Why and how decarbonization became a megatrend

Rama Variankaval is in his twentieth year working at JPMorgan Chase and at the end of 2020, he transitioned from the bank’s corporate finance advisory arm to lead the bank’s strategy on decarbonization, which refers to reducing or eliminating carbon dioxide emissions from a system or process.

He believes that decarbonization is a megatrend for the global financial markets, much like digitization has been for the last few decades.

“At any point in time, there are certain megatrends that impact more than just a narrow part of the economy,” Variankaval told CNBC in a video interview earlier in August. In his career at JPMorgan, Variankaval’s mission has been to identify and have a viewpoint on what those megatrends are and then to “direct our energies, our efforts, our balance sheets, to align with those megatrends.”

He believes decarbonization is a megatrend because global regulations to reduce greenhouse gas emissions will touch every business in every part of the world.

“It doesn’t matter whether you’re an energy client, or a consumer products client, or a retail client, there is something about this megatrend that is going to impact your business model, your business,” Variankaval told CNBC.

JPMorgan is looking be a big lender in the sector. The bank has said it is aiming to finance more than $2.5 trillion in the coming decade to advance climate and sustainable development goals.

The topic of ESG investing — which stands for environmental, social, and corporate governance and is describes an investing strategy which incorporates non-financial measures of responsibilities — started coming up in 2018 “quite frequently,” Variankaval told CNBC. The focus on ESG was a harbinger of the forthcoming and increasingly intense focus on climate.

Climate change has been an issue for much longer than decarbonization has been a global financial megatrend, but a number of factors coincided to make decarbonization a business imperative.

The Paris Climate Agreement, adopted by 196 parties at the United Nations Climate Change Conference in Paris in 2015, was “a fairly massive catalyst,” Variankaval said.

By 2020, large asset owners, like pension funds and sovereign wealth funds, started to prioritize decarbonization “with higher intensity,” says Variankaval.

As the largest asset owners started to prioritize decarbonization, their influence trickled down and influenced the behavior of other financial gate keepers. Asset managers started asking the companies where they were making investments to start focusing resources and operations on decarbonization. For publicly traded companies, that pressure came in the form of proxy votes on issues relating to decarbonization.

In 2020, JPMorgan formally announced its Center for Carbon Transition, a group responsible for designing and implementing the JPMorgan strategy around climate and sustainability as it pertains to its client-facing businesses, and to also engage with those companies about that strategy “because we felt everyone was thinking about these topics” at the same time, Variankaval told CNBC.

The Biden administration’s landmark climate bill, the Inflation Reduction Act, signed in August 2022, further established the megatrend, accelerating the flow of capital into decarbonization and low-carbon technologies like solar, wind, green hydrogen, sustainable aviation fuel, carbon capture, and other areas.

The IRA lowered the net cost of capital for these decarbonization technology companies by as much as 5% (500 basis points), according to Variankaval, because it made it cheaper for decarbonization companies to put together their capital stack, or financing for deals. Deals that were typically done with a combination of debt and equity got a third source of capital added to the mix: Tax credits and the associated tax equity.

The IRA happened just as the broader economy simultaneously slowed down because the Federal Reserve raised interest rates to combat rising inflation. The higher interest rates in the broader economy counteracted some of the incentives of the IRA, but even against the backdrop of a softening broader economy, the IRA has already turbocharged the sector. By JPMorgan’s count, more than $100 billion of investments have been announced in just the last year with a direct link to the IRA, says Variankaval.

Also, there’s about $50 billion a year going into climate tech companies via private funding and venture capital funding pathways, says Variankaval.

“We see massive amounts of capital formation happening around the climate theme, or around the decarbonization theme, and we absolutely want to be the bank that is a leader in helping our clients navigate that, whether they are small clients or big clients,” Variankaval told CNBC.

While the IRA is specific to the United states, companies and governments are re-evaluating their own industrial policies around the globe to focus more on resiliency than they previously have, says Variankaval.

“We went, I think, a period of 15, 20, 30 years, where efficiency was the number one guiding principle of how you organize yourself,” Variankaval told CNBC. The thinking was: “let’s find the cheapest place to do every part of our supply chain, and stitch it all together,” Variankaval said.

But now, the resiliency of a company’s supply chain is being given as much priority as efficiency. And sustainability is a keystone of resiliency.

In addition to a sharpening global focus on decarbonization, the Covid-19 pandemic brought a particularly strong spotlight on the importance of supply chains, their vulnerability, and the importance of focusing on resiliency in supply chain management.

“All of these are coming together in a way to, I think, be perhaps the largest change in how capital flows that at least I have seen in my lifetime,” Variankaval told CNBC.

In addition to helping its clients adapt to a decarbonizing economy, JPMorgan also sees opportunity in being the bank for the burgeoning and potentially high-growth sector of climate tech companies.

“We absolutely want to be there with them at the ground level, and then have these companies grow with us. We want to be the bank of their choice,” Variankaval said.

Right now, Variankaval says, it’s too soon to know exactly which climate tech companies are going to the winners and losers.

“In a more traditional way of bringing about changes, a lot of research gets done in academic labs and government labs, and then people take it out and test it out in the commercial setting, and figure out what works, what doesn’t work. It’s a multi decade-long process,” Variankaval told CNBC.

It took two decades for the Internet from invention to wide business adoption, but “we don’t have the luxury of time when it comes to climate tech to go through the long-run process,” Variankaval said.

In some segments of climate tech, there are debates about which solutions are better than others that take on a near religious fervor. That’s not particularly helpful in his view.

“We have to deploy capital across all likely solutions, knowing that some may not really work as promised and the use cases may not quite be what we think they could be today. But others might surprises. And some might kick into action sooner, some might just take longer to kick into action. So you need to diversify in terms of technologies, but also in time horizons,” Variankaval told CNBC.

“You can’t really pick winners and losers at this point. We’re just too early. And that is at least how we think about it.”