Why Nations Will Meet Paris Climate Agreement Goals

Paris Agreement and Climate Change Risk:

The Paris Agreement was the first time all countries came together to work toward a reduction in global greenhouse gas emissions in an effort to mitigate climate change. In a 2015 study published in Nature if the world was able to maintain its commitments toward meeting the Paris Agreement goals then it could be expected that:

  • A third of oil reserves
  • Half of gas reserves
  • 80% of known coal reserves

will stay in the ground. Although this would be good for the overall health of the planet by reducing impact of climate change, it would be disastrous for resource extraction based companies. However, with recent reports, companies that work on the extraction of oil, gas and coal may not have much to worry about if current trends continue. Even with the Paris Agreement accords we see many countries not meeting their goals and actually increasing their emissions. Globally, we see more coal plants coming online to support developing countries appetite for growth. Also, we continue to see increases in emissions from the transportation sector.

Is this growth in emissions a hiccup and expected to be short lived? Some would argue that it is.

Why could this be just a hiccup?

Due to growing global climate change risk countries and companies continue to take steps to transition from the burning of fossil fuel. With decreasing costs of fossil free alternatives, the effort to debarbonize is becoming much easier.

The most recent levelized cost of energy studies, show all PV solar and wind to be cost competitive with natural gas and coal fired power plants. This was not necessarily the case at the signing of the Paris Agreement. Costs will continue to decrease for these generation assets and it will be more difficult to fund more expensive fossil-fuel alternatives. Further, as more renewable energy facilities are built out, the diversity of locations for these systems will reduce the intermittency issues that have been a concern for power grid operators. Not only the number of systems and the diversity of location are a benefit, but so is the significant ongoing decrease in the price of battery storage. On a regular basis, new reports are published on the ongoing decreasing cost of battery storage.

The technology is coming quickly and is ready for deployment. Much of the barrier is now political. Globally, risk adverse elected officials responding to very powerful fossil fuel interests, has resulted in an unlevel playing field with markets and regulations not properly accounting for and allowing new clean energy technologies.

What happened after the Paris Agreement?

 It was expected that when the Paris Agreement was signed  everyone was ready to go and begin to implement all these climate change mitigating measures. The fact of the matter is that there were many well meaning pledges, but the economic and political reality was not yet there for many parts of the world. Although we needed these goals to be met sooner rather than later, it takes time.

Technologies needed to be further developed and costs had to continue to decline. The financial markets and capital providers had to become more comfortable with valuing and funding these new technologies. Government regulators and policy makers had to better understand the barriers to deploying these systems and start making the appropriate changes that would not hinder the deployment of clean energy systems. Finally, the clean energy sector needed more allies and a bigger voice to compete with the more powerful fossil fuel lobby. 

Winds of Change

Financing and Investment in Clean Energy

Things are looking up. Specific to investing in clean energy, in 2017, clean energy investment outpaced fossil fuel investment by a significant amount, $333 billion vs $144 billion, respectively.  A specific funding instrument growing in popularity are green bonds. They are becoming one of the largest investment vehicles for energy efficiency and renewable energy investments. In 2018, it is expected that there will be $250 billion in green bond new offerings. This is 60% higher than 2017, which was $155 billion.  2017 saw a 60% increase in investment from 2016 (See graph below).

Source: Bloomberg

Political Winds are Changing

On the political side, at least outside of the US, we see a more robust shift to taking serious steps toward decarbonization and reducing climate change risks. The European Parliament is getting more serious in supporting plans to facilitate EU capital markets to meet long-term sustainability goals, which includes decarbonization, disaster resiliency and resource efficiency.

On May 29th the European Parliament adopted the sustainable finance resolution. Which includes:

  • Rules to orient financial markets towards environmental objectives
  • Policy framework to encourage investments into sustainable assets
  • Divestments from fossil fuels and unsustainable energies

The first two items are key areas that all countries must further develop to ensure Paris Agreement goals are met and exceeded. Without the proper market and regulatory framework in place, the investment community and companies will be less willing to transition to cleaner technologies. Item three, divestments are already happening. They will only become more rapid as the rules and frameworks around clean energy are developed.

Divestment Continues

What we are seeing in the market in regards to divestment should provide some hope for clean energy and concern for fossil fuel interests.

For example, hedge funds are seeing a 50% increase in demand for responsible investment offerings from current and prospective investors. This is according to a survey of about 80 managers from the Alternative Investment Management Association.

Another significant move was made by the state of New York and and New York City to actively divest from existing and future fossil based investments. To date, endowments and portfolios managing over $6 trillion are actively divesting from fossil fuel assets. Pension funds have come to the realization that they must protect their portfolios from climate change. Fossil fuels are not the future and their investments are at risk.

Stranded Assets Due to Climate Change

As divestment occurs, one of the primary concerns is the threat of fossil fuel stranded assets. These are largely reserves that will not be used as global markets move to clean energy resources.

What is a stranded asset? According to University of Oxford Smith School and Enterprise and the Environment, a stranded asset are “assets that have suffered from unanticipated or premature write-downs, devaluations, or conversion to liabilities and they can be caused by a variety of risks.”

At risk are assets listed on the financial statements of energy producers and a reduction in anticipated cash flows for future production which may be reflected in company stocks.

Risky Business

Oil and gas companies may see transitioning their business model to clean energy as risky. Some have made some initial transitions, Total, Statoil, Shell and BP for example. At this time, their clean energy investment is still minor compared to their overall fossil fuel investment strategies. For example, of Shell’s $30 billion investment budget only $2 billion goes to renewables.

Although this climate change transition may be risky, not paying serious attention and taking serious steps toward transitioning to clean energy assets may be even more risky. There is a lot of uncertainty as to the speed to which this transition will happen. A miscalculation in the speed of this trend could have dire consequences for fossil fuel companies. A recent report by the Oxford Institute for Energy Studies, “The Rise of Renewables and Energy Transitions,” lays out the significant risks of stranded assets that could be faced by those who do not choose wisely ( a little Indiana Jones reference). Moving to be an integrated energy company rather than an oil and gas pure play is probably the most appropriate choice in the current energy landscape. A recent study by Wood Mackenzie, finds that over the next 20 years renewables will be the fastest-growing primary energy source worldwide. They anticipate average annual growth rates of 6% for wind and 11% for solar. In contrast demand for oil, is anticipated to grow about 0.5% per year.

Growth in Renewable Energy vs. Fossil Fuels

Concerns over climate change risk are real and are being taken seriously by financial decision makers and policy makers. This would suggest that fossil fuel companies can no longer take a wait and see approach. The technology and markets are changing rapidly and for their own viability and of the communities they serve, they probably should get on board.

 

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More Green for Green Infrastructure – Funding to Mitigate Climate Risk

green infrastructure
Street Side Bioswale – mitigate climate risk; storm water damage

In the United States, it is estimated that $4.6 trillion will need to be spent to meet our current infrastructure needs. As of the 2017 ASCE Infrastructure Report Card funding may be available for about half of that amount; there is a funding gap of $2.1 trillion.  In the 2016 report Failure to Act: Closing the Infrastructure Investment Gap for America’s Economic Future,  the ASCE does a nice job in explaining what may happen in case we do not take this funding gap seriously. According to the latest report card, taking it seriously means investing about $206 billion per year. However, it is important to keep in mind that the $206 billion per year does not take into account future damage to our infrastructure due to climate risk.

Recently, I posted a blog about the possibility of closing the funding gap using resilience bonds. As I mention in the blog, resilience bonds are an interesting idea that is waiting for the right circumstances. There is growing interest in these bonds, as a way to pay for more resilient infrastructure to reduce climate risk, but the right projects have not been identified.

Environmental Impact Bonds

To deal with climate risk what seems to have a bit more traction are environmental impact bonds (EIB).  One has been issued in Washington DC for stormwater mitigation and a second is being considered in New Orleans.

The EIB is a tax-exempt municipal bond that utilizes a pay for success approach to financing infrastructure. The bond provides upfront capital for innovative resilience-focused projects and shifts downside risk from government agencies to the private sector investors. The public sector repays investors based on the whether the agreed-upon environmental outcomes are achieved. If agreed upon performance is not achieved, the investor covers the loss.

Washington, DC – Storm Water Mitigation

The first EIB was closed in September 2016 with the DC Water and Sewer Authority. This is a 30-year, $25 million bond with a mandatory tender after five years. The interest rate is set at 3.43%. With this bond, DC Water is looking to implement green infrastructure to mitigate stormwater risk but lacked capital. Further, the utility was attempting to implement a new, more innovative approach to stormwater mitigation and was concerned about performance risk. The EIB investors took on this risk and will pay DC Water if the infrastructure under-performs. The investors in this project are Goldman Sachs and Calvert Foundation.

At the five year mark, an additional payment of $3.3 million will be made, either by DC Water or the investors. Who pays will be dependent on actual stormwater runoff reductions. Who gets paid is determined by an independent evaluator. The evaluator set the performance metrics for the project. If reductions in stormwater runoff are greater than 41.3% then DC Water will bay an outcome payment. If the runoff is reduced less than 18.6%, Goldman and Calvert will pay a one-time risk share payment to DC Water.

New Orleans – Wetland Restoration 

New Orleans just started down its own EIB path July of 2017. The focus here is on the

NASA-completes-study-of-Louisiana-Gulf-Coast-Levees-and-Wetlands
Louisiana Coastal Wetlands

restoration of coastal wetlands. The coastal wetlands act as a natural buffer from sea level rise and storm surge. The wetlands have been damaged by natural events, but this damage has been exacerbated by oil and gas exploration activity. It is anticipated that without restoration of these wetlands, approximately 1,750 square miles of wetland could be lost by 2060. This would result in significant economic and community costs.

The desire here is to restore this natural infrastructure.  EDF will be working with Louisiana’s Coastal Protection and Restoration Authority to identify the specific coastal restoration project. A portion of this restoration work is expected to be funded by RESTORE dollars. However, additional funding is needed to complete the work to mitigate this climate risk. The additional funding will be provided by NatureVest in the form of an EIB pay-for-success bond.

The United States faces significant costs to bring existing infrastructure up to standards, as well as prepare for and recover from natural disasters. Non-traditional financing mechanisms are available to help fund this infrastructure. Earlier, I discussed resilience bonds as a possibility. Reliance on traditional bond funding, and federal and state dollars are not sufficient to manage the existing gap, much less prepare for future climate risks.  It is good to see that some cities are taking innovative steps forward to build and prepare for the future.