Carbon Pricing: What’s your Exposure?

A complimentary webinar for corporate sustainability professionals and ESG investors

11 July 2017

Thomas KerrPrincipal Climate Policy OfficerIFC, Climate Change Department

Agenda

Libby BernickHead of Corporate BusinessTrucost, part of S&P Dow Jones Indices

Rick LordLead, ESG Management and Value Creation Trucost, part of S&P Dow Jones Indices

• Introduction to Carbon PricingLibby Bernick, Trucost, part of S&P Dow Jones Indices

• Setting the Scene on Internal Carbon PricingThomas Kerr, IFC, Climate Change Department

• Setting and Applying an Internal Carbon PriceRick Lord, Trucost, part of S&P Dow Jones Indices

• Conclusion and Q&ALibby Bernick, Trucost, part of S&P Dow Jones Indices

Carbon Pricing - Global contextJuly 2017

T O M KERR, PR I NCI PAL CL I MAT E PO L ICY O F F ICER

I NT ERNAT IONAL F I NANCE CO RPO RAT ION, W ORLD BANK G ROUP

Growing momentum to support carbon pricingSeptember 2014: at UN Climate Summit, +1000 companies & investors and 74 national governments call for a price on carbon

June 2015: Letter from the CEOs of six global oil and gas companies to the UNFCCC and COP President, calling carbon pricing

September 2015: Joint declaration by major US banks on climate change states that policy frameworks must recognize the cost of carbon

October 2015: Launch of the Carbon Pricing Panel consisting of 6 heads of state

Open Letter to UN and Governments from 6 oil and gas companies

November 2015: Convened by WEF, the Climate Leadership Group - a coalition of 73 CEOs - calls for pricing carbon as a top priority

June 2015: G7 communique supports more action on carbon pricing

December 2015: The Paris Agreement sets ambition for achieving < 2 degrees C; at COP21, Carbon Pricing Leadership Coalition launched; Carbon Pricing Panel features 6 heads of state

2016: nearly half of NDCs explicitly reference carbon pricing/markets

December 2016: Canada sets first national carbon price with 8 provinces joining the deal

2017: China expected to launch the national ETS towards Q3/Q4 of 2017; possibility of carbon tax if not ETS

Expansion of jurisdictions putting a price on carbon

42 national jurisdictions

25 sub-national jurisdictions

15% of global emissions (8 GtCO2e)

Source: World Bank Group, State & Trends of Carbon Pricing (October 2016).

The annual value of instruments implemented is just under

US$ 52 billionPrices used vary from

US$ 1-131/tCO2e

Key developments (2016-17):

Australia, British Columbia (Canada), Fuijan (China): 3 ETSs implemented in 2016

Washington State, Ontario: 2 ETSs in 2017

Chile, Colombia, Alberta: 3 carbon taxes in 2017

Mexico announcednational carbon market starting in 2018, with an ETSas the preferred option

Chile and Colombiaconsidering setting up ETS

More companies are using internal carbon pricing

1200+ companies

disclose the use of an internal carbon price –or intend to do so in the next 2 years

517 companies are already using internal carbon pricing as an accounting and risk management tool (19% increase from 2015)

Source: CDP, Embedding a Carbon Price into Business Strategy (September 2016).

Source: World Bank Group, State & Trends of Carbon Pricing (October 2016).

Prices and coverage of

existing carbon pricing systems

will notput us on a

2-degree path

A common set of key issues

• Competitiveness and concerns about carbon leakage• Distributional impacts – e.g., higher energy prices for low-income households• Alignment of carbon pricing with other policies• Productive use of revenues – to ease the transition, accelerate technology innovation• Linking and networking different carbon pricing systems

How do we work?Three work streams pursuing one common strategy

Fostering Government Leadership

Building & Sharing the

Evidence Base

Mobilizing Business Support

Communications Network

Broadening, deepening and converging carbon pricing schemes worldwide

Carbon Pricing Leadership Coalition – 4 Working Groups

Leading businesses are using carbon pricing

Mahindra Group, India: First Indian company to announce an internal carbon price: $10/ton. Their goal is to reduce carbon footprint by 25% over three years.

Engie, France: Uses carbon pricing to account for the costs that climate change will add to projects – this has accelerated the company’s to clean energy: in 2016, Engie ended investments in coal-fired power generation.

Royal DSM, Netherlands: Established an internal price of EUR50 per ton of CO2e. The company believes this will cause a discussion around how to reduce investment’s footprints and ‘future proof’ their business against climate impacts.

Brazil: Since 2015, 20+ companies have voluntarily simulated a cap-and-trade, this lead them in 2016 to issue a communiquè to the government supporting more aggressive carbon pricing policies.

Find more examples visiting: www.carbonpricingleadership.org/

Following the recommendations of the Task Force on Climate-related Financial Disclosures(TCFD), leading financial institutions are exploring how to use carbon pricing – and the use of corporate internal carbon pricing – to help them analyze the potential impact of climate change on their operations and investment portfolios.

Among these leaders are CPLC partners: AXA, Commerzbank, Grupo Financiero Banorte, HSBC, National Australia Bank, Garanti Bank, and TD Bank.

Financial Sector and Carbon Pricing

Join Our Coalition of the Working

Setting and Applying an Internal Carbon Price

Rick LordLead | ESG ManagementTrucost, part of S&P Dow Jones Indices

11 July 2017

Carbon Pricing is Increasing GloballyCarbon taxes, emissions trading schemes and fuel taxes are expected to feature prominently in global efforts to address climate change

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Source: World Bank, Ecofys and Vivid Economics (2016 )

Carbon Taxes and Emissions Trading Schemes have been implemented in 42 countries, cities and regions

Almost 15% of global emissions are currently priced, increasing to 23% with the introduction of the China national ETS in 2017

Prices range from US$ 1 to $US 131 per tonne CO2e, with most emissions priced at less than US$ 25 per tonne in 2016

Current Carbon Prices are Low

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Source: OECD/IEA (2017); CDP and CPLC (2017); CPLC (2017); Trucost Analysis (2017)

Regulated carbon prices will need to rise significantly to potentially limit climate change to 2 degrees celsius

0

50

100

150

200

Today 2030 2040 2050Effe

ctiv

e C

arbo

n Pr

ice

per T

onne

CO

2e

($U

S 20

16)

Paris Agreement Nationally Determined Comittments

2-Degree Aligned Scenario

Possible Future Carbon Price

IEA and IRENA (2017) project a carbon price of

US$120 per tonne in OECD countries by 2030 under a 2-

degree aligned scenario

Other recent reviews show similar

findings:

US$30-$100 per tonne by 2030

Carbon Pricing Corridors(CDP and CPLC, 2017)

US$50-$100 per tonne by 2030

High Level Commission on Carbon Prices

(CPLC, 2017)

Future carbon price trajectories are uncertain and likely to vary across geographies

Sector Exposure is Variable

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Source: OECD (2016)

OECD (2016) analysis finds that current carbon price levels and coverage are highly variable across key emissions sectors

Carbon prices in sectors with limited regulation may have further to rise to meet future carbon price targets

The ‘Carbon Price Risk Premium’

This premium, which varies by sector and geography, reflects the additional financial exposure of a company, sector or facility to carbon pricing regulations in the future and is a useful benchmark for setting internal carbon prices

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Source: OECD/IEA (2017), OECD (2016), Trucost Analysis (2017)

$0

$40

$80

$120C

arbo

n P

rice

($U

S 2

016

per t

onne

C

O2e

)Future Carbon Price (2030)

Current Carbon Price

Risk PremiumExample:United Kingdom Electricity Sector

Trucost defines the gap between current carbon prices and future carbon price targets as the ‘Carbon Price Risk Premium’

Carbon Pricing is a Key Transition Risk for BusinessAverage carbon prices in OECD countries could increase more than sevenfold to USD $120 per metric ton by 2030, as countries take action on the Paris Agreement.

This is expected to increase the cost of fossil fuels, energy and carbon intensive goods and services – raising operating costs for many businesses

Demand for carbon intensive products could also decline as prices rise

Rising carbon prices should be considered when making investments for the medium to long term:

• Asset investment

• New product development

• Corporate strategy

Internal carbon pricing is a strategy to systematically integrate the future financial risks of climate change action within corporate decision making and strategy

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Source: OECD/IEA (2017), OECD (2016), Trucost Analysis (2017)

Corporate Benefits of Internal Carbon Pricing

Key benefits for corporates adopting internal carbon pricing include:

• Increase Resilience: Pricing-in future regulatory costs in investment and strategic planning to increase resilience in the transition to a low carbon economy.

• Drive Efficiency: Strengthen the business case for energy efficiency and investment in renewable energy to unlock financial returns.

• Increase Competitiveness: Improve cost competitiveness and market positioning in an increasingly carbon constrained economy.

• Demonstrate Leadership: Improved reputation, investor relations and access to capital by demonstrating active management of climate change risks.

• Access New Markets: Identify new opportunities and markets for low carbon and carbon abatement products and services in sectors and geographies with high carbon price risk premiums.

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Setting an Internal Carbon Price

Setting the Right

Internal Carbon Price

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Inside Out Outside In

Set Price Based on Future Cost

ExposureChoose a Price to Reflect Exposure

to Current and Future Carbon

Prices in Regulated Markets

Set Price Based On Emissions

Reduction TargetChoose a Price Aligned with a Science Based

Emissions Reduction Target

Implementation Options

Carbon Taxes and Fees Shadow Prices

Possible Approaches to Setting an Internal Carbon Price…

Drive Emissions Reductions Manage Transition RiskCapture Low Carbon Opportunities

Trucost Internal Carbon Pricing Approach

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Map Emissions by Sector and

Geography

Identify Current

Carbon Prices

Define Future Carbon Price

Targets

Calculate Carbon Price Risk Premium

Set Internal Carbon Price

Facility

Business Unit

Enterprise

Trucost recommends setting an internal carbon price at the Carbon Price Risk Premium associated with the unique sector, geographic and emissions profile of the business.

Variable internal carbon prices can be set at the facility, business unit or enterprise level to account the expected future cost of increasing carbon prices over time horizons of relevance to the business.

An internal carbon price can be an important tool in assessing the implications of rising carbon prices on key financial metrics

Internal Carbon Pricing ApplicationsFinancial Implications of Rising Carbon Prices

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Financial Risks of

Carbon Price Regulation

Direct Carbon Pricing Risk Indirect Carbon Pricing Risk

Purchased Energy

(Scope 2)

Regulatory Costs Taxes & Emissions Permits

Rising Electricity and Energy Prices

Rising Supply Chain Costs Pass-Through of Carbon Prices

Reduced DemandRising Product Use Costs

Rising Logistics and Travel Costs

Pass-Through of Carbon Prices

Operations(Scope 1)

Value Chain

(Scope 3)

Impacts on Revenue and Operating Expenditure

Internal Carbon Pricing Applications

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• Core Business: Diversified chemicals manufacturer

• Total Revenue: $64 billion

• Operating Margin: 32%

• Planning Time Horizon: 2030

• Greenhouse Gas Emissions:– Scope 1: 18.4 million tonnes CO2e– Scope 2: 4 million tonnes CO2e– Scope 3: 59 million tonnes CO2e– Total: 81 million tonnes CO2e

• Operating Geographies: Belgium, Brazil, China, France, Germany, India, Italy, Japan, South Korea, Spain, United States

• Average Carbon Price 2017: $8 per tonne

• Average Carbon Price 2030: $84 ($34 - $115) per tonne

• Recommended Internal Carbon Price: $76 per tonne

Example Corporate Application

$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

$7,000

Scope 1 Scope 2 Scope 3 Total

Car

bon

Pric

ing

Cos

t in

2030

($

US

2016

Milli

on)

Curent Carbon Cost Carbon Price Risk

Source: Trucost Analysis (2017)

Internal Carbon Pricing Applications

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Understanding Carbon Price Risk Exposure

Identify operating geographies with highest carbon price risk

$0.00

$0.10

$0.20

$0.30

$0.40

$0.50

$0.60

Car

bon

Pric

e R

isk

(Milli

on p

er M

illion

R

even

ue)

Company A Competitor B Competitor C Competitor D Competitor E

Compare carbon price risk exposure with sector competitors in key markets

Belgium

Brazil

China

France

Germany

India

Italy

Japan

South Korea

Spain

United States

Source: Trucost Analysis (2017)

Internal Carbon Pricing Applications

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Increasing operating expenses due to rising carbon prices could reduce operating margins by between 3% (low) and 12% (high)

Scenario Analysis - Business Model Stress Testing

Future Carbon Price Scenarios:• Low: Implementation of Paris

Agreement commitments• Mid: 2 degree aligned

scenario – delayed action• High: 2 degree aligned

scenario 26%

27%

28%

29%

30%

31%

32%

33%

Ope

ratin

g M

argi

n (%

) in

2030

Operating Margin - Baseline

Operating Margin - Low Carbon Price Scenario

Operating Margin - Mid Carbon Price Scenario

Operating Margin - High Carbon Price Scenario

Source: Trucost Analysis (2017)

Trucost Carbon Pricing Tool

Trucost is launching a desktop Carbon Pricing Tool to help companies set internal carbon prices and understand carbon pricing risks and opportunities.

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References

World Bank, Ecofys and Vivid Economics. 2016. State and Trends of Carbon Pricing 2016 (October), by World Bank, Washington, DC.

OECD/IEA. 2017. Chapter 2 of Perspectives for the energy transition – investment needs for a low-carbon energy system. [Online] Available: http://www.irena.org/DocumentDownloads/Publications/Perspectives_for_the_Energy_Transition_2017.pdf

CDP and CPLC. 2017. Carbon Pricing Corridors: The Market View. [Online] Available: https://b8f65cb373b1b7b15feb-c70d8ead6ced550b4d987d7c03fcdd1d.ssl.cf3.rackcdn.com/cms/reports/documents/000/002/112/original/Carbon-Pricing-Corridors-the-market-view.pdf?1495638527

OECD. 2016. Effective Carbon Rates: Pricing CO2 through Taxes and Emissions Trading Systems, OECD Publishing, Paris. http://dx.doi.org/10.1787/9789264260115-en

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