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  • Writer's pictureNic Pittman

Climate Scenario Analysis: ASX300's Financial Exposure

Climate scenario analysis is now mandated under the International Sustainability Standards Board (ISSB) and other financial climate reporting mandates around the world. These mandates require at least three scenarios including a ‘hot-house’ and ‘net-zero’ scenario, with the Network for Greening the Financial System (NGFS) mostly becoming the default standard for many countries. The NGFS have updated their latest climate scenarios, so in this post, we investigate how those transition pathways translate into climate financial risk, along with what is required for climate reporting from climate scenario analysis.


NGFS Release New Phase 4 Climate Scenarios

Climate scenarios are essential tools for understanding future carbon and financial risk. Various climate scenarios undergo different future assumptions on how the world will grow and decarbonise, so they allow quantitative descriptions of various climate pathways and the costs associated with them. In November 2023, the NGFS released new Phase 4 scenarios. which are illustrated in Figure 1 (v4.2 used here, released March 2024). These seven climate scenarios are divided into four key categories and differ in their representations of global carbon budgets and carbon prices in regards to the trajectory towards 1.4°C (more transition risk) to 4°C (more physical risk, Table 1). We demonstrate these trajectories in Figure 1, highlighting the key differences between various global climate scenarios and the costs associated with them. These scenario trajectories highlight the need for meaningful reductions, with carbon predicted to cost between $140 to $500 per tonne in order to reach these climate targets.


Summary of Seven NGFS Phase 4 Scenarios

1. Net Zero 2050

Net Zero 2050 aims for a 1.5°C limit on global warming by 2050 through immediate, ambitious climate policies and minimal carbon dioxide removal, offering a 50% chance of staying below this threshold with high transition risks.

Type

Physical Risk

Transition Risk

Temperature Alignment

Orderly

Low

Medium

1.5°C

2. Low Demand

The Low Demand scenario reduces energy demand through significant behavioural changes, achieving global net zero CO2 emissions by 2050 with a lower economic cost than Net Zero 2050, targeting the same warming limit.

Type

Physical Risk

Transition Risk

Temperature Alignment

Orderly

Low

Medium

1.5°C

3. Below 2°C

Below 2°C scenario aims for below 2°C global warming with a 67% probability by gradually increasing climate policy stringency, achieving net-zero CO2 emissions after 2070 with low physical and transition risks.

Type

Physical Risk

Transition Risk

Temperature Alignment

Orderly

Low

Low

2°C

4. Delayed Transition

Delayed Transition presents no emission reductions until 2030, requiring strong policies thereafter to stay below 2°C warming, facing medium transition and physical risks due to limited negative emissions technology.

Type

Physical Risk

Transition Risk

Temperature Alignment

Disorderly

Medium

High

2°C

5. Nationally Determined Contributions (NDCs)

Nationally Determined Contributions (NDCs) scenario follows pledged but unimplemented policies, leading to 2.6°C warming by century's end with moderate to severe physical risks and low transition risks.

Type

Physical Risk

Transition Risk

Temperature Alignment

Hot house world

High

Low

2.6°C

6. Current Policies

Current Policies scenario continues existing policies without further action, resulting in 3°C warming by 2080 and severe physical risks, highlighting the long-term dangers of inaction.

Type

Physical Risk

Transition Risk

Temperature Alignment

Hot house world

High

Low

3°C+

7. Fragmented World

The Fragmented World scenario features delayed, inconsistent global climate policies, resulting in high physical risks globally and elevated transition risks in some countries, with partial achievement of zero targets.

Type

Physical Risk

Transition Risk

Temperature Alignment

Too little, too late

High

High

2.3°C




Figure 1: Three IPCC Scenarios and seven NGFS Phase 4 Scenarios. The Left shows the global carbon emissions budget and the right shows carbon prices over time. Grey shaded area indicates Paris-aligned transition pathways, between NGFS 2°C and Net Zero 2050.


At Emmi, we have updated our modelled scenarios to include the new NGFS scenarios in addition to the 3 IPCC scenarios for carbon diagnostics across any asset class.


Sector pathways in the climate scenarios are individually mapped to each industry class of a portfolio allowing more accurate representations of individual carbon budgets for each holding. Our NGFS-mapped sectors include Energy Supply, Residential and Commercial Buildings, Industry, Services and Transportation, however, in theory, could also include more bespoke industry categorisation or regionalization.



How does ASX300 perform under these various climate scenarios?

For each scenario, we calculate a company's Potential Capital Loss (PCL) which quantifies the maximum downside loss for a company without reducing emissions from today. We use the ASX300 as a case study on how various sector-specific NGFS pathways translate into financial transition risk in the real-world economy.


Potential Capital Loss is presented as a percentage of the total enterprise value in the ASX300 over time (Figure 2). Emissions Reduction requirements are based on the ASX300 emissions today in order to reduce their PCL to zero from today's emissions (Figure 3).

Under the Paris Climate Agreement, most countries have committed their economies to reduce emissions to limit warming of at least 2°C. Carbon risk and reduction requirement profiles consistent with the 2°C Paris agreement are shown in grey.


By 2030, the ASX300 will be required to reduce emissions by an average of about 30% to be Paris-aligned, increasing to ~65% by 2050 (Figure 3). Without reaching these emission reduction targets, the potential carbon liability is vastly different depending on the climate scenario, ranging from -50% liability under NGFS Net-Zero (1.5°C) to -10% under NGFS 2°C scenario by 2030. These potential liabilities grow from -37% to -100% by 2050 to be aligned with Paris.


The carbon price is an important factor in quantifying future carbon liabilities for companies and prices vary significantly depending on the climate scenario (Figure 1). The minimum carbon price for Paris alignment is about $50 by 2030 increasing to $120 by 2050.


For the ASX300, there is a clear relationship between increasing carbon prices and increasing PCL over time (Figure 2). For Paris 2°C alignment, a carbon price of $120 equates to a 30% loss of value. To be aligned with a 1.5°C, carbon prices need to be moving towards $500, where the ASX could lose somewhere between 40% and 100% of its total value unless deep emission reductions and meaningful technological improvements are made (Figure 2 right).



Figure 2: Potential capital loss in percent for the median ASX300 company, with the colours responding to the various climate scenarios over time (left) and over carbon price (right). Grey highlighting indicates scenarios with global temperature trajectories between 1.5° and 2°C.



Figure 3: Emissions reduction requirements in percent for the median ASX300 company, with the colours responding to the various climate scenarios over time (left) and over carbon price (right). Grey highlighting indicates scenarios with global temperature trajectories between 1.5° and 2°C.



Climate Scenario Analysis for companies: Qantas example

We use Qantas as an example for climate scenario analysis. Qantas, which has a market capitalization of approximately $10 billion and ranks in the top 25 world airlines for passenger-kilometres flown, faces a more challenging transition curve compared to the median ASX300 company due to its heavy reliance on fossil fuels.


Up until 2035, the future carbon liability for Qantas varies dramatically depending on the climate scenario chosen. Under the 1.5°C Net-Zero scenario, 100% of Qantas enterprise value is wiped by 2030. However, the low-demand and delayed net-zero scenarios translate to very little financial impact on Qantas by 2030. Under those scenarios, the transport sector gets allocated more carbon budget over the next ten years than other sectors since there are no current low-carbon fuel technologies yet, particularly for air travel. So the trajectory of carbon allowances is very different for different NGFS scenarios.


Overall, Qantas like any airline needs to make deep carbon emission reductions over the medium to longer term in order to avoid the large potential carbon liabilities and exposures in a low-carbon world.



Figure 4: Same as Figure 2 but for Qantas in real $ terms



Figure 5: Same as Figure 3 but for Qantas in real carbon emission terms


Climate Scenario Analysis and ISSB 

What is clear is that the carbon risk profiles dramatically change depending on the NGFS scenario chosen, whether for a company or portfolio. Even to be aligned with a 2°C world, the ASX300 has material climate risk and will need deep emission reductions over the coming decades, while Qantas may have no technological alternative yet, and will have to rapidly develop and scale low-carbon aviation fuel to avoid carbon liabilities under a Paris aligned world.


Climate scenario analysis is now mandated to be part of the International Sustainability Standards Board (ISSB) and other climate reporting mandates around the world. At Emmi, we make the quantitative analysis needed for climate reporting easy - so get in touch with us if you need climate scenario analysis done for your company or portfolio. 



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