Time is not on the side of governments who have pledged to decarbonise their economy. There are less than 30 years left to achieve the 2050 target of cutting carbon levels to net zero and for countries like the US, the UK and Japan that timescale is becoming more and more challenging.
Switching the global economy from extractive to regenerative energy means finding secure and reliable alternatives to burning oil and gas. So far, making such a breakthrough has proved difficult. Energy bills for homes, businesses and motorists have rocketed since the second half of last year. Increasing demand has hit the supply of traditional energy sources, such as gas, while modern, cleaner technologies like windfarms were the victim of there not being “enough wind” in the North Sea.
Shifting the world onto electrically powered vehicles will only push demand higher, and that is without getting into building the charging infrastructure needed to support the motoring revolution.
Oil and gas have powered the world for more than 100 years. It is deeply embedded within the infrastructure of communities and has made parts of the world extremely prosperous.
Changing this is not easy – and the challenge is not limited to finding alternative sources of energy. Millions of people’s livelihoods are directly connected to oil and gas and the industries they support. If governments work to replace fossil fuels with cleaner alternatives, they could be creating poverty.
Take the millions of people working in the mining industry in Indonesia. If the mines are closed, what happens to the workers? ESG-led investing is not just about protecting the environment for future generations. There is also a social element in the strategy, so putting lots of people out of work and, therefore, decimating communities to fix environmental concerns is a conflict within the ethos of sustainable investing.
People living in a world of lower temperatures and free from extreme weather patterns is not a trade-off for living in poverty. So, governments and investors are being encouraged to ensure that we have a just transition from fossil fuels to regenerative sources of energy so that no one is left behind as we move towards a sustainable future.
Yet this does not just affect people working directly in the oil and gas supply chain. Every industry will have to adopt to some form of change brought about by the transition. “There is almost no part of the global economy that is going to be unaffected by the energy transition,” says Nick Stansbury, head of climate solutions at Legal & General Investment Management (LGIM). “
It is not just that the fossil fuel industry will see demand for its products fall. Everywhere, from financial services to consumer goods, to food retailing, to the restaurant industry, to petrochemicals, every place in the global economy will, in some way, be affected and affected significantly. “It is more than thinking about the implications for the oil and gas industry,” he adds.
“We use energy in every part of the global economy. Everything we do is affected by energy. Therefore, big changes in the way we deliver energy to the global economy will impact all parts of our portfolios.”
Constructing portfolios with the impact of the energy transition not limited to one industry appears to be a common strategy among investors. “The global ecosystem is so interconnected, not just in nature but in how it intertwines with the economy, so doing one thing in isolation would be futile,” says Gabrielle Kinder, an environmental analyst at BNP Paribas Asset Management. “The energy transition theme is one of social justice not just environmental justice,” she adds. “By halting climate change there is a lot of climate change inequality around the world which would be abated.”
The desire among asset owners to pursue a just transition is gaining momentum, it is being mentioned more and more in conversations with their asset managers, says Therese Niklasson, global head of sustainable investment at Newton Investment Management. “We are still at the starting point where we are discussing a company’s commitment to its transition plan. You have to weave in a just transition at the outset when you develop your transition plan,” she adds.
The concept of a just transition emerged relatively recently because the nature and direction of what we now call ESG has changed many times since the 1990s. “In the early days, responsible investment focused on governance,” says Mark Jeavons, head of climate change insights and associate partner at Aon. “Then for three to four years it focused on environmental impacts. Now in the past 18 months to two years, there have been more discussions around nature and the social elements, and the frameworks to consider this in portfolios.”
Despite investors working to find their feet on this issue, one point is clear. “From a just perspective, the best thing to do as an investor is not to abandon the sector,” Niklasson says. “It would be socially irresponsible to make it harder for companies to turn themselves around,” she adds. “The cost of capital is affected if the investment community withdraws from it. Countries need capital to transition, to re-train communities and figure out what an employment system would look like in a world where the energy system is relying on more skilled labour. We need to invest in education to ensure that people can support that system.”
(Not) everyone’s a winner!
But it is still early days and the just transition is uncharted territory. “There is not yet a good enough understanding among the general investment community about what a just transition means,” Niklasson says. “We know that it is important, and that there are deep social and economic impacts to consider but knowing what a good transition looks like is tricky. “There will be trade-offs,” she adds. “Not everyone is going to be a winner in this transition.”
And emerging economies could be big losers due to their high dependence on the sectors net-zero plans are targeting. South Africa is an example of where a just transition could be a challenge. “It has a challenge ahead in terms of the transition itself in weaning the country off fossil-fuel intensive industries, but there is the added challenge of already high levels of poverty. “If investors stop financing the current set-up you risk cutting the lights off for millions of people. What needs to happen is a plan to finance the transition,” Niklasson says.
It is understandable that investors are following strategies that they believe will deliver a positive environmental impact while benefiting society. Jeavons points to the two elements needed to achieve a just transition. “First, you need to understand the risks from the transition and how that will impact social priorities. “Second, you need coherent policies and market frameworks that incentivise investors to support the just transition.”
“To achieve the rapid change needed to reach net zero, it needs society’s backing,” he adds. “This means making sure that the substantial benefits from the transition to a low carbon, sustainable economy are shared widely, and those that are negatively impacted economically are given the support they need to make a just transition.”
Jeavons says that at COP26, in a first of its kind agreement, South Africa will receive around $8.5bn (£6.4bn) from the US and countries in Europe as part of a “Just Energy Transition Partnership”. “This aims to accelerate South Africa’s green transition but some of the money will be investments in social infrastructure, to manage labour and support workers impacted by the transition. For example, the 90,000 miners involved in coal extraction will be helped to find other industrial roles or education provided to re-skill and work in other areas, such as renewable energy,” he adds.
But a just transition cannot happen unless governments, regulators, companies and investors have wider support. “If you want a circular economy instead of a resource-intensive economy, you need to have society on board,” Jeavons says. “Take the energy transition. Going from wood to coal and from coal to oil took 100 years. We are trying to change our energy systems within a couple of decades or so. That is a real challenge that is bound to throw up destabilising elements in the economy and within society. Managing the bumps in the road means you will ensure the economy remains dynamic and performs well, which will be positive for your investments,” he adds.
A holistic approach
But keeping temperature rises low and stopping the flooding and extreme storm patterns we are seeing around the world will not be solved by no longer burning fossil fuels. There are more proactive measure investors can take. “We have to take a holistic approach by reducing our negative impacts on the planet and increasing our positive impacts,” Kinder says. “The handprint has to be larger than the carbon footprint.”