Preparing for “net zero” carbon – the long road ahead
There has been encouraging progress in decarbonising the European and UK economies, but the hardest work is yet to be done.
As carbon prices rise, and the EU and national governments start to translate the net zero aspiration into concrete policies and targets, we expect a new phase of decarbonisation to be unlocked. This should create new market opportunities for the companies providing the solutions to climate change.
Coal in decline
In 2019, 79% of Europe’s coal-fired power plants were unprofitable, with predicted losses of more than €6.5billion1. The Institute for Climate Economics (I4CE) expects the EU’s overall coal and lignite (a softer type of coal formed from compressed peat) capacity to decline from 139GW in 2018 to 88GW in 2025 and 58GW in 20302.
The coal phase-out is well underway in Europe, as renewable energy sources grow increasingly cost competitive.
Impact of carbon prices
The rally in European carbon prices over 2018-19 will only increase the pressure on power generation from carbon-intensive fuels like coal and lignite. Many EU countries have made commitments to phase out coal production by a fixed date regardless of what happens in the carbon market.
However, the pressure of carbon prices and the availability of low cost renewables are accelerating the shut down.
In terms of the wider carbon market context, countries and regions representing 37% of global GDP are using emissions trading, and 8% of global greenhouse gas (GHG) emissions are covered by an emissions trading scheme (ETS)3. If China implements a scheme, as planned, 14% of GHG emissions will be covered.
EU 1-year forward carbon price (E/t)
Source: Bloomberg, as at 31 December 2019
The European carbon price trend is encouraging, but tackling power generation is only the first step. If the EU and UK are to have “net zero” carbon emissions by 2050 as planned, all sources of emissions will have to be addressed.
The carbon abatement cost curve below shows the carbon price (y axis) required to incentivise decarbonisation.
The chart shows how high carbon costs have to be to drive decarbonisation across power generation, transport, industry, agriculture and buildings, based on technologies that are commercially available at scale today. It poses a striking challenge to net zero plans, and shows that today’s carbon price (around €24/tonne) barely scratches the surface.
The carbon abatement curve
Measuring the rise in carbon cost needed to incentivise decarbonisation of GHG sources
Source: Goldman Sachs Global Investment Research
Preparing for net zero would imply:
- Significantly higher carbon prices. Carbon prices would need to be more than $100/tonne to have a meaningful impact on mobility, industry and buildings (excluding the impact of specific subsidies). The time frame for when (or indeed, if) significantly higher carbon prices are reached is uncertain but the direction of travel is clear. We expect to see upward pressure on European carbon prices as the EU is likely to tighten the supply of carbon credits to meet its net zero target.
- Scaling up and commercialisation of low carbon technologies. Currently, there are no commercially available large-scale technologies to tackle about 25% of emissions. We expect to see this percentage fall as the costs of technologies such as green hydrogen decline, driving the carbon abatement cost curve down.
- Greater investment in and focus on carbon capture and storage technologies for those areas that are ”not abatable”. Ultimately emissions from all activities can be tackled in theory – we could just stop doing those activities – but in practice this would be extremely disruptive. If emissions overshoot, as some climate models predict they will, direct air capture may have to be deployed.
The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.