Climate ‘fundamentals’ should guide net zero action amidst change, say experts

Michael Watson, a climate and sustainability adviser at Pinsent Masons, and Thom Wetzer, associate professor of law and finance at the University of Oxford, made the recommendation whilst acknowledging that many businesses may view how they respond to the climate crisis as more complicated now than even a year ago.

They cited geopolitical turbulence, increasingly vocal climate scepticism and the expected roll-back of climate policies in some parts of the world as factors in that regard, as well as the emergence of gaps between ‘net zero’ policy ambitions and the realities businesses have faced in pursuing them.

Watson and Wetzer were commenting in the aftermath of a recent event hosted by Pinsent Masons in partnership with Wood Mackenzie, where those issues dominated discussion.

Wood Mackenzie presented authoritative data showing the various energy transition scenarios that are reasonable to predict – all envisage global warming this century happening to a greater extent than the 1.5-2 degrees aimed for in the Paris Agreement.  Watson said the data indicates that the “real economy” is not transitioning to net zero fast enough to provide the financial sector with sufficient investable businesses and projects to enable it to achieve the net zero commitments it made following COP26 in Glasgow in 2021.

“Business leaders are having to adapt their understanding of the global response to the climate emergency, what that means for the transition to a ‘net zero’ global economy, and what the impact is for their companies, in light of recent developments,” Watson said. “What may have been perceived as a very clear path even just a year ago has been muddied by geopolitical events.”

“An example of this is the effect arising from the enhanced focus given to energy security in recent times. The Western response to Russia’s war in Ukraine has been to consider its reliance on costly foreign imports of energy and this had led to vocal calls from some for the focus to be on sourcing cheaper energy domestically, including via a new wave of oil and gas drilling. That approach certainly appears to be favoured by the new Trump administration in the US, with Trump having further signalled his intention to put US economic interests about all else – including climate action – with the indication being that, at federal level at least, this will entail a roll-back of some existing climate policy,” he said.

Wetzer said: “In the EU, rules and regulation have emerged more prolifically than anywhere else to underpin climate action. When a recent publication of a report into EU competitiveness by Mario Draghi suggested that excess regulatory burdens hamper the EU’s growth, political leaders have chosen to interpret that, at least in part, as a call to ‘simplify’ climate-related rules and regulation in particular. To some degree, this reflects valid concerns about needless complexity in the EU climate policy. But opportunism lurks too. Political parties that always had reservations about the green agenda have gained ground in recent European elections and appear intent on using this political window in favour of deregulation to dismantle, rather than merely simplify, parts of the climate agenda. That has created uncertainty around the future of EU climate policy in key areas for businesses.”

Watson said business leaders are taking note of the changing picture and asking themselves whether they need to rethink investment strategies.

“Sudden change is a cause of uncertainty, and unpicking the reasons for that change and understanding what it means for companies and strategic investment decisions is understandably a focus of business leaders right now,” Watson said. “In the climate context, the changes seen in the past year have also coincided with a period in which climate ambition has not always matched up to climate reality and where some activity has been confused with progress.”

“The implementation of net zero-aligned financing strategies by financial institutions in the aftermath of COP 26 in Glasgow is an example of this, as it has become clear that the availability of vast amounts of capital to support the net zero transition can only serve as the catalyst for change anticipated of it, if the parameters for investing that capital reflect what is happening in the real economy – unfortunately, the reality is that the availability of finance alone cannot drive the necessary change in business operations and consumer habits – clearer policy and regulatory direction is required in some areas to effect this change,” he said.

“In tandem with this, while net zero-related transition costs in general may be falling, investment in certain activities or technologies linked to that transition are still very risky for the institutions to support. In any event, the approach taken to analyse the risk associated with those activities or technologies may, in a rapidly transitioning climate scenario, over-estimate the risk and underestimate the opportunity occasioned by increasingly deploying capital to those markets,” he said.

“A year ago, we discussed the challenges and opportunities of being a climate leader. While these recent events may well create some ‘noise’, the fundamental steps recommended then remain valid today – to ensure that business strategy is aligned with the economic opportunities and to mitigate the economic risks caused by climate change. Scenario planning and transition plans are fundamental building blocks to facilitate corporate strategic decision making,” he said.

None of the policy changes or ‘noise’ means that business leaders would be right to slow or abandon efforts to align with the ‘net zero’ agenda, according to Wetzer.

“Business leaders should focus on the climate fundamentals: the planet is getting warmer, the climate is shifting, and the adverse impacts of those changes are real and worsening. Extreme weather events increasingly cause a major human and financial toll – think of the floods in Spain and wild fires in Los Angeles. The science is clear: human-induced climate change makes contributes meaningfully to those risks. Until we reduce emissions, climate change will get worse and its costs will grow. Climate change is therefore not a ‘hype’ that moves with political cycles, but a secular trend that frames societal challenges over the next decades,” Wetzer said.

“Given that secular trend, businesses will only succeed long-term if the goods and services they produce make sense in the context of a decarbonising global economy. Even climate sceptics will, over time, come to realise that an ostrich strategy that ignores these stark realities will fall flat in the face of the costs of climate change. Lest we forget: whilst climate sceptics may be in charge in some parts of the world, other major powers forge ahead with decarbonisation plans for their economy. Even within the US, major states like California – the world’s fifth-largest economy – plan to introduce more stringent climate rules despite the federal rollback. Most people acknowledge the realities of the climate emergency and want to see resultant change in the economy,” he said.

“In practice, this means there will be climate-related law and regulation, there will be an energy transition, and there will be electrification of key sectors like transport. Businesses that take little or no action risk irrelevance. Worse, as the harms caused by climate change grow, people will continue to turn to climate litigation to hold those who continue to emit greenhouse gasses accountable for the harms their emissions generate,” Wetzer added, citing the need for businesses to continue to plan towards net zero.

Watson said: “Business leaders should develop strategic plans based on the guidance developed by the Transition Plan Taskforce, which should explore both what is in companies’ own control to change and the things that they depend on, to transition successfully to a net zero operation.”

“In tandem with this, businesses should seek to engage with governments to provide long-term certainty over policy and regulation to give those companies sufficient confidence to invest in the changes they need to make to meet their transition plan objectives.”

“In 2025, whilst there may be lots of political noise and less promotion of net zero targets per se, the increasing alignment between economic success and climate transition, and the increasing risk of climate litigation driven by the fundamental impacts of climate change, is likely to be the focus for strategic decision making and capital allocation,” Watson said.