Over the last 12 months, the global pandemic has shaken our lives in many ways. With many of us largely limited to staying at home, it has given us time to think about those things that matter the most in our lives. While good health and social interactions are probably top of mind for most of us, the environment and climate are also among our key concerns.
Indeed, last year in the midst of the global health pandemic, on the 50th anniversary of Earth Day, Ipsos, a market research firm, conducted a poll1 which showed that globally “71% agree in the long term, climate change is as serious a crisis as COVID-19” and that “68% say their government will be failing them if it doesn’t act now to combat climate change”.
2020 has indeed not only been the year of the global pandemic but it has also marked the end of the hottest decade on record while recent global events, such as wildfires in California, floods in Australia or heatwaves in Europe, have made the consequences of climate change ever more apparent and strengthened public support for measures to shift to reduce society’s carbon footprint.
Our CO₂ emissions are indeed at the center of the problem. Historical data show a strong correlation between the CO₂ concentration in our atmosphere and global temperatures while once emitted, CO₂ can stay up to 1000 years in our atmosphere. This is why, the drop of CO₂ emissions recorded last year during the lockdowns have not led to a reduction of the CO₂ concentration in our atmosphere, and on the contrary it has recently risen to 415 parts per million, which is the highest level in at least the past 800,000 years.
Global policymakers have long been debating how to collectively address climate change but neither the Kyoto protocol, signed in 1997, nor the Paris Climate Agreement, signed in 2015, have led to the agreed reduction of Greenhouse Gases (GHG) emissions, which has reached to approximatively 50 billion tons of CO₂ equivalent today.
In this context, many countries and regions are now stepping up their climate ambitions. Within Asia, the number of economies committing to net-zero emissions by or near the middle of this century equates to 79% of Asia’s 2019 GDP and 46% of the population in 2019, according to World Bank data. In particular, within China, in the recent National People’s Congress, China premier Li Keqiang re-emphasized the target to hit peaking of CO₂ emissions by 2030 and to accelerate the transition to a green economy so as to become carbon neutral by 2060 (Exhibit 1). Globally, a total of 58 countries, representing 54% of global GHG emissions, have agreed to adopt climate targets and this number should continue to increase ahead of the 26th United Nations Climate Change Conference of the Parties in November 2021 and which could lead to a new Grand Climate Accord.
EXHIBIT 1: GREENHOUSE GAS EMISSION TARGETS
BILLION TONNES/YEAR, CO₂ EQUIVALENT
The election of Joe Biden as 46th president of the United States has indeed fueled expectations of an increase in global momentum on tackling climate change, and so far he has delivered on promises as the U.S. has already rejoined the Paris climate agreement and committed to reach net zero emissions by 2050. Even though Joe Biden is currently focusing on dealing with climate change at home with the preparation of a USD 2trillion Plan to Rebuild Infrastructure and Reshape the Economy, he is also keen to fully integrate climate change into U.S. foreign and trade policies in order to get every major country to further ramp up their domestic climate targets.
This is why this year’s Earth Day could become a new milestone in global climate policy. Indeed, 51 years after having introduced the concept of Earth Day, the U.S. has decided to leverage that day to organize a global leader’s climate summit in order to put climate change at the top of global policymaker’s agenda.
The transition to a low carbon economy will require huge changes in the way we live, produce and consume. The impact on economic growth will depend on whether the transition is “sticks-based”, with private businesses bearing the bulk of the cost of the transition, through for example new regulations and taxes, or “carrots-based”, with governments supporting the transition, through subsidies and other forms of fiscal stimulus2.
Policymakers will need to find the right balance between those two policy levers but a sticks-based approach will definitely need to be part of the global policy mix3 to speed up the reduction of our emissions. The most common such approach is the implementation of a carbon tax, or more generally of a carbon price that can be set either through taxes or through Emissions Trading Schemes (ETS) to incentivize carbon producers to reduce their carbon intensity.
Ultimately, the carbon prices in each country will be the measure of its climate ambitions which is why it is important to create a global level playing field for carbon prices, either directly through taxes or ETS or indirectly through “carbon border tax adjustments4” to avoid regulatory arbitrages.
What does this mean for investors?
Investors should, at the very least, be aware of how climate-related regulatory and policy initiatives might affect the value of investments in their portfolios. However, this awareness doesn’t mean simply being short the fossil fuel energy sector. In our view, actions to tackle climate change will have a broad impact on companies across sectors and countries. Investors will need to actively manage the carbon intensity of their portfolios if they are to reduce the direct and indirect impact of the transition to a net zero economy on their investments.
However, being prepared for carbon transition means more than just being climate-aware. An active approach to carbon transition can help investors capture the relative value opportunities that are being driven by climate change and/or the policies being put in place to help slow the rise in global temperatures. Instruments designed to address climate change, such as green bonds and thematic equity funds, are also increasingly available to investors.
By going well beyond simply shorting those countries and sectors that are major GHG emitters, and by focusing their capital on those companies and governments that are driving the solution, investors have a unique opportunity to enact real change.