Two Business Cycles to Prepare for A Low-Carbon World
December 7, 2018
Climate investment was $70 BN in 2016. 990 institutions with $7.2 TN of AUM declared some form of fossil fuel divestment. Going forward, 2,400 asset managers representing $82 TN have agreed to UN PRI commitment on ESG issues. Total AUM committed to PRI has grown 19% in the past 12 months.
This week, as delegates from nearly 200 nations congregate in Katowice for COP24, the 24th annual UNFCCC conference on climate change, ‘tis the season to take stock of the state of climate politics around the world. Spoiler alert, it’s not a particularly jolly read.
Paris, at least on the surface, serves as a great metaphor for global climate politics. Three years ago, those same COP delegates gathered with their political masters in the City of Lights to sign an historic agreement committing the world to limit global warming to below 2°C. Today, Paris is again in the news – but this time for riots triggered by increases in fuel tax designed to help deliver France’s climate goals. Lofty ideals, soaring rhetoric, ambitious targets – meet popular push-back!
But is Paris really shorthand for what the state of the climate world, or is the reality more complicated?
Reasons to be fearful
Events around the globe certainly make it easy to paint a picture of climate policy in disarray. Exhibit A is, of course, President Donald Trump’s decision in June 2017 to pull out of the Paris agreement. But this year has delivered a number of other high-profile examples.
Ontario Conservative Premier Doug Ford campaigned and won on a promise to pull the province out of its cap-and-trade scheme. Tony Abbott and his merry fossil-funded clique in the Australian Liberal Party used concern over the cost of climate action to wrest control from more moderate colleagues for the second time. A year ago, Scott Morrison was brandishing a lump of coal on the floor of the Australian parliament and telling his fellow MPs not to be scared of it; today he’s Prime Minister.
In Brazil, during his successful presidential campaign, Jair Bolsonaro used a threat to quit the Paris Agreement to signal his business-friendliness. He has since relented, but one of his first acts as President was to rescind the country’s offer to host the next COP meeting after Katowice. China is once again using coal-fired power station construction as a means of delivering economic stimulus at home and securing influence overseas.
Even Germany’s commitment to climate action looks wobbly. The ruling coalition’s governing document abandoned the country’s 2020 goal of a 40% emission reduction over 1990 levels, replacing it with a longer-term goal, and abrogated the selection of a year by which the country’s coal-fired power plants would be closed – delegating the decision to a special “Coal Commission” that looks set to miss its year-end reporting deadline.
Global emissions, almost flat between 2013 and 2016, returned to growth in 2017, and will be up again in 2018. Once again, the European Union has proven long on rhetoric but short on action: with emissions growth of 1.5% in 2017, it has no moral high ground in Katowice from which to lecture the U.S. – where coal plants continue to close and emissions to drop.
But before you conclude that the world is failing to address the climate challenge, and that wait-and-see or business-as-usual are viable business strategies, read on.
Reasons to be cheerful, part 1: it’s not all about climate politics
First of all, you should never assign excessive weight to global climate diplomacy.
After all, what are the delegates gathering in Katowice to discuss? The Paris Rule-Book. I’m sure climate aficionados will in time treat the eventual product with the reverence of a Medieval palimpsest, but I can only get so excited about a set of binding rules designed to track voluntary commitments.
The struggle to produce the Rule Book is in reality another skirmish in two ancient (in climate negotiation terms) conflicts between the developing and developed worlds. The first revolves around whether both should follow the same procedures to track commitments, with the developing world arguing for leniency and the developed world pushing back; the second is the old chestnut of climate finance, with the developing world trying to shake down the developed world for $100 billion annually by 2020, as promised in 2009 in Copenhagen, and even bigger sums beyond.
It’s not quite two bald men arguing over a comb, but not far from it. The UN Framework Convention on Climate Change recently reported that north-south climate investment reached $70 billion in 2016; so just a 9% annual increase over the remaining four years would see the developed world live up to its Copenhagen commitment – not that this will mollify many developing countries, which wanted the money to be handed to them to spend as they saw fit, rather than invested in directly relevant projects.
Meanwhile, the topic that should urgently be on the agenda in Katowice – trade – is missing. In 2016, the world’s major emitters failed at the last moment to sign an Environmental Goods Agreement that would have significantly lowered the cost of clean energy and transport; today, they are turning those same sectors, so vital for climate action, into battlegrounds in the trade war that is the biggest current threat to the global economy. This needs to stop.
Perhaps the most interesting thing about the talks in Katowice is that U.S. negotiators – many of them the same people as have been negotiating for years – seem as interested as ever in winning negotiating points, despite the fact that officially the U.S. is pulling out and will not be bound by the results. It does rather look like they are hedging their bets, in case either the current unpredictable President or the next one recommits the country to the Paris Agreement.
Reasons to be cheerful, part 2: clean energy and transport fundamentals
Just as the Paris Agreement in 2015 did not drive the precipitous drop in wind and solar power prices that began in 2010, any agreement in Katowice is not needed to drive the mainstreaming of electric vehicles that began a few years ago. Climate economics precede climate diplomacy, not the other way around, and the economics keep looking better and better.
In the second half of 2018 alone, the BNEF global benchmark levelized cost for solar fell by 14% and the wind benchmark by 6% (client links: web | terminal). Despite cutting support for solar power mid-year, China looks set to install another 40GW by year-end, down around 25% on last year, but with the entire shortfall set to be taken up by growth in other markets. 2018 might end up seeing the slowest rate of growth for PV installations globally since at least 2012, but the big Chinese solar manufacturers are all planning two- to three-fold increases in capacity in the next two to three years. The solar industry will return to strong growth in the near future, powered by its unbeatable value proposition, as well as strong national and sub-national policy signals – such as California’s pledge to reach zero net emissions by 2045, Spain’s target of 100% renewable power by 2050, and Queensland, Australia’s promise to reach net zero emissions by 2050.
The wind industry is set to have its second-best year ever, with around 55GW added. The next few years will see installations get into record territory, with 30GW of new projects in the U.S. alone by 2020, and the arrival of giant offshore turbines which will power over 100GW of offshore projects by 2030.
In transportation, 2018 saw demand for electric cars reach 5% of sales in China; China’s internal combustion car market is flat, with all growth now being absorbed by EVs. Progress has been a bit slower in Europe and the U.S., with sales only reaching around 2% of new cars but, with the launch of the Tesla Model 3 and hundreds of new models from big manufacturers reaching the showrooms, things are going to be moving fast.
On the streets, the Charge of the Chargers has begun – and it’s going to be a battle royal between big oil and big utility. Shell has bought New Motion, BP has bought Chargemaster, Total has bought G2mobility. Equinor-backed Chargepoint has just closed a $240 million Series H funding round – with Chevron, among others, as an investor. (Disclaimer: I am a minor shareholder in Chargepoint.)
Lithium-ion battery production reached an important milestone in 2018, with more than 50% of output devoted to EVs, rather than consumer goods. The battery supply chain may look a bit constrained between now and 2021, but at that point lithium-ion manufacturing capacity will soar to 630GWh, three times current output. Tesla’s 100MW, 130MWh Hornsdale Power Reserve battery has proven unbeatable at providing short-term grid services, earning its owners very healthy returns in the process.
These pioneering sectors of wind, solar, EVs and batteries are being joined by others. The digitization of energy and transport infrastructure is starting to create value in the billions of dollars. Utility-of-the-future business models, designed around time-of-day pricing, are starting to get real traction. The next generation of clean technologies in heat, industrial processes, recycling, shipping, heavy road transportation and power-to-gas are readying themselves in the wings. Over 150 million people in the developing world have received their first ever modern energy services courtesy of distributed systems.
It is clearly riskier to bet against this march of clean energy and transportation than to bet on it.
Reasons to be cheerful, part 3: finance is waking up to climate risk and disclosure
The third reason that investors and executives need to beware of misreading the Zeitgeist is that shareholders and lenders are becoming increasingly uncomfortable with high-carbon business models.
While only 990 institutions – with $7.2 trillion under management, just 3% of total global savings – have actually declared some form of fossil fuel divestment, these are only the lead steers. More importantly, the main herd of investors is spooked and starting to eye its escape route.
The UN Principles of Responsible Investment (PRI) commit asset owners and managers to incorporate environmental, social and governance issues, to seek disclosure from the entities in which they invest, and to disclose their own ESG activities. Climate and emissions are, of course, core areas of ESG focus. Nearly 2,400 major asset owners and asset managers with $82 trillion under management have already signed up to PRI, with total assets subject to PRI growing by 19% in the past 12 months. PRI is on its way to becoming a global industry standard.
Another important initiative is the Task Force on Climate-Related Financial Disclosures (TCFD), set up in 2017 at the request of Mark Carney, Governor of the Bank of England and chair of the Financial Stability Board, and with Michael Bloomberg, founder and majority owner of Bloomberg LP as chairman. By September, institutions with over $100 trillion of assets under management had indicated support for its recommendations.
It’s not just about disclosure and scrutiny. Activists are becoming more confident, more organized and more confrontational toward those delaying climate action. New climate warriors on the block, Extinction Rebellion, underlined their radical credentials last month by occupying the offices of Greenpeace, accusing them of being complicit with the corporate world’s dash through the planet’s remaining carbon budget. The Sunrise Movement – supported by new Democrat superstar Alexandria Ocasio-Cortez – occupied the office of U.S. Democrat party grandee Nancy Pelosi. Some 15,000 Australian school children took part in a one-day school strike to protest their government’s lack of climate action.
Investors and executives should be concerned not just about direct action by activists, but about the threat of legal jeopardy into which excessive emissions or poor climate governance may place them. So far only Mexico and the U.K. among the major economies have enacted binding climate legislation, the London School of Economics has identified 25 climate-related lawsuits brought against governments or their representatives.
The courts have already ruled against the Dutch government, forcing it to accelerate cuts in carbon emissions. In the U.S., a number of cities and counties in California, New York, Colorado, Washington and Maine have filed civil lawsuits against oil and gas companies. The landmark Juliana versus United States case pits 21 plaintiffs aged between 11 and 22 against the U.S. Federal government. Even if it is thrown out, the NGO coordinating it, Our Children’s Trust, has initiated similar suits in state courts from Alaska to Florida.
The era of corporates and investors turning a blind eye to climate change, pretending it presents no risk or treating it like someone else’s problem, is surely drawing to a close.
Reasons to be cheerful, part 4: When in the pits, look out for the pendulum
The fourth reason why investors and executives should not take their cue from the words of anti-climate populists is that those populists may shortly find themselves on the losing side of history.
In the 2018 midterm elections, President Trump hung onto enough seats to maintain Republican control of the Senate; Democrats gained control of the House and picked up seven governorships. Three of them – Nevada, Maine and New Mexico – were in states where renewable energy mandates had recently been vetoed by Republican governors. Wisconsin’s governor-elect, Tony Evers, campaigned on a pledge to join 17 other governors committed to the goals of the Paris agreement. Clearly the public likes renewable energy a lot more than many corporate leaders or lawmakers think.
Climate action at the sub-national level is in robust good health. In the run-up to Katowice, the Climate Group, Carbon Disclosure Project and PwC reported that 120 states and regions from 32 countries, representing 21% of the global economy and 672 million people, have signed up to their own climate targets. Most pledges were from members of the Under2 Coalition, committing to reductions of 6.2% per year, the rate required to keep the planet below 2°C of global warming.
In Australia, Morrison’s time as Prime Minister looks set to be limited. In October, he lost his parliamentary majority when outsider Kerryn Phelps, campaigning on a platform including support for climate action and opposition to the controversial Adani Carmichael coal super-mine, won the by-election in Malcolm Turnbull’s old seat. The country must hold a general election before May next year, and electoral meltdown for the Liberals is a distinct possibility.
Canada is an important market to watch in 2019. Ottawa has decreed that all provinces must impose a carbon price of at least C$20. Those states that do not already do so will be subject to a Federal levy, but it will be returned directly to residents. The experiences of Australia and Ontario have showed how easy it is for populist conservatives to attack carbon taxes or credit auctions that are not fiscally neutral. If Canada’s scheme secures good public support, that will surely encourage fans of Carbon Fee and Dividend, the fiscally neutral approach promoted in the U.S. by the bipartisan Citizen’s Climate Lobby.
Even when it comes to the riots in Paris, the lesson is not that the public reject any and all action on climate. It is that the public expects climate action to be efficient as well as effective; policy to focus as much on the carrot of affordable clean solutions as on the stick of raising the cost of dirty ones; costs to be equitably shared; and for the benefits to be clearly communicated.
Make no mistake, the political pendulum is on the move back toward rapid climate action almost everywhere in the world.
Some thoughts on business cycles and speed of change
If the past 15 years have demonstrated anything, it is that the transition to clean energy and transportation will not be smooth. It will continue to be characterized by cycles, every six or seven years.
The first cycle of the modern clean energy transition ran from 2004 to 2010. We saw an explosion of interest in clean energy; investment grew from around $100 billion per year to $350 billion; cleantech went through its big bubble; many were foolishly optimistic and ended the cycle bitterly disappointed. The second cycle has run from 2011 until now, producing dramatic falls in wind and solar costs, and the beginnings of real scale. While investment stalled at an average of $350 billion per year – around one dollar in every six invested in the energy sector – by the end of 2018 wind and solar were generating around 7.5% of all electricity in the world.
The idea of the six- or seven-year business cycle is useful in thinking about how the energy and transport transition might play out. Bill Gates’s favorite economist, Vaclav Smil, points out that it took the better part of a century for coal to displace wood, or for oil and gas to start displacing coal; however, Peter Tertzakian, executive director of ARC Financial Corporation, urges us to focus on transformations market by market. What we see is that in one business cycle, sectors can be utterly transformed. In the past six years, LED lighting has gone from less than 5% of the global lighting market to more than 40%; coal in the U.K. has gone from over 40% to under 5%; plug-in vehicles in Norway have gone from around 5% of sales to nearly 50%.
The recent Intergovernmental Panel on Climate Change Special Report (SR15), published this October, makes clear that by 2030, one of two things will have happened: either we will have reduced emissions by 45%, or we will have burned through the remaining 580 GtCO2 carbon budget for a 50% chance of holding average temperature increases below 1.5°C. For a 50% chance of keeping below 2°C, the required emission reduction by 2030 still has to be at least 20%.
That is just 12 years away. Think about it: not only does each 6-year business cycle bear the risk of destroying businesses or business models that currently look impregnable; in just two business cycles – well within the range of our remaining careers – we will find ourselves in a world where either carbon emissions are dramatically lower, or there will be no remaining carbon budget, and presumably no societal license to operate carbon-intensive businesses.
Once you accept that the world is going to look very different at the end of the next two business cycles, whether we listen to the warnings of scientists or not, priorities become refreshingly clear.
Ignore the noise, focus on the signal. Trump is noise. Katowice is noise. Weather is noise. News is noise. The signal is, where do you want to be at the end of those two cycles? What portfolio do you want to own? What business do you want to be in? What business do you not want to be in? And – crucially – what do you need to do right now in order to get an edge on your competitors?
I warned you I was not offering jolly seasonal thoughts. But hopefully they are thoughts you can turn into action. Perhaps more New Year’s Resolution than Christmas Cheer.
Two business cycles. Don’t waste them.