Speaking at the University of California, Irvine graduation ceremony, the US president noted, “The question is not whether we need to act. The overwhelming judgement of science, accumulated and reviewed over decades, has put that to rest. The question is whether we’re willing to act.”
The answer is still not straightforward. There have been reams of scientific research showing that the planet is definitely getting warmer. The latest is a report from the United Nations Intergovernmental Panel on Climate Change (IPCC) which blames human activity as the major contributing factor to an increase in global emissions of greenhouse gases (GHG). They have grown more quickly between 2000 and 2010 than in each of the three previous decades and it warns that if action is not taken temperatures will jump to dangerous levels. Avoiding this scenario means cutting GHG emissions by 40% to 70% from 2010 levels by mid-century and to virtually nothing by 2100 in order to keep temperature hikes to manageable levels of 2 degree Celsius. At current rates, temperatures are on track to increase by 3.7°C to 4.8°C by 2100.
New research from the federal agency National Oceanic and Atmospheric Administration (NOAA) in the United States adds credence to these findings. It shows that 2013 was the fourth warmest year on record. Last year was also the 37th year in a row in which global temperatures were higher than the 20th century median. In addition, most of the planet’s land and ocean areas were warmer than average, or broke heat records throughout the year. Evidence of these facts can be found in, for example, Australia which underwent the hottest year on record over 104 years and Botswana and Namibia which suffered their worst drought since the 1980s.
Translating this into a financial cost is difficult and studies vary but according to the NOAA, the US experienced seven severe weather and climate disasters costing at least $1bn or more in 2013 alone, while globally, there were 41 billion dollar disasters, second only to 2010. This includes the severe floods that hit parts of the United Kingdom earlier this year, which the country’s Federation of Small Businesses estimates the cost to affected businesses to be in the region of $1.3bn.
Looking at the bigger picture, the IPPC report cautions that world gross domestic product could shrink by as much as 2% annually if global temperatures rise by a widely predicted 2.5°C. The accumulated cost of crop losses, rising sea levels, higher temperatures and fresh water shortages could mount to between $70bn and $100bn a year, at the very least, in developing countries alone.
However, despite a large and growing body of evidence for climate change, there are still many sceptics who believe that climate change is cyclical rather than systemic. In consequence, they decry any action that they regard as having no overall effect on climate but which, they say, will hurt the pockets of individuals and corporations. For example, political opinion is divided in the US over the EPA’s plan to cut 30% of emissions from US power plans over the 2005 and 2030 period. It is the most ambitious programme to date and the agency is adopting a flexible approach with each state being allowed to set targets based on their individual circumstances. Some lawmakers have rejected the Obama administration’s approach as an outright threat to the economy and there is criticism over the cap and trade system whereby the government issues emissions permits which companies can buy and sell according to their needs.
The United States already has two schemes: the Regional Greenhouse Gas Initiative (RGGI), covering nine states in the northeast and a programme in California. They have though become a proxy for broader political fights over energy and the environment. For example, legislation to introduce a federal cap and trade programme failed in Congress in 2010, and Republican opponents have said such systems create a new tax on electricity, consumers and businesses. Chris Christie, the governor of New Jersey, pulled his state out of RGGI in 2011, claiming it had no discernible impact on the environment.
The US is not alone. The European Union, home to the world’s biggest cap and trade scheme, is also facing opposition. The EU just reported its greenhouse gases in 2012 were 19% below 1990 levels but carbon prices in the nine-year-old scheme have flagged since the eurozone crisis, denting its effectiveness. In addition, countries are arguing over a plan to strengthen the system.
Meanwhile, the jury is out as to whether China will deliver on its objectives. The country’s National Energy Administration has been applauded for its efforts to lower coal's share of energy use to below 65% this year from 2013’s 65.7%, three years ahead of schedule while twelve of the country’s 34 provinces are aiming to reduce consumption of the fuel by 655m metric tons by the end of the decade. This would cut carbon dioxide emissions by 1,300m by 2020, according to research from Greenpeace. The success of the initiative will hinge on whether China can develop renewable energy such as wind and solar to complement nuclear and natural gas to displace coal power. Although this capacity can be built, it is expensive, and provincial authorities as well as industry have little incentive to switch to costlier power sources.
“The politics of climate can be challenging,” says Vikram Widge, head of climate finance and policy at the International Finance Corporation (IFC). “There was a shift away from a sense of urgency in the wake of the financial crisis but it has come back on the agenda and governments are looking to shift to a low carbon environment due to the costs incurred if we don’t invest in new technologies and solutions today. I think we will also see more activity over the next 15 months in the run-up to the UN Climate Conference in Paris next year.”
Hans Mehn, Partner at Generation Investment Management, believes that significant progress is being made but there is still a lot more to do. “In the last six years, there has been a real discrepancy between the headlines and the trend lines regarding the transition to a low-carbon economy. Leading up to 2008, there was great enthusiasm that new technologies would be able to emerge quickly to solve the climate crisis. The emotional euphoria turned to despair with the financial crisis and created a perception that green businesses could not be successful businesses. The reality has been that, in aggregate, there has been a steady drumbeat of adoption for renewable energy, energy efficiency and other solutions.
The business case has been demonstrated through a very challenging period and solutions businesses have achieved success and scale in incumbent industries such as energy, buildings & lighting, transportation, etc. However, penetration of these vast, global markets is still in the early days, and there is a long runway of adoption to be realised in order to have a significant impact on the carbon intensity of these sectors.”
The investors’ view
James Cameron, non-executive chairman of asset management and advisory firm Climate Change Capital agrees, adding, “One of the biggest challenges is that we have been pretending that climate change is an issue for the future when the evidence over the last 30 years has shown that it is a problem now. There have been many reasons for this science works by disagreement and there is political and economic power vested in the status quo. However, I think now there is a strong resolution to act on the evidence.”
Some of the world’s largest corporations have taken matters into their own hands, launching sustainability programmes to cut their own carbon footprint as well as develop new technologies. “Sustainability has become mainstream and many companies are looking at how they can create business solutions and turn it into a competitive advantage.” says Charles Perry, a director at sustainability group Anthesis-SecondNature. “In each sector, there are leading companies ranging from consumer group Unilever to retail giant Walmart as well as General Electric, M&S, Waitrose and Nike.”
General Electric started down this path before it became fashionable and has reaped the benefits. For example, an investment of nearly $2bn in research and development for sustainability innovation two years ago translated into roughly $25bn in revenue as of mid-July 2013. Meanwhile, four years ago, Walmart, the US’ largest private consumer of electricity committed to cutting 20m metric tons of GHG— equal to taking 3.8m cars off the road for a year—from its global supply chain by 2015.
In the UK, supermarkets such as M&S and Waitrose as well as the Co-op and Tesco have taken the lead, introducing programmes that set carbon reduction targets, improve water and energy usage through efficiency measures in shops and across the supply chain, as well as investment in renewable energy to power their stores.
One of the biggest challenges, according to Perry is “investors on the whole are currently not analysing sustainability. This is why the work being done by Carbon Tracker (a non-profit organisation) on stranded assets is so valuable.”
The concept is that listed oil, coal, mining and other fossil fuel companies that have embedded carbon reserves will become “unburnable” because of public policy restrictions on carbon. They account for over 10% of the worldwide equity market value. Putting this into an investment context, a study from the stranded assets programme of the University of Oxford’s Smith School of Enterprise and Environment estimates that equity divestment of oil and gas companies could range from $240bn to $600bn, and about half that figure for debt holdings out of the $12trn assets of combined US, UK and other regional public pension funds and university endowments.
To date, only a small but growing number of investors, including Rabobank, the Netherlands-based lender and Norwegian insurer and pension fund Storebrand, which has around $80bn assets under management, have divested these stocks. However, they are minnows compared with those that have stayed the course, such as CALstrs, the $176bn pension fund for Californian teachers. A turning point could be if Norway’s sovereign wealth fund, the world’s largest with over $840bn assets under management, decides to shed its fossil-fuel stocks, which comprise around 8% of its portfolio. It has recently established a working group to consider the matter.
“When assessing the risk of stranded assets, investors will be looking closely at each company’s marginal cost of production”, says Ian Simm, founder and chief executive at Impax Asset Management, which manages about £2.6bn, with about a quarter of that in the renewable energy sector across both listed equities and private equity infrastructure. “As the EPA and other agencies prepare to impose restrictions on carbon dioxide emissions, many institutional investors are rationally apportioning a higher risk premium to the ownership of some fossil fuel assets.”
Next generation companies
In the meantime, investors seem more interested in the new generation as well as more traditional companies that are mining new opportunities borne from the shift to a low carbon economy.
Simm believes there are good prospects in companies involved in renewable energy such as solar and wind, sustainable food and agriculture, and water infrastructure. It takes a global view with its top holdings ranging from US based water technology group Pall and waste management company Clean Harbour to Irish buildings energy efficient firm Kingspan Group and China Longyuam Power.
Generation, on the other hand, has a climate solutions fund that invests in small cap companies at the growth stage to high profile firms such as SolarCity, a leader in rooftop power systems and 20 year old Finnish group Vacon, a global manufacturer of variable-speed AC drives for adjustable control of electric motors, and inverters for producing energy from renewable sources. “Through this period not all businesses or solutions have succeeded, but the aggregate effort of innovation has led to increasing adoption of low-carbon solutions. Simply providing a green product is not sufficient. Successful innovators also need to deliver a compelling economic proposition to their customers with high quality products or services. It has largely been these leading business innovators who have catalysed the initial phases of the transition to a low-carbon economy since policy has been anything but consistent over the last years.”
“We are definitely seeing a growing number of opportunities and funds that invest in low carbon infrastructure and renewable energy, such as solar and wind,” says Kate Brett, a responsible investment consultant at Mercer, the consultancy. “There are also other ways investors can hedge climate risks, such as passive carbon-tilted indices, which strip out the most carbon-intensive stocks from the benchmark. In addition, there is a growing market for climate or green bonds, those issued to raise finance for environmental projects.”
These have included financing for renewable energy, energy efficiency (including efficient buildings), sustainable waste management and land use (including forestry and agriculture), biodiversity conservation and clean transportation and water. Until recently almost all climate bonds were issued by multilateral financial organisations such as the World Bank and the European Investment Bank, but there has been a recent spate of corporate activity. The most notable and the largest ever green bond, worth $3.4bn, was recently issued by GDF Suez, the French power company.
The Climate Bonds Initiative, a non-profit organisation that promotes investments to combat climate change predicts that total green bond issuance from all sectors will reach $40bn in 2014. Corporations could account for half of this figure based on issuance to date, according to ratings agency S&P.
Although supranational organisations welcome the company in the green bond market, they have also stepped up their efforts. For example, in 2013, the IFCC made $1.6bn in climate-related investments; more than ten percent of its overall commitments for the year. Projects included solar facilities in Morocco, South Africa and Latin America as well as advisory work with governments in emerging markets to develop insurance products that can safeguard farmers' assets as well as cover bank risks in order to promote increased lending to farmers. The most recent partnership was with the Centre for Agriculture and Rural Development Insurance Agency to support the development of typhoon index insurance for hundreds of thousands of its farmer clients in the Philippines.
“We are definitely seeing greater interest in climate change initiatives from emerging market countries as they become wealthier and there is a greater demand for energy, transport and houses,” says Widge. “We are also seeing examples of smart policies such as in Morocco and this is creating a shift in thinking.”