Who can say why an idea blossoms, but the idea of setting an internal “carbon price” to illuminate hidden costs is certainly blooming in Asia. According to the annual Carbon Pricing report by CDP, released in October, 2017, “All eyes are on Asia. Over the past year, the number of companies using an internal carbon price in China, Japan, and South Korea has increased from 170 to 281. One hundred and two Chinese companies disclosed using or planning to implement an internal carbon price in 2017—nearly doubling from 54 companies in 2015.”
Of course, the world is waiting for the launch of China’s new national cap-and-trade system, due to be announced before the end of 2017. Details are scant but it seems as though the power sector will be the first to come under the cap-and-trade program, and this alone could well make the Chinese carbon market the largest in the world.
For investors, carbon pricing is both lotus and peony. Lotus because carbon pricing glances toward infinity; and peony because of the many layers at hand.
The core goal, of course, of carbon pricing through a cap-and-trade system is to put a fixed limit on permissible greenhouse gas emissions in a given time period, issue allowances that correspond to that number of permissible tonnes, keep good track to make sure no counterfeit allowances are issued, and then ring the “start” bell. Under a cap-and-trade system, when the start bell rings, emitters covered under the system must compete to see which emitter can reach its target most cost effectively, The emitter who is most efficient may have surplus allowances to sell to competitors, who may find it more cost effective to buy those allowances than to keep trying to make direct reductions in their own systems—some fossil fuel burning facilities are too old to ever be efficient, or perhaps all easy reductions have been made and further reductions await major technological breakthroughs. Commodities traders enter the market too, buying and selling allowances that become available from emitters and keeping the market liquid. The more tonnes reduced, the more trades made, and the more breakthroughs incentivized, the better for the market and the planet.
Setting an internal carbon price enables companies whether or not they will be covered by a cap-and-trade system to gauge their potential hidden liabilities—the carbon price tags each emission. The internal carbon price also serves as a critical planning tool.
For investors and wealth managers, engaging with companies on the degree to which they are planning for climate change risk is vital. Whether a company is prepared for supply chain interruption due to increasing extreme weather or overall resilience to consumer demand for enlightened corporate behavior, can be gauged by asking one question: are you using an internal carbon price? If yes, the company has a good feel for the climate change issue. If not, the company needs to catch up and may suffer a business shock.
Other interesting findings from the CDP report are:
“…Four years of steady growth of internal carbon pricing: From 150 global companies in 2014, the number has steadily grown to over 1,300 companies in 2017— including more than 100 Fortune Global 500 companies with collective annual revenues of about US$7 trillion—disclosing that they are using an internal carbon price or plan to do so within the next two years.
Companies use an internal carbon price to achieve different objectives. Companies disclose a variety of reasons for using an internal carbon price: to reveal hidden carbon risks and opportunities, or even as a deliberate tool to transition to a low-carbon business model. The most effective way to embed this into business practice depends on the objective a company is seeking to achieve.
It is not clear whether companies are prepared for the medium- to long-term. Only 15% of companies that use an internal carbon price to stress test their investments and operations disclose assumptions that the price level will increase over time, while the remaining 85% assumes a static price, or do not disclose their practice. Further, very few companies disclose price assumptions past 2025, although the ROI period for the assets of certain energy-intensive sectors extends far beyond this range.”
Of course, investors have their own yardsticks to use when gauging risk, and carbon pricing is only one indicator. However, the unprecedented increases in use of internal carbon prices do indicate a growing and likely irreversible consensus that, at the least, climate change is a potentially major and serious disruptor to business and social cohesion. In the United States, due to the series super-strong hurricanes that battered Houston and other cities along the Gulf of Mexico in October, 2017, 1.5 million people who had a job could not get to work during that month, the largest employment disruption in the U.S. in two decades. And Hong Kong itself had experienced a dangerous and very disruptive typhoon only weeks before. Not all these erratic events can be attributed to overall climate change trends, but the rise in ocean temperatures is not debatable: warmer oceans feed energy into developing storms, adding much more destructive power.
Lotus or peony, poets may debate. But, regardless, carbon pricing and pricing environmental destruction in general can help protect the garden we call earth.BM