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The Carbon Asset Risk Management Imperative

According to the Carbon Tracker Initiative's "Carbon supply cost curves: Evaluating financial risk to oil capital expenditures," oil and gas majors can, through carbon asset risk scenario analysis, enhance their value by decreasing their capital expenditure in oil and gas plays that are high-risk and dependent on long-term increasing demand for carbon-intensive fuels.

Tuesday, June 24, 2014

By Gabriel Thoumi

According to the Carbon Tracker Initiative's "Carbon supply cost curves: Evaluating financial risk to oil capital expenditures," oil and gas majors can, through carbon asset risk scenario analysis, enhance their value by decreasing their capital expenditure in oil and gas plays that are high-risk and dependent on long-term increasing demand for carbon-intensive fuels.

Currently more than $1.1 trillion of capex is budgeted for high-cost oil and gas projects that will only be profitable if oil prices remain above $95/bbl through 2025. Many of these investments are deepwater, oil sands, Arctic and other unconventional plays, which may not be profitable under certain conservative scenarios driven by carbon asset risk analysis.

In the PwC report " Low Carbon Economy Index 2013: Busting the carbon budget," given existing global fossil fuel reserves, we are estimated to exceed the global carbon budget for the 21st century by 2034 in a business-as-usual scenario.

This means that carbon asset risk may be a material financial risk to investors and asset owners under certain scenarios.

Carbon asset risk is defined as the assessment of an investment's risk profile incorporating the potential financial risk that climate change poses to the investment from both a current and forward-looking perspective.

Multi-factor Event Risk

Carbon asset risk is an event risk, because it can be driven by policy and economic factors - in addition to government actions, technology trends and others - that are inherently uncertain and outside the control of asset managers, with unknown probabilities and impacts.

Carbon asset risk may also be driven by the lack of appropriate action by the asset manager, or an asset manager's financial valuation of a security without considering its carbon asset-related risks.

Carbon asset risk management requires an understanding of the factors that drive supply and demand of financial assets, and the careful management of these assets utilizing all information that is material to a security's value, including carbon, in the management of these assets. This includes identifying, measuring, and monitoring explicit risk drivers that are under control of pertinent decision makers such as asset owners, asset originators, and asset managers.

If we want to avoid catastrophic global warming greater than 2°C in the medium term and manage carbon asset risk in our institutional investments, we need to incorporate carbon asset risk management into our portfolio management process.

Gabriel Thoumi (Gabriel.Thoumi@Calvert.com), CFA, is senior sustainability analyst, Calvert Investments, and co-author, along with PwC and many others, of the forthcoming WRI GHG Protocol on Carbon Asset Risk for Financial Institutions. His previous contribution to www.garp.org was " A Handle on Stranded Asset Exposure."




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