October 2023
Linking Climate, Companies and Communities: A Framework for Evaluating the Just Transition
This paper examines the "just transition" concept, which we believe is becoming an increasingly important topic for investors as countries and companies are strengthening efforts to decarbonize, green their economies, and build resilience for the future.
With the impacts of climate change worsening each year, many countries and companies are strengthening efforts to decarbonize, green their economies and build resilience for the future.
Achieving the goal of the Paris Agreement, which is to limit global warming to 1.5 degrees Celsius requires unprecedented change in how we do things. As history has often shown, changes of that scale can seriously disrupt workers and society. The energy transition has the potential to radically transform the global economy, resulting in significant risk and opportunities for the businesses, communities, governments, and individuals operating within it.
As these changes take place, momentum is growing around the concept of a just transition. The International Labour Organization (ILO) defines a “just transition” as “greening the economy in a way that is as fair and inclusive as possible to everyone concerned, creating decent work opportunities and leaving no one behind.”
From an investor standpoint, a just transition seeks to address the interconnected financially material issues of climate change, racial injustice, public health and economic inequity. For example, abruptly shutting down a coal plant might be a great decision from an environmental standpoint, but a company must consider the potential social impact and backlash from workers and the local communities that may be economically dependent on this business.
A company- or country-level climate transition plan that does not address critical social issues will likely pit the social wellbeing of its constituents squarely against their own and the rest of the world’s broader decarbonization goals, hindering progress in both domains. In addition, credible transition plans have the potential to help enhance human capital, grow regenerative enterprise value, improve corporate reputations and reduce systemic risk.
We therefore believe that the just transition is becoming an increasingly important topic for investors. Understanding these issues will take time, as climate transition plans and decarbonization pathways are still in the beginning stages. Throughout this paper we highlight some examples of the just transition, including those companies and partnerships that are progressing well and others that have more work to do.
Development: Now that many companies have established net zero goals, forward-looking companies, governments, as well as key sustainability standard-setters and policymakers, such as the Climate Action 100+ (CA100+) and the Global Reporting Initiative (GRI), are increasingly allocating time to understanding how the transition must occur to ensure it is fair to all key stakeholders. This includes taking job loss and growth into consideration, as well as the security of energy supplies, supply chain impacts, universal access to affordable energy and a fair distribution of transition costs and benefits.
Materiality: The investment industry’s understanding of the financial materiality of the just transition is in its infancy; however, a growing focus on this topic appears inevitable and we would benefit from an improved understanding of the risks and opportunities related to it. The materiality of this question exists on two levels: the country level and the company level.
Next steps:
We need to evaluate both national and corporate transition plans through a just transition framework to evaluate the likely effectiveness of an issuer’s transition plan.
The United Nations Framework Convention on Climate Change (UNFCC) estimates that the energy transition could negatively impact 1.47 billion jobs in sectors critical to climate stability:
Importantly, the just transition presents opportunities as well. Climate action, if conducted properly, has the potential to result in significant economic gains including a direct economic gain of $26 trillion by 2030 compared to business as usual and a net job creation of 24 million green jobs according to the International Labour Organization (ILO).
To better understand the just transition, we should examine the quantitative and the qualitative implications of climate strategies, so that all workers in the new economy are respected and able to contribute to thriving and resilient communities.
Thus far, when evaluating whether a company will be successful in transitioning their business to be climate resilient, we have largely focused on carbon reduction goals. However, considerations of the social dimension of carbon reduction plans are equally important. This aspect starts by asking if companies have a just transition plan in place. The initiative Climate Action 100+ has integrated a just transition indicator into its disclosure framework for the first time in 2022. The GRI, used by many companies across the world as a sustainability reporting standard, has also included a just transition dimension which will require industries like coal to disclose a forward-looking plan to mitigate job losses and income impacts on workers and communities.
Just transition corporate governance and oversight
Since the plans implemented by businesses over the coming years will be pivotal to the world’s decarbonization journey, leadership and governance are also key considerations when analyzing just transition plans. Decision-makers who fail to consider the social dimension of the transition may undermine the achievement of climate action ambitions and could face certain risks like reputational risk. Thus, strong leadership and governance across businesses is an important consideration to appropriately manage risks and leverage opportunities. To drive positive outcomes, corporate boards need to take a proactive role to ensure a just transition is a business priority.
There are various micro and macro examples of climate transition plans that have failed or may fail due to the lack of a just transition plan. Others have succeeded or appeared poised to succeed because they were able to balance social and environmental considerations. These examples span both emerging and developing markets, highlighting that the just transition is a universal challenge to companies in all geographies. A few examples are described below.
Air Products
Air Products, an American chemical company, is developing a large new green hydrogen project in an area in Texas that’s experienced economic decline due to a recent coal plant shutdown. This project has been aided by the new Inflation Reduction Act (IRA) legislation in the US, which includes green incentives, but it’s a good example of finding a community that has an industrial skillset that can be retrained to enable a greener future.
Enel
This company employs approximately 75,000 people worldwide with 36,000 in Italy. Enel faced up to the challenge of the energy transition and the EU’s tightening emissions limits by announcing the Futur-e Program, an initiative to close and repurpose legacy fossil fuel assets. In May 2017, it announced the closure of two large coal power plants by 2018 and a plan to close all its coal and lignite generation plants by 2030. Along with a 2050 carbon neutral target, ENEL announced the reconversion of 23 power stations with significant employment implications. The unions have always taken a very critical view of the “Future-e” plan and have been critical of the lack of information and their scarce involvement in these processes.
As a result, ENEL entered a social dialogue on a just transition framework agreement with its Italian union partners covering retention, redeployment, re-skilling and early retirement. It provides an example of a just transition plan that included provisions for recruitment using apprenticeship to ensure the knowledge transfer from elderly to younger workers. It also encourages mobility and training to optimize internal resources and dedicated training measures to ensure qualification and employability for the development of its new business.
Engie Australia
In November 2016, Engie announced the decision to close the Hazelwood Power station to reduce its carbon emissions. The state government responded by establishing the Latrobe Valley Authority (LVA) which began to engage unions, Engie and other power station owners, local government and community organizations. Four major initiatives evolved for assisting impacted workers and their families:
Ford automotive
Ford announced plans to cut 1300 jobs in the UK over the next two years, and 3800 jobs across Europe, nearly 2800 of which are engineering jobs. Just one day before its European layoff, Ford announced an investment of $3.5 billion in a new electric vehicle (EV) battery plant in Michigan. Without a retraining or relocation program for these workers, Ford risks lowering morale and talent retention across its workforce, especially its skilled employees, in addition to potential strikes by unions in Germany and additional political intervention in its restructuring program. Growing concern for the auto industry’s impact on workers in its shift from ICE to EV could impact the industry’s ability to attract subsidies.
Solar supply chain
Almost half of polysilicon used to make photovoltaic panels for the solar industry is produced in China. Import bans driven in part by human rights concerns could significantly slow down the uptake of solar required for the energy transition. Siemens CEO Roland Busch warned in December 2021 that “If [forced labor] bans are issued, these could mean that we can no longer buy solar cells from China — then the energy transition will come to an end at this point.” Can the concerns around human rights enable the development of an alternate solar supply chain in countries like India?
At the country level, Just Energy Transitions Partnerships (JETPs) are emerging initiatives aimed at bridging the gap between developed and developing nations in moving towards clean energy.
JETPs are financing mechanisms. In a Partnership, wealthier nations fund a coal-dependent developing nation to support the country’s own path to phase-out coal and transition towards clean energy while addressing the social consequences.1 They involve mechanisms intended to help a selection of fossil fuel-dependent emerging economies make a just energy transition within their self-defined pathway with minimal disruption to their economic development.
JETPs are a nascent concept and are still very much in the process of developing as they are being created through ongoing experience rather than from preexisting frameworks. While JETPs are worth monitoring, we do not yet have enough information to meaningfully engage with stakeholders that have a critical role in helping the JETPs be accepted and effectively implemented. It also remains unproven how JETP partnerships translate into national climate policy changes, which is required for sustained climate progress by countries and companies.
Early progress of the JETP in countries like Indonesia highlight how the program could be more material going forward.
Indonesia
At the end of 2022, Indonesia was offered a $20 billion package from an even mix of public and private capital, with partners including the US, UK, Italy, Norway, Japan, Canada, Denmark, France and other developed nations. While no formal investment plan has been published yet, the stated aims of the JETP are to accelerate Indonesia’s coal phase out which would peak its total power sector emissions by 2030 while also establishing a goal to reach net zero emissions in the power sector by 2050, bringing forward the country’s net zero power sector emissions target by ten years. The plan would also accelerate the deployment of renewable energy so that renewable generation comprises at least 34 percent of all power generation by 2030.
While this $20 billion package represents a small piece of the $600 billion required to fully decarbonize the country’s power sector, it is a precursor of the type of support that may be forthcoming from private and public sources.
Ultimately, the scalability of programs like JETPs will be worth monitoring as they will depend on whether emerging countries can create a credible just transition plan. While corporate success or failure in the transition is heavily dependent on national policy, corporate willingness to participate in the transition could determine whether they can stay ahead of the curve.
The investment industry still lacks standardized frameworks for evaluating a company’s or country’s management of the just transition. That said, the following questions would enable us to begin our analysis in this area when engaging with companies:
1 Source: What is Just Energy Transition Partnerships? - Green Network Asia
MFS may incorporate environmental, social, or governance (ESG) factors into its fundamental investment analysis and engagement activities when communicating with issuers. The examples provided above illustrate certain ways that MFS has historically incorporated ESG factors when analyzing or engaging with certain issuers but they are not intended to imply that favorable investment or engagement outcomes are guaranteed in all situations or in any individual situation. Engagements typically consist of a series of communications that are ongoing and often protracted, and may not necessarily result in changes to any issuer’s ESG-related practices. Issuer outcomes are based on many factors and favorable investment or engagement outcomes, including those described above, may be unrelated to MFS analysis or activities. The degree to which MFS incorporates ESG factors into investment analysis and engagement activities will vary by strategy, product, and asset class, and may also vary over time. Consequently, the examples above may not be representative of ESG factors used in the management of any investor’s portfolio. The information included above, as well as individual companies and/or securities mentioned, should not be construed as investment advice, a recommendation to buy or sell or an indication of trading intent on behalf of any MFS product.
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The views expressed are those of the author(s) and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation to purchase any security or as a solicitation or investment advice. No forecasts can be guaranteed.