I’ve written many times about realities of corporate climate commitments and how economics sometimes conflict with those. However, a number of recent potentially unanticipated developments have converged to this point:

Fossil fuel use is on the upswing globally.

This seems a paradox given the amount of public pressure, corporate Net Zero commitments, media coverage and investor action emphasizing carbon emission reductions. In many ways, this is another symptom that the real economy has become disconnected from capital markets. Operational realities and priorities continue to move in response to fundamental needs that differ from high level pronouncements and policies.

Why is this happening and what does this mean at a practical level?

What Is Happening?

To set the stage for today, I begin with a statement made six years ago. Mark Carney, the former Governor of the Bank of England and Chairman of the Financial Stability Board, in his September 2015 speech “Breaking the Tragedy of the Horizon – Climate Change and Financial Stability,” presciently pointed out that:

The speed at which [climate risk] re-pricing occurs is uncertain and could be decisive for financial stability. There have already been a few high profile examples of jump-to-distress pricing because of shifts in environmental policy or performance.

Today, we are seeing jumps and shifts speed pricing changes, but in the wrong direction.

The Reality – People Need Electricity Now

In China, energy shortages are putting pressure on power generation, especially in a context of COVID-induced supply chain crises creating chaos at manufacturing plants. The Chinese National Development and Reform Commission (NDRC) recently “ordered the country’s coal mines to ‘produce as much coal as possible’ ” to help reduce power shortages and electricity rationing during peak hours. As CNN reported:

“Beijing pushed coal mines to curtail production earlier this year as the country pursued ambitious targets to cut carbon emissions. But demand has surged for projects that require fossil fuels, and there just hasn’t been enough power to go around. To combat the problem, China began ordering coal mines to ramp up production, with authorities in Inner Mongolia, the country’s second largest coal-producing province, ordering dozens of mines to boost output earlier this month. Now, the NDRC is demanding that mines nationwide up production by as much as they can heading into the final quarter of 2021. Shutting down coal mines is prohibited…

The government has taken other steps to ease the crunch. It increased the price of electricity by 20% among provinces with higher demand, to close the price gap between coal and power.” 

During the October 20, 2021 US House Select Committee on the Climate Crisis hearing titled “Good For Business: Private Sector Perspectives on Climate Action,” Rep. Gary Palmer estimated that 4 billion people worldwide do not have access to clean energy for household use at this time, yet still need to heat their homes and cook their food right now. Those people have no Plan B if regulatory and market pressures eliminate fossil fuel energy before viable alternative sources are available.

What Was Cheap Isn’t Now

Most carbon pricing and energy transition scenarios anticipated that natural gas would remain the lowest cost fossil fuel. The unexpected global disruption caused by the pandemic, combined with gas fired asset shutdowns and public policy uncertainty destabilized natural gas prices, hitting values not seen since January and February 2014, and reflective of the low end of the record pricing run 2003 – 2008.

ESG Investor reported:

Over a fifth of European gas-fired power plants and nearly a third of US units are lossmaking, with surging fuel prices threatening to nudge more toward insolvency. A new report from UK think tank Carbon Tracker also revealed that developers of most gas plants currently planned or under construction will never recover their initial investment.

According to S&P Global, higher natural gas prices in the US are projected to contribute to an uptick in coal consumption, resulting in coal-related CO2 emissions increases of 20% in 2021.

What Was Supposed to be Expensive is Still Cheap

The cost of carbon emissions remains stubbornly economically insignificant. A new carbon emissions tax in Austria begins in 2022 at a price of 30 Euros/tonne ($34), growing to 55 Euros/tonne ($63) in 2025. This compares to EU ETS futures pricing for the first part of October 2021 of approximately 60 Euros/tonne ($69), close to its record high. The International Energy Agency (IEA) World Energy Outlook 2021 analyzed the more than 60 carbon pricing schemes in place in 2021 covering over 40 countries. The table below (Table B.2 in the report) shows established and projected pricing in the next three decades, which range from essentially meaningless early on to arguably crippling at the end.

Source: World Energy Outlook 2021

Governmental support for decarbonization has been less than enthusiastic, and not just in China. The U.S. does not have a regulatory regime in place to support a transition economy, although the Biden Administration is pushing for one. In the UK, The Treasury published their Net Zero Review, analyzing the economic impact to the UK of a decarbonized economy. From a tax base perspective, the UK is disincentivized to decarbonize. One article assessing the report found:

“The Treasury notes that revenues from Fuel Duty and Vehicle Excise Duty (VED), amounted to £37bn in 2019-20 – equivalent to 1.7% of GDP. As fossil fuels are phased out in the UK, revenues from these mechanisms decline, with the Treasury noting that most tax receipts from these activities declining near to zero over the next 20 years, leaving receipts lower in the 2040s by up to 1.5% of GDP. Additionally, the Treasury notes the introduction of carbon pricing mechanisms – most notably through the UK’s own Emissions Trading System – won’t be enough to offset these losses in tax revenue.”

Plenty of Investors Like Carbon

Large publicly-traded owners of fossil fuel assets have been selling those holdings as part of their decarbonization strategies. I am cynical of this as I have blogged previously because on the other end of a successful divestiture is a buyer. Bill Winters, CEO of Standard Chartered plc (London) and Chair of the Task Force on Scaling Voluntary Carbon Markets, predicts dependence on fossil fuels will continue for the next fifteen to twenty years. There are those out there who agree, see attractive economic fundamentals in fossil fuels and are buying these assets at bargain prices, taking advantage of the “fire-sale” pricing.

The New York Times summarized a new study on private equity acquisition of fossil fuel companies:

“Since 2010, the private equity industry has invested at least $1.1 trillion into the energy sector… The overwhelming majority of those investments was in fossil fuels… taking advantage of an oil industry facing heat from environmental groups, courts, and even their own shareholders to start shifting away from fossil fuels…”

Two such funds highlighted by the article claim returns of 100% and 377% in 2021.

The Moment You’ve Been Waiting For…

This increased demand for fossil fuel isn’t just transitory due to COVID and China isn’t alone. The Production Gap report, produced by the Stockholm Environment Institute, International Institute for Sustainable Development, Overseas Development Institute, E3G and United Nations Environment Program, shockingly concluded:

“According to our assessment of recent national energy plans and projections, governments are in aggregate planning to produce around 110% more fossil fuels in 2030 than would be consistent with limiting global warming to 1.5°C, and 45% more than would be consistent with limiting warming to 2°C, on a global level. By 2040, this excess grows to 190% and 89%, respectively.”

What This Means for You

I’ve covered a lot of ground in mind-numbing detail, so I’ll wrap it all up in practicality.

  • Operating companies: Assumptions embedded in your company’s climate goals and Net Zero commitments may not be valid anymore, especially with regard to Scope 2 and 3 emissions. PracticalESG Advisory Board Member Mark Trexler previously wrote about auditing your climate risk assumptions. Now is probably a good time to consider doing that.
  • Investors/asset owners: Rather than divesting fossil fuel holdings for a quick win on reducing your carbon footprint or climate risk exposure, consider actively engaging with those companies towards a defined transition plan. Transparent low-carbon transition plans benefit individual companies and also help stabilize systemic risk and mitigate energy pricing shocks (once enough companies make that choice).
  • These developments may put more pressure on the offsets market, resulting in increased costs and potentially more low quality or fraudulent offsets. Buyers should exercise extreme caution in considering offsets.

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