05 Oct 2021

The race to Net Zero: How to navigate a new world of climate commitments

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For marketing purposes - For qualified investors only
This document is reserved and must be given in Switzerland exclusively to Qualified Investors as defined by the Swiss Collective Investment Scheme Act of 23 June 2006 (as amended from time to time, CISA).

As tens of millions of viewers around Europe and the world tuned into the Euro 2020 football competition this summer, their eyes may have picked out a new slogan on the pitch side billboards.

Volkswagen, Europe’s biggest carmaker and one of the competition’s sponsors, was using its prime advertising space to promote their commitment to being carbon-neutral or ‘Net Zero’ by 2050. In their marketing speak, this was the ‘way to ZERO’.

Sometimes we can gauge the public mood by the adverts that companies choose to show them. The choice made by VW to advertise Net Zero at a European football competition reflects how quickly awareness of climate change has risen among Europeans. That rise is reflected in Google Trends rankings, where searches for ‘Net Zero’ hit a 5+ year global high in April 2021, and a new peak a few months later in September 2021. 

Net Zero

Source: Google Trends data, exported 30/9/21, data from 2/10/16 to 19/9/21. The left-hand axis shows “interest over time”, 100 being the peak popularity for a given search term in a given period.  

Search data shows what we can already feel from reading the news or watching TV: that more and more companies, investors, and governments are committing to carbon neutrality, to Net Zero.  

Why it feels like everyone is going Net Zero

If all areas of society – governments, companies, investors, even some normal citizens – are committing to Net Zero – the question is: why?

The answer is quite simple. If humanity will ever stabilise human-induced global temperature increases, no matter what temperature level is chosen as the maximum, whether it be 2°C or 1.5°C above preindustrial levels, at some point the planet must reach Net Zero on greenhouse gas emissions. Without Net Zero, global temperatures will keep rising forever.

When we look at a temperature goal such as 1.5°C, it’s important to realise that global temperatures have already risen a significant part of that. On average, temperatures today are above 1C higher than the preindustrial level – calculated using the reference period of 1850-1900 as this is the “earliest period with near-global observations”. 

While temperatures have already increased, going Net Zero has the power to cap the overall increase at a level that causes the minimum amount of climate change. That’s driving what we call “the race to Net Zero.” 

The race to Net Zero

  • Countries

Several countries seem to be racing each other for Net Zero. Germany is one: in May, the German government announced its intention to reduce carbon emissions by 65% by 2030, 85-90% by 2040, and to be Net Zero emissions by 2045. Germany has consistently been Europe’s highest CO2 emitter, and the country’s previous goals were a 55% reduction by 2030 and carbon neutrality by 2050. Among other notable government commitments, the US administration has announced a -50%/52% cut by 2030, and the UK has committed to a hefty -78% reduction by 2035.

  • Corporations

The race to Net Zero is reflected in the corporate world, too. Around 3,100 companies have set NZ goals by 2050 as part of the UN-backed “Race To Zero” initiative, and recent report found that “of the world’s 2,000 largest public companies, at least one-fifth (21%) now have Net Zero commitments, representing annual sales of nearly $14 trillion.”1 Dozens have committed to Net Zero even sooner. These include Schneider Electric by 2030, Unilever by 2039, Coca Cola, Orange, Amazon all by 2040, and Engie by 2045. Microsoft last year pledged to be carbon negative (i.e. not just neutral) by 2030, with or without compensation, and by 2050 to “remove from the environment all the carbon the company has emitted either directly or by electrical consumption since it was founded in 1975.” The Paris Agreement targets carbon neutrality in 2050, so we are seeing major companies commit to an even more stringent timeline.

  • Investors

Investors have also joined the race to Net Zero, with several setting very public targets for carbon neutrality in their portfolios, in some cases even sooner than 2050. Sweden’s Swedbank Robur and the UK’s Aviva target carbon neutrality by 2040, and J Safra Sarasin aims for the same by 2035. These investors are choosing to go one step further than the major asset-owner initiatives such as the “Net Zero Alliance”, and the latest asset-management initiative of “Net Zero Asset Managers”.

Looking at the climate pledges made across countries, companies and investors, a picture is painted of impressive progress towards climate sustainability and emissions reduction. However, as investors ourselves, we must resist the urge to get swept along by impressive announcements and stories, without subjecting them to proper scrutiny.

In truth, each statement above represents a slightly different reality, and we must be very discerning in our approach to overbidding in the race to Net Zero – especially ahead of November’s COP26 summit in Glasgow, which is likely to be accompanied by a crescendo of climate pledges. 

To navigate the new world of Net Zero, there are certain important tips to bear in mind which can help you to interpret what a commitment really means.

Step #1: Understanding what is meant by “carbon budget”

“Carbon budget”, like Net Zero, is a commonly heard but sometimes misunderstood term.

This term refers to the remaining amount of CO2 emissions that can be emitted globally, beyond which point a given temperature outcome (e.g. above 1.5°C or above 2°C) is ‘locked in’.

Carbon budgets can be accurately calculated because we increasingly understand the correspondence between cumulative emissions and the level of warming, and also between warming and meteorological changes across regions.

We know the current level of global warming (+1.2°C above the preindustrial2). We also have a maximum level of warming beyond which we can expect severe climate impact (1.5°C). And because of improved modelling, we understand that there is a ‘near linear’ relation between cumulative emissions and warming – put simply, a given amount of emissions leads to a given level of warming. With these three inputs, we can calculate how much CO2 can be emitted before we blaze through the 1.5°C and 2°C barriers.

Between 1850-2019, approximately 2,390Gt CO2 was emitted.To have a roughly 2/3 (67%) chance of keeping warming to 1.5°C, there is around 400-500Gt CO2 left to ‘spend’. Currently, the world emits 42Gt per year – a figure which would use up the remaining amount in 10-15 years.

When you hear someone talk about carbon budget, it really refers to a very simple concept. We have already spent 2,390Gt. We have around 500Gt left to spend. The carbon budget is all about how to spread out that final allowance over time.

Step 2: Paying attention to “base years”

Now that we are clear on the concept of carbon budget, the next most important term to understand when interpreting climate commitments is “base year”.

Base year refers to the anchor date used in any commitment to reduce emissions. This is just as important as the target year, and generally far less visible.

To illustrate: the EU’s latest “Fit for 55” legislation package targets a reduction in GHG emissions of -55% by 2030 (revised up from -40% then -50%). But this -55% target is calculated versus a 1990 baseline. The same is true for Germany’s updated -65% 2030 target, and the UK’s -78% - they all use 1990 as a reference point. But the US commitment, for example, is against a 2005 baseline.

So what? Well, when interpreting a commitment that promises a percentage decrease by a certain point, an ‘anchor point’ is required to make any sense of it. You can say “I will halve my consumption of chocolate” – but do you mean compared to the two bars eaten yesterday, or the 20 bars eaten on this day last month? 

To examine this idea further, we can take the example of Lyxor’s Paris-Aligned ETFs. These use a methodology that applies an immediate -50% reduction in GHG emissions in a portfolio allocation compared to its parent index (e.g. a S&P 500 Paris-Aligned ETF refers to the S&P 500 index). But having reduced by -50%, they then continue to decarbonise from this point at a rate of 7% per year.

Using our awareness of base years, we will want to contextualise these claims. So, we must ask ourselves: what is the base year? Lyxor’s Paris-Aligned ETFs are anchored to 2019, meaning they immediately reduce the portfolio’s carbon intensity by 50% from its 2019 level. By 2019, the EU had already achieved -25% emissions since 1990. In 2019, the UK’s emissions were already -40% below 1990, thanks to decades of coal decommissioning. So, the funds reduce by half, an already much-reduced figure – then continue reducing it further each year.

This methodology seems to go beyond the 1.5°C scenario codified in the Paris Agreement, which requires a -45% reduction in global carbon intensity by 2030 en route to achieving Net Zero by 2050. As we’ve seen already, the EU targets a more ambitious -55% reduction by 2030. So, with their immediate -50% reduction and -7% per year afterwards, Lyxor’s Paris-Aligned PAB ETFs overshoot both of these targets. We can predict, therefore, that our Paris-Aligned ETFs should be Net Zero sooner than 2050 – thanks to the relationship between the decarbonisation methodology and the base year used. 

Step 3: Challenging baked-in assumptions

So far, we’ve looked at the importance of understanding carbon budget, and interpreting emissions reductions targets in relation to the base year used.

There is one final point to remember to be an informed climate investor: aside from rare businesses which can ‘go Net Zero’ today, pledges are at best trajectories for change over several years, and those trajectories are based on important assumptions. These assumptions include the ability to decarbonise at a given pace in future, or that there will be development of effective carbon capture & storage solutions to mitigate emissions.

IPCC Model Pathway Reference (P2)

Billions Tonnes CO2

All of the central scenarios from Intergovernmental Panel on Climate change (IPCC) and International Energy Agency (IEA) rely heavily on negative emissions, meaning carbon removal. Carbon removal allows for some level of carbon emissions to continue, as the net balance is still neutral or negative. Reaching Net Zero before 2050 (e.g. 2040) would mean either decreasing gross emissions faster than 2050 scenarios, and/or using higher assumptions of negative emissions.

It's important to be realistic with ourselves about these assumptions. In some cases, the technology that is expected to deliver improved carbon removal, is still in the theoretical or prototype stage. This fact might explain why the latest report from the IEA, published in May 2021, recommends trajectories based on faster emissions reduction but lower carbon removals. The assumptions can change over time, and an informed investor must understand this.

To illustrate again with Lyxor’s Paris-Aligned PAB ETFs: earlier, we said that these ETFs should hit Net Zero before 2050. Our calculations, based on previous modelled trajectories, are that Lyxor’s global Paris-Aligned PAB ETF would be Net Zero 2043-2045. Based on latest IEA scenario (faster reduction/lower removals), we would expect that figure to be closer to 2049.

Net Zero is an extremely positive shift: but it still requires proper scrutiny

None of this is to take anything away from the importance of Net Zero and the great progress that has already been achieved. Lyxor is a firm believer in the urgency of climate change and the great opportunity and responsibility that lies with investment managers and asset owners to move this change forward.

We believe that all market participants should feel equipped with the best possible information to make the right choices – and this includes an ability to look beyond headlines and assess commitments with a clear eye.

Our Guide to Climate Investing was written with this goal in mind, to help investors put the Paris Agreement goals into practice. We are updating the guide this month with the latest climate developments. In the meantime, all the key information on Lyxor’s full climate ETF range is available on our new ESG Hub

1 Taking stock: A global assessment of net zero targets, ECIU and Oxford Net Zero, March 2021 https://eciu.net/analysis/reports/2021/taking-stock-assessment-net-zero-targets

2 World Meteorological Organization, 14 January 2021, https://public.wmo.int/en/media/press-release/2020-was-one-of-three-warmest-years-record

3 IPCC AR6 report, 7 August 2021, https://www.ipcc.ch/report/ar6/wg1/downloads/report/IPCC_AR6_WGI_SPM.pdf

Lyxor International Asset Management estimates, October 2021

This article is for informative purposes only, and should not be taken as investment advice. Lyxor ETF does not in any way endorse or promote any companies mentioned in this article. Capital at risk. Please read our Risk Warning below.

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