Why COP26 Matters for Markets
What is COP26 and Why Does it Matter for Markets?
Against the backdrop of rising energy prices leading to economic fallout for economies in Asia, Europe, and North America, COP26, a two-week event, is set to begin on October 31 in Glasgow, Scotland. The United Nations’ Conference of Parties (COP) was first held in 1995, and COP26 gets its name for this year’s meeting being the 26th iteration of such an event.
History of global temperature change and causes of recent warming (Chart 1)
COP26, later this month and in early-November, will be an attempt to get countries on the path to fulfilling the goals laid out in the 2015 Paris Climate Agreement. The Paris accord outlined the goal of keeping the planet from warming by 2 degrees Celsius by the year 2100, and if possible, to stop warming at 1.5 degrees Celsius (relative to pre-industrial era readings).
Per a report released this summer from the UN’s Intergovernmental Panel on Climate Change (IPCC), the planet has roughly ten years left to make significant cuts to emissions before the 1.5-degree Celsius threshold is reached, with the planet already having warmed by 1-1.2 degrees Celsius relative to the end of the 19th century.
Assessed contributions to observed warming in 2010–2019 relative to 1850–1900 (Chart 2)
A sense of urgency underscores COP26, but the October/November summit – whose aim is effectively to curb use of fossil fuels like coal and oil – is arriving at the worst possible time thanks to a budding energy supply crisis gripping most of the globe’s major economies.
Why Are Energy Supply Concerns Proliferating?
To meet their obligations laid out in the Paris Climate Agreement, many of the world’s major economies – China, the UK, the US, among others – have attempted to scale back their use of coal and oil as primary energy sources. But with the coronavirus pandemic’s impact still being felt, supply chains have been in disarray. Just days ahead of COP26, China announced that they would begin to restart coal production in order to meet the country’s energy needs.
Companies unable to secure raw materials in a timely manner as well as labor markets not recovering as quickly as anticipated have created job shortages in key areas like truck drivers, leaving energy supplies unable to be transported (Europe, the UK). Closures at ports have compounded the problem (the US). Trade tensions remain tense in some areas (Australia, China). Seasonally, with winter coming in the Northern Hemisphere, fears are that demand will continue to outstrip available energy supplies (fossil fuels or renewables) that could create a more significant economic issue over the coming months.
How Could COP26 Exacerbate Energy Supply Issues?
It is no secret that the world’s major economies are doing a poor job at achieving the goals laid out in the 2015 Paris Climate Agreement. Recent attempts to do so – by cutting coal consumption, for example – have created a scarcity of available electricity, which has disrupted global manufacturing chains based out of Asia (China), contributing to the rise in inflation felt in North America and Europe.
The goals outlined at COP26 over the coming weeks may be noble, but without available alternative energy sources – an abundance of renewables such as hydro, solar, and wind, as well as the typically controversial nuclear option – efforts to slow down and even reverse the planet’s warming may very-well provoke deeper problems for the world’s major economies in 4Q’21 and into 2022.
What Assets Could Be Impacted by COP26 Efforts?
From a trader’s perspective, the goals outlined at COP26 could prove to have a long-term impact on various markets, especially commodities and currencies. A reduction in oil production, for example, without available alternative energy sources, could provoke significantly higher energy prices in the short-term as demand remains robust.
Currencies whose economies are significant exporters of fossil fuels like the Australian Dollar, Canadian Dollar, and Norwegian Krone, could see increased speculation around potential for gains before the longer-term narrative of transitioning away from fossil fuels weighs on price action. Opportunity may continue to grow for those market participants that appear to be providing a solution to the problem, such as electrical vehicle companies like Tesla.
Long-term Technical Outlook for COP26-sensitive Assets
Oil and energy sit at the crossroads of geopolitics, largely because there are choices that can be made that can improve or diminish the supply/demand equilibrium of many of these markets. And while the various decisions around those choices may seem clear to you or I, messiness is a feature of democracy, not a bug, and this can often lead to an imbalance in policy from administration to administration. Messiness can set off a whole host of changes in the geopolitical picture.
This is very evident in oil production, which still succumbs to the supply constraints of major producers such as OPEC-plus, Russia, Canada and more recently, the United States.
As oil prices ran high in 2007 and 2008, the drive for US energy independence was high, and this led to significant investment in shale extraction which was previously thought of as impossible and/or far too costly. Shale extraction added significant supply to US oil potential but it also came with uncertain environmental consequences.
The concern around those environmental consequences has had profound impact, with support driven towards companies like Tesla that are working on a future with less reliance on fossil fuels.
But in crude oil, the move that showed this year has the power to continue and with oil prices hitting a fresh seven-year-high, and while overbought on a shorter-term basis, there is little standing in the way of a run up to the 90-handle. The 100 level is a major psychological level and this is the point where the politics of oil might find its way back into the headlines as a major inflection point: Whether or not that’ll induce price action remains another matter entirely.
Crude Oil Monthly Price Chart (Chart 3)
Natural gas faces some of the same problems as oil: extraction is dirty and brings unknown environmental consequences, adding significant red tape for new projects and this, of course, constrains supplies. It is necessary, however, for residential and commercial heating and the world relies heavily on this resource during the frigid winter months.
In Europe, there’s particular concern for this winter. Much of the continent’s natural gas supply comes from Russia or Norway, which makes them vulnerable to price changes and, of course, supply disruptions. The consequences of an adverse…
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