The investment case for net zero carbon

Management consultants have a plethora of frames, four box matrices and cute acronyms, such as SWOT analysis – strengths, weaknesses, opportunities and threats.

"In 2021, financial institutions issued more debt – bonds and loans – to the green and sustainable sector than the fossil fuel sector for the first time.”

But beyond the hackneyed analysis, the underlying truth is correct: there are threats and opportunities in responding to climate change.

The biggest threat, obviously, is the existential one. If the world, as a whole, doesn’t limit global warming it will be catastrophic for humanity and hence not particularly positive for economies.

There are though more proximate threats for the financial services sector, notably in terms of funding, risk and regulation.

The weight of global investment money is increasingly looking for targets that can either benefit from or manage the risk of the transition to lower carbon economies. Notably, in 2021, financial institutions issued more debt – bonds and loans – to the green and sustainable sector than the fossil fuel sector for the first time, according to data published by the International Energy Forum.

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That shift brings its own risks. If a company or organisation tries to “green wash” its response it will suffer. And institutions in financial services, because they are the conduits for economic flows, are under greater scrutiny.

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Race to zero

In April last year, the most significant of the campaigns to redirect investment into more sustainable ventures was announced.

The Glasgow Financial Alliance for Net Zero (GFANZ), chaired by Mark Carney, UN Special Envoy on Climate Action and Finance and former governor of the Bank of England, unites over 160 firms (together responsible for assets in excess of $US70 trillion and including ANZ) from the leading net zero initiatives across the financial system to “accelerate the transition to net zero emissions by 2050 at the latest”.

“All GFANZ member alliances must be accredited by the UN Race to Zero campaign,” the group announced. “They must use science-based guidelines to reach net zero emissions, cover all emission scopes, include 2030 interim target setting, and commit to transparent reporting and accounting in line with the UN Race to Zero criteria.”

However, no matter the good intention, putting these commitments into practice is no easy matter. Already some signatory institutions are struggling to implement or validate their commitments.

Overlaying that scrutiny is a regulatory one: central banks globally are paying much closer attention to the climate risks resident in bank lending portfolios and the measures being taken to understand and manage those risks.

For example, the European Central Bank (ECB) has launched a supervisory climate risk stress test to assess how prepared banks are for dealing with financial and economic shocks stemming from climate change.

The ECB says the test aims to identify vulnerabilities, best practices and challenges banks face when managing climate-related risk. This follows a study last year when the ECB uncovered significant shortcomings in the ability of EU banks to adequately cover their exposure to climate-related risk.

So financial institutions face considerable strategic, tactical and credit risks with their response to climate change. Then what of the opportunity?

Necessary investment

At ANZ’s 2021 annual meeting, the bank’s chief executive, Shayne Elliott, outlined his thinking on how this might play out given the trillions of dollars of investment necessary “making it one of the global mega-trends impacting banking and society more generally”.

“Firstly, the sectors that can decarbonise, such as vehicle fleets and manufacturing, are doing so at a rapid rate. This takes considerable investment,” he noted.

“At the same time, new sources of green electricity, improved battery storage, different distribution networks and hydrogen solutions will be developed with increased urgency. Again, significant investment will be required.”

Elliott argued ANZ, as Australia’s only truly regional bank, was well placed to shape and support the required transition.

“Our strength in the natural resources sector means we have deep relationships with those companies that will lead the transition. And with our dominant position in trade finance, debt capital markets and syndicated loans, we are starting from a position of strength. In fact, we estimate we already have a share of around 5 per cent of global flows in the Sustainable Finance market.”

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An extensive new report from McKinsey & Co, The net-zero transition: What it would cost, what it could bring, outlines the sheer enormity of the financing challenge – and opportunity – of this global mega-trend if the world is to achieve net zero carbon emissions by 2050.

The numbers are eye-watering.

“Capital spending on physical assets for energy and land-use systems in the net-zero transition between 2021 and 2050 would amount to about $US275 trillion, or $US9.2 trillion per year on average, an annual increase of as much as $US3.5 trillion from today,” the report found.

“To put this increase in comparative terms, the $US3.5 trillion is approximately equivalent, in 2020, to half of global corporate profits, one-quarter of total tax revenue, and 7 per cent of household spending. An additional $US1 trillion of today’s annual spend would, moreover, need to be reallocated from high-emissions to low-emissions assets.”

That amounts to as much as 8.8 per cent of gross domestic product (GDP) between 2026 and 2030 before falling.

Faster than expected

But critically – and something which needs to resonate more widely – is these massive sums are not “costs” over the long term.

“Many investments have positive return profiles (even independent of their role in avoiding rising physical risks) and should not be seen as merely costs,” McKinsey said. “Technological innovation could reduce capital costs for net-zero technologies faster than expected.”

(Although the emerging role of new technology doesn’t replace the need for other immediate action.)

McKinsey also forecasts the transition will add jobs - in aggregate.

“The transition could result in a gain of about 200 million and a loss of about 185 million direct and indirect jobs globally by 2050. This includes demand for jobs in operations and in construction of physical assets. Demand for jobs in the fossil fuel extraction and production and fossil-based power sectors could be reduced by about nine million and four million direct jobs, respectively, as a result of the transition, while demand for about eight million direct jobs would be created in renewable power, hydrogen, and biofuels by 2050.”

Clearly, even if job creative in aggregate, the displacement and shifts in the workforce will be a social, political and economic challenge.

However, such disruption is already occurring and McKinsey argues “while important, the scale of workforce reallocation may be smaller than that from other trends including automation”.

These are massive numbers. Massive costs for a massive challenge for the planet. But also a massive opportunity.

Andrew Cornell is Managing Editor of bluenotes

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