“We believe climate change is one of the biggest systemic risks we face.” — 120 investment institution chief executives in open letter to G7 finance ministers, May 2015
Governance and Sustainable Investment team:
- The stage is set in Paris for global leaders to secure a climate change deal, which would aim to curb fossil fuel use.
- China, India and United States are signaling their willingness to keep global warming to within two degrees Celsius.
- We have intensively engaged policy makers and companies advocating for reforms, which will result in a smooth transition path to a more sustainable climate.
A new hope
After 21 years of climate negotiations, the final stages may be just days away. Following the failure to secure a deal in Copenhagen in 2009, the negotiations, which are to begin in Paris on the 30th of November, stand a chance of securing commitments to adopt policies that would reduce emissions and keep climate change to ‘safe’ levels. This would definitively set the scene for a fundamental transition over the coming decades: an industrial revolution from a fossil-fuel based system, to a largely decarbonized economy.
In Cancun in 2010, governments had agreed to hold global warming to within two degrees Celsius (2 º C). Few concrete actions, however, were agreed upon to make this happen. The aim of the Paris meeting will be to translate that goal to specific country level reduction commitments. Although there remain disagreements around climate finance and the status of the final document, substantial progress has already been made. Around 160 countries representing 92% of global emissions have submitted Intended Nationally Determined Contributions (INDCs). These self-imposed targets have already reduced projected 2030 emissions by 15% from their business as usual trajectory, translating into a reduced warming of 2.7º C compared to recent estimates of 4º C to 5º C under a business as usual scenario.
There is still much ground to cover to align INDCs with the agreed upon 2º C goal. However, with the willingness of the large emitters, most notably China, India and the United States, a deal seems within reach. Indeed, observers who are pessimistic about getting a deal in Paris seem to be basing their future expectations on past performance (e.g., Copenhagen). However, the last six years have changed the fundamentals of the negotiations significantly. China’s air pollution concerns and the planned introduction of an emissions trading scheme are moving the country’s energy mix away from coal and making the country the largest renewable energy investor in the world. In the U.S., wind is now the cheapest form of energy in much of the country and with the fall of natural gas price, it has reduced carbon dioxide output by 12% in the last four years. India has just set a 100 gigawatt (GW) target for solar deployment by 2022.
Most importantly, however, the main argument against action on climate change — that it requires too great an economic sacrifice — has disappeared. According to recent estimates, the cost of following a
2º C pathway is actually on par with, if not slightly lower than, a BAU pathway (without considering climate related damages). Research by the International Energy Agency (IEA), Citigroup, Oxford’s Martin School and the New Climate Economy suggests that due to the falling costs of clean technology, increased investment in highly efficient infrastructure now will be offset by substantial fuel savings in subsequent years. Following this pathway, however, requires specific policies to facilitate the higher up-front costs. Interestingly, this investment stimulus may not be such a bad idea in the context of a global economic slow-down and historically low interest rates.
The Paris meetings have been a catalyst for a wave of stakeholder action on climate change.
Environmental NGOs have been focusing on climate change for decades, and now a new generation of organizations focused on the financial sector has come to the fore — the 350.org Divestment Movement and the Carbon Tracker Initiative are examples of these. Companies have also been very vocal and have come out with unilateral commitments to reduce their emissions or to shift energy procurement to renewables. Also, they are working collectively through groups like We Mean Business, the Oil and Gas Climate Initiative (OGCI) and the Magritte Group (of utilities). The OGCI recently convened a meeting, which we attended, between seven oil and gas company chief executives — including from BP, Royal
Dutch Shell, Total, and Saudi Aramco — with institutional investors and the Secretary of the United Nations climate process, Christiana Figueres. The CEOs stated that they too support a 2º C development pathway. Leading companies within the OGCI confirmed that the intense engagement on the stranded assets issue by BMO Global Asset Management and other investors has been pivotal in the formation of this group and the desire to send a clear signal at CEO-level.
Within the financial sector, multilateral development banks have been first to come out with bold climate action, with the World Bank’s International Finance Corporation rebalancing its lending portfolio away from coal. The European Investment Bank has also been active in creating financial products, which reduce the risk of investing in low-carbon infrastructure and has been the largest issuer of green bonds to date.
Institutional investors have also been vocal. Through the Global Investor Coalition, which BMO is an active member of through the Institutional Investors Group on Climate Change (IIGCC), investors have become outspoken advocates of predictable, long-term policies, which will result in a smooth transition path to a more sustainable climate. BMO contributed to a framework for investors to help integrate the impact of climate change into their investment decisions. This resulted in a document called “Climate Change Investment Solutions: A Guide for Asset Owners.”1
Financial regulators are also becoming increasingly involved. France passed its Energy Transition Bill in the summer of 2015, which includes requirements for certain institutional investors to prepare a carbon footprint, ensure their investment processes incorporate climate risks and describe how their investments are aligned with a 2º C economy. The Bank of England published a report in September 2015 on the risks the insurance sector faces from climate change. The Financial Stability Board and the European Central Bank are now conducting assessments of impacts of climate change on financial stability.
Disrupters and disruptees
While globally, the political path to action has been far from smooth, forward-looking businesses — spurred by national government actions, and seeing the future opportunities from the energy transition — have been investing in solutions. With the scaling up of renewable energy and clean technology deployment has come a dramatic reduction in costs, which means that the need for costly public subsidies is fast declining. The deployment and cost reductions of solar has been particularly dramatic. Last year, around 170 GW of solar capacity had been installed, compared with the IEA’s prediction back in 2007 of 20 GW. Costs have fallen by around 90% compared to 2008. Other technologies are also becoming cheaper. This has been particularly so with battery storage (a 60% cost reduction in the last 3 years) which would allow renewables to overcome the intermittency issue (i.e., not providing power on demand).
The deployment of these technologies will have profound consequences to incumbent companies even at moderate penetration rates. A good example of the disruptive impact is the European utility sector, which has over the past five years lost half of its one trillion euro market value. Weak energy demand, and a growth in output from renewable sources, led to a price collapse in wholesale electricity markets across Europe. The largest 12 utilities in the European Union (EU) have only five percent market share of renewable energy generation (excluding hydro power). This means that they are not benefiting from the new technology trends.
Our engagement with the utility sector has focused on ensuring the changing dynamics within the sector are being integrated into company’s strategic planning. The decision of the German utility E.On to split the company into conventional power generation (to be called Uniper) with E.On itself focusing on renewables, grids and energy services going forward is the most notable example to date of this being put into practice. We are now seeing nearly all utility companies in Europe reworking their corporate strategies and putting a stronger focus on their renewables and energy services divisions.
The debate with the oil and gas sector, which we described in our previous Viewpoint,2 also focuses on the fundamental question of the future business model in an industry where the core product may be under threat.
As well as engaging with companies, BMO’s Governance and Sustainable Investment team has worked primarily through the IIGCC to engage with policymakers on climate change. We drafted the letter sent to G7 and G20 finance ministers highlighting the nature of climate risk and the role finance ministries have in giving climate negotiators the necessary mandate to achieving a binding climate deal. The letter attracting the support of 120 finance CEOs, contributed to the momentum behind the G7 announcement of its intention to decarbonize the global economy within this century.
Other activities included:
- Traveling to Brussels to discuss with Members of the European Parliament, the European Commission and country representatives around the need for integrating the EU’s climate goals into the structure of the European Fund for Strategic Investments (the Juncker Plan), as well as the need to reform the EU Emissions Trading Scheme in order to remove the large surplus of allowances in the market.
- Contributing to a paper on the issue of climate finance,3 which highlighted policies and tools that can be employed to improve the risk-return ratio of investments in infrastructure in developing and emerging economies; this was shared with Angela Merkel’s office as part of her G7 chairmanship.
Our engagement on climate change in the run up to the Paris negotiations has focused on two main workstreams: the first focusing on corporates and ensuring they are integrating climate risks within their strategies, and the second targeting policymakers to make these changes come about. While the Paris meetings are without a doubt important, we see the more significant development as the technological revolution underway in energy systems, which we believe will only continue even if global policy efforts fall short of what is being hoped for.
From an investor point of view, once the Paris meetings are over, the question will remain about how to meaningfully integrate climate change into investment portfolios. Much of the focus to date has been on risk — on divestment or cutting down the carbon footprint. If the Paris meetings send a strong signal that the ‘green’ industrial revolution is set to continue, then the smart investor may switch their attention to looking at the opportunities this could bring.
2 ESG Viewpoint, “Stranded Assets: Planning for a carbon constrained world,” June 2015