Projecting carbon price impact on earnings
We selected Trucost’s medium (“delayed action”) carbon price scenario for our analysis. Despite it being the middle path, we feel this could actually be a conservative assumption of where the carbon price could go.
To look at how unpriced carbon price risk could affect companies’ profitability, we started with the MSCI World index. Using earnings statements, we tried to represent the carbon price risk and what that would represent as a share of their EBITDA. This gave us a measure of “earnings at risk”, or more accurately, EBITDA at risk.*
Our analysis highlights a significant risk to future earnings from the unpriced expected future carbon price, especially in sectors such as energy, materials and utilities. In the utilities sector for example, the projected carbon price increases might wipe out 50% of the sector’s average EBITDA by 2040.
It’s important to note that 2040 is far in the future, and that these results depend heavily on modelling and on what changes are made to companies’ emissions and business models by then. So, we can’t safely say that this will happen. However, based on all the data we have access to, we can start to see carbon prices might pose a significant risk for these companies’ earnings.
Climate Transition & Paris-Aligned solutions
To continue the investigation, we looked at the alternative exposures to mainstream indices, using Paris-Aligned and Climate Transition benchmarks, or ‘PAB’ and ‘CTB’ respectively. These benchmarks, and the ETFs tracking them, aim to reduce the carbon emissions of a given exposure immediately – by 50% for PAB and 30% for CTB – and put a portfolio on a trajectory of reducing carbon emissions over time, typically by 7% per year.
So, we conducted the same exercises as before – same benchmark, same universe, same portfolio. As the carbon emissions are cut by 50%, we can very simply divide the earnings at risk by a factor of two (see Earnings at Risk chart below).
We conducted the same exercise for enterprise value at risk, meaning the projected reduction in enterprise value in a portfolio (see chart below). This starts from Europe in light blue, to Climate Transition in turquoise blue, to Paris-Aligned in green. We can see here a quite mechanical reduction in risk when investing in CTB or PAB benchmarks, and one that is quite consistent across regions.
Scope 1, Scope 2 and Scope 3 upstream (supply chain effect) emissions are included, while Scope 3 downstream & upstream (change in demand due to rising costs) emissions are excluded in this analysis.
Source: S&P Global, Lyxor International Asset Management. Relevant Benchmark is the relevant MSCI standard index of the region, Climate Change / CTB index is the available Climate Transition Benchmark by MSCI and PAB Index is the corresponding Paris Aligned Benchmark published by S&P on the relevant region. Data as at 11/10/2021. Past performance and/or forecasts are not a reliable indicator of future performance.