Net-zero burns down the village to save it

Climate change concerns are now the single largest focus of shareholder proposals. Most aim to achieve the Paris Agreement’s goal of limiting global warming to 1.5 degrees Celsius by compelling companies to cut their greenhouse gas emissions to net-zero by 2050. 

The surge in net-zero emissions shareholder proposals follows new Securities and Exchange Commission guidance allowing shareholders to essentially micromanage companies to achieve social policies. Environmentalists feel increasing urgency to implement the Paris Agreement because the window to achieve its 1.5- degree target is rapidly closing — a new report from the Intergovernmental Panel on Climate Change says the world is on track to break through the 1.5-degree threshold by the early 2030s. Activists are turning to market power in a last-ditch effort to force through dramatic emissions cuts. A sympathetic SEC has now cleared the way for them.

These net-zero proposals are motivated by environmental concerns, not financial ones. They’re usually disconnected from companies’ missions and could require them to sacrifice their customers’ interests in pursuit of a political goal. They ask for radical changes in short time frames without regard to financial discipline. They’re not legally required. These proposals have no clear connection to increasing shareholder value, so shareholders should oppose them.

Activists often appeal to the claim that climate risk is investment risk. But the expected cost of climate change is likely lower than net-zero advocates claim, and the cost of slashing fossil fuel use is most likely higher than they acknowledge. Scientists now agree the world is on track to avoid catastrophic warming. A few years ago, scientists warned of global warming of 4 or 5 degrees Celsius, an alarming prediction because the expected damage of climate change rises exponentially along with warming. But forecasts have since become more optimistic: today, theUN and independent climate trackers agree the world is on track for only 2 to 3 degrees of warming above preindustrial levels.

To assess the cost of this level of warming, look to the IPCC’s own analysis of twenty studies. Their conclusion? Due to climate change, people in 2100 are expected to earn 3 percent less than they otherwise would, although thanks to economic growth they will likely still be far more prosperous than we are today. That means that instead of global GDP increasing 2 percent per year, it would increase 1.95 percent.

Expert consensus on the low cost of climate change is startling, given apocalyptic statements from media and politicians. One recent article examined 11 studies on the effect of 2.5 degrees Celsius of warming and concluded that “a century of climate change is about as bad as losing a year of economic growth.”Forsaking fossil fuels in a quixotic effort to salvage the Paris Agreement’s 1.5-degree target would cost far more.

The fundamental flaw with the Paris Agreement is that it focuses only on the costs of climate change; it doesn’t weigh them against the cost of cutting emissions. As Yale climate economist William Nordhaus said in his 2018 Nobel Prize acceptance, “However attractive a temperature target may be as an aspirational goal, the target approach is questionable because it ignores the costs of attaining the goals. If, for example, attaining the 1.5°C goal would require deep reductions in living standards in poor nations, then the policy would be the equivalent of burning down the village to save it.”

Nordhaus pioneered the study of the economics of climate change. Here’s his model’s answer about the level of warming that balances the costs of climate change with the cost of cutting emissions: “[I]t is essentially infeasible to attain the stringent temperature target of 1.5°C… Another finding, much more controversial, is that the cost-benefit optimum rises to over 3°C in 2100 — much higher than the international policy targets.” In the years since Nordhaus spoke, it has become clear that the world is currently on track for at most 3 degrees of warming, which happens to strike the balance his model recommends. 

One might wonder where the Paris Agreement’s 1.5-degree target comes from. The answer is that a coalition of small island nations concerned by rising sea levels successfully negotiated for it. Net-zero shareholder proposals meant to implement the Paris Agreement using the private sector are motivated by the belief that the broader world should halt all fossil fuel use as soon as possible to mitigate the effects of rising sea levels on these islands.

This is essentially a political compromise based on a contestable moral view, which potentially risks people around the world being harmed if the world immediately abandoned fossil fuels, and those harms would fall hardest on the poorest nations most in need of cheap energy. Nothing in American companies’ missions requires them to impose these sacrifices on themselves or the world. Nothing in law requires it either: U.S. presidents can only bypass Senate ratification to join the Paris Agreement because it doesn’t count as a treaty, since it doesn’t require any substantive actions. President Obama called the Paris Agreement a non-binding commitment to justify his unilateral decision to join it. 

Years later, activist shareholders are demanding companies constrain their operations to comply with that non-binding political commitment. It’s politics, not business. Reordering our economic system to avoid moderate warming would amount to burning down a village to save it from a minor danger.

Chris Nicholson is the head of research at Strive Asset Management. He holds a JD from Yale University and Ph.D. from the University of Michigan.