Investment Progress For 2024: Position Yourself To Be Prepared For A Decarbonizing Economy
The need for greater climate finance has been the focus of numerous industry analyses, including at the 2023 United Nations Climate Change Conference (COP28). The World Economic Forum explains that we are in a place in which investment levels remain multiple times below what is needed to reach net zero by 2050. Moreover, not all investments have the appropriate risk-return profiles to meet the fiduciary mandates of investors. Add to that there is often a mismatch between climate and investment time horizons, and it makes us wonder if decarbonizing economic efforts can truly and realistically become viable in our lifetimes.
Is there any hope for a net zero economy by 2050? Where do investors come into decarbonizing conversations?
The list of today’s fastest growing decarbonizing opportunities generally include hydrogen, biofuels, lithium, and electricity storage. The World Economic Forum (WEF) predicts that these opportunities are projected to achieve a compound annual growth rate of over 20% between 2022 and 2030, resulting in over $100 billion in enterprise value growth by 2030 in the net zero emissions scenario.
The WEF proposes that a multi-fold increase in climate finance needs to be framed in the language of investors: growth, returns, and valuation. The net zero narrative often centers on risks, with limited attention paid to the potential upside. Perhaps if investors understood decarbonizing in terms of revenues and value rather than financing gaps, they could develop a holistic and granular view of the decarbonizing opportunity set across asset classes.
Why the Consumer Disconnect?
On June 7, the US Labor Department will report on the number of jobs added in May, with economists forecasting a gain of 190,000. The unemployment rate is expected to hold steady at 3.9%. “The labor market is still pretty strong,” Allison Kaminaga, a professor in the economics department at Bryant University, told US News and World Report.
Inflation (as measured by the price index for personal consumption expenditures) “slowed markedly in 2023,” according to the Congressional Budget Office. In CBO’s projections, it slows further in 2024 — to a rate roughly in line with the Federal Reserve’s long-run goal of 2%.
Yet a disconnect is happening between the actual state of the US economy and the way people in the US feel about it. More than half of registered voters in 6 battleground states rated the economy as “poor” in a recent poll by The New York Times, The Philadelphia Inquirer, and Siena College. Despite consistent spending patterns and stable home budgets, pessimistic consumer sentiment is being driven by elevated inflation and high interest rates.
Shares by BlackRock: Be Prepared for a Decarbonizing Economy
When I received the recent iShares by BlackRock annual report, I was curious. What did one of the world’s leading investment, advisory, and risk management solutions providers have to say about the economy, particularly in relation to decarbonizing our portfolios?
They state that the combination of continued economic growth and cooling inflation provided a supportive backdrop for investors during the March, 2024 / year-to-year reporting period. Higher interest rates helped to rein in inflation, and the Consumer Price Index decelerated substantially while remaining above pre-pandemic levels. “Wage and job growth powered robust consumer spending,” the iShare report describes, “backstopping the economy.”
Equity returns were robust during the period, as interest rates stabilized and the economy proved to be more resilient than many investors expected. As a result, BlackRock has a plethora of US stocks, particularly because of the “promise of emerging AI technologies.”
Consumer spending continued to grow in both nominal and real (inflation-adjusted) terms. A strong labor market bolstered consumer spending, as employers continued to add jobs, and average hourly wages increased notably. Consumer spending was also supported by higher asset values, as both home prices and strong equity performance increased household net worth. Innovations in computing also drove enthusiasm for equities, as new technologies drove hopes for economy-wide improvements in productivity.
Of course, unknown future variables have the potential to alter the positive upswing moving forward. Geopolitics, for example, may become a structural market risk. The iShares report also notes that supply constraints are now an embedded feature of the new macroeconomic environment and will continue to make it difficult for circular economic stability. The total incremental enterprise value of the climate solutions supply chain will likely reach between $5 trillion and $11 trillion by 2030.
The most promising news from the iShares report suggests that investors should be thinking about a future net zero economy and world.
“Overall, our view is that investors need to think globally, position themselves to be prepared for a decarbonizing economy, and be nimble as market conditions change.”
Now, all things are relative. We must remember that BlackRock’s CEO Larry Fink caused a ripple in the investment community after the COP26 climate talks in Glasgow when he said, “We are on the edge of a fundamental reshaping of finance” to deal with the climate crisis. When political forces pressed him, Fink walked back the statement.
Then, later on, BlackRock added to its board of directors the CEO of Saudi Aramco, which “happens to be responsible for more carbon emissions than any corporation in human history,” according to CleanTechnica’s Steve Hanley. Aramco has stated it will invest to increase crude oil production capacity to 13 million barrels per day by 2027, expand its liquid to chemical production, and look to increase gas production by more than 50% by 2030 — at the same time it serves as the Formula One racing series’ sustainability partner. Hypocrites, everywhere hypocrites.
Decarbonizing the Economy Will Be “Bumpy and Dirty”
What will it take to reduce the emissions of the formidable power, buildings, transportation, and agriculture industries? It will require hundreds of wind turbines, solar panels, electric vehicles, and storage batteries. The production of these industries, in turn, will require water, energy, rare earth elements, and critical metals to produce, creating more emissions from production.
Dislocations and inefficiencies will go side-by-side with decarbonizing the economy. “The decarbonization pathway is likely to be bumpy and dirty,” predict Daniel Ingram and Eric Friedman in a Pensions & Investments journal article.
What will it take to decarbonize a portfolio?d It will involve shifting to securities with lower carbon emissions, and it may involve divesting from entire sectors. Instead of looking at resilience as an investment strategy, Ingram and Friedman argue that “dislocations and inefficiencies that will come from decarbonizing the economy can present investment managers with opportunities to outperform the market.” What needs to be done?
- Use information about climate-related costs and opportunities as part of an overall investment process.
- Balance climate-related factors with other risks and opportunities.
- Invest in carbon-intensive securities where active managers have considered the physical and transition risks from climate change.
- Recognize that there’s no free or perfect hedge to protect portfolios from complex climate risk.
Individual technical options, or “pathways,” for decarbonizing specific industries are necessary and starting to take place. Aligning investment and innovation cycles helps to reduce the residual emissions burden from existing assets. As we move away from our heavy reliance on fossil fuels, we’re getting ever-so-closer to tipping points as thresholds that will help transition the economy away from fossil fuels.
Decarbonizing the economy means that we investors have to push the firms we rely upon for professional advice to be as forthright and direct about the ways that our money is funding the climate crisis as well as options that keep us financially stable.
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