The twinned and conjoined crises of Ukraine and inflation might have dominated the year of your average fund CEO or CIO, and after years of endless growth and prosperity doubtless some have revelled at the challenges. It is also a welcome change from the more amorphous issue of net zero (without an overshoot) which has been at or near the top of board agendas for months, and in other cases years.
For the climate enthusiastic C-suites with a combined material and moral compass on their portfolios, they will not have forgotten those net zero commitments. For those who have aligned out of obligation, NGO pressure or peer pressure those commitments may already be deprioritised, if not forgotten.
But roll forward towards the end of 2023 and Europe will have somehow scraped through its feared gas constrained winter at a cost yet unknown and inflation will be at its most painful. However, with the interest rate medicine starting to bite, glimmers of light may be seen on the other side of multiple country recessions, if not a global one.
In the climate world the global emissions Stocktake under the Paris process will be the backdrop for COP28 in the UAE and it will be unwelcome news, even accounting for the drop in emissions which economic slowdowns bring.
It is then a two-year roller-coaster ride towards COP30 and the 2025 Paris Ratchet where the world expects the net zero momentum to peak in a flurry of new bold commitments to limit the worst of climate damages. Net zero pledges will be nearly five years old at both the investor and company levels and civil society will be hoping to have the champagne on ice, ready to declare victory.
Except the victory won’t happen.
The theory of change surrounding the net zero alignment initiatives has always been that mass collaboration at all levels of the investment chain will create unstoppable momentum that no policymaker can resist, as a private -sector led transition leaves them able to simply follow the wave of change. That they will almost reactively put in place policies to merely assist rather than radically transform the pace of transition being driven by company engagement and portfolio allocations.
The International Energy Agency (IEA) has long produced climate scenarios showing what numbers are needed to achieve certain climate outcomes and more recently, pushed hard by civil society pressure has even added a narrative and tone supporting the transition, but has always stopped short of forecasting the future.
That mantle fell in 2018 to a non-profit consortium called the Inevitable Policy Response (IPR) formally commissioned by the Principles for Responsible Investment that gently landed its first transition forecast in early 2019.
Set against a backdrop of a potential Trump second term and Asian intransigence, some funds, particularly US investors, thought IPR forecasts of acceleration optimistic. It became eerily accurate as a series of perceived low probability events, such as EU border taxes announcements, combined with high probability technological and private sector momentum saw a record number of country net zero commitments.
The IPR update in 2021 was released immediately prior to the giddy days of COP26 in Glasgow where the GFANZ initiative, chaired by former Bank of England governor Mark Carney rolled out its impressive list of supporting net zero private actors from the asset owner, asset manager, service provider and company communities
The IPR 2021 update and its subsequent quarterly updates have only cemented end points of its initial 2019 forecast – that net zero is somewhere between very unlikely and impossible. This sacrilegious language will be most unwelcome news to the net zero aligners who must already be preparing to defend it to civil society when the blindly obvious becomes….inevitable.
It is not that net zero itself is unlikely, it just that net zero without an emissions overshoot is now virtually impossible.
In the fine print of all those net zero commitments lies the caveats that “governments must play their role” for private sector actors to succeed. Some aligners are already changing business models or portfolios regardless of the policy settings – who knows the implications for those brave actors once the required net zero policy settings fail to materialise.
Even for those taking unilateral action, it is the type of action taken that is part of the problem. While the divestment community continues to claim victory, or at least masthead momentum, the reality is that divestment is leading only to a privatisation of high emitting assets and the capital released is not going directly into new incremental clean solutions but spread elsewhere.
Funds and companies can thus claim they are meeting their targets, but this new type of financial engineering will and is resulting in zero climate impact without investment in assets that can potentially reduce demand for fossil fuels. The supply side theories of change are failing and failing badly.
The key question for all stakeholders is to now ask themselves:
- How will this all unravel? “
- When will it all unravel?
- How can we maintain our reputations when it does unravel and
- Will civil society buy our defence when we point to the net zero fine print?
For funds and companies to come out of this remotely unscathed and without a chaotic war of words and blame games there now needs to be a new focus.
The Clean Capital, NETS & Asia Trifecta
Firstly, all net zero aligners need to focus on clean solution capital – large scale renewable energy investment and breaking down of the CIO arguments around illiquidity barriers.
Secondly, Negative Emissions Technologies (NETS) needs to move from a dirty word to a formalised discussion leading to huge collaborative investment between investors and governments.
Finally, Asia needs to become the predominant investment theme. The IPR forecasts that OECD countries will likely meet their 2050 net zero targets but this will be done with no impact on climate whatsoever at the current rate, due to the residual emissions left in Asian countries and supply chains.
Engagement at the sovereign and sovereign debt levels about how to switch this momentum is urgent to minimise the inevitable overshoot. We will now enter unchartered waters from a physical climate point of view. The battles to prevent overshoot are effectively lost and damages are already high. The war is not yet lost, but without an injection of realism into the net zero debate, the pain of recognition and adjustment will be greater.
Once the C-suites return from their summer breaks, they would do well to address these questions.
While the Ukraine and this economic crisis will pass and possibly several more cycles after them, the climate war is omnipresent as far as we can see into the future.
Only a dose of realism can save us now.
Julian Poulter is head of investor relations at Inevitable Policy Response (IPR) and a partner at Energy Transition Advisors (ETA).
The Inevitable Policy Response (IPR) is a climate transition forecasting consortium commissioned by the Principles for Responsible Investment in 2018 that aims to prepare institutional investors for the portfolio risks and opportunities associated with an acceleration of policy responses to climate change.
