Take-off for the Net Zero Transition  

COP28 may have not delivered all it promised, but investors now have a clearer idea of how the path to net zero will impact their portfolios.

After the sound, fury and compromises, what will investors remember COP28 for? In the short term, the drama of the final days, specifically the rows over wording of the ‘UAE Consensus’ on transition from fossil fuels, will dominate.

In the longer term, that headline-grabbing episode will be seen in context not just of the bigger picture of global decarbonisation, but also the many other firsts contained in that wrangled-over final text, and others which were unveiled at a dizzying pace from the Loss and Damage Fund announcement on the opening day onwards.  

In this summary article, ESG Investor covers some of the areas with the biggest implications for asset owners. We will look at the response to the Global Stocktake, and what it means for the goals of the Paris Agreement and the pace of renewables adoption globally; we will also explore the intensifying climate-nature nexus and the role of the finance sector in the transition to net zero.  

The disparate challenges of different countries will be a running theme, specifically the needs of emerging markets and developing economies (EMDEs), but adaptation will play a lesser role, having been covered in a recent deep dive, as will the failure to agree on carbon markets. 

Back on track?

The primary challenge for COP28 was to respond to the first Global Stocktake under the Paris Agreement. Ahead of the conference, the data had been collected and analysed, with assessments delivered on the effectiveness of actions taken to date, primarily in the form of signatories’ nationally determined contributions (NDCs) to the Paris Agreement.

The official verdict was clear. UN Climate Change’s NDC synthesis report found they would collectively only deliver a 5.3% reduction in CO2 emissions versus 2019, setting a course for 2.1-2.8°C of climate change by 2100.

We were “off track” and in need of “systems transformations”, not only according to UN Climate’s synthesis report on the technical dialogue of the Global Stocktake, but multiple other analyses highlighting persistent gaps between reality and professed ambition.

Less clear was how far governments would go to get us back on track, and what that would mean for governments, citizens, businesses and financiers across sectors and jurisdictions.

After two weeks of increasingly intense negotiations, the parties’ formal response to the Global Stocktake was issued; with one clause dominating a 21-page text. The first-ever mention of “transitioning away from fossil fuels” in COP final text was regarded as a major milestone on the path to net zero, even by those who acknowledged its multiple caveats.

How much of a milestone depends on other aspects of the text, related commitments made in Dubai, and how governments take actions forward over the next 12 months and beyond.

The Reverend Kirsten Snow Spalding, Vice President, Investor Network, Ceres, says the outcome was disappointing for investors, relative to expectations for greater certainty from policymakers on the pace, scale and nature of their decarbonisation commitments.

“I’m hearing a lot of hope about the signals around fossil fuels. But investors went into COP28 with expectations for a rapid phase out, real dates and policymakers beginning to act on reducing subsidies, setting goals, and embracing more robust NDCs.”

Jakob Thomae, Project Director at the Inevitable Policy Response (IPR), cautions against reading too much into a specific form of words in a single document. “From a concrete policy perspective, the language is irrelevant to investors, even though it does matter for the ‘vibe’ of COP,” he said.

“I’m much more excited about the commitment to triple renewable energy capacity because that is going to drive transition away from fossil fuel.”

In the context of prior agreements, including that reached in Paris, others see potential significance in the universal endorsement of what the best-available science says is needed, in terms of fossil fuel usage, to keep 1.5°C in realistic reach.

“Stronger wording might have been possible, but this was a big step in the right direction,” said Remco Fischer, Head of Climate Change, UN Environment Programme Finance Initiative (UNEP FI).

“The wording combines ‘transitioning away’ with the objective ‘to achieve net zero emissions by 2050’ and ‘in keeping with the science’ all in one sentence. That’s a good outcome for a consensus document.”

As Thomae suggests, the Global Stocktake response should be taken as a whole when investors assess its potential to course-correct the global trajectory toward net zero. They will also factor in the climate policy implications of initiatives such as the Global Decarbonisation Accelerator (GDA).

Unveiled over COP28’s first weekend, the GDA covered both supply and demand aspects of the clean energy transition, with governments and companies signing up to accelerate use of renewables, including hydrogen, while increasing efforts to decarbonise hard-to-abate sectors, through public-private partnerships such as the Industrial Transition Accelerator and related sectoral plans.

Thomae sees some evidence of transition costs becoming more tangible to investors, such as the investment required to finally address methane flaring, as promised by the Oil and Gas Decarbonization Charter (OGDC), part of the GDA.

“The cost profile [of transition] is going to become centre stage,” he notes.

Efficiency challenge

COP28 also recognised the importance of scaling up renewable energy capacity and improving energy efficiency globally. More than 100 countries pledged to triple renewable energy capacity to at least 11,000 gigawatts (GW) and double the annual rate of energy efficiency improvements from 2% to 4% by the end of the decade.

The Global Renewables and Energy Efficiency Pledge, calculated as being the minimum required to maintain a 1.5°C by 2050 trajectory, was endorsed and broadened to all parties through its inclusion in the Global Stocktake text.

While experts have welcomed the pledge, they warn that the realisation of these targets will not be easy. “We’re going to struggle to double energy efficiency,” says Annika Brouwer, Sustainability Specialist at global investment manager Ninety One.

“Across every single sector – construction, buildings, power systems, the light bulbs in your house – revisions to energy efficiency need to be made. The quantum of investment needed is almost unquantifiable, because it’s so far-reaching. There’s no one intervention that really gets efficiency at the jugular,” she explains.

If annual global progress is to grow by 4% every year, investments in energy efficiency will need to increase from US$600 billion today to over US$1.8 trillion by 2030, according to a report published by the International Energy Agency (IEA).

A separate IEA report noted that investments in energy efficiency have grown by 45% since 2020, but global improvements in energy intensity – a primary measure of energy efficiency – slowed in the year to November 2023, due to a rebound in energy-intensive sectors such as petrochemicals and aviation in some regions, as well as demand for air conditioning during a year of record heat.

“Grid capacity is an increasing concern,” adds Dave Jones, Global Insights Programme Director at energy think tank Ember.

“Tripling renewables means addressing land use and planning, threats to biodiversity, and supply chain-related issues,” he says.

The IEA has said that achieving all existing national climate and energy goals will require adding or replacing up to 80 million kilometres of power lines by 2040, which is equivalent to the entire existing global grid.

“You can build out renewable energy until you’re blue in the face, but if you don’t have a grid to accept and transmit that power, then it isn’t commercial and can’t be utilised,” Brouwer agrees.

The COP28 Global Renewables and Energy Efficiency Pledge also called for a phase-down of unabated coal power and ending investment in unabated new coal-fired power plants.

This will require substantial transition finance, such as that provided by Just Energy Transition Partnerships, but also an end to subsidies, which the Global Stocktake text did not emphasise as much as some would have liked. The UN Environment Programme’s 2023 ‘State of Finance for Nature’ report, also published at COP28, noted that government spending on environmentally harmful subsidies across agriculture, fossil fuels, fishery and forestry reached US$1.7 trillion in 2022.

A key question over the next 12 months will be how many governments take COP28’s pledges and texts as a trigger to join those already taking steps.

“Many governments have already committed to phasing out fossil fuels and fossil fuel subsidies while incentivising renewable energy,” says Julie Segal, Visiting Fellow at the London School of Economics’ Grantham Research Institute on Climate Change & the Environment and Senior Manager, Climate Finance at Environmental Defence.

“Others, like the Government of Alberta in Canada, recently set a moratorium on renewable energy builds, which discourages investment and creates an unstable environment. This is the reverse of the kind of policies we need to see consistent support for all kinds of renewable energy finance.”

Whole-economy transition

Given these new commitments to energy transition, investors should see major shifts in domestic policy, soon or later.

The IPR tracks policy developments on a quarterly basis, currently calculating that existing policies on climate action have us on track of for 1.8°C of global heating, lower than the trajectory implied by collective NDCs.

“NDCs are no longer a relevant benchmark for underlying policy ambition; they have become a lagging indicator. While we’re way off 1.5°C, the good news is that we’re way off 2.5°C too. The policy uncertainty window is narrowing,” says Thomae.

He expects NDCs to better reflect more ambitious policies over time, reflecting both the Global Stocktake text and other COP28 developments, but also predicts the political calendar will play a role in the determining policy implementation schedules.

“I wouldn’t be surprised if next year we see something of a policy pause in 2024, partly because of the nature of the election cycle,” says Thomae.

In the meantime, existing major initiatives such as the Inflation Reduction Act in the US and Europe’s Net Zero Industry Act and Carbon Border Adjustment Mechanism will continue to reshape the landscape.

Exceptions to the pause might include China, which not only paved the way for methane emissions reduction initiatives via its Sunnylands Statement with the US, signed in November, but also backed a number of nature-focused initiatives unveiled in Dubai.

Eliette Riera, Head of UK Policy at the Principles for Responsible Investment, says the next round of NDCs, due 2025, will be a key test for governments’ ability and willingness to provide comprehensive and detailed decarbonisation plans.

“In preparing these new national strategies, it is crucial for governments to take a whole of economy transition and build with the best available science. The private sector can support this approach, but only if policymakers lead the way in creating an enabling environment for such action,” she says.

In the meantime, investors must continue to closely track policy indicators.

“The tension between the global vision as represented by the UAE Consensus and the national ambitions and policy packages is increasing. That’s something that the markets and the investors need to navigate,” says UNEP FI’s Fischer.

Room for optimism

While many parties reacted strongly to the omission of ‘phase-out’ in the Global Stocktake draft circulated over the penultimate weekend, others noted a lack of equity in the transition demands of developed countries. Many medium- and low- income countries asked why they should forego the oil and gas revenues that had swelled the economies of rich nations, many of which were stalling on climate finance commitments.

Although COP28 started with agreement on operationalising the Loss and Damage Fund, the amount committed so far remains limited. Overall, significant amounts were pledged, with US$57 billion pledged by public and private sources in the first four days alone (US$84 billion by the close of COP28), including US$3.5 billion committed to the second replenishment of the Green Climate Fund.

UNEP FI’s Fischer believes the early deal on the Loss and Damage Fund helped to embed “more trust in the system”, and argues that continued delays on climate finance are not necessarily a cause for dismay.

With details to be finalised at COP29, a New Collective Qualitative Goal is set to replace rich countries’ longstanding commitment to providing US$100 billion annually in climate finance to developing nations. According to Fischer, an increasingly apparent appreciation of the type and sources of funding required stands a better chance of delivering results on the ground.

“What I see, with some degree of optimism, is a lot more nuance to these climate finance negotiations, which is leading to a more sophisticated approach to a more strategic use of limited public finance to mobilise private finance,” he says.

But Ceres’ Spalding still feels more needs to be done by governments to attract private capital.

“Investors agree that there is opportunity, but there’s a real need for governments to step up. Without government support, it’s going to be very hard for investors to move at the scale and speed necessary.”

The challenges facing investors in renewables projects in EMDEs is expected to be a key focus as governments returning from COP28 look to make good on renewables and efficiency commitments.

Jones says: “A large of amount of current renewables capacity is in developed countries; EMDEs have struggled to keep pace. There’s a huge amount of work to be done on how countries can access financing for these projects without having to pay extortionate rates of interest, which makes renewables far less viable for EMDEs.”

Concessional capital

This requires reform of the global financial architecture – most notably, multilateral development banks (MDBs), which play a vital role in creating an enabling environment for private investment and scaling project pipelines through grant-funded technical assistance.

MDBs, led by the World Bank, maintained a high profile at COP28, building on the progress on reforming public lenders’ processes and practices at the recent World Bank-IMF meetings in Morocco.

“The reform of MDBs and the use of concessional capital to set governments up to implement renewable energy at scale globally is key,” says Brouwer.

Following a joint commitment at COP27 to expand their support for countries’ climate transition efforts, 12 months on MDBs announced over US$180 billion in new climate finance commitments over the next decade, as well as pledging to support efforts to scale up climate adaptation financing through planning and policy, risk assessments, financing mechanisms, and capacity building.

Alongside this came a steady flow of funding announcements, including a blended finance collaboration between the US Agency for International Development (USAID) and several Nordic governments to channel private capital to climate mitigation and adaptation, biodiversity and nature-based solutions. It will use an asset owner advisory board to advise on potential transactions and private finance incentives, then engaging with asset managers on calls for blended finance vehicle origination and asset owners for financial pledges.

Additionally, Brouwer from Ninety One emphasises the importance of the UAE’s new US$30 billion Alterra fund, also unveiled during COP28, which aims to drive private capital at scale into both emerging and developed markets to support the scaling of climate infrastructure and transition efforts.

“This sets the bar for what a big and ambitious commitment looks like,” notes Brouwer. “Rather than trying to crowd out the rest of the private sector, it is trying to crowd them in.”

Strong signals

As the cost implications of decarbonisation further crystalise, especially in light of COP28’s outcomes and indicators for the energy sector and its customers, IPR’s Thomae expects competition for scarce resources to intensify.

“From an investor’s perspective, the land use story is becoming clearer. There will be so many people bidding into land in the next decades that it will become a much more competitive asset, with climate change also impacting availability,” he says, noting also the potential impacts of geo-political complexities.

“If energy was the first chapter of the decarbonisation story,” he adds, “land use will be the second.”

This year’s COP saw the greatest emphasis yet on the emissions profile of terrestrial and marine environments, both positive and negative, and an increased recognition of the need to consider, indeed leverage, the climate-nature nexus for mutual benefit.

“What we’re hearing from investors is a really strong signal that they consider nature and biodiversity loss a real financial risk that’s interconnected with climate risk. And what we got at COP was the strongest signal that countries are really considering these as integrated risks,” said Meryl Richards, Programme Director for Food and Forests at Ceres.

This manifested itself in the dedicated days allocated to nature, food systems and health in Dubai, which yielded multiple initiatives, funding pledges and commitments. It was also reflected in the final text of the Global Stocktake response.

COP28’s final text highlighted the importance of conserving, protecting and restoring nature to achieving the goals of the Paris Agreement, in line with the Global Biodiversity Framework. Further, it noted the need for increased support and investment to reverse deforestation and forest degradation by 2030, including payments and incentives to sustainably manage forests.

References to food systems in the Global Stocktake text were positive, experts say, but further steps would have been welcome. The text recognised the role of resilient food systems for adaptation, but made no explicit reference to the need to reduce its emissions. It noted the importance of transitioning to “sustainable patterns of consumption and production” without mentioning specifically dietary shifts. And while the text highlighted the need to scale down harmful incentives to fossil fuel usage, it did not refer specifically the phasing out of harmful agricultural subsidies.

Key related developments include the incorporation of food and agriculture into NDCs via the Emirates Declaration signed by more than 150 countries, a China-led commitment to closer coordination of national climate and nature plans, and timelines and guidelines for the transition of food and agriculture to a more sustainable and equitable future, under the UN Food and Agriculture Organization’s (FAO) net zero roadmap. Signatories of the methane pledge, promising further action and transparency, included several large firms from the food and agriculture sector.

“Previously, agriculture had got a free pass, now it’s under the microscope. The need to have country action plans to reduce those emissions trickles downs first to companies and then to investors,” says Sofia Condes, Head of Investor Outreach, FAIRR Initiative, regarding the Emirates Declaration.

“It signals to investors that the speed and scale of the transition in the food sector is likely to increase rapidly. It shows too that the climate and environmental transition is no longer something you can dedicate a small part of your portfolio to; it’s happening across different sectors. There will be a shift in practices and consumption patterns, as well as innovations and opportunities.”

The FAO’s roadmap will be updated over the next three years, but already offers “a welcome first step” to provide direction to governments, companies and investors on how to plan for the transition for the food sector, added Condes.

“As it evolves, we’re hoping it will have much more granular detail on implementation and will embed more nature priorities into its climate pathways.”

Blue breakthroughs

The role of oceans and coastal regions in both climate mitigation and adaptation was referenced for the first time in a climate COP closing text, which encouraged “further strengthening of ocean-based action”. While the latter was seen as a positive, references to “ocean-based mitigation” could be seen as opening the door to unproven and potentially damaging techniques of exploiting the oceans’ role as a carbon sink, especially alongside wording related to accelerating carbon removals innovations.

As well as mixed references in the global stocktake text – which set no new targets for protection or conservation – the profile of oceans and coasts was raised at COP by the COP28 Dubai Ocean Declaration, and funding pledges involving organisations including the Bezos Earth Fund, USAID and the International Coral Reef Initiative.

This builds on momentum generated by the release  in October, under the aegis of the Marrakech Partnership for Global Climate Action, of five ‘Ocean Breakthroughs’, aimed at accelerating investment and action toward a “resilient, nature-positive and net zero” future by 2050. The breakthroughs outline sustainable pathways for marine conservation, ocean renewable energy, shipping, aquatic food, and coastal tourism.

According to Karen Sack, Executive Director of the Ocean Risk and Resilience Action Alliance (ORRAA), among the most ocean-positive outcomes from COP28 centred on new approaches to investment in the ‘blue economy’ which could be used to de-risk multiple projects.

This “wave of action” included Deutsche Bank becoming the first global bank to sign up to the #BackBlue ocean finance commitment, intended to de-risk sustainable ocean and coastal-related investments. Sack emphasises the need to develop financing solutions at multiple levels, including those which can support the “missing middle”, citing the Outrigger Ocean Impact Fund, which invests small to medium sized firms in the sustainable and regenerative economies of Small Island Developing States.

Mainstreaming transition

It is widely understood that the transition to a 1.5°C temperature pathway will not be linear. Striking the right balance between supporting carbon-intensive companies in their climate transition – such as an energy utility transitioning to renewable power generation – and inadvertently greenlighting unsustainable processes has been challenging for investors.

With up to US$50 trillion required to transition global supply chains to net zero by 2050, clarity on what can be defined as a transitional versus sustainable economic activity is a must, experts agree.

Efforts are gathering pace across jurisdictions. The UK government is planning to conduct a transition finance market review, as its Transition Plan Taskforce continues to develop its ‘gold standard’ transition plan guidelines. The US Treasury recently published its Principles for Net Zero Financing and Investment, drawing on the transition-focused work of finance sector-drive body the Glasgow Financial Alliance for Net Zero (GFANZ).

In its 2023 progress report, published at COP28, GFANZ called for an acceleration in momentum globally for “mainstreaming transition planning in the real economy as well as financial sectors”.

Evidence in Dubai of government commitment came via the first annual high-level ministerial roundtable for the UN’s Just Transition Work Programme, with discussions focused on outlining just transition pathways for countries; each will differ according to dependence on fossil fuels, as well as poverty levels and other domestic challenges.

In terms of mobilising transition and climate finance in the right areas, the Global Capacity Building Coalition was launched to increase the availability and effectiveness of climate finance technical assistance programmes for financial institutions in EMDEs.

Additionally, the UN-convened Principles for Responsible Investment (PRI) responded to recommendations made at COP27 by the Secretary-General’s High Level Expert Group (HLEG) with the formation of the Taskforce on Net Zero Policy.

The taskforce aims to support transition planning by corporates and financial institution by providing a forum for discussion around policy hurdles for the adoption of net zero, balancing the needs of relevant private sector actors with the demands and timelines of a regulatory environment geared to a net zero future.

“I hope to see increased momentum pushing for the regulation of credible transition plans from the private sector,” says Segal.

Ninety One’s Brouwer notes that a broad global understanding of what constitutes transition finance would ultimately be useful for global investors, but total harmonisation would be challenging. The prevailing industry and energy mix across countries inevitably differs widely, for example, as does their present and previous contribution to global warming in a different way.

“For instance, the US has contributed the most emissions historically but today is on its downward trajectory. Does that mean it should have the same regulations, ambitions and expectations as an African country that has contributed zero to the problem but is likely to contribute a lot to the problem in the future?” she posits.

The same is true at an investor and company level, Brouwer says.

She adds: “COP is a place for these types of discussions, but it’s not the only place. Financial institutions and governments should be coming together outside of COP. I hope by next year we have more consensus around a consolidated and fair transition framework, but that work starts now. It doesn’t start in November next year.”

COP28’s final text does perhaps hint at the beginnings of such a framework, not least through its most-quoted output.

“Any definition of transition which includes the expansion of fossil fuels or considers any utility for fossil fuels beyond this decade is a greenlight for greenwashing and would go against what nearly 200 countries just agreed to,” says Segal.

A more focused lens

What will investors remember COP28 for? UNEP FI’s Fischer suggests it could provide a turning point, after which the implications of the net zero transition became much clearer for investors.

“These explicit references to renewable energy, energy efficiency, deforestation etc, will help asset owners to look at their exposures to various sectors through those lenses. Where they were once more focused on emissions, now they will take a more multi-dimensional approach,” he adds.

But the stark realities of the current gaps between action and ambition leave continued scope for uncertainty about future the pace, scale and effectiveness of policy, which can delay investment decisions.

One key outcome of COP28 could be a continued increase in investors’ focus on advocacy and engagement to better understand and influence policy. This has already been seen in the engagement initiatives announced over the past 12 months by investor networks, including the Taskforce on Net Zero Policy. It is also reflected in investors’ engagement priorities with corporates, ensuring their lobbying activities align with their stated commitments on net zero.

“While the deal at COP28 is a helpful and important signifier, we must be clear-eyed that countries need to take action themselves to facilitate change. Policy change is absolutely integral to this process,” says the PRI’s Riera.

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