As the effects of greenhouse gas emissions are cumulative, persistent and not localised, the response needs to be international. It requires a shared global vision of long-term goals and frameworks that will accelerate energy transition and other action over the next decade.
The ratification of the Paris Agreement was a step forward, and an example of the global co-operation required. To achieve the goals set in Paris, greenhouse gas emissions need to be substantially reduced. The Paris Agreement requires each country to set out – in its Nationally Determined Contributions (NDCs) – its commitment to reduce greenhouse gas emissions, and details of how it intends to adapt to the impacts of climate change.
There is a diverse range of views on what the reduction targets for greenhouse gases should be. At Ruffer, we expect that the NDCs or climate pledges will be tightened in 2023, to align with the pathway to meet the goals of the Paris Agreement.
For investors, there will be opportunities for companies that contribute to the mitigation of or adaptation to climate change. Yet the lack of clear and co-ordinated policies to mitigate the worst effects of climate change increases risks. The physical risks of climate change are becoming increasingly apparent: in a globalised economy with complicated supply chains, the number of companies affected is vast. This has caught the attention of central bankers, concerned about the threat to financial stability. The transition risks to companies are also significant, and the lack of clarity on government policies makes it difficult to plan effectively.
Work co-ordinated by the Principles for Responsible Investment (PRI) suggests that the delay in government action around climate change means the most likely policy response by 2025 will be “forceful, abrupt, and disorderly”.2
How companies manage their greenhouse gas emissions has become fundamental to their long-term financial performance. Investors need to consider these issues seriously, and incorporate them both in their analysis of individual companies and into their overall investment approach.
Some argue that companies which emit large quantities of greenhouse gases will never change, and so it is not possible to reconcile owning their shares with a concern about climate change. Others propose that by owning shares you have the opportunity to influence a company, encouraging its management to become part of the energy transition necessary to achieve the goals of the Paris Agreement. Others still seek to combine elements of these two approaches.
We discuss the options of divestment and engagement in more detail below, and introduce our approach at Ruffer.