What Climate Policies Should Investors Be Pricing In?

Copyright © 2021 Energy Intelligence Group

Investors are concerned that asset prices don't reflect the impact of climate risk, speakers told the UN Principles for Responsible Investment's (PRI) annual conference last week in Paris. They are also worried that serious policy response to the climate crisis may take place in a delayed and disruptive way, a poll among participants showed. "Investors tell us it's not about if governments will act, but when, how and with what impact," said the PRI's director of climate change, Sagarika Chatterjee (NE Oct.5'17). To help them, the PRI has developed its own forecast called the "inevitable policy response" (IPR) assuming forceful public action by 2025. "This is not factored in by the financial markets even though it's creeping into some sectors, but it's going to be very disruptive for companies," Chatterjee said. Parts of the IPR, notably its policy forecasts, were unveiled during the conference, while the rest of it will be available by end-September (see table). The IPR was designed as an alternative to existing scenarios from the International Energy Agency (IEA) or oil companies, and to be more directly usable by investors as it allows them to assess impacts on asset values. It is not a "hypothetical future scenario" or a temperature-constrained model such as the IEA's 2°C scenario, but a real forecast, said Mark Fulton from consultancy Energy Transition Advisors, a partner in the project. "It's quite aggressive, and if we are right, it will be disruptive," he said. Indeed, and even though the IPR would not achieve the Paris agreement's targets, it would be more disruptive than the IEA's 2°C and similar Paris-compliant scenarios because "you delay action and you have to push much harder," Fulton explained (NE May2'19). The forecast assumes policy announcements will accelerate in 2023-25 as countries prepare to submit their third round of climate pledges under the Paris Agreement. It also examines, in a more informal way, how the transition could accelerate further and achieve the 1.5°C target by 2100, particularly with the implementation after 2050 of negative emissions technologies such as bioenergy with carbon capture and storage (CCS). "We don't believe we can forecast those because the technologies are too uncertain, the policies too unclear and the time frames too far out, but we think our projections can be used as a basis for investors to push even harder, and for policymakers to recognize where a lot more credible public action will be necessary," said Jason Eis from consultancy Vivid Economics, another partner in the IPR project. In some areas, "the economics is supporting the change" and "there will be relatively sharp and decisive policy action," said Eis. Coal is "at the top of that list" and will be phased out "quite quickly" with first-mover countries in Europe implementing coal bans as early as 2030. Similarly, there is an "increasing number of rapidly announced, very credible bans" on internal combustion engine-powered vehicles. "This will begin to move quite quickly, with sales bans in place in leading countries by 2035 and followers to come in fast succession" (NE Aug.8'19). By contrast, "we're seeing places where progress is slower, and that's part of the forecast," Eis said, citing continuing deforestation and CCS, which has been "stuck in the mud" for over a decade (NE Sep.12'19). Similarly, land use-based carbon dioxide removal and availability of bioenergy, while accelerating, will be "much slower than most hypothetical scenarios have said," the forecast found (NE Jan.24'19). "There are real limits to how much the transition can rely on land-use change," which will have implications on other sectors, Eis said. Oil majors, for example, have recently emphasized the role of reforestation as a future tool to offset emissions caused by the use of their products (NE Apr.11'19). Eis anticipates carbon prices will reach $40-$60 per ton of CO2 by 2030 for first movers, with global convergence toward around $100/ton by 2050. "We don't see $200/ton, it's not going to happen, but there's a huge swell in energy efficiency and industrial decarbonization that can happen even at $50-$100, which is significant but not crazy." The IPR is intended as a business planning tool, Fulton said, and the PRI is indeed urging investors "to act now to protect and enhance value by assessing the implications of the IPR forecast for portfolio risk." Investors might revisit their long-term asset allocation strategies, which are based on views they have on expected returns by asset classes, regions and sectors. "What if those views are wrong and if, for example, the view of expected returns embedded in our equity forecast for the oil and gas sector is assuming too smooth a path to the future," asked Craig Mackenzie of asset manager Aberdeen Standard. "If we take into account the IPR and other climate scenarios, we will come up with different expected returns, which provides a foundation for a shift in capital for asset owners -- not necessarily directly from oil and gas to renewables because they have different risk-return characteristics, but maybe from oil and gas to other high-risk but less-carbon-intensive sectors." Philippe Roos, Paris Key Policy Forecasts Coal Phaseouts Steady decline from 2030 onward ICE Sales Bans Early bans by 2035 Very few ICEs on the road by 2050 Carbon Pricing $40-$60 per ton by 2030 for first movers Global convergence to $100-plus by 2050 CCS and Industry Decarbonization Limited CCS uptake by 2050 CCS primarily for industry Limited hydrogen ramp-up Zero-Carbon Power Significant renewable ramp-up globally Nuclear growing in a few countries,

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