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ESG Focus: Markets Eyeing COP26

ESG Focus | Oct 30 2021

FNArena's dedicated ESG Focus news section zooms in on matters Environmental, Social & Governance (ESG) that are increasingly guiding investors preferences and decisions globally. For more news updates, past and future:

ESG Focus: Markets Eyeing COP26 

Global share markets have been hushed in the lead-up to COP26, as big players prepare for potential capital reallocations.

-2050 carbon-neutral horizon may be brought forward
-Methane is the dark horse
-Carbon credit system on the agenda

By Sarah Mills

Global share markets have been hushed in the lead-up to COP26, no thanks to market jitters surrounding China’s deleveraging and supply-driven inflation fears.

Some market observers are concerned that an overly ambitious policy out of COP26 could provide a trigger for a sell-off in a nervous market.

Others believe it could provide a sorely needed boost – encouraging the investment needed to fire economic output.

Many expect the COP to be more grandstanding than substance, doubting that global policymakers will move sharply off current trajectories so as to ensure a smooth path for the transition.  

Already China, the greatest fossil-fuel consumer, has pre-empted the COP promising to reach peak CO2 emissions before 2030, and Russia, the fourth-largest emitter, has published its own plan. 

Neither announcement significantly shifted market sentiment.

COP26 starts this Sunday, October 31, and runs until Friday, November 12, and is expected to dominate news.

One of the main points of speculation is that the 2050 carbon-neutral horizon will be brought forward – some say as early as 2030, although this seems unlikely.

An announcement to bring forward the horizon would likely signal a huge acceleration in the flight of global capital from fossil fuels and into renewable energy. 

The other point of speculation is the possibility of an agreement regarding methane, which would have major implications for the oil and gas market.

Methane, the most potent greenhouse gas, can now be mapped from space and it is emerging as one of the most pressing and contentious climate-change issues.

Last year, methane leaks rose to the highest level on record, according to MethaneSAT.

“Forget cows belching,” says analyst for the Institute for Energy Economics and Financial Analysis (IEEFA) Tim Buckley. “The satellites are showing that by far the most gas is coming from old coal mines and well heads.”

“Methane reduction is one of the four top priorities this decade for the world, and we would expect a commitment soon to provide government funding to be free of methane.”

This week, the Democrats floated a US$1500 a metric ton methane fee in its spending bill (albeit coupled with US$775m in grants, rebates and loans to help oil and gas producers cut methane emissions). 

Buckley notes that BP has committed to measuring, monitoring and being accountable for all the methane leaks in its operations. He says this provides the company with an opportunity to improve its green credentials, access capital, and extract gas from those operations for sale.

Japan’s biggest gas buyer Jera announced in 2016 it plans to cut the amount of gas it buys under long-term contracts by -42% by 2030, preparing the Japanese market for renewables (which are designed for long-term contracts). 

While the writing is on the wall, an announcement on methane could hit sentiment in the gas market.

Oil and gas shares have tapered in the lead-up to COP and have taken only modest heart from soaring oil and gas prices this year, partly given the potential for US shale-gas producers to quickly bring operations back on line. 

The winners from an acceleration in decarbonisation timeframes would likely include renewable utilities and energy-storage manufacturers; and any company that has leaned heavily into the green transition.

Chemical makers and transport stocks are among the most vulnerable.

Sovereign and corporate-bond markets might also feel a pinch, as investors reset portfolios.

Goldman Sachs Group expects COP26 could trigger a recovery in ESG stocks, reports Bloomberg. 

ESG stocks have proved laggards over 2021, but with investors possibly feeling secure ahead of COP26, they might be ripe for an uptick.

The European Renewable Energy Index has fallen roughly -40% since mid-year and the S&P Global Clean Energy Index has fallen more than -30% from its January 8, 2021 high.

Even were COP26 prove to be a non-event, many observers believe weakness in the post-COP26 months prior to 2022 could prove an attractive buy point for ESG stocks heading into 2022, when investors are expected to rotate back in.

IEEFA's Tim Buckley is one of those that believe COP26 has more potential to fire markets than dampen them.

He notes the International Energy Agency is forecasting a doubling of clean energy investment to US$4trn over the decade – which should support economic growth.

He lays concerns regarding stagflation partly at the feet of the fossil fuel industry – or at least the world’s dependence on fossil fuels – blaming the economic recovery in China and Putin’s move to cut-off gas to Europeans for sending energy prices soaring.

Regardless of market reactions, investors will be looking to COP26 for guidance and opportunity. 

Top of the agenda will be a system of tradable credits that would offset polluting activities. 

Many corporations and private-equity investors have been laying plans to prosper from a trading credits scheme; and an announcement could set the game in play.

Buckley also expects emerging markets will be one of the major beneficiaries of COP26 because the numbers stack up.

He cites a recent discussion with one of the world’s largest infrastructure investors, in which the investor said he could lend to Germany for purchase power agreements at a 3% return on equity, or he could invest in Indian power purchase purchase agreements at 12%, which carry a 25-year government guarantee.

Such a deal carries foreign-exchange risk but under most modelling, 12% should cover such fluctuations over a 25-year period.

Might COP26 prove to be just as material?

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