eiffel tower with green trees in foreground

By Kent McClanahan

After years of signaling its intent to withdraw from the Paris Agreement to fight climate change, the United States made the decision official on Nov. 4, 2020.

The move was made with little fanfare, namely because it was so well-foreshadowed over the past few years and because it came just one day after the U.S. presidential election. Still, it was well-noted by climate activists and, yes, savvy investors.

That's because the decision to withdraw from the agreement could have a significant economic impact for the U.S., and as such, real ramifications for investors. Shrewd investors were eyeing President Joe Biden's intentions related to the Paris Agreement with great interest and see potential opportunities in 2021 and beyond.

What is the Paris Agreement and what did withdrawal mean?

Announced at the U.N. Framework Convention on Climate Change in 2015, the Paris Agreement is essentially a pledge by participating member countries to do their best to prevent the global temperature from rising two degrees Celsius above pre-industrial levels by assessing their carbon emission profiles and committing to reducing their carbon emissions.

Under the Paris Agreement, the short-term commitment from the U.S. for 2025 was to reduce greenhouse gas (GHG) emissions from power generation to 26-28 percent below 2005 levels through the adoption of renewable energy. The long-term pledge was for at least an 80 percent reduction of emissions from 2005 levels, but there was no concrete strategy behind that commitment.

An International Finance Corporation analysis found the agreement has created a $23 trillion global investment opportunity in emerging industries, such as solar and wind, as countries participating in the agreement seek to shift energy sources in order to comply.

With the Trump administration signaling in 2017 that it would pull back from these opportunities, China stepped in. Today, China is the world's largest producer of wind and solar energy and the largest investor in green energy projects around the world. Five of the six largest solar manufacturing companies, as well as the world's largest wind turbine manufacturer, can be found in China.

China and Europe have invested significantly in their renewable power infrastructure over the last 10 years. In fact, China's investment has accelerated since the Paris Agreement. Beyond investment in actual power generation, China has also stepped up its investment in green and sustainable research. China has seen a 138 percent growth in research papers on green and sustainable science and technology since signing the Paris Agreement in 2016, according to a recent article on Nature.com. And in October 2020, China made a commitment to reach net-zero carbon emissions by 2060. China remains the largest emitter of GHGs in the world, so this is a significant development.

Studies have found significant global economic risks should global temperatures continue to increase. For the U.S., which is behind on the commitments it set forth when it joined the Paris Agreement in 2015, 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 agreement are met, say the authors of research1 on the long-term macroeconomic effects of climate change.

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Rejoining Paris

Biden campaigned with a heavy focus on combating climate change and promised to immediately rejoin the Paris Agreement once he took office.

While Biden made rejoining the Paris Agreement a central point of his campaign, it's important to understand what that means. Getting back into the agreement is easy. The U.S. simply needs to notify the United Nations that it intends to rejoin. The difficult part will be making new commitments to reduce emissions and articulating the steps it plans to undertake to meet those commitments. Agreement members are currently making plans for 2030. When the U.S. does rejoin, it will be months, if not years, behind other nations on the planning and implementation of a climate plan.

The Biden campaign published a $2 trillion, multi-year plan with the ultimate goal of moving the U.S. to 100 percent clean energy and net-zero emissions by 2050, which would quickly move the U.S. back in line with the Paris Agreement. However, it remains to be seen how much of this plan can be implemented, the level of Congressional support it would receive, and how quickly it could be put in place. Despite these headwinds, it seems evident that climate change will be a priority under the Biden presidency.

Tailwind for responsible investing

The new administration's focus on climate risks and opportunities could be a strong tailwind to responsible investing, which looks at factors beyond simple financial considerations when assessing the risks and return potential of an investment. These factors generally include environmental, social, and governance (ESG) information and can be applied to investment portfolios in a number of ways.

Socially responsible investing

One of Biden's proposals calls for the removal of all fossil fuel subsidies for U.S. oil and gas companies, which amounted to $17 billion, and without them, 45 percent of U.S. oil production would be unprofitable, research from Oil Change International says. A growing segment of investors have already removed most—if not all—of these companies from their portfolios through a practice called fossil fuel free investing. These investors have already removed this risk from their portfolio. This is an example of socially responsible investing (SRI), which seeks to align portfolio holdings with an investor's values by either removing or targeting companies whose business either violates or aligns with their values. Fossil fuel free investing may see increased interest under this proposal.

In portfolios targeting companies that align with investors' values, one area where we've seen interest is renewable energy. The U.S. has invested less in this space than other large countries, as we highlighted earlier. To transition the U.S. to 100 percent renewable energy by 2050, it will cost an estimated $7.8 trillion. However, that investment could create 3.1 million jobs and reduce U.S. energy costs by $1.3 trillion, according to a Stanford University report. If the Biden plan is implemented, we'll likely see further demand for products focused on renewable energy.

Environmental, social and governance investing

When the U.S. announced the withdrawal from the Paris Agreement, several companies declared they were “still in" and continued to operate their businesses as if the U.S. had not pulled out. Biden's plan will impact public companies operating in the U.S. by requiring them to disclose climate risks and GHG emissions. Also, the Biden plan calls for a 50 percent reduction in GHG emissions of all existing U.S. buildings by 2050. If a company has not been planning for either of these developments, it's likely it will soon have to invest time and money into meeting these requirements. ESG investors view these as risks to future cash flows for companies. On the other hand, companies that continued to monitor climate risks will likely have a plan for how to address them.

Impact investing

Impact investing is a form of investing that seeks to create a measurable environmental or social impact. The Biden plan may present investment opportunities for individuals who are looking for environmental impact. As mentioned above, China has made investment in new technology a priority. Biden's plan calls for a $400 billion investment over 10 years in new clean technology. The plan uses examples such as new battery technology, carbon sequestration, carbon-free hydrogen, zero net energy buildings, and decarbonizing industrial production of steel, concrete and chemicals. Any of these new technologies would present incredible investment opportunities as well as the positive, measurable effects that impact investors seek.

Regardless of political winds or positions, responsible investing is here to stay. We've already seen substantial global growth in this space over the past few years.

While it's difficult to know which of Biden's proposals will actually make it into law, we can assume there'll be an additional focus on environmental issues for at least the next four years. This could create opportunity for a rise in responsible investing in the U.S. market and a chance for investors to consider adding responsible investing solutions to their investment portfolios.

1. https://www.nber.org/papers/w26167

Kent McClanahan, is head of responsible investing.

This article was originally published by ImpactAlpha.