The science behind climate change is now broadly accepted, and the impact of the increase of global average temperatures, likely to break a one-degree increase this year, must be taken extremely seriously.
The COP21 Climate Conference is a valuable chance for the world to achieve a consensus on a practical framework to address climate change. At a time of relatively intense global political interaction following recent terrorist attacks, and in the context of a difficult environment for decision making in the USA, representatives from more than 150 countries will gather in Paris for the COP21 climate conference. They will have an important opportunity to achieve a new global consensus and/or treaty to plan the way forward to tackle climate change. Previous events such as this one have generally been disappointing and much “kicking down the road” has taken place. Will this event differ and bring much needed positive outcomes, even with compromises? What will the investment implications be?
Climate change is an unusual "business issue" The issue of climate change should be seen as one of global resource management. As we have argued many times before, it is particularly acute because of the convergence of two additional key themes: demographics and emerging markets size and growth. How we respond to climate change issues is critical to world growth, its sustainability and the preservation of our habitat on an increasingly populated planet. The challenges in dealing effectively with the issue stems - in our view - from three basic principles. First this is truly a global topic where risk and reward are not balanced or symmetrical and where tools to remedy the situation are mostly local and disparate. Second it is an economy of “less” which is counterintuitive to many. Third, the “time dimension” as it relates to climate change is also unusual for traditional business matters. Climate change is a cumulative process, meaning that initiatives we take today will need a long time before progress can be measured - at least 10-20 years rather than the 4-year political cycle. It is also one where the passage of time does not have a “linear” impact - i.e. the longer we wait to push forward appropriate global actions the more difficult resolving the problems will be.
The political dimension of resolving climate change is therefore crucial to take into account. Not only is the mismatch between political cycles and climate change’s long-term nature difficult to reconcile, but the nature of long-term political agreements needed to resolve climate change and their enforcement mechanism are also at odds.
It is possible that advertising the impact of a potential two-degree temperature change (which is seen by some as very likely) more widely might become necessary to help bridge the gap between the long-term structural characteristics of climate change issues and short term-political tools available in a difficult growth environment. This might help create the needed pathways to reach an agreement to put in place effective measures. It needs to be understood that the current topical issues of population displacement and poverty induced terrorism will become more acute in a world that does not solve its climate issues…
Global Average Temperature Anomaly
Global combined land & sea annual average temperature anomaly vs 1951-1980 global mean of 14.0 degrees Celsius. NASA Goddard Institute for Space Studies
Potential for an agreement at COP21 Ahead of the conference the potential for an agreement looks good as there is mounting pressure on the larger participants. In Doha international leaders promised to achieve a legally binding climate agreement by 2015. China and the US, the two largest carbon emitters, have also made pledges to address climate change. Public pressure to reach an agreement is also growing, not just from the traditional environmental campaign groups. Multinational companies, including some energy companies, are increasingly, publically addressing the issue and making pledges. Divestment and responsible investment policies are rising amongst large asset owners and even the Pope published an encyclical on climate change. Political leaders need to achieve some kind of agreement to avoid the embarrassment of the 2009 conference in Copenhagen.
Reaching an agreement will not be easy and any treaty or agreement will be complicated. Carbon emissions measurement is crucial, but controversial in itself given the global nature of the economy today. China is the single largest emitter at close to 25% of world CO2 produced, but its products are bought by consumers all over the world. Should the costs of emission reduction be born by the producers only or by both producers and consumers? Then there is the question of funding. While there is a plan for a $100bn fund by 2020 to help with climate change, details about how the cash will be contributed is still unclear. Finally, the issue of enforcement remains a very challenging one, especially in the medium-term environment of low global growth. Finally, we believe it is important for governments to think more “out of the box” with regard to new initiatives that could have a real impact. For example, it is not often highlighted that meat consumption is a major driver of climate change as livestock contribute to 15% of global emissions*. This is estimated to be as large as global vehicle exhaust emissions. Notwithstanding all the health issues related to over-eating of meat, the expectations that meat consumption will grow by 75% by 2050 make it a logical sector for information disclosure campaigns that would help health issues (and budgets), as well as climate change.
As discussed above the potential for an agreement of some kind is strong, but achieving a treaty that is legally binding and properly funded is weak. This potential for reaching a legally binding agreement was dealt a particular blow from recent comments by John Kerry, the US Secretary of State, who is under pressure from a Republican congress to make certain any agreement will not be legally binding.
Impact on investing Environmental investing goes under many names, including sustainability, SRI, ESG and resource efficiency. We would argue that it is actually becoming mainstream in the sense that any issues impacting global competitiveness, cost of business and regulatory framework are crucial to comprehend for any investor. All investors should welcome a treaty in Paris and understand its ramifications. However, even if no legally binding treaty is achieved, this should not be seen as a failure in investment terms. Focusing on growing long-term profitable business activity to address climate change - rather than the political process - is essential for investors. Investors should not see climate change in isolation as a political issue. It is rather a convergence of issues needed to provide energy, resources and a safe environment for a growing, urbanizing population. As such its impacts will be felt by all investors, particularly in the event of a world of two-degree change where the non-linear impacts will fundamentally effect global growth. Governments increasingly understand the magnitude of this effect on investment and the SEC are beginning to hold companies to account for their climate change related disclosures. Climate change urgently needs to be incorporated into the risk management process for all investors.
Addressing climate change is an opportunity as well as a risk for investors. Environmental investing has historically faced the challenge that investment strategies most linked to political treaties and variable government subsidies have led to poor returns. The carbon price has collapsed and the renewable energy industry, despite having an excellent record in rolling out and improving cost effectiveness of wind and solar, has disappointed in terms of listed equity returns. Despite all this, investments targeted at energy efficiency, water, waste and pollution control have outperformed global stock markets.
Generic 1st EU Carbon Future
Environmental Sector Performance
FTSE Environmental Opportunities Renewable Energy, Energy Efficiency, Water Technology, Waste & Pollution and MSCI ACWI Indices
Private sector investment is as important in addressing climate change as political agreements. Both help to bring capital to areas that will provide solutions as well as providing good returns. There are many opportunities for investors to back these kinds of practical, profitable solutions to climate change. Examples include energy efficient semiconductors, pollution sensors, water technologies, drought resistant seeds and waste recyclers. The business models vary from defensive utilities to experienced multinational industrials or disruptive new technologies. The common thread running through them is that the broad challenges central to climate change provide the driver for long-term profit growth. This is what investors should focus on rather than politics and subsidies. The McKinsey greenhouse gas abatement curve shows that many of the technologies which address climate change are profitable in their own right.
McKinsey Greenhouse Gas Abatement Curve
Conclusion In conclusion while visibility on outcome of the Paris conference is low, we believe the stakes are high enough to offer potential upward surprise to current expectations. Politics does not make for good investment, but by focusing on long-term, sustainably profitable solutions, both specialist and generalist investors can generate outperformance with a core, environmental theme.
Lee Clements Virginie Maisonneuve
SOURCES * Laura Wellesley: Changing Climate, Changing Diet: Pathways to lower meat consumption
ABOUT THE AUTHORS
Lee Clements Independent Contributor Lee is an experienced thematic, environmental and ESG investor. Most recently he was a portfolio manager at PIMCO responsible for equity thematic research and sustainability. Prior to joining PIMCO he was Head of Thematic Research at Impax Asset Management and managed specialist resource efficiency and global thematic equity portfolios. Previously, Lee was an investment manager at Nomura Private Equity and WHEB Ventures and a corporate strategist at Lehman Brothers. He has 15 years of investment experience and holds a bachelor's degree in physics from the Imperial College London.
Virginie Maisonneuve Managing Director
Virginie is founder and Managing Director of Maisonneuve Global Advisors. Virginie’s background in asset management spans over 28 years and she served most recently as CIO-Equities, MD at PIMCO (London). Prior to this she worked as Head of global equities at Schroders (London), Co-CIO at Clay Finlay (New York) and held various senior portfolio management positions at State Street Research (San Francisco), Batterymarch (Boston) and Martin Currie (Scotland). She started her career as a consultant for the French Ministry of Foreign Affairs in Beijing (China).
Virginie has an MBA from ESLSCA (France) and a BA from Dauphine University (Mandarin Chinese). She also has a first degree diploma in Political Economy from People's University (Beijing, China) and is a CFA Charterholder.
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