Many companies have committed to net zero targets by 2050, but how likely are they to get there? To answer this, investors need to understand not only the actions firms take, but also the policy and technological context that companies operate in, abrdn says.
In 1623, the English church cleric and metaphysical poet John Donne wrote the now famous words: ‘No man is an island’, as part of a longer poem that emphasised the connection between all of humankind.
And just as no man is an island, no company exists in isolation either.
Companies function within an economy populated by suppliers, competitors and regulators, while their operations are impacted by supply, demand and technological progress.
This context is not only important for understanding how profitable a business might be in the future, but it also impacts how well they can execute on their strategy to reach net zero emissions by 2050.
The regulatory framework in a country, in particular the availability or absence of subsidies and incentives to decarbonise, can tell investors much about the likelihood a company will reach its 2050 and interim targets.
“We need a strong policy environment to enable corporations to achieve their targets. Without that, with all the best intentions, they’ll get to a point where it’s not financially viable to decarbonise at the pace and scale they would like,” Eva Cairns, Head of Sustainability Insights & Climate Strategy at abrdn, says in an interview with [i3] Insights.
We need a strong policy environment to enable corporations to achieve their targets. Without that, with all the best intentions, they'll get to a point where it's not financially viable to decarbonise at the pace and scale they would like
“The policy environment needs to have a carbon price or incentives, including subsidies and tax credits for technologies to allocate capital to the net zero transition.
“If we see that the policy environment isn’t moving along, is nowhere near being aligned with net zero 2050, then how can you expect companies and investors to be allocating capital based on a net zero 2050 aligned pathway?” she says.
It is not just the policy and regulatory environment that impacts the ability of companies to deliver on their net zero targets, but it is also important to identify whether the required technology is available and is scalable at a level that allows companies to reach their targets.
“Sometimes we see targets based on business model transformations reliant on CCS (carbon capture and storage) and hydrogen, but many of these technologies are still in an early maturity stage. We need to be realistic about the fact that those technologies are not moving at the pace that they need to,” she says.
Determining Credibility
To get a better understanding of a company’s ability to deliver on its carbon ambitions, Cairns and her team have developed a quantitative credibility assessment model that tracks a number of data points across three dimensions – company actions, technology and policy enablers.
The assessment looks at six key factors, including how well an emissions target has been designed, the current trend of a company’s emissions, technological readiness, policy supportiveness, a company’s track record of producing climate solutions and climate governance.
Then they translate the findings into a credibility score, which gives an indication of how likely a company is to achieve their carbon strategy.
“When we looked at the targets, we thought nearly everybody had set very ambitious targets, almost everybody is now on the net zero journey. But how do we actually know that they’re credibly implementing it?”
The key insight here is the dispersion of credibility scores within a sector to identify credibility leaders and laggards. This can be used when engaging with companies, but it is also critical to understand how it impacts the results of our climate scenario analysis.
Adjusting Valuations
The credibility score is not just an indicator of risk, but also helps investors adjust their estimates of company valuations. It forms the final step in a process that quantifies climate risks and opportunities and sets the base case scenario for climate change.
Although there are clear signs that the energy transition is taking place, it is not happening at the pace and scale needed to align with the Paris Agreement’s target of a 1.5 degree rise in temperatures.
abrdn’s climate scenario analysis suggests that temperatures will rise by 2.3 degrees by 2100, with considerably different impacts across firms
“In our climate scenario analysis, we found that there is a huge dispersion between firms that would experience a positive impact on their asset values and those that would experience a negative impact under our base case scenario of a 2.3 degrees increase,” she says.
“It reflects who is starting to prepare, who is better prepared and who is starting to transform the business model versus who is not.
“The next thing is then to say: ‘Well, but the firm is not a passive player in all this. They might go beyond and set a target that’s more ambitious’.
“We are trying to put a dollar value on the impact of climate change on assets today and quantify what we believe is not priced in.
“But then we adjust valuation impacts by saying: ‘They have set targets and those are not reflected in the pure economic modelling’.
“The asset values might be positively impacted because companies are actually doing lots of good things which are not reflected in that analysis yet. Then there is that final step of adjusting [valuations] down based on our credibility score. We can’t just take targets at face value and assume they will be fully implemented.
That credibility might ultimately have an impact on asset valuations, because if you can't assume that the target will be implemented, then that company's carbon costs might be higher, their demand destruction might be higher, reputational impacts might be greater and so on. So ultimately that will be reflected in asset valuation
“That credibility might ultimately have an impact on asset valuations, because if you can’t assume that the target will be implemented, then that company’s carbon costs might be higher, their demand destruction might be higher, reputational impacts might be greater and so on.
“So ultimately that will be reflected in asset valuation,” she says.
The credibility framework enables investors to develop a forward-looking view of a company’s net zero journey, the likely impact on asset values, which then allows investors to identify credible transition leaders.
abrdn has assessed the credibility scores of around 1,200 companies, and recently released a report on the findings for the Asia-Pacific region, titled: ‘The Transition to Net Zero: Identifying Credible Transition Leaders in APAC’.
It found that Australian companies are in line with the APAC average when it comes to credibility but underperform their developed peers globally. This is largely due to the fact that emission-intensive industries, such as materials and energy, account for a large share of the economy.
Japan, on the other hand, scored above average on most indicators.
But this quantitative approach needs to be complemented by active analysis and direct company engagement, particularly where data gaps exist, Cairns says.
“The credibility framework is a useful tool to help identify climate leaders and laggards. The team will still actively engage to get a better insight into the drivers behind the data,” she says. “So that’s why we do both. We try to have a more quantitative framework and complement it with a deeper analysis and engagement.”
This article is sponsored by abrdn. As such, the sponsor may suggest topics for consideration, but the Investment Innovation Institute [i3] will have final control over the content.
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[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.