Liontrust Asset Management : COP26 – the good, the bad and the moderate

With the book now closed on another COP event, debate has moved on to tallying up what the latest Climate Change Conference of the Parties actually achieved and whether it lived up to the considerable hype.

On the latter, the answer is an inevitable no but we have always said anyone expecting a single event to solve climate change should prepare for disappointment - and ultimately find some good, some bad and some moderate in our COP26 stock-take. Despite Glasgow ultimately flattering to deceive, however, we continue to believe tightening regulations to reduce Greenhouse gas (GHG) emissions are inevitable and the world will see huge disruption as the energy transition develops.

For those disillusioned by this latest event, it is worth looking back at 2009's COP15 in Copenhagen, which was widely deemed a washout apart from introducing the broad target of keeping maximum temperature rises to below 2 degrees compared to pre-industrial levels. At that point, when widespread acceptance of the science behind climate change was still some distance away, average global temperatures had increased around 0.8°C from the 1880 baseline and were on the way towards a 3.5°C rise by the end of the century. If anyone is thinking these are small numbers, a degree here and there can mean the difference between another ice age or not.

If we fast forward to 2015, COP21 in Paris is seen as the most successful so far, in that we finally saw a formally agreed goal to limit average rises to under 2 degrees, and ideally less than 1.5, by 2100. Countries were also asked to submit commitments on emissions reductions by 2030, called Nationally Determined Contributions (NDCs), to be reviewed five years later at COP26.

By that stage, the average temperature rise had already moved up by 1°C but the seminal Intergovernmental Panel on Climate Change (IPCC) report, published in October 2018, still shocked many with its conclusion: to meet the 1.5 degree target and stand any chance of keeping climate change manageable, we needed to halve absolute emissions by 2030. Even the most optimistic pledges and targets post-Paris still only put us on track towards a 3°C rise.

As with any such event, this year's COP in Glasgow faced many of the traditional sticking points: funding, of course, but also emission inequity between developed and developing countries - and the fact more vulnerable nations tend to want the fastest action - and a rapidly closing window for action as we approach 2030. This meant keeping 1.5 degrees alive and galvanising the pace of change were the central aims for the conference, in addition to protecting communities and natural habitats, mobilising finance and working together.

Starting with the positive side of the ledger, unprecedented levels of press coverage have certainly raised awareness of climate change and there were voluntary commitments on reducing methane emissions (30% by 2030), halting deforestation (albeit muddled by Indonesia apparently agreeing to this deal only to call it unfair days later) and the Glasgow Finance for Net Zero Initiative. Wording on stopping fossil fuel and coal development has also gone into the draft text for the event and, most encouragingly, the NDCs outlined in Paris now have to be revisited annually as opposed to every five years.

As for the bad, we saw a Global Coal to Clean Power Transition Statement signed by more than 190 parties but this was watered down at the last minute by China and India and we remain in a position where countries including the US, Japan and Australia are still not fully committed to phasing out coal. There are also continued delays around the pledged $100 billion a year to tackle climate change, with this failure particularly challenging for so-called least developed countries, which need more of this money to fund infrastructure and technology.

Elsewhere, for all the pledges and promises on decarbonisation, we feel much of this ambition lacks shorter-term targets and a credible way of halving emissions by 2030. It is also difficult to look past the fact that the largest single delegate cohort at COP26 comprised 500 lobbyists from the fossil fuel industry.

Finally, we come to the moderate: as outlined, the central goal of COP26 was to keep 1.5 degrees alive and it is - just about. The world has now moved up to 1.2°C warming and if we consider the most optimistic scenario, which assumes full implementation of all announced targets including net zero, long-term strategies (LTS) and NDCs, we would be under the Paris target of 2 degrees, at 1.8°C, by 2100.

Taking a more pragmatic view, real-world action based on current policies would see us well above the Paris Agreement by that point at 2.7°C, which suggests growing urgency at the remaining Climate Change COPs running up to 2030 - starting at next year's 27 in Sharm El-Sheikh - and those tightening regulations to reduce emissions globally over the next few decades.

As with many of the figures underlying our sustainable investment themes, data on climate change - particularly that current 1.2°C increase in average global temperatures - are alarming and the trajectory of GHG emissions does not look to be turning, with atmospheric carbon dioxide still rising. The world will continue to depend on plentiful, cheap energy for our modern way of life and we currently get 80% of primary energy from fossil fuels, which, tellingly, is still measured in terms of tonnes of oil equivalent.

Under the surface, however, there is evidence of an ongoing energy transition and we always stress that change is both non-linear and tends to happen quickly: once a better, cheaper alternative is found, it displaces the incumbent rapidly. GHG intensity has been falling across major economies over the last 30 years, with the greatest progress inChina where emissions per unit of GDP have more than halved.

Meanwhile, innovation and scale have driven down the cost of renewable technology, from solar, to wind, to lithium-ion batteries, translating into exceptional demand growth. From being prohibitively expensive a decade ago, solar energy is now the lowest-cost option available in the US, cheaper even than fracked natural gas. Alongside this demand growth for renewables has come demand destruction for high CO2-emitting areas: coal-fired electricity generation in the US has fallen 61% since 2008, for example, and dropped below nuclear in 2020 in terms of energy share.

In the Liontrust Sustainable Future investment process, we talk about an interlinked pyramid of actors driving structural shifts, with a combination of science (bringing greater understanding of an issue), society calling for change and governments setting policy and regulation, and finally businesses developing and distributing solutions. From our perspective as investors, these companies tend to have two advantages that are misunderstood by the wider market: strong growth and less competition.

There has been disappointment about a lack of progress at COP26 but our view is that all parts of the economy - government, companies and individuals - are ratcheting up their ambition in an iterative, interdependent process. As society demands greater action and businesses show what can be done, governments have the leeway to increase their decarbonisation targets. And so it goes.

Encouragingly, the path to zero carbon does not require amazing new inventions: we are on the way towards 25% more solar energy, 60% of global car sales being electric and all new buildings being zero carbon ready by 2030, for example. As US science fiction writer William Gibson said, 'the future is already here, it's just not evenly distributed', and we feel companies on the right side of the energy transition and providing lower-carbon solutions should benefit as this distribution improves.

As we have stressed since launching the Liontrust Sustainable Future funds in 2001, the required reduction in carbon emissions will impact the whole economy, including our energy system and how we heat and cool buildings, while also driving transformations in transport, industrial processes, agriculture and land use. Many of our sustainable themes are therefore linked to the shift away from fossil fuels, including energy and industrial efficiency, renewable energy and more circular economies, but also how we build our cities, how we feed ourselves and how we finance the investment needed to enable a rapid transition.

This move to an ultra-low carbon economy will also have a considerable impact on investment returns: companies contributing to the shift should prosper while those on the wrong side of the transition, or not confronting its ramifications, are at risk of secular decline. We continue to invest in the winners, avoid the losers, and engage with companies to encourage more ambitious decarbonisation targets as part of our 1.5 Degree Transition Challenge (for more on the latter, see the attached report).

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Key Risks

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Disclaimer

This blog should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Examples of stocks are provided for general information only to demonstrate our investment philosophy. It contains information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content of this document, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. It should not be copied, forwarded, reproduced, divulged or otherwise distributed in any form whether by way of fax, email, oral or otherwise, in whole or in part without the express and prior written consent of Liontrust. Always research your own investments and if you are not a professional investor please consult a regulated financial adviser regarding the suitability of such an investment for you and your personal circumstances.

Wednesday, December 8, 2021, 12:48 PM