Adding climate scenario analysis to Emmi's algorithms
Updated: Jul 3
Quantifying how your investment portfolios perform under a range of different future climate scenarios is required for disclosures like TCFD or to understand where your carbon risks and opportunities exist.
Using climate scenarios including those developed by the Intergovernmental Panel on Climate Change (IPCC) and the Network for Greening the Financial System (NGFS) enables investors to forecast future risks, costs, and opportunities, during the transition to a low-carbon economy.
Emmi has developed an NGFS aligned process that allows customers to chose from the 6 future climate trajectory scenarios for either the entire world, or Sector specific scenarios (Industry, Services, Transportation, Residential and Commercial Buildings & Energy Supply).
The Six Climate Scenarios
The six climate scenarios covered by NGFS cover three broad climate transition pathways and provide relevant carbon budget trajectories. NGFS uses three models to provide their scenarios, each with pros and cons. Below are trajectories from the GCAM, and REMIND-MAgPIE models.
The six NGFS scenarios
The six scenarios fit into three broad categories:
Orderly Transition: Assumes early and ambitious action to reduce greenhouse gas emissions, adhering to the Paris Agreement goals of limiting global warming to well below 2°C, preferably to 1.5°C above pre-industrial levels.
Net Zero 2050
Disorderly Transition: Involves delayed and sudden action to combat climate change, leading to disruptions and financial stress in the global economy.
Divergent Net Zero
Hot House World: Reflects a scenario with little to no effective action to mitigate climate change, resulting in severe climate impacts and large-scale financial instability.
Nationally Determined Contributions (NDCs)
There is a single global carbon price for each of the different Scenarios. For Emmi’s Potential Carbon Liability modelling, we apply the carbon price to the carbon emissions of a company’s carbon budget overspend. As prices change over time, the cost on the company balance sheet shifts, and has knock-on effects ultimately to the EV of the company, reflected as their Potential Carbon Liability (PCL).
Sector Specific GDPs
Knowing the Sector GDP is essential to run the Emmi Algorithm that generates Potential Carbon Liability. However, the NGFS models do not separate GDP by Sector, rather just provide the global number. The model Energy fractions have different industry mappings, and is also specified in their documentation that it is not possible to convert model ‘FinalEnergyUse’ or any other variable (including emissions) fractions into GDP.
We devised two methods to calculate a constant sector GDP fraction based on 2021 Financial breakdowns, and take the mean between, and multiply this fraction by the model global GDP.
Using the public universe as a proxy for the entire global economy
We assume that the Factset financials database is representative of the economy and take the Factset sector revenue fractions of entire economy as a constant based on 2021 data. The Factset universe includes 50,176 publicly listed companies in 2021, covering $69.5 Trillion Dollars of Revenue (of ~$96 Trillion = Factset covers ~72% of economy)
However, we devised a second method due to three concerns with the first method:
It assumes that the Public Factset universe is representative of the entire economy
Industry / Sector categories map poorly sometimes and are cross contaminated between categories, and
Transport sector seems to get a free pass, which is paid for by the Energy Sector, due to the coarse and non-precise mappings between Factset and EMMI-NGFS.
The UN provides sector specific GDP numbers in USD for regions and sectors, from 1970 to 2021. We mapped these sectors to our known industry categories and obtained very similar sector GDP fractions.
The Emmi algorithm uses the Sector GDP, Sector Carbon Budget and Carbon Price (provided by the models), as well as assumptions of Global Wealth, Global Debt, and Global Net Wealth to calculate Temperature Alignment, Potential Capital Loss and Reductions Requirements.
Comparing NGFS Net Zero to the IPCC 1.5º scenario
The NGFS Scenarios generally provide more achievable targets across all Sectors. Particularly for Transport and Residential Buildings sectors, compared to Energy Supply and Industry NGFS sectors, which are more similar to the IPCC numbers.
Note: Emmi uses the IPCC 1.5º scenario as our default scenario, so this comparison labels the IPCC scenario as "Emmi 2050"
We have created a set of six climate scenarios based on NGFS, and a framework for implementing more. Each scenario has a global carbon budget, divided into sectors, with sector-based GDPs calculated to allow for an economics-based apportioning of the sector budget.
These templates codify the parameters for Emmi’s algorithms to calculate Potential Carbon Liability (PCL), Temperature Alignment and Reductions Requirements for any asset covered by our multi-asset coverage. We then provide customers with an aggregated understanding of their portfolio’s transition risk, using our Carbon Diagnostics product.