Unravelling the Net Zero Challenge: building momentum for the ESG transition

Emerging from COP 26, the awareness and commitment to Net Zero have increased and are on the agenda. A fact to be welcomed. Progress from net zero to meet the 1.5 climate limit will require concentrating on several areas. A new sense of urgency, establishing the capital and investment at pace and ensuring a united approach is critical to success. More than anything we need to recognise this is a ‘system change’ for which we require a new narrative.

Size of the challenge

The world must achieve a 45% reduction of total emissions by 2030. Over 130 countries have committed or are in the process of committing to carbon reduction targets by 2050. While several of the published targets at the country level have raised questions or have little detail, we should welcome this first step.

Top ten nations

The largest countries responsible for 68% of GHGs and carbon are Canada, Iran, Indonesia, Brazil, Japan, Russia, India, the EU, the USA, and China. The top three (EU, USA, and China) contribute 16 times the emissions of the bottom 100 countries. This is before we’ price in’ in the macro carbon economic factors of the current energy and inflation crisis.

Substantial commitment from companies.

As it stands, more than 3,000 companies have made net-zero pledges. Yet PWC recently reported that 64% of CEOS and boards in the UK have still to develop firm plans and make commitments. Capital markets are building in emissions risks. Investors are increasingly seeking evidence of company behaviour in ESG commitments, materiality mapping, investment in technology and net-zero targets.

All these factors contribute to the fact that it will still be tough to achieve a GHG reduction at the rate and pace required to meet planetary targets. This is even with commitments at the country and corporate level. However, there are things we can do.

Increase the commitment from the public, private and capital markets.

Despite fiscal pressures on the public purse emerging from COVID, the energy crisis and rising inflation, governments must find the capital to follow through on Net Zero Commitments. In addition, the government needs to tilt the policy framework to drive the speed of EE measures in the commercial and domestic sectors.

If this requires fiscal expansion and the creation of dedicated sovereign funds, then it should be done. On a country level, energy efficiency in the commercial and domestic sectors is the path to long-term energy independence and economic activity.

The pump must be primed to develop low carbon-intense power systems, hydrogen, and biofuel. There needs to be a dramatic increase in the use of electric vehicles, currently at 2% globally, and a more significant investment in low carbon municipality urban transportation. The investment in low carbon agriculture must be accelerated and alternative low carbon production within the cement, steel, and aluminium sectors achieved.

Increase focus on carbon measurement

Across the board, the measurement of carbon 1, 2 and 3 by governments and the markets must increase. Over time the markets will start to naturally price in this data and apply it to the valuation of an asset. This will increase the demand for low carbon technology and energy while accelerating the capital investment in the sector which needs to grow from $5.1 trillion to $9.2 trillion over the next decade. The acceleration of this investment will, via attrition, link non-financial data to financial data and increase asset valuation.

Utilise sovereign capital to reduce investment risk.

The more shareholders involved will add to more significant momentum. Removing barriers to the flow of capital to speed the investment cycle and capital layering into the low carbon market. The priority must be de-risking capital at the sovereign fund and long capital level. The de-risking of the investment cycle can be achieved if the assumption is that these are commercial assets that can be scaled and listed at speed. This upfront priming of the process will make these businesses more attractive for PE and general investor capital over the short and long run.

Close the capital gap

The delta between ‘green’ and traditional ‘brown’ capital allocated in the banking and finance system reflects the challenges with understanding the risk vs opportunity paradigm. The slow pace of government, and the missed policy opportunities, to commit sovereign capital to de-risk key sectors such as green technology and energy efficiency has stunted development. A short-term policy focus coupled with the headwinds of political inconsistency is at odds with the net-zero transition, requiring long-term patience and pragmatism.

Develop a united globalised approach

Climate and its risk are a global challenge. Achieving net-zero requires pragmatic leadership at both the corporate and the governmental level-a big challenge in a polarised world. The top ten high carbon countries must take the lead, and some would say morally. Weak or convoluted net-zero targets from the perceived global leaders leave room for others to follow a path of delay and inaction.

Unlike the global rollout of the covid vaccine, leadership, and support for emerging and developing countries needs to be demonstrated. There are geopolitical challenges. No more so in the nations reliant on fossil fuel whose economies have emerged over the last fifty years. The global south poorer countries, already suffering, must be supported with a finance mechanism tied to achievement economy-wide targets and effective and swift technology transfer.

Embracing the system change

Net Zero is a critical element of the ESG transition. It is a system change that requires a shift in our business practices, lifestyle, and understanding of the investment and capital risks that we have developed over the last one hundred years. The low level of CEO and board commitment does not indicate inertia but the size of the challenge.

These are long term investments and changes measured by markets which are short term and sporadic. So it is still a challenge for CFOS to go out on a capital markets day and impress investors that ESG is not only pleasing but is also about value creation.

Establish a new narrative

The system change requires all shareholders to form a’ grand coalition to achieve net-zero-a move from the debating society and our collective focus. The narrative needs to shift from the ‘what’ to a specific focus on the ‘how’ and the ‘when’. A shift from self-interest to a focus on the multiple returns to capital, climate, and economy over the long run are the net-zero dividends.

Originally published at https://www.themartelloadvisory.com on May 14, 2022.