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Decarbonisation set for a boost in the EU

The EU is stepping up its efforts to tackle global warming. A new tougher target to cut air pollution should enhance the economic incentive for companies to switch to more environmentally friendly ways of doing business.

That is the conclusion chief sustainability strategist Mark Lewis draws from the European Commission’s plans to aim for a 55% cut in greenhouse gas (GHG) emissions by 2030 as part of a broader European Green Deal programme to reach climate neutrality by 2050.

Lower emissions - Necessary and urgent

He argues the target is not only realistic, but also necessary and urgent in the face of an unabating stream of climate-related natural disasters that can be seen as wake-up calls, including wildfires in Australia and California, hurricanes and even unusual heat and tundra fires in Siberia.

The goal is definitely achievable, not least because good progress is already being made in decarbonising the power sector in Europe, cutting emissions in the process.

In addition, the drop in social and economic activity resulting from COVID-19 measures has caused emissions to tail off as well.

While the lifting of restrictions has led to higher emissions again, the pandemic looks set to have changed behaviour structurally with more and more people opting to continue to work at home and a potential lasting drop in business and long-haul tourist travel.

Cost of renewable energy is falling

On the cost side of decarbonisation, renewable energy technologies have continued to become cheaper and cheaper. Batteries, which hold the key to storing solar and wind energy, are improving, resulting in more efficient storage and cost advantages.

Among the alternative energy sources, green hydrogen should take a more prominent role since decarbonisation cannot be achieved by renewable energy sources alone.

As part of its Green Deal, the EU has marked green hydrogen as a priority. It estimates that cumulative investments in renewable hydrogen in Europe could reach EUR 180 billion to 470 billion by 2050. Moreover, the model used to scale up renewable energy sources in recent decades can be used to scale up green hydrogen as well.

Carbon pricing – The growing incentive to switch

The EU’s more ambitious emissions cutting target involves changes to the carbon market, known as the Emissions Trading System (ETS). The ‘cap-and-trade’ market works with tradeable ‘permits’ held by emitters in certain sectors and industries which they must surrender when they emit a tonne of CO2 in a certain year (also see our separate article Climate action 101 – The EU Emissions Trading System)

The number of permits, or allowances, is capped and the maximum amount declines every year to encourage emitters to shift to greener technologies. The price is set based on supply and demand.

The new target can be expected to result in a significant tightening of the cap. This should drive up the already near record high price of carbon, in turn increasing the cost of polluting and adding to the pressure on sectors to switch to lower carbon energy sources.

Further upward pressure on the carbon price looks likely to come from companies reluctant to sell allowances that might not be needed this year, but which they require in the future as the maximum falls.

Hence, dearer carbon will act as an incentive to decarbonise.

With the current price of carbon already near the ‘fuel switching’ level, i.e. the point at which utility owners are incentivised to run cleaner gas-powered plants ahead of coal-powered plants [1], this could be seen as a signal that the mechanism of pricing carbon can be applied more broadly.

Broadening the scope in the EU and beyond

While demand for allowances took a hit from the plunge in activity in the second quarter due to the lockdowns, it can be expected to get a lift when the scope of the ETS is extended to sectors such as road and marine transport and buildings are included.

Such a holistic approach would enable the EU to cut emissions dramatically and beef up the role of the ETS as the main driver of emissions reductions.

Equally, the ETS could be introduced outside of Europe. Indeed, we believe the world as a whole needs to think much more seriously about ways to cut emissions.

Having a well-running carbon pricing market can create more efficiency savings and give emitters an economic incentive to conduct business and produce in a more environmentally friendly way for our common future.

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[1] Fuel switching to abate carbon emissions consists in substituting combined cycle gas turbines (CCGTs) for hard-coal plants in off-peak power generation. Thereby coal plants run for shorter periods, allowing power producers to reduce their CO2 emissions. Source: Understanding fuel switching under the EU ETS


Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice.

The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

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