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Commentary

Overshoot is Here

Restoration capital will become core to the climate narrative towards the 2025 ratchet, says Julian Poulter, Head of Investor Relations at the Inevitable Policy Response.

If some current market signals are correct, then the fog of inflationary risks and forthcoming recession remains, but with an end in sight. There will be more hiccups, with poor earnings results likely and the emergence of some possible sovereign default risks that will see the bears with their fingers in the honey pot once more. But by the end of 2023, the climate issue will loom again for investor CEOs and CIOs, pushing up on board agendas previously crammed with Covid-19, Ukraine and macro-economic debates. 

This will apply particularly amongst long-term asset owners trying to divine the future pace of change through the coming climate policy cycle, against their 2030 and other emissions targets.   

Taking stock  

The 2023 Global Emissions Stocktake (GST) at the Dubai COP this November where nations will submit their climate homework is a planetary wide assessment, with a foregone conclusion, already confirmed by the draft IPCC AR6 Synthesis Report, set to be finalised by September. For those investors committed to climate action, it will be like a bad end-of-year school report arriving in the mail, with the result already known.  

Collectively, the key policymakers at COP will try to seek positives in the short term thanks to the US Inflation Reduction Act (IRA) package and the EU responses. It will only take two of the three geopolitical giants to compete on clean energy and technology for China to be forced to into the race 

However, despite a positive trend for climate policy acceleration as detailed in the Inevitable Policy Response (IPR) tracking reports since 2021’s COP26 in Glasgow, the lag between ambition and progress since the 2015 Paris Accord will be laid bare, no matter how it is dressed up. Some governments will blame others or their internal political opposition and the most climate-vulnerable of the South Pacific and poorer nations will fairly point fingers.  

Following the GST, governments, investors and companies will inexorably be drawn to the agenda for the big one – the Global Ratchet of 2025.  

Here, everyone will gather to raise momentum, an acceleration that the Paris 2015 pioneers, looking ahead 10 years, would have hoped was going to involve minor adjustments here and there on the road to low carbon success. Sadly not.  

Investor boards looking towards initial outcomes of the GST should really be looking well past 2025 as policymaker responses to the Ratchet play out through the remainder of the decade. Disorderly transition and portfolio risks loom large.  

2025 will cause a fundamental re-appraisal  

For investors with 2030 and net zero commitments, the Stocktake / Ratchet cycle will show that success from significant company and policy engagement since 2015 has been difficult to spot. Some investors can point to their own portfolio decarbonisation success, largely achieved through divestment but with little to show on the critical recycling of that capital towards to where it’s needed most, in new clean energy systems.  

The power shift in terms of lobbying away from high carbon energy is underway and it is conceivable that the clean energy lobby will start to play global fossil fuel interests at their own game in the coming years. This will take time and now time has run out for the new clean lobbying to have the necessary impact to save global net zero without an overshoot past 1.5°C. 

Overshoot becomes real  

The key change that investors must prepare for is the change in narrative. It is simply too late to believe in policies that hold temperature 1.5°C degrees without an emissions overshoot. With the overshoot label now liberally sprinkled through the AR6 Guide for Policymakers, it is now front and centre all the way to 2025.  

The 2023 Stocktake will reinforce what AR6 points towards. That an emissions overshoot for later in the century with unknown but inevitably nasty physical consequences, is inevitable. With insurance companies already withdrawing or outpricing coverage in huge areas of the globe this will result in the damages models being recalculated and the folly of using discount rates to calculate those damages will be clear – the discounting to present value of damages is less relevant when they are occurring…. errr …in the present. 

This means that the entirely predictable and necessary Ratchet-driven call post-2025 for increased policy and significant uplift of global investment into clean energy and clean technology systems must be heeded with a tagline of ’we really mean it this time’. US$5 trillion in annual green investment, once seen as overly ambitious, may emerge amongst new benchmarks. 

But critically there are two other areas which have been pushed to the background. They are non-OECD countries and negative emissions technologies (NETs). For net zero-aligning investors, not one of them will have a complete portfolio without reliance on high carbon economies in non-OECD countries feeding the supply chains of the underlying investments they hold.  

IPR forecasts the OECD to reach its net zero targets by 2050. 

Yet to claim to be on track as a pension fund or an insurance company is to deny the obvious that the fund may be clean under your own definitions, but the structural problems have not yet been addressed. The narrative around emerging economies and NET should be item one on the 2025 COP agenda, not an inquisition as to why we didn’t get there.  

The implications for support for developing nations in a Just Transition will also involve real economic sacrifice for OECD nations – the back burner will have become the front burner. Negative emissions investment will need to be seen not as a saviour for fossil fuel companies (their demand side destruction is assured) but a human and economic necessity. 

What restoration capital means 

Massive afforestation scale ups will be required, but it is already too late just to carpet the land with trees to save ourselves. We will likely also be lifting investments in the ‘out there’ technologies. Direct air capture (DACs) systems, geo-engineering (after all its what we are doing now, right?) and huge investment in Carbon Capture and Storage (CCS) to bridge the gap for the power sector and allow industrials a smoother transition.  

This will all fall under the lexicon of restoration capital, pulling the world back from emissions overshoot alongside investing towards net zero. None of this will be fun. Covid-19 gave us a glimpse of how assets can be repriced in emissions-intensive sectors and the bounce back bounty in coal and oil and gas has been very unwelcome in fossil fuel divested funds, but none of it matters any more. The writing may be on the wall, but instead of looking at the wall we might as well just turn around to see it happening for real.  

Yes, there will be investment winners through the resultant acceleration following 2025 and possible panic but watch out for the search for the guilty as the intergenerational and geographic unfairness of the GST report card and the resultant Ratchet response becomes better understood.  

No amount of IRA-driven investment or EU leadership positivity can now deflect attention shifting from the long-term comfort of 2050 to the short-term recognition that 2030 targets are now in trouble. The probabilities around temperature rises with which the climate community have become so renowned have now disappeared into irrelevance.  

The targets, emissions curves and final temperature results still don’t stack up. The Stocktake will reflect this. The Ratchet will be the next big chance to stitch them together. 2025 anyone? 

Julian Poulter is a founding partner of Energy Transition Advisers (ETA) and Head of Investor Relations at the Inevitable Policy Response (IPR). The views expressed in this article are personal and do not necessarily represent the views of IPR.  

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