COP23: incentivising low-carbon infrastructure in 2018

A look at project finance and infra in 2018

Against a backdrop of extreme weather events around the world, COP23 focused on the need to accelerate mitigation efforts and increase infrastructure resilience. S&P Global Ratings and Norton Rose Fulbright ask how these ambitions will affect the energy and infrastructure sectors in the year ahead, and beyond.

The close of 2017 saw a flurry of climate action: Syria and Nicaragua became the latest two countries to sign the Paris Climate Agreement; Fiji issued the first developing country sovereign green bond; and France hosted the One Planet Summit in mid-December to mark the second anniversary of the Paris Agreement and to push for commitments on carbon neutrality in the face of climate-related threats.
November’s COP23 was the nexus. Countries around the world came together and called for heightened adaptation measures, more climate-related financial disclosure, and enhanced incentives for mobilising capital to fund a low-carbon transition. The negotiations also considered the changing strategies of the energy and infrastructure sectors. So, what was discussed? What were the targets set? And what does it all mean for infrastructure and project finance in 2018?

Heightened disclosure: why it matters

Among the key outcomes from both COP23 and France’s One Planet Summit has been the successful early adoption of recommendations by the Financial Stability Board’s Task Force on Climate-Related Financial Disclosures (TCFD), which provide a framework for companies to disclose their exposure to both environmental and climate-related risks, as well as opportunities.
Widespread uptake of the TCFD’s suggestions was announced at the One Planet Summit, with 237 corporates – boasting a combined market capitalisation of US$6.3trn – declaring their support. But how will enhanced disclosure actually help?
Mark Campanale, the Executive Director of Carbon Tracker, a non-profit financial think tank that pioneered the ‘stranded assets’/’carbon bubble’ concept, explains that there is a disparity between financial and scientific forecasts, which needs to be dispelled. The so-called ‘brown economy infrastructure’ – or the fossil fuel economy – is forecasted by the International Energy Agency (IEA) to continue enjoying high levels of investment. Under current IEA scenarios, along with predictions from Shell and the Organization of the Petroleum Exporting Countries (OPEC),oil demand may increase by anywhere between 25% and 30% – which, in theory, is encouraging for carbon fuel investments. For Campanale, however, the science is incompatible: “If carbon emissions continue at the rate being experienced today, the world will eventually become uninhabitable.”

The TCFD will help corporates to graph a broad range of downside scenarios for investors, the market, shareholders and regulators

So, more green investment will be needed. Indeed, clean power technologies are likely to attract some $10 trillion of new capital by 2040 – or 60% of new investment – compared to just 14% for fossil fuels (according to Bloomberg New Energy Finance). Compared with coal-fired generators, solar and wind projects do not have a longstanding track record of operational financial returns that conservative credit investors can satisfactorily model. In some parts of the world, traditional bankers haven’t the experience of providing credit to renewables, making credit terms unnecessarily onerous.  
This is where the TCFD comes in: its role is to help corporates to graph a broad range of downside scenarios for investors, the market, shareholders and regulators alike – thus eliminating any discrepancies between the received wisdom around the effects of climate change and the world’s heavy-duty industrial past. TCFD-based disclosure can also help to identify those assets that will become stranded – that is, assets that will have to be retired before their economic life has been realised – as renewable energy sources become increasingly viable.
“The continued success of the TCFD’s recommendations can incentivise the world of business and finance towards allocating more capital to the low-carbon transition,” says Michael Wilkins, Head of Environmental and Climate Risk Research at S&P Global Ratings. Yet this depends on continued widespread adoption. The TCFD’s Recommendations are not yet mandatory – with France thus far the only nation in the world to introduce obligatory climate-related risk disclosure for companies, under the framework of Article 173 of its 2015 Energy Transition Law.

America: in or out?

While America’s position has – for some observers – been one of ambiguity, a number of prominent US companies have pledged their support for the Paris Agreement. What’s more, despite the current Administration’s stated intent to withdraw from the Paris Agreement, some US governors and senators are taking greater responsibility for promoting America’s climate change mitigation efforts. Sam Bickersteth, Director at PwC and CEO of the Climate and Development Knowledge Development Network, highlights that “momentum exists external to the federal process”. Indeed, action at state level is establishing the means of reducing America’s carbon emissions: New York State, which aims to reduce carbon emissions by 40% by 2030, is a case in point.

Irrespective of its official stance on climate change the US may yet realise its Paris Agreement pledges

Michael Lewis, Head of Sustainable Finance Research at Deutsche Asset Management, believes that economics and technology will likely outplay politics when it comes to implementing emission reduction strategies. This is because corporates with their own carbon targets may have increasing influence. During COP23, Microsoft, for instance, pledged to cut its operational carbon emissions by 75% before 2030. The tech firm also plans to relocate its suburban Michigan operations to Detroit, where the city’s Mayor, Mike Duggan, has committed the municipality to the principles of the Paris Agreement.
In addition, Michael Wilkins notes that some US states – such as New York, Massachusetts and California – have already introduced renewable portfolio standards (RPS), which are directly affecting the operations of locally-active electricity companies. An RPS necessitates that a certain amount of the energy generated by any given utility is derived from renewable sources. 29 states now have an RPS, but Hawaii is leading the way: the state has decreed that 100% of utility-sold energy be renewable.
So as states and municipalities coalesce for the common goal of reducing carbon emissions, there is continued momentum.As such, irrespective of its official stance on climate change the US may yet realise its Paris Agreement pledges – and American infrastructure practitioners should be preparing for the transition towards a low-carbon economy that is already underway.

Incentivising capital for the low-carbon transition

However, for countries’ ambitious Paris Agreement pledges – known as the Nationally Determined Contributions (NDCs) – to be met, mobilising more capital for initiatives such as renewable energy farms and sustainable infrastructure projects will be vital. Governments are already altering policies in order to encourage market engagement from private sector funds, where a majority of the NDC financing will likely originate. Yet regulation supporting NDCs may come too late. The formal process for reviewing NDCs is set to take place in 2023 – yet the pace of climate change is demanding the growth of green infrastructure and energy efficient solutions before then.
Moreover, the impact of severe weather events and ever-rising sea levels reminds us of the need for action – particularly in vulnerable or island nations – and the need for adaptation, as well as mitigation, efforts. Certainly, this matters for supply chains. Simon Currie, Global Head of Energy at Norton Rose Fulbright, notes that corporates need to be aware of the physical risks facing their global supply chains and work to ensure they are “adaptable and resilient”.
What has 2017 taught us? We know that in order to manage the increasingly acute environmental and climate-related risks, enabling finance for sustainable infrastructure that can mitigate climate change – or for infrastructure fortified to adapt to its effects – is crucial. In the wake of COP23, climate negotiations are already bringing repercussions on many energy and infrastructure sector assets: from enhanced resilience and low-carbon transportation projects, to the conversion of fossil fuel power plants. We can expect these discussions to continue throughout 2018.

The industry experts quoted were participants at the International Project Finance Association’s (IPFA) “COP23: Outcomes and Impact on the Energy and Infrastructure Sector” event in November 2017.