Final notes on COP26 – and the path to 27 in Sharm El-Sheikh

Written by Mike Appleby on 4th Apr 2022

This article is from our Good ISA Guide 2022, which shows you how to invest your ISA for the good of people and planet as well as your own future.

Another disturbing report from the Intergovernmental Panel on Climate Change (IPCC), published in late February, has warned of the ‘irreversible’ impacts of global warming. This latest research reveals close to half the world’s population are ‘highly vulnerable to climate change’ and warns each additional increment of global warming above the 1.5 degrees set out in the Paris Agreement will bring risks of new and worsened climate damages.

This comes on the back of November’s COP26 in Glasgow, where keeping the 1.5 degrees alive was a central goal, and our report card for the event reads some good, some bad and some moderate.

To give a quick history lesson, 2009’s COP15 in Copenhagen was widely deemed a washout apart from introducing the broad target of keeping maximum temperature rises to below 2 degrees compared to pre-industrial levels. At that point, when widespread acceptance of the science behind climate change was still some distance away, average global temperatures had increased around 0.8°C from the 1880 baseline and were on the way towards a 3.5°C rise by the end of the century. If anyone is thinking these are small numbers, a degree here and there can mean the difference between another ice age or not.

The landmark COP

If we fast forward to 2015, COP21 in Paris is seen as the most successful so far, in that we finally saw a formally agreed goal to limit average rises to under 2 degrees, and ideally less than 1.5, by 2100. Countries were also asked to submit commitments on emissions reductions by 2030, called Nationally Determined Contributions (NDCs), to be reviewed five years later at COP26.

The world has now moved up to 1.2°C warming and if we consider the most optimistic scenario, which assumes full implementation of all announced targets including net zero, long-term strategies (LTS) and NDCs, we would be under the Paris target of 2 degrees, at 1.8°C, by 2100. Taking a more pragmatic view, real-world action based on current policies would see us well above the Paris Agreement by that point at 2.7°C, which suggests growing urgency at the remaining Climate Change COPs running up to 2030 – starting at this year’s 27 in Sharm El-Sheikh – and those tightening regulations to reduce emissions globally over the next few decades.

As with many of the figures underlying our sustainable investment themes, data on climate change – particularly that current 1.2°C increase in average global temperatures – are alarming and the trajectory of greenhouse gas (GHG) emissions does not look to be turning, with atmospheric carbon dioxide still rising. The world will continue to depend on plentiful, cheap energy for our modern way of life and we currently get 80 per cent of primary energy from fossil fuels, which, tellingly, is still measured in terms of tonnes of oil equivalent.

The energy transition

Under the surface, however, there is evidence of an ongoing energy transition and we always stress that change is both non-linear and tends to happen quickly: once a better, cheaper alternative is found, it displaces the incumbent rapidly. GHG intensity has been falling across major economies over the last 30 years, with the greatest progress in China where emissions per unit of GDP have more than halved.

Meanwhile, innovation and scale have driven down the cost of renewable technology, from solar, to wind, to lithium-ion batteries, translating into exceptional demand growth. From being prohibitively expensive a decade ago, solar energy is now the lowest-cost option available in the US, cheaper even than fracked natural gas. Alongside this demand growth for renewables has come demand destruction for high CO2-emitting areas: coal-fired electricity generation in the US has fallen 61per cent since 2008, for example, and dropped below nuclear in 2020 in terms of energy share.

In the Liontrust Sustainable Future investment process, we talk about an interlinked pyramid of actors driving structural shifts, with a combination of science (bringing greater understanding of an issue), society calling for change and governments setting policy and regulation, and finally businesses developing and distributing solutions. From our perspective as investors, these companies tend to have two advantages that are misunderstood by the wider market: strong growth and less competition.

The path to net zero

Our view is that all parts of the economy – government, companies and individuals – are ratcheting up their ambition in an iterative, interdependent process. As society demands greater action and businesses show what can be done, governments have the leeway to increase their decarbonisation targets. Encouragingly, the path to zero carbon does not require amazing new inventions: we are on the way towards 25 per cent more solar energy, 60 per cent of global car sales being electric and all new buildings being zero carbon ready by 2030, for example. As US science fiction writer William Gibson said, ‘the future is already here, it’s just not evenly distributed’, and we feel companies on the right side of the energy transition and providing lower-carbon solutions should benefit as this distribution improves.

As we have stressed since launching the Liontrust Sustainable Future funds in 2001, the required reduction in carbon emissions will impact the whole economy, including our energy system and how we heat and cool buildings, while also driving transformations in transport, industrial processes, agriculture and land use. Many of our sustainable themes are therefore linked to the shift away from fossil fuels, including energy and industrial efficiency, renewable energy and more circular economies, but also how we build our cities, how we feed ourselves and how we finance the investment needed to enable a rapid transition.

This move to an ultra-low carbon economy will also have a considerable impact on investment returns: companies contributing to the shift should prosper while those on the wrong side of the transition, or not confronting its ramifications, are at risk of secular decline. We continue to invest in the winners, avoid the losers, and engage with companies to encourage more ambitious decarbonisation targets.

Risk warning: Past performance is not a guide to future performance. The value of an investment and the income generated from it can fall as well as rise and is not guaranteed. You may get back less than you originally invested.

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