Climate change a financing challenge and becoming more complex

The quality of life in China - and that means pollution - is at the centre of affairs. Pollution means not just the visible deterioration of air and waterway quality so often in the news but the underlying economic forces behind those environmental catastrophes.

"The need to accelerate climate change policy has implications for those financing future investment, be they banks, investment funds or private individuals"
Andrew Cornell, Managing Editor

Couple that with the accord between the two major world economies, China and the United States, which gazumped the recent B20 agenda in Brisbane and policy in Europe and the push towards a carbon-constrained global economy is clear.

Yet there remains a fundamental disconnect between where the world is heading based on the implications of these decisions and where it is heading based on announced policy.

This clearly is significant for resource and energy companies providing the raw materials and generation capacity. But equally it has implications for those financing future investment, be they banks, investment funds or private individuals.

At a forum at Melbourne University last week organised by the Grattan Institute on “What is the future of Australian energy exports in a carbon constrained world?”, the director of Grattan’s energy program Tony Wood put up a chart showing the drastic disjunction between global energy-related carbon dioxide emissions (CO2 ) under set policy and what is required to meet the so-called “450 scenario".

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The 450 Scenario from the World Energy Outlook sets out an energy pathway consistent with the goal of limiting the global increase in temperature to 2°C by limiting concentration of greenhouse gases in the atmosphere to around 450 parts per million of CO2.

Bluntly, a lot more is going to have to happen if that scenario is to become a reality and another presenter at the Grattan event, Fiona Wild, BHP Billiton’s Vice President Environment and Climate Change, sketched out what the world’s largest diversified miner is planning.

Not surprisingly, like the mainstream scientific, policy and corporate community in general, BHP is not in denial about climate change and the human contribution to carbon emissions. While plenty of airspace in the media still goes to various the mad uncles who love to yap at the dinner table, Wild said simply BHP knows the evidence is clear, warming is unequivocal, the human influence undoubted.

What is uncertain is impact. As with any set of forecasts with a range of variables, the possible scenarios for longer term impact are broad. The implications of the manifold human response alternatives are complex and entwined.

Critically, they are made even broader by influences outside the physical world – notably government policy and market signals.

For Australia, the import of this multi-generational shift in the global economy is enormous, particularly given Australia is a carbon-energy superpower. As the Grattan event noted “for the last decade Australia’s balance of trade has been heavily reliant on coal exports, and we have great expectations to become the world’s biggest exporter of liquefied natural gas.

“But things are changing: future global demand for coal looks soft, there is recent uncertainty about gas prices and Australia’s competitiveness, and demand for renewable energy is rising.”

At the more drastic end of scenarios, governments like China may well impose carbon taxes at such levels that some carbon-intensive assets become economically unfeasible to develop. Critically that could also occur if renewable alternatives, either through industrial advances or government support, become cheap enough to supplant coal.

As Wood pointed out, “the world is committed to lower use of coal and gas”. BHP is boosting investment in emission reduction and considering direct investments in reduction technology. The company has already invested around half a billion dollars in this area in the last decade.

Wild said BHP’s scenario planning covered outcomes which were “divergent but plausible”. BHP’s answer is high quality product which is better able to mitigate against the impact. That also recognises fossil fuels will continue to provide the major source of energy and hence policy and economic pressure will be on reducing emissions.

“The adoption of technology (to reduce emissions) must be much faster than the normal commercial cycle,” she said.

The Grattan event heard from speakers looking at carbon capture and sequestration and using concentrated solar power for outcomes long considered impossible, such as base load power or for steel manufacturing.

Nevertheless, and despite the constant improvement in energy efficiency (for example outlined in BP’s closely watched Energy Outlook), there is this widening gap between the 450 goal, government policy and technology.

Inevitably, while Australia has shifted away from it due to the political climate, the starting point for much policy is likely to be a carbon tax, a price on carbon which allows market forces to shift resources into areas with higher economic return.

Government policy, either through direct support or fiscal incentives, will play a role in steering markets.

And that’s why it’s not just BHP which needs robust scenario planning. The range of possible outcomes as the world grapples with and governments respond to the reality of climate change – particularly in the face of extreme weather events (whether or not directly linked to climate change) – is enormous.

For the providers of capital, the market risks are significant. They may be blunt: for example the disinvestment in fossil fuel companies by some institutions using various ethical screens or popular campaigns against coal investment.

But the more prominent risks are likely to be government policy. Westpac Banking Corp, for example, was very quick to establish an emissions trading desk a few years ago based on the reasonable assumption that this economically rationale approach to emission reduction was likely to become an important business. The political cycle put paid to that.

More recently, the beleaguered Australian Clean Energy Finance Corporation – which actually is a profitable investment fund in the emission reduction space – has faced calls to improve its returns without increasing risk. Extra return without extra risk is of course the Holy Grail of investment and like that mythical vessel has never been found.

Chinese Premier Li Keqiang made clear in his “work report” on the opening day of People’s Congress China is serious about constraining carbon as it plans to reduce energy intensity 3.1 per cent this year and cap carbon emissions by 2030.

The intergenerational challenge of climate change is so immense that any idea of an open, transparent market in the global economy is wishful thinking. But that doesn’t mean providers of capital – banks, funds, private investors – can ignore the pricing signals that are emerging and recognise the necessity for the kind of exhaustive scenario planning companies like BHP are undertaking.