Thought Leadership series: net-zero

In this third piece in the series of Thought Leadership, B-CCaS Member Dr Luca Taschini stewards the publication of three unique, yet complementary, viewpoints on net-zero, with guest pieces from Tim Smith of Lazard Asset Management and Stephen Porter of Scottish Widows.

Net-zero 2.0

Tim Smith, Lazard Asset Management

Setting a net-zero target at a corporate level is part of a 30-year commitment. Few companies have experience of planning on this horizon, while few investors have experience of investing on this horizon. The challenge for corporates is moving beyond target setting and into execution and operational delivery.

The challenge for investors is how to scrutinise these targets and evaluate chance of success. According to a recent academic study, as much as one third of targets set under the Science-based Targets are off-track, so the urgency for corporate execution and investor scrutiny could not be clearer.

While a multitude of recommendations exist for net-zero implementation, most share a few framework items. They require increasing disclosure standards, evidence of operationalising net-zero, robust corporate governance structures, and transparent investor approaches to climate engagement.

A company might have started their climate journey by disclosing Scope 1 and Scope 2 emissions, but best practice is moving quickly towards full Scope 3 reporting. Similarly, while net-zero targets might initially have been accepted across only Scope 1 and 2 emissions, there is now an expectation that these are expanded to total value chain emissions.

Companies should be expected to demonstrate how their capital expenditures (CAPEX), operating expenses (OPEX), and R&D are aligned with their net-zero strategy, or how internal carbon pricing guides these allocations. Among others, major questions a company should be able to address are:

• If a company plans to use offsets or carbon dioxide removal as part of their strategy, have procurement efforts started?
• Where emissions reductions efforts are a cost, can they be passed on, or will suppliers absorb them?
• Might customers be willing to pay more for sustainable products?

Many investors will want answers to these questions and now often expect a vote on climate strategies and for individual corporate directors to be held accountable for progress. Investors are also beginning to expect, through their engagement strategies, to see ratcheting net-zero delivery over time.

This is net-zero 2.0.

How to reach net-zero 2.0

Luca Taschini, University of Edinburgh Business School

The recent World Energy Outlook by the International Energy Agency (IEA) helps us to focus our thinking on the work that remains to reach net-zero. The IEA report compares the net-zero emission path (where we should be by 2050) with the:

1. Stated Policies Scenario, which tracks and projects emissions associated to existing policies
2. Announced Pledges Scenario, in which countries do what it takes to make good on the decarbonisation promises they have made so far

The difference between those two scenarios and the net-zero emission path tells a striking story: even moving from Stated Policies to Announced Pledges leaves a significant gap that requires a tremendous scaling up of policies.

That picture might be no different when comparing individual companies’ announced pledges versus actual emission reductions (mind you, emission reductions and not offsetting). However, to confidently measure net-zero progress we need accurate and consistent frameworks: as argued in the previous comment. Comparability of progress measurements is crucial as well, since we are dealing with a global phenomenon across all continents. This calls for a move towards mandatory reporting and disclosure of a key set of environmental and financial variables.

The enormous difference between pledges and projected emission reductions calls for a serious change in economic incentives too. Stronger incentives to change our economy and society are needed. While carbon pricing is already acting as a stick forcing companies to decarbonise in some parts of the globe and economy, financial services and (some) industries lament this is not sufficient.

A consistent price on carbon should be extended to more sectors and jurisdictions. We need to put an equal emphasis on what policy makers and regulators are doing and what the private sector should be doing.

So, how to reach net-zero 2.0? More regulations, please.

Stewardship for net-zero

Stephen Porter, Scottish Widows

When it comes to climate change what are investors to do? What influence do we have to turn the dial down on global warming, to achieve a net-zero economy? Quite a lot, actually; if we wield it effectively and with purpose. And 'it' is exclusion/divestment and engagement.

First, we can divest and exclude from our investment universe sectors of the economy that are at high risk of becoming stranded assets; those that will not be able to transition to a net-zero economy and/or have a steadily reducing social license to exist. In this camp we can place the extraction of thermal coal and tar-sands. Burning these highest polluting of fuels is not necessary for energy.

There are far cleaner energy sources available which are at or near price parity. The holistic investment case becomes weaker when we include the social cost — the often forgotten 'S' of Environmental, Social, and Corporate Governance (ESG) — of severe health impacts from the resulting air pollution.

Second, we can actively and collaboratively engage our investee companies to update their business models to survive and thrive in a net-zero economy. Owners of equity and debt hold much influence as was demonstrated this past summer with three climate-friendly directors elected to the board of oil major ExxonMobil.

We will need fossil fuels for energy generation for some time yet as alternatives are developed and scaled up. However, we do not need more exploration — we can’t burn existing reserves, never mind add to them.

Production can be run-down with fossil revenues re-purposed towards inward investment to transform and transition. This broad shift is needed from a climate and net-zero perspective but may only happen quickly enough through concerted engagement.

There are very real caveats in using divestment which are not often mentioned. Alone, this tool’s effects are indirect. Further, the buyer on the other side of sell trade is likely to care less about the issues causing the sale, which could lead to unintended negative outcomes. But, with the right incentives and investor involvement, (Dirty) Big Oil could become Big (Clean) Energy.

Being active stewards, engaging singly and as part of larger, coordinated collaborative efforts, combined with a real threat of large-scale divestment, should lead to better real-world outcomes. Investors can help net-zero happen.

Dr Luca Taschini is a member of B-CCaS and Reader in Carbon Finance at the University of Edinburgh Business School.

Tim Smith, Charter Financial Analyst (CFA) designation, is a Research Analyst in Climate Change and Energy Transition at Lazard Asset Management, and alumnus of the MSc Climate Change Finance and Investment programme at the University of Edinburgh Business School.

Dr Stephen Porter, CFA designation, is the Responsible Investment Lead at Scottish Widows, and Sessional MSc Research Supervisor and Lecturer at the University of Edinburgh.