The race is on for companies to declare their commitment to achieving net-zero emissions, as outlined in the Paris Agreement. But what does “net zero” really mean – and how can investors assist companies in their net-zero journey?
Marie Rupp Senior Sustainability Analyst, Allianz Global Investors
Once a piece of jargon used only by climate experts, the term “net zero” has entered the mainstream. Governments, companies and investors alike have announced climate-action goals, targeting net zero by a specific date, usually around the middle of this century. This increased mobilisation around net zero is encouraging, but it is useful to examine how the phrase “net zero” is understood and whether all net-zero goals are created equal.
What is net zero?
The term “net zero” derives from a 2013 Intergovernmental Panel on Climate Change report, which discussed the need to eliminate net greenhouse gas (GHG) emissions to stop global warming. This paved the way for the Paris Agreement in 2015. The word “net” relates to the balance between emissions generated by human activities and those removed either naturally or artificially through carbon-capture technologies.
Achieving net zero sounds simple, but the parameters around the underlying calculation are more complex, revealing competing definitions around the factors that are considered. For example, while a net-zero target should cover the full range of an entity’s activities, this is not always the case. Some organisations exclude certain geographic regions from their calculations or even specific parts of their business.
Ensuring that Scope 3 emissions are reflected
Net-zero reporting typically covers three classifications of emissions:
Scope 1: direct emissions from sources that an entity owns or controls.
Scope 2: indirect emissions from the generation of energy purchased by the reporting entity.
Scope 3: indirect emissions produced outside the company’s direct control through its entire value chain – from before goods enter the company’s gates (“upstream”) to during handling, distribution and usage of the final product (“downstream”).
For many sectors, Scope 3 emissions account for a substantial share of total emissions. However, some companies include Scope 3 numbers only partially in the calculations towards their net-zero targets, if at all. Inconsistency in the types of emissions that companies include in their net-zero targets can be confusing for investors. We therefore actively encourage companies to develop and implement policies and practices that target a fully scoped net-zero commitment inclusive of all emissions types.
The mix of greenhouse gas emissions differs widely by sector
Targeting gross emissions and the role of offsets
Another important factor is to determine interim targets for emissions reductions. This is because the journey to net zero is as important as the destination: the trajectory of cumulative carbon emissions during the run-up to net zero will likely define the final warming level. Reducing gross emissions before the target date is therefore vital. In effect, organisations should be making clear “stage payments” towards their net-zero target.
The other key question is what role do “carbon offsets” play on the road to net zero? They can help as an interim approach until mitigating actions to reduce gross emissions take effect; they can also be a solution for residual emissions that cannot be eliminated. However, we recommend that two conditions are attached to their use. First, they should not compromise actions to reduce gross emissions. And second, activities underpinning the claimed offsets should effectively, sustainably and verifiably reduce carbon emissions without undermining other sustainability aspects, such as biodiversity or social priorities. Here again, improved transparency of reporting around the use of offsets would be helpful for investors.
Our distinct engagement approach for climate
At Allianz Global Investors, we are focused on supporting companies in their journey towards net zero. Our approach to “co-investing” in climate transition favours engagement over exclusion or divestment. We work with our investee companies to ensure the data they report aligns with real progression towards net-zero.
Some key factors underpinning our climate-related engagement process include:
Using existing and evolving data sets to assess individual firms’ climate strategies, policies, initiatives and performance relative to peers. This helps us refine our engagement approach relating to specific elements of their transition pathway.
Seeking a robust understanding of how they calculate their targets and examining which of their business practices are covered.
Encouraging firms to align with best practices within their peer groups and ensure governance-related aspects are appropriately integrated into their climate strategies.
Focusing on “just transition” as we seek to ensure that environmental goals do not have detrimental social impacts.
Introducing binding goals, for review and tracking.
Consistency is key
Net zero is a powerful concept, but the reality of achieving it is complex. A robust framework to measure and scope out companies’ climate factors, supported by a rigorous, ongoing engagement process, is critical in directing capital towards achieving shared climate goals.
It is good to see the increased pledges to achieve net zero, and we hope they will be complemented by greater consistency and agreement on how net zero is defined. This, in turn, should help drive further mobilisation towards this critical goal on a global scale.
Read the full version of this paper on our website at: https://www.allianzgi.com/en/insights/outlook-and-commentary/net-zero
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