With the COP 26 global climate talks in Glasgow fast approaching, we held a workshop with a small group of investors, rating agencies, and corporates from the automotive, shipping and consumer goods sectors to discuss what it would take to accelerate action towards a net-zero economy.
The wide-ranging discussion focused on whether we should adopt an earlier date for net zero – which, put simply, refers to the balance between the amount of greenhouse gas produced and the amount removed from the atmosphere. Participants also raised a number of valid challenges regarding the 2050 goals as well as some issues that need to be addressed in climate finance, including whether a carbon tax is really a silver bullet and how to balance adaptation and mitigation strategies.
This issue of climate change has rapidly risen to the forefront of business strategy and public policy since the UN Paris Agreement in 2015, and the pace of activity has accelerated quickly since then. Many governments have set legally binding targets to reach net zero by 2050.
There was a general consensus that 2050 is too distant an objective that would distract attention away from implementing high-impact initiatives today. Long-dated climate targets can lead to greenwashing, overpromising and underdelivering. After all, most corporate executives and asset managers in charge of firms today would have retired by 2050, creating issues around accountability.
To have a decent chance of limiting warming to 1.5°C – the goal of the 2015 Paris Agreement – global emissions need to peak around 2025 and then plunge rapidly toward zero by 2050.
One strategy to accelerate decarbonization is to look for quick wins. Cutting methane emissions has the potential to accelerate decarbonization in the short-term. Methane has more than 80 times the warming power of carbon dioxide over the first 20 years after it reaches the atmosphere. So it sets the pace for planetary warming in the shorter-term. Using existing technology, the oil and gas industry alone could achieve a 75% reduction in methane emissions by 2030, according to the International Energy Agency.
Despite the promise of methane reductions, divergent baselines for reporting may derail progress. Although the Oil and Gas Methane Partnership (OGMP) 2.0 offers the best reporting framework and verification of emissions, the Securities and Exchange Commission (SEC) is considering requiring use of Environmental Protection Agency (EPA) estimates of baseline methane, which underestimate actual methane emissions caused by oil and gas production by as much as 76%. If the SEC adopts the EPA standards, the industry is going to be driven towards an EPA minimum baseline, which we know is wrong. Our hope is that the SEC, EPA, and OGMP can get together and figure out the right estimates that need to go into SEC reporting.
Beyond quick wins, corporates and investors increasingly realize that simply throwing money at the problem is not going to work. Despite our progress in understanding the array of climate solutions needed, the investment implications of decarbonizing are less understood. Simply scaling carbon offset markets, be it for voluntary or compliance reasons, avoids addressing the need to create more sustainable business models. Mid-range targets in the ballpark of three to five years are needed to develop proactive strategies.
In what has been described as a pincer move, investors and regulators can tighten scrutiny by emphasizing interim milestones and disclosures of “Scope 3” emissions, which are the greenhouse gases emitted along the whole supply chain and in the use of products or services.
A more comprehensive and reliable picture of emissions is likely to help companies focus on building a consistent climate strategy, and mitigating emissions by reorganizing operations to address material concerns.
But, to date, companies have hesitated to disclose estimates of their Scope 3 emissions, which are often overlooked by management because of the difficulty in data collection, questions about data quality, and the absence of direct control on the supply chain or other incidental activities.
Currently, the GHG Protocol is the only internationally accepted method for companies to account for these types of emissions. The GHG Protocol classifies Scope 3 emissions into 15 different categories, divided into upstream and downstream activities. Not all 15 are equally important for all firms. Their relative importance depends on the type of business activities companies are engaged in. Therefore, a tailored approach for each company is required.
“To have a decent chance of limiting warming to 1.5°C – the goal of the 2015 Paris Agreement – global emissions need to peak around 2025 and then plunge rapidly toward zero by 2050”
But complexity and nuance also bring challenges related to measurement and benchmarking. Naturally, this consideration calls for better and more refined data. From the investment side, climate risk is still in the early stages of being priced into assets. From a strategic perspective, however, companies can take action by leveraging their purchasing power to make the carbon intensity of their supply chains more transparent.
Measuring, benchmarking, and verifying carbon emissions across the value chain is a massive undertaking. Questions remain as to who will pick up the tab for auditing and inspections, as well as how to make these comparable across firms.
The Science Based Targets initiative (SBTi) helps companies in setting guideposts that are in line with climate science. However, the nuances of particular sectors such as midstream oil operations continue to be a problem. The SBTi has yet to unveil a sector-based roadmap for several high emitting industries such as oil and gas.
The current consultation process does not capture the upstream component of Scope 3 emissions for midstream oil and gas companies, which limits transparency on the methane intensity and emissions of what gets into the system. At last count, only nine oil and gas companies had joined the initiative.
Nobody wants stranded assets on their balance sheet. But the financial sector has a lot of catching up to do if it wants to accelerate the climate transition timeline. Solutions that are touted as silver bullets, such as carbon taxes, might even do more harm than good. Not all companies will be able to afford carbon taxes, especially if they have to account for Scope 3 emissions.
For firms that cannot afford a carbon tax, they could pass it along to customers through higher prices. In such a scenario, inflation would become a real concern, not to mention the question of whether society trusts government enough to manage trillions of dollars in carbon tax revenue.
Early innovations from the sustainable finance sector, such as exclusionary screening (removing companies that do not meet ESG targets from an investment portfolio) may also be detrimental to achieving a net zero economy. Essentially, exclusionary screening kicks the can down the road to the next asset manager.
Engaging with companies directly is a bottom-up approach that could be further complemented by regulation
If blanket carbon pricing and exclusionary screening fall short of moving the needle in a meaningful direction, investor/corporate engagement could be a solution. Engaging with companies directly is a bottom-up approach that could be further complemented by regulation. However, engagement today typically occurs through the proxy voting arm of asset managers. With small analyst teams and thousands of proxy votes occurring each year, in-depth due diligence remains elusive.
Allowing institutional investors the ability to vote on shareholder proposals might be a step in the right direction, but most asset managers still lack the deep subject matter expertise that can stimulate meaningful dialogue on strategies to reduce emissions.
How much do we expect COP 26 to accomplish given recent leaks of documents from governments and other global stakeholders that seek to water down the response to the climate crisis? We hope that COP 26 can galvanize investor and regulatory action on pressing issues we identified: (i) focus on methane; (ii) take control of scope 3 emissions with a tailored approach to upstream, midstream, and downstream; (iii) In the U.S., the SEC should ideally avoid EPA benchmarks of methane; (iv) carbon tax design needs careful thought; and, (v) effective engagement, not exclusion and divestment, is a better strategy in the asset manager’s arsenal for fighting climate change.
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