Equity investors warned of 20% shock from carbon tax

Global equity markets could fall by as much as 20 per cent if companies around the world were suddenly hit by a $75 a tonne carbon price, according to new analysis that argues investors are failing to account for climate risks in equity valuations.

The modelling, which looked at how hard a shock increase in the carbon price could hit share prices, said global markets would fall by about 4 per cent if just scope 1 and 2 emissions — which cover emissions from a company’s own operations — fell under a $75 per tonne carbon tax.

But Kempen Capital Management, the €86bn asset and fiduciary manager behind the research, warned of a 20 per cent drop if indirect emissions, known as scope 3, were included. The analysis also found that if the carbon price were to hit $150 a tonne, global markets could fall by as much as 41 per cent.

Nikesh Patel, head of investment strategy at Kempen Capital Management UK, warned that investors and markets were failing fully to factor in the impact of higher carbon prices. “The kind of risks that you will be exposed to over the next coming years are very different to risks from the past,” he added.

Earlier this month, staff from the IMF suggested the introduction of a global carbon price floor over the coming decade to meet the goals of the Paris agreement, where countries around the world agreed to limit global temperature rises. The IMF staff argued that such a move could “jump-start emissions reductions through substantive policy action”.

At the moment, 64 separate carbon pricing initiatives cover about 21.5 per cent of emissions globally, according to figures from the World Bank. Last month, the EU carbon price hit €50 a tonne for the first time, pushing up the cost of polluting in the bloc to more than double its pre-pandemic level.

“All of these systems are very complicated and don’t cover all the emissions,” said Jaime Ramos, manager of the global equities climate transition fund at Aviva Investors. “If we were in a scenario where China, EU and the US had proper carbon pricing that would be a very strong signal for the world and for markets.”

The Kempen research, which assumed the cost of the tax would hit balance sheets rather than be passed on to consumers, found that US equities could fall by almost 27 per cent on the back of a $75 carbon price, but this fall would be just 15.4 per cent in Europe.

Kempen’s modelling focuses on the worst-case outcome for markets of a sudden introduction of a global carbon price, whereas many believe a gradual rollout is more likely with a gentler impact on equity valuations.

Nick Stansbury, head of climate solutions at Legal and General Investment Management, the UK’s largest asset manager, said a big challenge of trying to calculate the impact of the carbon price on equity valuations was the question of how much of the cost would be passed on to the consumer and how much would hit a company’s profits.

In many cases customers will probably have to pick up a large chunk of the bill, he said.

LGIM’s own calculations estimate that global equities could be about 16 per cent weaker than they would otherwise have been by 2050 in the event of the imposition of a global carbon price. This is based on the assumption of an “orderly transition” and a carbon price that increases gradually to $383 per tonne by 2050.

The energy sector would be hardest hit under LGIM’s analysis, with more than 60 per cent of the value in the sector at risk over this timeframe as a consequence of carbon risks, while utilities and basis materials could also suffer.

“It is absolutely essential investors factor in the carbon prices,” Stansbury said.