- Green stimulus and energy transition hopes supercharge share prices
- European carbon price set to climb as cap and trade system expands
Polluters are crying out for more regulation. Miners want tighter environmental, social and governance (ESG) certification. Oil and gas companies are calling for carbon cap and trade systems. While such ambitions may help to set a level playing field – perhaps seeing European oil companies get a competitive advantage against their climate laggard US competitors – this kind of carrot-and-stick regulation is already proving a major earner for green companies. Investors have flocked to the likes of wind-exposed utility Orsted (Den:ORSTED), while oil and gas majors are trading near record lows.
As more countries announce net zero carbon emission goals – Japan being the latest – more government support is likely to come for technologies that replace major sources of pollution, like renewable energy, and balance out necessary carbon emissions.
This looks like it will ramp up in Europe in the coming years as part of the European Green Deal, which will expand the existing carbon cap and trade scheme to buildings and the maritime and road transport sectors. Carbon pricing in the European Union (EU) right now specifically pertains to the price of a permit to emit a tonne (t) of CO2 under the emissions trading system (ETS). A ramp-up is not in the distant future, either, with the commission lifting the 2030 emissions reduction target from 40 per cent to 55 per cent as of last month. Limiting carbon allowances will help this.
For companies producing more carbon credits than they need, or sitting well under CO2 emissions caps, their credits could become a more and more valuable commodity. Under BP’s (BP.) most recent climate forecasts, if the world can limit warming to 1.5 degrees, the carbon price will hit $100/t in 2030. In recent months, the EU’s carbon price has bounced between €25 per tonne (t) and €30/t.
Tesla's credits
Tesla (TSLA) is the key example of how to benefit from this kind of policy, selling credits for its zero-pollution electric vehicles (EVs) to other carmakers. This is the factor that has allowed Elon Musk’s company to deliver a profit. In the September quarter, Tesla had net income of $369m and brought in $397m in regulatory credits, compared with $134m a year ago.
Taking away this bonus income, the carmaker’s automotive gross margin drops from 27.7 per cent to 23.7 per cent, while Bernstein analyst Toni Sacconaghi said that the September quarter pre-tax profit margin dropped from 5 per cent to 1 per cent when the credits are removed. Tesla finance chief Zachary Kirkhorn said that the company was enjoying the credits while they last. “We don't manage the business with the assumption that regulatory credits will contribute in a significant way to the future,” he said in last week’s quarterly earnings call. Mr Kirkhorn forecast regulatory credit income of almost $1.2bn in 2020, double last year’s take.
These credits are from state-level emissions reduction schemes, where carmakers have to produce a certain proportion of zero-emission vehicles. Tesla only produces this kind of car, so it can sell on those credits to other carmakers. As Mr Kirkhorn says, this will shrink as other companies ramp up EV production.
Looking at other companies affected by carbon pricing or other government emissions reduction policies, there are those directly reliant on political action for revenue and others that are just adding to existing revenues or profits through inducements, like renewable energy companies.
Hydrogen company ITM Power (ITM) is in the former category. Investors have flocked to the stock this year, tripling its share price on the back of excitement in hydrogen technology. For a company that hasn’t made a profit and reported revenue of £5m last year, that is some performance. Like any Aim-traded, growth-focused company trading strongly, ITM raised money last week. The £165m placing was the same size as its market capitalisation a year ago, and bigger than its record-high project backlog of £119m as of 30 April. ITM specifically builds operations that produce hydrogen gas.
What subsidies?
Renewable energy projects have long been subsidised to encourage low-carbon energy generation. But solar and wind generation now competes with fossil-fuel plants on price. The International Energy Agency (IEA) christened solar the "king of electricity supply" earlier this month. Even going by current policies – without a major push from a new US administration, for example – renewables will meet 80 per cent of global electricity demand growth out to 2030 and “overtake coal by 2025 as the primary means of producing electricity”, according to the IEA.
ABN Ambro says that this renewables rise, in Europe’s case, would see forecasts of extremely high carbon prices go out of date fairly quickly. “With the phase out of coal and the rapid build of renewable energy sources (mainly solar and wind), the demand for carbon allowances will continue to drop within this sector,” said senior energy economist Hans van Cleef.
Beyond the US credits for EV-focused carmakers and the EU scheme, there are policies like this in place or in the works all over the world. But the primary goal is to make them unnecessary, as we’ve seen in the renewables sector. Companies – and their investors – have major opportunities to follow the green wave in the next few years before the energy transition transitions them out of existence. Tesla shareholders have shown themselves a bullish bunch, but they should keen a sharp eye on the regulatory credits, as profits aren't coming without them at the moment.
