The Iran War is causing havoc for energy markets and the economy. Oil prices have jumped while the head of the International Energy Agency says the impact of the Iran War is worse than the two 1970s oil shocks and the Ukraine War combined.

I have always been curious about how oil price shocks translate into the carbon ledger. The Iran War gives us a real-time natural experiment. Using public data, I’ve estimated the carbon signal impact so far, which equates to the annual emissions of Singapore.

Depending on how long it lasts, the cumulative carbon reduction could reach 1 billion tonnes, about the size of Japans emissions. That would make the Iran War one of the most significant carbon events since COVID.

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Measuring the Carbon Signal So Far

The Iran conflict is reducing carbon through two separate channels.

The first is mechanical: oil blocked at Hormuz does not reach refineries and does not get burned. The IEA estimates roughly 8 million barrels per day have been disrupted from global supply and 3 mb/d offset by strategic reserve releases, approximately 5 mb/d of oil is genuinely not being combusted. That is the supply channel.

The second is behavioural: Brent crude was $69 three weeks ago. Today Brent crude was at $112/bbl, up 62% from the pre-war baseline of $69.43. That means people are already driving less, airlines are cutting marginal routes, and businesses are switching where they can. But how can we try to quantify the impact?

Between 2014 and 2016, Brent crude collapsed from $99 to $44 with no recession, and global oil demand rose 3.3% in response1. Dividing that demand rise by the price fall gives a price elasticity of -0.04, meaning today's 62% price shock implies roughly 2.56 mb/d of reduced consumption from changed behaviour alone.

The demand and supply channels have two different CO₂ conversion factors. The supply channel uses 120.1 MtCO₂/mb/d/yr, derived directly from the the Global Carbon Budget 20252 data across all sectors. The demand channel needs a higher factor of 133.0 MtCO₂/mb/d/yr, because price-driven reductions concentrate almost entirely in combusted transport fuels rather than the ~10% of oil demand that goes into petrochemicals and other non-combusted uses.

So after 25 days since the war began, these two channels together have avoided approximately 55 MtCO₂.

Longer-term Scenarios

What about over the next 6-12months? The chart below shows cumulative CO₂ avoided if the partial closure continues. In every scenario, the supply channel carries three to four times more carbon reduction than the demand channel. This is not primarily a story about people responding to prices. It is a story about oil physically failing to reach markets.

The current partial closure (8 mb/d) held for a full year reaches 951 MtCO₂, near equivalent to Japans annual emissions - this would make it the largest carbon event since COVID. The war adds short-term noise to a global decarbonisation signal that was already turning - but it’s temporary.

A Third Channel: Iran’s Power Grid

On March 21 President Trump threatened to "obliterate" Iran's power plants if the Strait was not reopened within 48 hours. He has since issued a 5-day postponement pending talks, but the threat remains on the table. The power plant threat introduces a different kind of carbon signal, and the two should not be conflated.

Using Climate Trace’s facility-level emissions data3 for Iranian power plants, Iran’s thermal fleet emits ~207 MtCO₂/yr. Three scenarios follow Trump’s stated sequencing of “starting with the biggest”:

D1 (surgical, top 5 plants): 26.6 MtCO₂/yr net. The five highest emitters by measured output are Shahid Salimi, Ramin, Bandar Abbas, Damavand, and Shahid Rajaee. Notably, the largest plant by capacity (Damavand, 2,879 MW) ranks fourth in actual emissions because it is a modern combined cycle unit. Net figures account for Iran’s standard backup response of diesel and fuel oil generation at roughly 40% of lost capacity. Recovery: 12 to 24 months.

D2 (sustained campaign, top 15 plants): 63.0 MtCO₂/yr net. Recovery: 3 to 5 years.

D3 (full grid destruction): 99.1 MtCO₂/yr net. Recovery: 8 to 15 years.

The IRGC has stated that any strike on power plants triggers permanent Hormuz closure. If that escalation materialises, the combined first-year CO₂ reduction would exceed 1.1 Billion tonnes of CO₂.

During COVID, global CO₂ emissions from oil dropped 1.6 Billion Tonnes - so if things escalate the Iran War has 60% of the COVID oil signal.

Take-Home

The Iran War is having a measurable impact on global emissions with key drivers:

• Oil supply dominates the signal but that can be reversed in weeks.

• The power plants (if destroyed) are much smaller than the supply channel, but more permanent.

• The weakest carbon signal comes from the price of oil.

• Geopolitical shocks are not a substitute for structural decarbonisation. But the arithmetic of this one is a useful reminder of the scale of what structural transformation still has to deliver.

Thanks for reading.

Until next time, Ben

If you found this post useful please click “❤️ Like”. It helps others find my research. Thanks!

In my last post, I explained how traditional acute physical climate risk tools have been built for property insurers - creating blind spots for investors. By focussing just on the facility-level they miss enterprise-wide impacts from supply chains or customers and ignore company diversification and resilience measures.

Today I want to show you the alternative built for investors: a market-based approach that extracts storm vulnerability directly from how stocks actually performed following major extreme weather events.

Markets Price What Actually Matters

When Hurricane Florence hit the Carolinas in 2018, traditional insurance-based risk models would calculate damage and repair costs for substations and transmission lines. They’d produce facility-level loss estimates based on wind speeds, flood depths, and infrastructure age.

But that’s not what investors care about or experienced.

Over the coming months, stock prices reflected the true financial impact at the enterprise level: the cost of building repairs, insurance re-pricing, supply chain disruptions, pass-on costs to customers, any additional regulation, reputational impacts, and competitive repositioning. Everything that determines actual investment outcomes is reflected in reported numbers.

Our approach is one that is specifically built for investors: it captures this cumulative market impact by measuring systematic relationships between storm damage and stock performance across multiple events. We’re not modeling what should happen based on facility locations. We’re measuring what did happen at the enterprise level when climate disasters actually struck. That can then be used to understand the future.

How to Quantify Market-Risk to Storms?

The methodology builds upon recent event studies in the scientific literature focussing on how extreme weather events impact financial markets1. Hurricanes demonstrate particularly strong and persistent impacts with research showing firms in hurricane-prone regions experience 5-10% volatility spikes lasting up to three months after landfall.

The goal for our research is not to understand short-term volatility within firms, but explore the relative longer-term market impacts across industries, to be used as a baseline for future extreme events across many climate scenarios throughout the next 50-70years.

Our market-based approach follows four steps:

1. Identify major storm events: In the United States, there have been 23 significant weather disasters with >$5billion in damages from 2000-2024 (tropical cyclones, wildfires, floods)

2. Measure actual damage: Total economic losses from each event

3. Track stock performance: Excess returns relative to the S&P 500 over 4 to 26 weeks following each storm (this timeframe captures both short-term restoration costs and any longer-term impacts reflected in quarterly earnings reports from supply chain pricing or revenue hits from customer demand)

4. Extract sensitivity patterns: Statistical analysis reveals which industries demonstrate consistent negative relationships between storm damage magnitude and stock performance

The result: storm damage functions that assign storm sensitivity parameters to companies based on how they actually performed historically, not theoretical facility-level exposure.

Example: Electric Utilities

We’ve conducted this analysis across 37 industries with direct weather exposure. To show you how it works in practice, let me walk you through the Electric Utilities industry as a detailed example.

Electric utilities make a good case study because they face direct physical exposure to multiple storm types (hurricanes, wildfires, floods), operate infrastructure that must function during disasters, and have transparent financial reporting that reveals how storm costs flow through to investors.

We found that Electric Utilities demonstrate significant storm vulnerability, with each additional billion dollars in major storm damage corresponding to a 0.11 percentage point decrease in industry stock performance relative to the S&P 500 over the subsequent 26 weeks.

The statistical evidence is strong: 99.4% probability this relationship is truly negative, and storm damages explain about 24% of the industry’s excess return variation during major weather events.

The scatter plot shows industry vulnerability across multiple storm types. Tropical cyclones (blue circles) are the largest and most frequent events. You can see how events causing $5-30 billion clustering around positive and negative performance (negligible impact). However beyond the $50billion event threshold, negative performance dominates for electric utilities.

Forward-Looking Applications

These damage functions across industries enable practical portfolio risk assessment:

Scenario Analysis: If Category 4-5 hurricane damages increase 30% by 2050, the historical damage model provides a quantifiable basis for estimating amplified portfolio vulnerability.

Stress Testing: Test portfolio resilience under tail-risk scenarios (e.g., $200 billion hurricane) using empirically-validated damage functions rather than theoretical models.

Regulatory Compliance: Climate mandates around the world require quantifiable climate risk disclosure. Market-based damage functions provide defensible, statistically robust metrics without requiring proprietary facility data most companies never disclose.

Investment-Native Physical Climate Risk

We built this new approach because traditional tools that were designed for property insurers, create systematic blind spots for investors.

Institutional investors managing diversified portfolios need to understand:

• Systematic vulnerabilities affecting multiple holdings simultaneously

• Enterprise-wide resilience after companies deploy risk management

• Supply chain and competitive dynamics transcending facility locations

• Financial materiality driving actual investment performance

We believe market-based damage functions deliver quantifiable, statistically validated storm sensitivities extracted from how companies actually performed when disasters struck, providing universal portfolio coverage without requiring data most companies never disclose.

This is investment-native climate risk: anchored in observable market outcomes, transparent in methodology, directly applicable to portfolio decisions.

When to Use Traditional Geo-location Methods?

Although the market-based methods will cover the largest materiality for the vast majority of investments for multi-asset portfolios, traditional location-based approaches are still important for site-specific precision for concentrated assets whether for insurance underwriting at facility-level or for real estate.

Here’s a guide for institutional investors on what methods will work best:

For Equity Investments (Public & Private):

• Diversified companies → Use market-based methods

• Single-location companies → Use market-based methods with location-based risk to support if data available

For Specialized Asset Classes:

What do you think?

Does this market-based approach help address the blind spots in traditional physical risk tools? Are there other industries where you’d want to see similar storm vulnerability analysis?

FYI: I have a detailed research whitepaper coming out soon on this new approach - respond to this post if you would like a copy and will send it through..

Until next time,

Ben

Portfolio emission footprints are an important first step to understanding climate transition risk, but provide absolutely nothing useful for investors making useful financial decisions. Fundamentally, the questions every investment team must ask are these:

Which of my investments are going to be materially hurt by decarbonisation? What investments will thrive in a low-carbon world? What internal carbon price should we set moving forward to answer question 1 and 2?

The only way to answer these questions is to financially stress-test your investments over a range of different carbon pathways and prices. In this week’s newsletter I want to take you through this for the S&P500, as an example.

1. Quantify your financed footprint

S&P500 Footprint: ~13billion tonnes

For any carbon stress test, you need have complete coverage of your current emissions footprint. Using a combination of reported emissions and estimates via Emmi machine learning, we estimate that during 2024, the S&P500 directly emitted about 1.16 billion tonnes (Scope 1) of CO2e, which is ~10% of company emissions globally1. Including Scope 3 estimates, the overall footprint is ~13billion tonnes.

2. Source global carbon scenarios

NGFS Carbon Budget Scenarios: 7

In this example we use the NGFS climate scenarios data which can be seen to diverge significantly over the next five years. The Net Zero 2050 pathway shows the sharpest decline by 2030 with a 26% reduction to 24.8 GtCO2, with carbon prices surging from $15.6 to $128.6. In contrast, the Current Policies scenario shows a slight increase, maintaining a $10 carbon price. The NDCs and Fragmented World scenarios show modest reductions of 5-7%, with carbon prices remaining below $21, while the Below 2°C pathway achieves a 15% reduction with prices rising to $66.8.

These carbon budgets and carbon prices are needed to stress-test portfolios.

3. Quantify emission reductions needed to avoid carbon costs

Each company has a ‘fair share’ of the global carbon budget which they are allowed to emit under each carbon scenario moving forward, but how do we distribute the budget fairly?

Apple, for example, emits 30million tonnes of carbon each year, similar to Porsche. But Apple is 25 times larger financially. To fairly distribute carbon budgets, we need to quantify a company's carbon financial performance relative to global budgets for a particular scenario. At Emmi we apportion each company’s carbon budget using carbon efficiencies of revenue, enterprise value, along with assets and liabilities².

If a company is already at or below the carbon budget allocated for a given scenario, it is operating carbon efficiently and therefore has no carbon costs. This approach is consistent with setting a ‘cap’ for companies operating carbon budget, like the trading schemes in place around the world.

As carbon budgets get tighter (caps get lower), however, there will be a point at which its carbon emissions result in material carbon costs to the company. The reductions required to avoid those carbon penalties are calculated for each holding, aggregated to the portfolio level.

For the S&P500 to have no carbon costs by 2030, emission reductions of ~20% will be needed to be aligned with a (1.5°C) Net Zero scenarios. Even under business-as-usual Current Policies scenario, on average S&P500 companies will need a 9% reduction by 2030 to avoid any carbon costs. What this means is that a proportion of the S&P500 is operating under very low carbon efficiency even in a world where future emissions don’t increase.

4. Quantify the carbon liability in $

If there is a carbon gap between current emissions and the allocated carbon budget for a given scenario, this carbon overspend is then priced using carbon prices moving forward. We call this a ‘Potential Carbon Liability’, which is also converted into a percentage maximum downside loss on the company’s enterprise value.

Carbon prices by 2030 under the (1.5°C) Net Zero scenarios are high (over US$100), so the liability across the S&P500 translates to US$7trillion annually. For the 2°C scenarios, the liability drops to over $2trillion, while even the business-as-usual Current Policies scenario liability is close to $1trillion by 2030.

How much value of the S&P500 would be eroded from those liabilities by 2030? About 15% under 1.5°C scenarios (Net Zero), 5% under 2°C and even 1.5% devaluation if existing policies were maintained.

The company liabilities estimated above are large, but likely the worst-case because many companies would pass on the carbon costs to the consumer. In reality, market power will determine whether it is the supplier or consumer that pays the price, creating big risks and opportunities.

Carbon Stress Testing in One Chart

Taking the analysis above and combining all scenarios (including the IPCC) and plotting the annual potential carbon liability (PCL) of the S&P500 by 2030 as function of carbon prices gives the investor the best overview of the range of scenarios, prices and the minimum and maximum losses that can be expected.

Most importantly it allows investment teams to manage where they expect carbon prices to be in 1-year, 3-years or 5-years, and then understand the liabilities for their investments.

For the S&P500, as the carbon price increases, the carbon liabilities increase - but what is most interesting to me is that the market shadow price of carbon is about ~US$10 today (that will be another post), so even under today’s prices, there is a potential $1trillion liability across this major market. That means, every investment team should look to introduce an internal carbon price when considering investments (more on that in a later post too).

Key take-ways for Investment Teams

1. Portfolio foot-printing is the start, but tells you nothing about the financial downside for your investments

2. Carbon stress testing your portfolios will give you the knowledge about your financial exposure and how to manage for future carbon pricing

3. For the S&P500 even the business-as-usual carbon price of $10 gives up to $1trillion annual exposure by 2030

4. Introduce an internal price on carbon for your investments even $10 - if not, start thinking about it and I’m happy to help present the above analysis to your team if that helps.

Until next time,

Ben

I’m excited to release a new global research analysis that quantifies the climate transition risk within the corporate bond market.

Covering $24 trillion of outstanding debt, we examine the carbon pricing impact of climate scenarios on this debt and how much is exposed to financial risk. We also explore ‘Green Bonds’ and if they are effective for investors.

Key Findings:

• By 2030, over US$1 trillion of corporate debt will face extreme financial liability under NGFS Net Zero 2050 scenario, covering ~4% of the listed corporate bond market.

• Electric Utilities, Oil & Gas and Aerospace & Defence have the highest climate transition debt exposures.

• Over $200 billion of corporate debt will face significant exposure even under the more modest Paris-aligned 2°C scenarios.

• We find 18% of 'Green bonds' may also carry significant climate transition risk, and while intended to support environmentally friendly projects, do not alone reduce climate transition risk for investors.

Full Report

You can download the full white paper here:

If you have any questions about the analysis or would like to speak with me directly, just reply to this from your inbox.

Until next time,

Ben

Scope 3 emissions for a company are those indirectly produced by their customers and suppliers. So for a financial institution, Scope 3 is dominated by the direct emissions produced by their portfolio companies. For a gas company, Scope 3 is dominated by the burning of their products by their customers.

The new ISSB standards are mandating Scope 3 disclosures (remember you can get our free ISSB template here). The European Union, California, UK, Singapore, Australia, and New Zealand are requiring Scope 3 disclosures for both public and even private companies. The US SEC is currently discussing whether or not to mandate these disclosures too.

For investors, Scope 3 exposures are now important. What companies and sectors are most exposed to emerging Scope 3 mandates? In this weeks newsletter, I provide a simple way to look at Scope exposures using the Emmi emissions data for +45k public companies.

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Quantifying Scope 3 exposures

In the past decade, regulators have focused on disclosures and reductions in a company’s Scope 1+2 emissions (direct operational emissions). For instance, in Australia, only the top 200 companies with high operational emissions are subject to emission caps. Companies that have high Scope 1 emissions include fossil-fuel electricity generation, steel production, or cement manufacturing - so regulators have focussed on them. However, service-based industries like finance, technology, and healthcare tend to have lower Scope 1 emissions and therefore faced minimal carbon risk in the past. With the latest regulation mandating disclosure of Scope 3 emissions, we now need to better understand which companies and sectors will be most affected.

Scope 3 Exposure Index

In order to analyse Scope 3 exposures, we can compare companies where Scope 3 emissions make up a larger percentage of their overall footprint compared to their controllable operational emissions (Scope 1 + 2). To determine this, I have calculated a Scope 3 exposure ratio by dividing Scope 3 emissions by the sum of Scope 1 and 2 emissions for each company.

A lower Scope 3 exposure ratio indicates that a company's operational emissions are greater than the indirect emissions from their customers or suppliers. A higher Scope 3 exposure ratio suggests that a business is more susceptible to carbon exposure from their customers' operational emissions.

I’ve used Factset Sector classifications to show the mean Scope 3 exposure index across all 20 sectors (blue bars) and have also plotted the sector total Scope 1 footprint (red line).

The largest average Scope 3 exposures (>100) are for the Non-Energy Minerals, Finance and Utilities sector, while Transportation, Government and Communications have the lowest Scope 3 exposure. It’s somewhat misleading given the diversity of companies within each sector since cement is found in the broad sector of ‘Non-Energy Minerals’. So I’ve gone deeper to show the Scope 3 exposure index amongst the 130 Factset industry categories (chart below). This gives much clearer perspective - although apologies that you may not be able to read all the Industry classifications!

Overall, with the exception of 'Electric Utilities', industries with a higher Scope 1 footprint (red line) tend to have lower Scope 3 exposures (blue bars). In particular, banks, insurers and precious metals all have >300 Scope 3 exposures. You can read more why financial institutions have higher Scope 3 exposures in my previous article here.

On the other hand, heavy industries like Steel, Construction, Chemicals, Aluminium, Railroads, and Trucking have at least 10x lower Scope 3 exposures. This means the shift towards Scope 3 mandates will have lesser relative impact on these heavier industries than other industries.

Industries such as Coal and Integrated Oil do have lower scope 3 ratios than other industries, but it’s important to recognise they are being compared to a much larger scope 1 base. The scope 3 exposure ratio is most helpful when comparing with order of magnitudes of the underlying scope 1 emissions. Understanding the number of companies within a particular industry that share the emissions is also important. This all highlights the importance for investors to understand the level of risk within Scope 1, 2 and 3 - which I will write about in my next newsletter.

There is a clear inverse relationship between Scope 1 footprint and Scope 3 exposures (chart above). As carbon pricing and consumer demand for low-carbon products continue to shape the economy, sectors that are not typically considered high-risk in terms of carbon emissions will see their value decrease proportionately with the inclusion of Scope 3. For example, industries like Healthcare and technology may be classified as low-carbon, but with Scope 3 inclusions, their carbon footprint becomes more exposed compared to Scope 1 emitting sectors. As a next step, it’s therefore important to also analyze how potential climate scenarios and carbon pricing may materially impact these industries in the future (which will be discussed in my next newsletter).

Scope Exposures: Portfolio Example

Say we had a portfolio with three companies that included Airbus (European Aerospace Manufacturer), Linde (European Chemical Company) and Southern Company (US Electricity Utility). Total emissions are ~630 million tonnes in 2022 and lets say we’ve invested equally into each company across the fund. What happens to the portfolio carbon exposure if including Scope 3? I’ve created a bubble chart that shows the relative exposures across each Scope within each company of the portfolio.

As you can see, the carbon exposure depends heavily on the type of Scope that is taken into account. When only Scope 1 emissions are considered, Southern Company, a gas utility, holds the largest share of exposure across the portfolio. However, when Scope 2 is included, the exposure shifts to Linde, a chemical company that heavily relies on electricity in their operations.

Notably, without taking Scope 3 into consideration, the main drivers of exposure are companies that directly emit Scope 1 emissions, such as utilities and chemical companies. But once Scope 3 is factored in, Airbus emerges as the most significant contributor to exposure, as most of their emissions originate from downstream usage of their products by governments and airlines. Including Scope 3 makes a huge difference to the exposure of this portfolio.

Scope 3 is not just an added mandate for reporting standards, it will fundamentally alter where climate transition risk lies within a portfolio. In a follow-up newsletter I will go into the details in how including Scope 3 fundamentally alters the carbon risk and liability landscape for investors.

Thanks for reading.

Ben

In my previous newsletter on climate scenario analysis, many readers were unaware of the new ISSB climate reporting mandates, how imminent they are in some countries and what to do. So in this weeks newsletter, I thought it would be helpful to share some expected timeframes, offer first steps to prepare and also provide a comprehensive template for investors.

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What is the ISSB and why is it a big deal?

In June 2023, the International Sustainability Standards Board (ISSB) published a landmark climate standard known as the IFRS S2 Climate-related Disclosures. The ISSB is part of the International Financial Reporting Standards (IFRS) foundation, which is the global body that develops accounting standards that most major jurisdictions adopt as part of their accounting standards. The objective of IFRS S2 is to mandate companies into revealing information about their climate risks and opportunities.

For the first time reporting entities will have a legal obligation to report their climate information to the same level of quality as other financial information in their general purpose financial reports.

Who is impacted and when?

Australia: The Australian government plans to require businesses and financial institutions to report their climate-related financial information as early as 2024 and will “be aligned as far as practicable with the final standards developed by the ISSB”.

New Zealand: Climate reporting is already mandatory in New Zealand for certain large entities and are based heavily on the Task Force on Climate-related Financial Disclosures (TCFD) framework, which nows falls under the ISSB.

Singapore: The government announced in July it will require public companies to report on climate using the ISSB standard beginning in FY2025, and FY2027 for large private companies.

United Kingdom: The government announced on 2 August 2023 it “has been a strong supporter of the ISSB since its launch” and will be based on the ISSB standards.

Hong Kong: Hong Kong Stock Exchange (HKEX) has proposed making climate related disclosures mandatory for all issuers, requiring ISSB reporting from 1 January 2024

.

First steps to prepare for ISSB

1. Are you a reporting entity?

In general large, listed and financial institutions are the entities required to report under ISSB, but those definitions vary for each country. Singapore for example, is mandating even large private companies by 2027.

2. Get your climate data pipeline ready

Under ISSB, entities must report their climate-related financial disclosures alongside their financial statements for the same reporting period.

This is challenging since typically climate analysis takes months and significantly lags financial reporting by 6-18months. At Emmi we have solved this headache for investors by quantifying and integrating climate analytics with the latest company financial disclosures.

If not using Emmi, you need a climate analytics provider that will allow you to report climate disclosures at the same time as your financial disclosures.

2. Financed emissions coverage

You need to quantify your financed emissions footprint - since the ISSB requires Scope 3 disclosure for investors.

There are huge data gaps in carbon, but don’t worry - at Emmi we use award-winning machine learning predictions to help you fill the carbon gap across all asset classes in days, not months. You can read more about our financed emissions module from a large Asset Owner case study here.

3. Scenario Analysis

ISSB mandates that companies conduct climate-related scenario analysis to evaluate their climate resilience.

See my previous newsletter here on how you can achieve this using the ASX300 as an example.

4. Transition Plan

ISSB requires companies to disclose details of their transition plans, such as critical assumptions and how they plan to resourcing activities outlined in the transition plan.

These plans must be specific enough to illustrate a company's overall strategy for transitioning to a lower-carbon economy, providing targets and actions for reducing greenhouse gas emissions.

ISSB Reporting Template for Investors

The ISSB climate related disclosures require information on current climate exposures and how entities manage for future climate risks and opportunities. Some elements of IFRS S2 require qualitative descriptions of an entity’s process, but a large majority of IFRS S2 requires quantitative information like scenario analysis.

To help investors, we’ve gone through the IFRS S2 in detail pulling out the clauses where descriptive and quantitative analysis is needed and filling in the types of analysis you would need to report under ISSB. We provide a suggested structure that can be followed, explaining where entity specific narratives/qualitative information is needed.

You can sign up for our free ISSB template below and we'll walk you through everything you need.

Get your free ISSB template

Hope this helps and if you want to contact me you can just reply to this in your inbox..

Until next time.

Ben

Big news came in on June 26th with the International Sustainability Standards Board (ISSB) releasing their climate disclosure standards here. In July, the ISSB also announced they are taking over the Task Force on Climate-related Financial Disclosures (TCFD) reporting. So that means no more TCFD, just ISSB climate disclosures, with many national accounting bodies taking on ISSB in 2024. So what is needed?

In terms of the type of disclosures needed for ISSB alignment, there are four sections ‘Governance’, ’Strategy’, ‘Risk Management’, ‘Metrics and Targets’. You can get a detailed overview on each section here on our website.

Many investors have calculated their Scope 3 financed emissions footprint but under ISSB, the new disclosures specifically require investors to declare climate risks in particular: “The amount and percentage of assets vulnerable to transition risks – i.e. risks arising from transition to a lower-carbon economy”. This is where you need to run multiple climate scenarios through your portfolio to understand and disclose that climate risk.

In todays newsletter I wanted to give you a guide to answer those ISSB questions using the ASX300 portfolio as an example.

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How to quantify climate transition risk?

You may have already quantified your financed emissions footprint (if not reach out). Estimating footprints are important first steps, but they tell you nothing about whether an asset or portfolio is a risk to the carbon transition.

Carbon transition risk really comes down to understanding how dependent an asset is on producing carbon emissions per unit of economic value.

Steel companies or airlines, for example, must produce lots of carbon emissions in producing and selling their products - they have no way around it, at least today. On the other hand, timber companies or trains are more carbon efficient resulting in lower carbon transition risk.

But aside from qualitative hand-waving arguments, how do we quantitatively assess carbon transition risk? Within a sector, what makes one company less risky than others? That is where combining climate with finance is important.

Consider two companies making widgets that both emit 1million tonnes each year. One company is 100 times the size of the other, meaning it has 1/100 of the carbon efficiency as the other company. Calculating the carbon efficiency (using Enterprise Value or Revenue) is a common way to compare carbon efficiencies of companies. I’ve plotted the carbon efficiency of revenue for the ASX300 in Australia using our latest 2023 footprint predictions at Emmi and broken it down per sector.

The range of carbon efficiency dramatically varies from near 0 for Scope 1 for financial companies to more than 10,000 for Scope 3 energy companies. Where is the cutoff for carbon risk amongst this huge range of carbon efficiencies? And how do you adjust company valuations due to emerging carbon prices?

That is where integrating climate scenario analysis is important. It can guide us on how global emissions can change, how carbon might be priced and ultimately what the financial implications will be for each company, asset and portfolio.

So in order to disclose the amount and percentage of assets vulnerable to climate transition risks under ISSB you need four things:

1. Footprint: Financed emissions footprint for each asset in your portfolio - including Scope 1 and 2 at least (see my earlier post on how to do this)

2. Scenarios: Choose 2-3 scenarios covering low carbon world (Net-Zero or below 2°C) and Hot-house world (3-4°C) - see below

3. Value-at-Risk: Translate footprints for an asset into financial terms like Potential Carbon Losses or Value at Risk (VaR) for any given climate scenario (see my earlier post on how this is done)

4. Portfolio: Aggregate those potential carbon losses across your portfolio to report on the risk

What climate scenarios to choose?

Climate scenarios have been developed using a variety of global climate models that quantifies alternative storylines about how the world might develop over the coming century. Each scenario is developed with different assumptions for population, economic growth, technology advancements, energy demand/supply, land-use changes and greenhouse gas emissions.

Some of the most prominent scenarios are the Intergovernmental Panel on Climate Change Shared Socio-economic Pathways (IPCC-SSPs), the Network for Greening the Financial System (NGFS), and the Principles for Responsible Investment Inevitable Policy Response (PRI-IPR).

There are many scenarios to choose from and the ISSB is yet to prescribe scenarios, however as a minimum, a low carbon ‘Net-Zero’ scenario and a ‘Hot-House’ scenario is needed to give the adequate spread of climate risk.

What does carbon look like in future?

To give you a perspective of the different future carbon budgets under NGFS, I’ve plotted the global industrial carbon budget in billions of tonnes below for all scenarios. The ‘Current Policies’ scenario is characterised as a ‘Hot-house’ scenario with carbon increasing until 2080 with 3°C warming (red-line). Meanwhile the ‘Net-Zero’ and ‘Below 2°C’ scenarios follow a steep decarbonisation by 2050 that limit warming to 1.5-2°C (light and dark blue lines).

How do your assets get impacted under each scenario?

Each climate scenario has a future carbon price projected which depends on a range of factors. By 2030, those prices range from $10 to $180 per tonne depending on the scenario. Under NGFS Net-Zero scenarios carbon prices reach $400-500 tonne by 2050 (see below).

So how does that future carbon price impact an asset? It entirely depends on whether an asset is emitting under their carbon budget allowance for a given scenario. The amount of carbon a company is emitting versus their carbon budget allowance is known as the ‘carbon gap’ or carbon over-spend. The carbon gap is where potential carbon costs/liabilities are expected under that scenario.

The key takeaway:

If a company doesn’t need to reduce emissions, then there is no flow-on carbon liability or financial risk from carbon prices.

One of the biggest challenges in performing climate scenario analysis is translating climate scenarios into financial impacts attributed within each sector. Airlines for example are under the ‘Transportation’ sector within the NGFS scenarios which have a very different carbon budget trajectory than other sectors like ‘Services’.

So in order to understand the financial impact of each scenario for a given portfolio, sector carbon budgets are required for each that can be mapped specifically down to the company level. At Emmi we have mapped all 46,000 publicly listed companies into aligned sectors, allowing company level carbon budget allowances for any climate scenario.

So lets take a look at the largest 300 companies in Australia (ASX300) as an example.

ASX300 Case Study

Here’s the summary for the ASX300.

How much does the ASX300 need to decarbonise?

The first thing to quantify for each portfolio holding are their decarbonisation reduction targets (or carbon budget allowances) under various climate scenarios. Although the reductions needed vastly change depending on the carbon efficiency of a particular company, the spread of the reductions required by 2030 are shown below.

Some companies don’t have reduction requirements so don’t have any risk, but the majority of companies are within the -20 to -65% by 2030 range to be aligned with either the Net-Zero or NGFS 2°C scenarios. And then their are other companies needing greater than 50% reduction by 2030 to be aligned with a low-carbon scenario. Interestingly, most companies will even need to decarbonise between 10 and 25% by 2030 in order to be aligned with the ‘Current Policies’ scenario.

How do decarbonisation needs change for each sector and scenario?

I’ve charted these for each sector on ASX300 below across IPCC and NGFS scenarios. For the Utilities and Energy sectors, deep decarbonisation is required for all scenarios, while for other sectors, the spread is quite broad.

You can see for the Financials and Healthcare sectors, the NGFS scenarios have the most decarbonisation requirements in comparison to the IPCC. That is because some of the carbon allowances in carbon efficient sectors like Financials and Healthcare are shifted to the hard to abate sectors (like transport and energy) under the NGFS. There’s lots to digest in this chart, but it gives a good perspective of the decarbonisation requirements for sectors under various climate scenarios.

What’s the amount and percentage vulnerable to transition risk?

If carbon were priced today, how much of your capital could be at risk now, and how will this change over time as carbon becomes costlier under different scenarios? That is what ISSB is looking for. Typically the metric used to quantify transition risk is called ‘Value at Risk (VaR)’. We refer to a similar metric at Emmi called ‘Potential Capital Loss (PCL)’ and is a measure of how much enterprise value is eroded over time from carbon costs (see how we do this here).

For the ASX300 companies, the amount and percentage of assets vulnerable to the transition differ significantly between each scenario, as shown below.

Under the Net-Zero scenarios at least 30% of the ASX300 companies value is at risk amounting to an average company liability of $1.7billion per year by 2030. For the 2°C scenario, the potential capital loss drops by more than half to 14% and $700million average company liability. Meanwhile for the Current Policies scenario, the amount and percentage vulnerable to the transition drops to just 3% and potential carbon liability of $129 million on average.

As you would expect, there is a large tail in the breakdown of the sectors most financially vulnerable to the climate transition. Those highest risk companies are found in the Utilities, Energy, Materials and Industrials sectors, with some even vulnerable under the Current Policies climate scenario.

Climate Scenario Analysis for your Portfolio?

In order to inform ISSB reporting, quantifying how various climate scenarios will impact your investments is becoming mandated by 2024 in most jurisdictions. The ASX300 example above was a brief run through of how our climate risk engine at Emmi provides all the science-backed analytics and insights needed for your ISSB reporting. Reach out if you want to find out more on how we can help for your portfolio.

Until next time.

Ben

Carbon pricing, whether formal or informal is expanding. A new analysis from the World Bank shows there are now 73 Carbon Trading Schemes or carbon taxes across the world covering 23% of global greenhouse gas emissions. In reality however, a shadow carbon price is already in-effect at least in the advanced economies, with consumers heavily shifting away from high-carbon producing goods.

So what’s the best way to quantify the impact of a carbon price on your investments? In this newsletter I wanted to share our methods at Emmi using a fictional company to help..

If you want to see a real-world example of a company to see every stage of this methodology played out, we can walk you through a publicly listed company as an example. Get in touch with us here or just reply to this post.

Get in touch

Acme Steel Inc.

Acme Steel is a 6,000 person manufacturer, based in Australia. OK, so what are the steps needed to understand their current and future carbon liabilities?

1. Estimate their carbon footprint

Like 90% of the market, Acme haven’t yet reported their carbon emissions - so we can estimate their emissions via their business metrics, like revenue and geography, to predict Scope 1, 2, and 3 emissions. We do this using Machine Learning. Our models are trained on 6,000 public companies that have reported and verified emissions, which can then be used for any company in the world. You can read more how we do that here.

Acme Inc. has $10billion in revenue, is based in Australia within in the Materials sector with a capital expenditure of $500million and net property, plant and equipment value of $4billion. Based on these factors, Emmi estimates it has 8.6million tonnes of Scope 1 emissions, 1.5million tonnes of Scope 2, and 14.3million tonnes of Scope 3 emissions for the year 2023. In total, a footprint of 24.4million tonnes.

2. Allocate carbon budgets from climate scenarios

We need to quantify Acme's carbon budget for today and the future. We'll use the IPCC's 1.5°C scenario (Net-Zero emissions by 2050). How do we allocate global budgets down to each company for that scenario?

2.1 Assessing a companies carbon efficiency relative to the world

Apple, the company, emits 30million tonnes of carbon each year, similar to Porsche. But Apple is 25 times larger financially. To fairly distribute carbon budgets, we need to quantify a company's carbon financial performance relative to global budgets for a scenario.

We assess a company's carbon efficiency through five factors: Revenue/Carbon, Market Capitalisation/Carbon, Enterprise Value/Carbon, Assets/Carbon and Net Assets/Carbon. Acme's efficiency is then benchmarked against the global carbon efficiency requirements using GDP, Global Wealth and Global Debt.

For example, Acmes Scope 1 carbon efficiency of revenue is $1,163 per tonne of carbon. The global benchmark for a 1.5°C scenario is $3,571 (GDP/Global carbon budget). Since Acme's rate is lower, they need to increase the amount of earnings per ton to avoid penalties for being above the 1.5°C scenario budget. They need to reduce their emissions by 67% to be at the "on-budget" ratio. We calculate this for the same 5 economic factors across Scope 1, 2 & 3 to gain a comprehensive understanding of the company's reduction requirements.

When considering reductions requirements in the context of potential carbon liability, we ignore any efficiently performing emissions scopes to void any upside for assets that could emit more because they are currently tracking underneath the carbon budget. We focus on risk of not reducing, not reward for increasing emissions to match a budget.

2.3 Assessing a companies financial resilience to carbon costs

Assessing a company's carbon efficiency is an important first step, but it doesn't tell you if the company can withstand new carbon costs. The next step is to understand when carbon costs significantly erode the value of the company, or carbon resilience.

To assess this carbon financial resilience we consider 7 other factors:

1. Adjusted EBITDA vs EV multiple, to assess Enterprise Value erosion as a result of new carbon costs

2. Adjusted earnings to Price earnings ratio, to assess Market Cap erosion as a result of new carbon costs

3. Dividend erosion, to assess the asset’s continued ability to pay dividends with new carbon costs

4. Debt to EBITDA, to assess the asset’s continued ability to service it’s debt with new carbon costs

5. EBIT coverage ratio, another way assess the asset’s continued ability to continue to service it’s debt with new carbon costs

6. Assets to liabilities, to assess the asset’s ability to pay it’s liabilities with it’s assets with new carbon costs

7. Cashflow from operations , to assess how effected the asset’s cashflow would be with new carbon costs

We combine the 5 carbon efficiency factors and 7 financial resilience factors into one emissions reduction number and carbon allowance for any given climate scenario which gives a comprehensive measure of the budget and reductions needed for a company to avoid financial downsides from new carbon costs.

3. Calculating the carbon ‘over-spend’

We now have the allocated company carbon budgets for the 1.5°C scenario until 2050, which allows us to calculate the carbon gap or ‘over-spend’ which is done by subtracting allocated budgets from todays actual emissions (assuming no change). Subtracting their total emissions of 24.4million by their allocated carbon budget of 15million tonnes, means they have a ‘Carbon overspend’ of 9.4 million tonnes CO2e for 2023. These are the emissions that will incur a carbon price under that scenario, creating an annual cost and value erosion over time. Projecting today's emissions estimates into the future reveals how this gap widens over time.

4. Using carbon prices to calculate the carbon liability

For any future climate scenario, there is an associated carbon price. These carbon prices are then applied to the Carbon Overspend in order to answer this question: How much of a companies value, in todays terms, is eroded if there was a price on Carbon for a given scenario?

Given Acme has an overspend budget of 9.4million tonnes, the $145 carbon price implies a carbon liability of $1.363billion in 2023. This annual carbon cost will hit the bottom line, so we deduct it from the companies operating performance or EBITDA. So Acmes carbon-adjusted EBITDA is $1.6b - $1.363b = $0.237billion.

We use an EBITDA multiple as a quick way to re-value a company today or into the future. This is a financial ratio that compares a company's Enterprise Value to its annual EBITDA - for Acme that would be $8.2b/$1.6b = 5.125. So their new 2023 Enterprise Value would be expected to be $0.237b x 5.125 = $1.21b. In percentage terms, this equals (1 - 1.12/ 8.2) = 85% erosion of EV in 2023. This is the percentage value erosion reported as Potential Carbon Liability.

In 2030, the carbon price for a 1.5°C world has increased to be $218 per tonne while their fair-share carbon budget allocated has reduced to be 10 million tonnes. Without any changes to Acme’s emissions (24.4million tonnes), their annual carbon cost is $3.14billion in 2030, reducing their carbon-adjusted EBITDA to zero and effectively eroding the entire Enterprise Value of Acme due to carbon pricing.

NB: As an investor, you own a portion of the company, so the above calculations need to be scaled with financed emissions using your weight allocations across your portfolio, then aggregated at the portfolio level to quantify your total carbon liability at the portfolio level

The importance of scenario analysis

The future is uncertain and carbon prices could bite quickly or be gradual. To understand the impact of carbon on your investments, stress-test them across possible future scenarios. This will help identify potential downsides and whether targets are achievable.

What would happen to Acme in a 2°C world or one with delayed transition? What happens when sectors get different carbon budgets? Or what about different asset-classes? How does fixed-interest, infrastructure or sovereign assets get impacted by different climate scenarios and prices? That is where Emmi helps by providing you to quantify a range of future scenarios and prices to your investments. Reach out if you want to find out more on how we can help.

Until next time.

Ben

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