Originally published in Environmental Finance here

Co-written by Sourajit Aiyer and Sandeep Bhattacharya, India Projects Manager, Climate Bonds Initiative

Clean energy investments apart, the reduction of greenhouse gas (GHG) emissions from fossil
fuels is also critical to achieve the Paris climate goals and the IPCC’s target of below 1.5oC,
perhaps more so given the latter’s share in our energy and emissions mix.
Energy majors like BP recently said it would achieve “net-zero” emissions by 2050, followed
by Shell and Total. But the fine print tells an inconvenient truth! First, most pledges aim to
increase spending on renewable energy and create forestry-based offsets, rather than cut fossil
fuel emissions by significant amounts. In this model focusing on overall emission intensity
rather than fossil-fuel emissions, often emissions move north along with a growth in clean
energy assets due to increased consumption. This was seen in Total, as per a Transition
Pathway Initiative report, where the dip of 6% in emissions intensity following the scale-up in
biofuels, gas, etc. was accompanied by an 8% increase in total emissions. Shell suggests it may
also witness this in the future.

Next, electricity/heat comprises 41% of the 30 billion tonnes of CO2 released annually,
followed by transport at 22%. But the pledges focus on direct emissions from the processing
of fossil fuels, rather than the emissions from transport that uses that energy. Last, carbon removal through reforestation has limited value, since the food demand for the world’s ever-
growing population is putting a continual pressure to convert forest cover into farmlands.

Many green bonds focus on clean energy investments to offset or displace fossil fuel emissions,
but do not demand an absolute reduction of emissions. But CO2, the main GHG, has a long
life, once emitted. This leads to an issue of accumulation, which it is imperative to reduce. At the same time, the economic slowdown due to the Covid-19 pandemic has reduced spending
on fossil fuel exploration. And with the dip in oil prices, the economics from fossil fuel
projects are not too different from their renewable energy counterparts. Thus, now is an
opportune time to think about reducing emissions from fossil fuels – and transition bonds will
hold key!

Transition bonds are a variant of sustainable bonds that focus on achieving the targets for
decarbonisation of the existing energy portfolio and improving its energy efficiency, rather
than just investing in clean energy assets. In other words, they help companies transition
from brown to green! Most of these decarbonising opportunities are typically outside the
scope of green bonds, which direct proceeds towards climate friendly clean energy.
In terms of targeted sectors, electricity apart, transition bonds can also look at transport,
materials, industrial resource efficiency, cobalt mining, etc. Technological advancements have
opened opportunities to facilitate a transition from carbon-intensive to low-carbon areas, with
smart devices for better demand-side management at the grids, better performing electrical
batteries or devices that enable energy efficiency.

An early attempt to issue a transition bond was by Repsol, the Spanish energy company, in 2017. Its proceeds funded energy efficiency projects and technologies to reduce methane
emissions from refineries. At that time, neither the use of proceeds nor its corporate strategy
was aligned with the Paris Agreement. In 2019, Repsol committed to be zero net carbon by
2050, which implies the transition or green label might apply for future bonds.
A recent issue in transition bonds was by Cadent, the UK gas distributor, in 2020. Its proceeds
were directed to the adaptation of its gas network for hydrogen as an energy carrier. This also
aligned with the EU Taxonomy, which was based on rigorous scientific inputs. In 2019, Snam,
the Italian gas company, issued a climate action bond to fund investments in biomethane and
energy efficiency while Marfrig, the Brazilian beef producer, issued a transition bond to fund cattle bought from ranchers who complied with non-deforestation, animal welfare and fair-
labour practices.

Other notable developments include AXA Investment Management, who put forward their
interpretation of transition bonds and activities in a 2019 publication. The reporting
requirements lists indicators, such as emissions avoided and energy efficiency achieved, etc. It
also mentions that carbon neutrality is targeted by 2100, not 2050, which is not in line with the
Paris Agreement.

However, while the advent of transition bonds is encouraging, many issuances have not been
accepted universally as being free of greenwashing. The absence of a credible market standard
about what “transition” comprises of handicaps the segment’s potential growth. Interested
investors end up following different standards. Thus, transition bonds need to close the gap in
terms of a globally accepted standard and taxonomy, whilst ensuring issuer transparency to
avoid greenwashing. This is likely to be addressed by an upcoming paper by Climate Bonds
Initiative on transition bond standards, to be announced in their September 2020 conference.
Unless fossil fuel emissions reduce globally, the world will not get close to the 1.5oC target.
To achieve this and mitigate the impact of climate change, we need to reduce GHG
emissions by 7.6% per year between 2020 and 2030. Transition bonds, along with green bonds,
hold key towards this objective!

At the end, while the political economy around fossil fuels poses a systemic challenge, the
growing awareness of the fine-print of energy majors’ pledges, the fact that green bonds alone
may not suffice to meet the emission targets, the findings demonstrated by research done on
climate issues and the need to reduce secondary impacts of fossil fuels like health deterioration,
etc. does indicate that the time for transition bonds is now!