For example, oil and gas producers will see carbon intensity fluctuate with energy prices, despite absolute emissions remaining largely unchanged (see How energy price fluctuations can impact carbon intensity).
SBTs reveal how companies are managing risks and planning to develop climate resilience across their value chains
In contrast, SBTs reveal how companies are managing risks and planning to develop climate resilience across their value chains. For investors, they can also mean allocation decisions have greater impact, because the impetus to decarbonise can trickle down the supply chain to companies in which the manager does not hold a stake.
There are challenges; carbon accounting is young, and SBTi is yet to devise a framework for target setting in some of the world’s largest-emitting sectors such as oil and gas and steel. In these areas, consultation is under way and sector-specific methodologies are imminent.5,6
Nevertheless, in setting SBTs and not relying on offsets or novel technologies for carbon reduction, the private sector will arguably be doing the best it can to address climate risk and accelerate the transition.
While net zero is the destination, near-term targets grounded in climate science are the signposts to get there. The direction of travel needs serious realignment; the sooner the process begins, the better.