Many point to COP27 as being a ‘quiet’ year for COPs, given the five year-cycle peaks embedded within the event; the last being COP26. These five-year cycles relate to countries being required to update their decarbonisation plans, known as nationally-determined contributions (NDCs), every five years. But COP26 signalled the need to move away from these cycles, given the urgency to track actions to keep warming to 1.5 degrees centigrade.
The final agreement asked for governments to update their NDCs further by the end of 2022, to COP27. Since 2021, only 21 countries have submitted an update to their NDC, 19 of which came from developing nations (is this a sign of developing countries’ increased engagement?). Whilst there has been a continued increase in announced net zero commitments over the course of 2022, it appears that five-year cycle has not been fully broken; questioning the level of action expected from COP27.
The urgency to have yearly action-driven COPs comes from the increased realisation that just half a degree difference between 1.5C and 2C unleashes a far more severe version of climate change and its effects. To put some examples to this (taken from the IPCC 1.5C special report).
- Sea-ice free summers in the Arctic moves from at least once every 100 years to at least every 10 years
- 14% of world’s population will face severe heat at least once every five years at 1.5C to more than a third of the population.
- The number of people experiencing water stress is 50% lower under a 1.5C scenario
The world has already warmed to around 1.1C above pre-industrial times and is considered to have less than 10 years left to limit warming to 1.5C. According to the IPCC, the global CO2 budget runs out at the end of 2030, leaving only one of these ‘peak-year’ COP meetings before 2030. We need to move beyond these five-year action cycles of COP and see year-on-year action-driven events.
A key component to this year’s COP, is that it is being hosted by an Africa country, placing Africa’s climate needs high on the agenda. Africa in particular, but also other emerging and frontier markets, will be in the spotlight both as receiver of funding to decarbonize, but also as providers of investment opportunities that can leapfrog the current climate stalemate. Climate finance will likely be a dominant theme within many, if not all, of the discussions. Climate finance refers to sources of finance that seek to support mitigation and adaptation actions to address climate change, with natural capital viewed either as it’s own pillar or embedded within both mitigation and adaptation efforts.
Throughout multiple COPs, parties have established financial mechanisms designed to fund climate change activities. Article 9 of the Paris Agreement stipulates that developed countries shall provide financial resources to assist developing countries with both mitigation and adaptation needs. The $100 billion annual commitment by developed nations, which was set in 2015, has yet to be reached. Clearly, the discussions need to move forward and developing nations need to be the protagonists in climate action as the current market circumstances are certainly not accelerating developing nation’s access to climate finance.
Most public climate finance to developing nations has gone to projects that reduce carbon emissions as opposed to helping people adapt to climate change. Moreover, both remain vastly under-funded, according to the UNEP Adaptation Gap Report. However, something that is often overlooked by developed nations is how their domestic policies can affect the competitiveness and affordability of various climate solutions across other parts of the world. For example, the cost of solar panels in the US can impact the access to and cost of the same in India.
This year has brought energy security to the forefront of many governments minds; attempting to reconcile climate commitments with the immediate demand for energy. But the increased concern for energy independence and self-sufficiency has the potential to damage the global and integrated efforts towards climate change, largely in developing countries. Previous COPs have examined the continuation of fossil fuels subsidies.
However, developed market policies around subsidising the cost of renewables to encourage further expansion – President Biden’s $396 billion program is a point in case - and push in some cases for local production at all costs, can outprice developing countries by reducing their purchasing power for renewables even further. In short, subsidies in the north for the energy transition result in impeding the energy transition in the south.
The subsidies example demonstrates two aspects. Firstly, how important collaboration between governments is on the global issue of climate change and just how valuable COP discussions could be as developed and emerging markets look at the impacts subsidies can have globally. Secondly, it demonstrates the important role of private finance within developing markets to aid the transition to clean energy sources and other climate solutions.
If this is the COP for Africa, adaptation is likely to move up the agenda given how widely African livelihoods depend on activities already feeling the impact of climate change.
- Agriculture’s presence in Africa and its direct exposure to physical climate risks. 23% of sub-Saharan Africa’s GDP is from agriculture and more than 60% of the Sub-Saharan population are smallholder farmers.
- Within Sub-Saharan Africa, 95% of arable farming relies on rainfall as opposed to irrigation, combined with African countries facing some of the highest water risk in the world.
Africa is a clear example of the two-fold effects of climate change; firstly, the direct exposure to physical risks is greater than the global average (examples include the frequency of heat and water-related stresses) and secondly, through lack of financing to build resilience and a capacity to cope with climatic change (adaptation). Insurance is a key area within climate adaptation, not only by providing an element of climate resilience for the agriculture sector but also by mitigating risks and enhancing bankability for a large range of entrepreneurs and their businesses.
Current estimates indicate annual climate adaptation costs in emerging economies could reach $330 billion in 2030 (UNCTAD Trade and Development Report); whilst the Glasgow Climate Pact’s definition of adaptation is, ‘helping those already impacted by climate change’. These two statements demonstrate the dual-action between financing future climatic change vs the immediate climate finance needed by many already facing the perils of climate change. Knowing that in the most fragile economies and vulnerable sectors, such as agriculture, the impact of climate change can threaten the livelihood of entire communities.
Natural capital is a key component of climate finance, aiding in both adaptation and mitigation actions. Nature-based interventions can help to deliver carbon reductions, generally at a much lower cost compared to engineered solutions, providing a more holistic strategy to reaching net zero. COP27 is likely to discuss this holistic approach in more detail compared with previous COPs; talking both about natural capital as a climate solution but also how nature is already being impacted by climate change. Countries like Gabon and Nigeria have been committing to create millions in carbon credits, with some of these sold in what would be the single largest issuances in history. So clearly the African carbon market is moving fast in partnership with the United Nations Framework Convention on Climate Change(UNFCCC).
With a developing market focus, many areas have high exposure to natural habitats and contribute significantly to GDP. Forestry for example, contributes to up to 30%-40% of national exports for some African countries, with tourism, another key industry, dependent on natural assets. Schroders recognises the importance of natural capital; recently partnering with Conservation International to accelerate natural climate solutions in Southeast Asia, establishing Akaria. Specifically, within Africa, blended finance is high on the agenda, with the likes of British International Investment, Norfund and Finnfund following on their pledges of COP26 to scale up Sub-Saharan Africa’s sustainable forestry by investing into the African Forestry Impact Platform.
Climate financing flows between developed and developing nations are expected to remain limited given the scarcity of public finance. To meet Africa’s climate finance needs, the private sector will need to play a more prominent role. Mobilising climate solutions investments in Africa, and other developing nations, will require innovative financing structures to overcome current financial barriers.
The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.