Analysis

By Colin McLean

 

Already this year, new challenges have hit climate change and sustainability. Rocketing energy costs are forcing politicians around the world to make hard choices, and the European Union’s attempt to address sustainable investment looks like a big step backwards.

What looked settled after COP26 has quickly become confused. This year may be less about the direction of travel than pace of change and fairness in transition.

In any clash of beliefs, logic takes a back seat. Concepts like "sustainable growth" and "just transition" are nuanced and emotive. For many, in a climate emergency, nothing is too fast.

But even now, there is little agreement internationally on how change should happen. What roles should government, business or consumers have in driving change?

Environmentalists once imagined high oil and gas prices as inevitable to reflect the true costs of carbon. But this year has brought an unexpected hike in prices that looks unlikely to end soon and has not come with the alternatives needed. Too much, too fast. It has caught governments off-guard that were making early moves out of coal, oil and gas, and forced some into policy reversals.

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The biggest of these is the European Union’s plan on taxonomy – a plan to rule on what is good and bad in the world of sustainability. Perhaps anticipating that this would disappoint, the proposals came out on the very last day of 2021, with the aim of completing the legislation very quickly.

What emerged is that nuclear power and gas are deemed green. These reflect the various national interests of different major countries, with France and Germany championing the energies they use most. Businesses and investors will need to work with this classification, a retrograde move for many that are already focused on sustainable alternatives as the future.

It highlights that classification is really an issue of government policy – how the tax system and public projects should be directed. It may be a distraction for the corporate world where different incentives are at work.

Certainly, favouring gas and nuclear calls into question Europe’s leadership on sustainability, with implications for its advocacy internationally as well as for the credibility of its businesses and investment firms. The EU taxonomy sits uneasily with separate drives on net zero which will have some contradictory classifications, making it harder to align investment portfolios with the net zero by 2050 target. The proposal looks like giving a green label to activities that many do not consider sustainable. Detractors have already labelled it greenwash.

READ MORE: SNP ministers failed to explore impact of nuclear power station closures on energy bills

Scotland’s investment sector could be hit by this. Irrespective of UK regulation, the classification risks compromising Europe’s status as a global leader in sustainable finance. Even after Brexit, British firms are still seen internationally as reliant on Europe’s financial integrity. We are not helped by EU divisions on sustainability.

The investment industry is already debating how to balance a rules-based classification approach with the engagement that is typically needed to change what businesses do. Re-purposing firms within the global economy will need to come from an evolution of existing activities.

Much of the development of new alternative energy supplies will be driven by the established oil and gas majors and utilities, redirecting existing cashflow into alignment with net zero. Net zero tomorrow will not come from banning all of this today.

More subtly, simply withholding stockmarket investment or bank lending from perceived “bad” sectors may not change what they do. There is little agreement on whether avoiding shares in a “bad” company by itself actually sends much of a signal. Do well capitalised, cash generative companies actually care about who is missing from their shareholder register?

Many legacy ‘bad’ businesses are cash generative and fully capable of accessing the capital they need without stockmarket investors or banks. And others may prefer to move from the stockmarket into private hands, making public accountability even harder.

READ MORE: Windfall tax calls ramp up after BP registers £9.5bn annual profit

Newly added to the complex mix of carbon, politics and business is the question of energy security. Ukraine has suddenly brought a reality check into assumptions about how readily energy can flow between nations. Europe is estimated to depend on Russia for about one-third of its gas supplies. Energy transmission has been drawn into politics and the potential for conflict. At the very least that will bring some caution and delay into setting new energy policy.

In the short term, even Scotland is impacted by this, despite its progress in wind and hydro and plans for more tidal and other offshore generation.

In Scotland there is significant current employment in the oil and gas sectors, which will take time to repurpose. While progress on alternative energy should ultimately ease security concerns, in the short term more storage is needed along with a balance of supply. Even alternative energy needs some traditional carbon-based materials such as steel.

There is also much debate about exactly what role hydrogen might have. Energy alternatives are needed, but the realpolitik is that we must build a bridge to that brighter future.

A divisive taxonomy on nuclear and gas seems to cut across both scientific evidence and the beliefs of citizens on what sustainable means. But the debate also highlights that a focus on classification and company accounting is backward looking, a rear-view mirror – it will be slow to bring change, if indeed it does.

Missing from the proposals is any idea of how to measure impact as distinct from numbers in company reports. Instead of directing investors to engage with companies and direct their voting to make change, it brings a box-ticking approach.

And in all the plans for what the financial and business sectors are meant to do for net zero, the issues of consumer responsibility and fairness in transition have been little considered. Rising energy prices should surely bring a rethink to whatever was planned. Climate change will impact nations around the world unfairly, but decarbonising economies is beginning to show potential for adding to inequalities, too. Despite broad agreement on 2050 aims, a new debate is needed on the road map.

Colin McLean is managing director of SVM Asset Management