Utilities may suffer 'significant losses' from carbon taxes

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Some of the world's major industries face having their profits all but wiped out by the advance of carbon pricing systems, research released last week has suggested.

A new paper from Trucost, part of S&P Dow Jones Indices, suggests major companies across the electric utility, chemicals and automaker industries could suffer "significant losses" from new carbon pricing policies or carbon taxes introduced as part of nations' climate efforts.

Since nations around the world signed up to the Paris Agreement in December 2015, there has been a growing momentum behind carbon pricing schemes. Not only has the EU finally agreed upon substantial reforms to the EU Emissions Trading Scheme (ETS), to take effect from 2021, but China has started the launch of its own long-awaited carbon trading program and countries across North and Central America have teamed up to deliver further action on cross-border carbon trading.

While this might be good news for cracking down on greenhouse gas emissions, it is not such good news for companies ill-prepared for the financial implications of carbon trading.

The Trucost research warns that although current carbon prices today average $40 per tonne, they are expected to increase to $120 per tonne by 2030, if the world follows the 2 degrees Celsius trajectory set out in the Paris Agreement. Even if governments fail to crank up prices in line with a 2C trajectory, reforms that are already planned in the EU and elsewhere are expected to drive up prices considerably during the 2020s.

Rising carbon prices will have a direct impact on energy costs for many businesses, but measuring the impact of this shift solely in terms of a firm's carbon footprint could leave businesses and investors blind to its impact in other areas, Trucost argued.

"Carbon footprinting is a great measure of how companies may be exposed to carbon pricing risk in the long term," explained Libby Bernick, global head of corporate business at Trucost. "It is standard practice  it's good practice  for companies to measure their carbon footprint. It's a measure of the intensity at which they operate.

"But what we found in the research is that carbon pricing risk often is dictated by the specific location where the business operates, and the business model. And the carbon footprint doesn't provide any insights on those two aspects. So while carbon footprinting is a good first step, if that is the only measure a company relies on to understand their risk, then there are blind spots."

To shine a light on these "blind spots," Trucost used its in-house carbon pricing tool to measure the total risk faced by companies in each sector.

It calculated the carbon pricing risk premium  the gap between current carbon prices and expected future prices under a 2C scenario. It then applied the risk premium to a company's regional greenhouse gas emissions, effectively calculating the regulatory costs that a firm could incur over the low-carbon transition. The study also conducted an "asset-level scenario analysis" to judge the impact of rising carbon prices on profitability.

It concluded that although the profit risk for companies varies widely within sectors and geographies, carbon pricing risk across the auto, chemicals and power sectors is set to grow significantly over the next two decades.

The electric utility sector  perhaps unsurprisingly  is judged to be the most vulnerable, with profits at risk potentially running to 90 percent of margins by 2030 and 150 percent by 2050 under a 2 degrees Celcius scenario. Meanwhile, the chemicals sector risks 30 percent of its profits by 2030, and 60 percent by 2050, while auto manufacturing could be subject to 15 percent profit risk by 2030, rising to 30 percent by 2050.

These are scary numbers for business executives. "The amount of carbon pricing risk that an electric utility would be exposed to would more than wipe out all of its profit [under a 2C scenario]," Bernick warned.

The variation in risk exposure is mainly down to the carbon intensity of the businesses, Bernick explained, as well as where operations are based. Because utilities tend to have the highest carbon footprint per unit of revenue and assets concentrated in few countries, they are most exposed. In comparison, automakers and the chemicals industry operate at lower greenhouse gas intensity and have operations and supply chains across numerous jurisdictions, making it simpler for them to switch countries in response to changes in carbon pricing rules.

Some firms within sectors will fare better than others. For example, those in the utilities sector which already have invested in clean energy assets and wound down some of their most polluting generators will be less exposed than those still heavily reliant on coal power.

Moreover, the companies best able to weather the risk posed by increasing carbon prices are those which have control over the efficiency and emissions throughout their supply chain, or those which have a flexible supply chain that enables them to easily switch suppliers in search of greener alternatives.

In fact, supply chains are the key to understanding the scope of carbon pricing risks faced by firms, Trucost said. "Supply chain activities often account for a larger share of a company's carbon pricing risk exposure than operational emissions — on average, 80 percent for automobile manufacturing, 53 percent for chemicals, and 29 percent for electric utilities," the report stated. "By analyzing supply chain impacts, a company could understand where risk exposure is concentrated and adjust its procurement strategy to minimize financial cost."

"Companies may think that a lot of the risk is within their direct operations, but really there's a significant amount of risk for the company that's going to be passed through the supply chain," confirmed Bernick.

So what should companies do to manage the risk coming down the road from carbon pricing? "The first thing is to understand the timing and magnitude of when these carbon pricing risks will actually be realized on the books of a business," Bernick advised. "That means looking at where your operations are, what your supply chain risk is, and what the potential is for reduced demand if you make energy-intensive products.

"Once a company has that information, then it can begin to understand how to manage the risk. Will it absorb the cost and reduce its profitability? Will it pass them through to its customers? Or will it need to prioritize investment in low-carbon technology?"

For some sectors, the need to shift towards greener business models is all but certain. The utility sector, for example, faces a complete decimation of its profits if it ignores the low-carbon shift underway around the world. For other companies in other sectors, the risk may be less pressing but still material.

If the world sticks to its promises and limits warming to 2 degrees Celsius, profits will be hit unless firms take steps to limit their exposure. It seems the measuring a businesses carbon footprint is only the first step in that journey.

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