Investment needs and risks for net zero

The initial brief was to model the capital investment required worldwide to achieve the Paris climate goal. As we assessed the existing literature on the physical and transition costs of climate change, and the different existing modelling frameworks, it became clear that while numerous studies existed, none had yet taken a systematic approach from the macroeconomic perspective towards global investment needs. The International Energy Agency, for example, tells us the amount of investment in different energy systems required to get to net zero, but this is calculated from the bottom up rather than the top down, and covers only one part of the total picture.

Fathom’s approach differs by employing robust macroeconomic methodology. To answer the question we used a modified Cobb-Douglas approach, in which ‘clean’ and ‘dirty’ capital were identified – that is, assets that were already consistent with the transition, and assets that would need to be replaced for net zero to be accomplished – and simulated economic growth and changes in the capital stock, and its composition, in a business-as-usual and net-zero scenario.

As a result of our preliminary work the client decided to expand the brief in two ways, with an eye to increasing the practical value of the final report to its own investment clients. The first change was to include modelling the risks associated with the transition on a sector-by-sector basis — a new approach which adds clarity and perspective. The second was to map where investment was most needed, both geographically and on a sector-by-sector basis, which again we believe had not been attempted before and is of clear practical use to investors.

In collecting and cleaning the data for modelling, we drew on pre-existing Fathom research and expertise in creating our proprietary, sector-specific transition pathways. We identified investment needs and stranded asset risks by comparing sector-specific depreciation rates to decarbonisation pathways.

It is interesting to note that where other attempts have been made to form an overall estimate, in several instances the numbers aren’t a million miles away from the Fathom/BNY Mellon Investment Management study’s eventual finding of $100 trillion: for example, Mark Carney, the head of the GFANZ group, reached the same figure. This adds confidence, although we believe that our findings are the most robustly based of any international study to date.

Our study concluded that meeting the Paris climate goals could result in the largest redeployment of capital in history, with huge implications for a range of stakeholders, not least investors. Our study breaks down the investment needs and risks associated with the transition, helping investors manage risks and take advantage of the opportunities created by this process.

Impact

The project helped our client and their clients form a thorough understanding of the issues and investment implications related to net zero.

The client uses the results in its own analysis, and has shared them with its internal stakeholders, including senior investment executives of the various BNYM group investment companies. The report’s findings now inform investment strategy among these groups. They also inform the work being done by the client’s responsible strategy team.

The client also dispatched the report to the group’s institutional client base, giving its customers a deeper understanding of the issues, most notably investment opportunities and transition risks.

The widespread and positive coverage of the report in the media alerted the wider public to BNY Mellon Investment Management’s leadership in the economics of climate change and climate investing.