Carbon Pricing: Where are We Going?
The COVID-19 pandemic has shown the power of governments to address urgent challenges. Across the world, countries have implemented unprecedented fiscal measures in response to the crisis.
The COVID-19 pandemic has shown the power of governments to address urgent challenges. Across the world, countries have implemented unprecedented fiscal measures in response to the crisis. This shows the power of governments to implement necessary change to ensure a sustainable and resilient future. One of the key tools in governments’ armoury has been to introduce a price on carbon emissions. An increasing number of countries and jurisdictions are implementing carbon prices, impacting the operations and asset valuations of companies across regions and sectors. This piece explains why investors should evaluate the impact of such measures.
Governments aiming to reach low or net zero carbon emissions have many tools at their disposal, from cutting subsidies and political support for high-emitting fossil fuel industries to enabling the transition to cleaner, renewable energy. The piece focusses on the use of market prices to limit anthropogenic carbon emissions, initiatives that many countries continue to adopt and expand as a key policy lever to reach net zero emissions. Given the increasing implementation of carbon pricing in many countries, investors will have to differentiate between companies that are taking steps to limit the risks stemming from carbon pricing and those that are failing to adapt. The latter are likely to face risk of increased liabilities, reputational damage and stranded assets. Armed with this knowledge, we hope investors will be better equipped to decarbonise their portfolios and to see climate change — and the initiatives to tackle it — as both an ever-present risk that should be managed, and an opportunity to allocate capital accordingly.
The Inevitable Low Carbon Future
Recent years have seen a growing acceptance among academics, policymakers and the public that climate change is real and poses a threat to many aspects of our lives. The global annual temperature has increased at an average rate of +0.18°C since 1981 and the five warmest years since 1880 have all occurred since 2015.
Faced with increasingly dire predictions from the UN-backed Intergovernmental Panel on Climate Change’s (IPCC), policymakers are committed to cutting carbon emissions and reshaping their economies.
As a result, investors should prepare for the inevitable policy responses from governments around the world, driven by evidence of the successful implementation of economic recovery packages focussed on environmental and social targets (for example, South Korea).
Encouragingly, global sustainability initiatives are continuing amid the pandemic, particularly in China, continental Europe and the UK. The European Union has ambitious plans to expand its Emissions Trading Scheme — the largest carbon pricing system in the world. Carbon pricing measures are growing globally, being utilised at both the national and company level. This trend is being driven by governments eager to implement a market price on the cost of pollution and due to pressure from investors looking to assess the risks associated with climate change on companies’ earnings and assets. The transport (shipping and airlines) sectors are imminently expanding the use of carbon pricing measures.
China, which is the largest user of fossil fuels and largest emitter of greenhouse gases in aggregate, has continued to focus on green initiatives while tackling the pandemic. Chinese authorities are implementing several recovery packages that include carbon pricing, clean energy subsidies and targets for new energy vehicles penetration.
The global economic slowdown arising from the pandemic may delay this trend, but is unlikely to derail it. The revenues generated from carbon tax schemes currently equate to around 1% of global corporate earnings but could ultimately rise to 12x that, and therefore remains a long-term earnings headwind for many companies.2 However, the direction of travel is clear. It pays to be structurally cautious of climate change laggards in these sectors as they face a potential double impact of lower earnings and lower multiples.
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