Zero hour

This year’s UN Climate Change Conference in Egypt was notable mostly for the lack of both progress and enthusiasm in meeting previously agreed emissions goals.

The 27th United Nations Climate Change Conference began with UN Secretary-General António Guterres warning that progress on reducing emissions has been insufficient to save the planet from excessive warming.

“We are on a highway to climate hell with our foot still on the accelerator,” Guterres told delegates at COP27 in the Egyptian seaside resort town of Sharm el-Sheikh. He said any hope of limiting temperature rises to 1.5°C, as agreed at last year’s Glasgow meeting, means achieving net global emissions by 2050. However, that goal is “on life support”.

COP27 agreed to set up a fund to compensate vulnerable countries hit hard by climate disasters and moved a little closer to a global carbon trading scheme — but failed to agree on phasing down or phasing out fossil fuels.

COP stands for Conference of the Parties under the 1992 UN Framework Convention on Climate Change (UNFCCC) — a treaty that binds every country to “avoid dangerous climate change” and reduce greenhouse gas emissions globally in an equitable way. Meetings are usually held two years apart, but COP27 came just a year after its predecessor in Glasgow, which might explain why there seemed to be less interest than usual. The conference was attended by Australian Minister for Climate Change and Energy Chris Bowen.

Certainly, for Beyond Zero chair Geoff Summerhayes GAICD, a senior adviser at climate change consultancy Pollination and a director of Zurich Insurance Australia, it wasn’t a memorable climate summit, unlike the 2015 Paris conference when a 1.5°C–2°C global warming target was agreed, or the Glasgow meeting where the weight of responsibility for combating climate change shifted from governments to the corporate sector. “Egypt will not be remembered as a landmark COP,” he said. “There are a lot of tougher mechanical issues that need to be worked through.”

COP participants had previously agreed to strengthen their emissions targets at subsequent COP meetings, in what is known as the “ratchet”. However, there was no such reduction at the Egypt meeting and some countries tried to renege on the 1.5°C goal and abolish the ratchet mechanism altogether.

There had also been hopes that COP27 would agree on phasing out burning of coal, gas and oil, but instead the conference stuck with the Glasgow resolution to phase down the use of coal. The final text also contained a provision to boost “low-emissions energy” — which critics said could be interpreted to include gas, which has lower emissions than coal.

“We have to face up to the fact that the world is going through an energy transition and we can’t all go to zero emissions immediately,” because some of the required technological advances aren’t immediately available, said Penny Bingham-Hall FAICD, a director of Fortescue Metals Group and Dexus, and chair of Vocus. “As a director, you have an obligation to understand what the pathway might be.”

She noted there is also a debate for directors about what net zero means, which doesn’t necessarily mean what Bingham-Hall calls “real zero”, which is where fossil fuels have been eliminated.

Several nations — including Canada, Britain and the US — signed an agreement that called for an end to all new direct public support for the international fossil fuel sector by the end of the year. Australia failed to do so.

“While the minister’s [Bowen] acknowledgement of the terrible costs of climate change and his commitment to keeping 1.5°C alive are welcome, these are just words,” said Climate Council member Nicki Hutley, who also attended the summit. “In his speech, the minister has sidestepped the critical need to phase out Australia’s fossil fuels and step up its commitment to global climate finance. This is a missed opportunity and leaves several critical gaps in Australia’s climate policy armoury.”

Value for directors

COP conferences have taken on an increasing importance for directors in recent years, said Bingham- Hall. “Five years ago, did I really look at the outcomes of COP? Probably not to the same extent I do now. The whole issue of what net zero needs and how climate is impacting on your business has become much more at the forefront of directors’ minds.”

The meetings are a good chance for directors to get a sense of the global view on climate strategies and how Australia is responding — and whether we are doing enough, she said.

Ming Long AM GAICD — a director of IFM Investors, QBE Insurance, Telstra and CEDA, and chair of AMP and the Diversity Council of Australia — said that while COPs were important, they didn’t have much immediate relevance to the way directors carry out their ongoing duties.

“Am I really looking to get direction from a director perspective about what needs to happen? We haven’t even caught up to previous COPs in terms of implementing some of the directions coming out from COP,” she said of the broader corporate world.

Nonetheless, the meetings do provide a good summary of the latest science around climate change, and its impacts in different parts of the world — including where companies are located.

“Unfortunately, if I try to reconcile [progress on emissions reduction] to what the science is telling us, we need to be accelerating, because we’ve been so slow off the mark,” says Long.

Taking responsibility

The major achievement of COP27 was agreement that wealthy nations will pay vulnerable countries for the damage and economic loss caused by climate change, based on the argument that industrial nations enriched themselves through the use of fossil fuels and so should assist poorer nations. Despite being hailed as the major achievement of this year’s climate conference, the agreement only begins the process of establishing a fund — and contributions will be only voluntary. The text of the agreement avoids terms such as “liability” and “compensation”.

Nonetheless, Long said an important question for directors will be the principles the fund uses to determine responsibility.

“Those principles can then attach liabilities to companies so that as a director, I need to be considering if our current practices are causing loss and damage to others, for which the company will be responsible in the future,” she added. “It can’t just be the government that fronts up to that [liability]. It will mean that the people within that country will need to grant up to that liability and companies will have to be part of that.”

Summerhayes expects that governments or the World Bank will take on the first risk layer of funding repairs to damage and economic loss, with the private sector coming in as co-investors. “There was a lot of talk about how we unlock sustainable finance,” he said. “What are the commercial opportunities of that? Where will those funds come from? Obviously, investors can make a big difference there, [as can] credit providers and insurance companies.” he said, adding that these investments can’t be judged purely on their commercial success, but also need to take account of their broader social purpose.

Another significant event during COP27 was the promise by the Glasgow Financial Alliance for Net Zero — a global coalition of leading financial institutions committed to accelerating the decarbonisation of the economy — formed at COP26 to assist Indonesia with a US$20b Just Energy Transition Partnership to support its phase-out of coal by 2030. The announcement at the G20 Summit in Bali in November, was a demonstration of the corporate sector taking on some of the responsibility for global emissions reductions, said Summerhayes.

Carbon conundrum

Article 6 of the Paris Agreement provides high-level principles for how countries can “pursue voluntary cooperation” to reach their climate targets — essentially a carbon trading scheme. While its agreement at the 2015 talks in Paris was a major breakthrough, subsequent climate meetings have made slow progress in developing detailed rules on the practical implementation of a trading scheme.

Another breakthrough came at COP26 in Glasgow, when countries agreed on a package of rules to govern and implement international carbon market mechanisms under the UNFCCC. There are two key sections of Article 6 relating to carbon trading. Article 6.2 allows countries to trade emission reductions and removals with one another through bilateral or multilateral agreements. Article 6.4 aims to create a global carbon market.

A draft document of around 60 pages released at the Egypt meeting outlined how inter-country carbon trading might function under Article 6.4, but left many sections up for debate, with decisions to be made at future COP meetings.

Despite the slow progress, Summerhayes said directors should expect a carbon market in the future.

“If you were looking for a lot of clarity coming out of Sharm el-Sheikh, you probably didn’t get it. But you would be wrong to bet against the direction of travel on carbon markets. Nobody is suggesting we shouldn’t decarbonise the global economy. Therefore, nobody is suggesting that it doesn’t imply that carbon has to be measured and therefore have a price on it.”

Sticking points include an agreed taxonomy of carbon credits and rules to stop double counting needed to establish a credible market.

“One of the shortcomings of emissions trading is that everyone has their own idea what an emission is and how you measure it,” said Jillian Broadbent AC, a Macquarie Group director, who emphasised she was speaking in her own capacity. “You don’t want to be trading some dodgy definition with some sort of high-standard definition. There really has to be some sort of agreed international definition.”

Walking the talk

COP27 has left Australian directors with a lot to consider, including whether their companies will have to pay for climate change damage, changes to global finance and placing a value on natural capital, say experts from Deloitte.

Deloitte Access Economics lead partner Dr Pradeep Philip formed part of the global consulting giant’s delegation to the COP27 meeting, supported by energy, climate and sustainability partner John O’Brien FAICD, and director of climate governance Rebekah Cheney GAICD.

This was the first COP meeting since the change of government, and since last year’s conference in Glasgow, when Australia was widely criticised for its modest emissions reduction targets. With more aggressive climate targets adopted by the Albanese government, the reception at this year’s meeting was quite different.

“The COP 26 in Glasgow last year was all a bit awkward, to be honest,” says O’Brien. “No-one quite knew what to do with Australia. This year it was ‘welcome back’, and while Australia is saying the right things on climate, other nations now want to see those words put into action.”

The major achievement of COP27 was the agreement on a new loss and damage fund to provide financial assistance to nations that are most vulnerable to, and impacted by, the effects of climate change. Governments — including Australia’s — agreed to establish a fund whereby wealthy nations will pay poorer countries hit hard by climate disasters, based on the argument that industrial nations enriched themselves through the use of fossil fuels and so should assist vulnerable developing nations, which contributed less to the problem, but are disproportionately impacted.

While it’s an agreement between governments and for governments to provide the compensation, it will have flow-on effects for directors, says O’Brien. “That needs to be considered as part of a just transition strategy and really start to think through how companies engage on this issue.”

It could ultimately lead to historically high-emitting companies being expected to foot some costs associated with the fund. “Is this going to spur climate litigation against companies and against directors, maybe personally, around the liability for historic emissions?” asks O’Brien.

Cheney regards the loss and damage fund as a major historic event because developed nations have acknowledged their responsibility to address loss and damage for those most vulnerable, in spite of concerns raised about legal liability. “Recognition of the need to provide funding arrangements that respond to climate loss is an important step forward in rebuilding trust between developed and developing nations,” she says.

Cheney also questions who will ultimately pay for the fund — taxpayers may argue that, as company shareholders made the money from their companies emitting actions, they are the ones who should pay. At this stage, only a handful of nations including Germany, Belgium, Austria, Canada and New Zealand have actually made commitments to contribute to the fund. The majority — including Australia — haven’t.

Funding a low-carbon economy

COP27 also focused on financing a just transition to a low- carbon economy — and on how the world will mobilise finance on a much larger scale. The final text stated that up until 2030, the world would need to spend US$4 trillion a year on renewable energy and another US$6 trillion on transforming economies. It raises the issue of how Australia and other nations will start restructuring the finance system and transforming their economies, says O’Brien.

Philip notes there will be a transformative change to the financial system as governments and companies confront the challenge, and he urges companies to take part in the discussions. “Through government mechanisms, through the private market, there is a chance for business to shape some of this,” he says. “It is better to be at the table than to be a passive recipient of what global changes take place.”

He adds that funding instruments will become more sophisticated and start to reflect more ESG objectives. Global funds will be allocated — not just on the narrow return on investment metric that’s been used for the past 50 or 60 years, but will also start to incorporate social outcomes. It will drive a major change in where global capital is allocated and the sort of activities it funds. The pace of change is accelerating and boards need to stay abreast of the trends.

The transformation goes to the fundamental production systems of the economy and will involve recalibrating and modernising our business operations and the capital stock of the economy. It will provide a major investment boost, unlock a lot of productivity and stimulate innovation, says Philip.

Potential benefits

Analysis by Deloitte finds that embracing coordinated and meaningful action on climate change will provide an $890b benefit to the economy over the next 50 years Not doing so could see the economy suffer a $3.4 trillion detriment. Investing in new “green economy” skills is central, and doing so will drive the transition and the resulting dividends.

“We spent some time with global auto companies,” says Philip. “They are right on this issue. They’re recognising that skills for their workforce [will] transform their production systems. It’s not just capital, but the skills of their workforce. We’re seeing the emergence of a green collar workforce — a workforce where the demand from climate change creates jobs, where the transformation of their skills will create jobs, and where there’ll be completely new skills and jobs that are created that we haven’t even thought of.”

The time for investing in transformation is limited and if everyone moves at the same time and there is a rush to get everything done, there will be a scarcity of resources and it will become more expensive, says Philip. An orderly transition involves directors planning ahead so that their strategies will take account of the limited runway, of what competitors are likely to do, and of what the advantages are for their business in investing early.

Nature to the fore

COP27 also addressed the issue of nature — putting a value on nature — and the role nature-based solutions can play in climate mitigation and adaption. This may lead to the creation of new assets and liabilities on company balance sheets and directors should be open to this becoming a new class of assets.

Alongside this, stakeholders are starting to put pressure on companies to take biodiversity into consideration, says Cheney, noting that there are also revenue opportunities.

“There are assets previously there that will end up on the balance sheet, but in a different form, and not perhaps with the same value,” she says. “And there will be new income streams. For example, you might have land that you’ve been using for other purposes that you can now use to create biodiversity credits.”

Just as Australian companies need to understand the impact of scope 3 emissions — those indirect emissions that occur upstream and downstream in their value chains — they will also need to understand the impact of their value chain on natural capital and biodiversity.

Methane pledge

While the negotiations between governments on the final text at COP meetings attract a lot of attention, O’Brien says a lot of other agreements happen between financiers, industries, companies and individual governments. For instance, the Australian government signed the global methane pledge — agreeing with other nations to reduce global methane emissions by at least 30 per cent from 2020 levels by 2030.

The agreement will sharpen a focus on fugitive emissions from coal and gas operations, which the energy sector is already acting on. There is likely to be more impact in agriculture — the source of the majority of Australian methane emissions — with a renewed focus on solutions such as seaweed feed supplements, which can reduce emissions from cattle, as well as soil sequestration.

Supply chains

Another major focus of this year’s COP27 meeting was on global supply chains. Companies with supply chains that span the world should be thinking about the physical damage of climate change and the impact on their supply chains, says O’Brien.

“Companies should already be looking at the vulnerability of those supply chains. This will potentially enable them — or at least the host country — to access funding to build more resilience or maybe repair the damage, or build back better when those supply chains are damaged.”

There is also the issue of how supply chains can be decarbonised and the opportunity to innovate and think differently. Boards should expect management to provide them five-year plans for decarbonising supply chains, which will take them almost to 2030. Supply chains will require different commercial arrangements with different people — and collaboration along the supply chain. This raises the question about what capabilities a CEO will need to lead such a transformation.

“Quite often, those CEOs who were brilliant in the 1990s at banging heads maybe won’t be the best people at collaborating along a value chain,” says O’Brien.

The new dynamic will increase the importance of innovation and entrepreneurship as part of stewardship, says Cheney. Companies looking to the future and how, potentially, their products might need to be redesigned, will have to embed innovation and entrepreneurship in everything they do.

1.5°C climate goal: How the ASX 200 stacked up in 2022

Scope 1 and 2 emissions: Signs of momentum

84 of the 187 companies assessed (45%) have a scope 1 and 2 net zero target.

3/4 of this group (63 companies) have scope 1 and 2 net zero targets in line with 1.5°C.

96% of scope 1 and 2 emissions reported by the ASX 200 companies assessed in this report are covered by net zero targets.

Scope 3 emissions: Action is emerging for the largest source of ASX 200 emissions

16 of the 177 companies (9%) where scope 3 emissions are deemed applicable have set a net zero target for scope 3 emissions in line with a 1.5°C pathway.

31% of the 177 companies fully disclose their scope 3 emissions and 21% report on some, but not all.

28% of the ASX 200 reported scope 3 emissions are covered by a 1.5°C aligned net zero target.

All emissions: Progress to date across scope 1, 2 and (if applicable) scope 3 emissions

23 of the 187 companies (12%) assessed have a net zero emissions target for applicable emissions scopes.

- 2/3 of this group (16 companies) have net zero targets in line with 1.5°C.

56% of ASX 200 reported emissions assessed are covered by net zero targets.

Challenges to be addressed

10 of the 187 companies assessed (5%) have set an interim emissions reduction target covering all applicable scopes, yet ambitious short- and medium-term targets are imperative for all companies to align with a 1.5°C trajectory.

36% Based on current targets and commitments, the ASX 200 will overspend its 1.5°C carbon budget by 741 MtCO2e (36%) for the period 2021–50.

44% of ASX 200 reported total emissions are not covered by any net zero target.

Source: ClimateWorks Centre Net Zero Momentum report (Dec 2022)