Many of you probably saw the headlines over the weekend that the United States has agreed to formally participate in a successor treaty to the Kyoto Protocol, which is set to expire in 2012.
This is being heralded as big news, because the Bush administration had opted out of this climate treaty in 2001. But the reality is that tough negotiations on a new agreement are not going to take place until 2009, after President Bush leaves the White House. And virtually all of the candidates to succeed him have acknowledged the need to re-enter the post-Kyoto negotiating process.
So, in effect, the Bush administration is running out the clock on its term in office, while sparing the U.S. further ignominy of being the last industrialized nation to embrace the need for greenhouse gas controls. (Australia had been the other holdout, but it endorsed Kyoto last month after holding federal elections.)
The other thing that happened at Bali–or actually didn't happen, I should say–is that no agreement was reached on the how much to cut future greenhouse gas emissions. The European Union had been calling for industrialized countries to achieve a 25 to 40 percent cut below 1990 levels by 2020. But the U.S., Canada and Japan insisted that this figure should be worked out in the next two years of negotiations, not decided at Bali. These are among the industrialized nations whose emissions have grown the most since 1990, so they'll have the hardest time achieving such cuts.
Nevertheless, the U.S. delegation at Bali did agree to language that calls for "deep cuts in global emissions," as called for in the latest report from the Intergovernmental Panel on Climate Change (IPCC), whose authors share the 2007 Nobel Peace Prize with former Vice President Al Gore. And by deep cuts, the IPCC means really deep cuts!
If the goal becomes to hold the global temperature increase below 5.5 degrees F (or 3 degrees Celcius), the IPCC says industrial nations will need to achieve emissions cuts in a range of 40 to 90 percent below 1990 levels by 2050. And if the goal is to hold the increase below 3.6 degrees–which the IPCC believes would be much better for the climate and global environment–then industrialized nations would need to achieve cuts of 25 to 40 percent below 1990 levels by 2020, as the E.U. is recommending, and cuts of 80 to 95 percent by 2050. For all practical purposes, this would mean a virtual "de-carbonization" of industrial economies over the next half-century.
One final thing that came out the Bali climate negotiations–and a sticking point that almost derailed these talks–is that industrialized nations agreed to provide technical and financial assistance to developing nations so that their greenhouse gas emissions also are reduced from baseline forecasts as their economies grow. The U.S. delegation objected to this language, but finally relented after other delegates accused it of abrogating its leadership role in these talks.
So why does all of this matter to investors? First, it means that global warming is no longer a debate about science, but rather one about politics and economics. Second, it means that carbon emissions are going to become a big factor in global trade, with industrial countries earning credits for clean technologies that they help finance and deploy in emerging markets. And third, and most important, it means that carbon will come with a market price on emissions, which will have a profound effect on future investment decisions.
One investment banking analysis released just yesterday projects that carbon dioxide emissions now being traded in Europe will rise to 35 euros ($50) per tonne for allowances traded in 2008 and beyond. In the power sector, that would have the effect of making new gas-fired power plants competitive with new coal-fired ones, even though coal fuel costs are 50 percent cheaper than natural gas. The ripple effects would be felt throughout many industries that are heavy electricity or fossil energy consumers.
At the same time, carbon pricing is also going to have a profound effect on commodities trading, investment and lending decisions, asset liabilities and credit ratings. Just last week, four major banks teamed up with the New York Mercantile Exchange to announce the formation of the Green Exchange, a new commodities exchange that will offer a range of environmental futures, options and swap contracts for climate change-focused markets, starting in early 2008.
Also stay tuned for a RiskMetrics report to be released next month–commissioned by Ceres and the Investor Network on Climate Risk, an investor coalition with $4 trillion in assets under management–that analyzes how climate change will affect all facets of the banking industry. We'll be holding a webcast with Ceres in early January to discuss the report.
*This commentary expresses the views of the author alone and does not purport to represent the views of RiskMetrics Group or its clients.