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April 15, 2022

Latest IPCC Report Demonstrates Urgency & Opportunity of Reaching Net Zero

Natalie Ambrosio Preudhomme
Moody's ESG Solutions
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The Intergovernmental Panel on Climate Change (IPCC) recently released the third and final part of its sixth assessment report, Climate Change 2022: Mitigation of Climate Change. This follows the first report on the latest in climate modeling released last fall and the second report focused on impacts and adaptation released in February. This third report takes stock of the current trajectory of temperature rise based on global climate policies and examines various possible futures. Among its key findings are that to keep global temperature rise to 1.5°C by 2100, we must reach peak emissions by 2025, but that current policies, if not changed, would lead to a median of about 3.2°C temperature rise (with grave consequences for humankind that have been highlighted in other reports). The report also emphasizes the uneven distribution of emissions with the wealthiest countries most responsible for climate change, continuing to emit the most greenhouse gases.

The report’s findings have significant implications for financial stakeholders, both in terms of the real risk of stranded assets (which stop providing financial returns  before the end of their expected life) in the near term, as well as the wealth of investment opportunities that comes alongside the need to rapidly transition our economy. In this brief analysis, we’ll unpack these key implications for investors, lenders, insurers and corporations.

Getting Ahead of Transition Risks is Imperative

A near-term transition to a low-carbon economy will save significant lives and costs in the long term. Limiting temperature rise to 2°C is projected to leave between $1-4 trillion in unburned fossil fuel and stranded fossil fuel infrastructure, with coal stranded before 2030 and oil and gas becoming completely unusable by mid-century, with sub-economic returns in the nearer term. Keeping temperature rise to the 1.5°C target would in turn leave significantly more stranded assets, and even sooner.  

However, modeled projections demonstrate that global GDP could continue to grow even with mitigation efforts that reduce emissions by at least half of 2019 levels by 2030, and that 2050 GDP would be just slightly below projections for GDP under current policies. This does not consider the economic benefits of the mitigation, including the lives, operations and assets saved from avoiding the worst physical impacts of climate change. Further, the IPCC report explains that research examining these benefits finds that they exceed the costs associated with the mitigation and that more extreme mitigation measures lead to greater economic benefits.

Understanding that this essential transition both presents long-term benefits and near-term risks enables investors, lenders and companies to prepare proactively: Contributing to emissions reductions allows companies to manage growing reputation risk alongside operations risk from physical climate hazards, potentially increasing market share, while reducing the risk of holding stranded assets and helping to prevent systemic economic disruption.

A range of existing datasets, from GHG emissions and carbon intensity to climate-adjusted probability of default models and data on the implied temperature rise associated with a company’s emissions reductions targets, provides essential tools for financial stakeholders to lead the way in the transition to a low-carbon economy. For example, Moody’s Temperature Alignment data finds that the average implied temperature rise of about 4,400 assessed companies was 2.9°C and that only 17% of companies mention net zero targets, which the IPCC report underscores as essential to mitigate the worst impacts of climate change. Detailed data on companies’ emissions reductions targets can inform investors’ and lenders’ own temperature alignment strategy.

Although these findings also underscore the need for greater ambition in corporate emissions reductions, as only 9% of our assessed universe of companies published quantifiable targets.  This demonstrates the need for improved, comparable disclosure of transition plans, which are essential for their lenders and investors to identify their own financed emissions and to align portfolios with net zero. There is also a need for broader datasets examining the way that targets are framed, the internal structures that companies are putting up to drive delivery, and the real economy actions that they are taking in their pursuit of emissions reductions, for example by reducing the emissions expected in the life cycle of their products. Such data would give a more nuanced perspective of which companies are more likely to hit their targets and those for which their targets are more aspirational or, at worst, “greenwashing.”

The Need for Innovation Presents Investment Opportunity

While underscoring the urgency of transitioning to a low-carbon economy, the IPCC report also demonstrated that this transition is far from impossible and the technological means by which to do so exist today. Firstly, renewable energy technologies such as wind and solar have decreased in cost and increased in use. Secondly, there’s a range of new technologies in pilot or near-commercial stages, including low-carbon inputs into industrial materials like cement, and carbon capture and storage mechanisms that are required to reach net zero in several (though not all) of the scenarios reviewed.

The IPCC report examines the implications unique to key high-emitting sectors, including transportation, energy and industry. For example, the report highlights that without mitigation efforts, transport emissions could grow by 65% until 2050. However, there is a huge opportunity to reduce global emissions through a focus on transportation. While battery-electric vehicles have lower life-cycle GHG emissions than internal combustion engine vehicles if charged with low-carbon electricity, batteries present various resource, supply chain and human rights challenges. Yet, developing batteries with a focus on recyclability is one way to minimize these concerns. Likewise, hydrogen fuel cell vehicles require their own charging infrastructure and technology, but also help to support the decarbonization of more heavy-duty vehicles and aviation, and may reduce the supply chain challenges. This is just one example of the need to scale-up existing technology with significant potential to contribute to emissions reductions.

Similarly, industry accounted for about 24% of GHG in 2019 and would require scaling up of infrastructure to support low emission primary production processes to reach net zero. Materials such as cement, plastics and steel can be produced with a range of emerging technologies to reach near-zero emissions. So solutions do exist. In addition to demonstrating the significant impacts on emissions when people adjust their travel habits, the COVID-19 pandemic also demonstrated the potential for record-setting development of urgently needed innovations, such as vaccines. This shows the speed and scale of development that is possible with concerted effort from both private and public sectors, and this is perhaps an achievement that can be replicated with rapid advancement in low-carbon technology.  

Overall, the report shows that reducing emissions will be challenging but is technologically feasible. Investors can leverage data on which companies are developing products or services related to the energy transition to align their portfolios with this financing need. By unpacking such datasets by sector, investors can identify top performers, even in hard-to-abate industries. For example, Moody’s EU Taxonomy Alignment dataset identifies which energy companies derive revenue from research and development related to carbon capture and sequestration or distribution of renewable energy, and thus lead the way in transition efforts in this sector.

The IPCC report also had an unprecedented focus on the demand side, including shifting consumer behavior away from carbon-intensive activities and products. While this factor has not typically been included in many pathways, and thus is not yet well understood, the report finds that low-demand pathways will reduce the need for carbon removal technologies, particularly uncertain options such as bioenergy with carbon capture and storage (BECCS). The food and land transport industries show the greatest potential for emissions reductions based on reducing demand, for example through encouraging car sharing, public transportation, low-meat diets, reduction of food waste and much more. This understanding provides useful insights for companies seeking their niche in a low-carbon economy by appealing to consumers that are increasingly committed to climate action and may be further empowered by this report. Likewise, this can support targeted shareholder engagement.  

Conclusion

The final IPCC sixth assessment report delivers yet another urgent message of the limited time humankind has to transition to a net zero economy and to safeguard our society against the worst impacts of climate change. However, this message comes with much positivity in terms of the technology we have available to undertake this transition. This presents substantial near-term transition risks for businesses and investors but the data exists today to assess and manage those risks. Likewise, there is a huge investment opportunity and rapidly developing datasets enable investors and lenders to integrate climate change into their strategies, managing their transition and reputational risks while actively helping to finance the transition to a low-carbon economy.

Moody’s ESG Solutions provides insights and analyses on ESG themes and multi-stakeholder performance, climate-related risks and opportunities and global sustainable finance trends.