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COP26: smoke gets in your eyes

For financial professionals only

Alok Sharma brought down the gavel on COP26 on 13th November holding back his tears, ashamed and frustrated at having to tell delegates that one of his key goals, the banning of coal, had not been achieved. Instead, proposals for “phasing it down” were included in the final communiqué. Coal is the dirtiest fossil fuel and phasing it out is critical to staying within 1.5C of global heating. At a personal level, Sharma, given his family connections to India, understands the imperative to do something about global air quality, to defend the health of millions. A quick glance at a real time global air quality chart shows large areas of the sub-continent coping with unhealthy and very unhealthy air quality[i]. Much of this smog is caused by burning coal – and neither India nor China can see a quick way to exit from their coal dependency.

Impenetrable science, direct experience

Personal experience of the current global environmental crisis, like suffering from acute air pollution, really brings home the priority of action. Anyone who has faced the nightmare of their home flooding here in the UK would agree. But making sense of the scientific complexity inherent in modelling the future climate of the entire planet is hugely challenging. Exactly what is the evidence? How can we be certain about the relative effects of a 1.5 or 2.5 degree increase in surface temperatures? A good summary of the big picture can be found at the Intergovernmental Panel on Climate Change[ii].

It’s such a big and complex topic, and whilst scientific consensus exceeds 99% as of October 2021[iii], what there isn’t consensus on is what it’ll actually mean in an economic and political context. A smaller scale study in Nature[iv] focused specifically on the transition away from fossil fuels and included 72 academic citations.

It supported the conclusion that switching from fossil fuels, without complementary investment for diversification in the oil and gas producer nations will lead to global financial and political instability.

So when both the modelling of the world’s climate is so complex AND the consequent knock-on impact on markets, economies and politics is unclear, is making sense of all this information simply beyond us?

People’s choices

To understand the relevance of COP26 to investors, we need to take on board the importance of changing consumer attitudes. We may not share the attitudes of the mass of US consumers now behind the move to ‘net-zero’[v], but corporations who want access to the world’s biggest market now know that failing to pull your weight on the journey to ‘net zero’ carries a stiff penalty. You’ll sell less of your products. This is how every UK investor can begin to rationalise ESG investing in a simpler, more obvious way. You don’t need to understand all the science – or share anyone else’s point of view.

What portfolio will do well?

Investors must think about how their portfolios are positioned for decarbonisation, which is a megatrend affecting all parts of the economy – not only our energy sources, but also our transportation, the buildings we work and live in, and how we manufacture products, the food we eat.

Traditionally, oil and gas companies, miners and financials have formed the bulk of UK investors’ portfolios.  Oil and gas and mining companies have relatively high emissions, while many banks continue to provide significant financing to the fossil fuels sector. While these companies will have a crucial role in the push to achieve net zero, will they perform as well as others? They may be investing in a transition in their businesses, but can they match newly established competitors in the green energy sector attracting huge flows of capital from investors keen to support them succeed with a ‘net-zero’ strategy? How would they be impacted by the introduction of global carbon pricing?

And it’s not just the risk and return aspects to consider.  Many clients are concerned about what’s the right thing to do and care about other people’s wellbeing.  In the way that many moved away from tobacco companies over the last 20 years, a simple ethical decision can push investors into supporting greener companies.

When it comes to ESG investing, is this a hand any of us, as investors, can afford to sit out? I don’t believe so.

 

For more insight from COP26, please join us on Thursday 25th November at 11:00am, for a roundtable discussion hosted by Simon Molica, Senior Investment Manager at Parmenion. Secure your place here.

[i] https://www.iqair.com/world-air-quality

[ii] https://www.ipcc.ch/sr15/

[iii] https://iopscience.iop.org/article/10.1088/1748-9326/ac2966

[iv] https://www.nature.com/articles/s41560-021-00934-2

[v] https://www.mckinsey.com/business-functions/sustainability/our-insights/solving-the-net-zero-equation-nine-requirements-for-a-more-orderly-transition