Perspective

Podcast: a "code red for humanity" but a green light for investors


The intergovernmental panel on climate change (IPCC) released a report which issued a "code red for humanity".

Below is the transcript and the podcast in which fund manager Mark Lacey discusses the details of the report, how he expects it to impact policymakers and what it means for investors in energy transition.

Part one: What’s so different about the IPCC report?

David Brett (DB):

So Mark, before we get into the finer details of the IPCC report, can you just explain what it actually is?

Mark Lacey (ML):

The Intergovernmental Panel on Climate Change, the IPCC, is the United Nations body for assessing the science related to climate change. So, it really is 100% science-based. And as part of this role, they provide policymakers globally with regular scientific assessments on climate change, its implications and potential future risks, as well as put forward adaptation and mitigation options for those policy leaders. This is the sixth report they've done. The last one they did was in 2013 and at the time was considered very balanced. I would say this one's extremely balanced, but the changes they presented to governments really should stimulate change.

DB: Can I just assume there's no government or country influence, and this is purely scientists working independently from any state regulators?

ML: 100%. And the summary report is 42 pages. The actual report itself is 1,356 pages. So, if you were to say, "Okay, is this a credible report?" it’s unbelievably credible because of the CVs of the people that are gathering this data. It's the top climate scientists globally all getting together. And the 42 page report is a summary for global leaders to digest the information in a way so that they can actually adopt policies globally.

DB: So, Mark, we've seen so many of these climate reports in different guises. What's different about this one in particular?

ML: Because as I said, it's thousands of experts around the world, all getting together to synthesize the recent developments in climate science, adaptation, vulnerability, mitigation. Bear in mind, governments are requesting these reports through intergovernmental process. And the content is deliberately policy relevant, but it definitely stays clear of any policy prescriptive statements. So it's agnostic. It's all data.

DB: So what's the report actually telling us? What are these scientists predicting?

ML: So the clear message from the reports is simple. Many of the effects of climate change are now unavoidable under all of the IPCC’s scenarios. Be that more extreme weather conditions, be that the fact that the Arctic is already suffering large scale melts, and as a result, you're going to get sea levels increasing.

To put into context what the data is highlighting, not only do we need to get to net zero emissions globally by 2050, which is a pretty well-known target now, but we would also need to proactively remove carbon from the atmosphere from 2050 onwards. And that's needed in order to limit global temperature increases by between 1 to 1.9 degrees Celsius by 2100.

We've always had this path of getting to net zero. The big change is that getting to net zero is not going to be the solution now, because by the time we get to 2050, we actually need to start removing carbon from the atmosphere. What does that mean? It means that we effectively need to be extracting carbon through technology, or we need to plant more and more trees and really start reforestation. We've seen a huge amount of deforestation over the last few decades.

DB: And that seems like a huge challenge. A big change in the mindset of the way we live and the way companies work?

ML: 100%. It will be a mindset change, not just at the company level. It's also at the consumer level, but they work hand in hand. If governments stimulate investment in such a way that encourages to actually bring the cost profile down for businesses that are introducing these new technologies, which we'll touch on in a minute, no doubt. At the same time, it makes it easier for the consumer to switch their habits, which reduces their own net emissions as well. The report is not telling people to suddenly stop flying, stop driving your internal combustion engine car. What it's doing is saying, this is the result if we carry on doing this. So we need to make changes now, which have an impact, and provide the right outcome for 2040, 2050, 2060, and beyond.

DB: Are there any specific data points in the report that actually point to a direct link between human activity and climate change?

ML: Yes, there are lots actually. I mean, and again, I would encourage people to read the 42 page summary because within that summary alone, you've got global surface temperatures are effectively 1.1 degree higher in the decade between 2011 and 2020, than between the whole of 1850 and 1900. The past five years have been the hottest on record since 1850. And we  are all seeing evidence of this, particularly with regard to forest fires and massive temperature swings globally at this point in time.

The recent sea level rise has tripled compared to the entire period between 1901 and 1971. Obviously, that's related to the melts in the Arctic… Human influence is very likely, and “very likely” means greater than 90% likely, the main driver of the global retreats in glaciers since the 1990s, and the decrease in the Arctic sea ice.

And then, at the same time, it is virtually certain that hot extremes, including heat waves, have become more frequent and more intense since the 1950s, while cold events become less frequent and less severe. They're using very, very careful wording in the report without saying it's 100% likely caused by human influence. It's just statistically and scientifically based. It's almost definite, but they obviously can't say that.

DB: That sounds almost unequivocal though. About as close as you can get to it.

ML: 100%. Yes.

DB: How can scientists be so sure of that link between the actions of us humans and the changing climate?

ML: You just have to look at the data, and look at where we are on CO2 emissions, or not just CO2 emissions, overall emissions which includes methane, et cetera. The past decade was probably hotter than any other period in the last 125,000 years, even though sea levels were much as 10 meters higher. So, if you look at the influences, it's combustion and deforestation that’s raised carbon dioxide levels in the atmosphere, higher than they've been in the last two million years., That's according to the report.

ML: And then, you also add on the fact that agriculture and fossil fuels as a whole have contributed to methane and nitrous oxide levels being higher than any other point in the last 800,000 years. Meaning that when you take all this data, it's pretty evident that humans are responsible for this.

DB: And you mentioned it just before, they haven't gone all the way, the scientists. So, have they given themselves a little bit of wiggle room or are the findings in this report definitive?

ML: The findings in the report are definitive because we're running out of wiggle room. That's probably the best way to describe it. We've already seen a 1.1 degree increase as I mentioned earlier in terms of global temperatures since pre-industrial times. So, to get to 1.5, we've not got a lot left. And the problem is that the path of emissions globally at the moment still is increasing. And they'll continue to increase in the next few years even if we stimulate a huge amount of investment just because of the scale of the change that's needed.

Part two: The key takeaways and will anything change?

DB: What are your three key takeaways as a leader and as an investor?

ML: First one is that the science is really clear. Data speaks for itself, and there's a huge challenge facing humanity for the next 100 years. I'm not being dramatic. We're just going to see policy momentum from governments swing more towards climate than has ever been the case  in the last 20 years. So, this is going to be front and centre of government minds in future policy now. So that's the first thing.

The second thing is carbon pricing, which is still a relatively immature market. It is going to become front and centre. And carbon prices have only a one way risk in terms of pricing and that's up. Because at the moment, prices aren't at a level - and are not adopted globally - that it deincentivises investment in fossil fuels. So carbon prices have to increase. And what does that mean? We are also probably going to get wider implementation of the carbon border adjustment mechanism (CBAM), which obviously the EU is phasing in over the next couple of years.

And then thirdly, and this comes back to Biden's influence and his welcome election as president in the US, you're going to have a more globally coordinated approach tackling this challenge. You can't have the EU doing it on their own. You can't have China saying, "Well, we might take another 10, 20 years later before we adopt our net zero policies." This is a global problem, and it's a globally coordinated approach that will be needed.

There are different levels of competence and affordability in different countries globally, and it is not the responsibility of just the affluent countries to basically say, "Well, we'll take up the reins." They have to help the other countries and support investment in those areas as well at the same time. And if you are slightly sceptical beforehand, you're not going to be now as a government leader.

I think this is going to solidify that coordinating policy;  it's going to galvanize it. We’re heading towards COP26 in November , which is as everyone knows is in the UK. And you're going to see a lot of announcements on policies that stimulate investment to, as I say, encourage that cost reduction in those key technologies, which will really put us on a path to getting to net zero in 2050.

So, you can look at the report and find it shocking - because that's the data. But at the same time, there's a huge part of myself and other people, that when they read the report thinks “this is great - this is what's needed in order to drive this path to net zero”. Making it more achievable. If anyone was sleeping ahead of this report, they've woken up now.

DB: What do you expect to change as a result of this report? I guess you sort of hinted at that in your last answer.

ML: It's more about actionable policy. The pace of it is going to change. That's the most important thing. Such as the Green Deal in Europe.

You've already got actionable policies to stimulate investment in wind, solar, hydrogen, storage. All of these technologies are needed to reduce emissions. But first, don't be surprised now if we start see more aggressive policies and more defined policies in the US. We know that's coming. We know that started with the infrastructure package that the US has put in place. But don't expect just Europe and the US to do this from now on. Expect to other areas to really start stimulating the investment rates in those key technologies, which will bring the cost down.

And it's the cost that drives the consumer. We cannot expect the consumer to, overnight, suddenly start paying three times more for a certain product, because obviously, we need to get to a path of net zero. Because consumers by and large can't really afford that. So, the investment will be stimulated here. That will bring down the cost profile of all these technologies, which makes it a win-win for both obviously, emissions, but also from the consumer from an affordability perspective.

DB: And we know there are businesses that aren't directly invested in this path to net zero. There are some with a vested interest, in fact, in not even meeting these goals. Without them, it might appear impossible to meet climate targets. How do we change the minds of those types of businesses?

ML: This is a good question. Okay. So, let me give you a nice positive view first. I think it's very clear, big businesses are already starting to listen. So, whether it's on the consumer side, like Amazon, Google, Apple. I'll take those three companies as perfect examples. Or whether it's on the producer side, big oil companies, which is a separate question in itself, they're already starting to listen. Okay - but how are they going to listen even more? And I think this is where we bring it towards investment now.

The role of the investor and the lender is going to play an extremely big part in helping companies evolve and adapt to a net zero world. So, as shareholders, I think most investors recognise that being a good steward of our investors’ capital has the responsibility of not just delivering industry leading returns. We've got to do it now in a way that through active engagement with these companies and big businesses you were talking about, that we can encourage and help these companies to reach net zero well before the 2050 timeline.

And if company management teams are not inclined to operate the company on that basis, they will get left behind with regards to access to capital in both the debt and equity markets. And when I say engagement, it's a process of encouragement and working with companies, not beating them with a stick. You can't just ask companies to change overnight, but you can encourage companies to have a clear policy where you can support them through that change through access to our capital.

So I think businesses are starting to change. I think it's consistent even if you look at the energy sector or the transportation sector. Volkswagen, BMW, Ford, GM, all have clear policies now delivering electric vehicles to the consumer on a cost viable basis. This is enabling the consumer and enabling that change, and I think that's very, very important.

DB: Okay. So we've been headed along this path for over a century albeit the effects of how we act on the climate have only really been known for the last few decades, but we are still heading along that same disastrous path. What gives you confidence we can make the adjustments needed now, having not heeded the warnings of the past?

ML: It ties in with governments. Now, they've got more access to data, which is unequivocal. You've got consumers who, over time, will basically take up the new technologies when there's a cost viability, but more importantly, you've got businesses going in that direction because everything runs through end products and a business. Businesses are going in that direction to deliver that.

And the key thing businesses need is access to capital, which encourages the change. That's where we play a role. The other thing they need is a very, very clear and supportive policy so they can effectively put in that advanced capital, which is where the returns are going to start to be generated in not just one or two years’ time, but five, six, seven, or eight years' time.

So stable government policy allows them to take the risk to reduce the cost in technology to develop, to deliver it to the consumer. And I think with all the data that we've got right now, everyone is starting to move in the same direction, which is why it's a bit more encouraging than previous policies and impact reports over the last few decades.

Part three: A code red for humanity but a green light for investors in energy transition?

DB: Why is this so important for investors in the theme of energy transition?

ML: Investing in energy transition, it's already recognised as a long-term structural investment thing because it has so much visibility with regards to capital flow and above average earnings growth. And it's really the capital flow and the investment rates, which have started to accelerate, that are needed to change the energy and the transportation system. That's what we mean by the energy transition. And that change is not occurring over the next one or two years. It's carrying over the next three, four decades.

But as we said for a long time now, when you look at renewable equipment or the transmission distribution sector, which needs a massive upgrade globally, or even you take something simple like charging infrastructure or even hydrogen in terms of producing and transporting and consumption of hydrogen. The current investment rates are running at less than half what we need to be running at right now on an annual basis in order to get anywhere near to net zero by 2050.

So, why this report is so important is it comes back to that stable government policy, which actually from here is likely to increase investment rates. And I don't mean investment rates just from those specialists in those individual sectors. I mean, also for example, the integrated oil companies will start to have more visibility on moving their business away from fossil fuels into effectively renewables or basically, zero carbon technologies. There is so much that is positive for the energy transition sector which is coming out of this report. But I certainly expect a bit more clarity on those policies to come through at the COP26 meeting at the beginning of November.

DB: Do we have a rough figure on how much this energy transition is going to cost?

ML: We've said this for the last few years, the early indication for the next three decades is between $100 to 120 trillion. It's about three to four times the fossil fuel capital expenditure that we're currently spending on an annual basis going forward.

So, another way to word it is the industry is going to go through a period of a massive step change in capital expenditure in order to transition. And every year, particularly for the last three years, we've actually seen a really big step up in those capital expenditure run rates. But still, and this is the key point for investors, those capital expenditure run rates are still insufficient to get to net zero in 2050.

DB: So that sounds like a massive opportunity for investors, which we'll get to in a second. But given the fact we're coming out of a pandemic, which has cost governments a lot of money propping up the economy and the businesses around it, where is the money going to come from to fund this energy transition?

ML: Let me answer that in two phases. First phase is that at the moment, if you think about the funding of the global energy transition sector, it's still slightly dominated around two thirds in the private sector, one third public sector over time. And you're seeing this with a high level of IPOs coming to the market. Now that might be valuation driven in the short term, but you're going to start seeing more and more of these companies as they scale up and access public markets.

And they need public market capital. They need investors to invest at the equity level to really put the investment in the ground to get to scale in order to provide a very, very profitable a creative product to the end user. So that's the most important thing first. The second thing is, don't write off the existing fossil fuel based producers. And what do I mean by that? I mean, traditional companies like Shell and BP. Just to be really clear, companies like that are going to be part of the solution, not part of the problem. Expect a huge amount of investment from those companies, which will slowly transition their business because they can't just turn oil and gas taps off overnight.

And they will slowly transition their business, taking that free cash flow they're generating from their existing business and moving into key markets like hydrogen. It is obvious that these companies are going to be dominant players in hydrogen, in charging infrastructure and potentially wind generation and solar generation as well. They all have very aggressive targets. The third point is the governments, they can't afford to just basically provide a load of subsidies.

Now, the European Union is providing subsidies for hydrogen in the near term, and that is purely to help the small companies get to a level of scale where they produce green hydrogen on a par with grey hydrogen today, which means it's viable for the consumer. And that's a short-term measure which won't be sustained. But again, it would be helpful if that level of early investment in stimulus occurred at this stage with all governments globally, because that would just speed up the entire process. And again, it's that coordinated policy that I think you're probably going to get from the COP26 minutes. You're not going to get a lot of these countries just throwing cash at this sector because as you rightly say, they can't afford it.

DB: Are there any areas of the market in particular the investors should be looking at that look set to benefit from the report?

ML: So, in the response that we wrote to the IPCC report, we mentioned obvious sectors such as wind. We mentioned batteries. We mentioned charging infrastructure as three sectors the investors can get their arms around in terms of, okay, when you scale up these businesses, they're obvious beneficiaries of a stable policy, and consumer take-up. Consumer take-up for wind generation spaces. Obviously, the electricity generation space and consumer take up for batteries and charging infrastructure will come through  with take up of the electric vehicle.

But that misses the point. The energy transition space is the entire value chain that is going to be replaced. So, when you ask about what sectors will benefit from the report: renewable energy equipment, solar, wind. We need to continue to encourage investment in these areas. And these are areas where we are seeing manufactured goods, which still are now already generating a positive return on invested capital. But at the same time, these technologies, wind and solar, they compete with combined cycle gas turbines and compete with coal.

So it's a no brainer for an energy generator to actually bring on these technologies rather than bring on new combined cycle gas turbines or even coal plants in this environment. But in order for all this to work, you need a massive amount of investment in transmission and distribution networks. And this is so important. In order for this to work, you need more efficient transmission and distribution networks. Not just in emerging markets; in developed markets as well. At the same time, we need huge amounts of infrastructure at the residential and commercial level with regard to buildings in terms of efficient use, whether it's efficient HVAC systems, or even just efficient lighting systems.

All of this is linked. We need new investment in the hydrogen networks with regards to storage, transportation, of course production. And then, as I mentioned, you’ve got charging infrastructure and batteries, and in all forms, not just lithium-ion. Vanadium flow batteries, for example. You're going to see evolving battery technologies which will cater for various applications, which is absolutely essential because it's not windy all the time, and it's not sunny all the time. It's the entire value chain which benefits, and it's the entire value chain that investors should be focused on investing in.

DB: And you mentioned the integrated oil companies previously -  disruption is going to be a big thing. Are there any that you suspect might get left behind or will the whole industry as we know change?

ML: I would love to say the whole industry is going to change, but that is unlikely to happen. And the reason is you can just take the coal industry as a case in point. But let me finish up before people get worried about integrated oil companies. Again, I'm going to repeat: they are part of the solution, not part of the problem. There is already a clear policy of change when you look particularly at the European integrated oil company space.

So, if you just take those seven companies individually, they're taking their power generation and renewables from five gigawatts to around about 135 gigawatts between now and 2030. These companies have a clear policy to change. Within the oil field services sector, these companies, particularly the asset light companies and  engineering based companies are already changing quite fast, moving from front end engineering on subsurface fields, both in oil and gas, moving their expertise into hydrogen. Moving their expertise into wind installation, into solar installation, into carbon capture, which is going to be a huge growth area as well.

Those companies are changing and they have adaptive business models which will no doubt benefit from this new investment phase in the alternative sectors. However, where I get concerned is in the companies like, for example, the exploration and production sector, which are oil and gas producers. More oil producers than gas at this point in time where they have short reserve life and there is no alternative policy.

Now, the companies that are thinking along these lines have to recognise that at the moment if they continue to go down that route of not looking at changing their business model, those businesses are not considered sustainable by definition. The same as with the coal producers, these are companies that could miss out if they don't start changing their methodology at the business level.

DB: A lot of us won't be around to see the effect if we do make all these changes that the report's hinting at. We won't be around to actually see the effects of the changes that we need to make in our lifetimes for the sake of the future. So, how do you convince some of those companies that you're talking about or the politicians or people in general to make those changes?

ML: Well, I doubt if they're just going to listen to me, but I think what the report does is highlight the fact that it's beyond doubt that anthropogenic climate change is happening; we're causing it. So, humans are causing it whether we like it or not, and you can't really argue with the facts. And you'll always get people with differing opinions. And we obviously respect that, but the differing opinions and the people that push back to the evidence of this climate change, they're fast becoming a minority.

So I think as people learn more about it, and it's information which is absolutely key, I think it's become a lot less polarising. And I think the better question here is, how should governments be addressing it, and possibly, who and how are we going to pay for the cost of addressing it? Because the responsibility does not just lie in the hands of governments to stimulate the investment and reduce the cost base of this alternative source of energy and method of transportation. It also lies with the consumer to make the change and have faith in the new technology. And if I just look at the progress we've made in the last three or four years, I think we're on the right path, and we're definitely getting there.