Is the Paris Climate Pact Bullish for Cars?

Renewable energy is now a significant asset class for investors. And emission standards, in the long run, may drive automotive innovation.

On December 12 the jubilation from Le Bourget, France, a suburb of Paris, was apparent. From a beaming Al Gore to a euphoric U.N. Secretary General Ban Ki-moon, conference participants cheered history being made as nearly 200 countries signed “the Paris Agreement,” a pledge limiting greenhouse-gas emissions in five-year increments.

Many of the signatories have already reported their targets for 2020, including the U.S. Still, after the champagne corks flew, just what did they agree to, and what will it mean to investors in a still-major industry, the auto industry, for the economy and the environment?

A number of environmentalists, including the “father” of climate change, Columbia University professor James Hansen, don’t think the document goes far enough. After all, U.S. secretary of State John Kerry made sure the word “shall” was replaced with “should” when the former was inserted, supposedly accidentally during typing, in a critical part of the pact. The reason: To ensure that the so-called agreement avoided Congress altogether.

It’s also unclear how a nonbinding agreement will affect industry. Carbon dioxide reductions that call for keeping emissions low enough to halt the temperature rise at 2 degrees Celsius aren’t necessarily in many companies’ short-term interests. Sure, oil and transportation companies flocked to the 21st Conference of the Parties meeting (COP21) outside Paris, but were their hearts truly in it? All you have to do is drive on a highway to realize that Americans remain almost pathologically in love with sport utility vehicles.

Brian Irwin, a Dallas-based partner at Chicago consulting firm A.T. Kearney who leads the firm’s automotive practice, says of about 17.5 million cars sold in the U.S. last year, only an estimated 3 percent of them were alternative-fuel cars and light trucks.

When it comes to adopting electric vehicles (EVs) and hybrids, Irwin is bullish, even though numbers haven’t spiked. “Back in 2011, we sold roughly the same amount [percentage-wise of alternative vehicles],” he says. “The penetration of alternative powertrain cars was similar in 2011 as in 2015 — as a percentage of total cars sold in the U.S. In both years that was roughly 3 percent.”

Tesla Motors, based in Palo Alto, California, sold approximately 50,580 EVs last year, mostly Model S sedans. High-profile Tesla buyers, such as The Late Show’s Stephen Colbert, have helped raise the profile of these EVs.

Harry Briggs, founder of Elkins Park, Pennsylvania–based HCB Investment Management and portfolio manager of its Tactical Energy strategy, says that whereas Tesla will benefit from “tailwinds” of Paris, the company’s current market capitalization, at $27.8 billion, demonstrates broader investor interest in clean and renewable energy.

Tesla’s valuation, says Briggs, “is clearly not based on the number of its vehicles on the road.” Most of the interest in Tesla, he believes, derives from the potential of the company’s home battery, the Powerwall, charged by rooftop solar panels.

In the U.S., the adoption of green vehicles has been slow. France far surpassed the U.S. in diesel-powered light-vehicle sales last year, 57.5 percent versus 2.5 percent. Diesel, even petrodiesel as opposed to biodiesel, produces fewer greenhouse gases. The French edge is much smaller, just a percentage point, in terms of hybrid adoption (3.2 percent instead of 2.2 percent), according to a survey cosponsored by A.T. Kearney. Germany has a goal of having one million electric vehicles operating on its roads by 2020.

Despite America’s slow adoption of alternative vehicles, 13 car manufacturers signed a CEO leadership statement during COP21 stating that they are serious about working toward the decarbonization of transportation. David Tulauskas, General Motors’ director of sustainability in Detroit, says that at the World Economic Forum in early December, GM and the other automakers “acknowledge[d] the Paris Agreement and developments at COP21 as a milestone.”

Both Tulauskas and Irwin insist that the auto industry, which is currently on display at the annual North American International Car Show in Detroit, is already well on its way to keeping its carbon footprint small. This is because of so-called CAFE (corporate average fuel economy) standards, which mandate that carmakers in the U.S. report overall fuel economy, including how many miles per gallon their vehicles are getting, which are matched against regulator-set standards.

Tulauskas argues that for investors, green investments are no longer the purview of fringe capitalists. “If you look at every major financial firm — from Deutsche Bank to Citigroup to Goldman Sachs — they’ve all allocated billions and billions of dollars to investing in clean, green, low-carbon technologies,” he says.

Tulauskas says investors are seeing green because “they can make [a] market at it today.” He adds, “The risk of that investment has been mitigated or, in some cases, eliminated. If renewables are not in your portfolio, you are missing out on a good return — like 4 to 12 to 15 percent returns that through diversification help lower risk in your profile. You’ve got to have it in your portfolio.”

Irwin points out that by 2025 the CAFE standard will be 54 miles per gallon. The Paris Agreement will be useful as a “common metric,” he says, which will help the world’s automakers understand the best way to deliver a “universally accepted goal.” Standards differ around the world, he says. But whatever the standard is, it’s tied specifically to the title of the car. “Each year it’s based on the footprint of the vehicle,” a measure that includes vehicle size.

National governing bodies generally “leave it to the car companies” to come up with their calibrations of fuel economy. Whereas U.S. fuel economy standards are set by the Environmental Protection Agency, in Japan they were issued by the Ministry of the Environment under something called the Automotive NOx and PM Law, which regulates nitrogen oxide and particulate matter. In the European Union, nations must follow the EU directive that includes the most recent tightening of its emissions standards. By last year, new cars registered in the EU were not allowed to produce more than 130 grams of carbon dioxide per kilometer. “Most developed countries have something equivalent [to CAFE], but some countries such as Canada piggyback on the U.S. for CAFE requirements,” says Irwin.

Standards are fine, but following them is another thing altogether, as Volkswagen recently demonstrated. The German automaker installed software so that some Audi and Volkswagen diesel models could pass emission tests. Because of VW’s subterfuge, its stock price crashed, CEO Martin Winterkorn resigned, and the company will spend years digging itself out of the mess. VW’s actions hurt the company and investors in ways the climate accord cannot, at least right away.

Jack Robinson, a portfolio manager with Boston’s Trillium Asset Management, which engages in sustainable and responsible investing, was invited by JPMorgan Chase & Co. to speak at the World Business Council for Sustainable Development, a colloquium in Paris held concurrently with COP21. One of Robinson’s takeaways from the sessions is a directive initiated by Tesla founder Elon Musk. “He, along with many others, signed a petition [that went] to Volkswagen requesting that they quit fooling with liquid fuels and switch to electric right away.”

Volkswagen continues to sell gasoline- and diesel-fueled vehicles. But in the wake of the VW scandal, carmakers increasingly find it in their interests to meet or beat emission standards — behavior that will dovetail with the Paris accord.

“Regulators are calling OEMs [original equipment manufacturers] to ensure they are in full compliance,” Irwin says.