Deep Dive on Engagement in Hard to Abate Sectors

Expectations are increasing of policy-makers to support decarbonisation of hard to abate sectors. The Energy Transition Commission has published a report ahead of COP 26 outlining six action plans that can deliver a 90% reduction in emissions. Two items of the six-point action plan target the hard to abate sectors – 1) decarbonising the power sector and accelerating the phaseout of coal and 2) accelerating supply decarbonisation in hard to abate sectors.

What are hard to abate sectors?

Hard to abate sectors are the ones where it is much harder to reduce CO2 emissions and the decarbonisation solutions carry a higher cost relative to  the current carbon-intensive technologies that these sectors use.

As per Energy Transition Commission’s 2018 report, heavy industries account for more than 30% of the world’s carbon emissions and will account for more in future as the rest of the sectors decarbonise.

Transitioning of the sectors

Overall, these sectors are currently not on track to meet the net-zero emissions targets. The use of fossil energy and fossil feedstock is deeply embedded in the production processes. For example, the use of coking coal for reducing iron ore in blast furnaces. To ensure decarbonisation, there needs to be a shift away from using these fossil-based energies and feedstock. This transition can be achieved through a range of activities including regulatory and policy changes, technological advancements and other factors, including changes in demand.

Many countries’ national strategies to meet the Paris Agreement on emissions reduction do not address hard to abate sectors. The Energy Transitions Commission goes on to say that these sectors can be abated by 2050 “at a cost to the economy of less than 0.5% of global GDP and with a minor impact on consumer living standards.”

All sectors need to play a part in the transition to a lower-carbon world. Increasingly, businesses want to go down the decarbonisation path. It helps them attract “ESG capital” which has led to preparedness to adopt newer technologies. Some companies within these sectors will become part of the solution and will create enormous opportunities for their investors. It is also important for the companies to transition to remain competitive in future.

Is divestment the answer?

We would argue that divestment out of these sectors is not the answer for the world to transition to low carbon. Divestment does not reduce the level of carbon emitted, there is only transfer of ownership. Sometimes this may be more harmful as the assets may be in the hands of owners who aren’t conscious of carbon risk and therefore reduce the chance of transition.

If not divestment, then what?

Asset owners and managers need to regularly engage with companies to accelerate the pace of change towards a more sustainable future. Engaging with management helps investors get a better idea of the impact and strategy of a company’s climate solutions—and the potential risks. Investors either directly engage or collaborate with other investors to undertake targeted engagements with companies to help them improve their overall approach to climate change and have an opportunity to contribute towards low carbon transition.

Engagement is successful not only when the companies have a willingness to take responsibility but also when engagement is relevant; solutions are actionable and the outcomes quantifiable. Companies will generally respond to constructive engagement in a positive way. For successful engagement investors are required to have deep understanding of the climate challenges, as well as individual companies operations.

Typically engagement with companies on climate change includes:

• Disclosure of data: The first step to assess the management of and progress against climate risks on company operations is to analyse the disclosure data. Investors engage with the companies to encourage them to proactively and clearly disclose emission data. Engagement helps improve the level of disclosures.
• Setting of decarbonising targets: It is crucial for companies to set emission targets and work towards them. These include setting short, medium and long-term decarbonising targets. Set targets encourage companies to have detailed planning to get there and encourages them to invest in R&D to create new technological solutions.  Investors engage with companies to develop pathways for achieving net-zero emissions.

Important issues to engage on in hard to abate sectors

Investors often engage with companies on climate disclosures, carbon targets and reporting. Hard to abate sectors face unique challenges and engagement needs to be at a much deeper level.

• Efficient use of current resources: Engaging with companies on more efficient use of current materials (recycling, reducing and reusing) and energy. Efficiency improvements have the potential to reduce emissions but only to a certain extent. Even then, these can be considered as first steps for companies on the path of net zero emissions.
• Technological advancements in hard to abate sectors: The development and deployment of zero-emission technologies are crucial for decarbonisation in hard to abate sectors. Currently, the industrial application of new technologies is in the earlier stages of development. Companies have traditionally shied away from developing these technologies as it requires investments, and the upfront costs make the companies less profitable in short term. However, the development of new scalable technologies will steadily bring the cost curve down. Investors should encourage companies to deploy the best available current technology as well as invest in developing and commercialising technologies. There are companies providing decarbonisation solutions for clean energy, resource efficiency, transportation and sustainable agriculture, as well as resiliency solutions for water and infrastructure.
• Aligning of capex with the emission reduction strategy: Engaging with the companies to ensure the alignment of capex on projects that are in line with the climate scenarios. As per Climate Action 100+, only six companies (out of 159 global companies) explicitly commit to aligning their future capital expenditures with their long-term emissions reduction target(s), and none of these companies has committed to aligning future capital expenditure with the goal of limiting temperature rise to 1.5 degrees celsius.
• Winding down of carbon-intensive operations: Encourage companies to wind down high carbon projects in a sensible way, rather than selling it to other businesses to reduce their own carbon emission exposure. Also retiring long-lived capital assets and switching to alternative sources incur large costs and therefore companies can be reluctant in switching.
• Just transition planning: There is a real threat of stranded workers and communities in the transition of these sectors. This has resulted in an increased expectation of companies to develop appropriate transition plans and consider impacts on their workers, as well as the communities they operate in. Planning and early action can minimise negative impacts and maximise opportunities.
• Buying Carbon Offsets: While buying carbon offsets may be an acceptable approach ahead of transforming operations, over the long term, only real operational changes can bring about positive climate outcomes. Companies that focus on offsets, rather than reductions, may ultimately create more problems, not solutions.

Engagement with regulators and policymakers

It is hard to see how the challenge of achieving deep emissions reductions in hard to abate sectors can be overcome without a multi-faceted policy response and government support. Asset owners and investment managers have increasingly been in dialogue with policymakers to support companies on transition.

Measuring the success of engagement

Engagements may not always achieve desired results. However, as with any company engagement tracking and measuring engagement outcomes is crucial for reviewing the progress. Engagement is an ongoing process and tracking and measuring engagement outcomes helps plan future engagements.

COP 26 may provide the much-needed support from policy-makers, but it is equally important for the finance industry to continue to engage with the companies on this challenging issue.