With new index series, investment community prepares for carbon pricing

carbon price risk

The new S&P 500 Carbon Price Risk 2030 Adjusted Index measures companies’ performance, taking into account the impact of future carbon prices.

With new index series, investment community prepares for carbon pricing

By Mary Gable

2018 might just be the year that Americans start talking seriously about climate solutions. Maybe it’s the heat. Record heatwaves have put millions of vulnerable Americans at risk nationwide, while wildfires continue to rage beyond our control along the West Coast. This year is set to be the fourth-hottest in recorded history (behind only 2015, 2016, and 2017).

Or maybe it’s the rain. Flash flooding has prompted evacuations up and down the Eastern Seaboard, and only this month was power fully restored in Puerto Rico, which has been living through a blackout for nearly a year since Hurricane Maria touched down last fall.

The signs of a changing climate are becoming harder to ignore. That might explain why solutions are gaining traction in new places. These solutions include carbon pricing proposals that would shift the costs of GHG emissions from society onto polluters. This fall, voters and legislators will consider state carbon pricing proposals in Washington state, D.C., and Massachusetts. In Congress, Republican Representative Carlos Curbelo recently introduced a bill that would use a carbon price to fund infrastructure improvements, joined by Rep. Brian Fitzpatrick (R-PA) and Rep. Francis Rooney (R-FL).

Another unexpected voice in the conversation: the investment community. The S&P Dow Jones Indices groups stocks into collections called “indices” (singular: index) that help investors track the performance of different sectors of the stock market. This includes well-known indices that chart the ups and downs of major U.S. companies, like the S&P 500 and the Dow Jones Industrial Average. It also includes custom indices that satisfy more specific investor interests.

In July, S&P Dow Jones Indices released the S&P Carbon Price Risk Adjusted Index Series, a group of indices that will measure companies’ performance based on expected 2030 prices on carbon.

How investors evaluate carbon pricing risk

The S&P Carbon Price Risk Adjusted Index Series is the first index of its kind. It’s a long name for a straightforward idea: today’s carbon prices (if they exist at all) fall far short of where they need to be to meet the goals of the Paris Agreement. If the world is to avoid climate catastrophe, businesses must radically change the way they operate, starting by transitioning away from fossil fuels and toward renewable sources of energy. It’s a tall order, and a carbon price can provide an important nudge in the right direction. Of course, businesses in some sectors will have to change more than others. Which ones, and how much? That’s what the index series attempts to answer.

The index series look at the gap between current carbon prices and the prices that would be required to meet the Paris Agreement’s goal of limiting future warming to 2 degrees Celsius or less. They call this gap the “carbon pricing risk premium.” Trucost, part of S&P Dow Jones Indices, calculated this gap for specific companies and markets using three things they know about hundreds of companies:

  • GHG emissions. High-emitting companies face a larger gap, and therefore more risk, than low-emitting ones.
  • Locations of operations. Those who operate in geographies that already have or are expected to have a carbon price are more vulnerable.
  • A company’s ability to pass on rather than absorb carbon costs. This has to do with the “elasticity” of demand in different industries. People may not shut their power off just because electricity costs increase, but might change how they spend on other goods.

You can probably guess where major differences pop up. Industries like energy and utilities, which have historically been powered by fossil fuels, will be more affected by carbon prices. And companies with operations in parts of the world that are already acting on carbon pricing, like much of Europe, are likely in for more change.

What this means for the carbon pricing movement

You have to be a Trucost customer to dig much deeper into the data, but the takeaway is clear. As carbon prices take hold across the globe, the S&P Carbon Price Risk Adjusted Index Series is a warning to companies of the need to decarbonize, making clear the disadvantages they’ll face if they fail to act. More importantly, it gives investors a glimpse of which businesses will succeed in a low-carbon future, and which will struggle—like getting a tip that a star player has a nagging injury and won’t last the season.

For the first time, investors can consider a company’s carbon pricing risk alongside its earnings, allowing them to make informed—and climate-conscious—decisions about whether to invest. The timing couldn’t be better. Investors are increasingly aware of the risks that climate change poses, not just to human life, but to businesses’ bottom lines. They are beginning to take action, from requiring companies to report their carbon emissions to adjusting their portfolios to exclude extractive industries. In addition to this new index series, the S&P Dow Jones Indices include specialty indices related to carbon efficiency, fossil fuel dependency, and sustainability, all of which help investors think about performance in more nuanced ways.

Most of us won’t give much more thought to the S&P Carbon Price Risk Adjusted Index Series, and that’s okay. But its creation is one more piece of evidence that carbon pricing is going mainstream. The S&P Dow Jones Indices estimate that average global carbon prices could increase more than sevenfold by 2030, to $120 per metric ton, and put $1.3 trillion in assets at risk. Companies can choose to weather this risk—or transform now.

Steve Hams on carbon pricing risk index

Steve Hams

“These indices make one conclude that carbon prices are inevitable,” says Steve Hams, Engagement Director for CCL’s Business Climate Leaders (BCL). “They are being embraced by the financial community, which makes it more important for companies to weigh in on policy and get ahead of the curve.”

You don’t have to be steeped in the world of asset management to understand why this matters. Investors’ acceptance of and preparations for carbon pricing is another arrow in the quiver of CCL volunteers—something we can share in meetings with business leaders, elected officials, and in letters to the editor.

It might be just the evidence someone needs to be persuaded that the odds—not to mention the science—are on our side. As our volunteers have long known, the more perspectives we can bring in to the conversation, the more successful we’ll be.

Mary Gable
Mary Gable is a writer and editor who focuses on sustainability and innovation. She's based in Seattle, but takes her work on the road whenever she can.

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