Compliance Carbon Market Risks and Opportunities
Businesses in energy-intensive sectors such as cement, power generation, and steel production are often covered by compliance (or mandatory) emissions trading systems. The reach of these markets is likely to grow in terms of coverage (regions and sectors) over time, with prices expected to rise. Many businesses purchase fuel and other products covered by specific carbon pricing measures.
The introduction of Carbon Border Adjustment Mechanisms (CBAMs) are likely to have a material impact on businesses affected. Some companies (for example, those in the UK exporting to the EU) will be impacted by CBAMs both in terms of their export and import activities. Carbon embedded in supply chains will need to be reported by exporting companies under many CBAM schemes.
The following section highlights some key risks and opportunities that a company and its board should consider in relation to compliance carbon markets.
Compliance market risks
- Increasing costs: On the whole, since carbon pricing generally aims to cut emissions across the entire economy, and increasingly - in the case of CBAMs - across borders, most businesses will need to adjust to higher prices for goods and services that cause greenhouse gas (GHG) emissions. This means that the carbon price levels in compliance markets both at home and abroad should be a key consideration for businesses looking at transition risk regardless of whether they are directly covered by an Emissions Trading Scheme in their own country.
- Stranded assets: As carbon prices increase, carbon intensive (e.g. fossil fuel) resources may become a liability before the end of their economic lifetime. These ‘stranded assets’ can potentially impact producers of such assets (energy companies), infrastructure providers and consumers (the aviation sector, for example).
- Future viability: Carbon pricing may pose a financially material risk, and for some companies could even impact the company’s future viability.
- Access to allowances: Under ETS, access to a sufficient number of allowances to maintain business operations is a risk that will need to be considered and managed by the organisation.
- Managing price risks: Some ETS markets have derivative markets to manage future price risk, these may be subject to illiquidity and volatility.
Compliance market opportunities
- Preparedness: Although the prospect of paying higher prices means that carbon pricing can be a risk to businesses, it presents an opportunity to focus minds on driving decarbonisation, cost reductions, building resilience and creating other opportunities. For example, businesses that are prepared for the introduction of, or changes to, carbon pricing regimes may gain a competitive advantage.
- New products and services: For some businesses, and in some sectors, the compliance market offers potential opportunities in terms of products and services. For example, financial institutions, can provide financial instruments to hedge against fluctuations in carbon pricing and assist clients in optimising their supply chains to minimise the impact of CBAM-related costs. It is even now possible to purchase emissions trading allowances as an investment asset. There are also likely to be opportunities stemming from blockchain and tokenisation in the global carbon markets.
- Joined up action: Considering the impacts of compliance carbon markets provides an opportunity to bring the company together around the net zero transition. For example, CBAMs are an enterprise-wide priority – impacting across finance, sustainability, procurement and tax. Putting effective strategies in place involves getting different parts of the company working together.