Stock market prices on a screen

Carbon emissions will determine future stock prices, study claims

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According to a study from the University of Waterloo, companies that fail to restrain their carbon output may face a decline in stock prices and asset devaluation.

Researchers from the institute based in Ontario, Canada, have said that firms within the emission-intensive sector that fail to take carbon reduction action could have a negative impact on the general stock market in as little as 10 years’ time.

Mingyu Fang, a PhD candidate in Waterloo’s Department of Statistics & Actuarial Science said: “Over the long-term, companies from the carbon-intensive sectors that fail to take proper recognisable emission abatements may be expected to experience fundamental devaluations in their stocks when the climate change risk gets priced correctly by the market.”

Fang added: “More specifically for the traditional energy sector, such devaluation will likely start from their oil reserves being stranded by stricter environmental regulations as part of a sustainable, global effort to mitigate the effects caused by climate change.

“Those companies may find that large portions of the reserves are at risk of being unexploitable for potential economic gains.”

As part of the study, the researchers undertook an intertemporal analysis of stock returns, examining 36 publicly traded large emitters and related sector indices from Europe and North America surrounding the ratification of major climate protocols.

Results found that only nine of the 36 samples were found to present recognisable carbon pricing, with the historical performance of the emission-heavy sectors - such as energy, utilities and materials - being compared against other industries.

Furthermore, the carbon-intensive sectors consistently ranked at the bottom of the list and had underperformed in the market indices in both continents.

“It is in the best interest of companies in the financial, insurance and pension industries to price this carbon risk correctly in their asset allocations,” said Tony Wirjanto, a professor at Waterloo’s School of Accounting and Finance and Department of Statistics and Actuarial Science. “Companies have to take climate change into consideration to build an optimal and sustainable portfolio in the long run under the climate change risk.”

Climate change has an impact on investment portfolios through direct and indirect channels, according to the study.

Directly, it elevates weather-related physical risk to real properties and infrastructure assets, which extends to increased market risk in equity holdings with material business exposures in climate-sensitive regions.

Indirectly, it triggers stricter environmental regulations and higher emission cost in a global effort in emission control, which shall induce downturns in carbon-intensive industries in which a portfolio may have material positions.

The indirect impact of climate change on investments is referred to as an investment carbon risk, in which this indirect effect will be transformed into a political risk, affecting particular asset classes.

The study, titled ‘Sustainable portfolio management under climate change’, was published in the Journal of Sustainable Finance & Investment.

In September, the Labour Party committed itself to lowering the UK’s greenhouse gas emissions to zero by 2050 as part of its climate change action plan.

Also, according to a recent study from the University of East Anglia (UEA), China’s carbon emissions are expected to continue to decline after the country reformed its industrial sector and maintained its energy efficiency drive.

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