07 Dec 2021

Earnings at risk: What climate change means for equity returns

climate earnings

Some investors are taking on more risk than they realise by assuming it’s ‘business as usual’ for high-impact carbon emitters. In a new normal where emitting carbon incurs higher financial penalties, investors need to take into account the carbon pricing risk, or unpriced carbon cost – the gap between the current carbon price and the future price they might face in a 1.5-2°C world. In this blog, Vincent Denoiseux, Head of ETF Research and Solutions, shines a light on what’s at stake.

More than ever, investors believe in the importance of responsible investing. In the climate arena, there is a growing agreement that humanity must change its course to protect the environment.

And yet, when we discuss this topic with investors, we find there are often some misgivings.

Yes, ESG and climate are important, we’re told – but it’s hard to understand exactly how important, and harder still to integrate these concerns into a portfolio.

These misgivings often reveal a sense of dichotomy. On one hand, mounting evidence that compels us all to make a climate impact with our portfolios; on the other, the fiduciary duty that instructs us to act in the best financial interests of the principal.

Lyxor has been a pioneer of climate investing, launching our flagship climate ETFs nearly two years ago. Recently, we have been looking for a way to bridge the gap between financial risk and climate risk, and to help investors connect the dots between the climate imperative and optimal risk-adjusted return.

Carbon pricing risk is a very interesting platform that allows us to do just that. In our view, integrating carbon pricing risk analysis will allow investors to get back to looking at financial risk and how to optimise a particular portfolio in relation to it. 

Carbon pricing risk: an increasingly necessary metric

Let’s examine what we have just called carbon pricing risk. To be more specific, we are referring to what might happen to a portfolio when we account for the carbon price in risk analysis. Carbon pricing is a network of global initiatives to curb carbon emissions. In the first chart below, you can see that 23% of carbon global emissions are now ‘covered’ by carbon pricing initiatives such as carbon taxes and emissions trading systems. The red bar shows EU allowances, and the big blue bar on the rightmost column is China. This chart shows that carbon pricing schemes are growing globally. The second chart shows how these schemes are spread around the world. 

Global emissions covered by carbon pricing initiatives

Source: S&P Global, Carbon Price Dashboard by WorldBank, IBRD and IDA. Past performance is not a reliable indicator of future performance.

Summary of current and future carbon pricing initiatives

Implemented, Scheduled and Under Consideration

Carbon pricing

Carbon pricing is proliferating, and even though it is still a nascent initiative and remains complex and fragmented, it will improve over time. What we want to highlight now is the important link between the carbon price and unpriced risks that might be embedded in a portfolio.

Unpriced carbon cost

Viewing the issue through a data scientist’s lens, a key metric to look at is unpriced carbon cost. This is the difference between what a company pays now in terms of carbon price and the price it will pay in future. For this we use data from Trucost, part of S&P Global.

Trucost defines three carbon price scenarios in its methodology. In each of these three forecasts, carbon prices rise dramatically over the coming years – meaning a growing gap between current and future price, and thus a greater unpriced carbon cost. Given that carbon pricing schemes are one of the main tools in the policymaker’s kit, we are confident in saying that carbon price will only continue to increase from here.

Projecting carbon price impact on earnings

We selected Trucost’s medium (“delayed action”) carbon price scenario for our analysis. Despite it being the middle path, we feel this could actually be a conservative assumption of where the carbon price could go.

To look at how unpriced carbon price risk could affect companies’ profitability, we started with the MSCI World index. Using earnings statements, we tried to represent the carbon price risk – again, that’s the difference between what the company pays today and what it might pay tomorrow – and what that would represent as a share of their EBITDA. This gave us a measure of “earnings at risk”, or more accurately, EBITDA at risk. (EBITDA refers to earnings before interest, taxes, depreciation and amortisation and is a common metric for evaluating a company’s operating performance.)

Our analysis highlights a significant risk to future earnings from the unpriced expected future carbon price, especially in sectors such as energy, materials and utilities. In the utilities sector, the projected carbon price increases wipe out 50% of the sector’s average EBITDA by 2040. By 2050, the entire average EBITDA of this sector would be gone.

It’s important to note that 2050 is far in the future, and that these results depend heavily on modelling and on what changes are made to companies’ emissions and business models by then. So, we can’t safely say that this will happen. However, based on all the data that we have access to, we can start to see that carbon prices might pose a significant risk for these companies’ earnings, on the basis of their current emissions and financial health.

One step further: loss of enterprise value

Climate Transition & Paris-Aligned solutions

In this article, we are ultimately performing a simple stress-test. How would a sector, or a portfolio, react to carbon price changes and how would this feed through to earnings and market value? To continue the investigation, we looked at the alternative exposures to certain mainstream indices, using Paris-Aligned (PAB) and Climate Transition Benchmarks (CTB). These benchmarks and the ETFs tracking them aim to reduce the carbon intensity* of a given exposure – by 50% for PAB and 30% for CTB – and put a portfolio on a trajectory of reducing carbon emissions over time, typically by 7% per year.   

So, we conducted the same exercises as before – same benchmark, same universe, same portfolio. As the carbon emissions are cut by 50%, we can very simply divide the earnings at risk by a factor of two (see Earnings at Risk chart below)

Earnings at Risk: share of projected 2030 EBITDA at risk

Average Earnings at Risk per Sector on MSCI World and S&P 


Scope 1, Scope 2 and Scope 3 upstream (supply chain effect) emissions are included, while Scope 3 downstream & upstream (change in demand due to rising costs) emissions are excluded in this analysis.

Source: S&P Global, Lyxor International Asset Management, Data as at 11/10/2021. Past performance and/or forecasts are not a reliable indicator of future performance.

We conducted the same exercise for enterprise value at risk, meaning the projected reduction in enterprise value in a portfolio (see Enterprise Value at Risk chart below). This starts from the parent reference benchmark in light blue, to Climate Transition Benchmark in turquoise blue, to Paris-Aligned Benchmark in green. We can see here a quite mechanical reduction in risk when investing in CTB or PAB benchmarks. It’s also interesting to note that this reduction is quite consistent across regions.

Enterprise Value at Risk: potential impact of the decrease in Enterprise Value, based on EBITDA at risk

Weighted sum applied on MSCI World, MSCI CTB / Climate Change Indices, S&P PAB Indices, medium 2030 scenario, per region

value at risk

Scope 1, Scope 2 and Scope 3 upstream (supply chain effect) emissions are included, while Scope 3 downstream & upstream (change in demand due to rising costs) emissions are excluded in this analysis.

Source: S&P Global, Lyxor International Asset Management. Relevant Benchmark is the relevant MSCI standard index of the region, Climate Change / CTB index is the available Climate Transition Benchmark by MSCI and PAB Index is the corresponding Paris Aligned Benchmark published by S&P on the relevant region. Data as at 11/10/2021. Past performance and/or forecasts are not a reliable indicator of future performance. 

What this means it that if you’re looking at a Europe, US or World portfolio, and want to reduce carbon emissions, that reduction comes with a commensurate reduction in financial risk. From an investment perspective, therefore, this might actually make that choice more fiduciary.

Our conclusion is the following: since carbon pricing is here to stay, and will only increase in future, it poses a huge and underappreciated risk for companies, especially in the energy, materials and utilities sectors. Climate indices such as the Paris-Aligned Benchmark (PAB) significantly reduce carbon emissions, and in doing so, significantly reduce the carbon pricing risk embedded in these companies today. Through our analysis, we can make a solid link between carbon emissions to the financial performance of a portfolio. 

To learn more about our Climate, ESG and Thematic ETFs, including detailed performance and risk breakdowns, please get in touch with Lyxor’s ETF Research & Solutions team (+33 1 42 13 42 14 ; client-services-etf@lyxor.com).

You can also learn more about the race to Net Zero and how our Climate ETFs can help.

*Carbon intensity is a measure of how much CO2 emissions are produced per kilowatt hour of electricity consumed.


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