Understanding the financial risks of a disorderly ...

Decarbonisation and Disruption | | 1

Decarbonisation and DisruptionUnderstanding the financial risks of a disorderly transition using climate scenarios

Acknowledgements

The pilot project was led by a Working Group of thirty-nine banks convened by the UN Environment Programme Finance Initiative:

ABN-AMROABSAAccess BankBank of IrelandBarclaysBMOBradescoCaixaBankCIBCCIMBCitibanamexCredit SuisseDanske Bank

Deutsche BankDNBEBRDFirstRandINGIntesa SanpaoloItauKBCLloydsMizuhoMUFGNABNedbank

NIBNomuraNordeaRabobankRBSSantanderScotia BankShinhanStandard BankStandard CharteredTD BankTSKBUBS

Authors UNEP FIDavid Carlin, TCFD Programme Lead ([email protected])

Oliver WymanCaroline Gourri, Knowledge Expert, Team Manager ([email protected])

Project Management The project was set up, managed, and coordinated by the UN Environment Finance Initiative, specifically: Remco Fischer ([email protected]) and David Carlin ([email protected])

mailto:[email protected]

mailto:caroline.gourri%40oliverwyman.com?subject=



DisclaimerThis report was commissioned by the UN Environment Programme Finance Initiative (“UNEP FI”) TCFD Banking Program Working Group, which includes the following thirty-nine banks: ABN-AMRO, ABSA, Access Bank, Bank of Ireland, Barclays, BMO, Bradesco, CaixaBank, CIBC, CIMB, Citibana-mex, Credit Suisse, Danske Bank, Deutsche Bank, DNB, EBRD, FirstRand, ING, Intesa Sanpaolo, Itau, KBC, Lloyds, Mizuho, MUFG, NAB, Nat West, Nedbank, NIB, Nomura, Nordea, Rabobank, Santander, Scotia Bank, Shinhan, Standard Bank, Standard Chartered, TD Bank, TSKB, UBS (the “Working Group”), to provide an overview of climate risk applications throughout the financial sector and specific guidance on good practice. This report extends the work of UNEP FI and the participating banks in Phase I of UNEP FI’s TCFD banking program. UNEP FI and the Working Group shall not have any liability to any third party in respect of this report or any actions taken or decisions made as a consequence of the results, advice or recommendations set forth herein. This report does not represent investment advice or provide an opinion regarding the fairness of any transaction to any and all parties. The opinions expressed herein are valid only for the purpose stated herein and as of the date hereof. Information furnished by others, upon which all or portions of this report are based, is believed to be reliable but has not been verified. No warranty is given as to the accuracy of such information. Public information and industry and statistical data are from sources UNEP FI and the Working Group deem to be reliable; however, UNEP FI and the Working Group make no representation as to the accuracy or completeness of such information and has accepted the information without further verification. No responsibility is taken for changes in market conditions or laws or regulations and no obligation is assumed to revise this report to reflect changes, events or conditions, which occur subsequent to the date hereof. This document may contain predictions, forecasts, or hypothetical outcomes based on current data and historical trends and hypothetical scenarios. Any such predictions, forecasts, or hypothetical outcomes are subject to inherent risks and uncertainties. In particular, actual results could be impacted by future events which cannot be predicted or controlled, including, without limitation, changes in business strategies, the devel-opment of future products and services, changes in market and industry conditions, the outcome of contingencies, changes in management, changes in law or regulations, as well as other exter-nal factors outside of our control. UNEP FI and the Working Group accept no responsibility for actual results or future events. UNEP FI and the Working Group shall have no responsibility for any modifications to, or derivative works based upon, the methodology made by any third party. This publication may be reproduced in whole or in part for educational or non-profit purposes, provided acknowledgment of the source is made. The designations employed and the presenta-tion of the material in this publication do not imply the expression of any opinion whatsoever on the part of UN Environment Programme concerning the legal status of any country, territory, city or area or of its authorities, or concerning delimitation of its frontiers or boundaries. Moreover, the views expressed do not necessarily represent the decision or the stated policy of UN Environment Programme, nor does citing of trade names or commercial processes constitute endorsement.

Copyright Copyright © UN Environment Programme, January 2021 This publication may be reproduced in whole or in part and in any form for educational or non-profit purposes without special permis-sion from the copyright holder, provided acknowledgement of the source is made. UN Environment Programme would appreciate receiving a copy of any publication that uses this publication as a source. No use of this publication may be made for resale or for any other commercial purpose whatsoever without prior permission in writing from the UN Environment Programme.

4 | Decarbonisation and Disruption | Contents

Contents

1. Introduction ....................................................................................... 11.1. Context for this paper.............................................................................................. 11.2. Risks of a disorderly transition ................................................................................ 31.3. Climate scenarios for disorderly transitions ........................................................... 51.4. Case study assessment methodology .................................................................... 8

2. The oil and gas sector .......................................................................... 92.1. Market trends .......................................................................................................... 92.2. The potential impacts of a disruptive transition ................................................... 102.3. Ensuring an orderly transition ............................................................................... 112.4. Climate scenario analysis of the disorderly transition .......................................... 12

3. Utilities and power generation sector ....................................................153.1. Market trends ........................................................................................................153.2. The potential impacts of a disruptive transition ................................................... 193.3. Ensuring an orderly transition ............................................................................... 203.4. Climate scenario analysis of the disorderly transition .......................................... 20

4. Metals and mining (industrials) sector ...................................................224.1. Market trends ........................................................................................................224.2. The potential impacts of a disruptive transition ................................................... 234.3. Ensuring an orderly transition ............................................................................... 234.4. Climate scenario analysis of the disorderly transition .......................................... 23

5. Agriculture sector ..............................................................................265.1. Market trends ........................................................................................................265.2. The potential impacts of a disruptive transition ................................................... 265.3. Ensuring an orderly transition ............................................................................... 275.4. Climate scenario analysis of the disorderly transition .......................................... 27

6. Participant case studies ......................................................................29

7. Conclusions ......................................................................................407.1. A looming threat ....................................................................................................407.2. The right tools for the job ......................................................................................40

8. Bibliography ......................................................................................42

Decarbonisation and Disruption | Introduction | 1

1. Introduction

1.1. Context for this paperIn 2015, the Task Force on Climate-related Financial Disclosures (TCFD) was created by the Finan-cial Stability Board (FSB) to support the disclosure of climate-related financial risks. The creation of the TCFD acknowledged the fact that climate risks are financial risks and firms, markets, and regu-lators need to prepare accordingly. A key aspect of that preparation would be the assessment and disclosure of climate risks in a decision-useful format for financial actors. To that end, in 2017, the TCFD published guidance on climate risk disclosures, with four guiding pillars and eleven recom-mended disclosures as shown below in Figure 1 (TCFD 2017).

Figure 1: TCFD pillars and recommended disclosures

Following the TCFD’s guidance on climate risk disclosures, the United Nations Environment Programme Finance Initiative (UNEP FI) convened a consortium of banks to implement these new recommendations. In a yearlong program, which became known as UNEP FI’s TCFD Bank-ing Program- Phase I, sixteen international banks collaborated with leading climate modelers and expert consultancies to develop approaches for assessing climate risks and opportunities in their portfolios. The banks engaged Oliver Wyman, a global management consulting firm, to develop an approach for evaluating corporate lending portfolio exposure to transition risk under different climate scenarios (UNEP FI 2018). The methodology developed for transition risk assessment is detailed in the UNEP FI report, Extending Our Horizons, and is reviewed again briefly in this report (UNEP FI; Oliver Wyman 2018). A similar effort was conducted to develop a physical risk assess-ment methodology in collaboration with Acclimatise, a climate-focused consultancy.

2 | Decarbonisation and Disruption | Introduction

Since 2017, significant advancements have taken place in the areas of climate risk assessment and disclosure. These changes have included greater knowledge and awareness by financial actors, increased regulatory requirements for disclosure, and new tools and scenarios for conduct-ing climate assessments. As a result, UNEP FI decided to convene another yearlong TCFD banking program in 2019. Termed “Phase II,” this new program sought to increase climate knowledge at financial institutions and provide an expanded toolkit for climate risk assessment and disclosure. Phase II saw a marked expansion in the number of participants, thirty-nine global institutions from six continents. Not only did this larger group support the goal of increasing global engagement, but it also provided a wide range of perspectives more representative of the financial sector overall. As a result, the program worked to propose industry-wide good practices for climate risk assessment and disclosure.

Phase II was divided into three major topic areas. These areas included climate scenarios, data and methodology, and reporting and governance. Each area was supported by a set of objectives as shown in Figure 1.

Figure 2: TCFD program key areas of focus- Phase II

In Phase II, the participating banks also explored the climate science and the dire implications of uncontrolled warming on physical, biological, and societal systems. A robust body of scientific research on the urgent need to limit warming was compiled by the Intergovernmental Panel on Climate Change (IPCC) in 2018 as the Special Report on 1.5°C (SR 15). This report explored the already growing harms of climate change and the importance of aiming for 1.5°C rather than a 2°C target. A few key takeaways from SR15 follow:


“One of the key messages that comes out very strongly from this report is that we are already seeing the consequences of 1°C of global warming through more extreme weather, rising sea levels and diminishing Arctic sea ice, among other changes.”

“Limiting global warming to 1.5°C compared with 2°C would reduce challenging impacts on ecosystems, human health and well-being, making it easier to achieve the United Nations Sustainable Development Goals.”

“Every extra bit of warming matters, especially since warming of 1.5°C or higher increases the risk associated with long-lasting or irreversible changes, such as the loss of some ecosystems.”

IPCC 2018.

However, given rising temperatures and atmospheric greenhouse gas concentrations, limiting warming to 1.5°C demands “unprecedented changes.” These changes will not be limited to certain industries and sectors but will require wholesale transformation of the wider economy. Further-more, given the little time remaining to curtail emissions and further warming, this transformation must be undertaken rapidly and aggressively. The emissions reductions consistent with a 1.5° C pathway demand reductions of nearly 8% annually in global emissions according to the UN Envi-ronment Programme’s Emissions Gap Report (UNEP 2019). For context, scientists estimate that the emissions reductions due to the COVID-19 pandemic will be comparable to that 8% figure.

The degree of climate ambition necessary to avoid levels of catastrophic warming is great. Only through concerted action from public and private sector actors will climate goals be attained. These changes will be affected through policy shifts, market movements, evolving consumer demands, and technological progress. These factors will alter all industries in profound ways. Financial institutions must understand the ways in which this transition can proceed and the risks it poses to their portfolio companies. Only through a keen understanding of transition pathways across sectors and geographies, can financial institutions manage their own climate risks and play a positive role in the low-carbon transition.

This paper examines sector specific drivers of an orderly versus disorderly transition to net zero emissions. In doing so, UNEP FI makes a case that climate transition risk is a significant near-term threat to a wide range of sectors and by extension to the financial industry and financial stability. This paper examines the potential drivers of a disorderly low-carbon transition in multiple sectors and considers the chaotic implications. Beyond identifying these risk factors in the real economy, this paper explores how these factors are (or are not) modelled in the climate scenarios used by financial institutions. These scenarios include both orderly and disorderly transition pathways, which are assessed through comparative analyses and case studies by banks that participated in UNEP FI’s TCFD program.

1.2. Risks of a disorderly transitionThe low-carbon transition, whether disorderly or orderly, will cost less in the long run than no transi-tion at all. The damage caused by unabated emissions and a corresponding acceleration in climate change impacts. Climate science indicates that the transition to a low-carbon economy is a neces-sary one, and technology suggests this is possible (Council for Science and Technology 2020). However, a disorderly transition could have devastating yet avoidable ramifications for the global financial system. To better understand what can be done to avoid a disorderly transition, it is valu-able to consider and quantify the possible consequences of climate disorder across the economy.

A disorderly transition, in which the transition to a low-carbon economy occurs in unexpected and chaotic ways, would present significant economic challenges. Companies would have little time to adapt to market changes by adjusting their portfolios and/or activities in line with the projected transition pathway. This is not to say that starting the low-carbon transition soon would spell disas-ter. The low-carbon transition is already underway. Rather, it is necessary for financial institutions to begin acting as early as possible to build the capacity to keep pace with technology-led change, and to have the management systems in place to respond to and adapt to a policy catch-up scenario. Firms who cannot manage the pace of change will face major losses, as seen in the telecoms sector and more recently in global coal markets. Some organizations could be impacted


by both physical and transition risks, thereby magnifying potential losses. Lack of readiness could trigger market panic and lessen international cooperation as organizations and nations focus more on the risks immediately relevant to them. The resulting failure to collaboratively mitigate climate risk impacts could lead to shocks:

Transition shocks will likely emerge as the global economy moves away from industries reliant on non-renewable resources, such as the coal industry. Financial institutions could incur losses on exposures to such firms with business models not built around the economics of an accel-erated low carbon transition. These firms could see their earnings decline, businesses disrupted, and funding costs increase due to policy action, technological change, and shifts in consumer and investor behaviour. Risks can materialize especially if the shift to a low-carbon economy is abrupt - as a consequence of prior inaction, poorly designed policy frameworks, or uncoordinated globally (Adrian, Morsink, and Schumacher).

Although the public is often focused on the physical impacts of climate change, economic transi-tions carry their own potential to significantly weaken firm-level and market integrity. Influenced by the shift to a low-carbon economy, disruptions in production and operations, changes in resource input prices, and shifting demand for products and services all have the potential to cause chal-lenges for financial actors (CICERO 2017).

Figure 3: Scope of climate risks and financial impacts

The risk of a disorderly transition has increased in recent years, as governments, businesses, and society begin to recognize the damage done by long-term inaction on climate and the limited time remaining to hit scientifically critical climate goals.

In addition, the rise of climate realpolitik could exacerbate market disruptions, with the imple-mentation of border climate tax adjustments (Bloomberg 2020) and divergences in the transition pathways of the world’s largest economies already apparent (Financial Times 2020). The route the world follows to net-zero emissions will have major implications for the level of transition risks faced by financial institutions and the wider economy.


1.3. Climate scenarios for disorderly transitionsFinancial regulators have increasingly recognized climate risk as a financial risk. The Network for Greening the Financial System (NGFS), a global collection of regulators and supervisors, takes the view that the combination of climate-driven physical and transition risks could have significant impacts on global financial systems.

In an expanding acknowledgement of the potential damage of a disorderly transition, micro and macroprudential regulatory bodies are increasingly acting to better understand individual and systemic climate transition risk. A growing number of jurisdictions have announced plans to create or explore climate stress tests in the next two years, alongside mandatory TCFD reporting for financial institutions and other large companies.

In Europe, several central banks and prudential regulators have made major progress with their climate risk stress tests. The Bank of France will define climate stress test parameters this year (Environmental Finance 2020); the Netherlands launched and analysed climate risk stress tests in 2019 (DNB 2020); Norway’s central bank announced a new requirement to integrate climate risk into its assessment of regulation entities’ financial health (Norges Bank 2020); Denmark is continu-ing to develop stress testing tools; and the Rijksbank, the Swedish Central Bank has divested from Alberta provincial bonds on the basis of climate risk (The Guardian 2020). The Bank of England is also proceeding with these enquiries (Financial Times 2020). In the Americas, the US Senate has proposed a ‘Climate Change Financial Risk Act’ that would mandate climate risk disclosures, and the Commodities and Futures Trading Commission, the US derivatives regulator, published an assessment of climate risks and opportunities in that market (CFTC 2020). With the global total notional amount outstanding for global derivative contracts estimated at $640 trillion by the Bank for International Settlements, bringing climate risk calculations into this market could be trans-formative (BIS 2020). The Canadian central bank has announced an intention to develop climate stress tests, and the Bank of Mexico is leading the continent with sophisticated climate risk models and networked financial valuation analysis (Battiston 2019). In Asia, the Monetary Author-ity of Singapore will begin climate stress testing regulated banks and insurers and the Australian Prudential Authority has put climate stress testing on the list of priorities for 2020.

Other regulations coming to the fore involve the way firms assess and manage climate risk. In the UK, the Bank of England’s Prudential Regulation Authority (PRA), who are at the forefront of this movement, have proposed supervisory expectations on climate risk management (Bank of England 2020). These expectations would require regulated financial institutions to consider and report on how certain climate-related scenarios would affect their business. This would include analysis on transition risks, as economies decarbonize to meet the climate targets agreed to in the Paris Agreement, and physical risks linked to increasingly severe climate (e.g. heat waves) and weather-related events (e.g. forest fires).

Prudential regulators, led by NGFS members, are also moving forward by developing an analyti-cal framework for assessing climate-related risks in order to assess the potential impact of these risks on both the economy and financial stability. These actions include reviewing the various outcomes of climate change and the policies required to mitigate, whilst assessing what the finan-cial impacts and the timeframe at which these risks could materialize.

In the US, a growing number of cities and states are adopting new climate laws to align financial market regulation and fiscal spending plans with the Paris Agreement. For example, a 2019 bill in New York, proposed a target of net zero greenhouse gas emissions by 2050 (Environment America 2020).

The simultaneous demand and supply shocks on fossil fuels during the COVID-19 crisis have pushed transition risk concerns into the mainstream by triggering write-downs and consolidation within the world’s largest fossil companies. COVID-19 has shown how energy market trends can rapidly accelerate, and that environmental factors can prove to be remarkably disruptive to estab-lished markets. A significant proportion of delinquent or defaulted assets held by global banks are from these fossil fuel companies as of Q3 2020, as a report from think-tank Carbon Tracker states (Carbon Tracker 2020).

Transition risks were already of increasing concern to regulators and financial institutions, but the acceleration of the energy transition through the pandemic period has been acutely felt in high emissions sectors such as coal, steel, aviation, shipping and upstream oil and gas. Such funda-mental changes will inevitably impact the balance sheet and the lending and underwriting oper-


ations of banks, leading to both risks and opportunities. For example, while mortgage portfolios in coastal areas may be exposed to the physical impact of climate change through rising sea levels and increased incidence and severity of flooding, massive amounts of capital and new financial products will be required to fund the transition and finance climate resilience, creating new demand for bank services (Morgan Stanley 2020). In any structural change to the economic system, there will be winners and losers. This means that banks and other financial institutions must be ready to manage the risks linked to incumbents entering secular decline and the opportu-nity for new players to grow into a changing energy landscape. The best way to ensure that banks will be capable of staying abreast of system-level changes will be to keep the low-carbon transition orderly and begin it as early as possible across key sectors of the economy.

An early transition to net-zero emissions will enable a smoother process, mitigating some of the risks associated with the transition. The key to an early transition is not just more transparent and systemic risk disclosure as described in the TCFD recommendations (FSB)—it also requires an understanding of financial institutions’ portfolio-level exposure to transition impacts. Confidence that risk modelling and scenario analysis is detailed enough to capture these risks:

Scenario analysis of a transition to a low-carbon economy is about more than just disclosure; transition risks are already an evolving reality for the banks and their clients. Just in the past year, climate policy has evolved in ways that could impact bank portfolios… Understanding the impact of potentially more aggressive policies and disruptive technologies on banks’ portfolios is critical from a risk management perspective (UNEP FI; Oliver Wyman 2018).

The NGFS has recognized the importance of climate scenario analysis in enabling financial actors and markets to evaluate and manage climate risks. In June 2020, the NGFS developed climate scenario guidance for regulators as well as a standard set of “reference” scenarios. The NGFS reference scenarios were developed with leading climate modelers (Potsdam Institute for Climate Impact Research (PIK), International Institute for Applied Systems Analysis (IIASA), and the Pacific Northwest National Laboratories and University of Maryland) and will increase comparability of scenario analyses (NGFS 2020). The climate research institutions involved and the integrated assessment models they use to produce the scenarios are:

◾ Potsdam Institute for Climate Impact Research (PIK)- Regional Model of Investment and Devel-opment (REMIND-MAgPIE 1.7-3.0)

◾ International Institute for Applied Systems Analysis (IIASA)- Model of Energy Supply Systems and their General Environmental Impact (MESSAGEix-GLOBIOM_1.0)

◾ Pacific Northwest National Laboratories and University of Maryland (PNNL-UMD)- Global Change Analysis Model (GCAM 5.2)

The NGFS scenarios explore different climate futures including both orderly and disorderly tran-sition scenarios. For each type of scenario, there is a specific storyline that has implications for the low-carbon transition, such as different temperature targets or different deployment of nega-tive emissions technologies. Figure 4 and Figure 5 show the different scenario classifications and storylines within the NGFS reference scenarios.


Figure 4: NGFS scenario classifications

Figure 5: NGFS scenario storylines


These reference scenarios will be applied by financial institutions conducting climate scenario analysis and by regulators designing climate stress tests. The wide application of these reference scenarios reflects the growing importance of climate scenario analysis for evaluating climate risks in the financial sector. As a result, it has become necessary that firms appreciate the assumptions and design of these scenarios. Through the comparison of different transition pathways, this report hopes to assist financial users in acquiring a deeper understanding of these scenarios and their suitable use cases, while also suggesting areas for future scenario enhancement.

1.4. Case study assessment methodologyIn this paper, participating banks in UNEP FI’s TCFD program provided case studies to explore and compare orderly and disorderly transition scenarios. These case studies offer unique perspectives on how these scenarios are applied by financial institutions to conduct risk analysis. They also enable the reader to see some of the challenges with climate scenario analysis and suggest areas for future enhancement of climate scenario models.

In order to produce these case studies, the contributing banks applied the transition risk methodol-ogy developed in Phase I of the TCFD banking program. While extensive details about the method-ology can be found within UNEP FI’s Extending Our Horizons report, the following overview of the methodology is provided to orient the reader (UNEP FI; Oliver Wyman 2018).

During Phase I, UNEP FI and a consortium of 16 banks collaborated with Oliver Wyman, a global management consulting firm, to develop an approach for evaluating corporate lending portfolio exposure to transition risk across various climate scenarios.

The program engaged with leading climate modelers to identify suitable climate scenarios for inclusion in the model. Through an evaluative process, the group selected the integrated assess-ment models (IAMs) produced by the Potsdam Institute for Climate (PIK) and the International Institute for Applied Systems Analysis (IIASA). As noted above these institutions were also selected to provide scenarios for the NGFS exercise.

The methodology incorporated the best available science through partnership with these globally recognised climate modelers. The three-step approach (see Figure 6) integrated climate scenario data and borrower-specific information to produce a portfolio-level view of transition risk. This dynamic methodology allowed for application into different sectors and geographies. By applying the pilot approach to their portfolios, banks were then able to better implement the TCFD recom-mendations to assess and disclose their climate risks.

Figure 6: Transition risk methodology from Phase I of the UNEP FI TCFD Banking Program

Initially, this methodology was implemented in an Excel workbook. However, to support the wide-spread exploration of climate scenarios and the application of the transition risk methodology, a webtool was developed with Oliver Wyman. This webtool, called Transition Check, provided a user-friendly interface for conducting scenario analysis. Participants submitting case studies used either the Excel workbook or Transition Check to generate their results. The primary focus of the case studies in this paper is on the scenarios themselves rather than on the methodology applied.

Decarbonisation and Disruption | The oil & gas sector | 9

2. The oil & gas sector

2.1. Market TrendsThe Oil & Gas sector has been facing headwinds for some time, both on the cost and revenue sides. On the cost side, there has been increasing public and governmental pressure on the sector, combined with growing policy pressure to ban activities including gas flaring (World Bank 2020), coal extraction (PPCA 2020), offshore oil and gas exploration, phase out the internal combustion engine (Electrive 2020), and to implement carbon taxes and more accurate mine closure and reclamation bonding fees (Carbon Tracker 2020). Action on the G20 longstanding commitment to phase out fossil fuel subsidies would further accelerate the shift in economics of energy away from fossil fuels (IEA). On the revenue side, markets have witnessed a collapse in prices arising from an OPEC price war, alongside a demand shift away from fossil fuels and towards renewables as they become more viable. COVID-19 has exposed the sector’s real vulnerabilities demonstrated by Shell’s plans to shed 9,000 jobs (The Guardian 2020), and by the rising proportion of delin-quent bank loans and companies that have declared bankruptcy. The second quarter of 2020 saw 18 bankruptcies for Oil & Gas producers, the highest quarterly total since 2016, with this figure expected to continue to rise (Reuters, 2020).

The cost competitiveness of renewable power generation with fossil-fired power continues to enhance the clean energy investment case for companies and their investors (Clean Technica 2020). For example, the price of Solar PV modules in 2015 is 75-85% lower than it was in 2009, whilst the cost of electricity between 2010-2014 has fallen by half (UN). Declining prices for solar and wind power generation combined with advances in battery technology make renewable energy more attractive for investors and consumers.

In 2000, wind and solar energy together accounted for 32 Terawatt-hours of global energy produc-tion. In 2018, that had grown to 1,854 TWH, a 56-fold increase in 19 years (RHS Financial 2020).

Alongside changing economics in power generation, the Oil & Gas industry is subject to increas-ing pressure from governments, investors, and the public to support the decarbonization of the energy system. As this pressure becomes more prevalent, political and environmental lead-ers have become wary of the future role of Oil & Gas companies in the energy system and their degree of influence over policymakers, with political and financial sector leaders advocating for the systematic wind down of fossil fuels in line with targets set in the Paris Agreement (Respon-sible Investor 2020). Financial markets are beginning to question the sector’s long-term prospects. The energy sector of the US S&P 500 has fallen by 48% since 2015, easily making it the worst performing sector in the index during that period. While lower Oil & Gas prices since 2014 have proved to be the major headwind to sector performance, dividends have continued to be strong, maintaining investor commitment to the sector (IEEFA 2019). The COVID-19 downturn coupled with the technology and policy trends described above have led more investors to contemplate the growing possibility of a ceiling for future hydrocarbon demand (S&P 2020). Absent economically viable emissions mitigation technology, the highest carbon segments of the sector - coal and oil sands - may already be entering secular decline (S&P 2020). Investors are focusing more on global warming, with entities representing $118tn of funds committed to making climate risk disclosures by 2020.

To date, over 100 global banks and insurers have announced their divestment from coal mining and/or coal-fired power plants (IEEFA). Investor coalitions like the Net Zero Asset Owners Alliance are leading a global shift in finance away from fossils to clean energy and Pair Agreement-aligned portfolios. As more banks begin to account for their financed emissions and then commit to end financing for the most carbon intensive activities, from thermal coal mining to tar sands extraction, the energy transition will accelerate. Global fund managers are increasingly marketing “fossil-free” and Paris-aligned index investment products. This could bring more of the US $6 trillion in ETF tracking assets (Nasdaq 2019) in line with low carbon transition pathways and will signal to the larger global pool of around $52 trillion (BCG 2020) in institutional investor capital, that new portfo-lio targets are necessary. Through the COVID-19 period stock indexes without fossil fuel holdings

10 | Decarbonisation and Disruption | The oil & gas sector

have outperformed otherwise identical indexes that include fossil fuel companies. Consequently, the weighted average cost of capital for the sector has risen, dampening valuations, and reducing capital availability, and market liquidity (Mills). The European Commission’s Sustainable Finance Action Plan and the introduction of Paris-aligned and low-carbon benchmarks will further acceler-ate the capital shift away from high carbon fossil fuels (S&P 2020).

Other companies are using their financial stake in portfolio companies to push them to adopt more sustainable business practices, and even COVID-19 has failed to slow down the pace of climate action pledges from the institutional investment community.

The price of crude oil had already been failing to keep pace with inflation over the past three years, but In April 2020, oil prices dipped lower than ever with the value of West Texas Intermediate crude dipping below zero for a few hours and trading as low as -$40 per barrel.

In addition to the sector’s long-term downward valuation and pricing trends, Oil & Gas compa-nies face several other sectoral changes that will further accelerate the transition this decade — increasingly competitive renewable energy options, public commitment to focus investment on clean energy in G20 markets, rising public pressure on fossil fuel companies to stop blocking action towards climate targets, growing policy pressure to phase out fossil fuel subsidies, bans on certain activities, the potential implementation of carbon taxes, and an increasing movement by financial institutions to align their investments and lending with net zero targets (UNEP FI).

2.2. The potential impacts of a disruptive transitionA rising number of institutions are committing to carbon neutrality as part of international programs such as UNEP-FI’s Net Zero Asset Owners’ Alliance. Whether or not one is ready to commit to the transition to net zero emissions, the question of whether the transition will be orderly or disorderly is important.

The COVID-19 pandemic is demonstrating how fast the pace of disruption can be. Disorder has already happened, and it resulted in market, financial and consumer chaos—only in miniature. What may be awaiting us in the next few decades could be much more severe.

Figure 7: Change in global fossil fuel emissions during the COVID-19 pandemic, %


As shown in Figure 7 above, the COVID-19 pandemic has demonstrated how fast the pace of disruption can be, with global emissions dropping by almost 20% at the peak of the lockdown. However, even a slower low-carbon transition could be catastrophic for the long-term performance of some sectors, highlighting the need for careful advanced planning and a clear wind down strat-egy for the most distressed segments of the fossil fuel sector. The Carbon Tracker Initiative, a think tank, notes that a 2% decline in the demand for fossil fuels every year could cause the Oil & Gas company revenues to collapse from an estimated $39tn to just $14tn (Carbon Tracker 2020). The market value of a quarter of the world’s equity markets is made up of fossil fuel companies who owe trillions of dollars to the world’s banks, making it easy to see how an even more rapid and disorderly transition to a low carbon economy could have a seismic effect on the global economy.

There are risks of stranded assets in certain fossil fuel sub-sectors, as the UNEP FI heatmapping exercise in UNEP FI’s Beyond the Horizon report has shown (UNEP FI 2020). The threat of stranded assets is likely highest in capital intensive mid-stream and downstream fossil fuel sub-sectors. The IEA explains that the natural depletion rate of upstream fields may limit the potential for overinvest-ment for some upstream producers (IEA 2020).

However, with the phase out of gasoline-powered vehicles in jurisdictions from California to the UK (BBC 2020) planned for 2035, oil demand will be curtailed in the transportation sector. Several major economies which rely heavily on fossil fuel production and exports will face challenges as energy efficiency and climate policies reduce demand and raise emissions costs. The COVID-19 pandemic has accelerated these changes, and Shell’s recent restructuring plan, and BP’s multi-bil-lion dollar write-downs (Wall Street Journal 2020) show that even supermajors are exposed to the large market shifts currently underway (Business Insider 2020). At the global scale, stranded fossil fuel assets could amount to a discounted global wealth loss of between $1 trillion and $4 trillion, with clear distributional impacts. Net fossil fuel importers such as China and EU would reap some benefits from this process, whilst those countries with large fossil fuel industries, such as Russia, the United States, Australia, Saudi Arabia, and Canada, potentially seeing their domestic industries nearly shut down (Mercure et al 2018). While it is likely that fossil fuels would eventually be phased out of the energy system in any kind of transition scenario, a more orderly process would enable entities with large stakes in fossil fuels to explore alternatives to compensate for their losses from asset stranding, or to divest early and re-invest the proceeds into cleantech and renewable energy solutions.

Beyond company and sector-level risk there is concern for the stability of some of the biggest oil producing states. If there is no longer a market for their resources these rentier states could see patronage systems reliant on fossil fuel revenues collapse with serious political consequences. During the COVID-19 pandemic, many of these states are facing acute economic strains. In April, the IMF said that real GDP in oil-producing countries in the Middle East and North Africa would plunge by 4.2% in 2020. Many are no strangers to war, corruption or economic challenges, and they will need to chart a course to recovery after the dramatic collapse of oil prices at the start of the global pandemic, inflamed by the Saudi-Russian price war, in an oversupplied oil market. Even strong countries like the US and Canada expect the path to recovery to be painful.

2.3. Ensuring an orderly transitionDuring the COVID-19 pandemic, individual countries took protectionist actions which resulted in their economies grinding to a halt, disrupted trade and devastated demand. An orderly approach, coordinated globally would have allowed industries, companies and consumers to be more prepared, lessening fear and confusion which would have reduced the ripple effects that will be felt for years.

Energy sector investors and policymakers can learn lessons from the COVID-19 process to ensure that the transition to a low-carbon economy is as smooth as possible. For example, subsidies for fossil fuels can be wound up in a transparent and orderly manner, starting with the G20. Global governments can show meaningful support for the build out of distributed energy systems. Policy coordination across markets will reduce investment costs and will help to maintain open markets that enable economies of scale in the financing and implementation of new energy systems.


2.4. Climate scenario analysis of the disorderly transition

Given the large contribution of the Oil & Gas sector to global energy systems and emissions, inte-grated-assessment models used to produce the NGFS reference scenarios provide a high degree of coverage. There are a number of key variables that can assist financial users in understanding the effects of a low carbon transition. A few of them are explored below at the global level to high-light the differences between orderly and disorderly transitions for this sector.

◾ Carbon price- used to represent a variety of policy decisions that shift economic decision-mak-ing and drive a low-carbon transition (relevant to economic decisions in all sectors)

◾ Primary energy- consumption of energy contained in raw fuels or as an unprocessed input

Figure 7 and Figure 8 below show carbon prices for the REMIND and MESSAGE baseline scenarios (Current policies) as well as for several 2°C scenarios. As noted previously, the carbon price is the key lever that climate scenario models use to effect a low-carbon transition. The prices represent a variety of policy actions whose impacts are converted into carbon prices. It is notable that in a world without concerted climate action (Current policies), the carbon price remains very low, and it is only through other market mechanisms such as technological advancements and consumer preferences that emitting industries are replaced. By comparison, in order to drive a transition in line with a 2°C world, carbon prices need to rise rapidly. In the scenarios below, two factors affect the carbon price required. The first is when concerted climate action begins and the second is how much carbon dioxide removal (CDR) the scenario assumes will take place. Timing is particularly important given the limited carbon budget. In the delayed action scenarios, which reflect disorderly transitions, the carbon price needs to rise far higher and faster. In addition, assuming limited CDR (as shown in the dark blue line below) demands an even higher carbon price to curtail emitting activities. These high carbon prices will reflect greater cost pressures on companies throughout the economy as well as consumers of their goods (via pass-through costs). Such a “price shock” has the potential to adversely affect many businesses and the economy overall.

Figure 8: Carbon Prices under REMIND 2°C scenarios (USD)


Figure 9: Carbon Prices under REMIND 1.5°C scenarios (USD)

Given the emissions from oil (most notably in transportation), nearly all ambitious climate scenar-ios require a steep reduction in total oil consumption. Figure 9 below examines some of the 1.5°C scenarios produced for the NGFS. For both the REMIND and MESSAGE models, the green lines represent disorderly transitions, while the blue lines represent orderly transitions. While all scenar-ios show significant declines in oil consumption, the drop is noticeably steeper in the disorderly scenarios. A sharper and deeper cut to oil consumption will create major challenges for oil produc-ers, but also may create price volatility and supply problems throughout the economy if down-stream industries are not prepared for these shifts.

Figure 10: Oil Primary Energy- Immediate 1.5°C scenarios (EJ)

In Figure 10, the green lines represent disorderly transitions, while the blue lines represent orderly transitions. The MESSAGE scenarios see gas as a bridge fuel, with its consumption growing in some regions as it replaces more greenhouse gas intensive coal. However, even when considering its potential as a bridge fuel, under a transition with limited CDR, gas consumption is curtailed. For REMIND, the effect is even more stark, as a gentle decline in gas under the orderly (CDR) scenario becomes a steep fall in the disorderly (low-CDR) scenario.


Figure 11: Gas Primary Energy- Immediate 1.5°C scenarios (EJ)

Figure 11 below shows combined primary energy consumption for the REMIND baseline scenario (Current policies) as well as for several 2°C scenarios. Under the baseline scenario where climate action does not take place, total consumption rises, largely driven by growth in developing regions. In the 2°C scenarios below, two factors influence the speed and degree of consumption decline required. The first is when concerted climate action begins and the second is how much CDR the scenario assumes. The most orderly scenario is one where climate action begins immediately and significant future CDR use is assumed (light green). By contrast, the most disorderly scenario involves delaying climate action until 2030 and then assuming only limited CDR capabilities (dark blue). Until 2030, the disorderly scenarios see a rise in consumption, which necessitates an even steeper drop in consumption when climate action begins. In the delayed and disorderly scenarios, the rapid curtailment of consumption will pose existential challenges not only to upstream produc-ers, but also to midstream and downstream firms.

Figure 12: Oil & Gas Primary Energy- REMIND 2°C scenarios (EJ)

Decarbonisation and Disruption | Utilities and power generation sector | 15

3. Utilities and power generation sector

3.1. Market trendsThe power generation sector is becoming ever more competitive as renewable energy investment and the buildout of generation capacity grows. The COVID-19 pandemic has also accelerated transformation of this sector to the extent that even the world’s largest commodities traders are now hedging climate risk with investments in clean energy (Financial Times 2020). With a fall in energy demand from lockdowns, renewable sources, particularly wind and solar, saw their share in electricity substantially increase at record levels in many countries as companies turned off fossil-fired power plants. In less than 10 weeks, the USA increased its renewable energy consumption by nearly 40% and India by 45%. Italy, Germany, and Spain all set new records for variable renew-able energy integration to the grid (IEA 2020). Renewable energy already represented almost 75% of all newly installed power generating capacity, and this trend is accelerating (IRENA 2020). The pandemic period has shown fossil fuel companies and their investors what a massive disruption in demand and the transition to clean energy systems could mean for investor returns in the sector.

Biomass, hydropower, geothermal and offshore and onshore wind can now all provide electricity competitively with fossil fuel burning power systems (Lazard 2019). The most competitive utili-ty-scale solar PV projects are now able to generate electricity for just US $0.08 per kilowatt-hour (kWh) without financial support, compared to a range of US $0.045 to US $0.14/kWh for fossil fuel power (UN). As transition pressures, including the withdrawal in subsidies and shifting consumer sentiment negatively impact fossil fuel power generation, clean energy prices will continue to fall. Through the 2020s, the business case for fossil fuel burning in power generation will continue to diminish as the deployment of renewable energy scales up across markets.

Relative cost is not the only factor to consider in assessing the pace of energy transition in power utilities. Per capita demand for energy is also changing, driven largely by technology advances. More efficient appliances, computers, and lighting systems linked to energy efficiency policy initia-tives are changing consumer demand profiles, with per capita demand growth largely flat despite rising populations (Carbon Tracker; HuffPost 2020). The implications of flattening overall energy demand are problematic for fossil fuel power utilities companies, as their increasingly costly carbon-emissions will not be reliably offset by revenue increases (Bloomberg 2016; WEF 2020).

Hydrogen is another promising low-emissions fuel that is being developed to replace solid fossil fuel in transport, particularly for aviation and shipping. Since almost all hydrogen is currently produced from fossil fuels, there will need to be significant infrastructure changes to support the expansion in production of “green hydrogen” - water electrolysis hydrogen production powered by wind and solar energy (EDF 2019). France has started a ‘Hydrogen Territories’ program, an initia-tive which should contribute significantly to H2 power development (BIG HIT 2020). Utilities and gas players are also starting to explore hydrogen as they are keen for natural gas to provide the energy input for hydrogen creation. French power utility EDF has launched Hynamics, a subsidiary to produce and market low-carbon hydrogen for energy, industrial, and mobility applications.

Much of the initial hydrogen production may come from natural gas with CCS (blue hydrogen), making it a low-carbon energy source (SINTEF 2019). However, the longer-term goal for hydrogen production is “green hydrogen” produced using renewable energy sources. Both types of hydrogen will help to shift demand away from fossil fuels in the transport sector (IRENA 2020). In the United States, while the Trump administration has not signalled an intention to support cleaner energy, the Biden platform promises $2 trillion in clean energy spending in a first term, while targeting a carbon-free power sector by 2035 (Biden campaign 2020). These measures will, however, require congressional legislative approval, but indicate the direction of travel in one of the world’s largest energy systems.

16 | Decarbonisation and Disruption | Utilities and power generation sector

The global power generation sector has considerable incentives to push renewable and low-car-bon technology forward. Rising consumer demand for greener energy, much like in the Oil & Gas sector, has expanded the market for such technologies and services and is changing the overall energy demand structure to reflect a system of more distributed generation assets coupled with battery storage. Consumer enthusiasm for green energy is driven in part by some of the less quan-tifiable benefits of green energy use. Technological advancements are enabling consumers to directly develop micro grids and community power systems. At the same time, renewable energy is becoming more accessible to urban consumers with digital power aggregators offering inex-pensive renewable energy to consumers across their local utility’s grid by connecting individual renewable sources like residential solar panels, putting increased cost pressures on incumbents to respond in a number of markets (IRENA 2019).

The shift toward cost-competitive renewable energy means shrinking demand for more emis-sions-intensive energy sources, even in formerly reliable markets. For example, coal, which has faced structural decline in the developed world, is also showing signs of decline in developing countries. In 2019, coal consumption declined by 0.6% and its share in primary energy generation fell to its lowest level (27%) in 16 years (BP 2019). In the US, coal has declined from serving 45% of US power demand in 2010 to just 23% in 2019. Coal has been declining in developed economies by a mixture of environmental policies and competitive pressure from increasingly affordable renew-ables (IEA).

Further contributing to the decline in fossil fuel power are emerging policies restricting all kinds of greenhouse gas emissions —not just carbon. Each year there are more regulations governing emissions-heavy transportation and programs to reduce pollution from transportation and logis-tics networks. A notable example is the introduction of Low Emission Zones (LEZ) in Europe, which set EU national emissions ceilings and 2030 targets for several pollutants (SO2, NH3, NMVOC, NOx, PMx). So far, 220 cities operate LEZs in 14 countries around Europe. The accelerated phase out of internal combustion engine vehicles at the national level, coupled with a transition to traf-fic-free city centres around the world (Bloomberg 2020) will further dent fossil fuel demand in the transport sector. While these policies are aimed at reducing the transportation sector’s emissions footprint, they have consequences for all high-emission sectors.

Figure 13: Renewable and non-renewable electricity generation CO2 footprints


Another significant area of concern for fossil fuel power generation remains carbon pricing. Carbon pricing schemes are gaining significant traction among policymakers, signalling a key development in the low carbon transition. Forty-six national and 28 subnational jurisdictions are now implement-ing carbon pricing initiatives, which generated $44 billion of revenues in 2018 (World Bank). How firms respond to the emergence of these pricing schemes will make or break their resilience strate-gies in the coming decades.

In addition to carbon pricing and emissions caps on fossil fuel power generation, the gradual shift in subsidies away from fossil fuels to clean energy is accelerating. IRENA estimates that total global subsidies for renewable and low carbon energies, including biofuels and nuclear power, reached approximately US$187 billion in 2017 alone (IRENA 2020). While this figure still does not equal the subsidies given to fossil fuel energy at approximately US$447 billion in 2017 (IRENA 2020) subsidies for renewable energy projects may still be a promising opportunity for developers and investors in jurisdictions including the EU, US, Japan, and India, all of which have been signifi-cant contributors of global renewable and low-carbon energy subsidies.

While disagreement over the pace of change remains, there is consensus that widespread deploy-ment of renewable energy systems and low-carbon electrification of currently fossil-fuelled activ-ities will accelerate this decade (IRENA 2020). The so-called ‘electrification of everything’ (Gerdes 2018; NREL 2018) will occur as energy becomes the prevalent power source over other forms of energy, powering more aspects of consumer, commercial and industrial life. Expanding electrifi-cation is most evident in the growing sales of electric vehicles—sales that in 2019 topped 2.1 vehi-cles million globally and accounting for 2.6% of global car sales. While the numbers of electric cars entering the market are small, a 40% year-on-year increase indicates that their share of the total will increase quickly (IEA). There is emerging evidence that the COVID-19 economic slowdown has even further hastened the rise of electric vehicles, which represented the only growth category in the European auto market during the slowdown (Forbes 2020). Similar to other technology adop-tion processes, the transition to electrification is likely to happen quickly.

Figure 14: Technology adoption rates for various technologies in the U.S.


As shown in Figure 14 above, it took over 65 years for landline phones to grow from about 10% of U.S. households to 90% of them. For mobile phones, a similar level of growth required only 20 years. Changes in technologies and adoption happen far faster today than in the past, with major implications for the speed of future transitions. However, owing to the complexity of the energy transitions, significant investments are essential to a smooth transition.

Investors are responding to the opportunities that renewable energy and electrification have to offer. In 2018, clean energy investments, including spending on the extension and moderniza-tion of electricity networks, as well as energy efficiency measures, amounted to approximately $300 billion (BloombergNEF 2018). What remains to be seen is whether the market will engage in a corresponding decline in fossil fuel investment, especially considering the instability of fossil fuel markets exposed by the COVID-induced economic recession. Worldwide shelter-in-place mandates led to a significant short-term reduction in carbon emissions and pollution driven by reduced consumption of fossil fuels—a change which further demonstrated the potential ramifica-tions of a rapid large-scale market abandonment (Reuters 2020; The Guardian 2020).

3.2. The potential impacts of a disruptive transition Risks to the utilities and power generation sector as a result of a disruptive transition are similar to those facing the Oil & Gas sector. Market volatility as a result of a disorderly transition could result in decreased equity values and negative impacts on bond investors and lenders. Costs incurred by carbon pricing and rapid implementation of necessary changes to infrastructure, like power storage and distribution networks, would place a high financial burden on states with major-ity publicly owned electric utilities. The United States has primarily public power utilities, heavily reliant on natural gas for power generation. Natural gas fired power accounts for around 40% of total US electricity production, and retired coal power generation is being replaced by natural gas (EIA 2020). A hasty departure from fossil fuel power generation could mean the destabilization of power resources within such states as a result of the massive short-term costs and technological challenges of modernizing the power grid.

A further cost consideration in a disruptive energy transition in power generation is stranded assets. As global power generation shifts away from fossil fuel burning, thermal coal-exporting states could see sizable losses in asset values and lose a significant component of their national wealth (Sydney Morning Herald 2020). Similarly, states that are reliant on coal-fired power gener-ation, particularly in the Asia Pacific region and Africa, would see power generation infrastructure become obsolete, incurring decommissioning costs as well as necessitating the deployment of renewable and low-carbon replacements. While obsolescence and stranded assets can be expected to happen in any kind of transition, whether disorderly or orderly, an orderly transition would give governments, investors, and companies an opportunity to seek out alternative invest-ments and begin updating their power generation infrastructure.

A poorly planned disruptive transition would significantly destabilize global power resources if renewable and low-carbon power grids are not ready for widespread deployment. This failing would be compounded by a lack of sufficient power storage capacity, from either conventional or fuel cell batteries (Wood Mackenzie 2020). Since power storage is necessary in renewable utility systems, investment in the buildout of battery systems and microgrids will be significant. If there is not an early and planned effort to bring these technologies to the appropriate technological maturity, then energy systems could be seriously threatened.

In order to develop the appropriate technologies to support an energy transition of any kind, supply chains of metals like lithium and cobalt will need to be strengthened, and states are acting to secure access to these materials. In a disruptive transition, we may see a scramble for these vital and limited resources linked to the energy transition. This could lead to problems of inequitable access, with less wealthy or powerful states left dependent on others for their energy needs.

Regulation of power utilities in the United States is largely conducted at the state level, with many large markets like California committed to cleaner energy sources (California Public Utilities Commission 2017). State level action to respond to climate risk in California is going to increase in response to the most recent wildfires (Energy Now 2019). In the United States and beyond, the world’s largest power utilities are planning for an accelerated energy transition (Reuters 2020). Increased incidence of extreme weather could increase the likelihood of a disorderly transition as regulators could be compelled to respond faster in mandating an energy transition and making power utilities cover the cost of climate adaptation (EESI 2020).


3.3. Ensuring an orderly transitionAs in all sectors, early preparation and planning by investors, companies, and market regulators will enable the smoothest transition. In the power utilities sector, grid modernization to enable the efficient incorporation of clean energy will be key (HYSERDA 2020). China is expected to lead the global transition to net zero power systems through the scale of its net zero 2060 commitment and associated infrastructure spending plans (Bloomberg 2020).

Regulators could consider time-of-use-tariffs, aimed at encouraging customers to shift power consumption to off-peak times to balance demand, as a way to stimulate the energy transition (Smart Energy 2019).


As energy plays a central role in the global economy and is responsible for a large share of global emissions, the integrated-assessment models used to produce the NGFS reference scenarios model energy system dynamics in significant detail. There are many key variables that can assist financial users in understanding the effects of a low carbon transition on energy systems. A few of them are explored below at the global level to highlight the differences between orderly and disor-derly transitions for this sector.

◾ Primary energy- consumption of energy contained in raw fuels or as an unprocessed input ◾ Primary energy mix- consumption of different primary energy sources

Figure 12 and Figure 13 below show an orderly and disorderly 2°C scenario respectively from the REMIND model. Major types of primary energy consumption captured in each scenario include biomass, non-biomass renewables, nuclear, oil, natural gas, and coal. These six sources comprise virtually all energy consumption. A few notable conclusions can be drawn from the comparison of the orderly and disorderly scenarios. In both, fossil fuel use declines significantly and non-biomass renewables (wind, solar, geothermal) rise as the century progresses. This is due to continuing tech-nological innovation that reduces the production and distribution costs of renewables coupled with increasing carbon prices that make fossil fuels ever less economical. However, given that the disor-derly scenario does not take concerted climate action until after 2030, the ramp-up of renewables and the phase-out of fossil fuels must take place far faster than in the orderly scenario. This rapid changeover will pose significant infrastructural challenges for energy producers and society overall.

Figure 15: Primary Energy Mix- Immediate REMIND 2°C scenario with CDR (EJ)

Figure 16: Primary Energy Mix- Delayed REMIND 2°C scenario low CDR (EJ)


Figure 14 below shows the primary energy mix in 2050 in three 2°C scenarios from the REMIND model compared to the current energy mix in 2020. The three scenarios include an orderly tran-sition scenario where climate action begins immediately and significant CDR use is assumed, a disorderly transition scenario where climate action begins after 2030 but significant CDR use is assumed, and a disorderly transition scenario with delayed climate action and limited CDR. This final scenario is the most disruptive as it demands the lowest total energy consumption in 2050 and the largest contraction in fossil fuels. Attaining the 2°C temperature goal in this scenario requires major investments in energy efficiency and renewables deployment.

Figure 17: Primary Energy Mix- REMIND 2°C scenarios in 2020 and 2050 (EJ)

Figure 15 and Figure 16 below show overall primary energy consumption for the REMIND and MESSAGE baseline scenarios (Current policies) as well as for several 2°C scenarios. Although the models have different projections for energy demand due to differing assumptions around tech-nologies, energy efficiency gains, and economic growth, there are some common conclusions that can be drawn. In both models, the Current policies scenario (black line) represents the high level of energy use. This is largely due to the fact that less efficient existing energy sources persist in this scenario and lower investments are made in energy efficiency and electrification. All of the 2°C pathways demand large investments in energy efficiency and shifts to zero-emissions energy


sources. The dashed lines represent disorderly scenarios where climate action is delayed until 2030. As compared to their corresponding orderly scenarios, these disorderly scenarios show a more pronounced drop in overall energy use. This drop in overall energy consumption may create headwinds to economic growth and will likely pose especially large challenges to developing econ-omies.

Figure 18: Overall Primary Energy- REMIND 2°C scenarios (EJ)

Figure 19: Overall Primary Energy- MESSAGE 2°C scenarios (EJ)

22 | Decarbonisation and Disruption | Metals and mining (industrials) sector

4. Metals and mining (industrials) sector

4.1. Market TrendsThe global Metals & Mining (Industrials) sector is used to managing a range of risks, including geopolitics, technological changes, changing consumer and industrial demand profiles, and increasing investor expectations on the need to respect environmental and social standards in their operations (CNN 2020). The energy transition to net zero emissions will mean a new set of risks and opportunities for the sector based on the rate of change in different jurisdictions. Mining operations are based on access to vast, local mineral reserves extracted and refined over decades, which means that companies in this sector must work to align and adapt their practices and proce-dures with jurisdiction specific emissions reductions targets and associated tightening of environ-mental regulations, including on bonding for mine closure and reclamation.

4.1.1. CoalDeclining demand for coal in power generation (Reuters 2020) means that coal demand in most markets is falling. In Europe, stagnant electricity demand, a rapid capacity build-out of new solar and wind power by several EU member states, and regional wide policies including the emis-sions trading scheme, and air quality directives to curb industrial pollution have all had an impact. National-level coal phase-out plans means that coal-fired power in Europe will continue to be wound down this decade. By 2030, coal will be mostly phased out of the region’s power supply system altogether. Investors and lenders to the sector are responding accordingly to withdraw or limit their exposure to both cola mining and coal-fired power generation (Reuters 2020).

4.1.2. Other metals and miningBeyond coal, there is increasing awareness of the needs to consider ESG procedures in all sectors of the mining industry as investors, funds and increasingly governments, are requiring demonstra-ble action on sustainability criteria ahead of securing finance.

Low carbon energy systems are more metal intensive than traditional systems which could have supply chain implications as demand could outstrip supply (Carbon Brief 2018). In particular, the global battery metals market is driven by strong global demand for electric vehicles, causing signif-icant volatility in prices for battery metals such as cobalt, lithium and nickel. Cobalt, which cannot yet be created synthetically and has no substitute in batteries, is likely to be in short supply from 2022. Exploration spending on battery metals such as cobalt and lithium has more than doubled in the past two years, and the push to electrify everything and build out power grids globally has further implications for copper demand, alongside other metals (Mining.com 2018). The World Bank Group estimates that production of minerals such as graphite, lithium and cobalt, could increase by nearly 500% by 2050, to meet the growing demand for clean energy technologies. This means that over 3 billion tons of new or recycled and reclaimed minerals and metals will be needed to deploy wind, solar and geothermal power, and energy storage at the scale required to meet the 1.5°C warming target set in the Paris Agreement (World Bank 2020). Mining majors are already considering these shifts in their capital planning.

The Metals & Mining sector will be part of the decarbonization solution as it will provide the raw materials needed for the build out of low-carbon technologies including wind turbines, solar photo-voltaics, electric vehicles, energy storage, power grids, metal recycling, hydrogen fuel cells and carbon capture and storage. Growth in these low-carbon technologies is already altering demand patterns for upstream mining commodities (McKinsey 2020). It is incumbent on the players in this industry to capitalize on these growth areas.

http://Mining.com

Decarbonisation and Disruption | Metals and mining (industrials) sector | 23

4.2. The potential impacts of a disruptive transitionA disruptive low carbon transition will pose several challenges to the Metals & Mining sector. There is a high risk of stranded assets in certain product segments, including coal, which occurs in this sector as it costs significant amounts to get rights to mine and once approved, the infrastructure to extract the minerals and get them to market is often costly and complex.

In order to reach true zero-emissions in its operations, the sector may have to embrace structural change. The shift to a net zero carbon Metals & Mining sector that is ready to meet the needs of a global energy transition would be as significant as analogous changes in the global Oil & Gas and Utilities & Power Generation sectors. Investors across asset classes and markets would be affected, as would banks who are lending and providing underwriting services to the sector, with impacts on prices, sector market values and the bond markets.

4.3. Ensuring an orderly transitionFor an orderly transition to occur, this sector must look at both the part it can play to support the decarbonization solution through its product output, but also how it can transition the energy used in mining operations to achieve targeted emissions reductions (Wood McKenzie 2020).

The Metals & Mining sector will be part of the decarbonization solution by providing the raw mate-rials needed for new technologies such as wind turbines, solar photovoltaics, electric vehicles, energy storage, metal recycling, hydrogen fuel cells, and carbon capture and storage. Their growth will alter demand patterns for upstream mining companies. (McKinsey 2020; IEA)

The sector requires massive energy use in the manufacturing of its product. If emissions were reduced with corresponding changes in the utilities market and if processes were powered with mostly renewable energy the sector would make a major contribution to progress against net zero targets. Combined with efficiency improvements in processes, for example by using hydrogen fuel in mining machinery (S&P 2020) and in the smelting process, it would result in steel, iron, and aluminium being more sustainably produced.


Although the Metals & Mining (inclusive of Industrials) sector contributes significantly to global emissions and are major users of energy, there is limited granularity available for assessing specific mining or manufacturing activities in the climate scenario models. However, there are some exceptions depending on the model for various types of metal and industrial production. Overall industrial activity is captured in terms of its emissions and its energy use. In addition, coal is modeled with some detail. Although the set of key variables to select for analysis is more limited for this sector, important insights can be gained. A few key variables are explored below at the global level to highlight the differences between orderly and disorderly transitions for this sector.

◾ Final energy- consumption of energy for end-uses including in the production of feedstocks ◾ Final electricity- consumption of electricity for end-uses including in the production of feed-

stocks ◾ CO2 Emissions- carbon dioxide emissions produced from activities

Figure 17 below shows combined final energy demand in the Industrials sector for the REMIND baseline scenario (Current policies) as well as for several 2°C scenarios. Unsurprisingly, energy demand is highest in the Current policies scenario, as that scenario reflects limited investment in energy efficiency and continued use of fossil fuels for manufacturing end-products. The dashed lines represent disorderly scenarios where climate action is delayed until 2030. As compared to their corresponding orderly scenarios (unbroken lines), these disorderly scenarios show a more pronounced drop in final energy demand, which will squeeze industrial firms who have not transi-tioned to low-emissions manufacturing processes.

24 | Decarbonisation and Disruption | Metals and mining (industrials) sector

Figure 20: Final Energy for the Industrials Sector- REMIND 2°C scenarios (EJ)

Figure 18 shows final electricity demand for the Industrials sector. One of the main ways that manufacturers and industries may decarbonize is through electrification. Compared to the Current policies scenario (black line) all of the REMIND 2°C scenarios require a significant growth in elec-tricity consumption. The dashed lines show the disorderly transition pathways as opposed to the unbroken lines of the same colour that signify orderly transition pathways. The disorderly transi-tions demand significantly higher electricity use due to the need to reduce emissions faster and more steeply than in the orderly scenarios. This is explored further in Figure 19 and Figure 20. High electricity demand could cause economic disruptions if it results in price volatility and potential stress on transitioning energy grids.

Figure 21: Final Electricity for the Industrials Sector- REMIND 2°C scenarios (EJ)

Figure 19 and Figure 20 below show emissions pathways of the Industrials sector for the REMIND and MESSAGE baseline scenarios (Current policies) as well as for several 2°C scenarios. Mining, manufacturing, and industrial activities are both major users of energy and producers of emis-sions. In the baseline scenarios (black lines) without climate action, emissions from these activi-ties stay constant or even rise. To achieve a 2°C goal, the emissions footprint of these activities must be reduced substantially, as shown in all the 2°C scenarios. However, under delayed, disor-

Decarbonisation and Disruption | Metals and mining (industrials) sector | 25

derly transition scenarios, the necessary emissions reduction is larger (as emissions in these scenarios continue to rise until 2030). Whether these emissions reductions are achieved by policy actions or market forces, industrial producers will need to rapidly rethink their production methods and business models.

Figure 22: Emissions for the Industrials Sector- REMIND scenarios (Indexed: 2020 = 1)

Figure 23: Emissions for the Industrials Sector- MESSAGE scenarios (Indexed: 2020 = 1)

26 | Decarbonisation and Disruption | Agriculture sector

5. Agriculture sector

5.1. Market TrendsAgriculture and the food system are critical to human life and the successful transition to net zero emissions. Agriculture accounts for around 10% of global greenhouse gas emissions (IPCC 2018) Much of the sector’s emissions profile comes from livestock raising, agricultural soil depletion (Rodale Institute 2020), and rice production. The agricultural sector accounts for 70% of global water use (World Bank 2017) and the agrochemical industry and its fossil fuel inputs are an addi-tional stream of emissions.

Agricultural related employment is also the most common occupation in the world, and it is critical to economic growth in many countries. However, the number of people working in agriculture is declining, down from 44% in 1991, to 26% in 2020 across the global market (ILOSTAT 2020) due to technology advances and increasing yields. The shift to regenerative agriculture and a renewed focus on the importance of agricultural land as part of a global carbon sequestration and biodiver-sity strategy could reverse this trend, creating important new employment opportunities.

Increased agricultural demand linked with rapid urbanisation and global population growth have spurred higher production of phosphate and potash, two key inputs for the manufacture of synthetic fertilizer. There is already discussion of ‘peak phosphate’ leading to world-wide short-ages after 2030 (World Agriculture 2013; Greenpeace 2012). Shortages in the inputs for synthetic fertilizers, the emissions profile of manufacturing these products, and the dangerous impacts on biodiversity (Grist 2010; IPCC 2018; McKinsey 2020) and human health suggest that the shift to regenerative agriculture could accelerate this decade.

Consumer demand for more sustainable food sources is also changing the market landscape. A survey by Tastewise, a food intelligence start-up powered by artificial intelligence, found that compared to a year ago, 23% more consumers in the United States are prioritizing sustainable food choices, whilst a survey conducted by Global Data, showed that 6% of US consumers claimed to be vegan in 2017, up from 1% in 2014 (Global Data 2017)..

The COVID-19 pandemic had significant impacts across agriculture, with disruption to the food supply chain and reduced food production. The impact on livestock due to reduced access to animal feed and slaughterhouses’ diminished output, resulted in domino effects through the agri-culture value chain, highlighting structural problems in the global food system (FAO). It was yet another demonstration of what a disruptive transition to a low-carbon economy could do to our agriculture systems, if not adequately prepared for.

5.2. The potential impacts of a disruptive transitionA disruptive transition could result in food supply challenges, ultimately leading to price spikes and at worst, catastrophic food shortages.

Rapid land use regulation changes (for example to produce biofuels) could reduce food supply if there is not enough time to correspondingly plan how to increase yields from less land.

Catastrophic sudden loss of revenue for smaller-scale farmers if the market for more methane-in-tensive products like beef is very quickly regulated, disproportionately harms developing countries where more of the population is involved in agriculture. (Cassidy, Snyder)

Decarbonisation and Disruption | Agriculture sector | 27

5.3. Ensuring an orderly transitionPhysical risks as a result of climate change pose huge threats to the agricultural sector. Damage from climate change may limit access to food, negatively impact food quality, disrupt global and local supply chains, reduce availability of certain crops and foods and trigger price spikes (IPCC 2019). All of these potential risks mean that investors and incumbent companies need to carefully consider the need for an orderly transition in this sector.

Investment in alternative proteins, regenerative agriculture and new land use methods to improve yields and wind down the use of synthetic agrochemicals, and fiscal policy measures to support more vulnerable communities and fragile food systems should all be considered as options to enable a smooth transition to a low-carbon economy. Changes to local and global food systems and supply chains will always be contentious.


The Agriculture sector contributes significantly to global emissions, and land use changes are typi-cally a component of climate scenario models. For emissions pathways, agriculture, forestry, and other land use (AFOLU) may be modeled together. However, market dynamics within the Agricul-ture sector are typically more stylized. As a result, there are fewer key variables for consideration for climate scenario analysis. A selected set of them are explored below at the global level to high-light the differences between orderly and disorderly transitions for this sector.

◾ CO2 Emissions- carbon dioxide emissions produced from activities ◾ Food Demand- total calories demanded from different food sources

Figure 21 and Figure 22 below reflect emissions for agriculture, forestry, and other land use (AFOLU) activities for the REMIND and MESSAGE baseline scenarios (Current policies) and for several 2°C scenarios. Such activities represent a meaningful share of global emissions and in some regions constitute the bulk of that region’s contribution to global warming (e.g. the Brazil-ian Amazon). In both models, 2°C transition pathways demand that AFOLU activities move from emissions sources to emissions sinks (shown by negative values on the graphs). The move to net-negative emissions for this sector will depend on major land use changes such as reforesta-tion and different agricultural practices. The dashed green lines represent disorderly scenarios where climate action is delayed until 2030. Although the effect is less pronounced in the MESSAGE scenarios, in REMIND, the reduction in emissions after 2030 is significantly steeper than in the orderly scenarios. The rapid changes in land use and agricultural practices will present challenges to existing agricultural firms that will likely be exacerbated in some areas by increasing physical hazards such as floods, heatwaves, and droughts.

Figure 24: Emissions for Agriculture, Forestry and Other Land Use (AFOLU)- 2°C REMIND scenarios (GT CO2eq)

28 | Decarbonisation and Disruption | Agriculture sector

Figure 25: Emissions for Agriculture, Forestry and Other Land Use (AFOLU)- 2°C MESSAGE scenarios (GT CO2eq)

Figure 23 below explores MESSAGE scenarios showing different levels of livestock demand. With-out climate policy (black line), livestock demand is likely to increase as a share of global diets, especially in the developing world. Livestock are a particularly emissions intensive food source and thus, the 2°C scenarios require a reduction in consumption relative to the baseline scenario. When comparing orderly and disorderly transition scenarios, the greatest reduction in livestock consumption is seen in the disorderly scenario (dashed green line). Due to the delayed action in this scenario and the limited potential for CDR, these steeper cuts in livestock consumption are needed to meet the demands of a dwindling carbon budget.

Figure 26: Food Demand- Livestock- 2°C MESSAGE scenarios (kCal/day)

Decarbonisation and Disruption | Participant case studies | 29

6. Participant case studies

As banks are the largest providers of regulated capital in the world, their views on climate change and the energy transition are important in establishing lending criteria across all sectors of the economy. As the world’s largest commercial banks and members of the UNEP-FI convened Principles for Responsible Banking (PRB) begin to inte-grate climate scenario analysis into their risk modelling and regulatory reporting work, the field is rapidly evolving. The case studies below provide insights into the experi-ence of banks who piloted climate scenario analysis during UNEP FI’s Phase II TCFD program for banks. Their insights show some of the benefits and limitations of the existing disruptive scenarios for assessing climate transition risks.

The following case studies were provided by UBS, Brad-esco, and ABN AMRO. The case studies cover the Oil & Gas sector, Transportation sector, and Utilities (Power Genera-tion) sector.

30 | Decarbonisation and Disruption | Participant case studies

Case study 1: Oil & Gas Sector- UBS

1 UBS corporate lending to climate-sensitive sectors. UBS Climate Strategy 2020. Found at: http://www.ubs.com/climate/

Purpose & ScopeThe pilot effort was to analyse impacts from a low-carbon tran-sition on UBS Oil & Gas lending portfolio, within the Investment Bank. Secondary objective was to compare outcomes driven by a range of 1.5 degree pathways, including an orderly and immediate transition, a disorderly and delayed transition, and a disorderly transition that assumed low reliance on carbon dioxide removals (CDR).

Less than 50 counterparties were analysed in the US and EU – including both lending and traded products exposure to corpo-rate entities classified in the oil and gas sector. Upstream oil & gas extraction, midstream oil & gas processing and transport, and integrated oil & gas companies were included in the analy-sis. Total exposure analysed was ~$1.4bn.1

CalibrationFirst, the portfolio was segmented according to risk char-acteristics. Leveraging risk segmentation work outputs from the UNEP-FI Phase II climate risk heatmap workstream, our counterparties were placed into conventional O&G/US Shale (combined), integrated O&G, and midstream O&G risk segments.

Second, the segments were rated from low to high, accord-ing their vulnerability to emissions costs, low-carbon capex, and demand/revenue shifts. These ratings were calibrated to those determined by the heatmap working group, and reviewed by UBS credit officers who cover the respective coun-terparties.

Finally, credit officers were asked to determine ratings impacts on our counterparties, based on scenario data. To do so, they

were given a set of scenario review slides that covered the three different transition risk scenarios and the nationally determined contributions (NDC) scenario (considered as a baseline scenario). Scenario variables in the packs included oil and gas demand, price, electricity technology use and pricing, and other macro-economic data. Regional (US and EU) and global views were created, to accommodate the geographic focus of the portfolio and the upstream segments.

Credit officers discussed and debated the relative risk factors within each scenario and re-rated each company in their respective portfolio, according to an approximate order of magnitude of credit ratings downgrades, for projected years 2030 and 2040. Both 2030 and 2040 were chosen to anal-yse impacts from both an immediate and delayed transition. Existing defaults during COVID/oil price shock in 2020 were considered within their determinations. Ratings estimates based upon mitigants (e.g. transition strategies) were also factored in. For example:

◾ Integrated O&G, as large-cap companies, are well equipped to forecast and strategize for their role in the transition to a low-carbon economy. For example, BP has made a net-zero commitment, and has the means to sustain shocks. Large integrated O&G companies are also considered to have control over major reserves, making them some of the last oil drillers in 2040 that supply resid-ual oil demand.

FindingsNo significant risk to UBS identified. Expected loss impacts to UBS exposure in the sector ranged from 0.4% to 1.1% in a delayed transition scenario and low-CDR scenario respectively, in 2040.


Losses were found to be lower in a delayed (disorderly) tran-sition, as certain companies may continue to produce oil over the next 10 years, generating cash to repay loans. A delayed action scenario also gives integrated companies time adapt, such as implementing stated net-zero commitments.

The exercise highlighted that improving the granularity of scenarios to capture regional dynamics of energy production and oil and gas prices, would yield a more robust analysis. Further efforts are required to continue to bridge methodolog-ical and data gaps (e.g. capturing systems impacts and down-stream impacts)..


Case study 2: Transportation Sector- Banco Bradesco

2 Análise das emissões brasileiras de gases de efeito estufa e suas implicações para as metas do Brasil 1970-2018 (SEEG, 2019)3 scielo.br/scielo.php?script=sci_arttext&pid=S0034-732920190002002034 scielo.br/scielo.php?script=sci_arttext&pid=S0034-732920190002002035 opetroleo.com.br/cabotagem-movimenta-608-milhoes-de-toneladas-entre-janeiro-e-abril/ 6 epocanegocios.globo.com/Economia/noticia/2020/02/governo-preve-investimento-de-r-30-bi-em-ferrovias-nos-proximos-5-anos.html7 epocanegocios.globo.com/Tecnologia/noticia/2019/09/carro-eletrico-no-brasil-do-zero-aos-bilhoes-em-10-anos.html8 epocanegocios.globo.com/Tecnologia/noticia/2019/09/carro-eletrico-no-brasil-do-zero-aos-bilhoes-em-10-anos.html

Brazil has particular conditions in terms of its transportation structure and dynamics. As an emerging economy with a continental geographic size, Brazil will face great challenges and opportunities in a transition towards a low carbon econ-omy.

To properly analyze the impacts of climate scenarios on the transportation sector in the country, a range of current elements and trends have to be discussed to understand their effects on bank portfolios.

Transportation in BrazilIn Brazil, the energy sector accounted for 21% of total green-house gas (GHG) emissions in 2018. Within it, the transport sector was the most carbon intensive and responded for 49% of the total GHG emissions (200.2 MtCO2e), followed by energy consumption in the industrial (15%), fuel production (13%) and electricity generation (12%) sectors2.

This paper brings a discussion on the effects at a segment level of transition scenarios on the transportation sector, which supported the assessment of Bradesco’s credit portfo-lio exposure to transition risks, also described herein.

Air transportBrazil, the fifth largest country in the world, is largely depen-dent on air transport which generates approximately 0.5% of the national GHG emissions, a proportion that is likely to rise as emissions from aviation have increased at a faster pace than other sectors of the Brazilian economy. Between 2005 and 2015, for example, GHG emissions from international flights operated from/to Brazil have grown at a 4.5% annual rate3.

As the segment is operated within international dynamics and regulations (even in the domestic activities), air trans-port is highly exposed to climate-related transition factors, such as new technologies and carbon pricing and offsetting demands4. Such elements can impose new significant oper-ational expenses and investments according to the climate scenario employed in the analysis.

Maritime transportBrazil plays a major role in global exports of key commodi-ties, such as iron and farming products, which are essentially dependent on maritime transport. Domestically, there has

been a recent development of the coast-to-coast shipping mode after a massive national strike by truck drivers in 2018, leading to an increase in the utilization of shipping for domes-tic freight transportation5.

Although more efficient in terms of carbon emissions per load, if compared to road transportation, maritime transport is still a carbon intensive segment. As in air transport, international shipping is exposed to a range of changing market conditions and regulations which may impose negative impacts on the segment.

Thus, considering the combination of high emissions per dollar exported and the growing domestic share, the maritime transport segment is expected to be considerably exposed to transition risks.

Rail freight transportBrazil is highly dependent on road transportation for freight, with only 15% of its freight transported by rail. A recent renewal of contracts with operators in the existing rail infra-structure provides for the modernization of these assets and can materialize in a greater amount of cargo transported by rail, contributing to a higher energy efficiency per load. Besides, it is expected to trigger the operationalization of new railway projects6.

Road transport Brazil has a network of 1,720,700 kilometres of national roads and highways, standing as the fourth largest in the world. Here, we analyse the impacts of developments on both passenger and road freight transportation.

Electric and hybrid electric vehiclesIn 2018, there were only around 11 thousand electric and hybrid cars running throughout the country, which represented only 0.025% of the total Brazilian fleet7. In 2019, a series of electric and hybrid vehicles were launched in Brazil, accom-panied by the installation of energy charging stations, a move seen as a warning by manufacturers that the country will not be left out of the global efforts towards the adoption of EVs8.

However, high prices at the national market are limiting to the consistent penetration of EVs and hybrid electric modes, which should therefore remain restricted to a small niche market, as there is no forecast of reaching a sales scale that

https://www.scielo.br/scielo.php?script=sci_arttext&pid=S0034-73292019000200203

https://www.scielo.br/scielo.php?script=sci_arttext&pid=S0034-73292019000200203

https://opetroleo.com.br/cabotagem-movimenta-608-milhoes-de-toneladas-entre-janeiro-e-abril/

http://epocanegocios.globo.com/Economia/noticia/2020/02/governo-preve-investimento-de-r-30-bi-em-ferrovias-nos-proximos-5-anos.html

https://epocanegocios.globo.com/Tecnologia/noticia/2019/09/carro-eletrico-no-brasil-do-zero-aos-bilhoes-em-10-anos.html

https://epocanegocios.globo.com/Tecnologia/noticia/2019/09/carro-eletrico-no-brasil-do-zero-aos-bilhoes-em-10-anos.html


justifies local production.

Despite the small share in the national market, there are ongo-ing discussions and programs to stimulate the production of EVs. An example is a national program, the Rota 2030 program, sanctioned by the Brazilian government in 2019, which offers a set of federal government guidelines for the auto industry in the next decade. The program, with a particular influence on the individual transport segment, includes energy efficiency targets for vehicles powered by fossil fuels and incentives for automakers of hybrid and electric vehicles.

In the city of São Paulo, electric and hybrid vehicles have a 50% discount on the Motor Vehicle Property Tax (IPVA) and are exempted from a vehicle municipal rotation, which prohib-its the circulation of cars in the expanded city centre once a week, at certain times, based on license plate ends9.

Although evolving at a slower pace than other countries, e.g. the U.S. and China, Brazil has been promoting electro-mobility and has the potential to further expand the segment if more ambitious target setting and supporting mechanisms are applied to incentivize it10.

BiofuelsIn Brazil, 65% of the cargo passes through roads on trucks11. While representing only around 1.5 % of the Brazilian GDP, the road cargo transportation sector’s impact on the economy can reach nearly 30%, once this modal allows for interconnections between producer and consumer markets, making the econ-omy flow.

In 2018, emissions coming from trucks amounted to 82.6 MtCO2e, more than total emissions from all operating ther-moelectric plants in Brazil12. Within this segment, biodiesel blends have been important players in terms of carbon foot-print reduction.

Brazil’s sugarcane ethanol is also an important player in the national transport sector emissions reductions trajectory, particularly for cars. For instance, a peak in emissions from the transport sector in 2009 was highly associated with a decrease in ethanol consumption, given a competitive disad-vantage against gasoline. Likewise, a decrease in emissions from the sector in 2015 resulted from the recovery of the etha-nol industry.

Fossil fuel replacement has been a key driver on emissions reductions in recent years. Between 2017 and 2018, a 5% reduction in GHG emissions from the transport sector derived mainly from fossil fuel substitution, i.e. gasoline by ethanol and the use of diesel with a minimum 10% blending percent-age of biodiesel, a mandatory percentage regulated by law.

The Biofuel was first tested in Brazil in the early 1940s, with patents being released in the late 1970s. It was only in 2004, though, that the first policy to promote the production and

9 cpfl.com.br/sites/mobilidade-eletrica/mobilidade-e/legislacao/Paginas/Governo-zera-imposto-de-importa%C3%A7%C3%A3o-para-car-ro-el%C3%A9trico-e-a-hidrog%C3%AAnio.aspx#:~:text=Mais%20incentivos,por%201%20dia%20da%20semana.

10 Na direção da eletromobilidade: uma transição possível? (FGV ENERGIA, 2019)11 O transporte rodoviário no Brasil e suas deficiências (Moreira et al., 2018)12 Análise das emissões brasileiras de gases de efeito estufa e suas implicações para as metas do Brasil 1970-2018 (SEEG, 2019)13 spglobal.com/platts/en/market-insights/latest-news/oil/061220-brazilian-carbon-credit-first-trade-at-near-10cbio

consumption of biofuel was created, as listed in the table below

Table 1 - Policies that helped to promote biodiesel in Brazil. Source: Oliveira & Coelho (2019)

Year Mechanism Program name and acronym (in Portuguese)

2004 Decree No. 5297

Social Fuel Stamp (SCS)

2005 Law No. 11097

National Program of Production and Use of Biodiesel (PNPB)

2009 Law No. 12187

National Policy on Climate Change (PNMC)

2014 Law No. 13033

Mandatory blend on diesel: increase to 6% and 7%

2016 Law No. 13263

Mandatory blend on diesel: increase to 8%, 9% and 10%

2017 Law No. 13576

National Biofuels Policy (RenovaBio)

RenovaBioThe National Policy on Biofuels or Política Nacional de Biocombustíveis (RenovaBio) integrates the national energy policy and brings a nationwide scope aimed at radically expanding the production and use of biofuel, outlining rules for marketing biofuels in the country and fostering credibility and predictability of national fuel supply.

In March 2018, the National Energy Policy Council (CNPE) defined annual compulsory targets to reduce emissions of GHGs, with individual goals assigned to fuel distributors by the Brazilian Petroleum Agency (ANP), which established fines to distributors that do not comply with their individual goals.

A new feature of RenovaBio policy is the creation of important market mechanisms: The Certificate of Efficient Production of Biofuels (CPEB), to biofuels producers, and the Decarboniza-tion Credits (CBios), to fuel distributors. The latter are instru-ments registered in the form of scripture to attest individual targets of distributors, whose achievement shall be assessed through the amount of credits held on the date defined by the policy.

Each CBio corresponds to 1-ton tCO2e and the calculation considers the difference between GHG emissions in the lifecy-cle of biofuel and its fossil substitute. The calculation includes energy efficiency and environmental impact. CBios first 100 units were traded in June, 2020 at a cost of US$10/CBio13. MethodologyIn the first Pilot-Project with UNEP FI on TCFD (2017/18), Brad-esco analyzed the exposure of our transportation portfolio

https://www.spglobal.com/platts/en/market-insights/latest-news/oil/061220-brazilian-carbon-credit-first-trade-at-near-10cbio


to transition risk pathways considering a 2º C scenario and applied it to the sector’s portfolio of late 2017.

The segmentation adopted for sensitivity analysis followed that suggested by UNEP FI, based on the ISIC classification of sectors14.

A multi-disciplinary squad, including representatives from economics, credit, risk and sustainability teams, conducted an assessment in order to translate the dynamics of the Brazilian transportation sector, the characteristics of Bradesco’s portfo-lio and the most probable impacts of climate scenarios on our local reality.

14 Except for “Other transport manufacturing”, which EAD demonstrated no significant materiality.

Bradesco’s case study of the present pilot features a review of Phase I heatmap analysis to adapt it and reflect a 1.5°C tran-sition impact perspective on the selected segments in 2040. The adaptation was made through an overall aggravation of the segments’ sensitivities that were applied to the previous 2°C heatmap, which results can be observed in Table 2.

The segment sensitivity assessment was then applied to the late 2017 portfolio and to an early 2020 portfolio, to allow for an analysis of the evolution in credit risk exposure over the period.

Table 2 - Sensitivity analysis of the transportation sector at a segment level

SegmentsRisk factor pathwaysDirect Emissions costs

Indirect Emissions costs

Low-Carbon CAPEX Revenue

Automotive manufacturers Moderately low High Moderately high ModerateAutomotive component suppliers High High Moderately high Moderately high

Maritime services and freight High Moderately low Moderately high Moderately lowGround transportation and logistics High Moderately low Moderately high Moderately high

Airline services and freight High Moderately low Moderately high Moderately high

CalibrationIn addition to the overall sensitivity analysis, from each segment, the 5 most relevant borrowers were selected for the bottom-up tool calibration of each portfolio. Their current climate-related practices and performance were assessed based on their CDP Climate Change scores - primarily at the company level or, in its absence, at group or multinational level.

The CDP score was considered a consistent and compara-ble metric to measure the level of readiness each company presents to properly act to mitigate risks and explore climate-related opportunities. After internal discussions, a methodology was developed to translate the findings into impacts on companies’ ratings, as presented below.


Table 3 - Impact on rating based on CDP score

CDP score Rating downgrade

A / A- None

B / B- 1 level

C / C- 2 levels

D / D- 3 levels

F or no report 4 levels

Selected scenariosThe REMIND0-MAgPIE model was selected for the scenarios analysis for its capacity to integrate the bioenergetic demand with changes in land use, a particularly relevant feature to the present study due to the role that ethanol and biodiesel have in the Brazilian transport sector. Thus, in order to assess the difference between the impacts predicted in Phase I and Phase II 1.5 ° C scenarios, the portfolios were subjected to the treatments described in Table 4.

Table 4 - Scenarios used in the analysis of the 2017 and 2020 portfolios

Portfolio Phase I 1.5°C Delayed 1.5°C (Phase II)

Transportation 2017

Tranportation 2020

Results and discussionThe scenarios impacted the PDs quite similarly in the two port-folios, demonstrating that there was no significant impact of the delay in taking actions to transition foreseen in the Phase II scenario. These results are partially explained by the alike composition of primary energy consumption predicted for 2040 in both scenarios.

The portfolios of 2017 and 2020 did not differ significantly in terms of exposure by segment and, between 2017 and 2020, there was a notable positive evolution in the credit profile of customers. However, in this same period, there was no greater transparency in climate risk management and disclosure by customers, leading to a higher impact on the 2020 portfolio average PD by 2040.

Conclusions This study presents some of the factors that can affect the credit quality of banks’ portfolios in the transportation sector. While there are evident risks arising from technological, polit-ical, legal and market changes in transition pathways to a low carbon economy, Brazil presents important opportunities to use its internal conditions to prosper in this new context.

The study also showed that transition risk analysis tools are important allies to identify subsectors that are most resilient to policies aimed at a low carbon economy, as well as those that are most exposed to these risks.

Banks should interpret the future scenarios of sectoral and sub-sectoral changes not only from the perspective of risk management, but mainly, as a strategic agenda for engaging with clients to encourage climate disclosure and to offer them financial solutions that will support businesses to become more carbon efficient and resilient to the broad effects of climate change in Brazil.


Case study 3: Transportation and Utilities Sectors- ABN AMROSensitivities for Transport and Utilities SectorThese main sectors tested in this analysis are Transport and Utilities. Further, based on more granular internal segmenta-tions, three groupings are created. These lower-level group-ings reflect the homogenous simple characteristics that will be used for assigning sensitivities, and also reflect the main

segmentation of the portfolio that is being used as an example.

The following sensitivities are assigned to each of the lower level groupings.

TransportSegment Direct emissions cost Indirect emissions

costLow-carbon capital

expenditureRevenue

Industrial Transporta-tion: Air

Moderately high Low Moderately low High

Industrial Transporta-tion: Land

Moderate Low Moderate High

Industrial Transporta-tion: Water

High High High Moderately low

Table 1

UtilitiesSegment Direct emissions cost Indirect emissions

costLow-carbon capital

expenditureRevenue

Utilities Electricity Moderately high Moderate Moderately high HighUtilities Other Services

Moderately high Moderately high Moderate Moderately low

Utilities Water Low Low Low Low

Table 2

Furthermore, these sensitivities of the lower level groupings were performed based on an individual heatmap exercise by

sectors experts of the respective lower level groupings inside the organization.

CalibrationA simple calibration approach was used. This was based on a linear conversion of the current ratings for the belonging average sensitivity and target year of the future rating (2030 or 2040). It was assumed that all exposures would face a down-

grade due to transition risk in the future. The magnitude of this downgrade (1,2,3 or 4) is then a function of the sensitivity of the lower level grouping where the exposure belongs.

Current Rating 1 Notch Downgrade 2 Notches Downgrade 3 Notches Downgrade 4 Notches DowngradeAA+ AA AA- A+ ABB+ BB BB- B+ BB B- CCC/C CCC/C CCC/C

CCC/C CCC/C CCC/C CCC/C CCC/C

Table 3

The average level of the sensitivity of the lower level subgroup-ing was determined by looking at the four elements of the sensitivity matrix and performing an expert judgement. As an example, a lower level subgrouping for which was determined

a Moderately high sensitivity would have all its exposures downgraded 2 notches in 10 years, and 4 notches in 20 years.


Nudges Downgrade Table

Average Score 20y Downgrade 10y Downgrade

High 5 3

Moderately High 4 2

Moderate 3 1

Moderately Low 2 1

Low 1 0

Table 4

ScenariosFour scenarios considered in the analysis performed. These scenarios were as follows:

Benchmark 1.5 °C ScenarioAs a benchmark scenario, the a 1.5 °C scenario was consid-ered from UNEP FI’s Phase I banking pilot. This scenario was interpreted as the scenario for which measures are implemented in a gradual way to curb the increase of global temperatures to 1.5 °C.

As comparison scenarios, three different scenarios were considered from Phase II. These were:

Delayed 1.5 °C ScenarioBased on the documentation provided by UNEP-FI, this scenario was interpreted as the scenario where measures to curb the increase to of global temperatures below 1.5 °C are implemented in a later stage, which leads to high disrup-tion in the market in later stages, but less in the early stages of the time span 2020 to 2050. We consider this scenario

as a comparable scenario to the benchmark Phase 1 1.5 °C scenario.

Low CDR 1.5 °C ScenarioBased on the documentation provided by UNEP-FI, this scenario was interpreted as the scenario where carbon dioxide removal technologies do not produce significant amounts of negative emissions.

Immediate 1.5 °C ScenarioBased on the documentation provided by UNEP-FI, this scenario was interpreted as the scenario where measures to curb the increase of global temperatures to less than 1.5 °C are introduced relatively early in the span of 2020 to 2050. This leads to a significant disruptive effect in the market early on, but less so in later stages.

DataFor this analysis, a proxy dataset was based on a portfolio data. It must be noted however that even though the proxy is based on portfolio data, the proxy data does not reflect the real composition on credit characteristics of the of the portfo-lio dataset. Instead, the proxy dataset reflects the structure of the portfolio data by mimicking the size of exposures and the sectors used for the analysis.

Results of scenarios ConsideredFor each of the scenarios considered in this analysis, a graph-ical representation in shown for each of the sectors and the lower level groupings of the respective sector. The goal is to compare how different the proxy portfolios behave given the different scenarios and keeping the sensitivities and calibra-tion fixed across scenarios.

Transport Sector - Expected Losses over Time in Various ScenariosIn the figure below, four different scenarios are shown for the Transport sector using the proxy portfolio and the sensitivities shown in table 1. The values of the Y-axis are indexed to mask the real values, however the actual positions of each scenarios across time are representative of non-indexed figures.

Figure 1

According to the documentation provided by the UNEP-FI, the following drivers were identified as most important for the Transport sector.

◾ CO2 Emissions and Carbon Prices ◾ Energy Demand and Prices for Electricity, Liquids and

Gasses ◾ Energy Efficiency/ Low carbon Investment

We note the following:

◾ We find that across all scenarios, expected losses stay relatively mild and aligned from 2020 up to 2024.

◾ Considering the applied sensitivities, we find that the Phase 1 scenario and the Phase 2 Low CDR Scenario have very similar results for the Transportation sector.

◾ Expected losses steadily increase from 2027 to 2040 and the Low CDR scenario’s expected losses just ends on a higher line than the Phase 1 scenario

◾ Immediate Scenario has the highest cumulative expected loss from all different scenarios. This is due to the substantial increase in EL from 2028 to 2033 and even with EL flattening out from 2033 to 2038.


Comparing the different scenarios and their respective area under the curve seems to show that the Delayed scenario leads to the lowest accumulated costs for the sector as

expected losses all the way to 2032-2033 and only catch up with the other scenarios by 2037- 2039.

Utilities Sector - Expected Losses over Time in Various ScenariosSimilar to the previous figure, figure 2 shows four different scenarios for the Utilities sector using the proxy portfolio and the sensitivities shown in table 2. The values of the Y-axis are indexed to mask the real values, however the actual positions of each scenarios across time are representative of non-in-dexed figures.

Figure 2

According to the documentation provided by the UNEP-FI, the following drivers were identified as most important for the Util-ities sector.

◾ CO2 Emissions and Carbon Prices ◾ Energy Supply ◾ Carbon Capture Sequestration (CCS) ◾ Low Carbon Investment/ Supply Side ◾ Energy Demand and Prices for Electricity, Liquids, Biomass,

Coal, Gasses and Hydrogen

Transport Different Subsectors Largest Exposure - Four ScenariosNext to the scenario results for individual sectors, results for the lower level groupings are also shown below. The lower level groupings for the Transport sector consist of:

◾ Transport Water ◾ Transport Land ◾ Transport Air

The sensitivities of each of the lower level groupings are found in table 1.

Figure 3

Figure 4

Figure 5

The following differences were noted between the subsectors of the Transport sector

◾ The first thing to notice is that the Transport Water sector’s Immediate scenario seems to behave quite similar to the Transport scenario as a whole in its pathway, but leading to lower probabilities of default than the rest of the scenarios

◾ Transport Land shows that the Delayed scenario is the only one which leads to a better pathway in term so financial planning up to 2037. Then the PD quickly increases to the level of other scenarios.

◾ Transport Air shows the least differences among the differ-ent scenarios (including the Delayed scenario). Further-more, Phase 1, Immediate and Delayed, even though increasing after 2030, flatten out more than other subsec-tors.

◾ Looking at the differences between the sensitivities of the subsectors and the behaviour of the different scenarios, we notice that the change in revenue is likely to be lead-ing to the different pathways for the Immediate scenario. Moderately Low change in might be the result for a lower PD in Water Transport compared to the other sectors.


Utilities Different Subsectors Largest Exposure - Four ScenariosSimilar to the previous section, the results for individual sector for Utilities are shown below. The lower level groupings for the Transport sector consist of:

◾ Utilities Electricity ◾ Utilities Other Services ◾ Utilities Water

The sensitivities of each of the lower level groupings are found in table 2.

Figure 6

Figure 7

Figure 8

The following differences were noted between the subsectors of the Transport sector

◾ The first thing to notice is the impressive bell shape of the expected PD’s in the immediate scenario. Clearly the predictions of the model advice to avoid the immediate scenario.

◾ The delayed scenario leads for all subsectors to a lower overall PD, where it surpasses the P1 scenario in the later years.

◾ The low CDR scenario seems to be on par with the delayed scenario, which is a surprising outcome since low CDR is considered a handicap not a benefit.

◾ The effect of the same scenario on different sectors is explained by the sensitivities that have been chosen. For example, Utilities Water always scores “Low” leading to lower relative changes in PD when compared to other segments (the peak of 8 for 1.5 Phase 2 Immediate is lower than 12 and 50 for Other Services and Electricity, respectively).

40 | Decarbonisation and Disruption | Conclusions

7. Conclusions

7.1. A looming threatAs the Global Financial Crisis demonstrated, disruptions in one sector can quickly radiate through-out the entire economy. In today’s interconnected world, the collapse of a major industry or insti-tution is likely to have severe cascading effects. Meeting global climate goals will demand major changes throughout the economy. New technologies and governmental policies are likely to upend the market dynamics in a variety of sectors. Whole industries may disappear if their busi-ness models are incompatible with a low-carbon future. The scale of the required changes to firms, markets, and societies makes some level of economic dislocation probable. These challenges are increased by the scientific consensus that the low-carbon transition must be completed in a few short decades. Urgent and aggressive action is required to have a realistic chance of limiting warming to safe levels.

The speed and scope of the low-carbon transition presents major risks (and opportunities) for financial institutions. These risks are not confined to portfolios and assets within highly emitting sectors nor are they distant challenge to be confronted in due course. A low-carbon transition represents a significant short-term threat to financial and economic stability. Some of that risk can be mitigated by pursuing an orderly transition rather than a disorderly one. Policymakers and regulators have critical roles to play in ensuring an orderly transition. However, financial institu-tions must do more than manage their own transition risks, they also must take steps to foster an orderly transition. These steps include working closely with clients to develop transition plans, directing capital towards firms aligned with a low-carbon future, and enhancing the climate risk disclosures they make to their stakeholders.

7.2. The right tools for the jobClimate scenario analysis is an essential tool for financial institutions in the assessment of climate risks and opportunities as well as the effective management and support of the low-carbon tran-sition. UNEP FI supports initiatives such as those led by the TCFD and the NGFS to encourage a wider application of climate scenario analysis among financial institutions. Increasing the detail and comparability of climate scenario analyses will enable regulators, firms, and stakeholders to understand the climate risks faced by individual institutions and the financial system overall.

However, as covered in detail in our joint report on climate scenarios and models with the Center for International Climate Research (CICERO), existing scenarios have meaningful limitations that financial users should understand (UNEP FI; CICERO 2020). Many of these limitations result from the fact that the scenarios currently applied for financial climate scenario analyses were initially developed for policymakers rather than purpose-built for conducting risk assessments. Through the UNEP FI TCFD pilot, participants discussed a number of areas for scenario enhancements to further improve the value of these important tools.

Decarbonisation and Disruption | Conclusions | 41

Figure 27: Suggested enhancements to climate scenarios

The NGFS and their climate research partners are already working on a few of these items, partic-ularly improved regional granularity. Another helpful option for to addressing gaps in scenario outputs includes the creation of granular sectoral sub-models that are consistent with the overall scenarios but model the economic dynamics of the particular sector.

In this report, UNEP FI has sought to provide insights from the existing orderly and disorderly NGFS reference scenarios. Thus, it is worthwhile to share conclusions on the current state of disorderly scenarios and how they can continue to evolve to meet the needs of financial users. In Phase I of the TCFD banking program, the only scenarios available to participants were orderly transition scenarios. In Phase II, the disorderly scenarios were welcomed by participants as a way to reflect more stressful conditions during a low-carbon transition. The intuitively greater severity and stress of the disorderly transitions has been demonstrated throughout this paper by comparisons disor-derly and orderly scenarios across key variables and losses (in the case studies). While the disor-derly scenarios have proved valuable to the participants in Phase II and others across the industry, they also will benefit from further enhancement along the lines noted above for climate scenarios.

A disruptive transition is a distinct and worrisome proposition for societies, economies, and finan-cial institutions. The financial sector will need to continue building the knowledge and analytical capabilities to assess and manage its transition risks. Mitigating risk and actively supporting an orderly low-carbon transition will be imperative for the continued stability of the financial system. Climate scenarios will prove an essential tool for financial firms seeking to thrive in the face of a rapidly changing world.

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46 | Decarbonisation and Disruption | United Nations Environment Programme Finance Initiative (UNEP FI) is a partnership between UNEP and the global financial sector to mobilize private sector finance for sustainable development. UNEP FI works with more than 350 members—banks, insurers, and investors—and over 100 supporting institutions—to help create a financial sector that serves people and pl

United Nations Environment Programme Finance Initiative (UNEP FI) is a partnership between UNEP and the global finan-cial sector to mobilize private sector finance for sustainable development. UNEP FI works with more than 350 members—banks, insurers, and investors—and over 100 supporting institutions—to help create a financial sector that serves people and planet while delivering positive impacts. We aim to inspire, inform and enable financial institutions to improve people’s quality of life without compromising that of future generations. By leveraging the UN’s role, UNEP FI accelerates sustainable finance.

unepfi.org

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