Speaker 1:
From the library of the New York Stock Exchange at the corner of Wall and Broad Streets in New York City, you're Inside the ICE House, our podcast from Intercontinental Exchange on markets, leadership, and vision in global business, the dream drivers that have made the NYSE an indispensable institution of global growth for over 225 years. Each week, we feature stories of those who hatch plans, create jobs, and harness the engine of capitalism. Right here, right now at the NYSE and at ICE's exchanges and clearing houses around the world. And now, welcome inside the Ice House. Here's your host, Josh King of Intercontinental Exchange.
Josh King:
Welcome to another transatlantic episode of Inside the Ice House that we are recording in the middle of December in 2022. As our listeners know, Intercontinental Exchange or ICE operates across the globe, and this episode brings together nearly every aspect of the company's diversified all-weather business. Our show today has its origins actually in Amsterdam of all places where ICE operates the market to trade and hedge Europe's most liquid natural gas hub, the Dutch Title Transfer Facility, or as its more commonly known, TTF. The physically delivered futures contract, produces a daily settlement price based on transactions of customers who are actually physically buying and selling natural gas, which is then used as a benchmark for the price of gas across Europe. Now, the ongoing conversations across the European Union to set a cap on the price of gas has put energy markets onto the center stage as winter begins to arrive in the Northern Hemisphere. It's cold up here above the equator, and as December, January, and February come around, the demand for gas heats up as it were.
As more talk of this price cap hits the headlines, my ICE colleagues in London and across the continent have been working around the clock to educate policy-makers, politicians, and journalists about the detrimental impact that a cap would have on markets on ensuring the steady supply of energy, and that its impact might have on consumers up and down the supply chain. The price cap will also, as it turns out, have an unintended impact on the efforts to combat climate change and inhibit the important carbon markets that we've discussed several times on this podcast, establishing its place as a key part of the energy transition and decarbonization efforts on every continent. And there's really no one better to talk about the confluence of carbon, climate, and energy than our guest today. Andurand Capital Management's head of climate research, Mark Lewis. Our conversation with Mark Lewis on the economics of carbon, the outlook for energy markets in 2023, and the development of the climate research discipline, it's all coming up right after this.
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Josh King:
Our guest today, Mark Lewis is head of climate research for Andurand Capital Management. Mark was previously head of climate change research at BNP Paribas Asset Management and has held several senior roles at the Carbon Tracker Initiative, Barclays, and Deutsche Bank. Mark's also a member of the Financial Stability Boards Task Force on Climate-related Financial Disclosures. Welcome, Mark, inside the ICE House.
Mark Lewis:
Thank you very much, Josh. It's a real pleasure to be with you today.
Josh King:
So, let me just set the stage then for a minute. After a lot of back and forth between different countries in the block negotiations of the so-called market correction mechanism or a cap on natural gas prices are in a deadlock. Last week, the European Central Bank led by President Christine Lagarde, issued an opinion piece regarding the European Commission's price capping. In her commentary, president Lagarde says, I'm going to quote her here, "The mechanisms current design may increase volatility and related margin calls challenge central counterparty's ability to manage financial risks, and may also incentivize migration from traditional trading venues to the non-centrally cleared, over-the-counter market." That's from Christine Lagarde. So, in other words, this is could effectively threaten the financial stability in the EU. So, Mark, with pushback by exchanges from, like ICE, energy traders, and now with the ECB weighing in, do you think it's justifiable for the EC to move forward with the proposal and what other measures should the policymakers really be focused on?
Mark Lewis:
Yeah. Well, you've outlined there all the many objections that have been raised, and I think, from my perspective as 25 years in financial markets, the most obvious one is that if you interfere with the price mechanism, with the price signal, you're going to have problem attracting gas to Europe. And that's not an immediate concern, right? I think, one thing we should remind ourselves is that we are in a much better position at this moment than we thought we were going to be four or five months ago. In July, August, if you just rewind back to that point in time when TTF prices, power prices, and even carbon prices hit they're all-time high in August, were ramping. We were very worried in Europe about whether we would have enough gas this winter now, because of a number of measures that were taken in particular, filling up gas storage across the continent, paying the price that was needed, whatever that price might be.
We're in this fortunate position today where we have gas storage facilities almost full about certainly, well over 90%. 96% was the most recent figure I read. We've been lucky with the weather. But the point is, the price mechanism is key to disciplining consumers as well. The other reason why we're in a good position is that demand has fallen significantly, both at an industrial level and at a residential level. I emphasize again, we have been helped out by the weather. But there's the price mechanism sends a signal to consumers to change their behavior, to look at efficiency measures, just to wrap up more warmly inside.
I can tell you that, for example, just from a personal anecdote, in our offices, we are setting the thermostat lower than we ordinarily would do. And I'm just taking an extra pullover in the morning. When you start messing around with the price cap, with prices, with wholesale prices in particular... I think that's an important distinction to make. You can, and many governments across Europe have, intervene to cushion the blow for consumers, and you can shift some of the burden for high prices from consumers, particularly the more vulnerable consumers, to government i.e., to taxpayers. But if you interfere with the wholesale price, you risk not getting the gas that you need. So, I think, it's very ill-advised to do that and that's why we're having such a protracted discussion on this topic.
Josh King:
So, notwithstanding Mark Lewis doing his own impression of Jimmy Carter with an extra pullover, like wearing a sweater in the Oval Office and lighting a fire in the fireplace.
Mark Lewis:
Right.
Josh King:
Let's do a little preliminary damage prediction here. How do you think the introduction of a price cap on natural gas could impact the price of carbon? How would such a cap potentially undo the work done in the EU emissions trading scheme?
Mark Lewis:
This is where it gets really interesting. We're in a kind of no man's land on carbon pricing at the moment. We've got all-time record high carbon prices. Today, we've closed at 90 euros a ton. The all-time high was in August, 99 euros a ton. Som we're very closed still to the all-time high. And yet because of the very high gas prices that we've seen over the course of this year, the so-called fuel switching level, that is to say, the carbon price at which you are incentivized to switch from carbon intensive coal to less carbon intensive gas and thereby reduce your emissions, the fuel switching price has been so high that it's simply been very little fuel switching from coal-to-gas. To put it into context, Josh, I mentioned we have a carbon price the day of 90 euros a ton. At the current TTF price and the current coal price in Europe, you would need a carbon price probably of around 350 euros a ton to incentivize coal-to-gas switching.
So, on that side of the equation, the short run incentive, even though carbon prices are close to all-time highs, there is zero incentive to switch from coal-to-gas. Now, on the other side of the equation, the peculiar thing about these very high gas prices. And this is, as far as I can tell, it's the only silver lining to have come out of this calamitous and tragic war that Putin is waging in Ukraine, is that very high natural gas prices in Europe make the case for green hydrogen versus gray hydrogen more appealing. And that gray hydrogen, which is all of the hydrogen that's produced in Europe, and nearly all of the hydrogen that's produced globally today is gray hydrogen. And the process for making gray hydrogen depends on natural gas as the main input, and therefore, the cost of gray hydrogen is determined primarily by the cost of natural gas.
Now, the fact that natural gas is so high today in Europe means that you would need a much lower carbon price to incentivize green hydrogen over gray hydrogen. And that's why I think you're going to see now an even greater intensification of efforts to spur green hydrogen production in Europe going forward, because although we don't expect gas prices to remain at the current very high levels for the next five, six years, I don't think there's any doubt that there has been a structural repricing of natural gas over the forward curve.
And we are not going back to the kind of long term gas prices we saw in Europe even two years ago where the long-term forward curve was telling you that by 2030 the gas price would be 15, maybe 20 euros a megawatt hour. I don't think we're going back to those kinds of levels. There's now too much insecurity in gas markets, particularly Europe, and there's a need to attract LNG, and LNG needs more investment. We need more supply over the long term. So, it's a curious situation, we're in a no man's land on carbon at the moment.
Josh King:
While the root of the political divisions both in the US and in Europe are long established, climate as a financial sector is younger than actually your career is, which began in the traditional utility markets. What drew you to economics academically and then launched your career as an energy analyst?
Mark Lewis:
Yeah. So, I studied economics as an undergraduate at university, and I then did a postgraduate degree looking at the economic history of Latin America. And I wrote my thesis on the Mexican debt crisis actually, of the early 1980s. I'd always been interested in macroeconomics. And then, I suppose, what got me into energy was, actually, in the mid 90s, I was working at Standard & Poor's as a credit analyst doing utility credit analysis, and I got contacted by a headhunter, "Have you ever thought of doing equity research in utilities?" So, the next thing I knew I was doing equity research in utilities. I did that for five years. And then, this now, we're talking, we've reached sort of 2004, 2005, the European carbon market was established from the beginning of 2005, and I thought that this was going to have a very profound impact on the profitability of the European power generation companies.
So, I wrote an in-depth piece on the carbon pricing dynamics and how it would affect the merit, the so-called merit, or the competitiveness of different thermal generation plants. And it just took off. It was one of those moments in anyone's career if you're lucky enough to have one where everything's aligned. I was working at Deutsche Bank at the time as a utilities analyst and published this report. I like to think it was a great report, of course, and it was a very in-depth piece, but at the same time, an unbeknown to me, Deutsche Bank were in the process of establishing a commodities trading division and a carbon trading division. So, I published this report as an equities analyst, and the next thing I knew, I had the head of commodities at Deutsche Bank calling me and saying, "Hey, do you fancy moving from utilities to becoming a full-time carbon analyst?" And I guess, I literally was the first full-time carbon analyst in financial markets. And for the next eight years, I rode that first wave of the global carbon markets very happily at Deutsche Bank.
Josh King:
Long before you got that call from Deutsche Bank, though you're at Sheffield University, and you're studying economics, but you're also studying language. And in some other interviews that we looked at, you've talked about your love of Shakespeare's ability to capture the entirety of the human experience, even today. And as Pete and I were working on the episode in our conversation with you, we pulled up from King Henry IV Part One, in which Shakespeare writes, and I'm going to quote him, "And that it was a great pity. So, it was the villainous salt-petre should be digged out of the bowels of the harmless earth. So Mark, great line. Your study of Shakespeare and your study of economics, what can we learn from Shakespeare, the conservationist?
Mark Lewis:
Since you raised that, Josh, I studied foreign languages in economics at university. I'd always had a big interest in literature, and I really started to get into Shakespeare. Obviously, everyone reads a bit of Shakespeare at school, but what sparked me off on my Shakespeare crusade as it were was, I was helping one of my daughters with the homework. They had to write an essay on Macbeth. This is 15, 16 years ago. And I got really into helping her with this essay. And I had read Macbeth many, many years before that as a student, when I was at school, but reading it in my early 40s, I thought, "Wow, this is really... I'm going to have to go back and read this." And I made a pledge to myself in this industry, it is very easy to be consumed by the job on a 24-hour basis.
It's relentless. Markets are relentless, the news flow is relentless. And if you're not careful, and for many years I was not careful, you end up doing nothing but read work-related material all the time. And so I made a pledge to myself, whenever I'm traveling and including on my daily commute, I'm going to read all the classics that I wanted to read and that you're meant to read to live a well-lived life. And so I made a pledge to myself that I would read the complete works of Shakespeare, which I did. And then, I started looking for themes within Shakespeare that corresponded to the job. And in my case, great line that you picked out there on the mining industry from King Henry IV. There are many, many quotes actually in Shakespeare on climate change. Perhaps one of the most famous speeches in all literature is Hamlet's speech at the end of Act II when he is in despair and he talks about the overhanging firmament, the sky, the atmosphere being nothing but a pestilent congregation of vapors.
And that's literally 400 years before the IPCC published its first assessment report on the concentration of greenhouse gases in the atmosphere, which I like to think Shakespeare anticipated, with Hamlet's words of the pestilent congregation of vapors. And of course, as we all know, the tragedy of Hamlet is uncertainty or inaction, actually. He's indecisive, he dithers. And as a result, at the end of the play, because he hasn't taken decisive action in time, basically, everyone, all the key players in the action, die on stage. And so the moral of Hamlet is really, we have to deal with our own pestilent congregation of vapors today, and that means taking decisive action today instead of dithering and hesitating as Hamlet did.
Josh King:
And I think people like Mark Carney and John Carey would agree with you, but after that, digression through the complete works of William Shakespeare, Mark... Let's return to this moment while you're at Deutsche Bank in the early 2000s, you're beginning to write about these nascent carbon markets in Europe.
Mark Lewis:
Yeah.
Josh King:
What interested you about carbon pricing and despite all the political rhetoric around sustainability, why is the actual pricing of carbon, in the way that you see it, is actually politically neutral?
Mark Lewis:
Yeah, I mean, it's a great question. Honestly, I think what attracted me to it was first of all, the intellectual curiosity. Because economics is all about... Well, the economic problem, I remember from my time doing A-level economics, when you're a student in the UK, 16 to 18, you take your A levels. And so, I started learning economics when I was 16 years old. The first page of the first textbook tells you that the economic problem is the allocation of scarce resources, right?
Josh King:
Yes.
Mark Lewis:
That is the economic problem. And we have a pricing mechanism to enable the efficient or the most efficient allocation of scarce resources. That's what the pricing mechanism is there for. Now, when you come to thinking about carbon pricing, what is it that we're actually putting a price on? What is the scarce resource that we are trying to allocate as efficiently as possible via the pricing mechanism?
And one's first instinctive response to that is, well, it's the tons of CO2 that are going into the atmosphere, but that's not really the scarce resource. On the contrary, we've got too many of those. We're trying to reduce the amount of tons of it. So, the actual scarce resource that we're tying to price here is the limited amount of space left in the atmosphere for further concentrations of greenhouse gases. And that's premised of course, on a global budget for carbon consistent with different temperature outcomes as explained at length in the many IPCC reports.
So, it just struck me that here was a way in which we could use economics and the most fundamental aspect of economics, the pricing mechanism, to enable us to confront the problem of climate change. And I always been very interested in this idea of externalities. I remember reading as an undergraduate, a book by Jeremy Rifkin called Entropy, which is a fantastic... This is 1985, 1986 study before environmentalism had really taken on the kind of had become part of the economic mainstream, but he was setting out a case for a more sustainable way of dealing with the world's resources.
And so, that had kind of been at the back of my mind for a very long time. And then, in my professional career, many years later, when I saw carbon pricing become a topic, I thought it made a link with that. And I thought, "Well, this is one way in which I can have a very interesting career and hopefully, also contribute to a purposeful outcome for the entire world."
Josh King:
Purposeful outcome for the entire world. I don't know whether that was accelerated by your move to Andurand a couple of years ago, but it did spark a number of headlines at the time, declaring we have entered the age of the Rockstars and ESG investment, those kinds of headlines, Mark. What did it signal to the market that Andurand was so invested in climate as a sector, and how did the opportunity come to you to join the firm?
Mark Lewis:
Well, yeah, quite simply mean. Andurand Capital was established by our CIO and founder Pierre Andurand, a very well-known, probably best known in his career, Pierre, for trading oil, so for trading conventional energy commodities, but is also somebody who's been thinking very deeply about the energy transition for many years. And the way my hiring came about was that in my previous employment at BNP Paribas Asset Management, I had written a piece about green hydrogen and carbon pricing. We touched on it a few moments ago, this is two and a half years ago, when the long-term forward price for natural gas in Europe was indicating 15 to 20 euros a megawatt hour by 2030. And I wrote a piece saying, this decade, the decade we are now in, is going to be all about a shift in the pricing paradigm for carbon from the fuel switching paradigm in the power generation industry to a fuel switching paradigm in industry. And that means, first and foremost, switching from gray hydrogen to green hydrogen.
So, I wrote this very long report, and I was lucky enough to have an op-ed in the Financial Times published on the back of it, and I was contacted by Andurand Capita who had seen the piece in the FT and said, "Hey, very interesting piece in the FT. Would you be interested in having a chat?" So I said, "Sure, I would, but why don't you read the full report? That's just a snippet from the full report. Why don't you read the full report and then we can talk more about it." So, we did that and I established a dialogue with them. One thing led to another, and Pierre and the team, now my close colleague, Casey Dwyer, were in the process of launching the Underground Climate and Energy Transition Fund. And that was a fund that I thought that would be very exciting to work on because it covered all aspects of the energy transition and all asset classes of the energy transition.
And so, there we are. I just thought at this stage in my career, it would be a very interesting and exciting opportunity to get our hands on. So, I'm the head of climate research, as you said, I'm not the portfolio manager. Pierre and Casey do that, but I'm following all of the trends and feeding ideas in.
Josh King:
So friend of the ICE House pod, Gordon Bennett recently wrote, and I'm going to quote Gordon here. "We need to pivot away from the debate around compliance and voluntary markets and focus more on what the purpose of the underlying instruments are." So, Mark, how do you feel about removing voluntary in voluntary carbon markets, and can you break down the difference between compliance and voluntary for our listeners?
Mark Lewis:
Yeah, absolutely. So, if we begin with that with the second part of your question, Josh, compliance markets are effectively what we call cap and trade schemes. In other words, governments regulate these markets. They set an environmental target whereby the cap on emissions declines over time to meet a predetermined outcome, a policy objective if you will. And so, the defining feature of a cap and trade scheme is the amount of emissions is capped, you know what the quantity of emissions will be over the period, and through to the end of the scheme, you don't know the price. So, you're solving for quantity rather than solving for price. It's the opposite of a carbon tax where there you're solving for price and you let their market determine what the quantity will be. So, it's an environmental policy, first and foremost, rather than a fiscal policy.
Whereas a carbon tax is a fiscal policy, first and foremost, rather than an environmental policy, although obviously, they overlap with one another now. So that's the essence of a compliance scheme. It's a government regulated cap and trade scheme designed to achieve a given environmental outcome. Voluntary markets are project are emissions reductions, projects that produce credits that entitle you to offset emissions, but they've been more or less controversial over the last 20 years depending on the quality of the methodology that the project is using to reduce emissions. Te first large scale use of project credits was done under the Kyoto Protocol and under the Kyoto mechanisms, that is the clean development mechanism and the joint implementation mechanism. Many of these were renewable energy projects based on not necessarily an absolute reduction in emissions, but on saying, here's a baseline of what emissions will be without this project and this project will lead to lower emissions than otherwise would've occurred in the absence of the project. Whereas a compliance scheme is telling you, this is what the absolute level of emissions is today and this is where it needs to go down to in the future.
Now, both these kinds of markets have evolved a lot in the last 20 years. We now have an increasing in the compliance space, the largest markets in the compliance space of the European Emissions Trading System, the UK Emissions Trading System, the Californian Emissions Trading System. China has launched a nationwide emissions trading system, which will ultimately become the biggest in the world, but that's got a soft start. Chinese authorities quite naturally are giving that a soft start. And there are regional schemes in the US as well. Washington State has just introduced one, the RGGI initiative in the Northeast, the Regional Greenhouse Health Initiative in Northeast of the US. Now, some of these schemes are already aligning or looking to align with net zero. So, Europe being the first one.
And what that means is the cap is going to decline in line with what the science is telling us needs to be achieved in order to deliver net zero globally. So, in other words, the European Union is now effectively saying we are going to get to net zero by 2050 and the European Emissions Trading system is going to be the cornerstone policy for achieving that for the EU as a whole. California also has a net zero target on a statewide basis for 2045, actually, slightly earlier than the European Union. And the Californian scheme covers a bigger proportion of the Californian economy, 85% as compared with about 50% in Europe. So, that's become now, I would say, the cutting edge of compliance markets is they're looking to align their emissions reductions with a net zero outcome by 2050 in accordance with the Paris Agrement.
Voluntary markets, and I think the part in your question, which was particularly intriguing, Josh, is are we moving away now from the idea of voluntary markets. In my view, the agreement that was struck at the Glasgow COP last year, just over a year ago, November 2021, was very important on this. So, what you have in the Paris Agrement is Article VI, which is essentially trying to allow for the trading of emissions obligations on one level between different sovereign states. So, Peru and Switzerland entered into the first emissions trade between two sovereign states, whereby Peru effectively sold to Switzerland the right to use emissions reductions that were achieved on the territory of Peru for the compliance obligation of Switzerland under its Paris Agrement target. And obviously, that precludes then Peru from using that same emissions reduction for its own compliance obligation. Now, you can do that on an intersovereign basis, but Article VI also allows for governments, sovereign states to sell emissions reductions to non signatories of the Paris Agrement, in other words, to private corporations.
And so, the way this would work, and this is where Glasgow was so important, that the COP in Glasgow last year, is that what needs to happen there is that if we take the same example of Peru just for sake of it. Peru could say to a BP, "I don't have obligations under the Paris Agrement, but you need to reduce your carbon footprint." Civil society globally wants all companies with significant carbon footprints to reduce those carbon footprints. There's a lot of pressure on private sector corporations also to reduce their carbon footprint in line with the Paris Agrement. And therefore, what I think the direction in which this is going is that in future it will be harder and harder for private sector corporations to buy credits that do not have this Article VI stamp of approval, and the technical term for that is a corresponding adjustment.
And I think this is a term that your listeners are going to be hearing a lot more about going forward because it means you effectively have a guarantee that that emissions reduction credit is not being double counted. Because the whole point of Article six is that you are aligning physical emissions reductions in the world with the accounting of those physical emissions reductions. The voluntary market, as we know it today, stands entirely outside the global accounting system of the Paris Agrement. You are effectively creating a quasi-compliance market and any credit in the future that does not have a corresponding adjustment attached to it, that will be your pure voluntary market as it were.
But a credit that has a corresponding adjustment will allow BP, or Shell, or any corporation that wants to address its common footprint, to say effectively to its stakeholders, that is its shareholders bond bondholders, anybody who has an and to civil society, to the NGOs who are keeping a close watch on what these companies are doing to say, Hey, we have here an emissions reduction that is counting towards the Paris Agrement that Peru or whichever country they've bought it from, cannot use for their own compliance purpose with Paris.
And in effect, therefore, you are buying a gold standard credit, which actually goes beyond... This is the interesting thing. It goes beyond what the Paris Agrement requires because Peru or whichever country they've bought that credit from, still needs to reduce their emissions in line with the Paris Agrement. So, I think, in the future, credits with a corresponding adjustment will command a premium to all other forms of voluntary credits, and in a way, they won't be voluntary credits at all. As I say, they are quasi-compliance units. And I think, here's the thing, Josh, it's probably premature to have this debate, but people are having it anyway, and I'm talking about it whenever I'm on platforms.
Think of it this way, the EU ETS, I mentioned a few moments ago, is the cornerstone policy for Europe achieving its 2050 net zero target. What many people, including many people in the market itself, have not fully appreciated in my view is that for Europe as a whole to get to net zero by 2050, the EU ETS has to get to zero by 2040, the cap in Europe is going to fall to zero, in fact by 2038. Okay. Now, what does that mean? It means in practice, any European industry covered by the EU ETS will no longer be able to emit a single ton of CO2 beyond 2038. Now, the question that an increasing number of people are asking is that realistic? Is it realistic to assume that European industry will be producing zero carbon emissions by 2038? And if that is not realistic, one would hope that... I like to be an optimist and think it'd be great if we could engineer that outcome. But realistically, we may need to start using some form of offsets i.e., net zero rather than absolute zero. And what better instrument could you devise than a credit that is captured under the accounting mechanism of the Paris Agrement?
Josh King:
After the break, Mark Lewis the head of climate research for Andurand, Capital Management, and I will look more into the crystal ball, maybe not all the way out to 2030, but 2023 discussing the current events impacting the carbon and energy prices, and focusing our outlook on the outlook for the coming year. That's all coming up right after this.
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Josh King:
Welcome back. For the break, Mark Lewis, the head of climate research for Andurand Capital Management, and I were talking about the development of climate research and the carbon markets. So, before the break, also, Mark, a lot of talk that you and I had about COP 26 around this time last year. We had Mark Carney on the program who gave us a recap of what had been accomplished in Glasgow at COP 26 previously. As I mentioned, we also had Secretary Kerry talking about the many other schemes for measurement that you were mentioning before the break. Just looking at the last 12 months, what progress, if any, have we made since then?
Mark Lewis:
Yeah. Well, let me answer it this way. I think, we would've made a lot more progress if we hadn't had Putin's invasion of the Ukraine, has really scrambled global energy markets, and scrambled global policy, and scrambled global diplomacy. And so, this has been, in all my time in global energy markets, which is 25 years now, I've never known a year like it. But what I would say, Josh, is this. It still feels very different from the last time we had a major global policy and financial market disruption to compare with what we've seen over the last nine months since the invasion, by which I mean the global financial crisis in 2007, 2008, I mean coming out of the Barley Cop in 2007, there was actually a lot of optimism that we were finally getting on track, that the world was coming together, the outgoing, as it turned out, the outgoing administration of George W. Bush in 2007, even the United States under George W. Bush in December 2007, finally started to get on board with the COP process.
So, there was this sense of a constructive attitude globally developing on the need to address climate change. And then, the global finance financial crisis came along. And to be honest, we lost five years. It wasn't really until the Peru COP in 2014, the one before Paris in 2015, that the Lima COP 20 where you started to get this sense that the policy making agenda was veering back towards a constructive attitude globally towards the need of addressing climate change. Now, the good news is, despite this terrible development, the cruelty and all the rest of it, the invasion, we have not seen any significant backsliding on the global climate commitment. In and of itself, I think, that is extraordinary. I think, it's truly extraordinary. Anybody who's been following the climate space for the last 20 years, if you'd said to me even a year ago, Russia's going to invade Ukraine, it's going to put European gas prices...
I think, at the peak we got to 300 euros a megawatt hour for TTF, we got to 1,000 euros a megawatt hour for German power in August. If you'd said to me 12 months ago, this is what's going to happen, I would've said, "Well, that's going to be extraordinarily difficult for the global climate change policy making agenda." Now, all of that being said, there have been some problems, right? Sharm el-Sheikh was not a COP. I don't think that will go down in the annals of the UNFCCC as a particularly progressive or successful COP. But to me, the most important thing is the show is still very much on the road, and every year that goes by, the economics of the energy transition become that much more compelling. And to me, if I had to single out one thing that has made me more optimistic as I've covered the energy transition and policy making around climate change and financial markets engagement with climate change over the last 20 years, it's really that the economics have shifted inexorably towards clean energy, renewable energy.
And there's no going back on that, that's just physics. And once you've developed stuff at scale, once you've developed technologies at scale, they take on a life of their own. In fact, I often say that the reason that the renewable energy revolution is unstoppable is that renewable energy is qualitatively different from fossil fuel energy in the sense that fossil fuel energy is inherently inflationary, whereas renewable energy is inherently deflationary. And what I mean by that is, it's quite simple, it's just physics. Fossil fuels are a finite resource. You tend to exploit the most readily accessible resources first, those are the cheapest to access by definition. And then, as they are depleted, you move further and further up the long run marginal cost curve. So, over time, inexorably fossil fuels become more expensive. Now, of course, technology improves over time, and that's why you often hear in the fossil fuel world, this line about the cost of fossil fuels is always a battle between geology and technology, right?
Geology makes resources more expensive over time, technology can mitigate that but not fully. If you think about renewable energy, there's no need to explore the resources. There's no need actually even to develop them. All you've got to do is build infrastructure to capture the energy that you already know is there. We know where the wind blows, we know where the sun shines. If we build infrastructure there to capture the energy, which act source arrives free of charge, then over time, as you build more infrastructure, the cost falls. Because going back to our Economics 101, that's also one of the first things you learn as an economic student, there is such a thing as economies of scale. And so, when you build infrastructure scale, the cost falls dramatically and you get the technology bonus on top. So here, economies of scale and technology are pushing in the same direction, whereas for fossil fuels, it's geology fighting technology. And that's why we've seen this phenomenal reduction in the cost of renewable energy over the last 15 years.
I can remember being just a normal utilities analyst in the early two thousands when Germany was starting to try and develop solar resources and wind resources. And I remember being told by the CEO of a large German utility company, there aren't many of those around, so you can guess as to which one it was, but he told me, "Listen, solar energy is never ever ever going to be competitive. And here we are today, with solar energy is by far the cheapest source of new energy, particularly in the right jurisdictions. But even in Germany, even in Northern Germany, you can do solar now at utility scale for less than 50 euros a megawatt hour. And whereas, 15 years ago, the cost of that would've been well over 400 euros a megawatt hour.
Now, look, it was subsidized at the beginning, but you needed that to kickstart the industry. Now, we really just have to accelerate the deployment of energy transition. And again, a silver lining from the Russia's invasion of Ukraine is that everybody is more aware of the need for energy security of supply. And the great thing about renewables is not only do they help you fight climate change, by definition, they give you greater security of energy supply because they're all local. In the same way that people always say all politics is local, all renewable energy is local, right? And renewables are also a very good source of local employment. There are lots of reasons to renewable energy beyond the fact that they help us spike climate change. So, I think, you'll see an increasing acceleration on that front. And obviously, we need to scale up other technologies, batteries, storage, green hydrogen we've talked about.
But that's a long answer to your question of what's changed in the last year. I think, if I had to reduce it to one sound bite, having said all of that, the synthesis of everything I've just said is that... What we've learned in the last year, is that the energy transition is a global imperative, not only because it will enable us to fight climate change, it will also give us greater energy security of supply. So, climate change and energy security of supply are now two sides of the same coin.
Josh King:
In recent episodes, the topic of the richer nations creating a loss and damage fund to respond to the climate crisis has come up. For many, just getting the topic on the COP 27 agenda was a victory for the developing world. Were you surprised that an agreement was reached?
Mark Lewis:
Well, I think, getting the agreement is one thing, and it's certainly for the reasons you just mentioned, Josh, is certainly not to be sneezed at. But the execution and the implementation is going to be the real test, right? If you go back to the Copenhagen COP 15 in 2009, we had the agreement to provide 100 billion a year of climate finance for the developing nations, which was trumpeted at the time as a major diplomatic achievement. I think, that was meant to be ramped up by 2020, and we're still not seeing that level of transfer.
So, the devil is always in the detail, and it's about not only achieving headline breakthroughs in the diplomatic talks, it's about the follow-up and the implementation and the execution. So, having been a long time observer of these things, I know that it takes time, often, unfortunately much longer than we would hope for these things to translate into meaningful change on the ground. But I am cautiously optimistic that... I mean, that was a very meaningful breakthrough. I'm certainly not trying to downplay it. I'm just trying to provide some context that the important thing now will be following up and maintaining the momentum.
Josh King:
So, zooming out from our focus on Europe then, Mark, when talking about upstream, and midstream, and energy, typically, people think of oil and gas. What are some of the investment opportunities and infrastructure needed to build out that same infrastructure for renewables, such as you mentioned solar in Northern Germany, but what about energy storage? Talk about that aspect of the industry.
Mark Lewis:
Building out the energy storage part of the equation is now the real challenge and potentially the major constraint on the speed with which we can execute. I think it's become very clear that that renewables are the answer for power generation going forward, but we really do need that backup. Some people talk about carbon capture and storage also. This is a technology that has gone through a number of ups and downs really over the last 20 years. And it's one that I am a little bit skeptical about in the sense that in 2007, 2008, I remember that CCS was a very, very hot topic, and there were lots of conferences in Europe on CCS. And at that time we were being told by the CCS industry, the people pushing CSS, that a carbon price of $40 to $50 a ton would really enable this industry to take off.
And what has happened in the following 14, 15 years is that, as I say, the cost of renewables came down very dramatically over that period, and the cost of CCS, not only did it not come down, it appears to have gone up, in the sense, if you look at what the CCS industry is telling us today, it's more like carbon price of $100 a ton is what we need to make it. Now, that doesn't mean there isn't a role for CCS. I simply think that it will not have the same kind of role as was envisaged 15 years ago because the people who were pushing CCS 15 years ago... And it wasn't just the industry, it's lots of consultants, very well-known consultants, were pushing this idea that we couldn't get to a climate change settlement, we couldn't solve the problem of climate change without large scale CCS
And first and foremost, what was meant there was, as regards the power generation industry, as I say, the phenomenal reduction in cost in solar and wind has meant that CCS is not going to be needed at anything like the scale that was being talked about 15 years ago for the power sector. It may well be, however, that there are very important niche applications in industry for CCS, but they need to get on with it, and we need that technology to be developed at scale. When it comes to battery storage and also to EVs, because transportation, again, electric vehicles have made enormous strides over, not just the last 10 years, in particular, over the last five years. And the logic for that is obvious. Because it's actually, when you boil it all down, the energy transition is really all about improving energy efficiency. Electric vehicles are three times, three and a half times more efficient in their use of energy than internal combustion engine vehicles are.
So, over time, as the technology improves, there's no way the internal combustion engine can win in the long term against. And it's the same with wind and solar, they reach a point. The energy efficiency is much greater. If you burn coal to generate electricity, you're only getting one third of the energy out of that process. And the same, if you run gasoline through an internal combustion engine, you're only getting 20% of the useful energy out of it. It's a criminal waste of valuable energy, really. However, we need a certain number of resources to... It's an entirely different infrastructure that we need. And obviously, we need a lot of metals do this. We need copper, we need nickel, and we need lithium. And over the long term, that's where we're going to need huge amounts of investment in these areas.
Josh King:
And as we get to that, Mark, let's look at the balance between private sector and public sector investment. Here in the US, the government has typically subsidized the building of infrastructure from the canals of the 1700s through the dams of the 20th century, and even into space travel, talking now about who's going to be responsible for what above the atmosphere. But then, the government mostly stepped out of the way and let private enterprise flourish. How do you think about private versus public investment now in the energy ecosystem of a zero carbon future?
Mark Lewis:
The carbon market is a great example of a policy idea where you needed governments to implement a framework. It's an entirely political construct, carbon market is an entirely political construct. But once you've developed a market, you let the market deliver the outcome via the price mechanism. So, this gets very contentious very quickly. But the IMF of all bodies, which is certainly not Greenpeace or an environmental NGO, has now for a number of years, I think, for four or five years, been producing estimates of the total amount of subsidies in global energy markets. And for fossil fuels, depending on what you include as an externality, that number can be as high as $5 trillion when you take into account not just the direct environmental impact, but the impact on public health. So, I know it gets very contentious and so on, but I think it's important to remember that the true cost of fossil fuels versus the true cost of renewable energy is we are never going to agree, nobody's ever going to agree on all the numbers.
Josh King:
Is there tipping point though? Is there an actual number of-
Mark Lewis:
Yeah, I think we're already through it.
Josh King:
Yeah.
Mark Lewis:
Yeah. I think, we're already through it. That's really my point about the economics of tipped inexorably now in favor of renewables and of clean energy. And I think that's only going to accelerate going forward. Lots of developing countries are, for the first time, waking up to the incredible possibilities that they have. Many of them in regions closer to the equator, fantastic renewable energy resources, even countries in the Middle East where they have obviously the best endowments of fossil fuels, they have tremendous natural renewable energy resources, solar, wind, and so on. And I think, it will be interesting to see how all of this plays out. There's a lot of talk, for example, about countries as such as Saudi Arabia or Australia becoming the global powerhouse for the green hydrogen economy, and that you can produce it very cheaply and then you can export it in the form of green ammonia.
So, it's impossible to know exactly how this is going to play out. And the most important thing is that countries look at this in the light, not only of the need to tackle climate change, which is for me, the most important objective, but all the other benefits that come from this that I talked about earlier, the security of supply, the local, the jobs and so on. It's inevitably, human beings, there's a lot of institutional inertia. I think, if were starting from day one today, you would never produce another internal combustion engine car, right? If were starting from today, from scratch, it's obvious that an electrified economy, wherever possible, is the way we should be going. But we don't start from scratch. We start from a given infrastructure base, and we start from people who benefit from that given infrastructure base and want to continue benefiting from it.
And so, politics is a very crucial part of this, and we have to make information as widely available as possible on this... On the key point of economics in particular, I think, one of the other revolutions I've seen in the last two, three years is the way in which mainstream media in Europe has woken up to the fact that the economics of renewables are cheaper than the economics of fossil fuels. This is still a relatively recent phenomenon, even though it's been true for six or seven years now. So it takes time for mainstream to catch up.
Josh King:
So, if we have passed the tipping point then, Mark, as we wrap up our conversation here, you said back in 2021, a year ago that, I'm going to quote you here. "Energy transition is the biggest investment story in the next three decades. But while the direction of travel is clear, there will inevitably be steep hills and sharp drops in the road in places." So, you and I are recording this in late 2022, and I'm listening to what you just talked about. Like if we started from zero right here, we'd never create another internal combustion engine, we'd go directly to EVs. Where do you see drops in this? And you've said over and over that you're an optimist, what would be the pessimistic argument that says we will go backward in any way?
Mark Lewis:
Well, I think, the pessimistic argument would be that politics would get in the way. I think there was a lot of pushback in the immediate aftermath of Russia's invasion of Ukraine where many people said, "Oh, this shows that we can't rely on clean energy." It was a complete misreading of the situation, but it was an example of politics distorting a rational response where many people... I'm based in the UL, and there were certain people in the UK who've never been fans of the energy transition, let's put it that way, who said, "Oh, this just goes to show that we've spent too much time in the last five years talking about renewables, and we need more stable forms of fossil fuel imports. We can't rely on Russia." Actually, in the contrary, it's true. That tells you that you should be doubling down and accelerating your efforts to move away from fossil fuels and concentrate on renewable energy.
So, there's still an argument to be had. However clear the economics are, and I believe the economics are very clear now, there are still political blinkers in place in all countries, in some much more than in others, obviously. But I'd say that's the single biggest obstacle to a smooth energy transition, that that politics will get in the way and other agendas will get in the way. If we're guided simply by the economics and the other benefits, the ancillary benefits here, then I think, it's clear that we are going to see an acceleration. Now, that's not to say, "Look, we're going to need fossil fuels for the next 20 years at least." And one thing we've seen with Russia's invasion of Ukraine is that if a major fossil fuel supplier becomes a pariah in the world, and certain countries don't want to buy oil, gas, coal from them anymore, it can distort prices.
We've seen investment in oil and gas over the last five years, not running at the levels commensurate with demand. And in a way, one of the problems we have here in the energy transition is the risk, is we focus too much on supply before we've got demand sorted out. So, in other words, if the demand is still there and you've spent time saying, we need to reduce investment, we need to reduce the supply of oil, we need to reduce the supply of gas so that we can meet the climate change targets. But in the short run, there is no alternative to that, then you'll get price spikes, because demand hasn't had time to adapt yet.
So, we haven't spent much time talking about efficiency on this because we can't talk about everything, but I think, energy efficiency remains the hidden jewel in the energy transition crown. And we need really much more investment and we need to talk more about energy efficiency and the benefits it can deliver. Because as Amory Lovins and many others scientists have said, "The cheapest form of energy is the energy you don't consume." And it was Amory Lovins who coined the term, the negawatts, i.e., the megawatt that you do not consume is the cheapest form of energy. And that's really what we ought to be having a bigger conversation about in the next 10 years as well.
Josh King:
Well, as we always talk about in the podcast area, Mark, always leave them wanting more. And there's going to be a COP 28 in about 12 months, and you and I can get around these microphones together in 12 months and talk about how that went, and how these 12 months did evolve in the energy efficiency space, and what we see for 2024 and 2025 ahead. So, I'd love to have you back inside the ICE House.
Mark Lewis:
Thank you, Josh, it will be my great pleasure. Thanks a lot.
Josh King:
And thanks so much for joining us today. And that's our conversation for this week. Our guest was Mark Lewis, head of climate research for Andurand Capital Management. If you like what you heard, please rate us on iTunes, so other folks know where to find us. And if you've got a comment or question you'd like one of our experts to tackle on a future show or other guests like Mark Lewis, which Gordon Bennett made sure, "You got to have Mark Lewis on the show," email us at [email protected] or tweet at us @icehousepodcast. Our show is produced by Jess Tatum and Pete Asch, with engineering and editing from Ken Abel and Ian Wolff. I'm Josh King, your host, signing off from the library of the New York Stock Exchange. Thanks for listening. Talk to you next week.
Speaker 1:
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