Industry Trend Analysis - Risks Rising From Carbon Pricing - DEC 2017

BMI View: The increasingly widespread and consistent use of internal carbon pricing mechanisms in corporate strategy will raise the risks to long-term attractiveness of investments in 'carbon-intense' activities, threatening O&G firms ' conventional business models.

The use of a carbon price is viewed widely amongst economists as one of the most effective market-based methods of addressing the negative externalities associated with the emission of carbon. The use of a carbon price, which attaches a hypothetical cost of carbon to each tonne emitted, is an attempt by a company to reveal hidden risks and opportunities throughout its operations and supply chain and to support strategic decision-making related to future capital investments.

Internal carbon pricing has been widely used in the oil and gas sector for many years in an attempt to reduce future risk from increasingly punitive emissions standards set by governments and industry collectives. More recently, there has been an increasing investor focus on how carbon pricing is being integrated into the business models of all companies, not just those exclusively in energy-intensive sectors. This is due to the increasing shareholder awareness of the future economic risks of climate instability and the risk of future carbon regulation. Subsequently, the carbon price mechanism is an increasingly popular gauge to assess whether business planning and operations are sufficiently evolved to manage future risk.

Growing Use Of Carbon Pricing
Sectoral Breakdown Of Current & Future Carbon Price Use, % Of Market-Cap
Source: CDP, BMI

Carbon Price Inflation

For the oil and gas sector specifically, the increasing pervasiveness of carbon pricing and the likely increase in the price of carbon will threaten the long-term viability of companies with a high exposure to the upper end of the carbon price curve i.e companies with core businesses in highly carbon-intensive activities such as oil and tar sands, where emissions are high. It is widely opined that the current price of carbon in various markets is too low, with the necessary price levels to decarbonise global markets, particularly in the energy space, required to be at a much higher level.

Subsequently, carbon price inflation is likely, raising the risk to conventional business models of O&G companies (see ' O&G Companies Must Adapt Or Decline', September 15). As well as facing a potentially higher price for emitting carbon, the companies may also face increasingly high cost of capital as investor concern about the financial implications of climate risk continues (see ' 2degC Transition Series: Environmental Risk To Drive Up Cost Of Capital , August 9). This has already been witnessed in the O&G markets, with most recently BNP Paribas one of the world's largest banks, announcing that it would no longer finance new shale or tar sands projects, nor work with companies mainly focused on those resources. This typifies mounting scrutiny that O&G companies will face with regard to their carbon-intense activities, as well as their best-practices in climate-related risk disclosure.

It must be noted that at present, on a global level, there is considerable uncertainty about what emissions targets are achievable over what timeframe, and subsequently, what carbon price is appropriate to impose the necessary limits. Internal carbon pricing on a sectoral and company-specific level therefore remains highly fragmented. This is particularly true between companies facing an actual price on their carbon emissions, such as those under the jurisdiction of structures such as the European Emissions Trading Scheme, and those that do not have a direct carbon cost but use internal carbon pricing as a stress-test for future investments or strategy.

Divergence in the assigned carbon prices stems from the complexity in defining and quantifying the future effects of carbon emissions and subsequent climate instability. Nevertheless, increasing data availability and efforts to standardise analytical approaches to the impacts of the low carbon transition should help investors to better approximate carbon price moving forward.