Cost of carbon: the G7’s commitment to fossil fuels opens the way to “net zero emissions” – EconomieMatin

Leaders of the Group of Seven (G7) countries agreed to end fossil fuel subsidies within four years. This pledge, the most ambitious of the summit held from June 11 to 13, 2021, builds on current commitments to transition to zero-carbon economies within three decades. For investors, this decision represents challenges, but also unprecedented growth opportunities in new technologies and rapidly changing sectors.

Since 1970, carbon dioxide emissions have increased by around 90% and fossil fuels are responsible for 78% of this increase. From now on, more than 100 nations have committed to achieving carbon neutrality by 2050, while China has set the same goal by 2060. The commitment of the G7, which brings together the United States, Germany, Japan, France, the United Kingdom, Canada and Italy, to phase out subsidies granted to fossil fuels will be decisive in the achievement of these objectives and could redirect significant financial resources towards the development of renewable energy production facilities.

Clearly, the fastest way to reach the net zero emissions goal would be to stop subsidizing fossil fuels. However, just as bread was politically sensitive in ancient Rome or in Bourbon France, the price of fuel is today in most countries around the world. However, according to the International Monetary Fund (IMF), the total elimination of these subsidies would reduce carbon emissions by more than a quarter and nearly half the deaths linked to air pollution. From an economic point of view, spending on fuel does not lead to increased economic output, but less efficient use of energy.

Globally, the scale of subsidies granted to fossil fuels is considerable. In total, they represent 85% of all public aid, according to an IMF study carried out in 2019. Just before the pandemic, the planet witnessed an increase in these subsidies for the first time since 2013. The IMF estimated that in 2017, 6.5% of global gross domestic production was devoted to them, compared to 4.5% for education. In 2015, China spent $ 1.4 trillion in this area, more than double that of the United States.

Set the price for carbon

The end of subsidies would also allow market prices to better reflect real energy costs. Because they skew the relative price of energy in favor of fossil fuels, despite the dramatic drop in the absolute cost of renewable energy sources in recent years.

Among the efforts to fix the price of carbon more fairly, we can mention the main carbon market in the world, the European Union’s Community Emissions Trading System (EU ETS).

The EU ETS sets pollution ceilings for some 12,000 power producers, businesses and airlines across the continent. Until 2018, the price of carbon permits under this European cap and trade system did not exceed EUR 10 per tonne. Since October 2020 the price has more than doubled to a record high in mid-May at 56.65 EUR per tonne and is currently trading at 52.09 EUR per tonne (see graph).

The demand for these emission rights and the prices that go with them has increased with plans to impose stricter pollution targets. Unless emissions are reduced, carbon trading alone will not reduce greenhouse gas pollution. According to the EU executive, even if the mechanism seems to work, the price of carbon “should be much higher” to effectively contribute to the fight against pollution in the long term. To achieve the objective of the Paris agreement, consisting in limiting global warming to 1.5 degrees Celsius, the price will have to approach 100 EUR per tonne during this decade already, underlines the World Bank.

Fix a floor

On June 18, 2021, the IMF presented a proposal to set three minimum carbon prices for the US, EU, China, India, Canada and UK by 2030, namely 75, 50 or 25 USD per tonne, i.e. differentiated prices for countries at different levels of economic development. This would set an international floor price and keep emissions for this decade below the two degrees Celsius target set by the Paris climate agreement. According to the IMF, four-fifths of global emissions “have not yet been priced,” with an average price of $ 3 per tonne.

On July 14, the European Commission is expected to release a new set of measures that will revise and possibly expand the EU ETS market in line with the EU’s goal of halving carbon emissions by 2030. We expect these new measures to accelerate the 2.2% annual reduction in the number of programs offered., expand the number of polluters who must pay, gradually eliminate free allowances and introduce a carbon tax at borders. All of these measures would be additional structural support for an increase in the price of carbon.

But the higher carbon price will only really show its effects when it is applied to all sectors and all countries, thus motivating industries to take the plunge and reduce their emissions, and encouraging research and investment. in innovative alternative energies. As the energy market evolves, the demand for metals and minerals essential for the production of renewable energy will only grow.

Because alternative energy sources use technologies that depend on many metals and elements. Solar panels need arsenic, gallium, germanium, indium and tellurium, while wind turbines rely on aluminum and other rare elements. As for energy storage in batteries, it depends on cobalt, graphite, lithium and manganese, while all machines require copper, the demand for which is expected to increase by 60% over the next two decades.

The G7 also agreed to increase investment in the technologies and infrastructure needed for decarbonization. In the wake of the pandemic, the US, EU and Japan have all pledged to implement large-scale infrastructure projects that will support the recovery and foster the transition to a zero-carbon economy.

Positioning of portfolios

The exposure of the carbon market to changing supply regulations makes this asset difficult to value and subject to short-term volatility. That said, in the long run, the price hike is more than likely. According to numerous studies, prices will be in a range of between 150 and 300 USD per tonne by 2040. As investors take into account the scale of the transition to a net zero emission economy and devote ever greater attention to corporate climate action plans, there could be a rapid shift in market sentiment.

In terms of consumption, trends change quickly, leading to differentiation within sectors. For a growing number of them, starting with energy providers, utilities and materials, valuations will begin to reflect the rising price of carbon. This means that investors should focus on companies that are furthest along the “net zero emissions” path and apply a thematic approach.

In the long term, there will clearly be winners and losers in the alternative energy and infrastructure sector, depending on which energy source emerges as the dominant fuel to achieve carbon neutrality. Investment strategies should reflect this transition to new business models and identify opportunities present in industries with high carbon dioxide emissions where there are solutions to reduce these emissions with the greatest impact on the climate.

We call these companies “ice cubes” because they have the potential to “cool” the climate as they work to meet the goals of the Paris Agreement. Others, who fail to make a transition to net zero, are more categorized as ‘logs on fire’ and risk ending up with assets that risk significant impairment as they fight. to operate in a regulated net zero world.
Investors will need diversified exposure to sustainable energies. Given the potential volatility of the latter, they will benefit from active management.