Fossil fuel credit ratings unmoved by Paris Agreement

| 14th December 2015
Transmission lines across the Ohio River. Photo: Iris Shreve Garrott via Flickr (CC BY-NC-SA).
Transmission lines across the Ohio River. Photo: Iris Shreve Garrott via Flickr (CC BY-NC-SA).
The impact of the Paris Agreement on leading rating agency Moody's assessment of the world's fossil fuel companies is ... nothing at all. The one change is in Europe, where thermal generators have a worsening outlook, and renewables are 'credit positive'.
Although it confirms the momentum for tackling climate change the Paris Agreement does not provide detailed objectives relative to greenhouse gas emissions nor does it impose any legal obligation to limit or reduce them.

What's the best way to see what the Paris Agreement really means for the future of fossil fuels?

For a start, see what the credit rating agencies have to say about the prospects for fossil fuel corporations. It so happens that, quick off the mark, Moody's has already released its assessment. And to read it, it's clear that much has changed - at least, not yet.

According to Moody's Investors Service, the agreement reached at COP21 "could have material credit implications for certain sectors globally. However, significant uncertainty persists over the magnitude and pace of carbon emission policies."

Significantly, credit ratings of fossil fuel companies have not been revised as a result of the deal reached in Paris on Saturday. But that could yet change, says Brian Cahill, a Moody's Managing Director:

"The Paris Agreement will likely lead to an increased uptake of carbon reduction policies worldwide and, as such, the credit implications for a number of sectors will grow absent substantial counter-balancing initiatives by entities within these sectors."

Too many uncertainties

Moody's conclusions were contained in a just-released report, 'Paris Agreement Advances Adoption of Carbon Regulations; Credit Impact to Rise'.

According to the agency, "the cornerstone of the deal is the objective to limit global warming to 'well below 2C above pre-industrial levels' and' pursue efforts' to limit the temperature increase to 1.5C by reducing greenhouse gas emissions." It also notes that "governments will revisit their emissions reduction targets every five years."

However it says the agreement also creates major uncertainties as far as its consequences are concerned, owing to the fact that large parts of it are not legally binding, and that, in any event, the commitments made are insufficient to achieve the desired outcomes.

A key problem, says Cahill, is that "intended nationally determined contributions (INDCs) - a public outline of a country's post-2020 climate actions submitted at COP21 - are both voluntary and, as the Agreement states, not sufficient to meet the 2C limit goal.

"This makes more detailed assessment of the credit impact of the Paris Agreement difficult, although the trend is clear and broadly negative for those sectors with the highest exposure to carbon emissions regulation that we have identified."

$3.2 trillion of debt at risk

The ratings agency recently identified three sectors - unregulated power generation, coal mining and coal terminals - with very high credit exposure to carbon regulations, and a further 11 sectors with high credit exposure. Combined, these 14 sectors account for approximately $3.2 trillion of rated debt.

But to assess what the Paris Agreement will mean for those sectors in specific jurisdictions remains difficult as there is no standard format for the INDCs, says Henry Shilling, a Moody's Senior Vice President:

"Specifically, we believe that greater clarity on country-specific measures and improved disclosure around the implications of such measures by individual entities will allow market participants to more effectively assess the credit implications for a sector and differentiate between entities in those sectors."

"Ideally, an entity's specific disclosure would be done in a globally consistent manner and in a way that is independently verified."

There is also a potential for "meaningful regional variations in the pace of adoption in INDCs" including in how they are achieved, for example using emission trading schemes, carbon taxes, or other policies, and their enforcement.

"Clearly, the future course of emissions remains highly variable, depending on the extent to which governments implement their INDC commitments and further tighten over time their targets", says Cahill.

But in the EU decarbonisation policies will bite fossil fuel generators

In a separate report report focusing on the EU, 'After COP21: Decarbonisation Policies in the EU Will Continue to Shape the European Electricity Sector', Moody's concludes that the Paris Agreement "reinforces the pursuit of decarbonisation policies in the EU."

"EU directives and/or national policies will lead to the closure of a large proportion of coal-fired plants by the middle of the next decade. In addition, utilities with conventional generation will continue to see their volumes reduced and their margins squeezed as new renewable capacity further push thermal generation out of the merit order ...

"However, the push for new renewable capacity will be credit positive for renewable energy companies, whose growth will allow their parents to replace in part the lost earnings from declining thermal generation.

"Increasing renewable capacity will also require sizeable capex programmes to connect new capacity and manage the intermittency of these sources. This will provide grid transmission companies with the opportunity to grow their asset bases, but will also create operational challenges."

Energy efficiency measures will also challenge the unregulated utilities, said Paul Marty, Moody's Vice President and Senior Credit Officer: "A decline in electricity consumption driven by higher levels of energy efficiency and resulting in lower revenues would be credit negative for the sector."

He added that "utilities with a low proportion of contracted / regulated activities such as networks or renewable generation supported by feed-in tariffs are most at risk."

However, the agency points out, "Although the deal confirms the momentum for tackling climate change, and reinforces policies restricting greenhouse gas emissions, the Paris Agreement does not provide detailed objectives relative to greenhouse gas emissions nor does it impose any legal obligation to limit or reduce them."



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