- Climate activists hope COP26 will jumpstart a global push to cut emissions.
- But the world is on track to increase emissions 16% by 2030, not cut them 25-45%.
- COP26 could persuade countries to up their commitments, yet has little control over actions.
- Biden has committed the US to halving emissions by 2030, but that requires his climate change legislation to survive largely intact, which looks unlikely.
- If the US cannot lead, many other countries will also refuse to cut emissions much.
- We have recommended clean energy-related ETFs as a medium-term macro trade.
- This is because we believe global warming will make a wholesale shift to decarbonization inevitable. The only question is when.
- Given a less constructive outlook for COP26 and Biden’s climate change agenda, the clean energy sector could experience a selloff. We would view this as an opportunity for patient investors to add to clean energy positions.
There is talking the talk and walking the walk. With climate change, we see plenty of the former and little of the latter. Consider a few examples:
Off Target – In 2015, 191 nations agreed in Paris to limit global warming to well below 2.0°C and preferably 1.5°C. These goals require cutting global carbon dioxide and carbon equivalent greenhouse gas emissions (CEE) by 25% and 45%, respectively, relative to 2010 levels by 2030.
But consider the latest nationally determined contributions (NDC) from each country being compiled in preparation for next month’s UN Climate Change Conference (COP26) in Glasgow. Current commitments imply a 16% increase in emissions by 2030. And that generously assumes countries honour their commitments (Chart 1). That would entail a 2.7°C temperature increase by 2100.
Carbon Pricing Struggles – About 64 countries now have a carbon pricing scheme in place, in the form of either a carbon tax or an emissions trading scheme (ETS). They cover about 22% of global emissions. That is up from 15% in 2019, largely because China introduced an ETS program covering its power sector in 2020.
However, to reach the 2.0°C target, carbon prices now have to be in the USD40-80/metric ton range as of 2020 and rise to over USD50-100 by 2030. Today, carbon prices in that range cover only 3.76% of global emissions. Further, to reach the 1.5°C target, carbon prices may have to reach USD160 by 2030.
Revenue Shortfall – Carbon pricing revenue should make the costs of decarbonization more equitable. For example, it should provide tax rebates for lower-income people and fund research and development into carbon-neutral technology. To reach the 1.5-2.0°C target, global investment of some USD1-1.5tn must happen annually.
But in 2019, carbon pricing schemes generated USD53bn – a mere USD1 per ton of carbon and carbon equivalents.
What COP26 Must Do
If press reports and news releases are any indication, there are high hopes the COP26 meetings will address these issues head on and get global decarbonisation back on track. Given the status of NDCs to date, that will be a tall (if not impossible) order.
Cutting emissions by 25% or 45% by 2030 is the easy-win part. We could accomplish much of this by switching power generation from coal to natural gas and renewables and becoming more energy efficient. The hard part comes after 2030. But the risk is that trying to convince countries to recommit to cutting emissions significantly by 2030 will divert efforts from longer-term issues that also must start being addressed now.
What COP26 Really Must Do!
Carbon Pricing Is a Start –Carbon pricing is an idea ahead of its time. It can send economic signals to encourage people and businesses to choose less carbon-intense products and energy sources.
But today, carbon price schemes are tentative and largely ineffective. In fairness, many countries are experimenting with them to learn how to implement and operate them. Yet many politicians are still reluctant to impose the full cost of decarbonization on society. Even as concern rises about climate change and global warming, no one is ready to pay the price.
That COP26 will push many nations to increase carbon prices to the USD40-80 threshold is unlikely. Even if it does, current carbon pricing tends to favour shorter-term behaviour at the expense of longer-term benefits.
For example, so far, only a few countries have outlined a path for carbon prices between now and 2030, and no country has a carbon pricing plan beyond that. Companies planning longer-term capital investments will take carbon prices into account to the extent they have the information. Otherwise, they may opt today for more carbon-intensive investments.
To be effective, any carbon pricing policy must be sufficiently high and provide a vision for future pricing.
Replacing Capital Equipment –To reduce future emissions, society must start replacing fully depreciated carbon-intensive capital equipment with greener alternatives now.
A good example is automobiles. A new car today may be in operation for 10-20 years. A buyer today has the option of buying an internal combustion (ICE) car or an electric vehicle (EV). If someone opts to buy an ICE car, it may be 2035-2040 before an opportunity to replace it with an EV arises.
Today, EVs are not particularly green if the electricity to power them comes from fossil fuels. But as utilities switch to renewables over the next decade, that will change.
The ICE vehicle is a known-known. The EV faces various issues, at least in the US. They are expensive. There are few charging stations available, and little effort is being made to build more. Utilities are doing little or nothing to enhance the electric grid to handle incremental electrical demand, raising the risk you might be unable to recharge an EV during an extended power outage.
A similar problem arises with heavy-duty trucks, industrial equipment and buildings. All have long lives. If purchasers are not making energy- and carbon-efficient choices today, it will be decades before they replace them unless they retire them early. The difference between EVs and many other capital goods is that at least with autos, a choice currently exists. It does not for many capital goods.
Carbon pricing schemes – at least as they are conceived today – will not address these longer-term issues. They will not encourage utilities to build more robust electric grids to deliver electricity and meet increased demand. They will not make heavy-duty trucks that run on hydrogen cells or electricity available soon. And were they imposed on carbon-intensive industrial equipment or steel and cement, where few (if any) substitutes are available, they could push production prices to politically unacceptable levels.
Such developments will require significant investment, research and development, visionary government policy, and public/private partnerships and cooperation, starting now. True, investment is happening. Bloomberg News estimates climate-related investment now totals about $500 billion annually and ranges from purchasing EVs to installing solar panels and wind farms, and to basic research into less carbon-intense industrial processes. But as noted, that is under half what is needed.
Ideally COP26 must get countries to commit to realistic carbon pricing schemes and more climate-related research and investment. But these priorities probably await future COP gatherings.
COP26 will succeed only to the extent that individual countries commit to action.
Achieving the goals of the 2015 Paris agreement was always going to be a stretch under the best of circumstances. But former US President Donald Trump scuttled any momentum when he unilaterally withdrew.
President Joe Biden has rejoined and expressed strong support for halving emissions by 2030. But he needs money that could come via the $3.5tn social and infrastructure bill now being debated in Congress. Republicans are united in opposing the bill, and Senator Joe Manchin insists a provision to phase out coal-fired power plants be removed. If he is successful, there is little chance of meeting Biden’s emissions goal.
Even if climate-related language is enacted in some form, Republicans could withhold funding if they win control of Congress in the 2022 midterm elections. And they could simply cancel any climate-related programs if they win the presidency in 2024. Democrats must maintain control of the government through 2028 if federal climate change policies are to generate unstoppable momentum.
As the US goes, so may many other countries. If the US cannot phase out coal-fired power plants and Republicans limit climate change policies, it will almost certainly lose moral suasion to convince other countries to curb emissions more aggressively.
Clean Energy Investments May Face a Selloff
COP26 may be able to convince many countries to up their NDCs to curb emissions on paper. But it has little control over what they ultimately do. The true measure of success will be how much countries pull together individually and collectively to address climate change.
Doubtless, that will happen. The question is when. Alternatively, when does the ongoing process of global warming and climate change force more countries to act?
We have recommended several clean energy ETFs as medium-term investments because the transition to clean energy and decarbonization is inevitable. These include battery technology (BATT, LIT), renewable power (FAN, TAN), power grid (GRID, PBW) and hydrogen (HDRO, HJEN).
If Biden’s climate change legislation largely survives and is enacted, substantial new money will soon flow into the sector, almost certainly boosting clean energy equity valuations. If his agenda is largely gutted, the money flow and equity appreciation will be more measured and clean energy a more patient trade.
Investors should prepare for less from COP26 and Biden’s climate change proposals. We see risk the clean energy sector could face a selloff if these expectations play out – but this should provide opportunities for patient investors to add to positions.
Over a 30-year career as a sell side analyst, John covered the structured finance and credit markets before serving as a corporate market strategist. In recent years, he has moved into a global strategist role.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)