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ESG Focus: Climate Summit’s Coal Story

ESG Focus | May 11 2021

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ESG Focus: Climate Summit’s Coal Story

While the US grabbed April’s climate summit headlines, India and China had a few less-encouraging words. This article looks at the broader global commitment landscape; Australia’s plans; and the outlook for coal.

-US commitments appear hollow without methane target
-China keeps its options open
-India and other developing countries holding out for aid
-Australia to hand out $20bn to Aussie companies

By Sarah Mills

April’s Climate Summit appeared to give more air to the sceptics than the true believers; a notable lack of specificity leaving investors none the wiser.

China and India played their cards close to their chests; the US target appears unachievable without a methane commitment; and Australia’s commitments partly translated to subsidies for fossil fuel industries.

While the public message was steady as she goes, politics was the name of the game.

Despite solar being a cheaper option, particularly for developing countries, many are holding out for Paris Climate Accord pledges to mobilise US$100bn a year in public and private financing to aid the effort, says The Wall Street Journal.

So, while India was probably the biggest puzzle given it did not alter its carbon emissions policy (under which emissions are forecast to rise 50% by 2040), much of this bluster is part of the bargaining process.

Also, momentum is building in the investor space with US$37trn in assets under management (AUM) committed to net zero portfolio emissions by 2050 via the Net Zero Asset Managers Initiative, so the investment world is taking the lead, regardless of geopolitics.

And impending regulation from the European Union, particularly the adoption of a carbon border tax, is likely to do the rest of the heavy lifting.

US commitments

Methane emissions proved the elephant in the room at the Climate Summit.

Many had expected a special and specific mention of the greenhouse gas, which is far more damaging than coal, but Biden may have been averse to grabbing this hot potato so early in his presidency.

Morgan Stanley notes US President Biden’s 2025 commitment implies a -44% reduction in carbon emissions from 2019 levels.

According to the University of Maryland’s Center for Global Sustainability, this means power emissions need to decline by -65% from 2019, while transport emissions need to fall by -40% – implying a massive cut over the next four years.

Most analysts say the US target will be impossible to achieve without methane cuts.

Morgan Stanley says it will also require an extension of tax credits for solar and wind; and significant electric vehicle incentives to drive 65% penetration across new cars and SUVs; and 10% penetration for new trucks.

Morgan Stanley’s autos analyst Adam Jonas doubts the US will meet the penetration rates required to meet the 2030 US target.

Morgan Stanley also estimated the target would require carbon capture & storage (CCS) on new natural gas plants starting 2025; and a doubling of tax credits for carbon capture & storage.

While Morgan Stanley estimates that CCS will become a US$2.5trn market by 2050, the Institute for Energy Economics and Financial Analysis (IEEFA) does not expect the power sector will need CCS, which will only be achievable through massive subsidies.

IEEFA has also repeatedly highlighted the lack of viability of carbon capture & storage technology, suggesting that CCS subsidies are shaping up as a disguised fossil fuel subsidy. 

This suggests CCS is more of a fossil fuel play than an ESG play – for the time being at least – and not likely to yield the long-term sustainability premium for investors, short of quantum leaps in CCS technology over the next five years.

China’s commitments

As expected, the world’s largest consumer of fossil fuels, China, sucked the air from the summit, offering morsels.

The world’s largest consumer of coal reaffirmed that it would reach peak emissions by 2030 (a -65% reduction in emissions intensity) and be carbon neutral by 2060.

But it is a moot point.

As the biggest electro-state in the world, China has every reason to progress the adoption of green energy before the US and Europe establish competing manufacturing operations.

President of the People’s Republic of China, Xi Jinping, has already said coal-fired power generation projects would be strictly controlled heading into 2025 and that coal consumption would be reduced over the following five years.

While emissions may rise ahead of 2025 as demand for green infrastructure skyrockets over the next four years, China’s green energy consumption is also rising.

Last year, coal comprised 57% of China’s energy according to the nation’s statistics bureau and the nation proposed 73.5 gigawatts of new coal-fired power last year –more than five times as much as the rest of the world combined.

But, as The Wall Street Journal notes, many of these may never be built because they aren’t economically viable, not to mention desirable for health reasons. Coal-fired power plants in China are already idling for roughly half the year.

Much will depend on the speed of the early transition but China is unlikely to forgo the early manufacturing advantage it has in this market; and coal is its backstop to ensure it can meet demand.

The thermal coal price has already surprised the market, rising more than 80% over the past year in anticipation of the green transition; and in tandem with the global economic recovery.

The next four years may prove to be thermal coal’s last hoorah should the green transition bolt from the barrier.

Analysts broadly believe thermal coal should continue to find support at these levels (above US$90/t) for the next few months but expect a retreat to the US$70/t mark later in the year.

KPMG expects Newcastle benchmark thermal coal price will trade at roughly US$70/t out to 2025.

Similarly, copper, steel and other “green” manufacturing materials are expected to remain well bid over the next four years.

The very real prospect of a European Union carbon border mechanism and the review of its emissions trading schemes later this year could also hit carbon demand.

India’s commitments

Back to the summit, the world’s third biggest consumer of coal, India, remains one of the few countries to baulk at a net zero commitment – perhaps more for political than practical reasons.

Prime Minister Modi has reiterated his commitment to reduce greenhouse gas emission intensity of its GDP by -33% to -35% (which actually translates to an increase) below 2005 levels by 2030, but steered away from a net zero commitment.

But the nation is already on the path to renewable energy.

Given renewable energy is cheaper than coal, and given India does not have much legacy infrastructure, and given the transmission infrastructure to favour coal (nor centralised solar for that matter); then the net zero aversion appears either a precaution heading into an anticipated period of industrialisation; or a ploy for green and social funds; or a nod to corruption.

India is also the only G-20 country whose climate actions are already compliant with the Paris Agreement goal of keeping global temperatures from rising beyond 2 degrees Celsius.

India has undertaken one of the world’s largest solar energy installation initiatives and reaffirmed its intention at the summit to install 450 gigawatts of renewable energy by 2030.

This speaks strongly to the role of renewable energy in the nation’s future.

Like China, India has approved new coal-fired power plants but as it does not yet have the manufacturing base to compete with China in the green market. Less relative demand is likely to emerge from India for coal to feed the early green transition.

Also, given solar is cheaper than coal, it is unlikely the majority of approved plants will proceed, especially given coal imports are an expense the developing country can poorly afford.

It also has an opportunity to build its industrialisation on new technology rather than old, leapfrogging competitors with legacy systems.

In relation to the green and social funding, Prime Minister Modi used the summit to unveil a partnership with the United States to expand renewable energy – the India-US Climate and Clean Energy Agenda Partnership for 2030.

India is pushing into the EV market and battery production; and the partnership suggests the US is seeking to diversify green energy manufacturing into India to counteract China’s extreme dominance of the market.

 “The partnership will aim to mobilise finance and speed clean energy deployment; demonstrate and scale innovative clean technologies needed to decarbonise sectors, including industry, transportation, power and buildings; and build capacity to measure, manage and adapt to the risks of climate-related impacts”, according to a US State Department media release.

India is likely to be among the many developing countries holding out for Paris Climate pledges to mobilise US$100bn a year in public and private financing to aid the effort.

Already western countries have formed an alliance, offering US$1bn to developing countries that can show they are preventing tropical deforestation and emissions.

India is also likely to try and tie “social” funding to green targets.

In all, India is in one of the strongest bargaining positions of any developing country: the nation has every reason to abandon coal; but it wants more and will be a winner either way.

Indonesia and South-East Asia

South East-Asia is more vulnerable and less well positioned to take advantage of a green transition.

Vietnam, Laos and Thailand appear to be on track. They are vulnerable to Belt & Road Initiatives that export dirty industries out of China but on the flipside, they are close enough to China and India to benefit as well.

Indonesia and Malaysia are the main laggards on coal. Already we noted a dubious Multilateral Investment Guarantee Agency deal supporting an Indonesian power company’s transition; and it is likely the area attracts more subsidies than genuine investment.

Investors seeking sustainability premiums beware.

Australia – new targets on the way

Australia’s Prime Minister Scott Morrison announced an extra $20bn to promote clean hydrogen, green steel, energy storage and carbon capture.

These are already areas flagged for support.

Australia plans to be the world’s cheapest clean hydrogen producer by 2030, targeting a price of $2 a kilogram, down from $5/kg-$6/kg now – also an area already flagged for support.

But Credit Suisse doubts hydrogen demand will explode before the 2040s, and given carbon capture prospects appear extremely low at this stage, the government's CCS would appear to be more of a fossil fuel handout.

The analyst notes that companies with green hydrogen ambitions include Fortescue Metals Group ((FMG)), Origin Energy ((ORG)), Santos (STO)), Worley ((WOR)) and Woodside Petroleum ((WPL)).

Credit Suisse also notes Santos is the likely lucky recipient of the carbon capture largesse, and is awaiting carbon credit approval for its CCUS project. Carbon capture, utilisation & storage (CCUS) differs from CCS in it does not result in permanent geological storage.

The government’s support for green steel is a touch more interesting, although much will depend on the application of these funds.

With the pending introduction of carbon import taxes globally, steel producers with high carbon footprints could see their profits slashed by -40% on average.

Bluescope Steel ((BSL)) has been well bid this year, heading into the anticipated firing up of the EV and construction markets.

It will also be interesting to see how the company’s plans in the solar roofing market have progressed, given Tesla’s solar roof ambitions.

Bluescope has been working on solar technology for its successful Colorbond projects for several years now; although if it has made significant progress on this front, it is certainly hiding its light under a bushel.

Apart from steel, Australia appears positioned to miss out on many downstream opportunities but will benefit from the resources demand, at least in the early stages of the transition.

Prime Minister Morrison also announced plans to unveil a new long-term emissions reduction strategy and target closer to the COP26 in November.

Other global commitments

CNBC reports:

-Japan will cut emissions -46-50% below 2013 levels by 2030, “with strong efforts toward achieving a 50% reduction” (its previous goal was -26%); 
-Canada increased its previous target to reduce emissions -30% below 2005 levels by 2030 to a -40-45% reduction from 2005 levels by 2030; 
-Argentina will strengthen its NDC (nationally determined contribution), deploy more renewables, reduce methane emissions, and end illegal deforestation;
-The UK will embed in law a -78% greenhouse gas reduction below 1990 levels by 2035;
-The European Union is embedding in law a target of reducing net greenhouse gas emissions by at least -55% by 2030 and a net zero target by 2050;
-The Republic of Korea will end public financing of overseas coal plants and strengthen its NDC this year to be consistent with its 2050 net zero goal;
-China will join the Kigali Amendment, strengthen the control of non-CO2 greenhouse gases, strictly control coal-fired power generation projects, and phase down coal consumption;
-Brazil committed to achieve net zero by 2050, end illegal deforestation by 2030, and double funding for deforestation enforcement;
-South Africa will strengthen its NDC and shift its intended emissions peak year ten years earlier to 2025; and
-Russia called for international collaboration to address methane.

Carbon border adjustment mechanisms

A recent BCG report titled ‘How an EU Carbon Border Tax Could Jolt World Trade’ discusses progress on implementing a carbon border adjustment mechanism (CBAM), noting that in some sectors, a carbon border tax could rewrite the terms of competitive advantage.

CBAM price imports will account for carbon useage and is also known as a carbon border tax.

The widespread adoption of CBAM will create major handicaps and challenges for companies with a large carbon footprint in a transitioning world.

As an example, BCG estimates that an EU carbon import levy of US$30 per metric ton could cut the profits of foreign producers by -20%, if the crude oil price ranges between US$30 to US$40 a barrel.

BCG estimates the levy could reduce profits for flat-rolled steel imports by as much as -40%, the impact of which would flow to downstream products.

Special President Envoy for Climate, John Kerry, has aired the prospect of a border adjustment mechanism, similar to that proposed in Europe, but Morgan Stanley doubts it will gain legislative votes and may be politically untenable.

The EU, in contrast, is highly likely to adopt the mechanism this year, and this is likely to provide a considerable incentive to the rest of the world.

As Morgan Stanley notes:

“The EU’s review of its emissions trading scene could hit global carbon prices – proposals for the much touted carbon border adjustment mechanism are expected which should have knock-on effects.”

BCG notes:

A European carbon border tax would impact, either directly or indirectly, all industrial sectors that rely on imports in the EU and would influence sourcing decisions throughout entire value chains.

The impact would be governed by two factors: carbon intensity and trade intensity. So high emitters with a high proportion of EU trade will be hardest hit.

On this basis, BCG estimates the sector most directly hit would be coke and refined petroleum products, as well as mining and quarrying; given the tonnage of carbon is usually diluted in the downstream processes.

Of the 44 sectors that the EU regards as high priorities for new carbon measures, 85% are related to materials, energy, and other sectors that provide raw ingredients for industrial processes,” says BCG.

“Sectors such as chemical products, basic metals, paper products and non-metallic mineral products, while less dependent on trade, would also be directly affected because of their high carbon intensity.”

Japan is also reported to have aired implementing a carbon border tax at the April Climate Summit.

The country also took the opportunity to nearly double its 2030 emissions target to -40-45% below 2013 levels, compared with -26% recently.

It would be fair to assume that, should the EU proceed, a carbon tax will be adopted by many global economies within two to three years.

Sovereigns set to grow market in 2021

All of the Climate Summit emissions commitments will find expression through the sovereign bond market.

Britain, Canada, Spain and up to eleven other sovereign nations are set to issue inaugural green bonds in 2021.

The European Union (EU) announced in September that it will sell EUR225bn of green bonds as part of its pandemic recovery fund, making up about 30% of the EU's EUR750bn rescue package.

China has announced green financing for Belt & Road initiatives; although many perceive this as a bid to export dirty manufacturing out of China to avoid environmental regulation.

As always, it’s buyer beware.

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