Following April’s global climate summit, Kris Atkinson, Portfolio Manager, Fidelity International consider the opportunities for bond investors arising from the US’s plans to decarbonise the world’s largest economy.
The announcement by President Biden on April 22nd of a target to halve US greenhouse gas emissions by 2030 (from 2005 levels) and his announcement in March “to create millions of good jobs” in clean energy, electrified transport and general decarbonisation will generate opportunities for bond investors and transform the US bond market.
In line with the new target and its ‘American Jobs Plan’ (AJP), the US government aims to spend over $2 trillion this decade on infrastructure projects. These are broadly defined as activity related to carbon emissions reduction, climate change resilience and ensuring inclusive growth and social equity during the low-carbon transition. This could lead to the following changes for US bondholders.
1. Green/sustainable bond market comes of age
The green bond market has grown rapidly since the Paris Agreement was signed in 2015, but still accounts for just 1 per cent of global developed market debt. The US has fewer issuers than the size of its economy should warrant. But the proposed $2 trillion of spending, aimed squarely at improving environmental and social sustainability, opens the door for a significant increase in US green government bond issuance (or ’Greasuries’ pending a better title), and sustainable bonds generally.
Companies seeking additional funding as they build utility infrastructure or capacity for zero-carbon transport will add to this green fiscal boost. Some portion (likely most) will be funded through the debt markets, and much of it will be issued in a green, social or sustainable format.
Meanwhile, across the Atlantic, the European Union is due to launch its €800bn Next Generation EU programme designed to rebuild economies after Covid-19, of which a third could be financed using green bonds. Increased supply would bring sustainable finance fully into mainstream debt investing and ease the current imbalance of high investor demand and limited green and sustainable supply, potentially making these kinds of bonds cheaper and more liquid.
2. Evolution in credit risk for different sectors
The US spending plan is likely to reduce credit risk in beneficiary sectors while increasing it in sectors that lose out from this transformation, offering opportunities for active credit managers to add value. However, shifts in the cost of capital for different sectors could be rapid and therefore require close monitoring.
3. Changing M&A targets for legacy firms
A merger is not always good news for corporate bondholders, as the new company’s credit quality will depend on the relative credit strengths of the target and the acquiror as well as the funding mechanism. In the past, legacy fossil fuel industries have adopted different strategic responses to the shifting energy complex, split broadly down geographic lines. US oil majors have sought to capitalise on the depressed valuations of US oil and shale producers to pick up cheap resources (such as Chevron’s acquisition of Noble), while the European oil majors, driven by a much greater regulatory and investor focus on decarbonising, have paid full valuations for clean energy assets and infrastructure.
Now, however, that picture could change as US energy companies are encouraged to invest in clean energy. Ultimately, we see the lines between utility and oil companies blurring as clean hydrogen, produced by renewable electricity, replaces hydrocarbons in the energy value chain. Both strategic approaches will present opportunities for credit investors, since they typically involve companies with strong credit ratings acquiring weaker ones. Bondholders in target entities will benefit from capital gains as credit risk reduces. However, identifying which targets will be the subject of a bid that increases credit value, rather than one that proves dilutive, will require careful due diligence.