Moody’s to analyze carbon transition risk

MOODY’S Investors Service says that in assessing the credit implications of carbon transition risk it will use a central scenario based on the national commitments put forward as part of the Paris Agreement signed on April 22 by 174 countries. “The near universal adoption of the Paris Agreement substantially increases the likelihood of coordinated and effective policies to materially reduce carbon and other greenhouse gas emissions over time, which has in turn the potential to become a significant ratings driver in a broad set of industries,” says Brian Cahill, a Moody’s managing director and head of the corporate finance group and public, project and infrastructure finance team in Asia Pacific. “Our baseline scenario is a forecast of the global emissions pathway if all countries were to implement their national contributions put forward as part of the Paris Agreement,” says Ilya Serov, a Moody’s senior vice president. “While not sufficient to meet a less-than-2°C warming objective, this baseline represents a plausible central scenario, given the current policy commitments of national governments and technology trends,” adds Serov. Cahill and Serov were speaking on the just-released Moody’s report titled “Environmental Risks: Moody’s To Analyze Carbon Transition Risk Based On Emissions Reduction Scenario Consistent with Paris Agreement”. While not the subject of this report, Moody’s also considers the credit implications of direct climate change hazards, including environmental risks induced by a possibly slower pace in the reduction of greenhouse gas transmissions. However, based on the current limited visibility into the nature, probability and severity of the follow-on risks to global warming trends, and the extremely long projected time frame, direct climate change hazards are not at present a material driver for most ratings. Moody’s plans to address the risks of climate change and carbon transition faced by sovereign and sub-sovereign issuers in a separate publication. Moody’s has identified four primary categories of risk associated with carbon transition that it will use to assess the credit implications for corporate and infrastructure sectors. These categories are as follows: 1) Policy and regulatory uncertainty regarding the pace and detail of emissions policies; 2) Direct financial effects, such as declining profitability and cash flows, due to higher research and development costs, capital expenditure and operating costs; 3) Demand substitution and changes in consumer preferences; and 4) Technology developments and disruptions that cause a more rapid adoption of low-carbon technologies. Moody’s report says that sectors and individual entities are likely to differ in terms of their ability to mitigate such risks based on their relative exposure and their financial, operational and technological flexibility. Moody’s has identified 13 industries in its corporate and infrastructure portfolio as most exposed to carbon transition risk. For three sectors ? coal, coal infrastructure and unregulated power utilities ? material credit impacts and rating adjustments are already being felt. For the others, Moody’s expects that they will be affected over the next three to five years. For each industry, Moody’s analysis will consider the specific ways in which the four categories of risk will most likely develop under Moody’s central emissions scenario. Moody’s will focus on specific risk factors and metrics that assess an individual company’s exposure to those risks and assess the credit implications by considering the impact for each entity in that industry in the context of its existing credit rating methodology. Moody’s report points out that considerable uncertainty over policy implementation and the pace of technological innovation could affect the timing and magnitude of carbon transition risks. As a result, Moody’s will also consider scenarios consistent with the 2°C warming objective, a “business-as-usual” scenario, and other alternative scenarios that may be plausible at a national or regional level. Moody’s will review, and if necessary, adjust its central scenario, if one of these other scenarios becomes more plausible.