How can financial markets and their regulatory requirements drive better pricing in climate risk?
An acute increase of carbon dioxide content in the atmosphere over the past 100–150 years (that in turn leads to climate change) is the fundamental challenge of our time.
Other problems humanity faces today do not stand even merely close to the one of CO2, which is more difficult for us to notice, since gas cannot be touched or seen.
The main reason for the critical growth of greenhouse gases is the way human life, culture, and economy are organized. Consumption and overconsumption of resources and products and services are the cause of the unthinkable release of carbon from the bowels of the earth into its atmosphere.
Why is climate change so scary and urgent?
Well, honestly, because everything else is ridiculously irrelevant if there is no place and conditions for us to do whatever we were doing before.
People all over the globe already feel what is called ‘climate despair’, suffering from mental illnesses and grieving about their future, understanding it may not come: young people don’t want to start a family and have kids, they give up on their dreams such as moving somewhere, as they learn these places will (most probably) disappear soon.
At this point, what must we do?
Those whose hands concentrate most impact and power, those whose daily financial decisions make a change and really matter need to effectively act together for the climate.
In October 2018, the Intergovernmental Panel on Climate Change (IPCC) released a special report on the impacts of global warning of 1.5˚C and the emission pathways to achieve this goal. The results of the report are expected to put more pressure on policymakers across jurisdictions for timely changes to carbon and energy policies, and greater needs for investors to assess the impact on their investment portfolios.
Putting a price on carbon means bringing down emissions and drive investment into cleaner options.
A price on carbon helps shift the burden for the damage back to those who are responsible for it, and who can reduce it. Instead of dictating who should reduce emissions where and how, a carbon price gives an economic signal and polluters decide for themselves whether to discontinue their polluting activity, reduce emissions, or continue polluting and pay for it. In this way, the overall environmental goal is achieved in the most flexible and least-cost way to society. The carbon price also stimulates clean technology and market innovation, fuelling new, low-carbon drivers of economic growth.
With the introduction of the European Emissions Trading Scheme (ETS) investors have had to integrate a carbon price into their analysis of sectors covered by the scheme.
Where policy incentives exist, investors will start focusing on the issue and it becomes almost a standard part of their investment analysis. It is much easier to quantify policy risk when a policy like carbon pricing is in place. Even if the carbon price is low — as it is currently the case, with €24.21 per ton carbon dioxide EU emission allowance (EUA) in the beginning of 2020 — it is still integrated into the analysis because the broker model does that automatically. If it is too low, however, it does not have an impact on companies’ investment decision-making, which is why the IIGCC advocates measures to push up the carbon price.
EU carbon prices are set to double by 2021 and could quadruple to €55 a ton by 2030 if the European Commission ultimately legislates to align the bloc’s current emissions targets with the Paris climate agreement, according to Climate Tracker, an independent financial think tank that carries out in-depth analysis on the impact of the energy transition on capital markets and the potential investment in high-cost, carbon-intensive fossil fuels.
About a third of the almost $5 trillion in planned fossil fuel capital investment from 2018 to 2025 risks being rendered near-worthless under policies that achieve the 2C target, according to the above-mentioned Carbon Tracker. It coined the term “stranded asset,” not to argue against such policies, but to get financial markets to consider the economic risks of climate change.
With faster action to address climate change, fewer companies would invest in what would become stranded assets. A delay would mean more money spent on projects that turn out to be unnecessary, and meeting the goal would require more urgent and more costly measures — and not only for energy companies. Implementing the needed measures today would cost the globe’s 30,000 biggest companies $4.3 trillion over the next 15 years, but waiting another decade to impose stricter limits on carbon output would boost that to $5.4 trillion, according to the UN Environment Program Finance Initiative, a collaboration with institutional investors.
A big part of the reason for carbon pricing slacking is lack of progress on the regulatory frameworks necessary to set the context for those signals, which is why institutional investors are collectively calling on governments to implement policy changes and provide stronger regulatory frameworks through collaborative organizations such as the IIGCC.
National and global climate and clean energy policies to support investment in low-carbon assets are largely needed because unless you get the right price and market indicators there are not enough low-carbon assets to invest in.
Thus, collective engagement with policy-makers is also an important strategy for mitigating the risks arising from climate change.
