Sustainability Newsletter – September 2023

Since the US Inflation Reduction Act (IRA) passed into legislation a year ago, there is greater clarity on how key aspects of the bill are being implemented and the implications for industry.

Economic Boon

According to RMI, at least USD $278 billion in new private clean energy investments have been announced in the IRA’s first twelve months. The economic boon promises more than 170,000 new jobs, with some 272 new clean energy projects announced to date, covering 91 new battery manufacturing sites, 65 new or expanded electric vehicle manufacturing facilities and 84 wind and solar manufacturing announcements.

RMI also points to IRA-fueled ‘unprecedented progress’ in five key areas: 1) electrifying transportation through incentives spanning from electric school buses to battery factories and new charging infrastructure, 2) incenting green buildings with funding for home energy rebates, appliance efficiency standards and electrified retrofits, 3) decarbonizing electricity by scaling wind and solar power, rural electrification programs, and energy infrastructure reinvestment, 4) transforming hard-to-abate heavy industries by incenting low carbon energy alternatives such as hydrogen, greener raw materials and recycling options, and 5) unlocking finance through reform of tax credits and innovative financing that prioritizes climate-friendly investment in historically disadvantaged communities.

US Emissions Trajectory

According to the Rhodium Group’s annual Taking Stock 2023 report, current IRA policies will lead to a reduction in US emissions of 29-42% in 2030—an increase from the previous years’ expectations for US emissions trajectory but falling short of its Paris pledge to reduce emissions by 50-52% below 2005 levels by 2030.

Over the next year, Rhodium Group anticipate that the Biden administration will rush to finalize many important regulations before the end of this presidential term. An important goal will be targeting joint action with state-level governments. By ramping-up states’ clean energy standards, ZEV mandates, adoption of low-carbon fuel standards, and implementation of other decarbonization policies, joint action could reduce economy-wide GHG emissions to 3.2-3.9 gigatons in 2030, or a 41-52% reduction below 2005 levels – keeping the 2030 Paris climate target within reach.

Canada by comparison

With measures like the IRA, the US has stepped up and stepped into a climate leadership role leaving Canada at risk of missing an important window to buffer the competition gap.

Earlier this year, Canadian Manufacturers and Exporters (CME) – an industry association representing over 2,500 Canadian manufacturers – conveyed concerns that government delays in qualifying the types of investments for certain new tax credits would stall manufacturers’ expansion decisions in the transition to net-zero. For Canadian oil and gas companies, there is a similar worry that the sector would be at a competitive disadvantage with the US in areas such as carbon capture and storage projects.

Conversely, commentators note that Canada may also benefit from the IRA due to extended concessions (IRA could be as much a challenge as it is an opportunity), and that Canada has an energy transition framework with a wider array of funding tools across different sectors, compared to US mostly subsidies with limited direct impact.

Chart: US greenhouse gas emissions with joint action

The high, mid and low ranges reflect uncertainty around future fossil fuel prices, economic growth, and clean energy technology costs.

Net million metric tons (mmt) of CO2 equivalent (CO2e)

A recent BloombergNEF analysis on Clean Energy Exposure Ratings finds that USD $2.56 trillion in clean energy revenues was generated by globally listed companies in 2022, representing 2.6% of the world’s Gross Domestic Product (GDP).

Sectors contributing the most share of clean energy revenues include power utilities with USD $1.06 trillion (42%) and renewable energy manufacturers and developers with USD $628 billion (25%). Conversely, automakers – who are among the biggest revenue earners in the rankings – have a lower clean energy exposure contributing USD $370 billion (14%).

The assessment is based on 8,182 listed firms (out of 50,000 assessed), of which only one fourth explicitly disclosed relevant revenue, while BNEF analysts identified the remaining. The analysis aims to provide investors with transparency into the opportunities of low carbon transition.

Chart: Clean Energy Exposure Percentages of 20 largest companies by overall revenue, 2022

According to the Institute for Energy Economics and Financial Analysis (IEEFA), credit ratings are underplaying climate risks. It warns that if the ratings system continues the status quo, bond issuers – especially those dependent on hydrocarbon – could see greater ratings volatility and instability.

Major ratings agencies are beginning to highlight the potential for climate-related risks as significant drivers affecting creditworthiness over time. Fitch cautions that 20% of global corporates – mainly oil and gas producers, pipeline and energy midstream companies – could be downgraded by 2035 due to exposure to climate vulnerabilities; and Moody’s warns that sectors with high or very high inherent climate risk account for 10% of total rated debt outstanding.

The IEEFA is calling on regulators to take a more active oversight role, and for rating agencies to adopt more near-term forward-looking methodologies from a climate risk perspective. If the status quo remains, issuers could face greater refinancing cost or may have to pledge more collateral.

Climate Bonds Initiative (CBI) released 12 Policies to Unlock Deep Decarbonization. Recognizing the need to develop targeted support for hard-to-abate sectors, the report issues a set of recommendations aimed at policy makers to address gaps that can facilitate more rapid emissions reduction, drive new opportunities and investment flows, and help avoid stranded asset risks.

The 12 recommendations include:

1. Establish clear definitions through standards
2. Mandate climate disclosure requirements
3. Establish energy transition mechanisms
4. Adopt economy-wide carbon pricing
5. Implement carbon border adjustment mechanisms
6. Establish green de-risking facilities
7. Incent carbon contracts for difference
8. Provide a green trade window
9. Identify priority infrastructure investments
10. Support underdeveloped decarbonization technologies
11. Boost green public procurement
12. Diversify critical raw materials supply

While every sector or country has different decarbonization pathways, it is worth noting that Canada is working to develop a green and transition taxonomy, sustainability-related disclosures, a carbon border adjustment mechanism, and a regime for carbon contracts for difference.

Chart: Key transition policies and implementation in the G20

Cdr.fyi, an open data platform monitoring the carbon dioxide removal (CDR) market, released a 2023 Mid-Year Progress Report.

The first half of 2023 is seen as a ‘defining period’ for the CDR market, with purchases of 3.4 million metric tons – a 5.6x growth compared to full-year 2022. The report forecasts full year CDR purchases could reach 6 million metrics tons (a 10x growth compared to 2022).

The share of CDR methods is currently dominated by BECCS – Bioenergy with Carbon Capture and Storage – with 86% of the tons purchased; while biochar accounts for 5%, bio-oil 4%, and direct air capture 3%, among others. The average price was USD $450/tCO2, representing a slight decline from 2022. Wide price variances exist between CDR methods, indicating a highly illiquid market that is dependent on transaction-specific price negotiations.

Despite the momentum, CDR needs a further 40-50% compound annual growth rate over the next 27 years to achieve gigaton-scale removal to meet a net zero trajectory. Key to this will be bridging innovative methods from the lab, building-up infrastructure with corporate buyers and public sector, and setting prices on a downward and more affordable path.

Chart: Carbon Removal Purchases

Many misconceptions exist about hydrogen. The Rocky Mountain Institute (RMI) presents a compelling examination of Five Hydrogen Myths – Busted.

1. Should clean hydrogen be used for everything? Clean hydrogen is a low carbon alternative especially for heavy industry applications. However, micro-uses such as heating buildings, generating power, or fueling light-duty vehicles, are better suited for investments in energy efficiency or direct electrification. Hydrogen should be prioritized after energy efficiency when direct electrification is not possible.
2. Is all clean hydrogen the same? Clean hydrogen production pathways – including green and blue – are different and can have different emissions risks depending on the supply chain and technology performance. Clean hydrogen produced from renewable electricity is the most straightforward way to ensure near-zero emissions.
3. Does hydrogen contribute to greenhouse gas? The potential for leaked hydrogen in the supply chain can act as an indirect greenhouse gas. However potential emissions-impact risks are less than those of natural gas and improved leak prevention technologies are making systems more reliable.
4. Is green hydrogen decades away? Many countries have developed strategies around hydrogen, which is facilitating a number of gigawatt-scale green hydrogen projects today. Electrolyzer manufacturing is rising to meet the demand for more project plans.
5. Does green hydrogen consume a lot of water? In the context of other large-scale water consuming processes, green hydrogen production consumes less water than typical coal or nuclear electricity production. Developing efficient process designs could help to minimize hydrogen’s reliance on freshwater with alternatives like treated water or desalinated sea water.

Many companies are looking to recalibrate how they navigate Environmental, Social and Governance (ESG) considerations as result of recent backlash in the US and beyond

Examining this shift is a new report from The Diligent institute, in partnership with Spencer Stuart, titled Sustainability in the spotlight: Has ESG lost momentum in the boardroom?.

Based on a survey of almost 1,000 global board members, the findings expose a geographical divide in attitudes towards ESG. European directors perceive ESG as more of an opportunity (56% of respondents) versus a risk (13%). For US companies, ESG is seen as more risk (34%) than opportunity (30%). Furthermore, US boards are less likely to have conducted ESG scenario planning than their European counterparts or incorporate ESG metrics into fewer areas of the business. Fewer US directors than European directors predict that their companies will embrace a more concerted focus on ESG initiatives in the next five years.

The global picture is different. 29% of directors predict a stronger focus on ESG objectives in the next five years. Another 19% predict a continuation of current efforts around ESG, and a similar number (18%) predict a stronger linkage between ESG and business impact.

The importance of governance and the nature of an organization’s environmental and social impact will continue to be key considerations for boards of directors and investors alike.

The European Commission adopted detailed rules on the implementation of the Carbon Border Adjustment Mechanism (CBAM)’s transitional phase, beginning October 1, 2023 to the end of 2025.

During the transitional phase, EU importers of covered goods – cement, iron and steel, aluminum, fertilizers, electricity and hydrogen – will be required to calculate and report the embedded carbon emissions of their products, though imports will not yet be subject to financial adjustment payments. The first reporting period for collected fourth quarter data will be due by January 31, 2024.

During the first year of implementation, companies can report in three ways: (a) full reporting according to the new methodology (EU method); (b) reporting based on equivalent third country national systems; and (c) reporting based on reference values. From January 1, 2025, only the EU method will be accepted.

Further guidance has been published and tools for calculating and reporting emissions are currently being developed. Affected companies should make use of the training materials, webinars and tutorials to support their businesses when the transitional mechanism begins.

The US Department of Energy (DOE) announced the ‘world’s largest’ investment in engineered carbon removal – up to USD $1.2 billion for the development of two commercial-scale Direct Air Capture (DAC) facilities in Texas and Louisiana.

The two projects are expected to remove more than 2 million metric tons of CO2 emissions each year – equivalent to the annual emissions of 445,000 cars – and create some 4,800 jobs. Each hub will eventually remove more than 250x more CO2 than the largest DAC facility currently operating. 19 additional projects were also announced for future DAC Hub demonstrations.

President Biden’s plan for a net-zero emissions economy will require the removal of 400 million to 1.8 billion metric tons of CO2 from the atmosphere annually by 2050. This has jumpstarted a new industry in what the White House terms as ‘Bidenomics’ – which is helping to boost manufacturing and positioning America for the industries of the future.

The Government of Canada released draft Clean Electricity Regulations (CER), putting the country on a path to a net-zero grid by 2035. A companion publication also sets-out the government’s strategic vision for broader electrification and grid decarbonization.

The proposed regulations set an annual emissions performance standard of 30 tons of CO2 per GWh of electricity produced with limited exceptions – including emergency circumstances, the application of CCUS (if the unit started operating within the last seven calendar years, it can emit up to 40 t/GWh if specific criteria are met, up until Dec 31, 2039) and for peaking power (if units operates for 450 hours or less and emits no more than 150 kt of CO2 per year).

A 75-day consultation period will conclude on November 2, 2023, with a final version expected in 2024 and implementation from January 1, 2025. The regulations would apply to grid-connected fossil fuel generation units of 25 megawatt or greater, which signals that unabated natural gas plants may not be commissioned after 2025.

The UN Principles for Responsible Investment (UN PRI) published a discussion paper that delves into ESG considerations in Canadian provincial and municipal bonds. The paper explores how ESG factors can affect risk-adjusted returns for bondholders of Canadian sub-sovereign debt, and how investments in this market can contribute towards sustainability outcomes.

Canadian provincial and municipal bonds are exposed to ESG factors in ways that differ from other asset classes, such as geographical concentration (raising taxes from a smaller area can increase vulnerability to environmental or social problems that are specific to a region) and exposure to entire population and economy (through tax revenue in a way that corporate issuers are not). Furthermore, environmental risks are particularly pertinent for many provincial and municipal issuers given the heavy weighting of natural resource-intensive sectors it hosts like fossil fuel, agriculture, or mining industries. Funding for public services and infrastructure can also be impacted by environmental risks as shown by recent devastating wildfires.

One area for future work in this market involves data and disclosure, as Canadian provinces and municipalities are less used to disclosing ESG information in an investor-friendly format than listed corporates, although some have moved in this direction.

The single costliest type of natural catastrophe for insurers in 2023 isn’t hurricanes or earthquakes or volcanic eruptions — it’s thunderstorms, according to Axios based on data from Swiss Re.

Save the Date – Carbon Summit, October 26, 2023

The CIBC logo and “CIBC Capital Markets” are trademarks of CIBC, used under license.