Recognition, but not acceptance, of temperature overshoot may become a necessity for investors, companies and policymakers.
At the time of writing, it has been confirmed that more than 100 people have lost their lives to the wildfires raging across Hawaii’s Maui Island – the deadliest US wildfire in over a century.
“This summer is giving us a mere taste of our future, and we’re still only at 1.3°C of [global] warming,” Jakob Thomae, Project Director at the Inevitable Policy Response (IPR), tells ESG Investor.
The possibility of limiting global warming to 1.5°C is rapidly falling out of reach, despite the fact most net zero commitments set by governments, investors and companies target a 1.5°C temperature pathway.
Science journal Nature surveyed scientists in 2021, with 60% of the 92 respondents predicting global warming will reach 3°C by the end of the century. Another paper forecast just a 6-10% probability of limiting global warming to 1.5°C without first exceeding it.
The UN World Meteorological Organization said in May there is a 50-50 chance that temperatures will reach 1.5°C for at least one individual year between 2022-26.
It’s widely understood that failure to mitigate climate change will be catastrophic at a human and financial level, inflicting estimated damages and losses of over US$20 trillion annually by 2100.
“The dangers of climate change are becoming increasingly clear and vivid, including how our societies and the infrastructure that backs them will operate beyond their tolerance levels and become more susceptible to disruption,” says Anderson Lee, Research Associate on Sustainable Investing at the World Resources Institute (WRI).
“Corporations’ physical and transition risks will be exacerbated which in turn will affect investors,” he adds.
Yet addressing the realities of a 1.5°C overshoot still feels like the elephant in the room.
When reaching out to investors on this topic, many declined to speak, admitting that they are only just beginning to discuss how to fold the reality of a 1.8°C+ world into their existing climate-related engagements with corporates.
Even if temporary, the threat must be acknowledged if it is to be tackled.
“Every fraction of a degree matters,” says Bettina Reinboth, Director of Sustainability Initiatives at the UN-convened Principles for Responsible Investment (PRI).
“Investor action must continue to increase in its ambition and scope, with a view to managing down the long-term risk implications of increasing warming.”
The 1.5°C track
Climate-focused stewardship has rocketed up the agenda for investors in recent years, as firms look to align their portfolios with a 1.5°C temperature pathway.
Major investor-led engagement initiatives, such as the Net Zero Asset Owner Alliance (NZAOA) and Climate Action 100+ (CA100+), have outlined in their guidance that climate-related engagements and net zero targets should be aligned with a 1.5°C pathway – typically without referencing the likelihood of temperature overshoot.
The NZAOA asks members to set quantitative 1.5°C-aligned targets with ‘no or low overshoot’ scenarios, but acknowledges that these targets “may not be attainable with an engagement-only approach without appropriate related government policy and corporate actions”.
Tim Mohin, Partner at Boston Consulting Group (BCG), questions whether there is a time lag in capital markets which has prevented the consideration of a temperature overshoot in climate engagements. “Many [investors] claim the true cost of climate change has not been priced in even now,” he says.
Overshoot or not, there is acknowledgement amongst investors speaking to ESG Investor that the window of opportunity for a 1.5°C world in 2050 is closing very quickly.
“Is it impossible to keep to 1.5°C? No. But is it increasingly unlikely? Yes, we think it is,” says Nick Stansbury, Head of Climate Solutions at Legal and General Investment Management (LGIM).
“An objective look at the data shows there’s a limited amount of time left to sufficiently reduce emissions.”
For many investors, the focus isn’t on the end destination but the journey itself.
In June, mining major BHP warned investors that the combination of new growth projects and underdevelopment of carbon abatement technologies would likely result in an uptick to its emissions in the near term, before eventually declining closer to the end of the decade, putting its 30% decarbonisation by 2030 target out of reach.
“Despite BHP’s new ‘canary’ status when it comes to potential net zero challenges of miners, we don’t think its distress call should drive investors from the sector,” says Sarah Peasey, Head of Europe ESG Investing at Neuberger Berman.
“BHP’s early warning should actually be welcomed by proactive and forward-looking investors as a sign of transparency and an opportunity to recalibrate expectations and more effectively engage on decarbonisation with BHP and its peers.”
She says Neuberger Berman has adjusted engagements with mining companies to deal more with the testing of carbon abatement technologies and to “reality check” management timelines.
Lee from WRI argues there is a danger of a “self-fulfilling prophecy” happening if investor engagements shift to focus on preparing for higher temperature scenarios.
“It may result in C-suite executives thinking that 1.8°C is now acceptable,” he says.
What investors can do instead is continue to demand net zero transition plans aligned with 1.5°C and ask about the barriers to implementation, Lee notes.
“The fact that we may not be on track for 1.5°C today doesn’t mean we should give up on that particular objective,” agrees Thomas Hohne-Sparborth, Head of Sustainability Research at Lombard Odier Investment Managers.
He says investors need to continue to be very clear with companies on three points: Have they set a net zero target? How are they going to achieve and implement this? Do they have a plan in place?
“Corporations and investors should use this decisive decade to keep 1.5°C alive – for everyone’s sake,” adds Lee.
Prepare and plan
Amy O’Brien, Global Head of Responsible Investing at global investment manager Nuveen, a wholly owned subsidiary of Teachers Insurance and Annuity Association of America (TIAA), says that the increased possibility of temperature overshoot doesn’t negate the urgency of ambitious decarbonisation strategies for companies.
“Rather, it heightens the need for resiliency planning conducted in tandem,” she notes.
Climate scenario analysis has been recognised as a potentially effective way for investors to map out the different risks and impacts various temperature pathways will have on their portfolios.
It should be “central to all investors’ risk management processes”, O’Brien says, noting that TIAA utilises climate scenarios set out by the Network for Greening the Financial System (NGFS) to stress test investment processes.
LGIM’s Stansbury emphasises that, when it comes to tackling climate change, it’s best for investors to “prepare and plan – don’t predict”.
LGIM has developed its own climate scenarios, which it regularly updates to reflect any global changes, such as Russia’s invasion of Ukraine.
Transitioning to a below 2°C outcome would lower global GDP by a “statistically insignificant amount” – as little as one basis point per month over the next quarter century, LGIM’s recent report on its scenario findings noted. Further, a delayed below 2°C scenario, where global action isn’t taken until the 2030s, is “highly economically disruptive and costly”.
Earlier this month, the UK’s largest pension fund, the Universities Superannuation Scheme (USS), announced its trustee board would be reviewing the scheme’s approach to climate scenario analysis alongside the University of Exeter, noting “significant limitations”.
All pension funds in the UK are mandated to conduct climate scenario analysis under the Task Force on Climate-related Financial Disclosures (TCFD) framework, but USS has said scenario modelling is predominantly focused on long-term horizons and has the potential to miss crucial tipping points.
A warmer world
Companies and investors can only make so much progress on their own – policymakers must pave the way to net zero with ambitious policies and regulations that are as closely aligned to 1.5°C as possible, experts say.
The IPR forecasts that climate policies put in place since COP26 set the world on a 1.8°C temperature pathway.
Last year, the UN Environment Programme’s (UNEP) ‘Emissions Gap Report’ said climate policies enacted worldwide could result in 2.8°C of global warming by 2100 – and between 2.4-2.6°C at best. Even if all commitments made by countries are met, temperatures would still hit 1.8°C by 2050, the report said.
The most damning report of all, the IPCC AR6 Synthesis report, confirmed policy action remains insufficient to achieve the commitments made under the Paris Agreement, with the world hurtling towards a 1.5°C overshoot.
“1.5°C is a high bar to clear – this doesn’t mean policymakers aren’t jumping pretty high relative to the rate of progress even a decade ago,” says IPR’s Thomae.
Peasey from Neuberger Berman is similarly optimistic, noting that policymakers are “finally sending all the right signals to give companies reason to financially commit to the transition”.
The bill is expected to cut US emissions by over 40% from 2005 levels by 2030, boosting the country’s prospects of achieving its 2030 nationally determined contribution (NDC) and reaching net zero by 2050, tilting the market to incentivise increased investment in green solutions.
But, like the rest of the world, the US government is failing to detach from fossil fuels, with Biden approving an Arctic drilling project expected to produce oil for the next 30 years.
COP27 also ended without a resolution to phase down oil, gas and coal.
This is despite the fact there is large consensus that new oil and gas fields are incompatible with a 1.5°C target.
With 2023 marking the first Global Stocktake, the need to transition away from fossil fuels is likely to become even more apparent as all parties conclude their assessment of progress toward achieving the goals of the Paris Agreement. It’s hoped that this will fan the flames of ambition at COP28 in Dubai and inform the next set of NDCs.
A complex transition
“This is a phenomenally complex transition,” says Hohne-Sparborth from Lombard Odier IM.
“It’s only going to work if infrastructure, policy frameworks, products and investment instruments are moving in the same direction at the same time.”
Investors therefore have a big role to play in engaging with policymakers on climate, ensuring they maintain a level of ambition aligned with a 1.5°C temperature pathway.
What investors can’t do is rest on their laurels.
It’s time for a bigger conversation to take place on the global stage, according to Mohin from BCG.
“Missing 1.5°C won’t be the end of the world – we will continue on – but we are reaching the point where we collectively need to readjust our global climate framework,” he tells ESG Investor.
“What does a 2.1°C or 2.3°C world mean for humanity? What does everyone need to do – from policymakers to investors and companies and consumers? We need to seriously be thinking about how to harness the power of capitalism to do good.
“But we’re only just at the beginning of the conversation – we’re not there yet.”