By Rodolphe Bocquet, co-founder and director, Beyond Ratings, an LSEG company
In recent scientific research, it is suggested that the Anthropocene era – the first era in which human activity has been the dominant factor in shaping the environment on Earth – has initiated the sixth species mass extinction. Unsurprisingly, climate change is cited as the “biggest single threat to the economy” by many, including Henry Paulson, the former chairman of the Federal Reserve.
The task ahead is daunting. According to the Intergovernmental Panel on Climate Change, Greenhouse gas (GHG) emissions must be brought down to 2t of CO2 equivalent per capita per year by 2050 to limit global warming to the critical threshold of +2°C. A return flight in business class from Paris to New York alone can emit 5t of CO2 equivalent…
Looking at the trend of emissions per capita, there is little sign of improvement. Average GHG emissions remain four times higher than the 2050 2°C target, whereas the development pathway of the BRICS (now accounting for 40% of global GHG emissions) is yearning at reaching the unsustainable model of high-income countries. Worse, when accounting for the GHG emissions content of consumption, G7 emissions per capita raise by 28%, illustrating that part of the BRICS emissions are dedicated to serve Western consumption needs in a globalized market.
“Colonize Mars,” urges Elon Musk. While the prophets are warning for the coming ecological collapse, the wizards are praising technological breakthroughs as the way out of natural resources scarcity. Low carbon technologies are certainly required but the ability to successfully fight climate change depends on much more challenging skills.
First comes the urgent need to reduce energy demand, though massive deployment of energy efficiency in electricity consumption, buildings and transportation. As highlighted in the early 2000s by Prof. Socolow of Princeton University, energy efficiency would represent two thirds of the GHG emissions reduction to be achieved, whereas renewable energy and carbon capture and sequestration would only account for the remaining third. One could argue that beyond energy efficiency additional behavioral changes in standards of living are also required. By 2040, the International Energy Agency estimates that the energy needs of the water sector will have risen by 140% vs. 2014, partly driven by new needs associated with water transfer and desalination.
Second, limiting global warming requires unprecedented international coordination: i.e. multilateralism, as facing such global issues countries prove to be interdependent:
The recent Amazonian forest fire crisis shows the need to protect some international assets to avoid a tragedy of the commons
As of today, only 15% of total GHG emissions are subject to a tax, which is insufficient to send the right price signal in a globalized economy
According to the IEA, 78% of fossil fuel reserves are owned by sovereigns and their distribution is unbalanced, which can be a future source of geopolitical risk
Finally, current migration flows and the associated political turmoil are only harbingers of those to be later generated by climate evolution
Sovereign bonds are the largest asset class. Their performance is likely to be impacted by climate change in many ways: higher expenditures (to face extreme climate events), lower revenues (as the economy transitions to low carbon business models), increased “green” debt (to finance the needed low carbon infrastructure), and political instability, as implementing a “just climate transition” might prove challenging. Yet the climate performance of sovereigns will not only impact sovereign bonds portfolio but will determine the intensity of climate change systemic risk for the whole financial industry.
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