Have we reached a sustainability tipping point?
The push to net zero carbon emissions by 2050 has taken on increasingly political dimensions over recent years, so how is this affecting opportunities and investment decisions on the ground?
We may have seen 196 parties at COP21 sign up to the legally binding Paris Agreement in 2015 to pursue efforts to limit temperature rises to 1.5 degrees above pre-industrial levels, but nearly a decade later, we are seeing pushback on taking actions that would deliver this commitment from several directions, including sections of the US Republican party.
With US elections taking place this year, there may be some disquiet among LPs that have made their own net zero commitments and are investing private markets fund managers to help them get there. “Some LPs are concerned about the consequences of a change in administration in the US,” says Heather McGeory, Head of Sustainability at Fifth Wall. “We have looked very closely at this.”
While, she says, it would be very difficult to pull back on the entire Inflation Reduction Act (IRA) and the Bipartisan Infrastructure Law, both of which include incentives for developing and implementing low carbon technologies, a new administration could frustrate action here. “The IRA provides for grants and loans for energy transition technologies and companies and for climate justice,” says McGeory. “A new administration could put people in place who just decide not to give out loans and grants and not to re-up on tax credits when it’s time to renew. It could also put someone in charge of facilities and infrastructure who would not build any new power transmission lines.”
These are genuine risks, in particular as many US-based businesses targeting energy transition and climate-related opportunities may well have built grants, loans and tax credits into their business plans, and a failure to upgrade the grid would stifle efforts to electrify the economy.
From macro to micro
Yet away from policies, the decarbonization story may be taking a different turn. “We are seeing a lot of sponsors launching decarbonization funds,” says Paul Barker, Partner at Kirkland & Ellis. “This includes strategies pursuing value creation by transitioning assets from gray to green – it’s a compelling investment strategy and it’s what many LPs are looking for.”
Other, more nascent strategies are also attracting attention. “Natural capital is a rapidly evolving asset class,” says Barker. “We are seeing a number of funds being established to target opportunities that could have a tremendous impact on climate mitigation. It also offers LPs making climate investments greater diversification – they don’t just have to target energy transition and renewables.”
And for those already investing in decarbonization, it seems there has been a shift over recent times. “In climate tech 1.0, demand was the fundamental constraint,” says Sameer Reddy, Managing Partner at Energy Impact Partners. “In this new wave of climate tech, we are seeing end markets that are essentially unconstrained by demand.” He points to figures from the International Energy Agency, which estimates that the world has to add or replace nearly 50 million miles of transmission lines to electrify economies. “In every end market, from electric vehicles to grid modernization to energy storage, we are seeing incredible demand drivers.”
He adds that, while interest rates may temper this a little, the next generation of climate technology companies will not win or lose because of demand. “This wasn’t the case historically,” says Reddy. “But today, companies are in control of their own destiny – execution will determine who succeeds, and that’s a powerful place to be.”
Peter Grubstein, Founder and Managing Partner of NGEN agrees, saying that talent is flowing to sectors driving sustainability. “I’ve seen every swing in the environmental world,” he says. “And I’ve been in this world a long time. In the nearly 50 investments I’ve made, problems come from bad management, not from bad technology. For the first time, I’m seeing great CEOs, heads of marketing and so on move from the consumer sector or biotech into our sectors to push forward sustainability. My sense is that these companies will be really successful.”
In the nearly 50 investments I’ve made, problems come from bad management, not from bad technology
A sense of inevitability?
There are also signs of change further up the private markets food chain, as LPs are becoming more systematic in their approach to generating sustainable outcomes from their portfolios. “I have noticed that we are now starting to receive requests from LPs in our proptech fund for data on our emissions,” says McGeory. “This means that they are tracking their scope 3 emissions, whether they or not they are saying that publicly. That is a change from just a year ago and it signals that there is an inevitability about this.” She adds that she has also seen behavioral change in her immediate circle. “I see people who are not motivated by climate making purchasing decisions, such as electric vehicles or installing solar panels, because they see that this is the way the world is going,” she says.
The fact that social justice is increasingly considered alongside energy transition and decarbonization should tip the balance further towards a more sustainable future, too. “We have to decarbonize the grid as quickly as possible while also meeting the step-changes in electricity growth we're seeing,” says Reddy. “This is especially true as we layer on exponential trends like generative AI, which are creating demand that we haven’t seen in over 100 years. That said, to be successful, we have to develop cleaner solutions that are not only reliable but are also affordable so we can take people along with us. If we were to encounter resistance, we couldn’t get to net zero as quickly as possible.”
The agreement reached at the end of 2023 at COP28 to “transition away” from fossil fuels may not have satisfied everyone, but it does signal a direction of travel, including a tripling of renewable energy capacity globally by 2030. This should help investors navigate some of the uncertainties – including political shifts - associated with sustainable strategies and unlock further capital. “If we look at the scale of what’s needed to reach net zero by 2050, it is estimated we need to be investing somewhere between $6trn and $10trn a year,” says Reddy. “We are massively undercapitalized across the private markets spectrum of infrastructure, growth capital, private equity and venture capital. Investing in this comes with a lot of complexity but also a lot of opportunity. This is a super-cycle that will be much bigger than the cloud or the internet.” And where there is opportunity in private markets, history suggests that capital will follow it, regardless of potential political shifts.
If we look at the scale of what’s needed to reach net zero by 2050, it is estimated we need to be investing somewhere between $6trn and $10trn a year
