The new Complementary Delegated Act to the EU Taxonomy Regulation sets out transition criteria for fossil gas and nuclear activities.
The EU Taxonomy, launched in 2020, provides definitions of how economic activities can be considered environmentally sustainable. It is designed to help shift investment flows to finance decarbonisation, create investment security, and prevent greenwashing. The first Delegated Act setting out criteria on sustainable activities for climate change mitigation and adaptation entered into force on 1 January 2022. This has been an extraordinarily impactful legislative initiative, both in Europe and globally.
A Complementary Delegated Act (CDA) was adopted by the European Parliament six months later; it adds climate mitigation and adaptation criteria for some fossil gas and nuclear energy activities. It is set to enter into force on 1 January 2023.
The Climate Bonds Initiative was vocal in its concern that adding gas measures would send a confused signal to markets; however, we also regard the gas criteria as having so many qualifications that actual utilisation is likely to be minimal.
The European Commission has included gas under the transitional activity category of the Taxonomy Regulation to “allow us to accelerate the shift from more polluting activities, such as coal generation, towards a climate-neutral future, mostly based on renewable energy sources.”
Fossil gas is a fossil fuel, made mostly of methane, a potent greenhouse gas with a global warming potential over 80 times that of carbon dioxide (CO2) on a 20-year time scale. Its net zero transition requires a rapid decline, including the early retirement of existing gas-fired power plants. and thus requiring rapid decline.
There is concern that the inclusion of gas into the EU Taxonomy opens the floodgates for fossil gas to receive green investment, however we expect only a very small number of gas investments to qualify
The CDA covers a number of specific activities for electricity and heat/cool generation from fossil gas and nuclear.
One set of fossil gas criteria uses the lifecycle 100g CO2e/kWh threshold for electricity generation established in the 1st Delegated Act. This is a robust threshold, based on the EU’s carbon budget and projected electricity demand. To meet this threshold, fossil gas power plants would need both substantial value chain leak detection and reduction and carbon capture and storage (CCS) technology.
The alternative set of criteria are only available for plants permitted before the end of 2030.
Nine requirements that make the Complementary Delegated Act’s criteria are extremely challenging:
- The plant must replace an existing coal generation plant.
- There must also be a national coal phaseout plan in place. At this stage, only 13 member states have coal plants and a phaseout plan.
- The gas plant cannot exceed the replaced facility’s capacity by more than 15%. Low coal capacity in several MS means very few fossil gas plants would be eligible for the criteria. For example, at least 38% of new planned gas capacity in Italy would be excluded from the Taxonomy.
- The project will also need to prove that the replacement cannot be made with renewable energy.
- The replacement must also reduce emissions by at least 55%.
- The facility must be designed to use renewable/low-carbon gases and will fully switch to these gases by 2035. Uncertainty on fulfilling these subjective criteria creates a reputational and investment risk.
- All fossil gas activities also require a leak detection and repair programme.
- Direct emissions cannot exceed 270g CO2e/kWh. Average emissions intensities of gas plants are far higher than this, so even this lower threshold would require high efficiency and possibly CCS.
- The alternative average annual direct emissions threshold of 550kg CO2e/kW of capacity over 20 years opens up investment risk as compliance with the threshold will not be able to be proven for 20 years.
Nuclear criteria are more generous, so certain nuclear investments will qualify
A key criterion for each of the nuclear energy activities is that they are located in a Member State with “a documented plan with detailed steps to have in operation, by 2050, a disposal facility for high-level radioactive waste”. Currently, only France, Finland, Estonia and Sweden meet this requirement. MSCI have calculated that only 14 major European nuclear firms have been added to the taxonomy-aligned space by the CDA.
In addition, MSCI found the inclusion of nuclear to have a limited impact on ESG investing as only 10% of ESG funds and 0.03% of Article 8 and 9 funds apply nuclear exclusions.
The Climate Bonds Initiative view is that nuclear-powered electricity is clearly low-carbon; whether current technologies should be a priority investment in the context of the risks of waste disposal and decommissioning is a matter for further discussion.
Investors have made it clear that they do not want fossil gas investments
During the process of portfolio construction, investors will still be able to choose not to invest in fossil gas projects, using additional proprietary screening criteria.
Following the publication of the CDA, many investors made clear their opposition to the inclusion of any form of fossil gas investments in the EU Taxonomy.
Investors and issuers wishing to communicate that they don’t invest in fossil gas can also align with the Climate Bonds Taxonomy which excludes unabated fossil gas energy.
Investment in CDA activities must also be disclosed in Taxonomy reporting, and possibly Sustainable Finance Disclosure Regulation reporting. This demonstrates that gas and nuclear are a category apart and will enable investors to avoid exposure.
The Climate Bonds Green Bond Database excludes unabated fossil gas energy. Issuers may well choose not to include CDA-aligned fossil gas in their bond use of proceeds to prevent exclusion by the indices that utilise the Climate Bonds Green Bond Database.
Investors are recognising the stranded asset risk posed by declining fossil gas consumption.
The EU’s legal commitment to achieve climate neutrality by 2050, with the intermediary 55% emissions reduction target by 2030 will require a 33-37% decrease in fossil gas consumption; this is expected to accelerate as part of the EU’s response to the invasion of Ukraine and subsequent gas supply restrictions. Global demand for fossil gas is set to decline 55% by 2030.
The forward-looking gas switching requirement also introduces a high level of stranded asset risk as some plants built during the CDA’s window will only see 5 years of operation before they have to switch to renewable or low-carbon gases in 2035. There is no guarantee that these gases will be available at sufficient scale in 2030, so plants will have to be retired early if switching is not possible, or lose their Taxonomy-alignment.
Investors are also choosing not to invest in fossil gas, due to increasing understanding that methane leakage brings carbon intensity of fossil gas-fired power near that of coal. The IEA has found that global energy sector methane emissions are 70% higher than official figures. This underreporting introduces further investment risk.
If other taxonomy developers include fossil gas with less stringent criteria, they would risk doing harm to their own economies.
Investor concerns over the EU Taxonomy prove that including fossil gas may reduce demand for the specific region’s green bonds. Particularly for emerging market taxonomy developers, green capital markets hold strong potential for accessing the financing needed for transition. It is vital that their taxonomies, and so locally-issued green bonds, are aligned with investor requirements.
All global taxonomies exclude CCGT plants, given strict carbon intensity thresholds. For taxonomies’ scientific credibility, it is important to align with the findings of the IPCC and IEA that limiting warming to 1.5°C means no new unabated fossil fuel infrastructure or investments.
Taxonomy developers should also consider the purpose of taxonomies. While exact purpose will vary country-to-country, most aim to channel investment to green activities to facilitate the net-zero transition. Energy sector CAPEX and OPEX are dominated by fossil fuel spending, fossil fuels see little difficulty in accessing global investment markets. Fossil fuel spending does not need taxonomy eligibility.
'Til next time.
Climate Bonds
