COP25: Companies will need to invest USD 2.5tn to comply with intensifying climate regulation

• The COP25 summit is likely to be a catalyst for intensifying climate change regulation: we calculate a total impact on global industry of nearly USD 2.5tn over the next ten years.
• The energy sector will be hit the hardest (USD 900bn), followed by steel (USD 300bn) and air and marine transport (USD55bn).
• Companies are insufficiently prepared for this regulatory wave: after a margin compression from rising cost of emissions and tighter regulations in the immediate future, the ultimate risk is complete loss of value of certain assets or entire businesses.

Paris, 3rd December 2019 – As the COP 25 conference opens in Madrid, greenhouse gas emissions are still rising (+2.0% pa in2018) despite 1500 climate change laws enacted all over the world. Efforts need to be stepped up by a factor of five according to the United Nations Environment Programme (UNEP). We hence expect climate change regulation to tighten and intensify in number and reach around the world.

“To quantify the impact, we grouped the most important measures into four categories: carbon pricing; energy mix and efficiency; mobility regulations; industry specific taxes, fines and levies. We find that the negative impact on global industry will be nearly USD 2.5tn over the next ten years.”, said Catharina Hillenbrand, Sector Advisor for Energy, Metals, and Machinery and Equipment at Euler Hermes.

Which sectors are the most exposed?
We believe that almost all of the global economy will be impacted and hence calculated the impact per sector (see the full list here), but some of them will obviously be hit the hardest:

• Climate-related regulation has already cost the energy sector USD 1.4tn over the past ten years, and we expect a further USD 900bn in the next decade.
• As an energy-intensive sector, steel will be the second most impacted industry: USD 300bn over the next 10 years.
• Air and marine transport come third (USD55bn) because of the combination of carbon offsetting schemes (USD16 to 42bn), increased taxation and/or CO2 levies, as well as global incentives for a rail switch. Both of these segments will also be hit by new fuel sulphur content regulations.

How should businesses prepare for this regulatory wave?
In order to prepare, businesses need to consider direct and second round effects:

The direct impact will be a reduction in gross margins as a result of rising cost of emissions. This can maybe be transposed onto other costs, i.e. opex or capex, for example. But it can also translate into reduction of operating profitability as it may have been achieved through raising other costs, for embarking onto higher cost processes or greater R&D expenditure.

Indirect risks should also be addressed, from supply chain transmission and multiplication of risk to the exposure of end customers. Moreover, any of these issues may bear a visible impact on companies’ balance sheets and solvability.

Depending on speed of adaption, which is today insufficient, the ultimate risk is complete loss of value of certain assets or entire businesses. The coal sector is a first example of a stranded industry but many other sectors will be affected across the economy.