01 Sep 2020
Maria Elena Drew, Director of Research, Responsible Investing
Limited impact on near-term cash flows is masking longer-term risk.
Last year we saw a dramatic increase in concern over climate change, which was reflected in its prominence as an investment issue. Despite all this attention, however, climate change has only had a significant impact on the valuations of select sectors—specifically those facing extremely elevated transition risk, such as fossil fuel producers. We believe valuation dislocations have been limited to a narrow universe of companies because climate change has not been particularly impactful to near‑term cash flows for the broader market.
Science indicates that keeping the global mean surface temperature rise to less than +1.5°C will be extremely challenging, if not impossible. Therefore, in our view, the probability that our investments will need to be capable of adapting to either a +1.5°C or +2.0°C scenario is high. Even keeping global warming within these parameters means there will be climate change impacts that will affect the investment landscape, such as rising sea levels, increased storm frequency, hotter, more frequent heat waves, and shifting growing seasons.
(Fig. 1) Required reduction in net GHG emissions
In its 2019 Global Warming of 1.5°C report, the IPCC aggregates the various scientific climate models that keep global warming within a +1.5°C pathway. Taking the midpoint of these models implies a massive re‑engineering of the world’s energy infrastructure, including significant energy efficiency gains as well as transitioning away from fossil fuels and into renewables between now and 2050. Potentially even more material to many investment cases is how the regulatory landscape might evolve to meet a +1.5°C or +2.0°C scenario.
We believe that almost the entire investment universe will feel some impacts of climate change—through revenues, sourcing, or cost structure...
A profound disparity exists between science and policy regarding climate change. Despite the prominence of this issue in society, we continue to see varying levels of commitment from governments on combating rising temperatures. On the global stage, nations were unable to come to an agreement at the UN Climate Change Conference COP 25 summit held in Madrid. However, on a regional and national level, there has been action to push policy closer to science. Perhaps the most notable is the European Union (EU) Green Deal, which contains a series of proposed legislation aimed at moving the EU to net zero GHG emissions by 2050.
Climate Change and the Investment Universe
(Fig.2) The impact will be felt more materially in certain sectors
While we have seen improvement over recent years, an ongoing issue that impacts the quality of environmental, social, and governance reporting we can provide to our clients is corporate disclosure. Even for the most widely reported environmental metrics, namely total GHG emissions and total carbon emissions, we find that disclosure levels are low across most benchmarks.
Despite the prominence of [climate change] in society, we continue to see varying levels of commitment from governments on combating rising temperatures.
We can compensate to some degree for low disclosure levels by using estimated carbon emissions (provided by third parties), but it still does not allow for full coverage of benchmarks and portfolios in many cases. Additionally, estimating carbon emissions for a company is a very difficult task, so accuracy is a concern, and we would caution clients about making decisions based solely on this quantitative dataset. As companies start to report these data more consistently, and in a standardized format, we will likely see notable adjustments.
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