First serious test of climate policy

by: Hans van Cleef

At the moment, governments the world over are doing everything to contain the coronavirus so as not to overburden their healthcare systems. Partial or complete lockdowns have been imposed, causing society to grind to a halt or to operate at half steam. This has major implications for the economy and the demand for energy.

I am increasingly being asked how the corona crisis might impact the achievement of the climate targets. There are two parts to the answer to this question. First off, it is difficult to pinpoint the exact impact of the coronavirus at this time, simply because we do not know how long the lockdowns will be in place and when it will be safe to lift other restrictive measures that have been taken to contain the virus. The measures not only affect the economy, but also weigh down the prices of raw materials and carbon emission allowances (European Emission Trading Scheme – EU ETS). This may have a temporary adverse effect on companies’ willingness to invest in new carbon-neutral activities.

Yet, I am not pessimistic. The corona crisis will result in a deep recession in many countries. That said, the economy – and hence the scope for investment – may well recover quickly as soon as the measures are relaxed. Climate policy, which ultimately aims to achieve the climate targets by 2050, would not be worth much if it were to falter at the very first sign of a recession.

If this situation persists for a long time, we might even come close to achieving the targets defined by Urgenda

At it stands, authorities are asking the public to display a high level of flexibility and adaptability. Most of this will prove to be temporary. But some things will change permanently. People who claimed not being able to work from home turn out to be able to do so now. And the need for meetings and conferences, both at home and abroad, will also be reconsidered once the corona crisis is over.

If this situation persists for a long time, we might even come close to achieving the targets defined by Urgenda, a Dutch foundation whose objective is to accelerate the transition towards a sustainable society, with a focus on the transition towards a circular economy using only renewable energy. In the period between 2008 and 2012, the Netherlands unexpectedly met its Kyoto targets due to lower emissions during the financial crisis. Air pollution and carbon emissions are dropping now as well. But similar to the situation in 2010 when carbon emissions were back up due to the economic recovery, we cannot rule out that emissions will rise again this time around either.

We have a long way to go before our energy system is carbon-neutral. That is why we can reasonably assume that this crisis will not impact the achievement of the climate targets. In this context, we should, however, distinguish between sectors governed by ETS and sectors that are not.

The ETS policy is aimed at achieving the objectives by 2050. Until then, the number of available emission allowances will decline, creating scarcity, i.e. a carbon price. It is only natural that the price of ETS allowances has plummeted in recent weeks. The demand for energy – and hence for emission allowances – has dropped significantly. The fact that lower demand causes the price to drop is perfect proof yet again that the ETS market mechanism is working fine. So, a fall in prices does not have to be a problem. After all, carbon emissions are dropping and that is exactly what we set out to achieve.

For the time being, companies will continue to have to rely on government grants to come close to achieving the climate targets

In the unlikely event that the number of emission allowances should remain too high for too long, which would lead to investment problems, the European Commission will take additional allowances off the market to support the price. This Market Stability Reserve system (MSR) has been in place since the beginning of 2019 to facilitate exactly this. The risk associated with this system is that the European Commission needs some time to intervene. Market players may become less willing and able to invest in sustainable alternatives in the interim, the reason being that electricity and carbon prices are now relatively low, which has increased the risk of onerous contracts.

For this reason, investors and other commercial players in the value chain will continue to closely analyse the business model of large carbon-neutral projects and the balance between the expected return and the risks, especially now that many of them are forced to draw on their reserves. That is why, for the time being, companies will most likely continue to have to rely on government grants to come close to achieving the climate targets.

In sectors not governed by ETS, companies were already struggling to garner support from the public and the decline in consumer confidence because of this external shock will not help to increase the level of enthusiasm in the near future. Low electricity prices will lengthen the cost recovery period of solar panels, for instance. What is more, people will be more concerned about keeping their jobs than about insulating their homes. This will change again as soon as the economy and the labour market start to recover. In sectors not governed by ETS, the government will therefore continue to play a key role in maintaining the momentum for achieving the ambition of a climate-neutral economy.

We have 30 years to complete the energy transition

We have 30 years to complete the energy transition. It remains to be seen whether, in times of economic prosperity such as in the past five years, we can create the push that is needed to absorb recessions, which are bound to happen every few years. This corona crisis may put a temporary pause on some activities, but it will not change the ambition to achieve the climate targets. This period will prove to be a test of the viability and strength of our climate policy.

 

This column has been published in Dutch on Energiepodium.nl