Investing towards the Paris Agreement - It’s more than just clean energy
5 min read 29 Apr 24
You may associate investing towards the goals of the Paris Agreement with owning companies providing clean energy and climate technology, but this simply isn’t true. John William Olsen and Philip Kemp discuss how equity investors can contribute towards tackling climate change by holding a balanced portfolio of companies across sectors and industries.
We must first acknowledge the fact that achieving the goals of the Paris Agreement requires significant, absolute greenhouse gas (GHG) emission reductions. With this in mind, we believe investors must take a company-specific approach, with a focus on real-world outcomes.
Some approaches to alignment with the Paris Agreement focus solely on predetermined annual reductions to portfolio-level emission metrics, such as carbon intensity. However, prioritising such metrics above all else can be counterintuitive. For example, a fund manager could simply hold a portfolio of low-emitting companies, such as software developers, or gradually reduce their stake in the biggest emitter. While progress would look good on paper, this wouldn’t necessarily contribute towards the absolute emission reductions necessary to limit global temperature increases. The same level of emissions would still exist, but they would simply be outside of the fund.
We believe that a far more effective approach to alignment with the Paris Agreement is to focus on the concrete action being taken by individual companies. In particular, investing in companies that have set, or are in the process of setting, ambitious targets to reduce their own emissions, and/or those providing climate solutions that allow others to reduce their emissions.
Ambitious emission reduction targets
A good indication that a company is committed to the Paris Agreement is the setting of a science-based target. These are emission reduction targets, which are considered to be at a pace necessary to limit global warming to well below 2°C above pre-industrial levels, and ideally towards a 1.5°C target, in line with the goals of the agreement.
A widely accepted framework for assessing the validity of these targets is the Science Based Targets Initiative (SBTi). Companies from a huge variety of sectors and geographical regions can set science-based targets, and below, we have highlighted the global footprint of every committed or ratified science-based target that has been set with the SBTi.
Targets are generally set with a baseline year, from which the company measures its progress, and a target year (usually between 2030 to 2050), by which the emission reductions must be achieved. The process of setting a science-based target usually involves developing a specific decarbonisation plan with actionable steps. Companies must then report on progress annually. These requirements help to ensure companies are committed to decarbonisation, rather than simply setting a distant target with little accountability.
CASE STUDY
Novo Nordisk
Novo Nordisk, a Danish company specialising in diabetes and weight loss medication, had its emission reduction targets ratified by the Science Based Targets initiative in 2018.
The company aims to reduce emissions from its own operations (also known as Scope 1 and 2 emissions) by 100% by the year 2030, in line with a 1.5°C temperature pathway.
To achieve this, the company aims to design its product ecosystem so that items can be recycled or re-used, minimise consumption and waste, and work with suppliers that share its commitment to decarbonisation.
Climate solutions providers
Some companies contribute towards the goals of the Paris Agreement by providing climate solutions. These companies provide products or services for their customers, that can help towards saving or avoiding emissions and reaching their decarbonisation goals.
Of course, companies involved in the production of renewable energy fall into this bucket by definition. By facilitating the integration of clean energy into the wider energy mix, they help to avoid millions of tonnes of emissions that would otherwise be generated by the burning of highly pollutive fossil fuels. However, emissions could be saved or avoided via a huge variety of products and services, such as:
- Cloud-based digital storage powered by renewables
- Automation and energy-saving products for buildings
- The reuse and recycling of food or industrial waste
- Sustainable shipping and logistics solutions
CASE STUDY
Linde
Linde is a heavy-emitting producer of industrial gases, which helps its customers towards saving or avoiding an even greater amount of emissions. In 2022, the company generated almost 40 million tonnes of emissions through its own operations, but helped its customers to avoid approximately 90 million tonnes.
One of Linde’s key climate solutions is the production of hydrogen. This is an alternative fuel that, when produced from renewables, is expected to become a clean energy source across a range of industries in the coming years. It has other well-established applications, including desulphurising highly pollutive diesel fuel.
Linde’s other climate solutions include the production of oxygen gas, which helps to reduce energy use in the steelmaking industry, and the company’s carbon-capture-and-storage solutions also help to decarbonise other industrial processes.
Building a balanced portfolio
Companies with science-based targets and those providing climate solutions can be found across all geographical regions and industries. They also exhibit different maturities of business model – ranging from small companies developing cutting-edge technologies, to stable, market-leading behemoths pouring significant investment into cutting their operational emissions.
While the former tend to be riskier investments than the latter, investors can ensure that both provide smoother contributions to overall risk by focusing on position sizing. In other words, by taking relatively larger positions in companies that are deemed to have less risk, and smaller positions in those where they foresee a wider range of potential outcomes. This helps to keep overall portfolio risk in check without hampering the ability to find opportunities in the market.
Importantly, companies within each of these different buckets will perform better or worse, in relative terms, during different market conditions. This means that investors can hold a portfolio of companies that is balanced and fundamentally well-diversified, which could exhibit similar risk and return characteristics to the wider stock market, while still contributing towards tackling climate change.
The information provided should not be considered a recommendation to purchase or sell any particular security.
