Investing sustainably

Spotting companies that overhype their net-zero pledges and what it means for investors

04 April 2022

By Damian Payiatakis, London UK, Head of Sustainable & Impact Investing; Sophia Gläser, London UK, Quantitative Strategy Analyst

You’ll find a short briefing below. To read the full article, please select the ‘full article’ tab.

  • Summary
    • Some companies’ net-zero commitments may not be as good as they sound – and those that fall short face having future emissions capped, carbon taxes imposed or dealing with potential shifts in consumer behaviour
    • Finding out how ambitious – and credible – companies are in reducing their carbon emissions can tell you how likely they are to meet environmental targets that may influence future expected returns
    • We look at how investors can spot those likely to be successful in meeting these targets, and ones set to struggle
    • With no global regulation of emissions pledges in place, companies can commit to a variety of targets – but there are checklists you can use to see if their pledges to achieve net-zero carbon emissions by 2050 ring true
  • Full article

    Keeping warming to 1.5 degrees Celsius globally requires globally reaching net-zero carbon emissions by 2050. National carbon commitments to the target now cover around 90% of global gross domestic product. We examine how companies tackle the challenge of aligning policies with the emissions-reduction pathway, and point out what factors might prove worthwhile for investors to keep an eye on.

    Zeroing in on carbon emission: There is work to do and pressure on companies is high

    As highlighted in the sixth assessment report of the Intergovernmental Panel on Climate Change (IPCC), published in August 2021, carbon emissions are the main contributor to climate change1. With global emission levels at around 35 gigatonnes of CO2, aligning with the Paris Agreement goal of 1.5 degree Celsius above pre-industrial levels by the target date, is an ambitious goal.

    In looking to hit the Paris Agreement goal, 65 carbon pricing initiatives have been implemented globally, and more are likely to follow2. Additionally, almost 1,500 institutions say they will divest from fossil fuels, representing $39.2 trillion assets under management3.

    For companies, this transition generates new uncertainties and challenges. Depending on the nature of carbon pricing4, they face higher costs to tackle carbon emissions. There is also the need for investment towards stronger climate resilience.

    With most of the consequences of the shift to a low-carbon world to come, investors have a tough task in identifying which companies will be successful pioneers in following the emission-reduction pathway.

    A crucial building block in doing so will be to investigate companies’ plans to reduce emissions. Leveraging the Energy & Climate Intelligence’s (ECIU) Net Zero Tracker (NZT) dataset, we look at emission commitments for S&P 500 constituents5. The dataset is a collaborative effort involving the Energy and Climate Intelligence Unit, the Data-Driven EnviroLab, the NewClimate Institute, and Oxford Net Zero.

    The more they emit, the more they commit

    With no global regulation of emissions pledges in place, companies can commit to a variety of targets. The most common are having net-zero emissions, reducing emissions, achieving carbon neutrality, or setting a science-based target.

    Around half of the companies in the dataset disclose an emissions pledge, out of which 40% promise to achieve net zero (see chart). However, the fraction of companies with emissions pledges varies across sectors. Utilities and energy companies have above-average target rates, while real estate, financials, and healthcare are below the average target rate.
    Notably, sectors with high emissions rates, namely utilities and energy, have been under more pressure to reduce emissions. 

    Are emission targets credible?

    While setting emissions-reduction goals is important, without appropriate and immediate action they will be hard to achieve. The credibility of those set targets rests on two factors: a target’s quality or robustness, and its degree of ambition.

    Setting more robust goals

    In an effort to make emissions pledges more transparent and robust, academics and experts have developed criteria checklists that the targets should fulfil, such as the NewClimate Institutes’ Ten basic criteria for net zero transparency6 and the United Nations’ starting criteria for companies to participate in its Race to Zero campaign7

    Important quality criteria encompass government indicators, such as the existence of a publicly available plan, setting interim targets to ensure action proceeds in a timely fashion, and committing to publish regular progress reports along with holding the management accountable.

    Additionally, it is crucial to include details on the coverage of the targets, namely which gasses and emissions scopes are included in the target, and to specify to which extent offsetting is allowed. Offsetting emissions, by paying for emissions cuts or carbon removal, may simply shift emissions to other emitters (see chart).

    While having almost half of the companies in the sample committing to emission targets is far better than what’s been achieved in previous years, robustness of implementation varies.

    There is much room for improvement for companies that do not identify a plan on how to reduce emissions, including interim targets and regular reporting.

    Organisations striving for best-in-class in robustness are those including full scope emissions, not using or limiting the use of carbon offsets, and committing to account for delivering on the self-imposed targets to meeting global greenhouse gas emissions targets.

    More ambitious targets require a robust implementation

    Pledging to cut emissions in the short term is a considerable goal for large emitters, especially those with strict net-zero targets. As such, it may be sensible for such companies to aim for longer time horizons than businesses with lower emissions and simpler reduction targets (see chart).

    Analysing commitments adds information to third-party ESG scores

    Most third-party environmental, social and governance (ESG) scores have a standardised procedure for ESG criteria. Net zero pledges are voluntary, non-standardised information disclosed by a company. 

    Emissions pledges allow the evaluation of carbon emissions risk separate from other criteria that could contribute to third-party ESG scores. However, given the pledges are voluntary disclosures, it is important to carefully consider the robustness of the commitment.

    Short-term uncertainties can hide the long-run benefit of net-zero commitments

    Companies that do not align with the global-emissions-reduction pathway are likely to face a growing number of carbon-pricing initiatives, investor divestment, and potential shifts in consumer behaviour. For companies that do meet their emissions targets, expected returns in the next 10 to 30 years are likely higher.

    In the short run, however, financial outcomes may be heterogeneous. The positive effects of mitigating future carbon risk can remain masked, as initial investments, and hence costs, might be required to implement the emissions targets. Moreover, while uncertainty about future carbon-pricing regulation remains, markets can be more volatile as investors overreact to signals regarding future carbon regulation.

    For investors cautious about the environmental impacts and long-run expected returns on their portfolio, tracking net-zero commitments can help find out more about a company’s strategic position in the transition to a low-carbon world. That said, it is crucial to consider not only whether a pledge was made, but also how credible it is compared with current emissions, the timeline set and the robustness of implementation.

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