Achieving an LCCR future will require a deep and large-scale transition of economic activity. Some activities will be essential in this transition, while others will be phased out. There are many different pathways to achieving the goals of the Paris Agreement, but a common element is that all sectors reach close to zero emissions in the second half of this century. They do so on the basis of equity and in the context of sustainable development and efforts to eradicate poverty, while developing resilience to the physical impact of climate change. Using this Shades of Green analytical approach, S&P Global Ratings aims to capture the impact of economic activity on the transition and on the LCCR future.

We determine a Shade for an activity (see graphic 1) by weighing our analytical conclusions on climate and nonclimate environmental factors across the activity's value chain and considering jurisdictional differences. We assess these factors jointly and holistically; we do not assess them individually because environmental factors often have material interconnections. Our analysis does not reflect social risks or benefits related to an activity. We may, however, comment on any relevant social risks or benefits in communicating our opinion on an activity.

Graphic 1

If we have limited information to perform our analysis, we take a conservative approach to determining a Shade, using information about the industry, jurisdiction, and value chain the activity takes place in to support our analysis. Investments in activities consistent with the three green Shades are likely to support a successful implementation of the Paris Agreement's ambitions. Transition is needed in all sectors, and early movers with activities designated a Light green Shade can generate necessary and substantial emission reductions.

Determining The Shade For An Activity

Our assessment considers an activity's entire value chain, since material climate and environmental risks and benefits can manifest there. Both upstream and downstream risks and benefits can affect the Shade we designate.

Typically, consideration of climate risk forms the core of our analysis because it represents the main driver of an activity's role in an LCCR future.   We therefore usually start with an analysis of climate risk, then adjust for other relevant environmental factors (see graphic 2). When other environmental factors are, in our view, more relevant for an activity's role in an LCCR future, we would likely start with an analysis of those factors, then adjust for relevant climate risks we've identified.

Graphic 2

While Dark green activities and Red activities are universal, the jurisdiction can affect our assessment to determine all the other Shades.   For example, an activity in a jurisdiction with a rapid transition to an LCCR future could be subject to policy pressure sooner than in jurisdictions where the transition is slower. In other cases, a jurisdiction may have what we regard as relaxed waste-management regulations, increasing an activity's environmental risk. In addition, and where relevant, sustainability taxonomies can guide our assessment of an activity's climate risk in a particular jurisdiction. For example, an activity that aligns with an established taxonomy is likely to be consistent with one of the three green Shades.

Components Of Climate Risk

We define climate risk as the risk that an activity will be phased out, materially altered, or subject to physical risk through the transition to an LCCR future. Our climate risk analysis aims to capture how much an activity will need to change between the point of the analysis and the LCCR future.

We form a view of an activity's climate risk by considering its exposure to transition risk and physical risk.   The relative importance of transition risk and physical risk to an activity's climate risk--and hence the Shade we determine--varies, depending on the relevance of those risks to that activity. We may also choose to focus more closely on a particular risk factor if the activity we are assessing has high exposure to that factor.

A. Analyzing transition risk

Transition risk is the risk that an activity will be phased out, or materially altered, through the transition to an LCCR future. Our transition risk analysis considers obsolescence risk and climate impact.

1. Obsolescence risk

This risk forms the main component of our transition risk analysis, capturing how rapidly, and significantly, an activity will have to change to remain consistent with the transition to an LCCR future. For example, fossil fuel extraction activities entail high obsolescence risk, in our view, since they face near-term political and market pressure to cease or reduce output through the transition to an LCCR future, generating a risk of stranded assets.

A key concept that informs our view of obsolescence risk is "emissions lock-in".   This is when an activity delays or prevents the transition to low-carbon alternatives by perpetuating assets or processes (often using fossil fuel) and their corresponding greenhouse gas emissions. Such activities are not aligned with, or cannot adapt to, an LCCR future, and therefore carry obsolescence risk.

Importantly, activities that represent a step toward an LCCR future--such as energy efficient buildings--may still face some obsolescence risk.  This is because they may need incremental improvements in the longer term to be consistent with an LCCR future. Therefore, it is important to think of obsolescence risk as a continuum on which to compare how much, and how rapidly, activities will need to change to be consistent with an LCCR future, rather than as a uniform risk that is wholly inconsistent with an LCCR future:

• Some activities are already consistent with the long-term vision of an LCCR future, meaning they will be carried out in largely the same way, with the same or greater prevalence, in an LCCR future. Solar power generation is one example of a consistent activity that has low obsolescence risk.
• Other activities may play an important role in the transition but not be fully consistent with an LCCR future, and therefore face obsolescence risk at some point between the time of our analysis and the LCCR future. We consider, for example, the operation of a plug-in hybrid public bus to be a transition activity.
• Certain activities are not consistent with an LCCR future, such as burning coal to generate electricity. The transition entails phasing out these activities as rapidly as practically possible, meaning they have very high obsolescence risk.

Each Shade represents the different levels of obsolescence risk associated with an activity.  

• Dark green activities carry the least obsolescence risk; they are activities that we expect will exist in an LCCR future.
• Medium green activities generally include a technology with potential application beyond the short-term transition technologies designated a Light green shade, but with associated emissions and resilience not yet consistent with the LCCR future state.
• Light green activities carry the greatest obsolescence risk among the green Shades. We still consider Light green activities to be green because they contribute to achieving an LCCR future. However, they are not themselves consistent with an LCCR future.
• Yellow activities have implemented limited mitigation or resilience measures and have low emissions across the value chain. These activities may face some obsolescence risk in the form of pressure to adopt more sustainable practices. For example, we could determine a Yellow Shade for telecommunications services that are yet to implement material transition measures, or have implemented some mitigation or resilience measures but still have potential for emissions lock-in and a risk of stranded assets. Other examples of Yellow activities are certain modes of steel production.
• Orange activities generate somewhat lower greenhouse gas emissions than Red activities or processes, but may still lock in future emissions and face a risk of stranded assets. For example, we could determine an Orange Shade for conventional steel production.
• Red activities carry the greatest obsolescence risk since they have no place in an LCCR future. Typically, Red activities are those involving direct fossil fuel use, a high risk of fossil-fuel lock-in, or a direct link to deforestation.

The time horizon of an asset or activity is important when we determine a Shade, since it informs our consideration of emissions lock-in.   We do not generally determine a Green Shade for an activity if it is associated with emissions lock-in. In our analysis, we assume that society will reach close to zero emissions by the middle of the 21st century, meaning that it will transition in line with the Paris Agreement. If an activity supports an asset with a long life--such as a power plant--that could still be in use by the middle of the 21st century, then we assess whether that asset is consistent with the long-term vision of an LCCR future extending beyond the middle of the 21st century.

When an asset's useful life does not extend to the mid-21st century, we look at its consistency with the transition path rather than with the end steady state of an LCCR future.   The transition path is informed by relevant context, such as the sector and jurisdiction in which the asset is utilized. An asset with a shorter useful life, such as a hybrid vehicle, could play an effective role in the transition to an LCCR future, with limited risk of becoming stranded before the end of its useful life, even if--ultimately--it is not consistent with an LCCR future. In this case, we would take the view that investing in that asset does not lock in emissions because the asset's useful life is short enough that it does not impede an effective transition to an LCCR future.

2. Climate impact

Our climate impact analysis aims to capture an activity's ability to reduce greenhouse gas emissions. We consider an activity's climate impact relative to the obsolescence risk it introduces. An activity with high climate impact contributes to emissions reduction, and may therefore face lower transition risk than an activity with a low climate impact.

We consider climate impact in our analysis, since we believe emissions reduction is a fundamental part of achieving an LCCR future.   Climate impact is, however, inherently hard to measure, and an activity with a high climate impact can produce obsolescence risk. For example, replacing a coal-fired power plant with a natural gas power plant could have a significant short-term climate impact, but may lock in emissions in the long term.

We do not attempt to quantify climate impact but rather look for evidence of it.   We take into consideration the time horizon of potential emissions reductions and assets' useful lives, noting that, in some cases, short-term emissions reductions may be decreased or even outweighed by longer-term emissions. When looking for evidence of the climate impact, we consider aspects such as the reduction of the amount or intensity of emissions from an existing activity compared with that from other technological options. We also consider whether an activity enables emissions reductions by accelerating the transition of other entities, for example, by being a first mover in its sector, collaborating with other industry stakeholders, or other similar actions. We also consider the potential for activities to remove carbon from the atmosphere, such as via afforestation or carbon capture and sequestration. Other evidence we consider may include credible climate scenarios and decarbonization pathways, life cycle assessments, or relevant scientific research.

B. Analyzing physical risk

We define physical risk as the risk to an asset or activity due to its exposure to climate change. Physical risk can manifest as the impact of short-term events or the long-term chronic impact of changes in climate. Exposure to physical risk typically increases the amount of climate risk an activity faces. Similarly, investment in resilience measures can decrease the amount of physical risk, and hence climate risk, that an activity faces.

Any activity can be subject to physical risk, regardless of how sustainable it is.   For example, solar panels built on an area prone to flooding can face material physical risk, requiring investment in resilience measures to make them consistent with an LCCR future. If an activity focuses primarily on adaptation, we consider how effectively it reduces physical risk, alongside any transition risk it introduces.

Physical risks are not limited to damage to assets.   They can also materialize as supply chain issues, such as drought, which affects aquaculture feed producers and disrupts hydroelectric power generation. If an activity is exposed to unmitigated physical risk, we may determine a Shade of Yellow, Orange, or Red for that activity to reflect its higher overall exposure to climate risk.

Investment in adaptation and resilience measures can decrease vulnerability to physical risk.   For example, a water utility may invest in a desalination plant, thereby reducing the vulnerability of local communities and industries to droughts. If an activity focuses primarily on resilience improvement, we consider how effectively it reduces physical risk, alongside any transition risk it introduces. If an activity effectively reduces physical risk, and does not introduce material transition risk, we typically consider it consistent with the long-term vision of an LCCR future.

Other Environmental Risks And Benefits

Other environmental risks and benefits can influence the Shade we determine for an activity, or become the primary focus of our analysis, if they are sufficiently material.   We consider the environmental risks posed by an activity, such as water pollution and biodiversity loss, and could determine the Shade to be lower on the scale than would otherwise be the case, if we regard those environmental risks as material. Similarly, we consider an activity's environmental benefits, such as reducing water pollution, which could have a positive impact on the Shade we determine.

Environmental risk exposure can influence the Shade we determine for climate-focused activities.   For example, windfarms can interfere with bird migration patterns, large solar projects can interfere with flora and fauna, and new hydropower reservoirs necessarily entail a range of environmental impacts. Where there is potential for high environmental risks and we consider the entity conducting the activity to have insufficient procedures and policies in place to mitigate those risks, or we know that the entity has not considered such risks, that could have an impact on the Shade we determine.

How We Consider Jurisdictional Context In Transition Risk Analysis

Transition risk often depends on the jurisdictional context. The speed and ambition of a jurisdiction's transition to an LCCR future can influence the level of risk to investments and activities from the perspective of both public policy and market dynamics.

We may, for instance, assess the financing of public buses fueled by liquefied petroleum gas (LPG) in a developing country as Light green because such vehicles represent a transitional step toward public infrastructure powered by renewable sources and are unlikely to face near-term policy risk.

If the same LPG buses were deployed in Western Europe, where sustainable public transport infrastructure is already widespread, they may not qualify as Light green. This is because, in many Western European jurisdictions, LPG would be a step backward from current practices, such as the use of electric buses.

Incorporating A Value Chain Perspective

Our assessment considers an activity's entire value chain, since material climate and environmental risks and influences can manifest there. The risks and impacts from a sector or industry's upstream and downstream activity, and within an entity's operations, can affect the Shade we determine.

When we consider upstream risks, we look at whether an activity's inputs could be exposed to climate or environmental risks, or feature substantial emissions.   The extent to which these may influence the Shade we determine depends on how significant the risks or impacts are and how effectively they are mitigated. For example, the production of batteries exclusively for use in electric cars would generally be consistent with a Dark green Shade. However, because battery production currently has value-chain risks--including reliance on fossil-fuel-dependent inputs, with an impact on biodiversity from raw material extraction--achieving a Dark green shade would require systematic efforts to address these issues. We may classify the subset of battery production activities that rely on fossil-fuel-dependent inputs as Medium green, since they are subject to some climate risk. If an activity is supported by suitable mitigation actions (such as rigorous supplier selection) that represent best efforts to minimize climate and environmental risks and their impact, we are less likely to designate a Shade that is at the lower end of the scale.

Our consideration of downstream risks typically focuses on the end use of products, and whether those uses give rise to climate or environmental risks and benefits.   Downstream considerations become important when a product can be used in multiple ways. For example, a wind turbine can be used to generate power for a community--an activity aligned with an LCCR future--but can also be used to power an offshore oil drilling rig, thereby contributing to the fossil fuel supply chain. We consider a product's potential applications, including any binding commitments its producer has made on who it will and will not sell to, when deciding whether downstream risks could result in a Shade that is at the lower end of the scale.

We also consider jurisdictional considerations across an activity's entire value chain.   For example, when looking at the financing of a ship, we consider where the ship will be built, how materials will be sourced, where it is intended to function throughout its useful life, and where it will be broken down after it is retired. We consider the policies and practices of the entity conducting the activity to inform our analysis.

Related Research

• Analytical Approach: Second Party Opinions: Use Of Proceeds, July 27, 2023
• FAQ: Applying Our Integrated Analytical Approach For Use-Of-Proceeds Second Party Opinions, July 27, 2023