2010 has been a tough year for the global climate agenda. Policy pessimism after Copenhagen has been compounded by (largely unfounded) doubts over climate science along with governments backtracking on commitments in key countries. But looking through the fog of the carbon war, a new climate economy is starting to emerge, driven as much by resource scarcity and industrial innovation as by the raw realities of global warming.
According to the US National Academy of Sciences, it is now a "settled fact" that warming is taking place and that humans are largely responsible. This year’s extreme weather events – fires in Russia and floods in Pakistan and China – have reminded everyone that climate change is a threat that should not be ignored. Beyond this, it is self-evident that mounting pressures on energy, land and water resources require a step-change in economic behaviour, offering growth, employment and trade benefits for those countries that take a lead in climate business.
The low-carbon opportunity is defined by two complementary policy trends: first, taking energy out of the economy through improvements in efficiency; and second, taking carbon out of energy by curbing emissions from fossil fuels. Both trends have been structural features in the global economy over recent decades – but the rate of change needs to be accelerated if dangerous climate change is to be avoided.
The challenge for investors, however, is the lack of certainty over both policy intentions and actual implementation that could drive this shift. To map the range of potential outcomes over the next decade, we have constructed four distinctive scenarios:
– The Backlash scenario: this assumes that governments either renege on existing commitments and/or fail to implement these in practice.
– The Copenhagen scenario: this assumes implementation of the policies adopted in 2009 at the time of the Copenhagen climate summit.
– The Green Growth scenario: this assumes governments exceed their 2009 commitments over the next decade.
– The Conviction scenario: this projects what we believe is the most likely pathway to 2020 based on our current expectations. We believe that there will be diverging growth paths in the three key markets. In the European Union, we expect renewable but not energy-efficiency targets to be met; in the United States, we project limited growth in clean energy; and in China, we expect current targets for clean energy to be exceeded.
Using these scenarios, we’ve estimated the revenues generated from low carbon energy production (for example renewables, nuclear and clean coal) as well as from energy efficiency in buildings, industry and transport. We calculated both the baseline market in 2009 and also the market sizes that result from our scenario analysis.
Our conclusion is that the global low-carbon energy market was worth around US$740 billion in 2009 and will grow to between US$1.5 (10 trillion yuan) and US$2.7 trillion (18 trillion yuan) in 2020, with our Conviction scenario at US$2.2 trillion (14.7 trillion yuan). From a macroeconomic perspective, this means that the low-carbon energy market moves from 1.3% of global GDP in 2009 to 2.1% of global GDP in 2020. And in terms of market growth, this offers compound annual growth rates (CAGR) through to 2020 of between 6.6% and 12.5%, with our Conviction scenario at 11% for 2009 to 2020. This means that even in our most pessimistic scenario the market doubles.
Currently, the supply side dominates the low-carbon economy; by 2020, we believe this will change, with higher than market average growth in building, industrial and transport efficiency themes. In particular, we believe that the market for plug-in and full electric vehicles will grow substantially over the coming decade, with annual sales reaching more than 17 million units in 2020. This brings the prospect not just of enhanced energy efficiency and reduced greenhouse-gas emissions compared with the internal combustion engine, but offers the potential of providing storage for intermittent renewables.
In terms of low-carbon power generation, we estimate that renewable electricity revenues grow at a CAGR of 9.4% to a market size of US$544 billion (3.6 trillion yuan) in 2020; solar and wind revenues grow at CAGRs of 9% and 10% respectively, to US$115 billion (769 billion yuan) and US$285 billion (1.9 trillion yuan). The nuclear market grows at around 6% to US$368 billion (2.5 trillion yuan), while the market for carbon capture and storage (CCS) remains low at just US$7 billion (46.8 billion yuan), highlighting that this is largely expected to be a post-2020 phenomenon.
Our scenarios also show that the fastest growth is likely to occur in emerging markets, notably China and India, with the low-carbon energy market in both countries offering 14% CAGR. This delivers an important shuffling of the pack in terms of market share. The European Union remains the largest market, but its share falls from 33% to 28% by 2020. China grows from 17% to 24%, pushing the United States into third place. India also rises and becomes the fourth largest market, with Japan falling to fifth. Clearly, these growth rates are strongly influenced by the underlying economic dynamism in Asia – but they also reflect the growing strength of policy frameworks in these countries. Interestingly, our analysis suggests that just two regions – the European Union and China – already make up half the global market, and this proportion is projected to grow further by 2020.
The shift to a low-carbon economy invariably involves higher upfront capital costs, which are matched by lower operating costs, with positive returns in terms of fuel savings, particularly in building, industry and transport sectors. We estimate annual capital investment in our Conviction scenario will grow from an annualised US$460 billion (3 trillion yuan) in 2010 to US$1.5 trillion (10 trillion yuan) in 2020; in total, we estimate around US$10 trillion (67 trillion yuan) in cumulative capital investments will be required from 2010 to 2020.
A continuation of the historical 60:40 split between debt and equity suggests a need for US$6 trillion (40 trillion yuan) in debt and fresh equity of US$2 trillion (13 trillion yuan). Importantly, we expect that a third of investments will come from the household sector in the form of building efficiency improvements, decentralised renewables and low-carbon vehicles. We believe that this is a manageable amount as much of this is not new capital but will substitute for other expenditures.
Our Conviction scenario is one that is easily recognisable from today’s standpoint – a reflection of the limited ambition of most governments’ policies for low-carbon growth. But there are clearly significant uncertainties affecting our estimates. Added to the normal risks of projecting any market a decade into the future, plotting the trajectory of low-carbon economic growth relies on a range of dynamic assumptions, notably around policy frameworks, technological innovation, infrastructure capacity, resource availability, scientific consensus and public opinion.
In terms of our Conviction scenario, downside risks include the withdrawal of key policy incentives, serious implementation delays, in particular for energy efficiency, and higher than expected technology costs. On the upside, a spike in fossil-fuel prices, a global climate deal and faster breakthroughs in key technologies would provide additional momentum. Importantly, our Conviction scenario assumes only loose international cooperation as reflected in agreements such as the Copenhagen Accord. If governments choose to move together in a more decisive fashion in terms of finance, technology and markets, then not only would the size of the prize be larger, but the price-tag would be smaller too.
Nick Robins is head of the HSBC Climate Change Centre of Excellence.
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