Politics

Has The Climate Changed For Sustainable Investing?

What impact will the US withdrawal from the Paris climate accord have on environmentally focused investing? We think not much. The momentum behind green innovation looks all but unstoppable, galvanized by powerful economics.

Last week, the Trump administration announced that it would pull out of the Paris Agreement, a nonbinding pact on climate change signed by 196 nations in December 2015. According to the administration, remaining in the Paris accord would inhibit American economic growth. The controversial move has ignited a political debate within the US and has left investors wondering about the pace of the shift to more sustainable energy and the investing opportunities it has fostered.

As equity investors, we don’t take sides in a political debate. Our goal is always to discover investment opportunities that can deliver long-term returns for our clients. So, the question we must ask today is, What has or hasn’t changed in the long-term investment outlook for environmentally friendly initiatives following the US decision?

Innovation and the Environment

The Paris accord’s primary goal was to limit the increase in average global temperature to less than two degrees Celsius above preindustrial-era levels. Signatories, including the US, submitted nonbinding pledges to reduce carbon emissions, which they agreed to peer-review at regular intervals. While the accord has its flaws, it reflects growing global public and business support for environmental initiatives. As part of the agreement, the US had originally pledged to cut carbon emissions by 26% to 28% from 2005 levels by 2025.

Efforts to limit carbon emissions largely rely on innovation. Examples include new energy technologies such as wind and solar, and increased industrial and residential usage of homegrown, lower-carbon alternatives such as natural gas. We believe that successful innovation generally bolsters economic growth over time. And many of the environmental advances that are under way are increasingly economical. For these reasons, we expect greenhouse-gas emissions to continue falling.

Economics in the Driver’s Seat

The prospects for a coal-industry revival look particularly slim. Coal-fired power plants were a primary target of US efforts to reduce emissions. That’s because, of all fuel sources, coal generates the highest amount of CO2 per unit of energy produced.

Climate Change Sustainable Investing

But the coal industry has been in decline for decades. According to the US Energy Information Administration, the average age of the US fleet of coal-fired power plants is approaching 42 years, well beyond their 40-year average life expectancy. The majority of coal jobs in the US were lost between the 1950s and 1970s, as the industry shifted to more sophisticated, mechanized mining techniques. New US coal capacity has been moribund for the past two decades (Display).

Nearly all new energy-generating capacity since the early 1990s has been for natural gas (which emits half as much carbon per unit of energy as coal) and, increasingly, renewables (which emit none). While wind and solar currently account for just 6.5% of US energy production, they’ve represented more than half of all new capacity since 2014. In 2016, their share reached two-thirds.

Why has the US made such a dramatic shift away from the dirtiest fossil fuels and toward renewables? It’s not because of onerous regulations or agreements like the Paris accord, but because of technological advances and cost savings. Lately, coal has been declining because of competition from cheaper, cleaner natural gas, and a precipitous drop in the cost of renewables. The cost of wind power fell by 45% and that of solar by 74% from 2008 to 2016.

Ongoing innovation should continue to push costs down and make traditional fuel sources increasingly uncompetitive. McKinsey researchers estimate that these technology-driven advances could save the world $900 billion to $1.6 trillion between now and 2035, equivalent to the GDP of Indonesia or, at the higher end, Canada.

Federal vs. State and Municipal Policy

The federal government does not have sole authority to set domestic energy policy. States and local governments play a significant role. States regulate local utilities, levy taxes, control use of land and provide energy subsidies. For example, 29 states currently have renewable portfolio standards that require production of energy from renewable sources such as wind, solar, biomass and geothermal.

Many states and local governments have rebuked the administration’s decision to withdraw from the Paris agreement. To date, 246 mayors of cities representing 56 million US citizens have signed an open letter signaling their intention to uphold the Paris accord. They’ve pledged to increase investments into renewable energy, energy efficiency and electric vehicles, to cut greenhouse gas emissions, and to create a clean energy economy.

Public and business support for pro-environmental policies is solid. A recent Gallup poll found that 68% of Americans believe that human activities cause pollution. Surveys from Gallup, Yale University and The Washington Post-ABC News show that nearly the same number supported staying in the Paris agreement.

Businesses Stand to Gain

US businesses are also becoming more environmentally focused. They are increasingly investing to make their operations and products more sustainable, not only to appeal to shareholders but also to attract and retain employees, reduce risks to their brand value and improve their bottom lines. For example, RE100/The Climate Group reports that seven of the 10 largest US public companies have pledged to source 100% of their electricity from renewables over the next few years. Roughly 85% of the largest 1,000 companies in the world have targets to reduce carbon emissions, per the CDP. Even some fossil fuel companies are starting to put serious money into green energy.

Gale-Force Winds of Change

There are strong economic forces supporting the continued development of technologies that can reduce carbon emissions and improve the environment. Companies are also increasingly realizing that a better environment provides healthier societies and bottom lines. Of course, the political debate within the US over the Trump administration’s decision to withdraw from Paris is unlikely to fade. But we think the pace of investment and innovation isn’t driven by politics and will continue unabated.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

Article by Dan Roarty, David Wheeler – Alliance Bernstein