As part of the Paris Climate Accord in 2015, over 180 countries agreed to reduce greenhouse gas emissions and limit global temperature increases to below two degrees Celsius. One of the key parts of the Agreement is the objective of ‘making finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development.’ Five years on and the results are mixed at best. The good news is that over the last 18 months there has been more movement and change than there has been over the last two decades.
Going forward, a lot needs to be done to mobilise capital to significantly expand investment in low-cost clean energy technologies such as solar and wind, which are needed to achieve carbon-neutrality. But I must admit that I am very positive about the future.
It is easy to criticise the finance industry for financing billions of dollars of new fossil fuel assets that are built every year. The justification has always been that this investment is needed for our economies and that the returns are there to be made. One of the positives of Covid is that it has given the investment community a view of what peak fossil fuel demand will be like. Thanks to weak demand for oil caused by the travel restrictions related to the Covid pandemoniac, oil prices turned negative on April 20, 2020 – meaning that producers had to pay customers to take their oil. A first for oil, but a wake-up call as well!
This event gave investors a view of peak oil, but not peak oil supply as many formally touted but peak demand. The result was that investors rushed for the door on their fossil fuel investments with share prices collapsing across the border. The ExxonMobil share price, for instance, finished 2020 down nearly 40%. In addition, businesses such as BP and Shell made asset impairments totalling $40bn sighting long-term risks around carbon price and oil demand. All three combined generated losses totalling $70bn for 2020.
What we are now seeing is the financial market pulling forward risk as investors seek to avoid ‘stranded assets’ and reallocate funds to greener investments such as the US electrical utility company NextEra, which for a while last year became the biggest energy company in the Western world. Its share price finished 2020 up 20% as investors jumped on the decarbonisation opportunity.
What we are also seeing is that investors across the world are increasingly seeing climate risk as investment risk. There are two aspects to this: the first of which are physical risks, such as storm damage; and the second, climate policy. The latter is a risk particularly for owners of fossil fuel assets or those who are dependent on fossil fuels as an energy source – however, it is also an opportunity as new regulation and legislation drive growth, demand and capital flows into clean energy.
How we produce, use and transport energy is at the heart of the energy transition. The challenge, however, is much greater, requiring structural change in areas as diverse as housing, transport, agriculture, and heavy industry. We require creative thinking, technical solutions, business models, market mechanisms, and financial offerings to achieve net-zero. More importantly, the energy transition also calls for a profound rethinking of how we live and work. We also need to switch the thinking in the finance world from just measuring the risks of climate change to focusing on the opportunities that this transition provides.
The cheapest form of energy has always led to great periods of economic growth and comparative competitive advantage. Think of Britain with its cheap coal during the industrial revolution or Saudi Arabia with its low-cost oil. Today, the most affordable ways to produce electricity are with solar and wind, and as we electrify more and more of society, these technologies will become the bedrock of a 21st century economy. What makes these renewable technologies really interesting is that they have no fuel costs with minimal and highly predictable operating costs. In this new world the way to drive down costs and thus increase competitive advantage is to push down capital costs while at the same time building up the necessary skill set to ramp up and run an energy system based on these technologies.
The good news is that there is no shortage of capital across the world. In fact, the world is flooded with low cost money looking for a home. But this capital is not finding its ways to sectors such as hard to decarbonise on