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Keeping you in-the-know on environmental, social and governance developments

Readers are probably aware that I updated my book Killing Sustainability to reflect the deluge of ESG developments that have occurred since it was first published in 2018. What I haven’t mentioned is that it will be available as a free benefit of a subscription to the upcoming membership services under The book was substantially revised for 2021 and even includes developments, information and resources from COP26.

To give a preview, here is an excerpt from an early draft:

Climate Risk Management

An example of risk management in the ESG context is trying to claim the value of avoided carbon costs in the U.S. There are companies who assign an internal carbon cost for managerial accounting purposes. I am of mixed opinion on that. Doing so gets managers to consider emissions as part of everyday business which is good. However, it concerns me that values are purely speculative (at least in the U.S.) and may not adequately reflect actual or realistic tax values or real carbon reduction cost. For instance, if the cost is linked to carbon offsets, that is a lower cost/higher risk than direct emissions reductions. How those numbers could relate to tax values is another quandary.

Renowned Harvard Business School Professor Robert Eccles believes that “[t]hrough some combination of government intervention and the development of carbon trading markets, it seems inevitable that a price will eventually be put on carbon around the world.” I don’t disagree. He recently pointed out that

Economic models and the experience of the EU Emissions Trading System suggests that a price could likely be between $50 and $100 per ton of CO2 in the near term and rise from there. At $100 per ton that would represent five percent of the global economy. Five percent of the global economy is a huge number.”

He goes on to give an example that at reported 2020 CO2 emissions levels, Exxon would incur $11 billion in new costs against the $8 billion per year it has averaged in revenue during the past five years – undoubtedly a financially material matter.

Yet there is no consensus around that $100/ton figure – or any other figure for that matter – as a universal planning benchmark as Eccles suggests. I remember predictions years ago that $40/ton would alter the energy and emissions world. A new carbon emissions tax in Austria will begin in 2022 at a price of 30 Euros/tonne ($34), growing to 55 Euros/tonne ($63) in 2025. The International Energy Agency (IEA) World Energy Outlook 2021 analyzed the more than 60 carbon pricing schemes in place in 2021 covering over 40 countries which according to the World Bank addresses only half of “covered emissions” and 13% of total global emissions. Using that information, IEA projected pricing around the world for 2030 – 2050 using stated policies, announced pledges and Net Zero scenarios. Predicted pricing for the U.S. as an advanced economy is US$130/ton in 2030 growing to US$250/ton by 2050 –expressed as 2020 dollars. 

It is true EU ETS futures hit 80 Euros/tonne ($90) in early December 2021 – its record high. While that is the largest multi-country, multi-sector greenhouse gas emissions trading system in the world, it only applies to facilities located within the EU, which of course no longer includes the UK. The UK ETS launched in January 2021 has a Cost Containment Mechanism calculated monthly that allows the UK ETS Authority to intervene if prices are elevated for a sustained period. It triggered for December 2021 at a price of GBP52.88/tonne ($70.33).

Not only is the $100/ton figure not an agreed-upon global benchmark for planning, some believe a value well short of that would have devastating economic effects. Tom Steffen, a Quantitative Researcher at Osmosis Investment Management wrote in Responsible Investor “the aggregate net profit of the oil and gas industry is wiped out under a $70 carbon price.” Under Steffen’s pricing scenario, the global energy and transportation economy craters well before the $100/ton carbon price is realized, triggering a cascade of catastrophic consequences for most business plans built around $100/ton.

KPMG reported that 

“… the current weighted carbon price is around US$40, which is up from around US$20 near the end of 2020, according to the IHS Markit Global Carbon Index. It needs to remain in the US$40–80 range, according to leading experts. Otherwise, carbon pricing is not climate action, just virtue signaling.”

In June 2021, the International Monetary Fund (IMF) said carbon pricing “ambition varies country-by-country such that four-fifths of global emissions remain unpriced and the global average emissions price is only $3 per ton.”

I realize the purpose of planning is to anticipate future conditions potentially impacting the business. For long term capital investment planning in carbon-intensive industries, considering carbon costs may make sense because they could become a reality during the life of facilities being planned/built today. At the same time, it seems counterproductive to estimate costs that may be aligned with the current regulated trading market that only applies to the EU, while also thirty times higher than the current global average and three times higher than the most current national value in the largest tax market. Using numbers this far outside of current reasonable benchmarks risks setting up companies to make decisions (including missing good business opportunities) based on bad data and excluding near and mid-term opportunities to support needed energy and economic transition.

That brings us to a meaningful question as to whether the price will be determined by taxation or market-based solutions. The political nature of establishing taxes creates the likelihood of that being lower cost than a market solution – at least initially. In another piece, Eccles himself acknowledges political implications and difficulties: 

“… it is highly unlikely a meaningful carbon tax would ever be imposed on NOCs [national oil companies], so curbing their emissions will require other mechanisms. There is also the risk that such a tax on private-sector oil & gas majors will simply open the market up, at least in the short term, for NOCs until less expensive sources of energy are made easily available to their customers…. The other emerging difficulty is that a cut in oil and gas investment in the Western world will actually raise oil prices in the medium term and make the passage of a carbon tax a political impossibility even in the Western world.”

But markets are not wholly insulated from being politicized. After the EU ETS price hit its record high, EU parliament took up discussions on intervening to control it. The concurrent wave of global inflation and European gas crisis were top of mind for EU regulators to “fix”. At least one country representative put forth the idea of establishing a price cap on emissions to manage volatility. The UK’s new Cost Containment Mechanism could also be lumped into the category of politicization.

Moreover, markets by definition mean variable pricing, sometimes with dramatic swings in both directions that wreak havoc on models, predictions and business plans. As I mentioned above, EU carbon emissions futures hit a record high in anticipation of increased demand since the Glasgow agreement did not ban fossil fuels. The one thing about taxes – they are stable and can be planned for. Okay, maybe that is two things. In a December 2021 webinar, Desiree Fixler made a highly insightful comment that a carbon tax has another advantage of taking the issue out of the asset manager’s hands in terms of interpreting and predicting carbon market risk in investment analyses. Lowest cost will establish the market price. Right now, predicting avoided carbon cost is simply conjecture and could have unintended consequences in corporate investment analyses.

This insight – and much more – will be available to members upon launch.

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The Editor

Lawrence Heim has been practicing in the field of ESG management for almost 40 years. He began his career as a legal assistant in the Environmental Practice of Vinson & Elkins working for a partner who is nationally recognized and an adjunct professor of environmental law at the University of Texas Law School. He moved into technical environmental consulting with ENSR Consulting & Engineering at the height of environmental regulatory development, working across a range of disciplines. He was one… View Profile