Now that President Trump has announced his intention to withdraw the U.S. from the 2015 Paris Agreement, what does it mean for the stated goals of the accord, and what might be the impact on markets and investors?
To put it simply, very little changes. Current country commitments are already insufficient to hold global warming to under 2° Celsius from preindustrial levels, the stated goal of the accords. We acknowledge the possible risk that other countries could follow suit in withdrawing from the agreement, but none has voiced this yet, while Europe and China are doubling down. In fact, President Trump's decision diverges from what many companies and investors have been signaling lately. Further, we reiterate our view that most sectors are currently driven by economics and technology rather than policy.
In theory, the Trump administration could have done nothing on Paris, still rolled back environmental policies and suffered no real repercussions.
An exit from the agreement will take several years. Because the U.S. has already ratified the Paris agreement, officially retreating from its commitment would take four years—unless the U.S. were to exit altogether the 1992 parent treaty establishing the U.N. Framework Convention on Climate Change (UNFCCC), which presumably would void U.S. obligations to both agreements in one year. It's unclear which option President Trump is weighing.
Virtually No Cost to Stay
Upon exiting the Paris Agreement, the U.S. leaves some 190 signatory parties in uncertainty, while joining Nicaragua and Syria, the only two UNFCCC member states not to have signed—Nicaragua because it believed the agreement didn’t go far enough, and Syria due to its ongoing civil war.
Despite the President’s assertion that the current terms of the Paris Agreement were unfair to U.S. businesses, we believe the accord was intentionally designed to be risk-free. It lacked any legal enforcement of countries' commitments, allowing the U.S. to accept the agreement without a Senate vote. In theory, the Trump administration could have done nothing on Paris, still rolled back environmental policies and suffered no real repercussions.
To be sure, not everyone agreed that the accords pose no risk. In the weeks before the announced withdrawal, two letters to President Trump from elected officials—one from 10 state attorneys general and another from 22 senators, all Republicans, stated their support for a withdrawal, arguing that staying in the pact would open the U.S. to litigation risk if commitments weren’t kept.
Economics & Tech Still Rule
Still, economics and improving technologies, not regulation, are the driving forces behind many of the sustainability trends in global markets today. Our energy commodities team's fundamental analysis of power-generation economics shows that longer-term coal can’t compete with natural gas or renewables, even on an unsubsidized basis. In a recent report, the team cut its 2017 coal-burn forecast by around 4%, and now sees only a modest year-over-year improvement, with most of those gains lost by 2018, due to ongoing competition from natural gas and renewables.
At the same time, the rate of change in solar and wind economics is picking up, we think more rapidly than investors appreciate, with a nearly 50% price reduction in solar panels over just two years (2016-17, estimated) and wind power with an all-in cost in windier portions of the U.S. that is a third to a half of the all-in revenue needed for a new natural-gas-fired plant at $0.055-0.065 per kilowatt hour.
In May, one Arizona utility signed a 20-year contract to buy energy at what is reportedly the lowest price for solar photovoltaic power achieved in the U.S. to date—below $0.03/kWh. Wind has already achieved all-in costs of $0.015-0.025/kWh with tax credits, and could be a $0.02 -0.03/kWh product, even without tax credits, by early next decade, largely driven by improvements in wind turbine technology—taller tower design and wider rotor diameters that could drive net capacity factors to nearly 60%.
Opportunity to Step Up
What about the impact of the U.S. withdrawal on companies, investors and other countries? Some developing nations may want to follow suit, glad for an excuse to exit the agreement and shed the perceived burden. However, it’s worth noting that during the original Paris negotiations in 2015, countries agreed not only to hold the temperature increase to "well below 2°C" but also "to pursue efforts to limit" it to 1.5°C above pre-industrial levels—a more ambitious target designed to bring more countries into the agreement, rather than fewer.
Indeed, some other countries are already taking the opportunity to step up. In response to rising global climate concerns since the U.S. election, many have doubled down on their climate change rhetoric, instead of echoing the shifting stance of the U.S. on carbon. European foreign ministers have committed to raising awareness among partners and to reinvigorating global alliances on climate policies, including bilateral meetings with Canada, China, India, and Iran.
Some argue that China could take the renewable energy lead from the U.S. and play a critical role in the Paris climate agreement, if it continues along its current path. China’s coal consumption has declined for the past three years; and it has been shuttering small, inefficient coal mines, even as it has continued to invest in its renewables sector, both for its domestic market as well as export.
Acting Locally
Even individual U.S. states have been spurred into action. Recently, the California Senate has proposed a series of bills, ranging from accelerating renewable energy targets to keeping landmark federal environmental laws, such as the Clean Air Act and the Clean Water Act, enforceable under state law, even if they are eliminated at the federal level. These bills, in part viewed as "insurance" against federal action, follow the U.S. Senate’s rejection of moves to repeal limits to methane emissions from oil and gas drilling. Amid a growing string of recent U.S. environmental policy reversals, this was the first to fail.
Companies have been stepping up, too, arguing for competitiveness. A group of large public companies and CEOs signed two recent letters urging President Trump to remain in the Paris climate agreement for reasons of competitiveness, job creation, and business risk management. These follow on hundreds of others—including from energy and coal companies—that began shortly after last’s fall election. Most recently, local governments, companies, and investors have together expressed support in a letter titled “We Are Still In.”
Last, but not least, investors are also speaking up. In recent annual general meetings, shareholders have been particularly outspoken on climate-related proposals. More than 60% of shareholders of one major energy company recently voted—against management's recommendation—in favor of the company reporting on its climate progress. The same also occurred at another energy concern, and similar proposals at a number of smaller energy firms narrowly failed with 46%-48% of votes.
Adapted from a recent report, “US to Take the Path Less Traveled, Exiting COP21” (Jun 1, 2017). For more Morgan Stanley Research on sustainability issues, ask your Morgan Stanley representative or Financial Advisor for the full report. Plus, more Ideas.
