I talk to Jeff Snyder at the Broadcast Retirement Network from time to time about various issues related to ESG. Our latest chat – linked here – was about the trend to net zero. While doing my background prep, I was a little surprised to see just how quickly net zero has moved from being a vague aspiration to something that’s widely codified into laws, policies and corporate strategies.
The Paris Agreement – to which pretty much every country in the world is a party – came into force in 2016. The goal of this agreement is “to limit global warming to well below 2, preferably to 1.5 degrees Celsius, compared to pre-industrial levels”. And, while it was clearly understood when this goal was set that the key to achieving it lies in reducing greenhouse gas (GHG) emissions, there were relatively few concrete plans in place at a global level to make that happen.
Governments are acting
Since then, national governments have moved a long way. More than 100 countries – including China and the US, the biggest emitters – now have formal policies to reach net zero emissions. And at least a dozen have put these policies into law: Sweden was first (in 2017) and other major economies to have done so include the EU, UK, Japan and Canada.
These policies mainly set a target date for net zero of 2050. That might seem a long way off. But the extent of the change that’s needed to reach that target means that the energy transition has already started; every electric vehicle and every wind turbine we pass is evidence of that, and that’s just the beginning. Ultimately, it will require a complete reconfiguration of the economy: the way we travel and the way we transport goods; the way we make things; our approach to agriculture.
It’s a reasonable assumption that the main focus of economic development in the next thirty years will be on building a more sustainable, lower-emitting economy. Just as it is hard for teenagers today to imagine a world without smartphones – or for their parents to imagine a world without cars – the way we live in 2021 will be in many ways unthinkable to the next generation.
Some changes are relatively low-hanging fruit, others will take longer. For example, concrete and steel – literally the building blocks of modern cities – are together responsible for almost 10% of global GHG emissions but there’s no obvious low-carbon alternative to either. Bringing those emissions down looks like it might be one of the tougher parts of the puzzle.
But, since the human race has already added about 2 trillion tonnes of CO2 to the atmosphere since 1850, pushing average global temperature up by about 1.1°C, and each additional tonne pushes up the temperature dial a tiny bit more, every part of the puzzle is going to have to be addressed before too long.
It’s easy to foresee that big changes are ahead, but even the best-informed commentators can only guess at what the full impact of those changes will be.
Corporations are responding
Where governments have led, the corporate sector has been close behind. Run down the list of the world’s biggest corporations, and the ones who stand out are the handful who have not made some form of commitment.
Admittedly, some of these commitments are more substantive than others. But it won’t be possible to hide behind woolly promises for long: reporting requirements are getting more meaningful; there’s real scrutiny of what companies are doing; and there are plenty of organizations ready to call out the laggards and hold them to account.
Timelines vary. Google has been net zero for more than a decade. Microsoft (the world’s biggest company by valuation) aims to be carbon negative by 2030, while Walmart (the biggest by revenue) is aiming for 2040. The nature of the challenge obviously varies, too: it’s easier to create net zero software or financial advice than net zero steel. But this touches every country and every sector. The corporate world has always been one in which you adapt or die. Net zero is forcing adaptation at a scale and a pace that not every firm will be able to handle.
Investors are paying attention
This means that the implications of the energy transition reach well beyond the obvious areas like the oil majors and coal stocks to every part of the portfolio. Whether the impact comes through regulation, through changes to technology and the business landscape, through corporate strategy, or simply through the effect on security prices of other investors paying a lot more attention to these matters, net zero and the energy transition are relevant considerations in just about every investment decision.
The global investment community is not only responding to the movement to net zero, it’s also putting its own weight behind it. One more sign of the pace of change is the recent creation of the Net Zero Asset Managers Initiative (NZAMI), which just turned one year old. 220 asset management firms – including the three biggest: Vanguard, Blackrock and State Street Global Advisors – have signed up to this initiative, committing to support the goal of net zero emissions through actions such as active stewardship and TCFD reporting.
Just as these firms take many different approaches to adding value and managing financial risk, so there are many possible approaches to the incorporation of climate considerations into the investment process. But what nobody can afford to do is ignore it.
Endnotes:
Expanding on some of the points above, here are a few additional snippets for those who want more detail.
1. We’re about 50 billion tonnes (and rising) a year away from net zero today
Before the industrial revolution (which ran from about 1760-1840) global emissions of CO2 from the oceans, plants, animals and soil were about 800 billion tonnes a year, and roughly the same amount was absorbed. So the total amount of CO2 in the atmosphere was fairly steady at 2.2 trillion tonnes, or about 280 parts per million (i.e., .028%).
Since then, human emissions have totalled about 2 trillion tonnes, 80% of which has been since 1950. Roughly half of that has been reabsorbed by the oceans and soil (leading to an increase in the acidity of the ocean’s surface waters of about 30%, another cause for concern). The rest remains in the atmosphere, which is now above 410 parts per million CO2.
And case it seems like 0.04% surely can’t be that big a deal, just be glad it’s CO2 (carbon dioxide) and not CO (carbon monoxide): 410 parts per million CO would kill us all in about two hours. CO2 and other GHGs trap heat, and the more of it there is in the atmosphere the warmer the planet gets. The greenhouse effect is great news at 280 parts per million, because that results in a livable temperature for us. It’s not great news at 410 parts per million, which results in extreme weather patterns, rising sea levels, and a cascade of disruptive effects whose full impact nobody can predict with certainty.
Total emissions today are roughly 36 billion tonnes of CO2 a year, plus other GHG emissions (methane, nitrous oxide and various other nasty stuff with long names) which, when converted into CO2 equivalents (or CO2e), bring the total to about 50 billion.
2. It’s quite tricky to measure emissions
Many readers will have noted that I avoided digging into scope 1, 2 and 3 emissions above. Scope 1 refers to direct emissions from sources the company owns or controls. Scope 2 refers to indirect emissions, such as those associated with electricity purchased by the company. Both scope 1 and scope 2 emissions are fairly easy to identify and measure if you choose to do so. Most disclosures today are based on scopes 1 and 2.
But this only tells a small part of the story. Scope 3 is where the impact of the products sold and the goods and services bought by a company get taken into account, along with all of the other indirect ways that a carbon footprint is created. Scope 3 is what we’d really like to measure, but it’s a bit of a dog to calculate. Consider: if I drive to the store to buy milk, how should we divide the associated emissions between the gasoline company, the car manufacturer, the grocery store and the farmer? While it may not be simple, the measurement of scope 3 emissions is getting better, and a lot more data on these is likely to become available in the coming years. One more addition to the long list of things that are currently moving fast.
Another technical point: net zero is not the same thing as zero. Human activity adds GHGs to the atmosphere, but it can also remove them. Trees can be planted. Carbon can be directly extracted (albeit with difficulty). Companies can purchase carbon offsets, which result in lower emissions somewhere other than their own operations. We can expect increased activity in the coming years on this second side of the carbon balance sheet, too.
3. The alternative implications of not zero
The commentary above explores the implications of an energy transition that takes the global economy to net zero emissions in about thirty years, which seems to be the current best estimate of what’s needed to achieve the goals of the Paris Agreement. Net zero is a tough target, though, and there’s no guarantee that it will be achieved. There would of course also be implications for investors of such a failure. Those implications are much broader, more complex and more chaotic (not to mention disturbing) than those of a successful energy transition. But I’m well over my word count already so I’ll save that discussion for another day.