Investing for a green or dirty planet

Climate risk and corporate capex

Summary

The Covid-19 pandemic is a wakeup call regarding the interconnectedness of economical, human and economic health, which we believe strengthens the case for action on global heating. The unprecedented levels of pollution in India and last year’s bush fires in Australia also show that business as usual is not sustainable: attitudes, behaviours and investments need to change. In this article, we examine climate risk and whether equity markets reflect the risks of transitioning away from fossil fuels. 

We use DWS’s Climate Transition Risk rating to examine DWS’s proprietary CROCI11 data on nearly 900 of the largest global companies. What is presented here uses data before the Covid-19 pandemic, avoiding examination in a period of extreme market stress. While many companies’ economic and financial valuations may have altered slightly the distribution of climate risk, we see few signs that the pandemic has brought about a substantial repricing of climate transition risk across equity markets. 

The CROCI model seeks to calculate the genuine economic profitability and to identify the real value of each company, in order to enable the comparison of stocks across all regions and sectors. Our findings include:

  1. Only 12% of the market capitalization of the largest ~900 companies is from companies with high or excessive climate transition risk. Close to 60% of the universe’s earnings by market cap have moderate or low climate risk while, the US and Japan have the lowest earnings’ exposure to climate risks.[1]
  2. Yet companies with high climate risk make up 36% of corporate capex[1], three times the market cap exposure. More capex is required from an energy company to generate earnings compared to a software company.
  3. USD650bn annual capex from carbon intensive companies might need to be reoriented to avoid a dangerous climate future. Carbon intensive capex does not appear to be decreasing and has the longest economic life, expecting to earn a return on that capital until 2042.
  4.  We find no valuation premium for being invested in low or moderate climate risk stocks. This may indicate that at an aggregate level, equity markets are still not pricing in transition risks. We believe that this may be due to a combination of public policies not being strong enough or that some investors ignore or give less weight to climate risks. 
  5. Companies with high and excessive climate transition risk are less profitable and are destroying shareholder value. A prudent course of action for these high climate transition risk companies may be to reduce fossil fuel capex, redefine their business strategy to improve
    profitability by accelerating the low-carbon transition or just returning capital to shareholders. 
  6. Investor engagement is strengthening but some asset managers still vote against many  SG and climate shareholder resolutions. A climate emergency means asset owners being more demanding of asset managers who in turn should be more demanding of companies. 

Click here to read the complete article.

1. Based on the CROCI universe of 881 of the largest companies combined with ESG Engine data (January 2020)

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DWS Investment GmbH as of 6/4/2020
CRC 076315-1 (06/2020) UK: 1108

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