[MUSIC] Welcome to the Edhec Risk institute today we are going to talk about the risk exposure on equity portfolio posed by uncertainty about government prices. Now we are used to be using carbon footprint measures as a proxy for the contribution of the company to climate change. In other words, carbon footprint measures or normalized measures of coupled emission by a company. And the focus from investors in companies that have low carbon footprint reflects their desire to help or to provide incentive to companies to transition towards the low carbon economy. Now we are also often using carbon footprint as a proxy for the exposure of those company business models with respect to changes in carbon prices. And the question that we would like to discuss is whether this is a meaningful thing to do. Whether there is a 1 to 1 correspondence between the contribution to climate change and the exposure to climate change. After all, these two concepts are in principle, they are clearly different concepts. To address this question, we would like first to think about why, with carbon risk represents any risk factor on important risk factor for company business models. Well, remember that climate change implies two types of risk. Physical risks and transition risks. And when it comes to transition risks, we are talking about the impact of oil companies regardless of their strong or weak exposure to the physical aspect of climate change. But all companies, all business models, are potentially exposed to these risks legal, technological, business and otherwise involved in this transition to a low carbon economy. And remember that whatever the scenario, however, it happens whether it's happening fast or slowly. Any transition towards any process leading the transition towards a low carbon economy will imply higher carbon prices. So the key question is what is going to happen on the business model of these companies when, if and when carbon prices go up. Now, carbon prices can have an impact, direct or indirect impact not only on the revenues of the firm but also on the cost and revenues of the firm, but also on its balance sheet. So not only on the income statement side, but also on the balance sheet side, okay? Let's start with the income statement. On the revenue side well, there will be less revenues from carbon intensive products and services to be expected. There also will be operating expenditure, leading to higher carbon prices that will have to be faced and will have to be paid all along the way the supply chain. So that will lead to an increase in operating costs. It also will it potentially to higher capital expenditures, even when those companies will have to redesigned their production process has to develop and use new technologies that are more carbon friendly now. The transition risk also have an impact on balance sheets. If you think about the reserves, any company holding oil related reserves well. These may well become stranded assets, and that's going to be a problem and in a big loss of value for those companies. There's a lot of potential legal liabilities involved in holding an exposure to this transition risks. And in the end, there's also a loss of capital involved in, a loss of competitiveness from those companies that have exposure to transition risk. So clearly as we can see a potential increase in carbon prices, which is expected to be a key component of the transition towards a low carbon economy. Well, clearly, this will have a massive negative impact on some companies on most companies around the world. So the question is, can we measure that impact? Well, the most straightforward way to measuring this impact is to estimate what we call a carbon beta, which is a statistical measure of the sensitivity of changes in stock prices. In other words, relative changes in surprises, which we call the stock returns. The sensitivity of stocks returns with respect to changes in carbon prices. And, as you may know, we have observable proxies for carbon prices based on carbon markets that are developing around the world. In particular in the EU, there's a very well developed carbon market where we can obtain data on current levels for carbon prices. And what we see is that if we run this analysis and perhaps we want to control for different in market exposure. So we add a market return factor as a control variable if you will, in this analysis. What you find in this case, well, what you find years on this sample of Euro stoxx 600 companies. What we find is only very few companies in the sample seems to exhibit a significant carbon beta. In other words, for most companies, that seems to be a very low level of sensitivity of stocks return with respect to changes in carbon prices. And by the way, there seems to be a very weak, if any very weak relationship between exposure to carbon prices and carbon footprint. So, in other words, it's not necessarily the case that the companies that have the highest level of carbon footprint will have the highest carbon vita. That's not, that doesn't seem to be the case. Now, what's the explanation between these findings? Well, perhaps we have to recognize that the market has yet to recognize this problem or these, the emergence of this new risk factors. So perhaps this risk factor is staying a bit silent. And whenever carbon prices changes whenever they go up, and then this seems to have at least this level of analysis that seems to have only a week effect on, stock returns. And this is perhaps a normally given that we have a good economic understanding that such changes in carbon prices. Will definitely have eventually a massive impact on income statement and balance sheets of those companies. [MUSIC]
