With COP26 fast approaching, the carbon conversation is heating up. Following a damning, code red IPCC report, a debate at the UN General Meeting and letters from the FCA telling managers to act and evidence their efforts, decarbonisation is the word on everyone’s lips.
We can see this in the price of carbon. The cost of offsetting one tonne of carbon emissions is the highest it’s ever been – €64/tCO2 at the time of writing – where before last year it had barely broken through €30/tCO2. Carbon emissions are fast becoming a punitive cost of business, not a by-product.
Governments are staking their positions and all eyes are on which heavyweight global leaders will confirm their attendance in Glasgow in November. We have written before about the importance of the co-operation statement between the two largest emitters: the US and China. John Kerry flew to Chinese soil to broker that statement – will Chinese leaders fly to the UK to deliver on the urgent need for global decarbonisation?
See also: – IPCC report draws ‘line in the sand’ for decarbonisation of finance
As the market moves to provide better transparency, it is with some caution we consider the tools we have to hand. Single aggregated scores have a bluntness to be mindful of in application. As with use of all blunt tools, particularly for complex jobs, they can lead to unintended consequence.
As fund managers, we look to focus on real-world outcomes rather than aggregated scores or thermometers, particularly those that are measured on past performance and backward-looking data sets. Capital markets are transitioning, and we need a forward-looking investment framework.
Analysing the carbon transition
How carbon intensive businesses navigate the low-carbon transition is a deeply strategic issue, both in the context of their products and services and how they operate.
When looking at this in an investment context we need to consider the different scopes of carbon emissions, where they appear in the value chain, and what the implications of various low-carbon transition pathways will be on a company’s revenues, costs, competitive positioning and ultimately their licence to operate.
When considering what a company will do, as investors we need to analyse corporate strategy. Making a commitment to net zero or alignment with the Paris Agreement is an important first step, but to really convince us we want to see more businesses providing detailed, credible and irreversible plans on how they will achieve sustainable decarbonisation.
These will preferably be backed up with short-, medium- and long-term targets of both the emissions themselves as well as key strategic and capital allocation milestones. Without this, these commitments risk being empty promises, easily reversible by future boards and excos yet to be appointed.
Trying to both understand and quantify the potential future impacts of climate policy on a company’s operations and supply chain or demand for its products is complex, particularly in the absence of standardisation of measurement and harmonisation of reporting standards.
Ultimately what we look for is emission reduction. The credibility of a company’s low-carbon transition plan is embedded in the extent to which a company intends to continue with the status quo and use carbon offsetting and capture mechanisms to achieve its reduction targets, not least given the vast acreage that would be required to deliver the offsets through afforestation.
Be prepared
Climate risk disclosures will become more prevalent and standardised, and their quality will increase. In combination with the clearer policy direction that we expect in the coming years, this should allow investors to be more confident in internalising costs of climate change into their valuation models and seeing the direct effects of paying for carbon on a company’s cost base.
Being prepared across portfolios and asset classes for these inevitable policy developments be a key determinant of long-term returns. As fund managers it is important we help our clients understand capital allocation can play a crucial role in driving change for a better world, and how their savings deliver real world outcomes – to the planet, to people, and to profit.
