Talking Heads – What are the implications of climate change for investors?

This is an edited audio transcript of the Talking Heads podcast episode What are the implications of climate change for investors?

Andrew Craig: Hello and welcome to the BNP Paribas Asset Management Talking Heads podcast.

Every week, Talking Heads will bring you in depth insights and analysis through the lens of sustainability on the topics that really matter to investors. In this episode, we’ll be discussing climate change and the implications for investors. I’m Andy Craig, Co-head of the Investment Insight Centre,  and I’m joined today by Jakob Tomae, Co-founder of T Finance Labs, and you have co-led the incubation of a range of commercial and non-commercial sustainability solutions. You’re also research director at the Inevitable Policy Response and professor in practise at the University of London School of Oriental and African Studies. So welcome, Jakob, and thanks for joining me.

Jakob Thomae: Thanks for having me.

AC: Now let’s start with a recent report from the UN. It suggests that the world’s on course for a temperature rise of more than three degrees centigrade above preindustrial levels, or twice the goal set by the Paris Agreement. The research is from the UN Environment Programme, and they have found that the world’s ability to remain within the target of one to one-and-a-half [degrees} centigrade of global warming risks disappearing within a few years without rapid action. The conclusions are based on what we call the emissions gap or the difference between the level of greenhouse gas emissions that humans are adding to the atmosphere compared to the level that scientists say we should be achieving to curb heating of the planet. So, if we start here, Jacob, what are policymakers trying to achieve with their climate policies and where are we now?

JT: So, the problem is obviously that there are always so many temperatures being thrown around. You just illustrated that quite nicely. Let’s just dissect that. The Paris Agreement from 2015 defines the temperature target, which is technically well below 2 degrees above preindustrial levels and has an aspiration for 1.5 degrees, right. So, that’s the policy temperature target.

We will have to basically reach net zero emissions sometime in the second part of the century if we want to hit 1.5 degrees. That’s probably 2050, even a bit earlier for developed markets.

Those are the global goals. And then each country has their national targets and typically a country has two types of targets. The first is the nationally determined contributions.

Those go until 2030. Those are short-term commitments countries make about the emissions reduction they want to basically make over the next five to 10 years. And then they have net zero goals, which is basically when they want to reach that net zero outcome that’s going to stabilise temperature. And those are typically between the 2040s. For Europe, for example, it’s 2045 and somewhere around 2070 for China. And most G20 countries have a net zero target like that now.

One of the challenges we have is that future policy isn’t really going to look like today’s policy. So, if we’re thinking about 3.1° warming, that assumes effectively no additional climate policy, no acceleration of growth rates across any low-carbon technology, flat emissions more or less through the rest of the century.

That’s not helping us wrap our heads around the implications of policy objectives. How will the economy need to change to meet these targets over the next few decades? What sort of changes are we looking at?

We  need to decarbonise the power sector. That means that every new power plant that comes online should really be zero carbon. We’re not that far away from that. We need to get to zero carbon power grid; we need to get to zero carbon land mobility – that means road transport.

We need to look at the industrial sector. That means probably electrification of large swath of industrial heat, steel and cement, and chemicals. And we need to decarbonise agriculture and land use. That means ending deforestation for agricultural purposes and changing food production patterns and consumption patterns. Those are the key changes that need to happen.

AC: Now obviously, those sort of changes have major implications for investors. How would you say investors are looking at these changes? What do we know about their expectations?

JT: Investors are on the whole more pessimistic about the transition. There are a couple of reasons for that. One of them are reports that warn of three-degree warming. In light of what we know about zero carbon technologies, cost curves and all the rest, it’s just absurd.

When you actually look at the bottom-up trends that investors are mapping, there’s way more optimism. We are transitioning one way or another. When you get into the investment case, into the investment thesis, into the different sectors and industries, the optimism is much higher.

AC: you’ve talked about the fact that relative to the targets, there seems to be a disconnect between these investor expectations and reality. What does that mean for climate target setting and funds and portfolios seeking to be green?

JT: We’re now in a situation where we’re undergoing one of the biggest industrial transformations maybe ever. And that’s never easy. There’s going to be volatility. I know investors are worried about that. But the long-term macro trends are so clear and so well signalled and so clearly pointed out. There is a wide degree of consensus among investors that we’re going to be reaching net zero or near zero emissions across the G20 economies within the 30-year time bound. That is one important implication for investors. And thinking about climate target setting, the other one is that you’re probably actually underestimating how fast the transition is underway. You also have to just keep in mind that you’re buying into a radical transformation. It’s worth reminding every investor that whether the investor is green or not, they’re making a bet about that transformation. Just because you’re not in a green fund doesn’t mean you’re not betting on the transition in one form or another. There is no way out of this story. You have to take a view on it.

AC: Let’s deep dive into a sector. There’s a major challenge for traditional car manufacturers: the transition to electric vehicles. They’ve been in the news a lot about how this impacting the effects it’s having on employment potentially and on the incumbents in this sector. How realistic do you think it is, for example, that Europe will meet its policy goal of 100% deployment by 2035 of electric vehicles?

JT: Well, China has moved to 50% within the span of four years. So, this can move super-fast. We’re just talking about new sales. It doesn’t mean every car on the road has to be electric. There are huge policy incentives in place to make it happen and already cost competitiveness of electric vehicles is there across some segments in some markets. So, you have another 10 years of R&D [research and development] in the pipeline to get until 2035 and another 10 years of car manufacturers phasing out R&D in petrol and diesel vehicles. Norway is at 90% already today. There is no reason to believe we can’t get to 100% by 2035.

AC: Just to finish off, with regard to this transition, what do you think investors should look out for when assessing policies? What do you see as potential tipping points or flags or issues that should really be at the top of our minds?

JT: The first thing is to be very careful when looking at sort of the policy dynamic. The other thing to watch out for – somewhat counterintuitively – is policy phase-outs. In some cases, that’s because the technology is cost competitive. And then finally, it’s worth flagging that there are just a tonne of policy incentives out there. And those are going to be the ones that are going to drive a lot of policy action and a lot of deployment. We know the Inflation Reduction Act in the United States has had that [effect}. There is perhaps one other policy area that sometimes gets pushed [to] the side, which is financial regulation. So, we’re going to see a lot more conversation about greening financial regulation with real incentives over the next couple of years. And that’s going to really make a difference because it directly impacts cost of capital and all those things that are front and centre for the investment case. Nothing spells policy success on climate quite like policy phase-out because cost competitiveness is there. Those tipping points become really interesting for investors down the line.

AC: We’ll be looking out for those tipping points. Jacob, thank you very much for joining me.

JT: Thank you. That was a wonderful conversation. I appreciate it.