Carbon risk is investment risk
Updated: Nov 23, 2022
Larry Fink, CEO of Blackrock shared in his 2020 letter to clients, “there is a fundamental reshaping of finance” taking place where “climate risk is investment risk”.
What is climate risk versus carbon risk?
It’s important to understand that ‘carbon risk’ is not the same as ‘climate risk’, so let me explain. ‘Climate risk’ often combines two different risks: physical climate risk and carbon transition risk. Here’s a schematic to help.
Physical Climate Risk
Physical climate risk relates to physical asset damage associated with climate warming - things like the frequency and severity of extreme weather events, heat waves, storm surges with sea-level rise, droughts, floods, fires, etc. Aside from temperature, heatwaves, and sea level, however, the science of predicting shifting climate patterns and extreme weather events is very uncertain, particularly at the small-scale asset level.
Physical climate damages (eg sea-level rise) also occur on long timescales (50-100yrs). That is good news since even the most climate-exposed companies (say coastal infrastructure or agriculture) can adapt and absorb much of the risk over that time frame by investing in risk abatement. For example, investing in storm barriers, seawalls, or flood mitigation technologies will all help climate-exposed companies absorb and survive the worst parts of physical climate risk.
Carbon Transition Risk (‘carbon risk’ for short)
The other type of climate risk is called ‘carbon transition risk’ - which refers to the business impact caused by the transition from a high-carbon economy to a low-carbon economy needed to address climate change.
Each year about 36 billion tonnes of carbon dioxide are emitted from global industry. The Paris Climate Agreement—ratified by over 190 countries—aims to ensure that the increase in average temperatures above pre-industrial levels is kept to ‘well below’ 2°C by 2100. To achieve that, science suggests carbon emissions must go to near zero by mid-century. Most countries (even China) have now committed to achieving net-zero carbon emissions by 2050-60.
This global transition from a high-carbon to a low-carbon economy is enormous and this carbon risk has a much broader impact than physical climate risk since all companies have exposure to energy and transportation for example. A recent major UN-backed climate finance analysis suggested that carbon transition risk could impact “as much as 13.2% of overall portfolio value which would represent a value loss of USD10.7 trillion”.
Carbon risk will also occur on a much shorter time scale than the physical climate risk. Why? Because the legal, regulatory, market, or reputational risks are driven by policy and market behavior which can be imposed very quickly.
Glaciers melt slowly, but humans act quickly. As the global response to COVID-19 showed, market demand and governments can effectively shut down entire economies to reduce risk. The next decade is where most of the carbon risk will be played out - since that is when peak carbon emissions are likely to occur and financial markets demand lower carbon reliance.
What is Emmi? and why did we build it?
If a business is heavily reliant on producing carbon emissions, then in a world moving to net-zero emissions, it has a high carbon financial risk. But how can we score that risk for any company? Each company has wildly different carbon exposures.
Currently, there is no easy way to assess and track carbon transition risk in a standardized way. With our flagship metrics (carbon footprint backed by our emissions estimation models, emissions reduction requirements for scenario alignment, and Potential Capital Loss), Emmi solves that problem for investors and companies.
Emmi was built to make it easy to assess and track carbon financial risk for any company without needing a Ph.D. in climate science or finance. Using Emmi, institutional investors & corporates can understand the financial impact of carbon across any portfolio or company. This will allow them to avoid stranded asset risk and financial loss by using Emmi to understand, anticipate and accelerate the market changes required for a net-zero economy.
How can I access it?
If you would like to explore our carbon solutions (including our platform which features our flagship carbon metrics), talk to us today.
Stay safe and well,