Will the Carbon Bubble Drive Further Growth in the Green Bond Market?

Christopher Clement

As enthusiasm for the green bond market grows, the number of issuances has continued to grow at a rapid clip and is expected to hit somewhere between $50 and $70 billion in 2015, according to the United Nations. This growth has also seen a rapid expansion in the number and type of issuers entering the market, including the emergence of a large class of corporate and private banks issuers in recent years. What is motivating these new entrants, and how does this reflect on their perspective on risk management looking towards a carbon-constrained world?

Source: Carbon Tracker

Risks to carbon intensive enterprises may be mounting into a “carbon bubble”

  • Talk of bubbles is anathema in a bull market, but there are cracks appearing in the strong market returns of recent years. Among the risks that most concern investors is the so-called carbon bubble, the systemic risk that carbon intensive enterprises from oil companies to industry and transportation pose to the health of the economy. The concept of stranded energy assets, in particular, casts a shadow over the long-term viability of carbon-intensive investments as climate protection efforts escalate around the world. The CarbonTracker Initiative estimates that between 60-80% of the world’s estimated oil and gas reserves, worth an estimated $22 trillion, are unburnable if the world is not to exceed a global warming of 2oC. This amounts to over 2,200 GtCO2 of avoided emissions, which would mean leaving oil and gas in the ground all around the world, and undermining the value of the vast array of carbon intensive industries on which our economy depends.
  • It is an understatement to claim that our global economic system is driven by fossil fuel energy. Thus, we are confronted with an enormous dilemma when the lifeblood of our economy is threatened by the need for immediate climate action. Anthony Hobley, the CEO of the Carbon Tracker Initiative, claims, “There is a huge disconnect between the carbon budget that we can use if we are to stay below 2°C and real world assets that, if they are burnt, will put a huge amount of carbon into the atmosphere.” There are potential risks without historical precedent in maintaining investments in a carbon-intensive economy. This growing realization is starting to drive investors to seek ways to mitigate this risk. Hence, the emergence of a startling number of climate-related indices, investment funds, and investment instruments such as green bonds.

Will green bonds start to be seen as a hedge against exposure to the carbon bubble?

  • If the recent Hannon Armstrong green bond issuance is any indication, the answer may be yes. This bond was the first to be certified by the Alliance to Save Energy’s CarbonCount, with a rating of 0.39 metric tons of GHG emissions reduced annually per $1,000 of investment. It should noted that CarbonCount is limited to U.S. renewable energy projects, and thus cannot be the green bond industry carbon footprinting standard. This issuance, nevertheless, sets a new standard for the type of transparency in the environmental returns generated by a green bond. Even 3rd-party verified green bonds often lack this level of analysis, which creates a de facto level of accountability to investors beyond that which adherence to the Green Bond Principles can provide. While we have not seen a widespread move to post hoc verifications of green bond performance, the market could be moving in that direction over time as investors want assurance that their investment is doing more than just generating a coupon.
  • And why, you may ask, would investors demand that green bonds achieve the environmental returns they purport to finance? Beyond the increasingly common need to meet climate-related investment mandates, it is precisely to address the growing concern that investment funds must account for their carbon exposure and proactively seek verifiable investments in projects and companies that offer a hedge against the carbon bubble. However, a great deal of work needs to be done to ensure that green bonds are living up their label.

The rapid growth and lofty environmental claims of the green bond market beg the question – can they be used as a financing mechanism for climate protection and a hedge against the risks posed by a carbon bubble at scale? If the answer is yes, then the green bond market will, in fact, have a powerful driver for long-term growth. It remains to be seen if that will be the case, but we will keep tracking this issue with interest.

Article via IronOak Energy Insights. Contact IronOak Energy at info@ironoak.energy.

Christopher Clement
Christopher Clement has over 13 years of experience as a consultant, practitioner, researcher, and educator working at the intersection of the clean energy, sustainability, economics, impact investment, and innovation.