By Stephen Metcalf and Frédérique Carrier
We believe 2021 will see a new impetus for policy and action on climate change as two factors converge: the U.S.’s renewed commitment to the cause under Joe Biden’s presidency and the Democrat-controlled Congress; and the 2021 United Nations Climate Change Conference, also known as COP26. Recent extreme weather in the U.S. stretching from the Upper Midwest down to Texas, just the latest in a growing string of once-in-several-hundred-year climate disasters, is a stark reminder of the pressing need to tackle this issue. We look at the implications of climate change for portfolio management.
A new beginning
As pledged during the campaign, the Biden administration is treating climate change as a top priority. One of Biden’s first acts after his inauguration was to rejoin the Paris climate accord via executive order. Former President Donald Trump had exited this treaty, which binds nearly 200 countries to do their utmost to prevent the global temperature from rising 2 degrees Celsius above pre-industrial levels by committing to reduce their carbon emissions.
There are many other potential proposals to curb climate change that could come before Congress. Their prospects for adoption may depend on whether a proposal needs 51 votes (i.e., a party-line vote) or 60 votes (i.e., Republicans crossing party lines) in the Senate. For instance, tax breaks for wind energy, solar power, and electric vehicles and their recharging stations can be included in a “reconciliation bill,” which would require only 51 votes and is likely to pass as part of a long-term Biden agenda. By contrast, legislation regulating energy production would require 60 Senate votes and is less likely to gather the requisite bipartisan support, in our view.
Still, that the U.S. has prioritised climate change and rejoined the Paris Agreement is important for the overall global commitment to the effort. Because such a powerful player had previously opted out, many countries were reluctant to take the tough steps to curb global warming, calculating that the global effort would fail. In essence, why make sacrifices if others don’t?
Biden entered the White House with a much larger mandate on climate than any of his predecessors as the issue has gradually garnered more support among Americans. According to a January 2020 survey by the Pew Research Center, nearly two-thirds of U.S. adults think protecting the environment should be a top priority for the president and Congress. This is up considerably since 2009 and the start of the Barack Obama administration, when the corresponding figure was 41 percent.
This year will also see the UK host the COP26 summit in November, the most significant conference on climate change since COP21 in 2015, which led to the Paris accord. Accordingly, we expect to see an increase in policy commitments from national governments throughout the year.
More than 125 countries that account for some 60 percent of total global emissions have already announced some target for “net-zero” emissions, which is seen as a key tool for meeting the commitments of the Paris Agreement. This essentially means that any new carbon emissions will need to be offset by the removal of these gases already in the atmosphere—by planting new forests, for example, or building out other emerging carbon capture technologies. In order to meet the goal of limiting global warming to 1.5 degrees Celsius, scientists from the Intergovernmental Panel on Climate Change have calculated that the world would need to reach net zero for CO2 emissions by 2050, and for all greenhouse gas emissions sometime between 2063 and 2068. Greenhouse gas emissions include not only carbon dioxide, but also methane, nitrous oxide, and fluorinated gases. This will require significant reductions in gross emissions, through conventional mitigation techniques such as the substitution of renewable energy for fossil fuels, as well as greater use of carbon removal technologies such as carbon capture and storage.
The problem is that politicians are happy to set long-term targets, aiming to be at net-zero emissions in 2050, knowing they are unlikely to be running for re-election then, but they are very reluctant to make the necessary policy adjustments in the short term when the political cost could be high. For example, in the UK, fuel taxes have not been raised since 2011. Additionally, many countries’ current commitments have not yet been signed into law, and remain just proposals. As a result, a number of forecasting models suggest that based on current national short-term carbon emission reduction goals, the average global temperature is on track to rise by as much as 3 degrees Celsius.
Fortunately, the Paris Agreement, signed in 2015, includes a “ratchet mechanism” that requires the signatories to come forward with more ambitious short-term national climate goals every five years, taking into account the technological, economic, and social progress in the intervening years. This means some sort of convergence amongst net-zero commitments is likely at COP26, and for these to be formalised in each countries’ individual climate action plan, known as “nationally determined contributions” (NDCs).
We expect countries to announce new, enhanced NDCs at COP26 this November, and to flesh out their short-term plans in greater detail. This and the Biden presidency’s commitment to fight climate change should add momentum to the efforts to curb global warming.
The cost of no action
The consequences of climate change are well documented. From increased frequency of extreme weather events to rising sea levels and ocean acidification, the physical effects are potentially far-reaching. The climate-migration nexus will likely become a substantial challenge as well. The UN forecasts there could be anywhere between 25 million and 1 billion environmental migrants by 2050 as people are displaced due to intolerable heat effects on agriculture, or from rising sea levels inundating coastal areas where 40 percent of the world’s population lives.
Beyond these, there is also an economic toll. Studies conducted by the U.S. National Bureau of Economic Research have identified significant economic risks should global temperatures continue to climb. For the U.S., those risks range from a 10.5 percent decrease in GDP per capita if no action is taken worldwide to a nearly two percent decline even if the commitments in the Paris Agreement are met.
There is now a growing consensus that a successful climate transition is necessary to build more resilient economies.
The need for government action …
Part of the solution is to decrease economies’ reliance on carbon fuel. This requires the dual involvement of governments via policy support and regulation and the private sector with its capacity for innovation.
As the activities that cause climate change are deeply ingrained in the foundations of our economies, governments need to ensure that mitigating measures are broad enough and sufficiently planned to be effective over the long term. Governments must also see that support is given to those industries that need to transform into greener propositions as well as to nascent green alternatives.
One of the best examples of the effectiveness of government action to curb climate change is Germany’s solar energy subsidies. In the early 2000s, at a cost of some €200 billion over eight years, the German government guaranteed the price per megawatt hour sold from any installation at €457, about five times the cost of generating electricity from coal at that time. As other countries followed suit, the global market for solar panels expanded by more than 30 times, and the price of a solar panel fell to about a sixth of what it was in 2004 and has continued to decline ever since. In good weather conditions, new solar power installations can generate electricity at a lower cost than that generated from fossil fuels without needing subsidies to do so.
Likewise, the cost of wind power has dropped dramatically, powered by larger, more numerous installations worldwide and rapidly improving technology. Here too, government subsidies often provided the initial impetus. More will be needed.
… enhanced by private sector innovation
The private sector also needs to do its part given the 2050 targets are so ambitious. Only through innovation can they be hoped to be achieved. Much like the way personal computers revolutionised the world and our daily lives, and how new vaccines were developed in record time to help tame the COVID-19 pandemic, innovation is the key to solving our climate issues.
As RBC’s CEO Dave McKay remarked in his review of Davos 2021, “entire sectors will emerge—or be remade—through the 2020s as consumers look for technology to transform their lives, and governments spend trillions to lay the groundwork of a new economy.”
He is not alone. Larry Fink, founder of BlackRock, the world’s largest fund manager, urges CEOs in his annual letter to see climate transition as an opportunity—but not just for the climate. He calculates the world will need $50 trillion in new investments by 2050 to meet the net-zero goals, creating new technologies and new industries.
With industry, buildings, and transport the top three producers of emissions, together accounting for close to 60 percent of the total, many innovations focus on reducing emissions in these areas. Well-known examples of technologies that could go a long way to decarbonising the world include the rapid growth of renewable energy supplies and electric vehicle manufacturing.
There are also new technologies that are not quite mainstream yet, which show promise but need scale to help achieve a cooler planet. One is carbon capture and storage—whereby carbon dioxide emissions from industrial processes are seized, transported by ship or pipeline to a storage site, and deposited underground in geological formations. This technology could help industries achieve net-zero targets by offsetting emissions produced.
For buildings, one promising approach that dramatically cuts fossil fuel consumption uses geoexchange technology for heating and cooling. These systems are currently being used in Toronto to help new condos comply with the Toronto Green Standard, which calls for new buildings to have close to zero carbon emissions by 2030. Geoexchange draws heat and cooling from the ground, taking advantage of the earth’s constant temperature a few feet beneath the surface. In the winter, a fluid circulating through loops buried underground absorbs heat from the earth and brings it to the building. In the summer, the process is reversed. While the technology is expensive to install, it frees up valuable leasable space as bulky cooling towers, required for traditional heating/cooling systems, are no longer needed. That space can be used for penthouse suites or rooftop gardens. Some five percent of new condos in Toronto employ this new system, double the percentage of five years ago.
It is generally thought that perhaps 75 percent of the energy produced by human endeavours is lost as waste heat. Mechanical means of recapturing lost energy from industrial processes have long existed. Carbon taxes and emission reduction targets have spurred renewed interest in these sorts of installations, while newer applications and technologies are expanding the potential for utilising this vast unused resource for non-industrial purposes—e.g., data centres and commercial/residential buildings. Heating/cooling and power costs constitute the largest operating expense for most buildings. Increasingly, waste heat recapture installations are built and managed by third parties, often utilities, who sell the power back to buildings at attractive rates.
Additionally, “Smart City” technologies are already being deployed in cities such as Singapore. They aim to ensure that every watt of energy is utilised as efficiently as possible at any given moment. Such processes optimise data management and involve the development and expansion of 5G technology, the fifth generation of broadband cellular networks, which can connect smart electric grids to billions of data points—from rooftop solar panels to Internet of Things-based home appliances. Processing all this data, in conjunction with artificial intelligence-led local weather forecasts, can enhance efficient energy use.
Climate change is a risk investors need to prudently consider, as it can, for example, imperil supply chains, or cause unexpected financial liabilities or losses. We pointed out in a recent article that environmental, social, and governance (ESG) analysis has an important role to play in risk mitigation. As Habib Subjally, head of the global equities team at RBC Global Asset Management, suggests, “[for many companies] ESG also drives important risk mitigation with respect to regulators, reputation, the stability of supply chains, etc. For example, a company that has developed an understanding of the potential impact of climate change on its end markets, suppliers, employees, and facilities—and has a plan for dealing with it—is, in our view, a less risky investment than one that hasn’t.”
But beyond mitigating risks, there are opportunities. Investing in innovative technologies that have the potential to help decarbonise the environment and the economy can be done both at the stock level and through funds. At RBC, we refer to the combination of sustainability and technology as “SusTech,” and over the course of this year we will delve more deeply into this theme, looking in some detail at solution providers for the green economy.
Investing in solution providers, those companies that develop products and services to be used to adapt to or mitigate climate change are interesting investment opportunities in their own right and are perhaps the most direct way for a portfolio to gain exposure to these changes.
Short-term commitments are insufficient
Select countries’ short- and long-term commitments
|Short-term commitment/||Action plan||Long-term|
|Climate Action Tracker NDC rating*|
|Reduce greenhouse gas (GHG) emissions by 30% from 2005 levels by 2030||Net-zero carbon emissions by 2050||Insufficient|
|Carbon emissions to peak in 2030||Net-zero carbon emissions by 2060||Highly Insufficient|
|Reduce GHG emissions to 50%–55% of 1990 levels by 2030||Net-zero carbon emissions by 2050||Insufficient|
|Reduce GHG emissions to 26% below 2013 levels by 2030||Reduce GHG emissions by 80% from current levels by 2050 (base year not specified)||Highly Insufficient|
|Reduce GHG emissions by at least 68% by 2030, compared to 1990 levels||Net-zero carbon emissions by 2050||Insufficient|
|Reduce carbon emissions by 50% by 2035||Net-zero carbon emissions by 2050||Critically Insufficient|
** Canada has committed to review its national short-term targets by 2025.
Source - RBC Wealth Management, https://climateactiontracker.org/
Non-U.S. Analyst Disclosure: Stephen Metcalf and Frédérique Carrier, employees of RBC Wealth Management USA’s foreign affiliate RBC Europe Limited, contributed to the preparation of this publication. These individuals are not registered with or qualified as research analysts with the U.S. Financial Industry Regulatory Authority (“FINRA”) and, since they are not associated persons of RBC Wealth Management, may not be subject to FINRA Rule 2241 governing communications with subject companies, the making of public appearances, and the trading of securities in accounts held by research analysts.