The COP21 agreement to limit global warming to less than 2 degrees Celsius, signed in Paris last year by nearly 200 countries, finally came into effect this month. Along with it, however, have come warnings that the measures pledged by governments to meet this target are insufficient and would allow temperatures to rise by a potentially catastrophic 3 degrees Celsius. Adding to this grim outlook, Donald Trump’s surprise win in the American presidential elections has cast doubts over the agreement’s ultimate fate. Such pessimism aside thought, an examination of commodities markets, namely oil, coal and aluminum, shows that the lower emissions targets prescribed by COP21 are already starting to yield results, as industry actors are adapting to the new regulatory environment.
In the oil sector, the agreement's impact likely played a part in OPEC’s announcement of a production cut to reign in excess supply, created when Saudi Arabia ramped up output and tried and drive US shale out of business. The result, as intended, was a precipitous decline in the price of oil, which reached a 13-year low of $26 a barrel at the beginning of this year. Even if Saudi production surged by an extra 1 million bpd (to around 10.6 million bpd) since 2014, tenacious shale companies managed to weather the storm better than the Saudis had expected. By that point, the war of attrition was already eating into the Saudi state’s finances to an unsustainable degree. Unemployment rose and the budget deficit ballooned.
The government decided that a change of tack was in order and a radical overhaul of the Saudi economy was announced. The Vision 2030 program, unveiled earlier this year, calls for massive investment in the Kingdom’s underdeveloped private sector, with economic diversification rather than domination of the oil market, as the blueprint for future growth. That one of the world's oil-dependent economies is openly touting its efforts to move beyond a petrol-based rentier economy entirely speaks to how leading oil producers view long-term prospects for oil prices. As the American shale industry rebounds and the new US President-elect boasts about his commitments to increasing fossil fuel production, it is highly unlikely that Saudi or any other major producer will be able to plan around high prices at any point in the forseeable future.
The engine for investment will be Riyadh’s sovereign wealth fund, which would take over ownership of Saudi Aramco and bring the value of assets under its control to over $2 trillion. In this context, the Saudi commitment to cut oil production comes from the realization that a higher price means the PIF’s oil industry assets, including Aramco itself, will see their value rise and generate more cash for investments. The hype surrounding the plan has started to attract willing investment partners. In October, a Japanese tech company, SoftBank announced that it was creating a $100 billion tech fund with $45 billion in help from Saudi money. Additionally, Riyadh has been courting UK investors scrambling for returns in the post-Brexit environment. The UK is already one of the country’s biggest economic partners, and Prime Minister Theresa May has identified Saudi as one of the government’s priority markets abroad. A Free Trade Agreement between London and Riyadh is also being assessed.
As is the case with oil, the oversupply in certain energy intensive industries (such as steel and aluminum) is causing producers to do some soul-searching. The chief culprit in these sectors has been China, whose combination of shoddy industrial standards and over-reliance on coal has created not just unprecedented overcapacity but quite possibly the world’s most polluting industrial sector. Having come in for a barrage of criticism and seen huge tariffs slapped on its steel exports, the Chinese government, in line with the environmental commitments made in Paris, has moved to cut back its production of both steel and aluminum. By the end of 2016, China aims to have shut down 1,000 coalmines with a view to reducing output from 2.17 billion tons this year to 500 million within three to five years. Out of the 7000-odd industrial projects that were built without proper environmental approvals, Beijing will look to closing some 1300 by the end of the year as they’re considered unsalvageable. Related: What Happens To Oil If Trump Tears Up Iran Nuclear Deal
The drive, meant to take out inefficient or illegal producers, is in keeping with plans to reduce China's steel production capacity by 13 percent within five years. Similar measures are taking place in the aluminum industry. After the Chinese government stressed the importance of strictly controlling production levels, officials began checking the way current smelters operate and whether they meet environmental standards. While these measures are welcome, enforcement remains a real problem. Local governments have proven quite ready to turn a blind eye to transgressors and sanctions have largely been ignored. For example, Xinfa Group’s smelters, one of China’s biggest aluminum producers, are emitting particulate matter levels (19 mg/m3) that are almost double the national standard (10 mg/m3) with impunity, while Hongqiao, another aluminum producer that was told to shut down half of its production capacity, has so far not taken any action.
With the COP 22 in Marrakech in full swing we can already discern a movement in the right direction taking place in two of the worst offending industries, oil and coal. What the COP 22 hopes to achieve is to put in place a standardized framework within which each country's carbon reduction measures can be monitored and measured against the pledges made in Paris. The COP 22 also proposes a regular appraisal of progress towards meeting carbon reduction goals, which it is hoped will further encourage states to meet and exceed their targets.
The newfound commitment to tackling the oversupply of steel and coal in China and oil in OPEC countries should just be a first step in the continuing global effort to tackle climate change – with or without Donald Trump, market forces are already in motion.
By Richard Talley for Oilprice.com
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