Dirk Hoozemans, energy and utilities analyst within the Robeco Global Equities team, outlines why he is optimistic that the targets set at December’s climate change summit can be implemented.
Governments pretty much have their heads out of the sand now and are very well aware of the need to address climate change. There were 196 countries attending COP21 and 187 signatories. The good thing about what’s different from the previous way of dealing with this is that now it’s a bottom-up approach, with every country submitting its own NDC (Nationally Defined Contribution) on emissions, so it looks like we’re more committed than before to get there in the goal of limiting warming to two degrees Celsius while striving for 1.5 degrees.
What also came out of the conference is that current NDCs won’t support a two degree scenario, and that’s why countries have put in place a review mechanism to check the progress of every country on how it is delivering every five years, and also very likely continuously tightening the targets. So in that sense it’s a true milestone, and countries look quite committed to doing this. The bottom-up targets and ambitions in my view work better than a top-down approach in reducing emissions, where enforcement is tougher.
We will see much more tightening of climate policies, aimed at cutting carbon emissions by tackling the most carbon-intensive burners of fossil fuels first. I think the pecking order of what will be targeted is coal first – it accounts for roughly 45% of all C02 emissions in energy – and then oil next and gas last, as they are less carbon-intensive. At the same time, countries will need to invest more in renewable energy sources such as wind and solar power. The problem we face now though is that about a year ago, the oil price was very high and the costs of wind and solar were falling. That made renewables more competitive. But right now, hydrocarbons are very competitive with renewables again. So the big question mark is: how are the individual countries going to treat this? Do they focus on the long run and make big investments in renewables, or do they want short-term economic competitiveness and so plan to postpone investments as oil prices are so low?
The other thing that will change is the G20’s Financial Stability Board becoming more forceful in putting pressure on how companies disclose their exposure to climate change. But it’s not always possible to put a monetary figure on carbon risk. It’s more straightforward if you are a hydrocarbon producer or an airline, but it’s less straightforward if you are a bank or a retailer for instance. And then there are de-carbonization trends within the investment industry to contend with. The Portfolio Decarbonization Coalition (PDC) was formed to look at how investors are measuring carbon risks to portfolios, and how investors are tackling them with either exclusion or some sort of risk adjustment. So it’s a multi-faceted approach.
It’s evolution not revolution. Energy companies have a large vested interest in the hydrocarbon economy of course, but they are also very aware of what’s going on. Big oil companies are transitioning their portfolios from oil to gas, which is a cleaner fuel. But you can’t rule out traditional fossil fuels overnight. Under the scenario that would seriously limit global warming, electric vehicles would have to make up a quarter of the global car fleet by 2030 or so, and it’s now less than 1%. It would require massive growth, backed by massive infrastructure investment in this field. With high oil prices you are easily incentivized to switch car type, but much less so if gasoline at the pump is cheap again. Furthermore, emerging economies are still heavily reliant on coal for their power generation needs. So I think moving away from fossil fuels will be a gradual process.
Divestment out of polluters like coal is a case of voting with your feet, but engagement is another way of making a difference. Robeco for one has been sitting around the table with energy companies, talking to managements about their strategies for the future with renewables, making them understand that they need to prepare for a shift. You can’t ignore what’s going on outside your window. But the investment that is needed to get renewables rolling is massive of course. So the other thing that COP21 did was to identify the role of funding emerging markets by over USD 100 billion per annum by 2020 in developing renewable energy infrastructure.