From decarbonising portfolios to decarbonising the economy
As investors, a central part of a climate-ready portfolio is to understand the risks – both physical and transition risks – to the current and potential holdings. We can protect value in the portfolio through a variety of approaches: more detailed analysis of environmental factors via ESG analysis, measuring and cutting the carbon footprint, or reducing exposure to assets at risk from climate change.
However, protecting your portfolio does not protect the planet. Fundamentally, the global call to arms is to decarbonise our economies and human activity. While there will be winners and losers, this does not require an end to progress or prosperity. In fact, often the opposite. It does, however, require a realignment of economic activity.
For this we need more capital to catalyse the changes required. New innovations to be developed. Existing ones to scale. Novel solutions to be invented.
Private capital is essential
Arguably, the UN’s COP26 summit should inspire a step-change in the level of global commitment and action around climate.
But we can’t rely solely on governments, nor charities or corporations, to address climate change. As emphasised in our 2021 Investing for Global Impact survey, the vast majority (86%) of respondents, including individual investors, family offices and foundations, agreed that private capital, along with these others, will be essential.
Private capital will be vital to funding the solutions spanning three challenges - addressing climate change and energy needs, reducing our environmental footprint, and conserving biodiversity and ecological systems.
But investors should also seek to deploy capital into these themes, because the underlying companies solving them are also building businesses that are among the fastest-growing areas in the global economy. As such, we review these three environmental themes, and explore the opportunities and entry points for 2022 and beyond.
Addressing climate change and energy needs
Energy and climate change are intertwined. The total consumption of energy, across sectors, accounts for about three-quarters of all greenhouse gas emissions. These, human-caused greenhouse gas (GHG) emissions are central to causing climate change.
However, this relationship is not inextricable. Shifting to cleaner renewable sources of energy, at the same time as increasing electrification and improving its usage, will be key to addressing climate change.
In 2019, renewables reached almost 27% of global electricity generation. While noteworthy progress, this percentage needs to increase rapidly to ensure that half of all energy generation comes from renewables by the end of the decade. More capital, therefore, will be required to fund this additional capacity.
Alternative forms of renewables
Beyond improvements in familiar renewables (onshore and offshore wind, solar photovoltaics and hydropower), alternative forms of renewables are emerging. Wave, geothermal and hydrogen power are shifting from prototype phases to commercialisation. Government support is accelerating for this. For example, support for hydrogen in primary energy consumers (for instance, China, the EU, UK and US) has driven project investment to an estimated $500 billion, through to 2030.
Beyond producing greener energy, a successful energy transition requires better access, reliability and use of energy. Renewables have varying degrees of intermittence, so energy storage is critical to ensure full decarbonisation of the energy system. Already, capacity is being added. In fact, compared to 2020, the capacity of new energy storage installations is forecast to more than double by the end of 2021 (reaching 12 gigawatts (GW) from 4.5 gigawatts).
Thereafter, annual installations are expected to exceed 20 GW by 2024 and 30 GW by 2030.
Reducing our environmental footprint
With growing populations and expanding economic development and consumption, the natural environment and its limited resources are under increasing strain. Should the global population reach 9.7 billion by 2050, as some predict, sustaining current lifestyles would require the natural resources of the equivalent of almost three planets.
As the world becomes increasingly urbanised, with 70% of the world’s population expected to live in cities by 2050, environmental pressures are likely to increase. Cities and metropolitan areas are hubs of economic growth, occupying just 3% of the Earth’s land. That said, they account for 60-80% of energy consumption, 70% of carbon emissions and over 60% of resource use.
Beyond that, ageing infrastructure in the developed world and incomplete infrastructure in developing nations, necessitate construction – often needing cement and steel. Emissions from the production of these materials make up 44% of emissions coming from industrial sources. To meet climate goals, cement emissions intensity will need to drop 85-91% globally and steel emissions intensity 93-100% by 2050.
Similarly, though often overlooked, buildings will be central to achieving climate goals. Together, buildings and building construction sectors produce over one-third of global final energy consumption, and nearly 40% of total direct and indirect CO2 emissions. Existing buildings need renovation, and construction of new buildings must achieve higher energy efficiency and health standards through new materials, techniques and technologies.
We can also look for challenges and opportunities in responsible production and consumption. The dominant linear model of “take-make-waste” is ineffective in economic, environmental and climate terms.
Companies increasingly apply circular thinking and a “Cradle-to-Cradle” concept of Five Goods™ (good materials, economy, energy, lives and water) to build sustainability into the products and production processes. This aligns with consumer expectations of more transparent, ethical and sustainable goods and services – across a range of industries, notably fashion, plastics, food and the sharing economy.
Today, our world is only 8.6% circular, leaving a massive potential, and need, to increase the global operating models. At the same time, a more circular economy could generate $4.5 trillion in new economic output by 2030.
Conserve biodiversity and ecological systems
Following a year of increased focus on climate change, culminating with the COP26 summit, we would flag biodiversity and ecological systems as other key systemic challenges.
In the 2021 World Economic Forum’s Global Risks Report, biodiversity loss and ecosystem collapse were named as one of the top five risks in terms of likelihood and impact in the coming 10 years. According to the UN, human activity has significantly altered 75% of the Earth’s surface; there is a cumulative deterioration across 66% of the oceans; and over 85% of wetlands have been lost.
Thus far, these primarily have been considerations for risk management, but opportunities for private capital are emerging. Most obviously, there are direct links and value associated with sustainable agriculture.
Agriculture and oceans
According to the UN’s Food and Agricultural Organisation, food production will have to increase by 70% by 2050 to keep up with expected population growth. Therefore, pioneering farmers and agri-food companies, whose innovative and scalable approaches reduce the negative impacts of food production on the environment and society, are expected to benefit from this trend. Similarly, agricultural products that have been harvested organically and/or sustainably should profit from increasing consumer demand.
At the same time, there is a rising tide for the opportunities related to the oceans. Goods and services from the ”blue economy” amount to about $2.5 trillion each year – meaning the ocean might be considered the seventh-largest economy in the world.
Moreover, new research suggests that every $1 invested in sustainable ocean solutions, will yield a return of at least $5. Much of this growth will be driven by ocean-based policy interventions, as well as ocean-related industries such as energy generation, fishing/aquaculture, shipping, plastics and tourism.
Strong connection to climate change
In both of these cases, the connection to climate change is strong. Nearly a quarter of global emissions come from agriculture, forestry and other land uses. At the same time, land is a carbon sink, absorbing emissions through the natural cycles. Annually, from 2007 to 2016, this was equivalent to the annual greenhouse gas emissions of the United States, or about 10% of total global emissions.
Similarly, oceans have the potential to absorb around a third of global CO2 emissions. They also absorb over 90% of excess heat generated, keeping the Earth cool.
Augmenting these natural processes, are emerging “nature- based” carbon capture and storage solutions that can help to sequester more carbon. New opportunities are emerging to protect or increase the capacity of these existing natural carbon sinks which, as carbon prices continue to be established, and increase, will be increasingly attractive.
Deploying capital to catalyse solutions
Uncertainty remains about the shape and nature of economic recovery for 2022. What remains certain is that as the global economy emerges from the pandemic, greenhouse gas emissions will rise again, and continue to increase. At the same time, climate change, driven by human activity, remains a certainty.
If we find a corollary from the pandemic, climate change is global, respects no borders and needs a united response to tackle it. Part of that response will be by private investors, financially astute and/or personally moved, looking to deploy their capital into solutions to this challenge.
With several themes and entry points, in 2022 investors can explore potential investment opportunities, and more importantly allocate, in this area, for the benefit of portfolio and planet alike.