Beyond COP26: the key challenges and opportunities of transitioning to net zero

Early in 2021, the UN Secretary-General challenged countries to commit to ‘clear and credible’ net-zero targets. World leaders met in Glasgow in November 2021 to announce their countries’ commitments and explore what more can be achieved collectively to meet the Paris Agreement targets. Building on existing momentum, COP26 saw a stream of new net zero pledges, bringing the total count to 74 targets by the summit’s close. 

As the dust settles on COP26, we explain the key concepts and take stock of the key challenges and opportunities that lie ahead in transitioning to net zero for government, business and the wider community.

Net Zero

There is growing global consciousness around the importance of net zero, reflected in the proliferation of net zero commitments made by businesses, organisations, and nation States – including, recently, Australia.  

What does ‘net zero’ mean?

Conceptually, ‘net zero’ describes an overall balance between greenhouse gas (GHG) emissions produced and GHG emissions taken out of the atmosphere over a particular period (e.g. a given year). What this means in practical terms is that some emissions can still be produced in a net zero world, so long as they are offset by processes that remove GHGs from the atmosphere.  

Despite the apparent simplicity of this ‘balancing’ exercise, there is no universally applicable, legally binding definition of ‘net zero’.[1] As a consequence, net zero targets can and do vary significantly in their relative ambition. This is reflected in practice by limitations referable to, for example, the:

• types of GHGs covered: a net zero commitment can be framed by reference to carbon dioxide (CO₂) alone (sometimes called ‘net zero carbon’), or by reference to all GHGs;
  
  
• sources of GHGs covered: a commitment can be limited to certain ‘scopes’ of emissions, reflecting the characterisation of direct and indirect emissions as scopes 1, 2 and 3 in the Greenhouse Gas Protocol;  
  
  
• context: the commitment might apply to a particular business or a part of a business, an industry or group of industries, a portfolio of business investments, or economy wide; and/or
  
  
• jurisdiction: a commitment might operate at a local, regional, national or supranational scale.  

Such variations in scope are partly driven by necessity (reflecting the limits of control) and in some cases convenience or expediency.  

Net zero and the Paris Agreement

Net zero is conceptually recognised in Article 4 of the Paris Agreement. The latest IPCC report on the physical science warned that ‘reaching at least net zero CO2 emissions, and strong reductions in other GHG emissions’ is required to limit human-induced global warming to a specific level.  In other words, net zero is a critical milestone for achieving the long term temperature goal of the Paris Agreement to hold the global average temperature increase to well below 2 degrees Celsius  above pre-industrial levels, and pursue efforts to limit it to 1.5 degrees Celsius (as enshrined in Arts 4(1) and 2(1)(a) of the Paris Agreement).

Limitations of net zero

As alluded to, the ambition inherent in a net zero commitment can vary significantly, and the same can be said for how a net zero target is achieved (in particular, the extent to which emissions are reduced versus offset in order to achieve the balance required by net zero). A report prepared by CDP on behalf of the Science Based Targets Initiative explains that emissions reductions are paramount, and that in a net zero context offsets should be reserved for residual emissions only. What constitutes an acceptable ‘residual emission’, however, is unclear.   

A net zero commitment also has structural limitations. For example, net zero commitments are typically expressed in terms of a state of affairs to be reached at some future point, such as ‘net zero by 2050’. Such a commitment, by itself, says nothing about the volume of GHGs emitted before getting to that point. As a consequence, ‘transition pathways can be diverse and inconsistent’, as the Chancery Lane Project has noted.

To illustrate, a particular business might achieve ‘net zero’ in 2035 by a radical change (e.g. replacing a carbon intensive facility with a clean facility) notwithstanding that it makes no effort to reduce emissions before that change. The quantum of unabated emissions prior to 2035 may well be higher than if the same business had taken immediate and ongoing action through smaller scale projects to improve efficiency and incrementally reduce emissions, even if it takes longer to achieve net zero.  

Given that the cumulative volume of emissions on the journey to net zero is just as important as the ultimate goal, there are increasing expectations and demands for a ‘Paris aligned’ net zero ambition to be coupled with interim targets. Such an approach would encourage immediate action and ensure that the global carbon budget correlating to the long term temperature goal is not exceeded during the transition to net zero. 

It is also relevant to consider what will happen ‘post net zero’. The latest IPCC report warns that there will be a substantial lag between peak emissions and peak warming, indicating that it may be necessary to move beyond net zero (to become ‘net negative’) in order to stabilise the global surface temperature in the long term.

Relevance of net zero to Australian businesses

Whether a business chooses to sprint, walk or be dragged to net zero, ‘net zero’ is becoming an increasingly mainstream concept that is likely to continue to evolve and be relevant to Australian businesses. Its commonality, however, should not disguise its complexity.  

For example, any business that chooses to make a net zero commitment will need to carefully consider how that commitment is defined, how it can be measured, verified, and achieved, and how progress will be reported.  

In addition, business will increasingly be aware that any delay (or perception of delay) in pursuing a transition to net zero may result in pressure from supply chains, investors, employees or regulators.   

On the other hand, businesses should be wary of overstating their net zero ambitions and efforts. Experts warn that such statements could constitute misleading or deceptive conduct. For further information, we previously wrote about the litigation risks associated with ‘greenwashing’.

Carbon accounting and reporting

What is carbon accounting?

‘Carbon accounting’ describes a range of methods used to calculate how much carbon (that is, GHGs) is emitted as a result of a company or country’s activities.

Carbon accounting methods are generally divided into two categories:

• physical carbon accounting; and
  
  
• financial carbon accounting.

Physical carbon accounting

Physical carbon accounting aims to measure both the direct and indirect emissions of a company’s or country’s activities – in other words, a GHG inventory.

Emissions are classified in three scopes under the Greenhouse Gas Protocol: 

• Scope 1: direct emissions related to a facility, such as methane emissions from a landfill;
  
  
• Scope 2: indirect emissions caused by the consumption of energy, such as the use of electricity produced by the burning of fossil fuels elsewhere;
  
  
• Scope 3: indirect upstream and downstream emissions that are a consequence of an organisation’s activities, but occur from sources not owned or controlled by the organisation (e.g. the emissions generated by business travel on commercial flights).

The classification of emissions is ultimately an accounting and reporting tool, and there is overlap between each. For example, the Scope 3 emissions of a coal mine can also be the Scope 1 emissions of a power station that burns the coal, and the Scope 2 emissions of a factory that sources electricity generated by the power station.

Enacted in 2007, Australia’s National Greenhouse and Energy Reporting (NGER) scheme regulates corporate reporting of Scope 1 and Scope 2 emissions and energy information. The NGER applies to facilities and corporate groups that meet certain emissions or energy thresholds:

• Corporate group threshold: emission of 50,000 tonnes CO₂ equivalent or more of GHG, production of 200TJ or more of energy, or consumption of 200TJ or more of energy per financial year.
  
  
• Facility threshold: emission of 25,000 tonnes CO₂ equivalent or more of GHG, production of 100TJ or more of energy, or consumption of 100TJ or more of energy per financial year.

Entities covered by the scheme must report their Scope 1 and 2 emissions and energy production and consumption to the Clean Energy Regulator. This information is, in turn, used to determine whether large emitters are required to offset any Scope 1 emissions that exceed the prescribed base line (the ‘safeguard threshold’) by surrendering Australian Carbon Credit Units (the safeguard mechanism under the Emissions Reduction Fund).

For more information, read about the evolving regulatory landscape on Scope 3 emissions.

Financial carbon accounting or ‘carbon pricing’

Financial carbon accounting (or ‘carbon pricing’) aims to give the carbon produced and absorbed a financial market value. 

The two most common forms of carbon pricing are emissions trading schemes (for example, the EU ETS or China ETS); and a carbon tax, as in Norway. 

There are currently 64 independent carbon pricing schemes around the world. These schemes differ in structure and operation and in prices paid for carbon. As at 17 November 2021, the price for carbon under the EU ETS sits around €67, compared to £60 under the UK ETS.  

For more information, read about the rationale behind pricing carbon and different carbon pricing models.

A global carbon pricing mechanism

A key focus of negotiations at COP26 was to reach agreement on the rules for an international carbon pricing mechanism to simplify and harmonise carbon accounting practices across jurisdictions. Such a mechanism is infinitely preferable to the existing patchwork of independent pricing mechanisms because of its capacity to provide greater certainty to business, to mitigate ‘carbon leakage’ and to unlock private-investment in emissions-reduction technologies.  

After five years of intensive negotiations, states parties to the UNFCC finally reached agreement at COP26 on the future structure of an international carbon market under Article 6 of the Paris Agreement. 

Double counting and corresponding adjustments

Under Article 6 of the Paris Agreement, countries can use emissions trading to help reach their nationally determined contributions (NDCs), meeting their 2030 emissions reduction obligations under the Agreement.

The new rules for the international carbon pricing mechanism agreed at COP26 provide that voluntary emissions reductions may only be used towards a country's NDC if they are authorised by the UN, and the host country must apply a corresponding adjustment for any units sold abroad. 

This addresses the risks of double-counting, in which more one than country claims the same emissions reductions as counting toward their climate commitments. For example, an emissions reduction project could be applied simultaneously by both a host country (seller) and a (buyer) country to show progress towards their respective NDCs.

Incorporation of Kyoto’s Clean Development Mechanism

The new carbon pricing mechanism effectively replaces the Clean Development Mechanism (CDM) of the Kyoto Protocol. The new rules, however, allow for countries to carry-over old carbon credits generated under the CDM to help meet their NDC commitments under the Paris Agreement. 

The use of carry-over credits is, however, subject to two constraints. States can only: 

• use CDM credits produced between 2013 and 2020; and
  
  
• apply them towards their first NDCs in the period to 2030.

Adaptation funding

The new rules also provide for a fixed tariff on emissions trading that aims to generate funding for climate adaptation in developing countries. Negotiators agreed this will be set at 5% of all emissions reductions created under the carbon pricing mechanism, levied at the point of issuance.

Mobilising private finance through standardised reporting on climate risks and impacts

Climate change adaptation and mitigation efforts cannot be realised with public funding alone; they will require billions in private capital investment each year. For this reason, the implementation of the climate goals set out in the Paris Agreement calls for a new-generation partnership between public and private sectors (Articles 6(4) and (8)).

There are, however, several challenges involved in ensuring that the private sector lives up to the task. Critical amongst those is the need for the performance of companies, banks, lenders, insurers and investors against climate targets to be disclosed in a transparent, accurate and comparable way.  

To this end, the International Financial Reporting Standards Foundation announced at COP26 the creation of a new international body – the International Sustainability Standards Board (ISSB) – to develop uniform global sustainability reporting standards for the financial markets.  

The anticipated sustainability reporting standards are set to replace the web of independent voluntary frameworks and standards presently available to entities wishing to report their climate-related performance and risks. The standards will introduce baseline requirements for disclosure of companies’ impacts on sustainability and climate matters that are relevant to assessing enterprise value and making investment decisions.  

It is expected that the new standards will make it easier for companies to measure their performance against sustainability and climate criteria and allow investors and stakeholders to choose where to invest, compare companies against their competitors, and hold businesses to account. In this way, the new standards are said to have the potential to tackle ‘greenwashing’ of non-environmentally friendly practices – a practice used by more and more companies to boost their environmental credentials – and to enable private finance decisions to be made in a way that contributes to the net zero transition.

A ‘just transition’

The concept of a ‘just transition’ recognises the fact that the costs of achieving net zero are not equitably distributed, nor the benefits universally accessible.

For example, the transition to net zero promises to be a powerful driver of economic growth. 

• It is estimated that shifting to a green economy could yield a direct economic gain of US$26 trillion through 2030 compared with business-as-usual. Doubling global renewable energy capacity by 2030 could save the global economy between US$1.2 and US$4.2 trillion each year, largely due to a massive reduction in costs from pollution.
  
  
• According to the 2018 International Labour Organisation (ILO) Outlook, the embrace and expansion of clean energy generation, electric vehicle manufacturing and construction of energy-efficient buildings could create 24 million jobs by 2030.
  
  
• In Australia, the green transition promises an increase of $890 billion to GDP and over 195,000 additional jobs by 2070.

At the same time, the concomitant shift away from high emitting industries presents significant challenges for impacted workers and communities. The ILO estimates that globally six million jobs in coal-powered electricity, petroleum extraction and other high emitting sectors could disappear by 2030. For many, transitioning to ‘green jobs’ will require re-skilling and even relocation. If not supported in making this transition, many workers and communities risk being left stranded.

Another significant imbalance arises from the vast variation in countries’ capacity to embrace and capitalise on a low-carbon future – and to support their communities to adapt to the effects of climate change. In many cases, those countries that face the greatest climate impacts lack the very resources needed to finance the green transition and to support their communities to prepare for and cope with such impacts.

Calls for a ‘just transition’ speak to the need to equitably manage the positive and negative implications of climate action across the whole economy and global community. The concept of a ‘just transition’ is founded on the principle that climate action should not be, and need not be, pursued at the expense of decent work, social inclusion and poverty eradication. Indeed, if intelligently designed and equitably financed, green policy and investment has the potential to advance social and economic goals, while securing better climate outcomes for all.

The imperative of a ‘just transition’ was acknowledged by governments in concluding the Paris Agreement. The preamble underlined the need for governments to take into account:

“… the imperatives of a just transition of the workforce and the creation of decent work and quality jobs in accordance with nationally defined development priorities.”

Key issues in achieving a ‘just transition’

Climate finance

As enshrined in Article 9 of the Paris Agreement, climate finance will be critical to ensuring all communities have the financial capacity to prevent and adapt to climate change. 

In recognition of this fact, developed countries pledged at COP16 to jointly mobilise US$100 billion per year by 2020 to assist less developed countries to tackle climate change and to make the necessary economic transition. At COP21 in Paris, this goal was reiterated and extended to 2025.

This commitment has not, to date, been met. The OECD put the total climate finance provided by developed countries to developing countries at US$79.66 billion in 2019, and has recently said that it does not expect that figure to reach the promised US$100 billion threshold until 2023.

In recognition of this shortfall, a number of countries have recently announced new pledges in addition to reaffirming the existing commitment. The European Union, for example, pledged an extra US$5 billion by 2027, while Australia committed to $2 billion by 2025 and the US committed to providing US$11.4 billion in annual financing by 2024.

As important as access to climate finance is, it is equally as important that that finance be mobilised towards both mitigation and adaptation initiatives in equal measure. The need for balanced financing of these two objectives was expressly enshrined in the Paris Agreement (Article 9(1)). To date, however, most climate funding has been put towards mitigation initiatives. In 2019, for example, only US$20 billion went to adaptation projects (less than half of the funds for mitigation projects). The UN estimates that developing countries already need US$70 billion per year to cover adaptation costs, and will need US$140 billion to US$300 billion in 2030. 

Support for regional communities

Rural and regional communities are at the frontline of climate change in Australia. As a recent report of the Climate Council found, these communities are disproportionately affected by the impacts of climate change, with prolonged bushfire seasons and more frequent droughts threatening lives and livelihoods. With a high concentration of fossil fuel based industries in regional areas, these communities also face significant economic disruption in the transition to net zero.

While the Federal Government is yet to release key details of Australia’s pathway to net zero, it has made clear its intention to place “the prosperity and wellbeing of regional Australia at its core”. In particular, the Government has committed to significant investments in rural and regional Australia to support economic growth in these communities. 

If the funding is directed towards the green transition, such funding has the potential to unlock significant economic gains for regional communities. Deloitte modelling of a coordinated net zero transition indicates that on average Australians will be around $50,000 better off per person in the year 2050, with regional Australians around three times better off compared to capital city residents.  

Indigenous participation

Indigenous participation is critical to ensuring a just transition to net zero. Questions of climate justice and the role of indigenous communities in a ‘just transition’ are likely to take centre stage at COP27 in Egypt.

At the most basic level, climate change poses a major threat to Aboriginal and Torres Strait Islander communities. As coastal and island communities confront rising sea levels, and inland areas become hotter and drier, Aboriginal and Torres Strait Islander peoples face the loss and degradation of the lands, waters and natural resources they have relied upon for generations. 

So great are these threats that Torres Strait communities recently launched a landmark climate class action against the Australian Government, arguing that it has a legal responsibility to protect them from climate change. Whatever the outcome in this case, these communities will require significant support in addressing and navigating these impacts into the future, and in accessing new opportunities in the ‘green economy’.

Equally as important is elevating the voices of Aboriginal and Torres Strait Islander peoples in policy discussions on the net zero transition. Historically, indigenous peoples have been excluded from national and international climate talks. 

First Nations leadership and traditional practice will, however, be “integral to tackling the climate crisis”, as Tishiko King, campaign director for SEED Indigenous Youth Climate Network, has emphasised. With so much at stake, and so much to learn from these communities, indigenous peoples must have a seat at the table. 

The decisive decade for climate action

There is no question that this is the decisive decade for climate action. The overwhelming scientific consensus – as manifested in the IPCC’s 2018 report on 1.5 degrees Celsius warming – is that global emissions must be halved by 2030 in order to keep global warming to a maximum of 1.5 degrees Celsius.

The case for robust emissions reductions is no longer simply a matter of prudent risk-management. The impacts of global warming are already apparent, with record-breaking temperatures, rising sea levels, more prolonged and intense heat waves, and more frequent and severe weather events. These impacts are expected to only intensify with further warming.  

Limiting global emissions will require far-reaching transformations across every sector and a rapid scaling up of technological carbon removal and climate finance. Such changes present significant opportunities for business and for economic growth, as well as major challenges. 

What is clear is that ‘net zero’ cannot be achieved in isolation. It will require effective collaboration across public and private sectors and a co-ordinated effort across jurisdictions to curb emissions, maximise economic growth and ensure a just transition.