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by  RBC European Equity team Feb 24, 2020

for thou out of the ground wast taken: know thy birth,
For dust thou art, and shalt to dust return

John Milton - Paradise Lost

Mention Gondwana to someone and they would be forgiven for thinking that it was a character from a popular fantasy novel, or perhaps Netflix's newest sword-swinging offering. But Gondwana was in fact a prehistoric supercontinent, the southerly brother of Laurasia, both formed after the split of Pangaea. Gondwana would eventually form the basis of the continents that we know today: South America and Africa splitting first, before Madagascar broke from India, while Australia and Antarctica remained in alliance for many years more, and remnants of Gondwana squeezed and crushed the Neo-Tethys Ocean basin. All very Game of Thrones.

Modern science has revealed the effect of all of these collisions and splits on the atmosphere of the planet. Almost incomprehensible levels of volcanic activity occurred as tectonic plates crashed and shifted, resulting in CO2 levels 250 million years ago that were nearly five times higher than they are today. These greenhouse gas emissions meant that the climate at the time was extremely hot and humid, and with far less fauna to remove CO2 from the atmosphere, the heating effect was particularly pronounced.

Perhaps even more interesting is recent research suggesting that the same process in reverse (i.e., the formation of mountains) resulted in two major ice ages 50 million and 80 million years ago, both as a consequence of extreme carbon capture events. When ancient volcanic rock was driven from sea beds to form mountains, rain striking the rocks resulted in a chemical reaction, which in turn meant that CO2 from the air became sequestered into mineral deposits within the rock. Incidentally this is why today, although Indonesia only accounts for 2% of the world's land area, this mountainous region accounts for 10% of its long-term CO2 absorption. The point here is that over very long periods of time the world has remained in relative balance through natural action and reaction.

Today however, humans have demonstrably altered the natural balance, resulting in a global warming problem that is a key concern for every government on Earth. In the first of a series of environmental articles, we look at the increasing importance of decarbonisation for all stakeholders. The world's population is now producing more CO2 than all of the volcanic activity on earth, and we “continue to affect climate in ways that are unprecedented and unnatural” as noted by the scientist leading the above-mentioned study on the tectonic shifts millions of years ago.1 Subsequently, decarbonisation is one of the most formidable requirements of our age, an event that has the potential, if realized, to upend industries and civilizations in ways not seen since the industrial revolution. Industries plural, because although it may superficially appear as such, fossil fuel companies are not the only ones threatened.

In 2016 the cement industry emitted 2.2 billion tons of CO2, equivalent to 8% of the global total, while the production and incineration of plastic will have added an estimated 850 million tons of greenhouse gases into the atmosphere in 2019.2 A company such as Nestlé which derives a significant amount of its input costs through plastics (the company used 1.7 million tons in 20183), has been forced to create an entire institute in an attempt to develop new - and less carbon-intensive - forms of packaging.

This is before the impact on countries has been taken into account. In order to meet the targets set out in the Paris Agreement for 2050, the permissible amount of fossil fuels that may be burned is roughly 1200 gigatons. For fossil fuel companies that traditionally keep 10-12 years of reserves, this is a significant figure as it suggests that only 41% of remaining proven fossil fuel reserves would be burnable. For countries such as Venezuela, which has over 100 years of proven reserves, this is almost unfathomable. It requires the rewiring of entire economies, even societies.

The mind-set required to address these issues is substantial, but perhaps opportunistic thinking remains a key weapon in the arsenal of the collective psyche. The trajectory required to decarbonise at the rates set out in the Paris Agreement is relatively clear; what is perhaps less clear is how consumers, corporations and governments are facilitated in reaching those rates. That isn't to say that the innately dynamic nature of mankind can't be mobilized; the 1987 Montreal Protocol, signed in response to the revelations of ozone layer depletion, was a significant event that remains on track to be a success.

For established companies, many of whom have existed for over a century, seismic shifts in business models may be required. Not that this should stop them; it is easy to forget that Royal Dutch Shell actually started as a company trading … sea shells. Today it is investing $1-2bn per year in new energies, with the largest oil majors targeting $5.7bn of renewables investment in 2019, representing 7% of total capex.4 Or that RWE, once a particularly prominent burner of lignite, is soon to become the world's second-largest operator of offshore wind. Incumbents are by no means the only solution in this mosaic of requirements, as there is no single answer to the issue. Technological innovation is imperative. Perhaps for newer entrants, opportunity may be easier to grasp, from renewable energy to hydrogen production and storage, from electric vehicles to vegan food companies.

From an investment point of view this should not be misconstrued as anything except intensely complex and nuanced, where risks and opportunities abound. However, the same opportunities exist for investors as they do for companies, governments and consumers. And perhaps therein lies the key: the recognition that whilst the consequences of avoiding the journey may be dire for all, every participant will be required to move for opportunity as well.

To read ' Decarbonisation part 2: techno-optimism or necessity?', click here.

[1] Plate tectonic controls on atmospheric CO2 levels since the Triassic, Douwe G. Van Der Meer, Richard E. Zeebe, Douwe J. J. van Hinsbergen, Appy Sluijs, Wim Spakman, and Trond H. Torsvik, 2014
[2] Chatham House, 2018
[3] Nestlé
[4] Royal Dutch Shell, 2019

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