With governments around the world responding to climate change, investors in these five sectors should consider whether financial markets are pricing in policy solutions fast enough.
Governments around the world are addressing climate change with a variety of new policies. In turn, investors need to consider whether financial markets have priced the effects these responses will likely have on certain sectors of the economy.
Regulatory efforts vary widely across regions. The EU aims to achieve carbon neutrality by 2050 through its European Green Deal, while in Asia, the Hong Kong Stock Exchange has increased its environmental, social and governance (ESG) disclosure requirements, and China has launched a national carbon-trading platform that could create the world’s biggest carbon-emissions market.1 The U.S. has paused or dialed back its regulatory responses, but that could change as well, amid key year-end elections. The Green New Deal, proposed by some congressional Democrats, for example, could mean a commitment to reach net-zero greenhouse-gas emissions by 2030.
The adoption of climate change policies around the world could alter the profitability and viability of companies across many sectors. For their part, investors can start to manage these risks—and explore potential opportunities—by identifying those areas where changing policies may eventually affect market pricing. Five sectors, in particular—financial services, mining, oil and gas, utilities and autos—are experiencing the bulk of this disruption.
1. Financial Services: At the Hub of Transition
As providers of capital, financial institutions can help to spur the global economy’s transition from traditional fossil-fuel energy to sustainable low-emissions producers. Decarbonization may present a material economic opportunity in this transition, representing $50 trillion in investment in the next 30 years.2
At the same time, financial companies also realize that climate change events could pose major risks to assets, loans and capital-market flows. Banks and insurers are thus attempting to use better quality data to assess exposures to direct and indirect sources of carbon emissions. Many have begun estimating the probability of defaults from brown assets, or those tied to fossil fuels—coal, oil and natural gas—and have shifted lending toward green assets, or those tied to solar, wind, tidal and geothermal energy.
2. Metals and Mining: Staying Nimble
Though climate-related concerns have already led to sharp output reductions and cost increases for metals and mining companies, as significant consumers of energy, they can adapt by shifting their mix of power sources.
Miners can also secure new sources of revenue, amid the global transition to lower carbon alternatives. The EU’s Green Deal, for example, will drive a shift toward electric vehicles and renewable energy, which could result in an estimated 67% increase in demand for lithium and an 82% increase for cobalt.3
Those that can source green energy and set up to deliver the raw materials essential to the new low-carbon economy are more likely to thrive.
3. Oil and Gas: Stranded Assets
Meeting the Paris Agreement’s goal of limiting global warming to less than 2 degrees Celsius in this century would entail stranding 30%-50% of existing oil and natural-gas reserves, which would require an increase in carbon prices and more stringent regulations globally.
Large oil and gas companies have an opportunity to lead the transition to a low-carbon economy, as renewable investments currently represent less than 1% of their capital expenditures.4 European oil companies, for example, are acquiring startup electric-vehicle charging companies and utilities in a transitioning economy.
Companies that fail to diversify their revenue streams may find their investments in developing oil and gas reserves eventually becoming nonproductive assets.
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4. Utilities: A Carbon Advantage
Decarbonizing power generation lies at the heart of achieving net-zero emissions. In 2018, energy from hydro, nuclear, solar, wind, biomass and other renewables represented more than 25% of global electricity generation.5 This trend is set to increase to 93% by 2050 as renewables become cheaper than fossil fuels.6
Early adopters in renewable power generation can gain market share from competitors and greater access to financing through sustainable debt issuance, which is set to exceed $400 billion in 2020, driven by climate action.7
5. Autos: Shifting Product Mix
Automakers are undergoing a major shift in product mix. As of January, EU passenger cars face a new emission target—and steep fines for exceeding it. In 2018, fleet emissions among EU manufacturers averaged more than this threshold;8 a large-scale rollout of electric vehicles is the only way to stay below it, but automakers seem unlikely to reach a sufficiently high level of market penetration for electric vehicles to avoid penalties.
The global surge in demand for electric vehicles benefits battery manufacturers, particularly those in South Korea, which have strong links with automakers, and Japan, where manufacturers are developing their own solid-state battery technologies.
Auto manufacturers unable to achieve scale in electric vehicle production are likely to struggle. Original-equipment manufacturers that aren’t meeting CO2 emissions targets will also see a decrease in profitability in their traditional business lines, such as the internal combustion engine.
1 Timperley, Jocelyn, “Q&A: How will China’s new carbon trading scheme work?” CarbonBrief, 29 January 2018, https://www.carbonbrief.org/qa-howwill-chinas-new-carbon-trading-scheme-work
2 Morgan Stanley Research, “Decarbonization: The Race to Zero Emissions,” 25 November 2019, https://www.morganstanley.com/ideas/investing-indecarbonization.
3 Kavanagh, Thomas, “EU green deal could transform metals demand,” Argus, 3 January 2020, https://www.argusmedia.com/en/news/2044840-eugreen-deal-could-transform-metals-demand.
4 Morgan Stanley Research, “Decarbonisation: The Race to Net Zero,” 21 October 2019.
5 IEA, Global Energy & CO2 Status Report 2019.
6 UN PRI, Inevitable Policy Response, Forecast Policy Scenario: Equity Markets Impacts 2019.
7 Moody’s Investors Service, “Sustainable Finance—Global: Green, Social and Sustainability Bond Issuance to Hit Record $400 Billion In 2020,” 3 February 2020, https://www.moodys.com/research/Moodys-Green-social-and-sustainability-bond-issuance-to-jump-24--PBC_1212910.
8 Morgan Stanley Research, “EV Battery Blueprint for Europe’s CO2 Emission Regulation,” 16 January 2020, https://ny.matrix.ms.com/eqr/article/webapp/1294aa90-60a5-11e9-9957-e2cf76cce1fa?ch=rpint&sch=sr&sr=3.