Tuesday, November 21, 2017

Green Bond Market Shows Promise

For green bond issuances globally, 2017 has been an extraordinary year. According to the Climate Bonds Initiative (CBI), issuances worldwide totaled US$55.8 billion in the first half of 2017 — up more than double from US$21.2 billion over the first half of 2016. While the European and Chinese markets have enjoyed most of the spoils, the U.S. green bond market has lagged behind — largely tempered by institutional and political challenges. Among them are the Trump Administration’s intent to roll back the Clean Power Plan (CPP) — the federal-level commitment to carbon reduction first proposed by President Obama — and the ongoing partisan disagreements over which direction, if any, the U.S. should take when it comes to climate initiatives.

However, these hurdles are not preventing environmental progress altogether; there continues to be a groundswell of support for decarbonization initiatives originating at the state level. In fact, many progressive states, often partnered with like-minded companies, are embarking on unilateral schemes that encourage renewable development, irrespective of the ambivalent conditions at the federal level. Though, overcoming these will be crucial if the U.S. is to play catch-up with the market frontrunners — and to realize the green bond market’s full potential.

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Market Uncertainty Slows Progress

Compared with burgeoning European and Chinese markets, green bond issuances in U.S. have received less traction for numerous reasons. Climate change mitigation — and the climate change debate, more generally — has long been subject to partisan intransigence in the U.S., evidenced in the last year by strong support, in some regions, for restoring the fortunes of coal. Establishing a consensus around cohesive principles that can underpin the U.S.’ carbon mitigation has, therefore, been fraught with challenges. And what has followed is an uncertain environment for investors and developers alike.

The lack of clarity around federal-level investment tax credits (ITC) and production tax credits (PTC) is a case in point. Introduced in 1992, PTCs have played a critical role in helping U.S. wind power generation to quadruple between 2007 and 2014 (as well as a role in solar development) — though its renewal beyond 2020 is in jeopardy as budget negotiations in Washington are underway. An absence of these incentives may hinder renewables development and the further growth of U.S.-based green bond issuances.

Compare this to the EU, for instance, where the bloc has enjoyed transparent and longstanding carbon mitigation frameworks. France’s Article 173, known as the French Energy Transition for Green Growth Law, mandates full environmental disclosure from the financial sector — and has been crucial to building investor confidence in green ventures.

The energy subsidy in Germany, the feed-in-tariff (FIT), has produced long-term, fixed-price contracts with renewable energy producers since 1991. With FITs, German developers have enjoyed certainty around reliable cash flows and without any exposure to energy prices. While the incentive has brought its own challenges (on windy days the German grid can become overloaded), the stability it has provided for investors has been understandably welcomed. What’s more, FIT’s role in modernizing the German grid is clear: 4.7 percent of U.S. electricity output was wind-generated; for Germany, it was 13.3 percent.

In this respect, the lessons to be learnt for the U.S. are evident: addressing the lack of near-term clarity on environmental policy and creating a supportive regulatory framework will be critical before the green bond market can flourish fully.

State-Level Initiatives Take Hold

Yet the U.S. climate-related markets are displaying signs of growth. Federal regulatory concerns aside, we’ve observed rising support for U.S. green projects at the state level — with the value of outstanding bonds that fund climate-related projects now eclipsing US$100 billion. Though many are not strictly green-labelled (i.e., assigned the “green” moniker at the point of issuance), these bonds all contribute to carbon reduction in some form.

Leading the charge are the country’s more progressive states and cities (New York, Massachusetts and California, in particular). New York City has committed to an 80 percent reduction in carbon emissions by 2050, which is helped by the issuance of green bonds that fund large-scale infrastructure projects — including a US$315 billion wastewater adaption project. Indeed, 70 percent of U.S. green bonds issued in the first half of 2017 were municipal — with both San Francisco and Los Angeles working to follow New York’s lead. With these progressive states taking the mantle on climate change, we expect renewable portfolio standards (RPS) to increase, aided by declines in installed costs — at which point more conventional solar, biomass and wind power projects, as well as next generation technologies such as offshore wind and battery storage, may enter development.

It is also believed that the development and expansion of RPSs may enhance the prospects for U.S. renewables. Mandated by 29 states (and three territories), the legally-binding agreements require utilities to deliver a specified amount of electricity using renewable sources.

The standards are determined locally and voluntarily: Hawaii and Vermont have the highest standards, at 100 percent and 75 percent, respectively; South Carolina passed an RPS as low as 2 percent; both extremes reflect the capabilities of the individual states. Ironically, some states have even introduced more ambitious RPS targets for new asset classes since the Trump Administration’s decision to roll back the CPP. And such targets are considered stimuli for new green issuances at the municipal level.

So, while the U.S. may be considered the laggards in the market by some, we see the U.S. green bond market as a potential source of growth in the coming years. Demand for green bonds continues to outstrip supply, making competition fierce and enabling municipalities the best chance of receiving a higher price for constructing green projects. And, if recent trends persist, we can expect to see more investment for climate projects coming from investor-owned utilities and public power entities in the near future.

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