How Asset Managers measure and manage financial carbon risks
Carbon Price Exposure is growing rapidly and is forecasted to be the main driver of financial risk in the energy transition for the next decade.
In this White Paper, we explore the underlying drivers of carbon price exposure, how carbon price risk can be measured and what investors do today to actively manage this risk.
Carbon pricing has emerged as the primary tool of climate regulation – being used now in jurisdictions responsible for 50% of global GDP and growing. Prices are expected to increase significantly over time, and subsidies in the form of free pollution permits are phased out in nearly all systems. This trinity amplifies the impact of carbon pricing on corporates and the macro environment via inflation.
To measure carbon price exposure, a granular bottom-up model is required that incorporates the individual aspects of each market and corporate, including its operations, the regulatory framework, decarbonisation and trading strategies as well as the ability to pass through carbon costs.
Using such a model reveals significant exposure of equity valuations to carbon pricing. Cushon, an innovative UK pension provider, models that its “green” equity portfolio could suffer by up to 3.5% by 2030, while the Stoxx600 could see a decline of up to 10.9% by the end of this decade.
Cushon hedges this exposure with a natural capital allocation in carbon removal projects, anticipating a convergence with compliance carbon markets. They find that a Natural Capital Allocation of 6-8% could financially hedge their exposure to compliance carbon pricing.