Carbon-intensive businesses are expected to present increased credit risks for lenders, leading to a reduced availability and increased cost of capital for fossil fuel projects and activities in the coming years.
That is the stark warning contained in a new briefing paper from credit ratings giant Moody's, which details how "the recent proliferation of net-zero targets among governments and the financial sector — coupled with the increasing focus on disclosure around the risks of climate change" — is expected to lead to a credit squeeze for carbon-intensive industries.
"In consequence, we expect pressure to inexorably rise for major producers and users of hydrocarbons to adjust business strategies to implement credible transition plans," writes James Leaton, senior vice president at Moody's Investors Service. "We expect the impact will be more significant than the limited effect to date of patchwork policy implementation, gradual changes in disclosure requirements or moves by investment funds to reduce their fossil-fuel holdings. However, the full implications for this decade of such initiatives will only become clear with the detail, breadth and speed of implementation steps taken under the net-zero initiatives."
The paper stresses how net-zero targets and strategies are starting to converge, with the U.S., EU, China, Japan and others all signing up to long and near term targets that point to more stringent climate policies and a rapid uptick in the pace of decarbonization over the coming decade.
Excessive reliance on greenhouse gases being absorbed by natural sinks or stored underground will undermine the validity and efficacy of targets.
It also notes how at the same time the world's leading financial institutions are signing up to net zero goals and cross-industry initiatives, which, "if followed through on, will require meaningful changes in portfolio investment and lending practices by the end of the decade."
The result is expected to increase pressure on carbon-intensive firms to come forward with their own net-zero strategies, with Leaton stressing that current trends "increase the likelihood that credible carbon transition plans will provide a greater differentiating factor for credit strength."
The report nods to concerns amongst campaigners that carbon-intensive firms will attempt to use investment in carbon offsets to justify continued investment in fossil fuel infrastructure. But it also suggests lenders will start to assess the precise nature of the net-zero strategies proposed by carbon-intensive firms and their level of reliance on offsets so as to gauge their credit risk.
"The growing list of net-zero targets demonstrates a clear direction of travel," the paper states. "But the underlying details can vary, especially when applied to individual corporate entities ... It is important to understand the assumptions around the use of offsets to determine the credit implications of each initiative and flow on impact for major emitters. If a target has limited scope and assumes significant offsets, then it will not require as significant a change in activities for the entity. At the country level, there has also been debate about the inclusion of non-domestic offsets to ensure against the double-counting of benefits. Excessive reliance on greenhouse gases being absorbed by natural sinks or stored underground will undermine the validity and efficacy of targets."
The report concludes that ultimately the cost of capital from carbon-intensive activities is set to increase and the availability of financing will start to be reduced. It also stresses that the trend likely will be accelerated by the adoption of more stringent climate risk disclosure rules in key markets around the world.
"Combined with emissions targets, the expected application of climate transparency requirements in major financial markets will open up fossil fuel exposure to greater scrutiny, further widening the gulf in the cost of/access to capital among companies based on the carbon intensity of their business," Leaton said.