Submitted by AllianceBernstein
The United Nations Glasgow Climate Change Conference, also known as COP26, concluded in November with 200 nations signing the Glasgow Climate Pact (GCP), an agreement that could accelerate climate action and drive big carbon cuts.
The problem? There’s not necessarily muscle—or an enforcement mechanism—behind ambitious commitments. That means investors will have a key role to play in monitoring countries’ and companies’ progress relative to their pledges and holding them accountable through active engagement.
COP26 Reflects Increased Drive for Climate Action
First, the good news: nations’ sense of urgency, unity and commitment has increased with every COP summit. As a result, the GCP represents the most ambitious climate policy declaration to date.
COP26 also saw better collaboration—if not smooth sailing—compared with earlier summits. For the first time, countries unequivocally recognized the key conclusions of the Intergovernmental Panel on Climate Change (IPCC), which then formed the introduction to the GCP. (As recently as COP24, the US and Saudi Arabia had rejected the IPCC’s conclusions on climate change.)
In addition, COP26 launched several key initiatives to address greenhouse gas (GHG) emissions and accelerate the energy transition. This could translate in 2022 into stronger Nationally Determined Contributions (NDCs) that take the world a step closer to the 1.5°C target.
On the emissions front, more than 100 countries joined a coalition led by the US and the European Union (EU) to cut methane emissions by 30% by 2030. This initiative aligns with the recommendations of the IPCC published in its Sixth Assessment Report (AR6) as a path to effectively reducing GHG emissions in the near-term. According to the IPCC, methane accounts for about half of the 1.0°C rise in global average temperature since the pre-industrial age.
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Pledges Aren’t Enough
While the agreements and pledges arising from COP26 are laudable, they aren’t enough. For one, countries’ pledges for reducing carbon emissions by 2030 fall far short of the levels needed to reach the 1.5°C global warming target set by the 2015 Paris Agreement. Instead, these 2030 targets are equivalent to 2.3°C, leaving the global climate at risk, particularly for fast-rising sea levels and extreme weather events. According to the World Resources Institute, “global emissions must drop by half by 2030 to prevent the worst impacts of climate change.”
Further, huge gaps persist between countries’ more ambitious climate pledges and the tangible policy steps needed to achieve them. For instance, governments have provided little clarity about how they’ll reach their net-zero carbon targets, mostly set for 2050 to 2060, that promise to take global warming projections nearer to 1.8°C.
So how do governments plan to close the distance between their weak 2030 commitments and their net-zero ambitions? It’s hard to say. This unknown has created a significant credibility gap that requires radical collaboration among many actors to narrow.
Big Polluters Must Lead the Transition Away from Fossil Fuels
Much of the responsibility for closing this gap lies with some of the heaviest polluters: the transportation, utility and energy sectors. But the lines of responsibility are tangled. For example, the ability of the auto industry to help curb carbon emissions is contingent on the pace at which utilities shift to renewable energy. After all, the benefits of driving electric cars are limited if batteries are charged by coal-fired electricity.
At COP26, some world leaders pushed for phasing down unabated coal power. That transition is already under way, particularly among European utility companies. While unregulated, independent power producers are a bit further behind than regulated utilities, they are also working to transition away from coal to gas and battery storage facilities. In the EU, most utilities have either already exited coal or will by 2030, given the EU’s plan to be the first climate-neutral continent by 2050. This does not include Poland or the Czech Republic, two of the three European countries with the highest coal-fired installed capacity.
Most regulated utilities in the US already plan to reduce their (less economical) coal generation and to build capacity in renewables (where they expect a bigger rate base). In short, these companies are generally willing to shutter coal plants. The question is, how quickly? The timeline for transition is determined in partnership with state regulators, who must consider grid reliability, the grid’s ability to support electric-vehicle infrastructure and regional coal employment. Even so, 75% of US coal capacity is likely to be retired by 2050.
As with utilities, integrated exploration-and-production (E&P) companies in Europe are paving the way for E&P globally, by setting ambitious and science-based carbon reduction targets and by directing a material portion of their capital budgets toward lower-carbon and renewables projects. US E&Ps are maintaining production discipline for fossil fuels and have scaled back investment in new drilling. Budgets for capital expenditure increasingly include low-carbon investments, such as biofuels, hydrogen renewables and nature-based offsets.
Where Investors Can Make a Difference
With companies facing mounting pressure to invest in green capex, we expect the market for green bonds and bonds linked to key performance indicators (KPIs) to continue to surge in size and importance. But labels aren’t enough. In order to fairly assess KPI-linked bonds, for example, investors must understand how companies set and achieve sustainability targets that decarbonize their emissions along the full value chain. A forthcoming global standardization of environmental, social and governance (ESG) reporting under the International Sustainability Standards Board will aid in transparency.
In the meantime, responsible investors must determine whether a company’s climate strategies are specific and actionable; how its emissions pathway compares to its peer group; if its plans are sufficiently ambitious relative to its emissions starting point; whether its net-zero target is science-based and how it aligns with NDCs; and how its net-zero plan breakdown between near-term (2030) and long-term (2050) goals aligns with NDCs.
Lastly, active investors can—and should—play a critical role in climate action by tracking countries and companies to make sure they’re on course to deliver on their ambitious climate goals. This often entails taking a seat at the table with a company’s management team to understand the impact of ESG factors on investments, to advocate for changes in corporate behavior and practices, and to hold companies accountable as stewards of our environment.
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