As the effects of climate change are felt stronger around the world, be it in gradually changing weather patterns or extreme weather events, the right to emit greenhouse gases into the atmosphere free of charge comes under a higher scrutiny.
Numerous attempts have been made to put a price on the tonne of carbon in order to limit emissions, all with a low rate of success. No industrial or energy generating asset has reported being forced to limit its output because of the cost of its emissions. The low price levels in the carbon trading markets where they exist (see the World Bank list of carbon pricing systems), multiple allowances and lack of global leadership to enhance the system have led to a no tangible impact.
According to OECD, members of which together with the other G20 countries account for 80 percent of global carbon emissions, the current level of carbon prices in most countries is not high enough to stay below 2Cº of warming, let alone a more ambitious 1.5Cº target. Carbon prices have been rising too slowly and at this pace will only cover the real cost of emissions to our planet by 2095. Considering how far the climate change movement has gone in the last year, it is highly probable that governments will have to act before. Steep price rises will be inevitable in the coming years. It can be expected that the EU will lead in line with its green new deal and changing mentality at multiple levels.
Two big questions arise for investors: when will the governments enact new policy measures and how much will a tonne of emitted carbon cost as the result. Up to now most asset managers driven by the rising investor pressure on ESG issues integration and reporting have focused on measuring the carbon footprint of their respective portfolios, which is a daunting task per se. Now comes the time to ask how much risk to valuations this carbon represents.
Global organisations give a varying set of projections. According to the International Energy Agency the price of a tonne of carbon dioxide needs to rise from $30 in 2019 to $140 in 2040 in Europe and from $5 to $140 in the US in a scenario consistent with Paris climate goals. The UN Intergovernmental Panel on Climate Change is much more alarmed: in both regions the prices will have to rise to $230 per tonne by 2040 to stay within 2Cº and 3-4 times higher to limit the maximum global temperature increase to 1.5Cº. The difference between 1.5Cº and 2.0Cº scenarii is staggering in terms of impact on the climate and biodiversity. Coral reefs would disappear with 2Cº of warming, but if warming were limited to 1.5Cº, some would survive. The Arctic would experience a sea ice-free summer once a decade, compared with once a century if warming were limited to 1.5Cº. Within 1.5Cº limit, 420m fewer people would face heat waves.
If implemented directly, an increase in carbon prices will hit at the asset level mostly as an increased cost of material and production, which will not necessarily be passed to consumer, or in worst cases as impairment of stranded assets. Mapping different scenarii will give a range of potential portfolio falls, and the figures may look harsh. Bad news is hard to swallow, especially when it all looks so far away and somewhat impossible. It might be difficult to digest that your portfolio is at risk of a 20-30% fall in two years. But only a few months ago no one expected the global travel, tourism and events industry to take a double-digit hit because of a global pandemic. Finance, commerce and industry are next in line. We live in times of rapid change, so think twice.