SustainaWeekly - German green bond supply to ramp up
In this edition of the SustainaWeekly, we first take a closer look at the outlook for the German government’s climate investment plans, the implications for green bond supply and the greenium. We then go on to assess the potential for bi-directional charging using EVs as a solution for the intermittency challenges of renewables. Finally, we set out the main conclusions from the ECB’s third review on banks’ climate-related and environmental risk disclosures practices and trends.
Strategist: We expect green expenditures to speed up in the coming years and with it additional financial resources via higher green bond issuance. Based on expectations for green investment, we estimate the German green bond annual supply to be at around EUR 25bn in 2025 which reflects around 15% annual growth.
Economist: Renewables have as their main problem intermittency meaning that there is substantial need for storage. In EVs there is lots of unused storage and the technology bi-directional charging could unlock this. Despite the major advantages there are also significant challenges currently for this technology to be widely adopted.
Policy & Regulation: The ECB released its third review on banks’ climate-related and environmental risk disclosures practices and trends. Supervisors recognise developments and improvements, but confirm that financial institutions are still lagging behind their expectations. In particular, banks need to further substantiate their disclosures.
Germany to speed up Green expenditures and with it its Green bond supply
The Federal government recently published its Green bond allocation report (2022) as well as its Green bond investor presentation to outline its former and future environmental plans
The German government continues its progress in trying to meet its climate targets
However, despite the recent ramp-up in green investment, more will be needed to meet those targets
As such, we expect green expenditures to speed up in the coming years…
… and with it additional financial resources via higher green bond issuance
Furthermore, the German greenium started to recover from its historical low in late 2022
We found that the greenium is partly driven by a liquidity premium…
… the poorer the liquidity conditions of Green bonds, the lower the greenium
However, the rise in green bond supply will affect the scarcity premium which may affect the greenium to the downside
On Tuesday 18th of April, the Federal Republic of Germany presented its Green bond plan () for the year as well as its Green bond allocation report late March from last year () and provide more details on the allocation of its green eligible expenditures. Germany has committed itself to various climate targets including the most well-known Paris agreement as well as the Net zero target (to reach climate neutrality by 2050). As such, the government continues to dedicate important budgetary resources but a lot more is still needed to meet those targets. To this end, the German cabinet established last year a ‘’Climate and Transformation fund’’ to fund the energy transformation and climate protection of the country. Around 177.5 billion euros have been allocated to this fund between 2023 and 2026. In addition, after its first green bond issuance in 2020, Germany is set to become a well-established permanent issuer of green bonds, and is now one of the most active eurozone countries in the sovereign green bond market space with an amount outstanding of EUR 48bn. As such, Germany’s plan to establish a green bund yield curve for the euro area continues to advance, particularly as green expenditures are set to rise every year going forward. Although, this increase in green bond supply might not have a positive effect on the German ‘’Greenium’’ in the future.
Higher green expenditures entail higher Green bond supply in the future
On March 2023, the Federal government published its Green Bond allocation report from 2022. Overall, the Federal government spent EUR 16.8bn on climate protection and environmental programs in 2021 from which, EUR 14.5bn was financed via Green bond issuance in 2022 (as shown in the graph below). In this report, we can find how and where the green-eligible expenditures have been allocated to. Green-eligible expenditures are expenditures from all areas of the federal budget that support the overall climate and sustainability targets set out in the Green Bond Framework (). The selection of eligible expenditures is made in accordance with the key objectives of Germany’s climate action policies and can be classified into five areas: 1) transport; 2) International cooperation; 3) Research and innovation; 4) Energy and Industry; 5) Agriculture, forestry, natural landscapes, and biodiversity. Like in previous years, the biggest green expenditures were allocated to the transport sector followed by international cooperation (to assist emerging and developing countries in their climate transitions) as shown in the pie charts below.
Although, we judge that the energy sector, which represented the third biggest expenditure in 2022, should take a bigger share in this green bond allocation strategy. Indeed, Germany is currently restructuring its energy system by moving definitely away from nuclear and fossil fuels to renewable energies. In the end, the energy sector is responsible for the largest share of emissions in Germany (roughly 30%). The Federal Government already shared its difficulty in meeting its climate targets notably the 2030 targets* () particularly due to its energy mix. Indeed, Germany’s electricity mix is still heavily dependent on fossil fuels. In 2021 half of the electricity was generated by fossil sources. Coal generation had halved since 2015 but its share in total electricity generation rose again to 29% in 2021 (23% in 2020), while natural gas currently makes up 16% of Germany’s electricity mix (Climate Action Tracker). Germany is already facing a shortfall of about EUR 12bn in its special climate-protection fund which also demonstrates the additional unexpected cost of greening the economy.
Therefore, to meet the goals set out in the Climate change act, Germany will need to ramp up its investment in the energy and climate transition. The government already increased its Climate and Transformation fund’s allocation to EUR 200bn to fund its industrial transformation between now and 2026 (incl. climate protection, hydrogen technology, and expansion of electric vehicles). One way for the Federal government to collect those financial resources is via Green bond issuance.
In the Green bond presentation, the Federal government indeed reaffirmed its will to build-on its green bond yield curve. The Federal government recently issued a new Green DBR Benchmark (DBR 15 Feb 2033) for EUR 5.25bn. Another longer maturity is also to be issued this year. As such, green bond issuance is set to rise again this year as shown in the graph below. An amount of EUR 8.25bn has already been issued since the start of the year via the DBR 0% 2025 reopening and the new 10y syndication.
As discussed previously, we expect the Green bond issuance volume to continue rising in the coming years. If we look at the green bond supply growth over the past years and assume a similar trend going forward, we could expect around 15% growth every year as additional issuance. Based on expectations for green investment, we estimate the German green bond annual supply to be at around EUR 25bn in 2025 which reflects around 15% annual growth. Aside from the extra push it will give Germany to finance its energy transition, the rise in green bond supply might also have a significant impact on the so-called greenium (the yield spread of a green bond against the non-green bond) as discussed in the next section.
Bund Greenium is slowly recovering from its 2022 historical lows
After falling to its lowest level, the German greenium** is slightly recovering from a turbulent 2022 as shown in the graph below. On average the Greenium is currently trading between 2 and 3bp for long-term bonds and even larger for the 3y green bond now at around 6bp. As such, green bonds recovered partly from their historic low with the greenium reaching as low as 0bp in late 2022.
In a previous piece (), we noted that there was a clear correlation between the bonds’ liquidity (measured by bid-ask spread) and the greenium. We performed a correlation analysis between the bid-ask spread and the greenium. On average, for the long-maturity German green bonds, we find a (negative) correlation of 66% which signifies a relatively strong dependency between those two measures. When conducting a regression analysis for each German green bond, with the liquidity variable (x-variable) and the greenium variable (y-variable) we also obtain a negative coefficient and get statistically significant results for each regression. Those results can be interpreted as when the bid-ask spread increases (so a case where investors could request a liquidity premium) the greenium shrinks. Indeed, the greenium decreases as the Green bond yield rises in order to compensate investors of the Green bond poorer liquidity (so-called liquidity premium). Thus, this proves that the liquidity premium plays a key role in the greenium development, as also shown in the graph below.
Moreover, the supply effect is an important underlying factor in explaining the German greenium. The supply is clearly not matching the demand at the moment. As stated by the German government itself, the issuance volume of the green bond is different and much lower than the conventional twin. Looking at the first years of the green bond issuance, the greenium was indeed higher and traded around 6bp compared to 2bp today. This was the period where the supply was at its lowest which then raise the question about the scarcity premium and its effect on driving the greenium. The rarity of the bond in the market leads it to trade at a higher cash price.
Indeed, we judge that the scarcity effect also plays a key part in the greenium development (which also correlates with the liquidity issue discussed above). In general, a lack of supply tends to drive the bond cash price up. Thus, a shortage of supply and excess demand in the green bond market might cause the existence of a scarcity as well as a liquidity premium. But those two have and will have different effects on whether the greenium will remain/increase or disappear if the green bond supply is indeed set to continue rising in the following years. On the one hand, a rise in issued green bonds will automatically lead to the scarcity effect fading as supply approaches investors’ demand. And on the other hand, this will lead the German green bonds to trade more frequently in the market and thus reduce the liquidity premium. The former would tend to reduce the greenium as the scarcity premium shrinks, decreasing the bond cash price. While the latter would mean that investors will stop demanding a liquidity premium which will then be beneficial for the greenium as the Green bond yield will fall.
Those two factors are difficult to isolate and thus determining each one’s effect on the green bond premium remains challenging. Therefore, as the growth of the green bond market continues, this will provide further answers to the greenium question and help to unveil which factor has the strongest effect on the greenium.
* Germany has made both national and international commitments to cut its greenhouse gas emissions by more than half by 2030, compared with 1990 levels. To do so, the government launched the Climate Action Programme 2030.
** The greenium is calculated as the difference between the non-conventional bond yield and the green bond yield