Vanessa Stevens & Olivia Sandlant, June 2022

World Environment Day is yet another reminder of the need for the global community to take action to solve a range of environmental issues, including, most crucially, climate change.

That’s why it’s good to see our government increasingly take its responsibilities in this area seriously. Notably, last month saw the release of the first ‘emissions budgets’ which set out the total amount of emissions that the government will allow across the economy over the next decade or so. These act as short-term waypoints ahead of the long-term goal of net-zero by 2050 (excluding methane from farming where the goal is a 24-47% reduction).

These emissions budgets are crucial in setting the number of units available under the emissions trading scheme (or ETS), which remains the backbone of the Government’s climate policy. The ETS results in a price for carbon, hitting emitters where it hurts the most – in the pocket. Since 2020, total units under the ETS are capped and will steadily decline in the years ahead in-line with the emissions budgets.

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Budget week also saw the Government unveil its emissions reduction plan, a range of complementary policies designed to help meet the emissions budgets. These include further subsidies to encourage the uptake of EVs, funding for alternative forms of transport such as cycling, money for research on agricultural emissions reductions and to decarbonise industry.

This has led some to question the validity of such direct interventions given we have an emissions trading scheme in place. The argument is that the Government subsidising EV uptake, for instance, will lower emissions in the transport sector but could, as the ETS has a set number of units available in any given year, result in an increase in emissions in another sector (say manufacturing) than would have otherwise occurred. This is commonly referred to as the waterbed effect – pushing down on one side of the waterbed causes the other side to rise as the amount of water in the bed stays the same.

So, should we throw our arms up in the air and rely solely on the ETS? There are a few good reasons why a suite of tools is important:

  • Government polices to lower emissions can result in the ETS cap being lowered faster while minimising the shock a more aggressive reduction could cause. In fact, the expected reduction owing to government policies are factored into each climate budget. Water is released from the bed at the same time as it is pushed down on.
  • One feasible option for a company to meet its climate obligations under the ETS is to offset its carbon emissions. We view carbon offsetting as a last resort, with the mass plantings of exotic (pine) trees having a much poorer impact on biodiversity than native plantings while taking productive land away from use. To the extent that government policies can reduce the need for carbon offsetting, they are valuable and have other environmental and economic benefits.
  • The ETS, while important, is a blunt instrument that may result in unequal outcomes across society. Policies that ensure greater equity (e.g., subsiding the high capital cost of home insulation to enable people to benefit from lower heating costs and lower one’s personal carbon footprint) are important.
  • Finally, the risk of stranded assets from climate change is high. A stranded asset is one which loses its value sooner than expected. An example could be internal combustion engine cars purchased at some point in the future. The government subsidising EVs and supporting EV infrastructure now, it can be argued, encourages mass adoption and reduces stranding risk down the track. It also sends a clear signal to the market.

For investors, the key takeaway is that policies to reduce emissions are only going to rise in importance in the years ahead. Additionally, companies are wanting to prove their climate credentials to consumers and investors, and are increasingly factoring in environmental considerations when choosing suppliers. Companies taking their climate obligations seriously are reducing risks appropriately and setting themselves up to succeed in the future.

We believe incorporating environmental factors into investment decisions, along with other social and governance factors, is crucial to future-proof portfolios. This year on World Environment Day, why not take the opportunity to look at your own portfolio and see what you can do play your part.