This white paper surveys changes sweeping the global energy industry as net-zero carbon policy and alternative technologies begin to displace fossil fuels.
Researched and wrote 5,000-word report, drawing on primary research, press coverage and subject matter interviews; researched and designed data visualizations.
Target audience: Finance, traders and risk professionals in the finance, oil/gas, utility and renewables sectors.
On behalf of the Global Assn of Risk Professionals. Published February 2021.
Better standards could help cut climate risk by deepening markets for green debt to fund low-carbon solutions
In the struggle to recover from the COVID-19 economic crash, the European Union has set out to rekindle growth via green stimulus. In early September, European leadership upped the bloc’s already ambitious green goals, aiming to cut emissions 55% by 2030 against 1990 levels, up from an earlier reduction target of 40%.
To fund the effort, Europe mapped out plans to issue €225 billion ($267 billion) in green bonds as part of the overarching €750-billion Next Generation EU coronavirus recovery fund. Some 37% of the fund will target climate-change projects such as hydrogen power, energy-efficient building renovations, and one million electric vehicle charging points, reports The Wall Street Journal.
The program accelerates Europe’s already world-leading push to hit net-zero emissions by 2050, a goal formalized as part of the European Green Deal. As a secondary benefit, a surge of EU-backed green bonds could help transform a nascent market with increased liquidity just as the appetite is growing for long-term, stable, green-tinted investments among insurers, pension funds, endowments, and other long-term investors.
Green bonds are growing quickly, but remain a niche in global debt markets. From less than $1 billion a decade ago, issuance of green bonds eclipsed $250 billion in 2019 (chart, via The Financial Times, or FT), comprising about 3.5% of the global total of $7.15 trillion, according to a recent note from the Bank of International Settlements.
Rising appeal — and challenges
Green bonds offer a way to raise long-term, lower-cost funds for projects that target climate change and/or benefit the environment. Green bonds let companies and governments tap into rising demand for environmentally-focused investments from insurers, pension funds, ESG funds, and the like.
Yet for all their appeal, green bonds are selling a promise of sustainability that, so far, lacks the sort of rigorous rules and rating regimes that define legacy bond markets. For that reason, a bigger wave of green bonds will up the pressure to improve standards and deepen confidence in a financial tool that could help firms and governments alike mobilize trillions of dollars of capital to fund climate-related transformation.
As green bond volumes rise, so too has scrutiny. In 2019, a top executive at Japan’s Government Pension Investment Fund — the world’s biggest pension fund — expressed concerns over the space. He told the FT that, without greater volume and higher confidence in selection standards, the asset class risks becoming “a passing fad.” Such doubts could slow green bonds’ growth.
In the wider bond market, where tiny differentials in risk and yield can rapidly redirect huge capital flows, green bonds’ smaller market size, relative immaturity, and rising popularity can lead to unexpected outcomes. For instance, in 2019, Verizon issued $1 billion in green bonds that were oversubscribed eight fold. This led to a yield that was lower than the company’s conventional bonds.
Verizon’s successful listing, albeit anecdotal, suggests that green bonds may benefit from the sort of investor enthusiasm that has already lifted flows into green equity markets. Stock funds focused on environmental, social, and governance (ESG) factors have outperformed conventional investments over the past decade. To be sure, green bonds are subject to different market dynamics, yet both asset types could benefit from rising public sentiment.
Cultivating greener standards
Debt markets could see similar gains unfold in green bonds but are more reliant on an ecosystem of regulated ratings processes and investment standards. Hence, the need for more evolved rules around — and understanding of — what qualifies as “green” in a bond, and why it should thus merit different pricing and risk consideration.
Specialized green standards are emerging, and Europe is taking the lead. In 2019, the EU approved a set of guidelines (see the April 2020 EU technical report on sustainable finance here) better defining what counts as a sustainable investment. The new rules are “a clear signal to the financial markets that sustainable investment should become the new mainstream,” Bas Eickhout, a Green MEP told the FT.
These extend a foundation of green bond certifications and standards developed by private rating agencies. Issuers can get a green label if individual projects are in line with standards set out by the Green Bond Principles (GBPs) of the International Capital Market Association (ICMA).
To widen these criteria, Torsten Ehlers, Benoit Mojon, and Frank Packer at the Bank of International Settlements have endorsed an approach that would create firm-level ratings based on carbon intensity (carbon emissions relative to revenue) that would complement project-level bond assessments.
Their proposal addresses another concern in the nascent market, where green bonds are not yet generating measurable carbon reductions for their issuers: “green bond projects have not necessarily translated into comparatively low or falling carbon emissions at the firm level.”
When factored into project-based bond issuances, a firm-wide measure of carbon intensity could help would-be buyers and rating agencies better assess the overall climate impact of a green bond offering.
By this logic, automaker ABC Co. with an all-electric fleet would be rated somewhat higher on a green bond to fund a new EV plant compared with legacy car company XYZ Inc. issuing a similar bond to build its first EV factory. Such a system could reward ABC Co. with a lower cost of debt, thereby incenting long-term, systemic commitments to a low-carbon strategy.
Imperative innovation
This is a helpful reminder that, for all of the necessary minutiae around green bond ratings and standards, the higher goal is to fund investments that cut carbon.
Indeed, vital as energy innovations are –– from high-output wind turbines to low-cost batteries — to solving the climate crisis, markets face a related urgency to advance the technology behind the financial instruments needed to efficiently fund the decarbonization of energy systems. Accordingly, financial instruments that advance environmental sustainability are a growing priority for asset managers, corporate debt issuers, and governments alike.
Financial innovation sits at the heart of the 2015 Paris climate goals. The accord includes language committing signatories to make “finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development.”
By this logic, the imperative is clear. For green bonds to fulfill their promise — to drive decarbonization and lower climate risk — the finance industry must advance reliable rules to incent long-term investments that begin to deliver real reductions in carbon intensity.
Adam Aston is a senior writer, editor, and content consultant specializing in energy and climate. Connect with him on LinkedIn and Twitter.
Improved climate model narrows prediction uncertainty and raises the odds of serious climate impacts from global warming
Risk managers and climate scientists share a fundamental challenge: How to identify, weigh, and process a dizzying mix of signals to better model a range of possible future outcomes. Accordingly, the complex mathematical methods underlying both disciplines tend to advance slowly. It’s rare to see big improvements in the precision of their forecasts.
Yet this past July, climate scientists achieved just such a leap, with the publication of an outlook — conducted under the World Climate Research Programme (WCRP) and published in the Review of Geophysics — for global warming that, for the first time, merges three disparate data sets and methodologies. Important as the technical improvements are, however, the conclusions have broader bearing for both climate science and risk managers.
The improved model predicts more warming in a world where CO2 levels hit twice their pre-industrial level, a threshold anticipated to hit mid-century, rather than closer to 2100. The findings thus boost the probability of serious climate impacts to energy operations, financial markets, human health, and the environment.
How much more warming by when?
To better understand the recalibration of this forecast, it’s helpful to revisit its predecessor. Since a landmark study published in 1979, scientists have expressed their outlook for temperature increase as a range — given a doubling of CO2 to pre-industrial levels — from a lower bound of 1.5°C to an upper limit of 4.5°C. From regulators to boardroom executives, planners have used this range as a reference for policy and business strategy over the past 40-odd years.
The new study narrows the bounds of this forecast range. It raises the lower limit of the estimate to 2.6°C while slightly reducing the upper bound, to 3.9°C by 2100. (See chart, via Science.)
“Narrowing the uncertainty is relevant not only for climate science but also for society that is responsible for solid decision making,” said Masahiro Watanabe, a professor at the University of Tokyo’s atmosphere and ocean research institute and one of the report’s authors, in an interview with The New York Times.
The study underscores a rising sense of certainty that the rate of warming is increasing. Today, global temperatures are already 1.2°C higher than their pre-industrial average.
The goal of the 1.5°C target was enshrined in the 2015 Paris climate accords, and has galvanized policy, business and public attention in part because it also represents what many scientists believe may be a critical threshold, a temperature gain beyond which the destabilizing effects of warming could accelerate sharply.
How is this study different?
For the first time, the new assessment unifies findings from three previously independent fields of climate research and analysis spanning vastly different eras.
The oldest numbers were taken from records of prehistoric temperatures preserved in sediment layers and tree rings. The next youngest come from direct measurement of temperatures taken since the start of the industrial revolution in the 1800s. And the most recent set of inputs was drawn from satellite measurements and computer models beginning in the 1980s.
On their own, none of these data sets could help refine the range of the temperature outlook. Simply synthesizing the disparate data sets was a challenge without precedent. The researchers were also able to enhance the precision of how feedback loops shape the outlook — for instance, how the loss of highly reflective white sea ice accelerates how quickly polar waters absorb heat. By merging and refining each vintage of findings, the meta-analysis delivered precision greater than the sum of its parts.
What’s more, the data proved to be more convergent than researchers anticipated. Co-author Gabriele Hegerl, a professor of climate system science at the University of Edinburgh, told The New York Times that she was surprised by the way the models converged. “We don’t expect these three lines of evidence to agree completely,” she said, but they did.
Data from the refined forecast will be used by the U.N.’s Intergovernmental Panel on Climate Change (IPCC) for its next major assessment in 2021 or 2022, Science magazine reports. From there, the data is likely to ripple into other national, academic, and private-sector models and inform projections for sea-level rise, economic damage, and other climate impacts.
Implications for risk managers
When offered equally probable good and bad outcomes, most folks tend to be too optimistic. Human nature is biased to think the good outcome is more likely; conversely, people tend to spend too little time thinking through the implications of the bad outcome. Put plainly, a lot of us tend to translate uncertainty as things should be okay.
Yet as risk professionals know all too well, uncertainty is always a double-edged sword. In the realm of climate change the risks vary from less severe and arriving more slowly to more intense and happening faster. To date, evidence is mounting that the outlook is tilted towards the bad, with disruptive changes happening faster and sooner than prior models anticipated. This has much to do with the complexity of the science behind modeling planet-sized physical systems. It also stems from science’s conservative culture: scientists tend to err on the side of caution when forecasting.
In the here and now, energy risk planners are already reckoning with climate phenomenon that are hitting energy markets and operations harder and faster than anticipated:
Wildfires are happening earlier, growing larger and impacting wider areas, in Australia, Russia, and the western U.S., damaging facilities and disrupting the extraction, processing, generation, and distribution of energy.
The intensity of hurricanes and tropical storms is rising at unseen speeds in the warming waters of the Atlantic Ocean and Gulf of Mexico, imperiling petrochemical plants.
Heat and heat-related illnesses kill more Americans each year than any other form of severe weather, according to the National Weather Service. Worldwide, similar patterns are likely, as heat stress raises physical and liability risks for workers and customers.
For business leaders, the challenge is growing more urgent. While the new scientific study shifts up the long-term temperature forecast, it remains in many ways a pure abstraction — an estimate off in the future.
And for risk managers, the challenge is to take these multi-decadal temperature forecasts and translate them into material risk recommendations. How will another degree — or more — of warming change business conditions? Over the next five years, the next decade, or by mid-century? Where and in what ways could the increase manifest?
