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Climate crunch: a closer look at the transition risks of net zero
Transitioning to a low carbon economy makes financial sense over the long run. However, the initial phases of the transition will present investors with risks they can’t afford to ignore.
We commissioned our research partner, the Institute of International Finance (IIF), to conduct a comprehensive study on the nature and potential severity of the most pressing risks associated with net zero. The risks that were identified fell into three broad categories:
| A growing debt burden |
Economic disruption |
The risk of capital misallocation |
Download the research paper, Climate crunch: a closer look at the transition risks of net zero
Download here
1. The growing debt burden
Increased investment in green infrastructure and clean energy – and the public spending required to ensure the most vulnerable in society are insulated from the costs – will require higher levels of borrowing. That will be the case for governments in both developed and emerging markets. Such borrowing will be ‘front-loaded’, accumulating predominantly in the initial phase of the transition. And it will come with costs attached.
Growing debt burdens are likely to have a negative effect on the credit profiles of the many countries that are already financially stretched in the wake of the Covid 19 pandemic. This could also dampen global economic growth prospects.
Andres Sanchez Balcazar, Pictet Asset Management’s Head of Global Bonds, commented on the implications for sovereign debt investors.
Growing debt burdens are likely to have a negative effect on the credit profiles of the many countries that are already financially stretched in the wake of the Covid 19 pandemic. This could also dampen global economic growth prospects.
Andres Sanchez Balcazar, Pictet Asset Management’s Head of Global Bonds, commented on the implications for sovereign debt investors.
2. Economic disruption
Although economists generally agree that energy prices do not impact inflation as significantly as in the past, carbon abatement policies such as carbon taxes, carbon credits and the EU ’s carbon border adjustment tariff will inevitably lead to higher energy costs for both households and businesses. Another source of inflation related to the net zero transition involves supply bottlenecks for commodities essential to the energy transition.
But volatile inflation is not the only side effect of the clean energy transition. Our research shows that as countries attempt to wean themselves off fossil fuels, they may experience a decline in consumer spending power and increases in unemployment, particularly in the initial years of the transition.
Arun Sai, Pictet Asset Management’s Senior Multi-Asset Strategist, shared his thoughts on the initial phases of the green transition in the equity markets.
3. The risks of capital misallocation
Capital projects, particularly those under the oversight or influence of governments and state institutions, are historically viewed by private investors as prone to poor management, especially in countries with weak institutional frameworks. This situation creates a dilemma for investors seeking to reduce carbon intensity. They might find themselves needing to allocate funds to unproven clean technologies or backing companies with a poor track record in carbon reduction, in the hope of future improvements—or possibly both.
This significantly increases the risk of inefficient capital deployment, characterised by the formation of asset bubbles on the one hand and unjustifiably undervalued assets on the other. While this scenario could give rise to numerous tactical investment opportunities, it could result in more frequent and severe market volatility.
Evgenia Moltova, Pictet Asset Management’s Co-Head of the Positive Change strategy, talked about the investment opportunities of the energy transition.
Related articles
Net zero funding and the implications for sovereign debt investors
We commissioned our research partner, the Institute of International Finance (IIF), to conduct a comprehensive study on the nature and potential severity of the most pressing risks associated with energy transition. Chief among them is the scale of the public investment required. How might all that extra borrowing affect government finances and sovereign debt markets?
May 2024
Equity markets and the initial phases of the green transition
We commissioned our research partner, the Institute of International Finance (IIF), to conduct a comprehensive study on the nature and potential severity of the most pressing risks associated with energy transition. Among the threats investors will need to attend to is the economic disruption caused by higher carbon taxes and bottlenecks in the supply of metals crucial to green technology.
May 2024
Transition and stock selection: the problems facing investors with sustainability goals
We commissioned our research partner, the Institute of International Finance (IIF), to conduct a comprehensive study on the nature and potential severity of the most pressing risks associated with energy transition. Among them was the very real possibility of capital misallocation and the emergence of asset bubbles among ‘green’ stocks.
May 2024
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