In its mid-year outlook ‘Back to a volatile future’, global asset manager Blackrock warns that the market is looking at long-term volatility. This is partly driven by the energy crisis and higher inflation but, it warns, another driver is that the net zero transition has not yet been priced into the markets.
Market volatility expected to grow
While the Blackrock analysis offers a vision for the future driven by themes of volatility and inflation, it is the bumpy nature of the transition to a net zero future that is of interest here. There are concerns about production constraints and geopolitical fragmentation but it makes clear that investors should start to position themselves for net zero and states that “our work finds that changing societal preferences can give sustainable assets a return advantage.”
The report also warns that “the transition to reach net zero carbon emissions by 2050 is likely to create a sectoral shakeout similar to the pandemic. The transition is essentially a handoff from carbon-emitting production methods to zero-carbon ones. This handoff can be rough.” The resulting periods of supply shortages and imbalances if the economy still requires carbon-intensive outputs will only contribute further to inflation and volatility.
The market has not yet priced in net zero
In 2020 Blackrock said that markets would, over time, value assets of companies better prepared for the transition more highly relative to others. While today’s policy environment is not yet sufficient to achieve net zero by 2050, that is clearly the direction of travel. According to Climate Action Tracker, as of March 2022, ‘33 countries and the European Union have set such a target, either in law or in a policy document. More than 100 countries have proposed – or are considering – a net zero target.
Blackrock says that the transition is likely to accelerate as technology develops, we see a continuing shift in societal preferences and the human and economic costs of change become ever clearer. At the moment, many industries are concerned about the short terms of transitioning to lower-carbon technologies and processes but if the wind and solar sectors have shown us anything, it is that with the right policy framework and incentives, technology costs will fall rapidly and substantially.
Net zero impact will differ by sector
There will of course be sectoral differences, as there are different exposures by sector. McKinsey published an analysis in early 2022 using the Net Zero 2050 scenario developed by the Network for Greening the Financial System (NGFS). The analysis said that the sectors with the highest degree of exposure are of course those that directly emit significant amounts of greenhouse gases or GHGs (such as oil, gas and power) or that sell products that emit GHGs. These cover roughly 20% of global GDP.
Another area with high exposure are sectors with high-emission supply chains, like construction, which account for a further 10%. While the remaining 70% are estimated to have less exposure, that doesn’t account for developing concerns about biodiversity and nature; nor does it account for the fact that, like an environmental ecosystem, the global economy is interlinked through its interconnected economic and financial systems. The concern about knock-on impacts of transition across markets is a core driver behind central bank action on climate risk.
Credible transition planning increasingly important
While there are obviously going to be increased short-term demands for specific commodities, especially around new climate technologies, the Outlook seems to suggest that one of the things investors should look for is companies that have credible transition plans. That means if your business doesn’t yet have one and you plan on raising money in the next few years, it’s time to take action.