Perspective

Has COP26 boosted the energy transition?


The last two weeks have been dominated by the COP26 climate conference in Glasgow, which saw representatives from all over the world discuss plans to reduce harmful emissions and limit temperature rises.

There has been a multitude of announcements and pledges. Here, we focus on the key announcements for energy transition investors.

Net zero targets

Firstly, the focus on net zero as an ambition is very positive. Previous conferences have spoken of reducing emissions so the change in emphasis to net zero is a step forward. It’s important because ultimately halting harmful new emissions is the only way to stop global temperatures from rising.

The EU, US and China already had net zero targets in place before COP26. India has now joined them, albeit with a target of 2070 rather than the 2050 commitment made by the US and EU. India has also committed to hosting 500GW of renewable energy generation by 2030. This should account for 50% of the country’s energy supply.

This is encouraging from a climate point of view. The IEA said during COP26 that pledges made so far – if implemented as scheduled – could limit global warming to 1.8 °C by 2100. Pledges are not policies though, and countries still need to do much more to firm up how they will meet their net zero targets.

From an investment point of view, there is a really exciting opportunity to try and find those companies who can help accelerate the transition to net zero beyond the stated goals.

Methane

There was some tangible progress at COP26 on the specific area of methane emissions. An alliance of 90 nations pledged to reduce methane emissions by 30% by 2030. This was non-binding and did not include China, India or Russia. Nonetheless, it is pleasing to see the commitment.

This is important because methane is a very powerful greenhouse gas and its effect on warming up the climate is significantly larger than CO2, although CO2 stays in the atmosphere for longer.

It will have an effect on some of the major oil companies who produce methane as part of their oil & gas output. The US, for example, has announced the Methane Emissions Reduction Action Plan, under which the Environmental Protection Agency will propose new regulations to broaden and strengthen methane emissions reduction for new oil and gas facilities.

Fossil fuels

Another important commitment came on coal phase-out. More than 40 countries – including some major coal users such as Poland – committed to shifting away from coal. Again, however, the deal did not include some key players with China and the US failing to sign up.

A separate commitment saw 20 countries, including the US, agree to end public financing for unabated fossil fuel projects overseas by the end of 2022. Such projects burn fossil fuels, like coal, oil and natural gas, without using technology to capture the CO2 emissions.

A disappointment is that COP26 saw limited discussion of renewable energy technologies.

Some COP participants and observers were disappointed that the Glasgow Climate Pact (the final conference text agreed by all countries) only mentioned the need to “phase down” coal and fossil fuel subsidies, rather than phase them out. However, this can be seen as progress as it is the first time that coal and fossil fuels have explicitly been mentioned in the final agreement.

We’d argue that the wording itself is perhaps less important than the actions that will follow. This is where both consumers and companies can be the driving forces of change.

Climate finance

There was an announcement that the US, EU and UK would step up with $8.5 billion of financing to help South Africa move away from reliance on coal.

Overall, though there was little progress on the financing front. The developed world has still not reached its promised target of getting to a US$100 billion per annum run-rate of climate finance for developing countries, and won’t get there for another three years.

That’s disappointing, not least because the rationale for climate finance in terms of generating returns on investment is far stronger now than it has been historically. We've seen so much innovation in the climate change and climate technology space over the course of the last two decades, which has meant these technologies are now cost effective.

As a result, it increasingly makes less sense to be investing in new fossil fuel capacity in developing markets, but going straight to renewables instead.

Transport

Again, a global agreement on transport proved elusive at COP but there were some positive steps.

Around 30 countries agreed a framework to help make zero emissions vehicles affordable and accessible everywhere by 2030. The UK also committed to end the sale of new diesel trucks by 2040.

In addition, 19 governments have stated their intent to support the establishment of “green shipping corridors” – i.e. zero emissions shipping routes between two ports. This will involve deploying zero-emission vessel technologies and putting alternative fuel and charging infrastructure in place in ports.

Carbon markets

We had been hoping to see progress on carbon markets. This is a topic that was pending after the Paris COP21 in 2015 so developments here are encouraging.

COP26 agreed rules that will create a market for units representing emissions reductions that countries can trade. The rules are fairly tentative but do iron out some of the loopholes that many climate experts had been concerned about.

What next?

We think there are three forces driving the investment opportunity in the energy transition. These are cost, consumer demand, and policy. The costs of renewable technologies continue to fall, enabling their widespread adoption. Consumer awareness of climate issues is also growing and resulting in increased demand.

The policy aspect is one where more detail from COP26 would certainly have been welcome. The final text from the conference keeps alive the ambition of limiting temperature rises to 1.5 °C from pre-industrial levels by 2050. However, we need to see much more progress from governments in terms of their Nationally Determined Contributions (NDCs).

The NDCs are essentially the actions countries will take to reduce national emissions. Current pledges for emissions reductions by 2030 are well above where they need to be, and put the world on track for warming of c.2.4 °C. The NDCs – and specifically action for 2030 - will be revisited at the next COP.

Long-term frameworks around topics such as carbon prices, climate financing and emissions reductions would create an environment of policy stability. In turn, that enables both corporates and consumers to deploy capital and make decisions with a long-term view in mind, and without worrying that the policy environment may suddenly change. That’s something to focus on as attention turns to next year’s COP27 in Egypt.

This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. 

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This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements.

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