05 November 2021
The climate challenge is a sobering one and all of us await the outcomes of COP26 in the coming weeks to see what commitments are made by global political and business leaders at this year’s milestone United Nations Climate Change Conference.
While the climate challenge may seem insurmountable, responding to it presents opportunity for innovation and, from that perspective, now is an optimistic time to be talking about investing for net zero. Something we think will happen more quickly than most people imagine, as the emissions reductions targets that have been set in the last 24 months start to have a ripple effect.
Two recent global trends are helping to drive this acceleration: carbon transparency and net zero supply chains.
Carbon transparency – in particular transparency through climate disclosures and carbon labelling – has come about as the proliferation of businesses and countries setting net zero commitments drives demand for robust measurement and transparent disclosure.
Stakeholders and communities want evidence of delivery against intent, and investors and markets need to better understand climate risks. In some countries, managing climate risk is incorporated into company directors’ duties. Meanwhile, measurement and disclosure are crucial to avoiding claims of greenwashing.
In the context of consumers, it’s now a cliché that carbon is the new calorie. Consumers are demanding new levels of information about the carbon footprint of the products and services they buy. And, like the nutritional analysis on food products, carbon labelling enables them to make choices based on their tolerance for carbon emissions.
In a 2020 survey of about 1,000 people, engineering firm GHD found that 81 per cent of UK consumers support carbon labelling1 particularly across energy and water bills, travel tickets, and broadband and streaming services. 59 per cent of those consumers would choose lower carbon options if informed about their overall consumption. And as many as 40 per cent said they would pay a higher price for environmentally friendly products and services.
Though a trend perhaps playing out more in developed markets rather than developing ones, this green premium creates demand for low-carbon product development, packaging, logistics and supply chains – all of which will require both substantial capital and innovation to achieve.
A related trend, which is really a consequence of increased carbon transparency, is the move to net zero supply chains. Just eight global supply chains account for more than 50 per cent of total global emissions.2 However, supply chains are the most challenging source of emissions to address. 90 per cent of the world’s businesses are small and medium enterprises, which makes consistency of measurement of data, targets and standards extremely challenging.
For major buyers, getting control of scope 3 emissions is critical. It’s therefore not surprising that in 2020 there was a 24 per cent increase in the number of companies asking their suppliers to report environmental data compared with the year before.3 Global brands are using their heft and resources to drive change.
This trend presents both risks to manage and opportunities to realise. For those that don’t meet these tightening requirements, there is a real risk of contracts not being renewed or being locked out of tenders. But for others that move ahead of the curve, there is a window of opportunity to attract a green competitive edge for their product.
Either way, responding to net zero supply chain requirements is going to require investment in logistics, innovation and reporting and this requires capital.
So how are capital markets going to respond to the challenge of accelerating decarbonisation?
Globally, there is no shortage of capital available for investment. The current level of unallocated capital of $US3 trillion is at or near all-time highs at close, and the large majority of it is private equity. Not all will be allocated to emissions reduction investment as investors diversify their exposures across investment classes and have different risk-reward requirements and investment horizons.
But it’s indicative of the scale of capital looking for returns, and it’s just as well that there is this ‘wall’ of capital for deployment. The International Energy Agency estimates the average yearly investment needed between now and 2030 to reach net zero by 2050 is $US5 trillion.4
To give you a sense of how that investment needs to be deployed between now and 2030, it’s accelerating the pace of renewables deployment from around 250 gigawatts a year to more than one terawatt, a fourfold increase. With renewables being the cheapest form of new energy generation in almost every part of the world, the case for investment is compelling.
So, we have quantified an unmet need for investment, and we know there is capital available for deployment. The bridge between the two is an investable pipeline – a defined view of where the investment opportunities lie that meet the risk-return needs of the investor.
Not all capital is the same – we need a spectrum of investment types, and that is great news for investing in emissions reduction. Solving for net zero by 2050 is going to require all types of capital: venture and start-up capital to invest in emerging technologies; development capital to build new emissions reduction projects; alternative asset capital for long-term investment; and public capital to provide early-stage support and invest where private capital is not appropriate.
Creating this pipeline, this bridge between an urgent need and the resources available to meet it, requires many inputs – some driven by governments, some by the private sector.
On the government side, many economies have signalled an intention to ‘build back better’ or mount a green post-pandemic recovery. Some, such as the Australian Government, have flagged priority technologies and pools of public funding to catalyse private investment, as well as strategies such as hydrogen hubs. Government policies such as these are important groundwork for building scale, which is much needed for affordability, efficiency and – therefore – impact.
Governments can play a powerful role in supporting new technologies, particularly in the short term as nascent sectors become more mature. Grants and subsidies are an obvious lever but there are also options such as targeted sector mandates, early offtake agreements, procurements, running pilot schemes and setting clear frameworks and processes so that projects can be de-risked, financed and progressed.
In Australia, the Australian Renewable Energy Agency (ARENA) and the Clean Energy Finance Corporation have made a considerable contribution to the maturation of wind and solar and the resultant drop in the cost of these technologies over time. We see them and other agencies as crucial to unlocking investment in the new, emerging technologies that will be required in a net zero future.
On the private sector side, ESG expectations, regulatory compliance, customer demand, cost and – ultimately – returns are factors driving investment decisions. For Australia, where trade is equivalent to 45 per cent of GDP and generates one in five jobs5, global trends are also highly relevant.
From our perspective, there are a number of key areas of focus for both the private and the public sectors to create the investment bridge, being investments in: (a) new technologies; (b) investments in carbon intensive sectors; (c) resilience and adaptation; and (d) emerging economies.
While the cost of wind and solar has come down considerably, it’s not – as the IEA notes in its report – enough for energy transition. Investment is needed in electrification and the grid, and – for hard-to-abate sectors – fuels such as hydrogen and delivering on technologies like carbon capture and storage.
Macquarie Group, GIG's parent company, is working with the Australian Government on the Low-Emissions Technology Roadmap which sets priorities and stretch targets and, by focusing government support, seeks to catalyse private sector investment. Like much of the market, Macquarie is at the early stages of progressing new technologies, but so far, it’s a promising effort.
There’s a lot of excitement across governments, industry and financiers about one of these: hydrogen. And we too have high conviction. We’re working with partners in the UK and Australia to develop hydrogen hubs that can support domestic industry as well as, in the longer term, seek export opportunities. Macquarie is investing in portfolio companies such as Cadent in the UK to trial introduction of hydrogen into the gas grid, and we are connecting renewables generation with the production of hydrogen.
The shift to these technologies is already seeing a group of new businesses form. While this represents a new set of investment opportunities, I am also excited about the opportunities for some of our largest existing companies as they use their revenues to invest in innovation and the transformation of existing carbon-intensive industry.
The transition of some of the European oil and gas players to low-carbon energy majors is one of the best examples of such opportunities. We are also seeing these entities partner with institutional capital to accelerate this transition. In Australia for example, Macquarie is partnering with BP on a feasibility study into a hydrogen hub on a former refinery site in Western Australia, that – all going well – will reinvigorate the site and repurpose it for a decarbonised economy.
From an asset management perspective, while some investors may choose to divest their interests in carbon-intensive industries, we see the value in committing to remain invested, engaged, and working through solutions. Much can be achieved in the course of a 10-15 year investment, and Macquarie’s Asset Management division is doing just that: managing its portfolio to net zero by 2040. The approach being taken is to actively work with portfolio companies such that each will have a net zero-aligned business plan within the next two years.
Sticking with carbon-intensive industries as they decarbonise supports an orderly transition. Many of these industries are based in regional centres where one industry may be the primary economic contributor and employer. Working with them on diversification, transitioning existing skills and developing new ones, and investing in new or adapted infrastructure is all part of good stewardship.
Another outcome of good stewardship is investment in adaptation and climate resilience. We have all witnessed the horrific effects of more and more extreme weather events. Sadly, as we know all too well, Australia is particularly prone to drought, flood and fire.
Responsible infrastructure investors in particular work with the teams in investee businesses to plan with urgency, as the frequency and ferocity of these weather events continues to increase faster than we had previously expected. Designing flood prevention into new infrastructure, burying powerlines, and using geospatial technology to pre-emptively mitigate wildfires are just a few examples of the type of investment taking place.
Macquarie has been an early supporter of the Global Centre on Adaptation, and we are supportive of the COP26 goal of planning and increased financing for early warning systems, flood defences and for building resilient infrastructure and agriculture.
Today, non-OECD countries generate around 65 per cent of emissions6 and achieving emissions reduction in these economies is challenging. Other than wind and solar, the cost of low-emissions technologies is not yet at parity – or below – conventional forms of energy. Communities in many of these economies are dependent on small-scale agriculture which is also a substantial source of emissions. These economies also often lack an enabling environment for private capital investment.
Supporting them through an orderly transition requires partnership across governments, multilateral development banks, and private capital. Governments will need to fulfil a longstanding pledge of $US100 billion in annual climate finance and build strong country partnership platforms. Multilateral development bank (MDBs), development finance institutions (DFIs) and private capital will need to better work together. And the private sector needs to respond to more robust frameworks and de-risking by investing.
Macquarie is honoured to work with the Climate Finance Leadership Initiative (CFLI) in India, and with the Glasgow Financial Alliance for Net Zero, to mobilise the private capital needed to give these countries the confidence to commit to more ambitious Nationally Determined Contributions.
As with any defining challenge, there are complexities to overcome and opportunities to realise. We are in the glass half full camp, the one that sees the vast amount of capital available for investment; the coalescing of communities, businesses and markets; and the speed of technological development.
Bringing these factors together to drive meaningful change requires pipelines and partnerships. What this looks like in each country is different – as it needs to be – to ensure that energy transition is orderly and inclusive.
1. GHD Committing to Carbon Transparency report (2020)
2. World Economic Forum, Net Zero Challenge: The supply chain opportunity (2021), Food, construction, fast-moving consumer, electronics, automotive, professional services and freight
3. CDP media release, 20 May 2020
5. 2020 figures, DFAT