To help decarbonise the world is a purpose which we have been investing in through companies such as Neste, Trane Tech, Nel Hydrogen and Schneider Electric. In this edition of Arcus, my learned colleague Kaia Tan will share with you how we as Panvestors are dealing with companies aspiring to become Net Zero or Carbon Neutral, what does it actually mean, who is leading the charge and what challenges it entails for investors who want to play their part.
Happy Panvesting,
Munib Madni,
Founding Panvestor
“We know investments impact climate change just as climate change impacts investments.”
Mindy Lubber, Ceres CEO and President
In the last few months, we have seen a flurry of announcements on carbon-reducing targets. It is impressive that such a significant number of organisations including titans like Shell and SAP, have pledged to reach net zero emissions by 2050 or sooner. Microsoft has taken an even bigger step by not only committing to reach net zero by 2030 but also having an additional goal of removing all carbon emitted since its founding in 1975.
What does “net zero” mean? There is a difference between committing to net-zero carbon emissions or being carbon neutral. Use the wrong terms and you may be accused of ‘greenwashing’. Carbon neutrality means balancing greenhouse gas (GHG) emissions by removing an equivalent amount of carbon from the atmosphere for the amount produced. This balance can be achieved by ‘offsets’, hence without reducing overall GHG emissions. Offsetting refers to buying ‘carbon credits’ which is a form of permission to emit amounts of CO2 or other greenhouse gases that match GHG-reduction initiatives elsewhere on the globe. In contrast, net zero GHG emission is achieved by not adding new CO2 or other greenhouse gases to the atmosphere and reducing absolute GHG emissions until equilibrium in the atmosphere has been reached. According to the Science Based Targets initiative (SBTi), the three most common tactics in corporate net zero strategies are:
Eliminating sources of emissions within the value chain of the company, i.e. a company’s scope 1, 2, and 3 emissions
Removing CO2 from the atmosphere and storing it in geological, terrestrial, or ocean reservoirs
Compensating* for value chain emissions by helping to reduce emissions outside of the value chain, e.g. through the provision of finance
*During a company’s transition to net zero, compensation and neutralization measures may supplement, but not substitute, reducing value chain emissions in line with science. At the time that net zero is reached, emissions that are not feasible for society to abate may be neutralized with equivalent measure of CO2 removals. (From Science Based Targets) How SAP envisages reaching carbon neutrality? Last year, the company reduced its greenhouse gas (GHG) emissions more than planned and a sharp decline in business flights contributed significantly to that. On 4th March this year, SAP announced on their website and in the 2020 sustainability report, their goal of becoming carbon neutral in their operations by 2023. This goal entails their commitment to reducing their emissions by 85% by 2050, including products in use at their customers. In compliance with SBTi requirement, the company has set out its approach of first avoiding, second reducing and third compensating emissions. The aim is to reduce business travelling by relying on telecommunication technologies. If emissions cannot be avoided, SAP will leverage on energy-efficient lighting in offices, efficient cooling systems in data centers, alternative mobility solutions and innovation. For unavoidable emissions, SAP will resort to offsets by supporting climate projects. Help is at hand One of the many initiatives, alliances and organisations dedicated to emission reduction efforts is the UNFCCC Race to Zero campaign. It is the largest ever alliance committed to reaching net zero emissions by 2050, supported by organisations, investors, universities, cities and others. For us as fund managers, another initiative is the Net Zero Asset Managers initiative (NZAMi), which was launched just in December 2020 and already has 87 signatories representing USD$37 trillion in assets under management (AUM). Members commit to setting a goal of net zero emissions by 2050 or sooner across all assets under management and to set an interim goal by 2030. The interim goal can be setting a net zero emission target for a proportion, say 30% of the portfolio. The approach should be aligned with climate science and the expectation is to reduce rather than offset unless there are no technologically or financially viable alternatives to elimination. As you can see any Fund Manager’s commitment to net zero is still left to much interpretation and requires much clarification. Fund managers and their institutional clients (SWF, Pension Funds, Endowments) also have initiatives such as SBTi, IIGCC and PRI (in collaboration with the London Stock Exchange) which are assisting with methodologies, guides on climate solutions and other resources. Asset Managers are encouraged to engage with companies and to align their voting with their net zero ambitions, once that ambition is fully understood. What is driving the commitment to such public GHG emission reduction targets? As seen below in the Climate action tracker: Even optimistic targets only predict a median temperature increase of 2.1°C above pre-industrial levels by the year 2100. Even the lower bound of optimistic targets see us fall short of the 1.5°C target the IPCC steers us toward.
(Exhibit 1)
As we head towards the next annual UN climate change conference COP26 in Glasgow in November, we are reminded of the massive endeavour that is required to limit global warming to well below 2°C (compared to pre-industrial levels). There will be a push to honour and fulfil the Paris Agreement by accelerating action. According to Climate Action Tracker, the recent net zero announcements have put the Paris Agreement goal of reaching 1.5°C within “striking distance.” Also, the EU has presented its strategy to achieve carbon neutrality by 2050 and President Biden is planning for the US to reach net zero by 2050. China has set a net-zero target for 2060.
Investors are following suit, but there are challenges ahead
Institutional investors who commit to a net zero target will come to expect their asset owners to also set similar targets. Asset managers will face the challenge of some companies setting targets today but not delivering them tomorrow. Also, the “how to get to net zero” is very much unknown territory for most companies. It is likely that one of the many end points of decarbonisation will be to face down the thorny compromises of social issues such as poverty alleviation versus environmental issues such as deforestation. The more sincere companies admit they don’t know how they will do it but they are determined to get there.
Shouldn’t every fund manager set a net zero portfolio target?
Well, it depends. Most of us probably agree that we should be giving our full attention to GHG emission reduction efforts as climate change is the “biggest threat humans have ever faced”, to quote David Attenborough voicing up to the UN. Countries, the private sector and individuals should step up efforts to eliminate greenhouse gas emissions. But is announcing a net zero target a prerequisite for supporting these efforts? The gamble is that portfolios’ start selling companies that are the first to honestly realise that net zero is not achievable. Another conundrum is that net zero portfolio promises by fund managers could force companies into hollow net zero claims. Will fund managers force themselves into a corner by only investing in unverified net zero companies?
At Panarchy Partners, as we track our portfolio companies’ Scope 1, Scope 2 and Scope 3 emissions, we ask ourselves – should we join the race to make our portfolio net zero emissions? How can Panarchy Partners best play its part in this crucial endeavour? The threats and opportunities are crystal clear, more so than the path ahead.
Companies including but not limited to SAP, 3M and Neste in our portfolio have set net zero or carbon neutral targets, admittedly with only a few having a clear roadmap on how to achieve it. Net zero claims are not a prerequisite for us to invest as we also support companies that are headed to carbon neutrality as a starting point. 64% of our portfolio companies have a net zero or carbon neutrality ambition. We believe portfolio companies should determine their own capacity and commitment to positive change, and our role is to help them achieve their targets by asking the right questions and guiding them with global best practices. As part of this approach, we also continuously engage companies on how they manage their climate-related impacts and through our proxy voting we set a clear stance on our support for decarbonisation.
Conclusion
At Panarchy Partners, we believe in companies that bring value on all four forms of capital: Human and Social Capital, as well as Environmental and Financial Capital. We seek to espouse companies’ Progress on a journey to transform their businesses in a world of disruption. Some of our companies have been on that journey for a long time and some have just joined in. These are companies with a clear Purpose to make a positive change by exerting significant influence, directly and via second-degree effects, on their extended ecosystem including the environment and its biggest challenge to decarbonise.
Happy Panvesting, Kaia Tan, Sustainability Panvestor