Blog — 4 Apr, 2023
Corporate Credit Risk and Climate Change: Energy Transition Opportunities and Physical Risk Challenges
This blog is written and published by S&P Global Market Intelligence, a division independent from S&P Global Ratings. Lowercase nomenclature is used to differentiate S&P Global Market Intelligence credit scores from the credit ratings issued by S&P Global Ratings.
Governments, policymakers, and financial regulators are zeroing in on the economic, societal and financial implications of climate change. On one side, it is important to mitigate risks connected to global warming. On the other, it is critical to understand the costs and investments needed to convert current technology into greener solutions over the next decades and manage credit risk of the companies involved.
The Network for Greening the Financial System (NGFS)1 provides an extensive set of granular and standardized scenarios that primarily focus on orderly and disorderly energy transition pathways. They include future carbon tax and emission projections at regional, country and sector levels and further macroeconomic variables (i.e., energy demand and Gross Domestic Product projections) with and without the damage caused by physical risk events. However, these scenarios do not, and cannot, account for the geographical distribution of a firm’s property, plants and equipment (PPE), their specific exposure to different physical hazards and the interplay between the speed of an energy transition and the future evolution of climate risk events within each country. This can lead to inaccurate analysis of individual and portfolio exposures and to incorrect strategic decisions in the reallocation of banks’ capital across investment and lending books, or in the management of non-financial corporates’ value and supply chains.
S&P Global Market Intelligence developed Climate RiskGauge to address this shortcoming. Climate RiskGauge is a robust tool that incorporates NGFS and user-defined scenarios, along with granular firm-level information on PPE geo-location and exposure to a comprehensive set of physical hazards. It leverages S&P Global Sustainable1’s database of more than three million physical asset locations for public and private firms. The tool enables users to generate projections of Scope 1 and 2 emissions up to 2100, as well as study the financial and credit risk implications of climate-related energy transition and future physical risk hazards, both at a company and portfolio level.
Figure 1 below shows the modelled credit score change for the constituents of the S&P 500 Index, between now and 2050 based on the “Net Zero 2050” NGFS scenario. The NGFS macroeconomic effects of physical risks at a country-level are combined with Sustainable1’s projections on the evolution of seven physical risk hazards by geo-location under SSPS1-2.6.2 This is aggregated into a firm-level impact using future expected damage caused to each firm’s PPE in their respective and precise locations.
This analysis demonstrates the importance of integrating granular considerations of physical risk hazards in climate-related scenario analysis, as a large number of company credit scores could be downgraded by 2050 as a result.
The average damage caused by physical risk events depends on the future severity of the modelled hazards and the geo-location of a firm’s physical assets across the world. It is expected to reach approximately 9% of projected future revenues by 2050 for S&P 500 companies in the Utilities sector, even over an orderly transition pathway.3
1 NGFS is a group of Central Banks and Supervisors willing, on a voluntary basis, to exchange experiences, share best practices, contribute to the development of environment and climate risk management in the financial sector, and to mobilize mainstream finance to support the transition toward a sustainable economy.
2 The Shared Socioeconomic Pathway (SSPS) 1-2.6 aligns with a green transition, where climate warming is limited to an average of 2.6 degrees by 2100.
3 This should not come as a surprise, because physical risk events are pretty much “locked in” for the next decades, as carbon concentration in the atmosphere is not expected to decrease much, even over the best energy transition pathway.
If you are interested in speaking with a credit specialist about Climate RiskGauge and how to leverage it for climate-related scenario analysis of large portfolios and TCFD reporting,request a meeting here.