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COP26 in review, implications for investing

Jorge Waayman | Posted on Nov 22, 2021
  • COP26 concludes with some progress made but not enough.
  • New Zealand updates emissions target and signs methane pledge.
  • International carbon credit trading supported through resolving technical provisions in Article 6 of the Paris Agreement.
  • Implications for corporates to address climate change risks given greater expected regulation and investor scrutiny in aligning with net zero targets and a 1.5-degree world.

COP26 concluded in Glasgow delivering many encouraging new collaborative agreements and targets, but still falling short in being fully aligned with a 1.5-degree goal[1] given resistance from some of the world’s largest emitters. The conference culminated in a final ‘Glasgow Climate Pact’ signed by over 190 countries, aiming to keep this 1.5 degree target alive by promoting further action. Other highlights included revised emissions reduction targets, a pledge to reduce methane emissions, agreement over settings of inter-country carbon trading and renewed ambition for climate financing to developing countries.

Signatories to the Glasgow Climate Pact agreed to commit to the phasing down of coal power and the phasing out of inefficient fossil fuel subsidies, marking the first time fossil fuels were mentioned in a UN climate pact, despite the language used on coal being weakened at the last minute (phase out to phase down). This followed from an initial pledge by over 40 countries to phase out coal power in the 2030s for large economies and 2040s for less developed ones. A separate pledge related to ending the public financing of unabated fossil fuel projects by the end of 2022 was signed by 20 countries including the US and New Zealand.

New Zealand was one of the countries who provided an updated emissions reduction target as part of our commitment to the Paris Agreement.  This new Nationally Determined Contribution commits to reducing the country’s net emissions by 50% below 2005 levels by 2030. This represents a significant step up from the previous 30% target that was not consistent with a 1.5-degree global temperature increase. However, some climate groups were still critical of the target given it specified net emissions reduction, allowing the use of carbon offsets to achieve the goal compared to a gross base level and making it seem more ambitious than it really is. New Zealand was also one of over 100 countries that pledged to reduce methane emissions by 30% from 2020 levels by 2030, although three of the largest global emitters of methane, China, Russia and India, were not amongst these signatories.

One of the key highlights from the conference was resolving part of the Paris Agreement related to carbon credit trading between countries (Article 6). This article provides a legal framework to create a global carbon market that better facilitates countries cooperating to reduce emissions and meet targets under the Paris Agreement. Global leaders finally agreed on some technical provisions in the article that ensured there is integrity in the carbon credits and to avoid any double counting. This development now allows the Paris Agreement to become fully operational and encourages significant investment into international carbon credit generating opportunities like tree planting and expanding renewables infrastructure.

On climate financing, countries acknowledged that they failed to meet the initial $100 billion per year pledge of financial support for climate transition to developing countries by 2020 and refreshed this same target, which is expected to be achieved by 2023. Multiple countries including the US, UK, Canada and Japan announced new funding to developing countries either leading up to or during COP26. Some countries also specifically increased the funding towards climate adaptation which will be important given the increased frequency and severity of extreme weather events as global temperatures continue to rise.

Investment implications

Although these agreements between countries are not perfect and will continue to be debated over time, the direction is clear and will have ramifications flowing through to corporates around the world, such as regulation limiting the involvement in certain fossil fuel-exposed sectors and incentivising opportunities in green solutions. New Zealand’s methane pledge may result in more regulatory intervention in the agriculture sector given livestock represents a significant part of methane emissions which will be particularly contentious given the role the sector plays in our economy.

Even companies operating in sectors not traditionally deemed as exposed to the physical effects of climate change will see second order transition effects from higher carbon prices around the world that could lead to increased operating costs through electricity and fuel for example.

In addition, those companies that are not sufficiently mitigating or adapting to climate change risks may end up with stranded assets, such as those using coal in their operations, and face higher costs of capital as the financial industry favours those companies that are aligned with a 1.5-degree scenario. This was highlighted through the new pledge from financial institutions known as the ‘Glasgow Financial Alliance for Net Zero’ representing US$130 trillion in assets committed to achieving a net zero global economy by 2050 along with interim targets for 2030.

Consumers will also play a role through changing their behaviour in purchasing decisions towards companies demonstrating sustainable practices with more activism expected, especially towards those involved in the fossil fuels industry. These preferences will be a key driving force affecting company bottom lines and often shift faster than government mandates.

Furthermore, there will likely be higher stringency on reporting requirements with the creation of the International Sustainability Standards Board (ISSB) that will be responsible for developing sustainability disclosure standards. This will help bring better structure and comparability to corporate ESG disclosure between companies but could potentially increase the reporting burden depending on how prescriptive the requirements are.

Overall, there were some positive signs from countries’ increasing ambition on climate change however some of the world’s largest emitters were notably absent from crucial pledges or watered down their requirements. Nevertheless, the key will be in translating this ambition into action which will largely be up to the private sector to implement.

Harbour’s investment process will continue to assess company’s exposure to climate change and seek to engage and invest in companies that will be part of the solution in keeping to a 1.5-degree world. This will be achieved through rigorous measurement and evaluation of company emission trajectories to 2050 which is challenging given the uncertainty and imperfect information but necessary to play our part in the transition.

Repositioning of economies to decarbonise will require innovative thinking and investment. Not all businesses will make this transition easily and we may see increased volatility. But, in our view, this investment will improve the quality of long term returns for investors.

[1] COP26 climate pledges could help limit global warming to 1.8 °C, but implementing them will be the key – Analysis - IEA

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