Financing the Climate Transition - Getting Started
The agreement from the 28th Conference of the Parties to the UN Framework Convention on Climate Change (COP28) held in Dubai in December, calls for “transition away from fossil fuels in energy systems in a just, orderly and equitable manner, accelerating action in this critical decade, so as to achieve net zero by 2050 in keeping with the science”. While this agreement is not as ambitious as needed, it was the first time that the reference to moving away from fossil fuels was clearly articulated in an international climate agreement.
According to the Global Stocktake, to keep warming to 1.5°C, by 2030 we need to reduce emissions by 43%, requiring “transformations across all sectors and contexts, including scaling up renewable energy while phasing out all unabated fossil fuels.”
How we get to this step remains a critical conversation as energy is foundational to our lives.
IPCC (2022): Transition is “the process of changing from one state or condition to another in a given period of time. Transition can occur in individuals, firms, cities, regions and nations, and can be based on incremental or transformative change.”
CDP: "Transitioning refers to taking actions that:
align a business model with a world in which two key outcomes are pursued:
the global average temperature is allowed to rise by no more than 1.5°C above preindustrial levels.
natural ecosystem health is restored.
enable a thriving economy that works for people and planet in the long term.”
How Companies are Transitioning
Since the Paris Agreement in 2015, many companies have committed to reducing their operations' impact on climate. According to the Net Zero Tracker, the share of large publicly listed companies with net zero targets has increased substantially in a little over two years, from 417 to 929. Over 70% of large listed Power Generation companies and about the same percentage of Fossil Fuel companies have set net zero targets.
However, the gap between these targets and the actions needed to achieve them is still large. The current policy pledges are expected to increase temperatures by 2.8°C, far above the 1.5°C limit. The details of how companies plan to transition away from fossil fuels are mostly unclear. This not only makes it quite difficult for investors to consider which companies to finance but also leaves companies open to the possibility of litigation.
In the power sector, for example, compliance with the 1.5°C pathway means coal will need to be phased out by 2030 and unabated fossil gas by 2035 in developed countries. In developing countries, coal and fossil gas will need to be phased out by 2040. For oil, the Tyndall Centre report, Phaseout Pathways for Fossil Fuel Production, indicates that developed countries need to phase out oil production by 2034 and developing countries by 2050. To stay in line with the 1.5°C pathway, reductions need to be underway already: for developed countries, oil and gas production need to be reduced by 74% by 2030 compared to current levels, and developing countries by 14%. Simultaneously, globally, over 80% of electricity will need to come from renewables by 2035 and by 2050, that number would need to be around 90-100%.
And yet, according to the UNEP’s Production Gap report, governments still plan to produce more than double the amount of fossil fuels in 2030 than what would be consistent with limiting global warming to 1.5°C.
Assessing Companies’ Transition Plans
Transitioning away from fossil fuels will require some time and major financing – the UNEP Emissions Gap report estimates the need for least US$4-6 trillion a year of investments in the low-carbon economy. The report calls for investments to “move away from fossil fuels and practices that destroy nature to support the vital transformations.”
“A climate transition plan is a time-bound action plan that clearly outlines how an organization will pivot its existing assets, operations, and entire business model towards a trajectory that aligns with the latest and most ambitious climate science recommendations. i.e., halving greenhouse gas (GHG) emissions by 2030 and reaching net-zero by 2050 at the latest, thereby limiting global warming to 1.5°C.” (CDP)
“A transition plan is an aspect of an organization’s overall business strategy that lays out a set of targets and actions supporting its transition toward a low-carbon economy, including actions such as reducing its GHG emissions.” (TCFD)
This necessitates empowering investors with the capacity to assess the corporate targets and subsequent transition plans. Numerous frameworks and methodologies are available to help investors assess the viability of the portfolios and the robustness of the pathway to a 1.5°C climate. To name a few:
The ACT – Assessing low-Carbon Transition initiative supports and assesses how ready an organization is to transition to the low-carbon economy. This methodology analyses the level of ambition of the climate strategy against the low-carbon benchmark relevant to the company. It also considers actions that the company implements in line with this strategy. This methodology is used by the World Benchmarking Alliance (WBA) to develop a Climate and Energy Benchmark.
The Transition Plan Taskforce (TPT), was launched by HM Treasury in April 2022 to develop a standard for private sector climate transition plans applicable to the UK, but globally transferable. It considers a transition plan as “integral to an entity’s overall strategy, setting out its plan to contribute to and prepare for a rapid global transition towards a low GHG-emissions economy”
The Impact Investing Institute created the Just Transition Criteria for “investors to align products (such as investment funds) and solutions to catalyze market momentum and competition to direct more capital towards a just transition”. The Institute doesn’t only consider transition but also includes socio-economic impacts as integral to the transition’s success
Across the board, each of the frameworks necessitates the following: a vision, targets, short- and medium-term actions, and governance and accountability measures (including reporting).
The OECD’s mapping of key elements in existing transition initiatives provides valuable insights for investors seeking alignment with their values. Notably, not all transition frameworks adhere to the 1.5°C climate scenario, and some lack sector-specific options. In addition, the Climate Bonds Initiative’s (CBI) five steps to protect transition pathways from greenwashing is a useful summary of criteria to consider when assessing if an investment opportunity or portfolio aligns with climate science.
5 Principles for an ambitious transition (Climate Bonds Initiative, 2022)
While the recognition at COP28 that we need to transition away from fossil fuels is promising, we now need action. To respond to the risks and opportunities that this transition will bring, investors must ensure that the companies in their portfolio have credible transition plans. However, replacing fossil fuels represents only part of the challenge. We need a broader systems transformation, involving all sectors, and considerations such as biodiversity impacts and social equity are also integral.
At ImpactARC, we eagerly collaborate with others to tackle the challenging questions on this journey towards transformation.