Outlook 2017: Paris Agreement focuses minds
The speedy ratification of the COP21 climate change deal cements the investment relevance of action against global warming, reports Susanna Rust
At a glance
•It is a year since the COP21 agreement on climate change was brokered in Paris.
•The agreement cements climate policy action as a reality businesses and investors have to take it into account.
•The drive to limit global warning is increasingly being recognised as a source of opportunities as well as risks.
•Renewables are forecast to grow more rapidly than previously assumed.
In November, less than a year after it was brokered at the 21st Conference of Parties (COP21) in the French capital, the Paris Agreement on climate change came into force.
It commits signatories to follow through with their pledges to help contain global warming to within 2°C of pre-industrial levels.
The deal has been hailed by many as a diplomatic success and its rapid ratification as unprecedented.
David Lunsford, co-founder at Zurich-based equity research firm Carbon Delta, says that the pace at which governments have moved to support the Paris Agreement “has probably surprised almost everyone involved in the policy-making process”.
“It’s been decades since such a profound international treaty has come into force,” he adds.
The agreement’s rapid adoption, it is said, means that the shift to low-carbon life on Earth is well and truly under way, even if it is only the beginning and neither the trajectory nor the outcome can be known.
From an investment perspective, it lends more weight to the ‘stranded asset’ narrative that has become so prominent in recent years (and, in somewhat circular fashion, also helped fuel the Paris Agreement).
Pascal Dudle, head of global trend investing at Vontobel Asset Management, says: “The Paris agreement aims to contain global warming within a two degrees rise from pre-industrial levels, which will trigger tighter regulation.
“It’s highly probable that a price on carbon emissions will accelerate the transition towards a low-carbon economy, segregating a few winners from the many losers.”
The agreement would also seem to close the door on any scepticism about climate change in practical terms. It cements climate policy action as a reality that businesses and investors need to take into account. This applies in their search to secure market share and profits or, in the case of pension funds, to be able to pay pensions.
“The finger pointing is over and action becomes the new centrepiece,” says Lunsford.
“At this point, companies and investors don’t need to decide if climate change is a material risk or what exactly its value is,” he adds. “We have consensus that governments will introduce legislation to mitigate climate change and enough research shows that climate risks could be huge, so it doesn’t really matter if climate change is actually taking place at a slightly faster or slower pace from one year to the next.”
He emphasises that the COP21 deal is not merely an international agreement, but one that is underpinned by national level action plans – Nationally Determined Contributions (NDCs), in COP21 parlance.
“The NDCs are where it gets really interesting,” he says. “Over the coming years you’ll see these plans being fleshed out into real policy proposals – if they aren’t already – and this means that companies and investors should starting taking notice right now.”
And it is not even just about the Paris deal. In October an international agreement was reached on greenhouse gas emissions from aviation, a sector that was left out of the COP21 deal, and there is pressure for similar action in the shipping sector.
Some caution against reading too much into the COP21 accord, even though it is a positive development.
Lucas White, equity portfolio manager at Boston-based fund management group GMO, says the Paris Agreement “certainly is an important step in the right direction” but that the immediate impact may be limited because of the agreement’s dependence on self-reporting and the lack of an enforcement mechanism.
“Longer term, we expect that more substantive agreements will push further progress,” he says.
Where does this leave investors? Meryam Omi, head of sustainable investment at Legal & General Investment Management, says: “The Paris Agreement was a pivotal moment for governments and investors to begin seriously thinking about climate change and policy directions.
“Our clients have increasingly been asking about the opportunities and risks posed by policy and technology shifts, particularly the impact these changes could have on investments,” she adds.
Vontobel’s Dudle suggests there is a long way to go in terms of investors’ thinking on climate change.
“While climate change has been a hot topic for years, the investment community still treats it as irrelevant as yesterday’s weather forecast,” he says.
Still, some investors have been considering the risks brought about by climate change-related impacts for some time. Indeed, in coalitions like the Institutional Investors Group on Climate Change (IIGCC) they have long been pushing for meaningful public policy on climate change.
So far, investment practices linked to climate change have centred on managing risk, in the sense of protecting portfolios from the potential devaluation of carbon-based assets.
Carbon footprinting, divestment, portfolio decarbonisation – for example, via low-carbon equity indices, and shareholder activism are some of the measures adopted in this context.
Attention has been concentrated on energy companies and heavy energy users. Environmental data and analysis organisation CDP carried out analysis of the extractives, steel and cement sectors, for example, concluding that 15% of earnings in the extractives industry are at risk from regulation associated with the Paris Agreement.
But investment thinking and behaviour are evolving, in that the fight to limit global warming is also increasingly recognised as a source of investment opportunities rather than just risks.
The IIGCC, for one, intends to expand its work on “the opportunity agenda” and the scaling up of investment into low carbon, which will be needed if the Paris Agreement targets are to be met. For example, the European Investment Bank estimates there is an annual investment gap of €100bn to upgrade Europe’s energy networks, to integrate renewables, improve efficiency, and ensure security of supply.
“We have a whole programme of work looking at what we call ‘solutions’, which is about enabling investors to reallocate their capital – for example, by investing in clean energy and other low-carbon opportunities such as green infrastructure,” says an IIGCC spokeswoman.
“It’s not just about risk. Investors are starting to do a lot more detailed work and thinking on how to advocate the kind of policy and the kind of business practice that will help them pursue more active investment in low carbon.”
Dudle, who is also a portfolio manager of a clean energy equity fund at Vontobel, encourages investors to steer their portfolios “to the probable winners” from the transition towards the low-carbon economy rather than worrying about dumping “the high-carbon emitters [that] are now thought to be the losers from this development”.
The probable winners, according to Dudle, “are companies that offer products and services that can avoid emissions”, often known as clean tech companies.
“The titans of the energy industry still have decades to go,” he says, “but if a price is placed on carbon emissions one day, it will provide a powerful tailwind for solutions to avoid emissions.”
In a move that would seem to back up this argument about investment opportunities associated with climate change, the International Energy Agency in October said it was “significantly increasing its five-year growth forecast for renewables, thanks to strong policy support in key countries [US, China, India and Mexico]”.
Last year’s agreement in Paris and its rapid entry into force show that policy-makers are getting serious about climate change. This is a reality that corporates and investors will need to grapple with for some time to come.