Business as unusual: The implications of fossil divestment and green bonds for financial flows, economic growth and energy market
Introduction
Climate change has been on the political agenda for decades but not been prominent among the ethical concerns and responsible investments in the society, partly because of lack of confidence in scientific documentation, partly because of the strong economic position and political influence of the energy sectors. However, this is changing. The IPCC 5th Assessment Report concluded that human influence on the climate system is clear and that recent climate change has had widespread impact on human and natural systems, also warning that climate change will amplify existing risks (IPCC, 2014). Increasingly people around the world perceive that the climate is changing and the challenge of climate change has reached the minds of both investors and consumers. Politicians have been negotiating with a meagre result, although the Paris Agreement might represent a change as the Parties confirmed their commitments to a maximum temperature rise of 2 °C above pre-industrial levels, and pledged to strive for lowering maximum warming to 1.5 °C (UNFCCC, 2017).
The business community already shows willingness to act. Global warming is a threat of a magnitude that might disrupt the global economy and political stability (Carney, 2015; TCFD, 2017) exposing business as well as society at large to transition risk and physical risk. Transition risk is associated with structural changes required to achieve a low-carbon economy, whereas physical risk relates to exposure to costs of global warming and extreme weather events (Aaheim et al., 2017; Roson & Sartori, 2016). Considering the mounting evidence of global warming, corporations and large institutional investors in particular now mobilize for a controlled phase-out of CO2 emissions (Arabella Advisors, 2015). The trend among investors towards responsible finance targeting climate change has surfaced as pledges to invest in green projects or to abstain from investments in fossil industries, in particular coal.
Besides being exposed to divestment driven by environmental priorities and economic stability concerns of investors, fossil industries are also vulnerable to future tightening of climate policy, adding to the risk of overinvesting in capital intensive fossil energy and turn productive assets into industrial ghosts. The risk of stranded assets in fossil industries is increasingly seen as a real and non-negligible threat even in the medium term (Climate Bonds Initiative, 2017). This applies not only to coal industries as petroleum companies are also exposed to high risk of overinvestment if the 2 °C target is to be met (Carbon Tracker initiative, 2017). A Citigroup report warns that the 2 °C target might involve stranded assets of USD100tr by 2050 (Citigroup, 2015).
In view of the 2008 financial crisis the G20 countries asked the Financial Stability Board (FSB) to review how the financial sector can incorporate climate related issues in reporting to avoid sudden loss of assets. A Task Force on Climate-related Financial Disclosure was established with the mandate to provide clear, comparable and consistent information about risks and opportunities of climate change, submitting its recommendations in June 2017 (TCFD, 2017).
Whereas financial disclosure of carbon related risk is in its early phase, business already influence the financial market through selective lending and investment. Two parallel pathways to climate friendly investments are dominating: divestment in fossil industries and finance earmarked for low carbon projects, e.g. labeled green bonds (Climate Bonds Initiative, 2017). Fossil divestment restricts finance from entering projects that extract, transform or refine fossil energy. Coal divestment is the dominating element, however, there are funds that also pledge to keep out of oil and natural gas. Further, there is green funding exclusively for renewable energy or other activities that strengthens sustainability, among them increased resilience towards climate change. As a result there is no longer a single market for finance, but various segments representing accessible finance for non-coal industries, for non-fossil industries and for industries without any responsibility label.
The idea of green finance is frequently met with the argument that financial flows will fill the gap in supply to the polluting industries, leaving the market unaffected. This is reasonable when the pledges represent a marginal share of the financial flows in an otherwise flexible financial market. On the other extreme, if no investment finance was available to coal, the industry would wither. Less drastic constraints on investment flows will also eventually affect the fossil industry, driving a wedge between the cost of finance for fossil versus other industries. Dedicated green finance plays a similar role by restricting funding from entering other industries than the preferred one. The financial flows are no longer roaming freely and the market is split in distinctive segments.
A timely question is therefore how green bonds and divestment in fossil industries will affect the economy at large and contribute to climate mitigation in particular. In this article we report from a study of how dedicated green finance and divestment in fossil industries might impact the economy, the financial flows, energy trends and CO2 emissions. For this purpose we use the multiple region, multiple industry computable general equilibrium (CGE) model GRACE, where supply of finance is modified to reflect the constraints imposed by the various green segments in the global market for investment finance reflecting the constraints on funding for coal, fossil or green finance.
Section snippets
Modeling green investment finance in GRACE
In the GRACE model households and companies are compensated for their contributions of labour and capital. A share of this income is being saved and invested, partly managed by banks and institutional investors like pension funds, faith based foundations, and university funds. Governments manage their savings as sovereign wealth funds, usually based on income from natural resources or trade surpluses. Flows of finance from these organizations are allocated to investors as loans, bonds or as
Scenarios
The diversity of divestment pledges makes it beyond reach in this context to design divestment scenarios that precisely reflect the status and momentum of future green finance. Hence, we introduce stylized scenarios building upon major real pledges that indicate scale and direction of financial greening and divestment.
We consider two alternative scenarios (SN1, SN2), both introducing labeled Green Bonds as the only source of non-fossil funding and in addition, a dedication among investor groups
Simulation results and discussion
Below we present results for both scenarios as deviations from BAU level in 2030. Our comments only address results of SN2, which shows similar pattern as SN1, but markedly scaled up.
When green finance is diverted from fossil industries, we find that GDP increases worldwide by 1.6% in 2030 (Fig. 5). There is enhanced GDP growth in every region but most pronounced in the European Union, followed by India, Japan and China. Interestingly, the impact is less in the United States and Russia with GDP
Conclusions and business implications
Pricing carbon emissions through a tax or cap and trade system has long been seen by economists as the preferred climate policy, however, the political barriers have led to less transparent solutions and the move towards climate targets have been slow. As a consequence, concerns have been rising about the risk of economic disruption from abrupt climate policy interventions and from physical damage in the wake of climate change. Green finance emerged as a voluntary bottom up-initiative by
Acknowledgement
We are grateful for constructive comments by the editor in chief and one anonymous referee. This study was supported by HSBC Climate Change Centre of Excellence and the Research Council of Norway (Grant 209701/E20). This analysis also benefited from the thoughts and suggestions of Zoe Knight and Ashim Paun, both HSBC.
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