In focus

What does Europe’s Green Deal mean for the energy transition?

The European Green Deal is a proposal from the European Commission to make Europe climate neutral by 2050. There are two main elements to this:

  1. No net emissions of greenhouse gases (GHG), which cause climate change;
  2. Economic growth is to be decoupled from the use of resources.

The Green Deal is ambitious and wide-ranging. It covers numerous areas such as “farm to fork” environmentally-supportive food production, energy-efficient buildings, ecosystem restoration, biodiversity, cutting pollution, and school education programmes.

For investors in the energy transition, the most significant aspects are those to do with shifting Europe’s economy away from dependence on fossil fuels and towards renewable sources of energy such as solar and wind power.

We see the energy transition as a once-in-a-lifetime structural shift that will transform the energy industry over the next 30-40 years. This is an investment theme that we think has longevity and potential for substantial growth from current levels.

Why is the Green Deal needed now?

The Green Deal proposal includes plans to strengthen the EU’s target for reducing GHG emissions. Between 1990 and 2018, the EU reduced these emissions by 23%; the proposal seeks a reduction target of at least 50% by 2030 (compared to 1990 levels).

While the overall aim is to make Europe carbon-neutral by 2050, it’s important to have interim goals like the 2030 target. The danger of far-distant goals is that they can seem like “someone else’s problem” whereas actually we need to start taking the steps towards carbon-neutrality now.

Achieving a climate neutral economy will require the full mobilisation of industry. It could take 25 years to transform an industrial sector and all the associated value chains. To be ready in 2050, decisions and actions need to be taken in the next five years.

Which industries will see the greatest impact?

Virtually every industry looks set to be affected by the Green Deal. Clearly, the need for renewable energy producers to supply clean power is critical. Smart infrastructure will also be needed to ensure Europe’s new clean energy networks are as efficient as possible. Technology such as smart metering, energy storage and carbon capture will be essential here.

The Commission proposes a move towards a circular economy for energy-intensive industries such as cement and steel production, so that materials are re-used wherever possible rather than disposed of as waste.

Transport is another obvious industry to pick out. It currently accounts for a quarter of the EU’s GHG emissions, and this figure is still growing. The Commission says that to achieve climate neutrality, a 90% reduction in transport emissions is needed by 2050. Road, rail, aviation, and waterborne transport will all have to contribute. The greater use of sustainable transport fuels, and a switch to electric vehicles, are crucial to this.

What does this mean for countries outside Europe?

The Green Deal doesn’t just cover proposals for countries within Europe; it also considers the impact on trading partners. The proposal states that Europe should use its “influence, expertise and financial resources to mobilise its neighbours and partners to join it on a sustainable path.”

However, there is clearly a risk that other countries may not be so willing. This creates a danger of what’s called “carbon leakage”, either because production is transferred from the EU to other countries with higher emissions, or because EU-made products are replaced by more carbon-intensive imports.

In this scenario, the Commission will propose a “carbon border adjustment mechanism” – a tax, in other words - for certain sectors. This would ensure that the price of imports reflects their carbon content. Clearly, if European producers are switching to clean power, they don’t want to be undercut by competitors who are still using polluting fuel sources.

What investment is the Commission proposing?

The European Commission has estimated that achieving the current 2030 climate and energy targets will require €260 billion of additional annual investment, about 1.5% of 2018 GDP. There is a role to play here for the European Budget, which could allocate a higher proportion of spending to projects to reduce GHG emissions.

The Commission will also work with the European Investment Bank (EIB) Group and other financial institutions to ensure financing is available. The EIB has said it will increase the share of its financing dedicated to climate action and environmental sustainability to reach 50% of its operations in 2025 and beyond.

But public funds are unlikely to be enough on their own to achieve a successful energy transition. The EU and individual member states will therefore engage with partners to bridge the funding gap by mobilising private finance.

What happens next?

The European Commission is set to propose a “Climate Law” in March this year that will write the objective of carbon-neutrality by 2050 into law. By June 2021, the Commission will review all climate related policies and update these if needed.

This Green Deal proposal from the European Commission highlights Europe’s ambition in terms of the energy transition. Political leadership is clearly welcome in this regard. But it’s not the be all and end all.

Even regions and countries that lack comparable commitment to the energy transition are seeing it happen anyway. This is down to two important factors: the falling cost of renewable energy and consumer demand for new technologies, such as electric vehicles.

When examining technology transitions throughout history – whether it be the emergence of the internet and digital technologies, the widespread adoption of the automobile, or the increased use of modern medicine – consumer demand and falling costs have always been the key drivers. The energy transition is the same, but with the added benefit of potentially significant policy support that will force the transition to unfold.

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.