The Energy Transition Risk Project
– a toolset for scenario-based energy and climate transition risks –
We had launched the business-relevant IEA scenario basis early this year, for your free use. Now, we have completed the financial impact analysis for all four sectors, complemented by an analysis on valuation impacts by KeplerCheuvreux, and provide a joint synthesis on the implications for investors:
Scenario analysis insights on earnings (The CO-Firm)
- The low-carbon transition is generally an earnings growth story for the sectors under consideration (utilities, auto, cement, steel, aviation, shipping), showing that on average, companies have a business-case positive pathway to transition. A more rigorous global warming reduction scenario might even lead to stronger earnings growth, e.g. in steel sector.
- If companies fail to act and adapt to the low-carbon transition, the earnings hit can materialize already in the short- to medium-term. In some sectors, impacts arise starting 2020.
- To gain a more complete picture, transition risks should be considered at the company level rather than sector level, if possible, because financial performance varies significantly across firms. Across sectors, selected companies can realize up to 150 % growth potential of their EBITDA if they prepare for a 2 °C world.
- The underlying analysis provides an illustration of potential winners and losers in the low-carbon transition. Financial stakeholders need to match our scenario assumptions with their company-specific knowledge and opinions.
- The key risk drivers differ across the sectors under consideration and the scenarios applied, but include: the evolution of technology, regional differentiation, as well as direct regulatory measures to promote the transition, e.g. CO2 prices.
- Adaptive capacity is a result of dynamic capabilities, which allow existing resources (assets, financial pockets, intellectual property) to be put to good use, by means of a strategy. The role of financial strength on adaptive capacity has proved to be significant.
Scenario analysis insights on valuation
- Transition risks can affect the investment case of a company. Even so, transition risks are discussed sparingly in current equity valuations and are actually integrated into valuations even less frequently.
- This is because analysts still tend to lack conviction that transition risks affect a company’s investment case, whether due to a perception of low probability, low severity or, most commonly, that the risk falls outside of the analyst’s time frame.
- Scenario analysis can help analysts reduce uncertainty on complex issues. It can indicate how transition risks could affect the future earnings and valuations of companies, sectors and regions, and how this might vary over time.
- Our analysis shows that there could be a discrepancy between company valuations in our climate change scenarios and a market consensus baseline, suggesting that the market is not pricing in all transition risks.
- Upon seeing results like those of this analysis, the next step for analysts is to assign probability weightings to each scenario and begin to factor in the assumptions/inputs of the most likely future into their base case.
Application of results
- Equity analysts and asset managers can validate their previous assumptions on key determinants of company growth and profitability in a transitioning market. Furthermore, the analysis supports you in stock-picking
- CIOs can see shifts between sectors, new risks and new investment opportunities.
- CROs can embed new climate change induced risk drivers in traditional risk assessments.
- SCR can better inform portfolio, risk and asset managers with an integrated numbers-driven approach, „connecting” Investment and corporate responsibility views, providing unique climate analysis that can feed directly into sector, company and country assessments.
- Companies are enabled to perform scenario analysis in line with TCFD, providing financial impact results, a profound understanding of material business risks and opportunities, and their drivers; and their embedding in traditional risk assessments, strategy and governance processes.
- Policy makers receive concrete suggestions on how to support the energy (climate) transition via e.g., investment thresholds for different types of regulatory interventions such as the required EUR level of feed-in tariffs for supporting a 2.7°C- or 2.0°C-aligned build-out of renewables, trade-off between carbon prices, feed-in-tariffs, capacity payments required over time, and impact of these regulatory interventions on electricity prices.
Overall, the developed approach is quite universal as the value added in using the results is the same across all asset classes: equities, bonds, company financing, etc.
Access to results
The framework consists of
- Energy Transition risk tool for scenario-based financial impact analysis of climate risks and opportunities, based on the tool developed by The CO-Firm: climateXcellence and
- The related reports with applications of the approach
- The Investor primer to transition risk analysis. The first report outlines a methodology for bottom-up modelling of climate risks and opportunities and illustrates how modelling results can be integrated into valuation methodologies.
- Sector and company reports (4 sectors): applied the approach outlined in the Investor Primer and show the results for three companies each in the utilities, automotive and steel and cement sectors, the latter being a case study on six countries.
- Transition risks: How to move ahead is a management summary illustrating the key findings and learnings of the collaborative project.
Project results are also available on the TCFD Knowledge Hub for resources needed to understand and implement the TCFD recommendations and on Bloomberg as well as incorporated in the proposal for the European Parliament Directive on disclosures relating to sustainable investments and sustainability risks (EU) 2016/2341. The entire ET Risk toolbox, developed by 2° Investing Initiative, Carbon Tracker, I4CE, Kepler Cheuvreux, S&P Global Market Intelligence and the University of Oxford is also available on: www.et-risk.eu.
If you are interested in participating in “1 on 1” trainings and events about our work please contact us via climateXcellence@co-firm.com.