The number of governments, businesses and financial institutions with a net zero climate target is growing steadily. Many investors realise that the climate transition will lead to material market shifts that they need to prepare for. But a lot of them also see that they have a key role to play in stimulating the climate transition.
Investors who recognised this and accordingly set climate goals at an early stage, are showing that it is possible to achieve substantial reductions in greenhouse gas emissions in portfolios without sacrificing financial results. ACTIAM has, for instance, managed to reduce the scope 1 and 2 CO2 intensity of its portfolios by more than 35% over the past 10 years. However, if you compare these encouraging results achieved by the early visionaries with global trends in greenhouse gas emissions, you immediately see that the world as a whole is not yet moving in the right direction. Indeed, we are still a long way off the international target of a 1.5°C average temperature increase.
A hopeful sign in this regard is that more and more governments and businesses are committing to a net zero climate target. Now is also the time for investors to set themselves the same goal and devise a strategy to achieve it. It is now sufficiently clear which instruments they will need to use in order to do so. This article notes that many investors have the right focus, but that it is also important for them to look beyond the energy transition. Achieving net zero emissions will need more than just renewable energy and energy efficiency, which is something that investors must also anticipate.
FOCUS ON ENERGY EFFICIENCY AND RENEWABLE ENERGY
Investors with a net zero climate target tend to focus on promoting energy efficiency and renewable energy. We see this clearly in the demands they are making on companies. Individual investors or collective initiatives such as the CDP and Climate Action 100+ are calling on hundreds of companies to formulate climate targets and to develop strategies for the energy transition. The number of climate resolutions adopted at annual meetings has also increased rapidly in recent years, and more and more investors are working together to encourage companies to take measures (for example https://www.sayonclimate.org).
Although many resolutions have not yet been adopted, the number of shareholders voting in favour of them is rising rapidly; see chart below. It is also becoming increasingly clear that many resolutions do not need to be put to the vote because companies are already adopting the recommendations put to them. The fact that investors are devoting attention to this is a good sign. But it is also important to look at other, potentially impactful market developments connected to climate change that receive a lot less attention from investors and the media. We will discuss three of these below.
Number of climate resolutions in the United States
Source: Horster en Papadopoulos, 20191.
DEVELOPMENT 1: OPPORTUNITIES FOR REDUCING THE SYSTEMIC RISKS INHERENT IN THE ENERGY TRANSITION
Many clean technologies can already compete with old, polluting technologies. Some recent developments include solar and wind energy, which is already competing with electricity from fossil sources; rapidly falling prices of electric cars due to the drop in battery prices; decreasing costs of hydrogen, and ever cheaper solutions for the chemical recycling of plastics, meaning a diminishing need for oil and gas for the production of new plastics. These examples show that producers cannot achieve the necessary market breakthroughs on their own. It will require infrastructure and cooperation between the parties in the chain as well as with governments.
- Dow Chemicals and ArcelorMittal can make the switch to hydrogen in Zeeland (the Netherlands) and Flanders (Belgium), provided that the supply is secured. Ørsted is developing plans for this, but it will have to work with governments and port operators to create the necessary infrastructure.
- With governments setting stricter emissions standards for cars and with carmakers also announcing the phasing out of petrol and diesel car production, the question is whether companies will be able to install enough charging capacity in time. Producers of charging infrastructure are expected to grow rapidly in the coming years.
- Chemical recycling is becoming less and less expensive, potentially leading to less demand for oil and gas for new plastics. Creating a circular plastics chain requires cooperation with waste companies and governments. Plastics manufacturers such as Amcor, Berry Global and Sealed Air are investing in chemical recycling and in waste collection together with supermarket chains such as Tesco and waste processors such as Suez and Veolia as well as governments. However, current rules on the use of recycled plastic for food packaging or the international transport of plastics are hampering progress in this regard and perpetuating the status quo.
These examples show that companies cannot do it all alone. Changes in regulations, cooperation between parties in the chain, new infrastructure and large-scale investments are needed. There are a lot of opportunities for investors to contribute to the energy transition, but systemic changes are often needed in order to achieve major breakthroughs. Given that investors have contact with all the relevant parties, they can act as a catalyst and simultaneously benefit from the expected growth.
DEVELOPMENT 2: A REVOLUTION IS TAKING PLACE IN THE AGRICULTURAL CHAIN
While improving energy efficiency and switching to renewable energy is already a global challenge, it is not enough. Fossil fuels account for about two thirds of total greenhouse gas emissions; see chart below. A significant amount of emissions also come from our food chain: from intensive land use, deforestation, draining of peatlands, animal husbandry, fertiliser use, overfishing and harmful fishing methods. Although demographic trends will continue to generate increasing demand for meat, food and soft commodities, we are slowly but surely seeing the outlines of changes that could shake up the market.
Distribution of global greenhouse gas emissions
Source: IPCC (2014)6
We can see a shift towards a more service-oriented approach, specifically from product-oriented to an information-oriented approach, in a number of agribusinesses. Bayer, for instance, is working on plans to help farmers apply crop protection products with precision, taking into account weather and soil conditions (thus reducing water pollution and health risks), rather than charging them by the tonne. Lely, a family business, has opted not only to sell milking robots and feeding machines but also to analyse data to match the quantity and quality of feed to the needs of dairy cows (resulting in better milk and fewer methane emissions).
Agricultural machinery manufacturers such as John Deere and AGCO are also helping farmers to use their machines more efficiently and apply precision farming based on agricultural data. There are now also drone suppliers that enable irrigation water and crop protection products to be better adapted to crop needs. All these developments will reduce agriculture-related greenhouse gas emissions and offer attractive opportunities for investors.
We also see meat processors taking steps. The livestock sector is certainly under pressure in Western countries due to its contribution to methane and nitrate emissions as well as deforestation, which are three major causes of climate change. JBS’s recent acquisition of Vivera is emblematic of a series of takeovers of meat substitute companies by traditional meat processors. Other examples are the takeover of De Vegetarische Slager by Unilever and investments by Bell Group in Mosa Meat and Hilcona. These takeovers reflect a shift in thinking in the meat industry. In many Western countries, meat substitutes are a growth market. ING Bank estimates revenue growth from € 4.4 billion in 2020 to € 7.5 billion in 2025, although the meat sector's growth prospects are limited, partly due to increasing pressure on the sector to reduce its contribution to climate change. Meat processing companies are making these acquisitions in preparation for inevitable market changes, thus also reducing investor risks.
ACTIAM’s net zero climate target
ACTIAM’s aim is to reduce the net greenhouse gas emissions of its investments to zero by 2050. This is important not just to achieve the Paris Agreement climate targets, thus keeping global warming to a maximum of 1.5°C, but also to manage the climate risks entailed in its investments. Since the scope for preventing greater warming is rapidly diminishing, rapid reduction will be needed over the next 10 years. ACTIAM has therefore set interim targets of a 50% reduction by 2030 and 75% by 2040 compared to 2020. It has a clear strategy for achieving them.
Greenhouse gas emissions reduction target pathway for ACTIAM
DEVELOPMENT 3: A MARKET FOR NATURE AND BIODIVERSITY
A third development, although still a modest one, is investment in reforestation and soil restoration. Most climate scenarios assume that it will not be possible to reduce greenhouse gas emissions all the way to zero. Some emissions will remain. To achieve net zero emissions, however, the capacity of the ecosystem to store greenhouse gases will need to be expanded.
There are already many initiatives whereby companies or consumers offset their emissions by paying an amount per tonne of CO2 emissions which is then used to plant trees. Apart from the fact that there is not nearly enough space to offset all emissions with new forests, this market also has major problems and many regard it as so-called greenwashing. It is therefore encouraging to see that the market for restoration finance is slowly but surely gaining a foothold; see the chart below. Many projects are still small, however, meaning that this is still largely the terrain of impact investors and investment banks. However, international initiatives such as the LEAF coalition and the conservation finance solutions being developed by the WWF are trying to make such projects suitable for sustainable investors.
In addition, several clothing brands are using regenerative agriculture to reduce their footprint by increasing the ecosystem's capacity to absorb greenhouse gases. By taking such steps, these companies are trying to accommodate increasing public pressure to reduce their footprint and thus remain interesting to sustainable investors. Such initiatives are still limited, but the expectation is that the renewal of the UN Convention on Biological Diversity’s international biodiversity targets later this year will lead to an increase in investment opportunities in nature and biodiversity.
Global financing of biodiversity protection in 2019
Source: Deutz et al. (2020)13
NET ZERO TARGET: SUFFICIENT OPPORTUNITIES FOR INVESTORS
This article demonstrates that a growing group of investors is now taking climate change seriously. There are sufficient opportunities geared towards achieving net zero emissions, and changes in the market make it clear that the energy transition is in full swing. However, it is important to look beyond the major fossil fuel users. There are a number of climate-related developments that offer new opportunities for investors, requiring them to step out of their comfort zone to help initiate the necessary systemic changes and capitalise on the resulting succession of changes. In addition, the social pressure on the agricultural chain ensures that new technologies are quickly adopted and form an attractive investment category. Finally, the barriers to investing in nature, which until recently was never seen as a serious investment option, are becoming lower due to the introduction of new financing models. All these developments, however, require investors to keep their eyes wide open in order to assess the opportunities as well as the risks inherent in them.