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Climate Transition
SOLUTIONS & MULTI-ASSET | GLOBAL BALANCED RISK CONTROL TEAM | INVESTMENT INSIGHT | 2021
Given the increasingly disruptive force of GBAR TEAM MEMBERS
climate change-related weather events, the
commitment of countries and companies across
the globe to achieving net zero carbon emission ANDREW HARMSTONE
Managing Director
by mid-century promises to be one of the Lead Portfolio Manager
themes driving investment markets over the
coming decades. The push from policymakers
poses risks to those in carbon-intensive sectors LI ZHANG
who lag, but may also open opportunities for Executive Director
enablers and innovators. Portfolio Manager
Recognising the importance of both capturing related
opportunities and mitigating the increasing risks, the Global
Balanced Risk Control team has developed an approach CHRISTIAN GOLDSMITH
that seeks to capitalise on these changes. Our science- Executive Director
Lead Portfolio Specialist
based approach decarbonises our portfolios’ core exposures
according to the 1.5°C scenario, aligned with the most
recent Intergovernmental Panel on Climate Change (IPCC)
recommendations and targets net zero emissions for our
equity exposure by 2050. We complement this approach by
assessing companies’ ESG and Low Carbon Transition scores.
This is implemented whilst maintaining our core time-tested
approach to asset allocation.
In this piece, we look at how countries and some key sectors
are responding to the challenge, and we also discuss potential
solutions for investors.
Taking the temperature: the current climate
The recent report by the IPCC on the physical effects of
climate change1 comes as governments update their Nationally
Determined Contributions (NDCs) in an attempt to achieve
the Paris Climate Accord goals to limit global warming to well
1
https://www.ipcc.ch/report/ar6/wg1/
INVESTMENT INSIGHT
below 2°C from pre-industrial levels, and
DISPLAY 1
preferably to 1.5°C by 2050. The IPCC’s
Global Commitments
message is unambiguous; human activity,
particularly the combustion of fossil
fuels, is heating the planet and causing
increased extreme weather events. The
economic and social consequences of
greenhouse gas (GHG) emissions have
long been projected to be devastating.
As early as 2006, the Stern Review on
the Economics of Climate Change,2
estimated the ongoing cost of inaction
on climate change to be equivalent to
5%-20% of global GDP p.a.3 The IPCC
demands urgent action, as without
sustained reductions in emissions over
the coming decades we will likely exceed
2°C global warming before the end ● Net-zero commitment* ● New or updated NDC** ● Net-zero commitment and new/updated NDC
of the century. In fact, in almost all
Source: *commitments planned or announced Energy and Climate Intelligence Unit **UNFCCC
emissions scenarios, global warming is
likely to hit 1.5°C “in the early 2030s”.
The commitments required to limit CHINA: QUEST FOR GLOBAL CLIMATE terms of emissions traded, which came
emissions will profoundly affect the LEADERSHIP VERSUS THIRST into force in July 2021. Whilst the price
highest-emitting business sectors. While FOR GROWTH is low compared with more mature
we cannot be certain of the outcomes, China’s remarkable economic growth schemes such as that of the EU ($60
we should analyse how the most highly means it now emits more than a in July versus China’s opening price of
exposed sectors are managing the risk quarter of global emissions, so its approximately $7), it should facilitate
and uncertainty. actions to reduce emissions over the companies migrating from existing
next decade will be crucial to limiting regional schemes throughout China.
Country level policy responses – global warming. China recently While we do not believe the current
Greater ambition, but still announced its aim to achieve net zero price is high enough to discourage coal
not enough before 20604 and to increase non- usage, this could change if we see any
Key to achieving the Paris Climate fossil fuel-generated energy to 25% of upward price pressure. China’s scheme
Accord goals are the NDCs and mid- total energy consumption by 2030. To will initially cover 40% of national
century goals. The increasing number help achieve this goal, China intends emissions5 (15% of global emissions),
of countries committing to net zero to double wind and solar capacity to but this is expected to expand over time.
emissions by mid-century is a bright 1,200 GW by 2030. While coal has
spot in climate policy. At COP26 in shown a downward trend in China’s US: CLIMATE U-TURN TO BUILD
November 2021, governments are energy mix, recent developments signal BACK GREENER
expected to update their NDCs for a misalignment between climate targets President Biden has made tackling
the first time since the Agreement was and policy. The 10% year-on-year climate change a cornerstone of his
signed in 2015. As of August 2021, 107 increase in coal consumption, and the policy agenda. On 20 January 2021,
countries have submitted new NDC development of new coal powered plants he reinforced this commitment by re-
targets. However, many do not match in the first half of 2021 demonstrate joining the Paris Agreement and soon
up to the ambition required to achieve a conflict between China’s economic after pledged to reduce net US emissions
the Paris goals. Furthermore, a number stability and climate goals. Uncertainty by at least half by 2030 (50%-52%
of countries have still not submitted any over China’s path will remain until the lower than 2005 levels), before hosting
targets at all. country officially submits its NDC. the Leaders’ Summit on Climate. Biden
clearly intends to take a lead role and
We now provide an update on the Another key component of China’s plan
align the US with their resubmitted
policies of some key countries in the is the introduction of the world’s largest
NDC target of net zero by 2050.
climate transition: national emissions trading scheme, in
2
N. Stern (2006), The Stern Review Report: 4
www.carbonbrief.org/qa-what-does-chinas- 5
https: //icapcarbonaction.com /en /news-
the Economics of Climate Change. 14th-five-year-plan-mean-for-climate-change archive/742-china-launches-operational-phase-
3
https://webarchive.nationalarchives.gov.uk/ of-national-ets , July 2021
ukgwa/20100407163608mp_/http://www.hm-
treasury.gov.uk/d/Summary_of_Conclusions.pdf
2 MORGAN STANLEY INVESTMENT MANAGEMENT | SOLUTIONS & MULTI-ASSET
CLIMATE TRANSITION
To an extent, US businesses were INDIA: YET TO GET ON BOARD WITH NET plans to invest heavily in hydrogen and
already driving change even under the ZERO COMMITMENTS carbon capture, utilisation and storage
Trump administration, with reductions India’s emissions have grown steadily (CCUS) technologies.
in emissions averaging about 0.4% per over the past decade and it is now the
year over the last decade, driven mostly world’s fourth highest emitter, behind In addition, Japan’s transition plan
by the shift from coal to renewables.6 only China, the US and Europe. will see natural gas’s contribution to
The Biden administration pledges to However, India’s per capita emissions electricity generation almost halve from
accelerate the transition by spending intensity is 60% lower than the global 2019 levels of 37%, to 20% by 2030.
billions on clean energy-related average and about seven times lower This is notable, as Japan is the largest
infrastructure and energy efficiency than that of the US. Developing global importer of liquefied natural gas,
improvements. This spending, alongside nations such as India have contributed for example representing around 21% of
extensive tax credits for renewables and comparatively little to global emissions global imports in 2020.15 Similar drops
an ambitious clean energy standard, and may justifiably feel aggrieved in in coal usage will be offset by highly
should support his claim of a clean having to adopt stricter climate change ambitious deployment of renewables
energy revolution in the US.7 However, targets.11 At the July 2021 G20 Energy which could make up 38% of Japan’s
the larger reconciliation bill containing and Climate Joint Ministerial Meeting, electricity mix by 2030. This may serve
many of the Democrats’ climate India signalled it would soon strengthen as a warning for producers who see gas
initiatives will need to win the approval its existing commitments but cautioned as the natural replacement for coal in
of a number of hesitant Democratic that developed nations should move the medium term.
senators, including Joe Manchin towards net zero sooner than 2050, to
of West Virginia, who chairs the free up ‘carbon space’ for developing UK: HALFWAY TO NET ZERO
Senate Energy and Natural Resources nations to grow. The UK was one of the first major
Committee. In 2019, West Virginia was economies to legislate a net zero target
the second largest coal producer in the However, India’s emissions growth by 2050, despite having notable oil and
US and coal made up 91% of the State’s and the burdensome physical effects gas reserves—around 10-20 billion
electricity mix.8 of climate change on the nation,12 barrels of oil equivalent.16 Winding
evident for example in changing down UK oil and gas production may
EU UPS ITS AMBITIONS WITH rainfall patterns, highlight the need to help to achieve the nation’s climate
“FIT FOR 55” contribute to lowering global emissions. goals; however, we note controversial
Despite rapid growth and falling prices plans to approve a new North Sea
Europe has long seen itself as a leader in
for renewables (solar being around project.17 Nevertheless, in 2020, the UK
tackling climate change and continues
14% cheaper than coal),13 the Indian was halfway to meeting its 2050 net
to make strong progress. European
government is encouraging more zero target, having reduced emissions
Union (EU) GHG emissions fell by
coal mining and production. Uptake by more than 50% from its 1990 levels.
24% between 1990 and 2019, while its
from the private sector has been slow, A large contributor is a shift in the
economy grew by approximately 60%.9
highlighting difficulties in funding new energy mix towards renewables, a shift
In December 2019, the EU adopted the
coal deployment globally.14 which since 2015 has been supported by
European Green Deal to advance the
goal of net zero by 2050. In July 2021, the UK’s Carbon Price Support. This
JAPAN BACKING ITS AMBITIONS WITH support, which is effectively a tax, was
the European Commission proposed
INVESTMENT IN NEW TECHNOLOGIES found to have accelerated coal’s decline
“Fit for 55”, an extensive legislative
package to support a more ambitious, Japan recently announced measures in the UK’s electricity mix by over
shorter-term cut in GHG emissions of to support its net zero goal by 2050, 90%.18 This demonstrates how effective
at least 55% by 2030. We believe carbon and to reduce GHG emissions by a robust carbon pricing mechanism is in
prices through the EU Emissions 46% by 2030 from 2013 levels. While aiding the transition away from coal.
Trading Scheme (ETS) are already Japan already benefits from an energy-
disincentivising the use of cheaper coal; efficient economy, some heavy industrial Sector carbon footprints:
in 2019, following a sustained higher processes require high-temperature Progress and challenges
allowance price, Europe saw a larger which could prove stubborn to further Against this somewhat uncertain policy
decline in the use of coal.10 decarbonise. To combat this, Japan backdrop, companies will be expected
6
UNEP - Emissions Gap Report 2020 11
UNEP – Emissions Gap Report 2020 15
IGU World LNG report - 2021 Edition
7
www.joebiden.com/climate-plan/ 12
w w w.worldbank .org /en /news /feature / 16
https://www.ogauthority.co.uk/data-centre/
8
West Virginia Profile (eia.gov) 2013/06/19/india-climate-change-impacts data-downloads-and-publications/reserves-
13
https://www.woodmac.com/press-releases/ and-resources/
9
www.ec.europa.eu/clima/policies/strategies/
progress_en india-leads-with-lowest-renewable-cost-in- 17
ht tps: // w w w. bbc .co.uk /news /science -
asia-pacific/ environment-56503588
10
https://www.eea.europa.eu/highlights/climate-
action-in-europe-eu
14
www.reuters.com/world/india/no-bids-over- 18
https://www.ucl.ac.uk/news/2020/jan/british-
70-indian-coal-mines-up-auction-2021-07-09/ carbon-tax-leads-93-drop-coal-fired-electricity
SOLUTIONS & MULTI-ASSET | MORGAN STANLEY INVESTMENT MANAGEMENT 3
INVESTMENT INSIGHT
to adapt their businesses. A recurring early on. Due to the cost advantages of assets over the life span of the project.
theme is the need for transitioning from renewables, utilities across the world We believe investors should monitor
fossil fuels, particularly coal and oil, to should continue to phase out fossil investee companies’ capex plans
renewable sources, as well as long-term fuels, especially coal, while accelerating carefully. Reducing scope 3 emissions
improvements in electrification and solar and wind deployment to meet over the long term may signal a
energy efficiency. We believe this is key near-term reduction targets. These company’s commitment to sustained
to aligning with national ambitions. efforts to decarbonise their energy sustainable value.
However, like national initiatives, the mixes will be key to how we assess
rate of change remains stubbornly utilities’ comparative advantages. Utility LEANING ON CARBON CAPTURE,
slow, necessitating an immediate policy companies’ Scope 1 emissions tend to UTILISATION AND STORAGE (CCUS) AS
response to reduce emissions in the be comparatively high. We believe those A SOLUTION
short term to avert climate disruption. that can decarbonise their portfolios Instead of reducing Scope 3 emissions
in an efficient manner can reduce their from the combustion of their products,
Utilities carbon pricing risk and may use their the industry has leaned towards
Electricity and heat generation make resources more efficiently. Over the increased capital expenditure on
up 31.9% of global GHG emissions,19 long term we believe a utility company speculative technologies to assist them
and this figure is only likely to grow. To will be more profitable if it makes more in exploiting their reserves. The oil and
lower emissions, the transition to clean efficient use of its own resources, so we gas industry accounts for more than
renewable energy in our electric system can expect companies with low scope 1 35% of overall spending on CCUS,25
needs to accelerate. As a result, utilities carbon intensity to outperform. and we believe spending will accelerate.
are one of the most exposed sectors US majors have led investment in this
to carbon pricing risk, making their Oil & Gas technology. While capturing carbon
transition plans an essential part of their NET ZERO TARGETS RARE may well play an important role in
value proposition. It will become increasingly important meeting global climate goals, the gap
for oil and gas companies to be between what is required and what is
The step-up in the EU’s net zero disciplined in their capex plans as possible remains large. We therefore
ambition and the Biden administration’s the energy transition accelerates, remain cautious as overreliance on
clean energy standard are likely to positioning themselves for the long future utility of these immature
lead to further tightening in the global term. Setting net zero targets is still technologies to achieve climate targets
carbon markets and regulations, with rare in this sector according to Climate could further delay emissions reduction.
significant implications for the utilities Action 100+, and even fewer include In lieu of feasible, climate stress-tested
sector. According to the Transition Scope 3 emissions in their plans.22 investments, and without significant
Pathway Initiatives’ (TPI’s) State of Addressing Scope 3 emissions is crucial strategic shifts, we believe oil and
Transition Report 2021, global electric for the Oil & Gas sector as 85-90% gas companies may be better served
utilities have reduced their emissions of lifecycle emissions occur as fossil using cash to deleverage and increase
significantly, primarily due to reductions fuels are combusted. We note that distributions to shareholders.
in the use of coal and increased use of the IEA recently recommended that
renewables. US utilities are on track to exploitation and development of new Transport
meet their 2030 targets, but TPI found oil and gas fields must stop this year if DRIVEN BY REGULATORY PUSH
they will miss 2050 targets at current we are to reach net zero by 2050.23 This Transport represents about 24% of
rates.20 Emerging economies remain is broadly in line with UCL research direct CO2 emissions from fossil fuels,
reluctant to phase out coal. Coal is from 2021 that estimated 60 percent of of which road vehicles contribute
the dominant fuel in both China and global oil and gas reserves must be left about three quarters.26 Automobile
India’s electricity mix, representing unexploited by 2050, though a portion manufacturers already face numerous
58% and 51% respectively.21 The sector of those fuels could be produced in national and supranational vehicle fleet
needs continued large-scale investment, the second half of the century.24 This emissions and fuel efficiency regulations,
but companies should benefit from first raises risks for investors. Considering including in large economies such as
mover advantages. the typical oil and gas project generally Japan, China and the European Union.
have a life span between 15 and 30 An increasing number of governments
We believe the current policy traction
years, capex decisions now may result including Japan, Spain, the United
will be a tailwind for those utilities that
in value destruction and stranded Kingdom and Canada have announced
have embraced the energy transition
19
Source: Climate Watch, based on raw data 22
www.climateaction100.org/progress/net-zero- 25
w w w.iea.blob.core.windows.net /
from IEA (2020) company-benchmark/ assets/4315f4ed-5cb2- 426 4 -b0ee-
20
w w w.tr ansitionpathw ayinitiative.org / 23
www.iea.org/reports/net-zero-by-2050 2054fd34c118/ The_Oil_and_Gas_Industry_
publications/82.pdf?type=Publication in_Energy_Transitions.pdf
24
Welsby, D., Price, J., Pye, S. et al. Unextractable
21
Source: IEA fossil fuels in a 1.5 °C world. Nature 597, 230–
26
https: //w w w.iea.org /repor ts /tracking-
234 (2021). transport-2020, May 2020
4 MORGAN STANLEY INVESTMENT MANAGEMENT | SOLUTIONS & MULTI-ASSETCLIMATE TRANSITION
dates by when the sale of new internal
DISPLAY 2
combustion cars will be banned. These
Electric car stock by region and technology, 2013-2018
regulations, combined with rapid
advances in battery technology,27 6
should drive demand for electric and
hybrid vehicles. 5
ELECTRIC VEHICLE (EV) SALES MUST
4
Million Cars
ACCELERATE
3
Growth in sales of electric cars has
strengthened over the past decade, with 2
global stocks of electric passenger cars
passing 5 million in 2018, an increase of 1
63% from the previous year. However,
0
this is still only about 2.6% of global car
2013 2014 2015 2016 2017 2018
sales and roughly 1% of the global fleet
in 2019.28 ■ China ■ Europe ■ United States ■ Other BEV+PHEV BEV
To achieve net zero, it is estimated Source: IEA www.iea.org/reports/global-ev-outlook-2019
that zero emissions vehicles will need
to make up about 60% of global new
car sales by 2030.29 This will likely However, the investments required for portfolio emissions as well as how
require sustained policy support and a green global economy are enormous. financial institutions influence their
further advances in innovation to With the proliferation in national net zero customers and investee companies to
achieve cost parity. Given the size targets and climate measures amongst align on a net zero pathway.
of the opportunity, we expect to see large economies,32 we are likely to see
automobile manufacturers further additional regulation in the financial Conclusion
transitioning towards electric fleets. industry. We believe this carrot and stick As the window for addressing climate
This scaling up and increased cost approach is driving the industry’s interest change rapidly closes, we believe the
competitiveness could help sustain in various net zero initiatives. world will continue to step up with
growth in sales and push us towards bolder climate action. We believe
The financial sector is impacted by
decarbonisation. Over the next decade the market will reward innovation
climate change in several ways. Firms
we believe heavy emission-tied fines and penalise inaction. An attempt at
that are particularly exposed to more
and loss of market share will penalise continued high-carbon growth is likely
carbon-intensive businesses through
manufacturers who do not prioritise the to be value destructive as a result of
their loan books or investment
transition, while policy initiatives and increased technological and regulatory
portfolios may be poorly positioned
investment flows continue to reward change. Innovation in low-carbon
if regulation or technological change
those that lead the way. solutions will be the critical driver of
renders these sectors less viable. On the
both economic growth and strong
other hand, those that seize the green
Financials emissions reductions. Considering this,
opportunity can enjoy the potential for
While the financial sector can play a we believe investors will continue to
increased revenues and the reputational
large role in determining our path to demand their portfolios are aligned to
benefits that come with being a green
net zero30 through its direct and indirect both mitigate the risks and potentially
enabler. We believe it is important to
influence on the economy, many areas of capture the opportunities that the low-
consider which institutions are leaders
the financial sector remain intertwined carbon transition presents.
or laggards by analysing financed and
with fossil fuel interests and funding.31
27
www.about.bnef.com/blog /battery-pack- 30
For those banks that disclose CDP found that banks financed fossil fuels with $3.8 trillion
prices-fall-as-market-ramps-up-with-market- financed emissions are over 700x larger than according to Rainforest Action Network
average-at-156-kwh-in-2019/ reported operational emissions – The Time to 32
Half the world economy now under some
28
www.iea.org/reports/electric-vehicles Green Finance sort of net zero commitment - https://www.
29
BNEF EV outlook 2021
31
In the 5 years since the Paris Agreement was businessgreen.com/news/4010947/half-world-
adopted, the world’s 60 largest private sector economy-eyeing-net-zero-transition-analysis
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