May. 10 2019 — Getting somewhere these days almost always means using some form of transit that emits carbon dioxide (CO2), one of the most pernicious gases contributing to climate change. For example, in the U.S., petroleum products—the predominant fuel for transportation—are responsible for the largest share of all energy-related (CO2) emissions (see chart 1). The good news is the transportation sector is also among the largest issuers of green and climate-aligned bonds. As of mid-2018, the transportation sector held the largest representation of the Climate-Aligned Bonds Universe (see chart 2), which is defined by the Climate Bonds Institute to include green bonds as well as bonds funding assets that generate, at minimum, 75% of their revenue from climate-aligned business. Despite a decrease in the overall level of issuance in 2018 relative to other sectors, we expect transportation companies will continue to be an active issuer of green financings over the mid-to long term. Such financings will fuel the development of greener infrastructure.
We see that railway operators (light rail and heavy rail) have expressed strong intentions to decarbonize through electrification, often a key factor for stakeholders in congested urban areas. Another area where achieving carbon neutrality appears to be on a fast track is with airports and airlines, where ground-based CO2 emissions include fossil fuel for electricity and heating the large terminals at airports, while air carriers are now required each year to report their CO2 emissions from international flights. (Although airport projects aren't typically included in the transportation sector, we will do so in this commentary, as we see similar characteristics in terms of credit profiles, long construction periods, and operations mandates.)
Beyond a growing environmental consciousness and regulatory pressures, however, there are other reasons we're likely to see more green bond issues in the transportation sector. Green bonds in the transportation sector, for instance, generally have longer tenors, which support the asset liability management requirements of institutional investors. Transportation assets also tend to be big—like New York's JFK International Air Terminal, the work at London's Heathrow Airport, or the new Purple Line light rail line outside of Washington D.C. The size of an issue is also a major consideration for some investors. And finally, the green bonds that finances these sorts of projects often come with investment-grade ratings, another big plus for many institutional investors.
Evaluating The Green Transportation Sector Bond
We assess transportation emissions and the associated risk through both our rating and non-ratings approaches. We start by factoring into our credit ratings any credit risk arising from environmental, social, and governance (ESG) factors. Then we can assess the relative net environmental benefit, including reduction in CO2 emissions through our green evaluations of transactions scoring. Under this analytical approach, we evaluate the relative environmental contribution (measured using carbon, water and waste) of a financial instrument for new or refurbished airport terminals, urban rail, electric vehicles, fuel-efficient vehicles, and both national and privately-owned freight rail systems at a point in time.
Finally, we can evaluate ESG factors of an issuer beyond the materiality for credit worthiness in a separate analytic approach that benchmarks performance on ESG metrics including emissions, pollution, impact on communities, quality of governance, and preparedness.
Since the inception of the green labelled bond market, investment in the transportation sector has been the dominant use of issuance proceeds. As of the first half of 2018, according to the Climate Bonds Initiative, there were $1.45 trillion climate-aligned bonds outstanding. As the green bond market has grown, investment in transportation has grown in lockstep, currently representing 44% of climate-aligned financings.
Investors Climb On Board
We anticipate that increased awareness of natural disaster-related economic losses from climate change will likely galvanize more investment in climate-oriented projects. Such natural disasters include hurricanes, tornados, fires, and earthquakes. For example, the five costliest hurricanes on record have all occurred within the last 15 years, three of which occurred within the last two years (see chart 3).
Because improvements in climate change mitigation and resilience are unlikely to materialize without ongoing investment in infrastructure and equipment, transportation is poised to maintain a large share of the green energy bond market even as the market expands. The need for such investment has already been recognized by many investors, as shown by their increased participation in the climate-oriented bond market. For example, socially responsible investors (SRIs)—those who seek to facilitate social and environmental betterment through the capital markets—collectively increased their assets under management (AUM) 33% between 2014 and 2016 to a robust $8.72 trillion. We expect SRIs to maintain a sizable appetite for transportation green bonds because transportation projects, in our methodology, rank among the highest in potential carbon and energy reduction/mitigation, making the significant representation of transportation relative to other green energy sectors seem natural.
The 2017 formation of the EU Green Securities Steering Committee also demonstrates investor appetite for green bonds, as this new debt market will increase liquidity in the market, which we expect will facilitate more climate bond issues in the medium term. In recent months, green bonds in Europe have been successfully securitized, as demonstrated by the first green bond CLO. Given the strong historical performance of European green bonds, we anticipate that appetite for green bond securitized products will grow, further enhancing liquidity, unlocking an additional avenue for issuance, and providing additional means to fund green transportation projects.
A new sustainability or ESG bond market has emerged where proceeds go towards both environmental and social projects. Since 2013, there has been $73.4 billion dollars of sustainability bonds issued in the U.S., and between 2017 and 2018 the market grew by 74%. Transportation features prominently, as evidenced by electric rail lines being built to service underprivileged and remote areas. Issuers are seeing the benefits of these bonds now, with some of these issues, such as the case with Adelaide Airport, having interest rates tied to their ESG scores, while some other bonds, such as the sustainability bonds issued by the Massachusetts Bay Transportation Authority, will be tax exempt.
Urban Growth And Green Bonds
As the world's population continues to grow, major metropolitan areas are becoming increasingly dense. This growth has taken a toll on urban infrastructure, which, in many instances, is already inadequate for public transportation needs. As a result, revitalization of transportation infrastructure has become a prominent component of urban planning. Many cities have turned to the debt markets as a source for financing a variety of initiatives such as expanding fleets of electric vehicles and charging stations, repairing and maintaining rapid transit systems, and replacing diesel-based rail systems with electric alternatives.
We are already witnessing this in the U.S., where low-carbon transport represented over half of total U.S. municipal bond green bond issuance in 2017, (see chart 4), while issues for green buildings and water predominated in 2018 (see chart 5).
U.S. cities are increasingly transitioning to electric-based systems and away from diesel-based ones for light rail, rapid transit, and commuter rail systems. For example, in 2016, the New York Metropolitan Transportation Authority issued $500 million in green bonds, a large portion of which will be used to improve its subway system in order to encourage commuters to switch from road to subway travel. We anticipate initiatives such as these, in conjunction with increased appetite for airport projects, will anchor transportation as a predominant sector for green bond issuance over the long-term, despite the relative decrease exhibited in 2018.
Overall, the states with the biggest green bond issues have been California and New York, with the former leading in the total cumulative amount of green funding and the latter in the cumulative number of green issues as of 2018 (see chart 6).In recent years, green issuance at the local level has favored transportation issues and new green construction (see chart 7).
Green Bonds Spur Related Green Issuance
Investments in other green energy sectors can have the effect of spurring on or incentivizing investment in green transportation initiatives, and we expect to see more of this phenomenon over the long term. U.S. airport infrastructure needs are estimated to cost, on average, $20 billion per year through 2021, which exceeds forecasted operating revenue and available government funding, according to Project Finance International: US Airports on the Runway. This underscores the need for investment in airport infrastructure. Airport projects often involve retrofitting passenger terminals, aircraft hangars, and repair facilities to make them more energy efficient and reduce their carbon emissions. Although we would categorize such projects as green building construction under our green evaluation analytical approach, these projects can be complemented by green transportation projects.
In this context, green transportation can apply in a multitude of ways, such as the use of electric busses and the construction of PeopleMovers to transport passengers about the airport and reduce reliance on gas-fueled taxis, vans, and buses. An example of such a project is the proposed Royal Schiphol Group N.V. €500 Million Green Bond, which will be used to install improved HVAC systems at its airports and finance electric buses for passengers.
Under our Green Evaluation analytic approach, both new green buildings and new green transport rank second in our carbon hierarchy, achieving a hierarchy ranking of significant de-carbonization of key sectors through low-carbon solutions, with a carbon hierarchy score of 90. Both those assessments compare favorably to other green energy sectors.
Due to this variety of applications, the dual-purpose nature of many airport projects often translates to a high mitigation score, per our green evaluation analytical approach, often leading to a strong green evaluation score (E1 or E2). Over the near term, airports could also benefit from increased interest of private sector investors to fund upgrades and expansions, as demonstrated through the 2016 LaGuardia Airport redevelopment, the 2017 Denver Airport Great Hall Project (evaluated as E1/87), and the 2018 Chicago O’Hare International Airport concession award, unlocking additional funding for green airport projects. Our green evaluations describe the technologies funded by the proceeds of financial transactions. We would revoke the Green Evaluation should the proceeds be reallocated to other non-green projects, as was the case with Mexico City Airport issuance in 2018.
Shippers, Ports, And Green Technology
Global shipping companies are facing higher operating and capital costs stemming from the International Maritime Organization (IMO) regulation to cut sulfur emissions to 0.5%, as of 2020, from 3.4% at present. This might, in our view, have an effect on the credit quality of these shippers as they face higher operating and capital costs to meet the standard. However, this also may spark green bond issuance under the pollution prevention and control principle.
Over time, global efforts to reduce maritime CO2 emissions could spur investment in port projects, further supporting transportation as a leading green energy sector. Historically, the performance of port projects has mirrored the shipping industry, of which CO2 emissions are expected to increase between 50% and 250% over the next 32 years. However, commitment to reverse this pace is evident. In April 2018, the IMO signed an agreement to reduce annual shipping CO2 emissions 50% by 2020, with the ultimate objective of eliminating carbon output entirely. As this goal can materialize through investment in green port projects, we see it as a medium-to-long term driver of port project issuance.
The successful May 2018 issuance of a ¥10 billion green bond by the Japanese shipping firm NYK Line shows an appetite for green bonds in the shipping industry that could spur demand for port investments. More generally, we expect investment in ports to be a primary means to reducing worldwide maritime CO2 emissions. Improvements in ship-port interfaces were identified as a major avenue to achieve these reductions. Such improvements would require increasing berth capacity as well as retrofitting existing berths to optimize efficiency, for which green bonds would be a prime source of funding. In addition, some ports, such as Rotterdam, have begun to offer digital services for ship operators, such as web-based platforms that enable operators to share real-time data and information about port activity. In the long term, such technology will reduce CO2 emissions by minimizing ship idle time. As environmental benefits are realized and port calls become more efficient, investment in such technology could become more appealing, which would further drive growth in green bond issuance.