Countdown to net zero: it’s urgent and carries a price tag

The climate crisis is right in our face and undeniable. We've seen continual headlines in the recent months alone about record temperatures being topped and other extreme weather events around our globe. Each passing year seems to bring a further intensification of climate change and its ramifications, affecting an increasing number of people worldwide.

To succeed in turning things around, the international community needs an urgent plan. This will carry a hefty price tag and, as capital allocators, investment firms have a clear role to play in the countdown to net zero. The “decade of delivery” for the United Nations Sustainable Development Goals (UN SDGs) can also be looked at as a massive opportunity for impact investors to intervene and help bring about positive change, with the UN Conference on Trade and Development (UNCTAD) expecting a significant increase in the current 1.3 trillion US dollars (USD) of funds dedicated to investment in sustainable development globally.

Commitments to change

The noise generated by the headlines is being matched by talk of action toward positive change. Indeed, the number of countries and companies pledging to achieve net-zero targets by 2050 has increased tremendously. Hence, you could conclude that the issue is being taken seriously. Some 149 countries had a net-zero target in June 2023, up from 124 in December 2020, while the number of companies jumped to 929 from 417 in that period, according to a Net Zero Stocktake report .

Even so, the timeframes set by companies differ substantially, and execution is lagging behind goalposts. According to a 2022 Bank of America (BofA) Global Research report that studied the commitments of some 3,400 firms, 76 percent had the goal of achieving net zero by 2050, while a mere 11 percent aimed to do so by 2030. This indicates that many may still lack tangible plans to implement measures to meet the pledges made.

Checking the pulse

Good intent and promises won’t be enough – the world needs urgent implementation. The UN Environment Programme’s (UNEP) Emissions Gap Report 2022 doesn’t paint a pretty picture. The nationally determined contributions (NDCs) that were adopted by world leaders at the 2021 UN Climate Change Conference COP26 in Glasgow have hardly scratched the surface. The world would need to cut 45 percent of current greenhouse-gas emissions by 2030 to get on track to limit global warming to 1.5 degrees Celsius (°C) and 30 percent to reduce it to 2°C, according to the report. Its authors emphasized the pressing need for a system-wide transformation and that a stepwise approach will no longer cut it.

A look at global energy-related carbon-dioxide (CO₂) emissions in 2022 might give cause for optimism at first glance: they rose by less than one percent, the International Energy Agency’s (IEA) CO₂ emissions report showed. That was significantly lower than in the previous year when we saw a jump of more than six percent. But it was also mainly driven by growth in sectors like solar, wind, and electric vehicles (EVs), which helped offset the impact of increased use of coal and oil amid the global energy crisis. The report made it clear: emissions remain on an unsustainable growth trajectory and bolder steps are needed for the world to accelerate the energy transition and meet its climate goals.

The massive gap comes with a price tag

According to BloombergNEF, global annual investment needs to triple throughout this decade to achieve a net-zero emissions world by 2050. This represents a massive USD 2 trillion investment opportunity, approximately two percent of annual global GDP.  Out of the total estimated cost of USD 195.7 trillion, USD 109.0 trillion is required to transform our energy-consumption patterns. The remaining USD 86.7 trillion will be directed towards energy-supply assets, to include upgrading and modernizing grids as well as implementing carbon-capture technologies. A substantial portion of capital spending will be allocated to investment in low-carbon power sources, such as wind and solar energy.

Governments alone won’t be able to foot the bill. Capital will be required from both public and private actors and, as capital allocators, investment firms have a clear role to play. This is where impact investing comes in. These investors seek to deploy their wealth in a way that benefits the environment and society, whilst also generating a financial return.

Climate challenges, the transition of the energy sector, and carbon-emission reduction are key areas for impact investors. For example, since energy accounts for most greenhouse-gas emissions, clean energy is key to addressing climate change and represents a significant component to mitigate human impact. The overall focus lies on emission reduction with electricity, hydrogen, and heat generated from renewable resources, and technologies enabling a reliable as well as smarter and greener grid. Investee holdings will be able to profit from the above-mentioned investments into the energy system.

Measuring the impact on the path to net zero

A major challenge for investors who opt for impact investing is measuring the impact of their investments. The approach we follow as an asset manager to select candidates for our portfolio revolves around the concept of "potential avoided emissions" ( PAE )¹.  We believe companies active in the energy-efficiency value chain have so far broadly been disregarded in ESG (Environmental, Social, Governance) investing. Our primary focus is on identifying and investing in companies and projects that act as enablers for the transition towards a net-zero carbon economy.

To assess the "right" candidates, we analyze the potential impact of their products and services on reducing carbon emissions. By evaluating how these entities contribute to avoiding emissions and supporting sustainable practices, we aim to build a portfolio that aligns with our commitment to a low-carbon future. Incorporating the PAE framework into our investment decisions, we strive to play a significant role in driving the global shift towards a more sustainable and climate-friendly economy.

PAE places its emphasis on curbing future carbon emissions. It quantifies the emissions averted through the positive and efficient impact of a company's products in comparison to the greenhouse gases that would have been emitted normally. By calculating the emissions saved, PAE provides a clear measure of the potential environmental benefits of such innovative products and services. Our PAE framework has been determined with Institutional Shareholder Services (ISS), a leading provider of corporate governance and responsible investment solutions, market intelligence and fund services for institutional investors and corporations globally.

The methodology description of PAE is available to institutional investors, together with our impact reports that outline the limitations of the PAE concept.

To make real progress in getting to a net-zero world, we will have to redouble the efforts we are already making. Professional and institutional impact investors with their considerable financial muscle are key for us to get a handle on developing clean energy, transitioning the whole sector to drastically reduced carbon emissions and thus laying the foundations for a low-carbon future that is better for everyone on our planet.

1. Avoided emissions are emissions that would have been released if an action or intervention had not taken place. The emissions avoided by using a more efficient product or service are often conditional on either consumer or market behavior. This analysis does not make absolute predictions about behavior or market developments. Consequently, ISS ESG has chosen the term potential avoided emissions (PAE) to underline that the avoided emissions presented are not assured or verified by a third party and are dependent on certain behaviors.

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