Bethan Rose, Sustainable Investment Analyst at Evenlode Investment, examines various carbon pricing mechanisms and the regulatory risks they pose on portfolio companies.
Energy supply issues, with shortages of oil and gas, were at the heart of the recent cost-of-living crisis, driving up gas and electricity prices and adding to inflation. The price of natural gas reached record highs and oil reached its highest level since 2008. This led to an increase in the use of coal, which when burnt leads to significantly higher amounts of carbon dioxide emitted versus other fuels like natural gas.
As this contributes to global warming, it highlights the importance of using climate mitigation policies and carbon pricing mechanisms to help reduce emitted CO2. Therefore, throughout the year we began to look at the carbon pricing mechanisms our investee companies are exposed to and how they are managing this regulatory risk and combatting change.
Regulations for decarbonisation
There have been a few emerging regulatory developments over the past year. One of these is the Carbon Border Adjustment Mechanism (CBAM), which requires firms in the European Union (EU) to pay tariffs on some of their carbon-intensive imports linked to the carbon price under the EU Emissions Trading Systems (ETS). This mechanism aims to prevent carbon leakage – which is where industries shift their production to areas where it is taxed less heavily.
Within the Evenlode portfolios, as part of our net zero analysis, we continue to note the impact of some other pricing mechanisms our investee companies are using or plan to use in the future. Additionally, we are witnessing an increasing number of companies modelling a carbon price when conducting scenario analysis or making capital allocation decisions.
For example, although Unilever is exposed to direct carbon pricing mechanisms already, like ETS, it also uses a mandatory internal carbon price of €70/tCO2 for all capital investment projects where the investment is more than €1m. Alongside this companywide approach, Unilever also have several brands using internal carbon pricing to create their own sustainable funds to invest, such as the ice cream brand Ben & Jerry’s.
Charting the path to a unified global tax
Last July, we completed our annual carbon emissions analysis and the first baseline assessment of investee companies on their net zero targets. Using this, we analysed the effect of a uniform global carbon tax at differing price levels – £50, £75, and £100 – on scope 1, 2 and 3 emissions for each investee company within the Evenlode portfolios.
We understand it would be hard to get all countries to agree to a global uniform carbon tax and to create a mechanism where you could tax a company’s scope 3 emissions. This is largely due to the lack of reporting and as a result, the use of estimates, alongside the complex issue of double counting. However, we have continued with this analysis as a thought experiment and as an indication of the future potential for a more blanket carbon tax mechanism.
Although there is a large portion of investee companies where the impact of a potential carbon tax and the analysis is less meaningful, this is not the case with the consumer goods sector. For example, Procter & Gamble (P&G) is one of the most carbon-intensive holdings across the Evenlode portfolios.
If P&G’s Scope 1 emissions from 2021 were taxed at £50 per tonne, this would equal a liability of approximately £111 million (US$140 million). Taxing Scope 2 would equal a liability of approximately £20 million and taxing Scope 3 would equal a liability of approximately £12.3 billion. Factoring in all scopes would equate to approximately £12.5 billion, which is about 21.47% as a portion of revenue in 2021.
This would be a considerable extra liability for any company. Part of our analysis assumes consumers will bear this extra liability at differing levels through some pass-through costs, which adds another dimension to our analysis and highlights how easily this cost may be passed through.
Combatting carbon-intensive companies
As a result of this initial scoping activity, this year we have decided to focus on the top 12 emitters in terms of carbon intensity across the Evenlode portfolios. These are also the investee companies classified as ‘High Impact’ under the Net Zero Asset Managers Initiative (NZAMI), including Unilever, Procter & Gamble, Nestlé, Smiths Group, Henkel, Nintendo, Fuchs, PepsiCo, and Heineken.
The analysis will explore both the financial effect of a carbon price on the company as well as the potential effect on the consumer, as companies look to pass through carbon-related costs. We’ll then use this as an engagement tool to encourage companies to take both the issue of carbon emissions and the resulting carbon pricing mechanisms even more seriously.