It’s Time to Have “The Talk” about Energy Transition in North America
In the run-up to President Biden’s emphatic executive orders on Inauguration Day, the climate conversation had rightly grown louder across corporate America – even quarterly earnings presentations suddenly feature more ESG slides placed earlier in investor decks. This is a conversation that sorely needs to happen, and for which we also need to gain a much deeper understanding. The stakes could hardly be any higher, both in the final outcome and in the complex decisions along the way.
A report from Princeton University, published in December 2020, gives us a measure of these stakes for North America. The scientific narrative is clear: the most compelling path to net zero 2050 entails both widespread electrification (notably in transportation end-uses) and a shift to hydrogen as a highly versatile intermediate fuel (which can and should be produced through electrolysis). Decarbonization occurs through both fuel transition and higher energy efficiency. The flipside, however, is that the electricity required is multiples of what the US generates today.
In a net-zero mindset, the available options to produce all this electricity are limited, and will require massive growth in wind, solar, and transmission technology to support carbon neutrality. How massive? Just look at land use considerations: depending on specific scenarios, the bookends of physical wind farm needs are between one quarter of a million to a million square kilometers -- up to 12.5% of the land area of the continental US. Total investments by 2030 across industries run to about $2.5 trillion, with the top seven spend areas (wind, solar, transmission, EVs, industrial processes, pipelines, and residential buildings) each north of $100 billion by 2030. The total number reaches $10 trillion by 2050, in line with existing global estimates.
Looking at this through political, economic, social, and cultural lenses, the odds of a compromise solution are high. Hesitation on wind and solar points us quickly towards either nuclear expansion or continued reliance on natural gas, but also requires massive carbon capture and sequestration. The numbers show us the scale of the challenge: the US currently emits roughly 6 billion tons of CO2 (or equivalent) into the atmosphere each year, about 90% of which is from industrial processes. The carbon “land sink” is currently well under a billion tons per annum, and while the geologic potential for sequestration is high, both the technology (e.g. direct air capture, among others) and the logistical limitations of sequestration in the US raise complex questions. Even outside of scenarios favoring sequestration, we are already looking at tens of thousands of miles of new pipelines for CO2 transportation across the nation—and no doubt a complicated tradeoff between environmental transition and conservation.
Already, we see early signs of novel and cross-sectoral pathways – for example, food production and fuel now have more intersections (and biomass can also help to produce hydrogen), and product development can spill over into infrastructure (think EVs and charging stations).
Across all of these possibilities, who shoulders these costs, and how? Corporate balance sheets are a little stretched already – data published by Moody’s Investors Service from December 2020 suggests that the aggregate credit quality of North American corporates is just shy of investment-grade -- and the financial burden on companies may well increase even further in the next decade as businesses, responding to various stakeholders, heighten cash allocation to tackle societal issues more aggressively.
These additional costs for the energy transition will require a step-change in at-risk capital, and we should remember that risk also increases faster than debt (adding debt is easy but building offsetting cash flow is harder). How this risk is spread around will be a crucial part of the equation. Already, we see early signs of novel and cross-sectoral pathways – for example, food production and fuel now have more intersections (and biomass can also help to produce hydrogen), and product development can spill over into infrastructure (think EVs and charging stations). New funding structures will also be required to facilitate these crossovers (with early examples taking shape around tax advantages for renewables and carbon capture, utilization and storage - CCUS) and will provide new vectors for those with financial flexibility to spare. And the risk is not inconsequential compared to the rest of the market – the US corporate bond market currently stands at around $8 trillion.
Policymakers and financial institutions need to unequivocally seize this opportunity to promote change around them and within themselves. The CFTC has already made its case vocally for carbon pricing late last year, and an economic framework such as William Nordhaus’s influential “climate club” can bring much-needed vigor to a foreign policy reset around climate targets. Among all market actors, financial institutions will be in a unique position to advise their clients across changing business profiles, cross-sector explorations, evolving market incentives and changing funding structures.
As the new decade opens, “funding the real economy” will require that financial institutions deploy their creativity, ingenuity, and risk acumen in entirely new and concrete ways. This is a new playbook we are writing, one where a different shared future will require all of us to quickly embrace a different (and better) sense of ourselves in the process.
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 “Moody’s Financial Metrics key ratios by rating and industry for North American nonfinancial corporates: 2020 Update”, from 17 December 2020.