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

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.

How energy price fluctuations can impact carbon intensity

Carbon intensity provides a snapshot of how much carbon dioxide is produced relative to an underlying metric. For the financial services industry and investee companies, it involves assessing the amount of carbon dioxide generated per unit of revenue. Its simplicity is part of its appeal. But carbon intensity data needs to be considered carefully as it can fluctuate without significant changes in absolute emissions, as Figure 4 shows.

In an energy crisis, a producer might generate a similar volume of absolute emissions in years 1, 2 and 3, but if the energy price is forced higher – say through conflict – the resulting revenue increase will mean carbon intensity improves while absolute emissions (the climate impact) remain the same. 

Figure 4: Carbon intensity may vary without changes in absolute emissions 

For illustrative purposes only.
Source: Aviva Investors, March 2023

Related views

Important information

THIS IS A MARKETING COMMUNICATION

Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (AIGSL). Unless stated otherwise any views and opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Information contained herein has been obtained from sources believed to be reliable, but has not been independently verified by Aviva Investors and is not guaranteed to be accurate. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Nothing in this material, including any references to specific securities, assets classes and financial markets is intended to or should be construed as advice or recommendations of any nature. Some data shown are hypothetical or projected and may not come to pass as stated due to changes in market conditions and are not guarantees of future outcomes. This material is not a recommendation to sell or purchase any investment.

The information contained herein is for general guidance only. It is the responsibility of any person or persons in possession of this information to inform themselves of, and to observe, all applicable laws and regulations of any relevant jurisdiction. The information contained herein does not constitute an offer or solicitation to any person in any jurisdiction in which such offer or solicitation is not authorised or to any person to whom it would be unlawful to make such offer or solicitation.

In Europe, this document is issued by Aviva Investors Luxembourg S.A. Registered Office: 2 rue du Fort Bourbon, 1st Floor, 1249 Luxembourg. Supervised by Commission de Surveillance du Secteur Financier. An Aviva company. In the UK, this document is by Aviva Investors Global Services Limited. Registered in England No. 1151805. Registered Office: 80 Fenchurch Street, London, EC3M 4AE. Authorised and regulated by the Financial Conduct Authority. Firm Reference No. 119178. In Switzerland, this document is issued by Aviva Investors Schweiz GmbH.

In Singapore, this material is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited (AIAPL) for distribution to institutional investors only. Please note that AIAPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIAPL in respect of any matters arising from, or in connection with, this material. AIAPL, a company incorporated under the laws of Singapore with registration number 200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and Asian Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Office: 138 Market Street, #05-01 CapitaGreen, Singapore 048946.

In Australia, this material is being circulated by way of an arrangement with Aviva Investors Pacific Pty Ltd (AIPPL) for distribution to wholesale investors only. Please note that AIPPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIPPL in respect of any matters arising from, or in connection with, this material. AIPPL, a company incorporated under the laws of Australia with Australian Business No. 87 153 200 278 and Australian Company No. 153 200 278, holds an Australian Financial Services License (AFSL 411458) issued by the Australian Securities and Investments Commission. Business address: Level 27, 101 Collins Street, Melbourne, VIC 3000, Australia.

The name “Aviva Investors” as used in this material refers to the global organization of affiliated asset management businesses operating under the Aviva Investors name. Each Aviva investors’ affiliate is a subsidiary of Aviva plc, a publicly- traded multi-national financial services company headquartered in the United Kingdom.

Aviva Investors Canada, Inc. (“AIC”) is located in Toronto and is based within the North American region of the global organization of affiliated asset management businesses operating under the Aviva Investors name. AIC is registered with the Ontario Securities Commission as a commodity trading manager, exempt market dealer, portfolio manager and investment fund manager. AIC is also registered as an exempt market dealer and portfolio manager in each province of Canada and may also be registered as an investment fund manager in certain other applicable provinces.

Aviva Investors Americas LLC is a federally registered investment advisor with the U.S. Securities and Exchange Commission. Aviva Investors Americas is also a commodity trading advisor (“CTA”) registered with the Commodity Futures Trading Commission (“CFTC”) and is a member of the National Futures Association (“NFA”). AIA’s Form ADV Part 2A, which provides background information about the firm and its business practices, is available upon written request to: Compliance Department, 225 West Wacker Drive, Suite 2250, Chicago, IL 60606.