Introducing Carbon Beta: What pricing carbon means for investors

For the first time ever, BlackRock is enabling all portfolio managers to stress test their portfolios to future carbon price scenarios. Andre and Mike explain why.

Investors already know that the transition to a low-carbon economy matters to their portfolios. But measuring how it matters has been incredibly difficult – until now. In order to answer this pressing question, BlackRock Sustainable Investing has developed a new cutting-edge investment metric called Carbon Beta. Simply put, it’s a way of measuring a company’s sensitivity to carbon prices.

Carbon Beta, which is integrated into our risk and investment management technology Aladdin, is designed to help investors better understand the energy transition. Using Carbon Beta, every portfolio manager at BlackRock can review the impact of future carbon price scenarios on their investment portfolios. This enables us to better understand the risks and opportunities of carbon pricing and deliver our clients solutions aligned with the low-carbon transition.

Carbon pricing gains traction

Why is this metric so urgent for investors? Because carbon pricing mechanisms—such as carbon taxes and emissions trading schemes—have taken center stage in the global policy debate. In order to manage risk and achieve out-performance, investors need to understand the different ways in which carbon pricing policies—and carbon prices more generally—could affect their portfolios.

The idea of pricing carbon and allowing market forces to reduce overall emissions is not a new one. In fact, 57 carbon pricing initiatives are now in effect or scheduled for implementation globally, up from 51 in April 2018. These initiatives currently cover around 20% of global greenhouse gases, more than five times what was covered in 2010. See chart below.

Despite the overall growth in interest, many jurisdictions have yet to take action, and both the amount and set price of emissions covered are still too low to meet the objectives of the Paris Climate Accord. In light of the United Nation’s warning last year–that without dramatic new limits on emissions, global temperature increases in the next decade could produce alarming rates of food scarcity, mass migrations, and instability as soon as 2040–more regulatory attention is warranted.

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Anticipating increased carbon pricing activity, some financial institutions and emissions-intensive industries are starting to apply internal carbon pricing in their investment decisions, consistent with risk guidelines provided by the Financial Stability Board’s Task Force on Climate Related Financial Disclosure. This summer, BlackRock and a group of global energy CEOs —including representation from ExxonMobil, BP, Royal Dutch Shell, Total, Chevron and Eni—joined the Pope at the Vatican in calling for economically meaningful prices to carbon to address global climate change. Due to these underlying forces, we anticipate more carbon pricing regulation to be implemented in coming years.

Introducing BlackRock Carbon Beta

To help BlackRock’s portfolio managers better understand the implications of regulation, we introduced Carbon Beta, a new approach quantifying a company’s sensitivity to carbon prices. Our assessment goes beyond a company’s carbon footprint by also considering its ability to absorb or pass through costs to customers and its potential to capture upside through new low-carbon technologies. We believe this approach provides a more holistic assessment of a company’s risk and opportunity in a low-carbon environment.

When applying our analysis to a global equity portfolio we find that–while many sectors may lose value overall–the pricing of carbon creates bright spots, or pockets of new investment opportunity rewarding carbon-efficient producers and incentivizing new low-carbon technology production. Furthermore, we also find risks and opportunities within sectors, suggesting that regardless of business-type, there will be investment winners and losers and potential benefits of adopting broad-based low-carbon investment approaches. See our analysis of a potential $25/metric ton tax of a standard global equity portfolio across sectors.

Recognizing the various potential paths to policy reform and carbon pricing standards, including variations across regions, prices and accompanying policies, we have leveraged Carbon Beta to generate a set of base-case carbon tax stress-test scenarios. These stress tests range from a low initial carbon price of $25 per metric ton to a relatively high initial price of $80 per metric ton. See a description of the tax scenarios below.

With the addition of these carbon tax scenarios to our internal risk framework in Aladdin, a BlackRock portfolio manager can now efficiently review their client’s exposure to carbon pricing across levels, identify where the potential risk and opportunity lie, and construct new pathways and hypothetical portfolios to improve outcomes.

Based on increasing political pressure to enact meaningful climate change regulation, we expect the growth of carbon pricing initiatives to accelerate globally. Our new Carbon Beta approach provides a view into a portfolio’s sensitivity to these prices and have informed a set of discrete shocks, offering our investment professionals and clients insight into how to best navigate the changing market environment. As fiduciaries and long-term investors, we cannot afford to do otherwise.

Andre Bertolotti is head of research and data for BlackRock Sustainable Investing. Michael Kent is a vice president and climate strategist for BlackRock Sustainable Investing.

Investing involves risks, including possible loss of principal.

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