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Estimating Financial Risks from the Energy Transition

Fearing widespread financial losses and a threat to financial stability from climate change, investors and regulators are urgently seeking to identify, quantify, and manage climate related-risks. But most models used to assess the impacts of a low-carbon transition lack financial sophistication. Our study set out to change that situation  for the better.

This study simulated the ability of 29 large European electrical utility companies to meet the requirements of rapid transition towards lowcarbon energy.  We paired scenarios generated by the GEM-E3/POLES integrated assessment model to an advanced structural economic model.  Our aim was to develop a robust, transparent methodology allowing for a comprehensive evaluation of potential financial stresses on firms subjected to binding emissions constraints.

The results show that aggressive climate mitigation policies affect both net profit margins and the required rate of capital expenditure. For example in the sample of high fossil fuel companies under the 2 degree scenario one company is seen to default before 2035. Before 2040 a further 3 companies incur negative annual earnings, reducing their credit ratings below investment grade. This implies that under this scenario around 50% of companies with a current high fossil fuel mix could default within 10–20 years if they fail to invest sufficiently in renewable generation technology.
 

Authors: Dr Chris Cormack (Quant Foundry and CCFI  Imperial College Business School), Dr Alexandre Koberle (Grantham Institute, Imperial College London), Dr Charles Donovan and Dr Anastasiya Ostrovnaya (CCFI, Imperial College Business School)