Asset Owners Call for Carbon-pricing Overhaul

NZAOA proposal would treble carbon price, providing “guardrails” to avoid shocks for investors and companies.

The United Nations-convened Net-Zero Asset Owner Alliance (NZAOA) has called on governments to back members’ net-zero carbon emission reduction targets with “effective, robust, reliable and fit-for-purpose carbon-pricing instruments”. In a discussion paper released today, the Alliance has proposed principles that should be applied to pave the way for 1.5°C-aligned emission regulation, including pricing of externalities.

“Well-designed pricing of greenhouse gas emissions is essential to decarbonise critical sectors,” said Thomas Liesch Co-author of the report and Lead, Climate Integration at Allianz. “A net-zero world will be hard to achieve without it. Not even 20% of global emissions are currently covered by carbon pricing schemes – the approaches put forward in the paper can help advance this in an equitable manner.”

The Alliance’s ‘Discussion paper on governmental carbon-pricing’ proposes a hybrid scheme between emissions trading or ‘cap-and-trade’ schemes, and carbon taxes or levies. The paper sets out the concept of a “carbon-pricing corridor”, based on a minimum market price (the floor) and a maximum market price (the ceiling). The “predictable and robust nature” of the hybrid carbon price corridor design would provide companies and investors with “greater certainty of future price levels for efficient capital allocation”. It would also create stable and reliable incentives for entrepreneurs, consumers, and other stakeholders to adopt or develop low or zero-emission technology, the paper states.

Guardrails for investors

Liesch says for emission reduction to happen in the real economy, policy-makers must provide guardrails for rapid decarbonisation. “Public spending and leveraging of private finance need to be combined with legislative targets on front-loaded emission reductions. This will require effective carbon-pricing as well as complementary sectoral regulation.”

The Alliance’s proposed floor price would provide a guardrail against price crashes, while the ceiling would protect against rapid increases in prices and prevent a backlash that could undermine political support for carbon-pricing.

In the Alliance’s proposal, both floor and ceiling would rise over time. To support efforts to achieve net-zero emissions by 2050, a central median estimated price of US$147 per tonne is required by 2030, according to the OECD’s estimate. This would be almost treble the current price of carbon in the EU, the paper said, where carbon has been trading at around US$59 per tonne since May 2021.

Carbon price impact on global equity markets

A global carbon price rise of US$75 per tonne on polluting companies could cause a 4-20% fall in global equity valuations, according to a separate analysis by independent wealth manager Van Lanschot Kempen. The wealth manager modelled the impact of a shock increase in carbon prices globally, implemented through either a carbon tax or emissions trading scheme.

“Most countries are currently well below this level and, with developed countries likely to set higher carbon prices than developing countries, it is expected that a significant rise in carbon prices is needed,” said the firm.

The firm modelled its analysis as a change in carbon pricing, not an absolute level to take into account the myriad pricing mechanisms in force globally. The majority of global economies are currently at a level less than US$30 per tonne, with the Nordics and Switzerland as outliers, with a range from US$60 per tonne to US$130. US$75 is the global average price needed to reduce emissions to a level consistent with the Paris Agreement’s 2˚C target. Given the accelerating pace of global warming, says the firm, it is likely that a US$75 rise in the global average carbon price might not be sufficient to meet the Paris targets. Recent research from Trove and University College London has also highlighted problems with current carbon pricing.

Van Lanschot Kempen’s secondary shock analysis of an increase of US$150 per tonne highlights that with a higher carbon price level, which accelerates beyond the Paris Goals, equity prices fall even more significantly over time, knocking an average of 9% off current values.

However, Michel Iglesias del Sol, Managing Director, Investment Strategy Advisory at Van Lanschot Kempen, said there is growing evidence that ESG-aware strategies have lower risk and potentially higher returns. “An investor such as a DB or DC pension fund with a time horizon longer than ten years is likely to be impacted by climate transitional risks, and investors with longer-term horizons are likely to face both transitional and physical risks if low carbon thinking is not built into equity portfolios.” Van Lanschot Kempen estimates that adopting a climate-positive portfolio could add 20% to returns over the next ten years, even compared to lower carbon / sustainable equity approaches.

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