The future of carbon investment after the Paris Agreement

17 November 2017 16:59 RaboResearch

The future of green investments is inextricably linked to the outlook for the cost of carbon. In this article, we look at the current path of carbon reduction and its outlook. We also look at regulatory and private sector trends in Europe. Co-author: Jurriaan Kalf.

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Scenarios for greenhouse gas emissions

In terms of climate change policy, the Paris Agreement, also known as COP21, is regarded as the most important milestone achieved in the last two decades. The agreement was reached in December 2015 and entered into force on 4 November 2016 and is now signed by 166 countries. Under the agreement, parties commit to a set of national determined contributions (NDC’s) and an obligation to submit their progress on reducing greenhouse gas (GHG) emissions. The outlook for GHG emissions is a crucial factor in understanding the long term viability of both low-carbon and carbon-intensive investments.In this article, we look at the current path of carbon reduction, its outlook, and regulatory and tax trends for European companies.

Most carbon outlooks focus on GHG emissions by the energy sector, as energy accounts for 2/3 of total GHG emissions and it will play the most important role in envisaged abatement policies. Moreover, energy is a basic input for most sectors and thus feeds into the whole economy. Therefore, we follow the same line of inquiry. Recent developments in the energy sector suggest the industry finds itself at a crossroads: overhang supply has been keeping fossil-fuel prices low for several years but the deployment of wind and solar has reached new historic highs.

Decarbonisation still has a long way to go, as fossil fuels still account for more than 80% of energy production. The future of GHG emissions hinges on two main factors: 1) climate change policy and 2) energy market dynamics. The way these two aspects will develop will define the price of carbon and thus the feasibility of projects with a high carbon footprint or carbon abatement solutions. Below, we use the scenarios developed by the International Energy Agency as a starting point, as the set up allows us to evaluate various paths for policy and market dynamics.

Key takeaways from IEA’s energy scenarios

Key takeaway: Policy makes a large difference

All IEA’s scenarios see a rise global in demand for energy, because of higher demand in emerging markets. This will inevitably be accommodated (partly) by fossil fuels, which means they will still play an important role no matter how stringent policy becomes. That said, policy can lead to significantly different outcomes. While under business as usual terms fossil fuels retain their supremacy and account for 80% of energy supply in 2040 (81% in 2014), policy related to the Paris agreement reduces their share to 74%. Oil and coal are affected in particular and demand for these fuels slows down. Policy necessary to curb temperatures below 2 degrees would further dent demand for fossil fuels and reduce their share in the energy fuel mix to 58%. Coal and oil production would once again take the hit, as demand for these two fuels would actually contract by 2040. The impact of policy would be mostly felt in the later years of the forecasting horizon. By 2025, the fuel mix is virtually the same as in 2014 (fossil fuels account for 74% of the total). GHG emissions would continue to grow up to 2040, though by a much lower rate than in the past, unless policy is adopted aimed at curbing the global temperature increase below 2 degrees. In this case, GHG emissions would peak before 2020 and decrease afterwards. Consequently, business as usual would increase global GHG emissions from 32.2 Gigaton (Gt) in 2014 to 36Gt in 2025. Policies related to the Paris Agreement would contain the increase to 33.6GT, while measure to limit the temperature increase to 2 degrees would reduce it to 28.9Gt during the same period.

Box A

Key takeaway: The rise of renewables unabated by policy

Renewables are by far the fastest growing source of newly-installed primary energy in all IEA’s scenarios. The rise of renewables is driven primarily by market dynamics, such as technological cost reductions in wind and solar energy. These developments make these technologies increasingly competitive, even in an environment of low fossil fuel prices. Solar and onshore wind are already competitive in comparison to new fossil fuel plants in Germany (Bloomberg, 2017), while the US and China are expected to follow suit around 2020. In the longer term, renewables are expected to become competitive with existing fossil fuel plants. This tipping point is expected to be reached in many countries by 2030. Consequently, the transition to a less carbon intensive economy is likely to gain traction even if climate change policy was to lag behind. In such a scenario without additional policy (also excluding Paris Agreement related measures), renewable capacity would more than triple by 2040. But with measures related to the Paris Agreement, renewables would become the largest source of electricity supply by 2030.

Box B

Key takeaway: Current commitments are not sufficient to keep temperature increase under 2°C

The measures announced to meet the Paris Agreement NDC’s reinforce momentum for reducing energy intensity, but they are not sufficient to curb temperature increases below 2°C globally. Measures shave off approximately 1.3°C from the otherwise expected temperature increase of 4 degrees Celsius. This conclusion is reinforced by various studies that have analysed the policy impact of the COP21 agreement (figure 1). That means that more stringent policies to contain GHG emissions can be expected in the future, increasingly so if the effects of climate change become more visible. The five year mechanism in the COP21 provides the platform for revising targets to more ambitious levels. Achieving the below 2 degrees goal would require a plethora of policies. These include the more rapid abolition of fossil fuel subsidies worldwide, a larger deployment of renewables and carbon capture and storage, widespread adoption of electric vehicles in transportation, stricter energy efficiency policies and more widespread carbon pricing. Amongst these measures, energy efficiency and renewables play a central role and the largest GHG reductions are to be achieved in the power sector.

Figure 1: Without new policy, emissions are likely to exceed the level consistent with 2°C


European climate policy developments

The European Union, the third largest GHG emitter in the world (around 11% of global emissions), has a track record of being a frontrunner on climate policy. Before the Paris Agreement, the EU was already working on reduction of carbon emission under the ‘20-20-20’ strategy. In 2015, emissions were already 24% below 1990 levels and the EU is on track to achieve its other 20-20-20 climate and energy targets, namely increasing the share of renewables in energy generation to 20% and improving energy efficiency by 20%.

Box C

Key takeaway: EU set to miss 2030 target under current policies

However, the pace of the yearly GHG reduction has slowed down in recent years. Under existing policy (EP) and under announced policy (AP), the EU is set to miss its 2030 emission target (figure 2). This emissions target is equivalent to a 40% reduction compared to 1990 emissions, which matches the EU’s COP21 pledge. It implies that if the EU and member states are committed to their targets, more policy measures will follow.

Figure 2: Emission projections exceed 2030 target

Source: European Environment Agency (EEA), Rabobank

Both ESD and ETS sectors are projected to fall short by 2022

The EU has two policy building blocks to reduce emissions. Energy and (energy intensive) industrial sectors[1] are covered by the emissions trading system (ETS). Together, their emissions are around 45% of total emissions. Sectors not covered by the ETS, such as transport, buildings, agriculture and waste are covered by the Effort Sharing Decision (ESD), which sets annual national emission targets. It is up to the member states to implement national policies for these sectors. The bad news is that, under current policy, emissions will exceed targets for both the ETS and ESD regimes by 2022 (figure 3).

[1] This includes energy-intensive industry sectors (including oil refineries, steel works and production of iron, aluminium, metals, cement, lime, glass, ceramics, pulp, paper, cardboard, acids and bulk organic chemicals), power and heat generation and civil aviation.

Figure 3: Both ESD and ETS sectors are dragging their feet

Source: European Environment Agency (EEA), Rabobank

But the EU is developing new regulation…

There is some good news though: the EU is in the process of developing additional measures that would facilitate meeting the 2030 NDC target. These include the implementation of the 2030 energy framework and energy union, which proposes directives on four fronts, namely energy efficiency, energy performance in the building sector, renewable energy and the functioning of the power market.

Box D

Key takeaway: The EU is currently developing many climate-related policies

The EU is a frontrunner in terms of building sector policies. Recent revisions of the Energy Performance of Buildings Directive and the Energy Efficiency Directive have brought these in line with the 2030 targets. The first directive requires all new buildings to be nearly zero-energy buildings by December 2020 (public buildings by 2018), mandates standards for renovation and contains provisions on renovation rates. These policies should shift projections for EDS sectors downward, although we have to wait for a new projection to be sure this additional policy is sufficient.

Box E

Key takeaway: Current CO2 prices are too low to support emission reducing investments

The EU is also discussing an overhaul of the fledgling EU ETS to improve its efficiency. As one of the oldest and the largest regulated trading systems in the world, the system is still not beyond its inception flaws. A combination of too many distributed emissions rights and the economic contraction during the last crisis, have caused emissions rights to slump to USD 6/tCO2e in the past 5 years (figure 4).

Figure 4: Carbon prices in the European Trading System


This holds back green investment, as the CO2 price is simply too low to make investments in carbon reduction financially attractive. The IMF estimates that a price of USD 50/ tCO2e is necessary to achieve the reduction targets in the Paris Agreement (IMF, 2016). Therefore, it is hardly surprising that research shows that the system’s impact on GHG emissions has been minimal and that is has failed to drive innovation. Divergence between the EU parliament and the EU council on certain aspects does not bode well for a fast solution, but companies are set to benefit from any overhaul (see box 1).

Box 1: The economics of carbon pricing

In theory, pricing carbon is the optimal solution for stimulating decarbonisation, because the price allows for an efficient allocation of resources. Namely, the carbon price gets taken into calculation by all business agents, so those with the lowest marginal abatement cost will act first. Normative regulation on the other hand, imposes standards on certain sectors/activities without considering the individual business cost-benefit analysis. Moreover, carbon pricing can drive innovation in carbon-intensive sectors beyond the current (and mostly average) state of technology, which is what most normative policy is based on. Third, carbon pricing is dynamic, as it continues to influence business decisions as the terms of the equation (e.g. cost of production) change, while normative regulation is static as it prescribes certain standards. Last, in countries where political changes create regulatory volatility, carbon pricing reduces uncertainty for investors. The US business community is reportedly supportive of introducing a national carbon tax particularly for this reason.

…and so are member states

There is also action on the side of member states: the EU ETS and EU directives and the targets included in them, are legally binding, and member states are pursuing policy to comply with them. Moreover, some countries have already went or are planning to go the extra mile. Denmark and Spain stand out in terms of the adoption of renewables, as their share in total power generation has exceeded 40% and 20% respectively, compared to 16% on average in the EU. Denmark is also aiming to increase the share of renewables in final consumption to 100%. Some countries are planning to abolish coal energy production: Denmark and France by 2023, the UK and Austria by 2025, Finland and Portugal in the 2020s and the Netherlands by 2030. The Netherlands and Norway stand out in terms of electrical vehicle (EV) adoption, as the first hosts the largest stock in the EU, while in the latter EV’s account for 30% of new car sales, the highest share in the world. The Dutch government will introduce a climate bill with a comprehensive package to reduce emissions. Amongst the measures are the closure of remaining coal-powered electricity plants and widespread adoption of carbon capture and storage and it will enshrine carbon reduction targets into national law. Outliers are present even in sectors where the EU is outperforming, such as energy efficiency in the building sector. For example, in France all new buildings meet the national zero energy building standard, while Denmark aims to construct ‘positive energy’ buildings. In the Netherlands, offices will need to have at least a C energy efficiency label to be eligible for rental, and that has also led to consequences for mortgage financing of such real estate.

Box F

Key takeaway: More regulation and/or taxation seems likely going forward

Whether these measures will suffice is the question: Under current policy, projections indicate that ESD and ETS sectors will exceed their emission target by 17% and 23% respectively. This suggests additional policy will have to put in place to reach the targets and achieve the NDC’s Europe committed itself to under the Paris Accord.

Box 2: The (lack of) impact of the Trump presidency

The United States, the second largest (around 16% of global GHG emissions) and largest per capita GHG emitter in the world, has ratified the Paris Agreement and pledged to reduce GHG emissions by 26-28% below 2005 levels in 2025. The election of Donald Trump as the new president of the US has raised concerns about this commitment in the future as he repeatedly threatened to withdraw the US from Paris Agreement and that he wants to abolish Obama’s Clean Power Plan. But what will really be the impact of Trump?

US climate change policy will likely suffer under Trump. Although the withdrawal from the Agreement can formally only take place after 4 years, the US can decide not to implement policies that support meeting the NDC’s. Obama’s Clean Power Plan (CPP) implemented in 2015 is an easy target for being repealed and the EIA estimates additions in renewable energy capacity would be 23% lower without it. Both would set back global efforts to reduce greenhouse gas (GHG) emissions somewhat, but it will not bring the process to a halt for several reasons: 1) gas and renewables are becoming cheaper, a trend that could actually find support with Trump’s pro-innovation agenda; 2) the extension of tax credits by congress (and thus irreversible) until 2020 for wind and 2021 for solar; 3) supportive state-level policies and 4) the commitment of US corporates to decarbonisation. The online initiative ‘We are still in’ is a clear evidence of the state and corporate commitment to COP21. Also, the lack of climate change policy during the Bush years did not prevent the carbon intensity of the US economy from falling and progress booked was similar to that recorded during the Obama presidency (figure 5). All in all, the net impact of Trump’s policies is likely to be modest as even Trump cannot beat market forces.

For more details on the impact of Trump on the US energy policy see Trump's impact on the economy.

Figure 5: Carbon intensity of the US economy

Note: GDP in purchasing power parity, constant 2011 prices; combustion related CO2 emission. Source: BP Energy Statistics, World Bank, Rabobank.

Growing trend of corporate climate commitments

Without sufficient movement on the policy front, the burden of climate leadership increasingly falls on firms, if global temperature are too be kept below 2°C. Some companies show more eagerness to pick up the glove than others but on the whole a lot more (coordinated) leadership on the part of corporates might be necessary to meet current goals.

Analogous to US firms that support the ‘We are still in’ movement, there are European companies that pursue their own climate commitments, regardless of policy developments. Some large corporates are installing their own energy capacity in plants they operate. An illustrative example in Europe is Heineken, which is reducing the carbon footprint of its production by installing solar capacity at some of its production facilities. Its flagship project in Massafra generates around 18% of the plant’s yearly energy needs (Heineken, 2016). Another way companies are increasing the share of renewables, is through power purchasing agreements (PPA’s) with wind farm projects. In Europe, already 2GW of power production has been contracted through corporate PPA’s (Wind Europe, 2017).

Box G

Key takeaway: To restrict global warming below 2 degrees corporates leadership is necessary to fill the vacuum left by policy makers

Several factors could spur these corporate initiatives. Considering the need for additional regulation and taxation, some firms may pursue decarbonisation to stay ahead of the regulatory curve and gain competitive advantages. With regard to PPA’s, we see that they allow corporates an attractive way to reducing their carbon footprint in the public eye while locking in energy prices for fifteen years. Perhaps for the latter reason, PPA’s currently attract the most attention from energy intensive sectors like chemicals and datacenters. Other factors seems to be related to public relations and marketing, especially in B2C markets. Climate change is gaining ground in public’s mind and for the first time over 43% of Europeans agree that businesses have a responsibility to address climate change (Eurobarometer, 2016). Social media and NGO’s regularly pressure on companies to take CSR responsibility.

But thinking beyond direct self-interest, corporates may well be motivated by genuine concern for the environment and by a long term view on the going concern for their company. Climate change is a low risk but high impact phenomenon. According to the IPCC “Continued emission of greenhouse gases will cause further warming and long-lasting changes in all components of the climate system, increasing the likelihood of severe, pervasive and irreversible impacts for people and ecosystems” (IPCC). For Europe, the IPCC assesses there is a medium to high risk of increased water restrictions and damages from urban floods even in the 2030-2040 time horizon (see IPCC figure). When policy makers do fall short, the world would benefit if more corporates step up to clog the hole that policy makers leave in their wake.


This Special shows that while the decarbonisation of economies through the rise of renewables seems unstoppable, it is timing that matters. Despite its ambitions, the Paris Agreement falls short in keeping global temperature increases below 2° Celsius, let alone 1.5°. In turn, current policy in the EU is insufficient to keep pace in reducing GHG emissions and in 2022 emissions are projected to exceed targets for both the ETS and ESD sectors. This could spell a new wave of regulation and taxation, as evidenced by current policy initiatives. The US’ decision to pull out of the Paris Accord will do little to change that, as even Trump cannot beat market forces.

Meanwhile, we see companies making their own climate commitments and acting on them and their leadership will be pivotal to to restrict global warming below 2 degrees, especially when policy falls short.


International Energy Agency (2016), World Energy Outlook 2016.

Bloomberg New Energy Finance, New Energy Outlook 2017.

Co author: Jurriaan Kalf