The ‘Road to Paris’: this time is different

There can be little doubt that momentum is growing ahead of December’s UN Climate Change Conference in Paris. A key question for investors is whether the conference will produce a meaningful result and therefore the impact it might have on capital markets over the long term. We haven’t forgotten the hope and expectation on show ahead of a largely calamitous Copenhagen conference in 2009. Rather, it’s because of the previous disappointments – and moreover the strategic lessons that have been learned – that we believe there may be a more constructive outcome.

The US and China step up to the plate

One landmark moment ahead of this conference has been the Obama administration’s pledge to cut carbon emissions by 26-28 per cent by 2025 compared to 2005 levels, and deliver an 80% cut by 2050. This is big news. There has never been a climate conference before which the US has made such a definitive commitment, and the country’s reluctance to commit has often been an impediment to the UN negotiation process. The fact it has come now marks a sea change in political attitudes and is symbolic of the legacy that President Obama wants to leave in his final term in office. His recent decision to formally reject plans for the ‘Keystone XL’ pipeline adds to US credibility on the subject of climate change.

China, meanwhile, has gone a long way to placating its “us and them” doubters in the West: politicians who have historically used the country’s seemingly unmitigated growth in highly polluting industries as a reason for not taking action to mitigate climate change. In March this year, China pledged that carbon emissions would peak in the country by 2030. In June, this commitment was backed up by an even stronger goal of cutting emissions by some 60-65 per cent from 2005 levels per unit of GDP over the same time frame.

Another noteworthy pledge in terms of scale came from the G7, which in June committed to cutting greenhouse gas emissions from 2010 levels by the “upper end of 40%-70%” by the middle of the century. The BBC said that this commitment has “effectively signalled the end of the fossil fuel era”. [1] Not only does the goal reflect the key recommendations of the recent Intergovernmental Panel on Climate Change scientific assessment report (AR5), but it came with the commitment by G7 leaders to strive for an “ambitious, robust, [and] inclusive” climate change protocol at the Paris conference.

INDCs set expectations

We believe the Intended Nationally Determined Contributions (INDC) programme, where individual UN member states have been invited to submit their plans for emissions cuts ahead of the conference, has been a real cause for optimism. This ‘bottom up’ approach replaces the idea – shown to be futile in Copenhagen – that an overarching global deal could be struck by establishing a cap on global emissions which is imposed on countries from the ‘top down’. Almost 150 countries have made pledges under the INDC scheme in recent months. In terms of the mechanics of the conference, we believe this scheme may prove to be a masterstroke of diplomacy. Regardless of their potential effectiveness, they have set expectations ahead of the conference, potentially averting some of the squabbles and backroom deals that featured in Copenhagen.

Will it be enough?

While individual country pledges for emission cuts have generally gone further than had been widely expected, the question about whether they are deep enough to prevent a rise in global average temperatures of greater than 2°C above pre-industrial levels is important in terms of how the conference might progress. Climate Action Tracker estimates that the INDC pledges will lead to a 2.7oC [2] increase in global temperatures, while study by the Grantham Research Institute on Climate Change and the Environment [3] estimates that the INDC pledges will result in annual global emissions of between 53 and 61 billion tonnes of carbon dioxide in 2030, substantially above the 36 billion tonnes prescribed by the UN Environment Programme. [4]

How the gap between what is needed and what is pledged is construed will set the tenor of negotiations. Although we generally believe that nations should be commended for what has been pledged so far, this understandably is unlikely to be a view shared by all who attend the conference. Bolivia, for example, which is a high risk country when it comes to climate change, is likely to be vocal about the short comings of the INDC pledges, and we expect similar protests from a number of NGOs on the side-lines of the conference.

We will be watching the ongoing debate about who should bear the brunt of the financial cost and the transfer of financial aid and technology from richer to poorer countries very closely. However, we believe any tension is likely to be limited in most part due to what we believe may prove to be one of the most compelling policy developments in the lead up to the conference so far. The draft negotiating agreement released in early October suggests that the INDCs should be reviewed every five years (while avoiding ‘backsliding’). If agreed, this could have significant implications for our investment area and bolster investment in rapidly developing, disruptive technologies – the development of which will be a shaping force behind future policy commitments, in our view.

Regional policies

Of equal importance to what is agreed at the conference is how these policies are executed at the regional and individual country level. Regional policies carry a lot of weight in an investment context and that is an area in which we conduct a great deal of research. One of the most highly debated of these has been carbon pricing, and this is the policy of choice for a number of European oil majors which have called for some form of carbon trading mechanism as part of the conference outcome. This is unlikely, in our view. The establishment of a global market for carbon emissions would simply be too challenging, and the problems faced by the EU Emissions Trading System have created some trepidation about introducing a multinational trading scheme. Nevertheless, we do believe that carbon pricing (which involves trading systems or explicit taxes) will remain an important part of the solution and will continue to be developed at a local level, even if it may not formally become part of the agreement in Paris. A further significant development ahead of Paris has been the proliferation of local-level INDC-style commitments from a range of cities, regions, counties and investors under the NAZCA (Non-State Actor Zone for Climate Action) scheme. This programme was established as part of the Lima Paris action agenda in 2014, with an aim of helping to provide confidence to governments ahead of the Paris talks. At the time of writing there had been some 6,600 pledges, many of which go beyond those of the INDCs. This includes large economic zones, such as California, the 8th largest economy in the world, which has made a significant pledge to reduce carbon emissions by 50% by 2020 versus 1990 levels, and 80% by 2050. We continue to monitor the impact of programmes like these on investment patterns and the potential opportunities they can create for environmental solutions businesses.

Our conclusions

Overall, we remain pragmatic. UN climate conferences tend to be fraught events. Seeking agreement at the supranational levels is bound to be challenging, especially given the economics and myriad vested interests involved. However we remain optimistic and believe that now key emitting countries such as the US and China have shown willing, the stage is set for constructive talks. And while there will invariably be shortcomings for now in terms of how aggressively the scientific community says the world economy needs to decarbonise, the potential introduction of a five yearly review of INDCs presents cause for optimism that the goal of limiting global warming to 2o C may ultimately be achieved, and has the potential to underpin the longer term growth of our investment area.