Listed companies appear to be competing with each other to be the most forthcoming on climate change disclosure.
We are in an era where investing on the principles of environmental, social and governance matters is on the rise and companies have responded. The ESG sections of company annual reports now provide expansive information on the environmental impact of such things as carbon emissions.
Less good though is the disclosure on the financial impact of climate change issues. If, say, a company was likely to face a bill in the future to buy permits to emit carbon, that is an impact that could be accounted for. Likewise if an ageing steel plant had to be written down in value because its longevity is curtailed by tougher environmental standards, then an impairment is required. But how and which costs should be accounted are still being defined.
I asked one steel sector analyst recently what they did to assess the financial impact of climate change issues on forecasts for the companies he covered. The response: “Nothing.” It was seen as too hard and there is too little clarity on what the standards of reporting should be.
Other analysts are making more endeavours but much more work needs to be done by investors, research teams and accounting rule-setters. Markets are clearly signalling it is important. Investors have already sniffed out which sectors have the greatest impact on global warming and priced them accordingly. Some sectors — such as oil and gas — have fallen in value greatly.
It would seem something is brewing among those who police financial reporting. Outside the US, both the International Organisation of Securities Commissions and the International Financial Reporting Standards Foundation are edging towards clearer standards. In the past week they announced they would set up a separate Sustainability Standards Board to finalise standards. While this board should be announced before the November COP26 climate change conference in Glasgow, the standards will not come so soon.
In America, responsibility for financial disclosure on these issues falls under the Securities and Exchange Commission. A new head of the SEC under the Biden administration has not yet been confirmed. But the acting head of the SEC, Allison Herren Lee, last month said the commission would “enhance its focus on climate-related disclosure in public company filings”.
One area worthy of better disclosure is in the management discussion in a company’s annual report. In particular, there should be much more information on the cost of carbon emissions.
For example, in the EU, companies which emit carbon are required to reduce these by 2030. Effectively they have carbon budgets. They can use up some of their own carbon credits, provided freely by the EU, or buy carbon credits in a traded market to offset their emissions.
Buying credits is a rising cost. The EU has cut back on the supply of available credits for industry and accelerated the required rate of emission reductions in the 40 years to 2030 from 40 per cent to 55 per cent. This has helped pushed the EU carbon price to $48 per tonne, up 83 per cent in one year. In regions other than the EU, there may also be a benchmark carbon price for companies to assess the costs of their emissions, albeit one that is less actively traded.
If a company has declared emissions and there is a carbon price benchmark, then it should be able to disclose its financial risk. Yet companies have no requirement to disclose this. Take BP, the oil producer, for example. It states that it assumes a $100 per tonne cost for its emissions for 2030. But despite reporting emissions and this estimated cost, it does not state the financial impact.
And the sums are not trivial for companies, particularly in sectors such as steel and cement which emit large amounts of carbon. If BP’s $100 carbon price was used as a benchmark, steelmaker ArcelorMittal and cement producer Buzzi Unicem generated emissions in 2019 worth as much as 3.5 times their earnings before interest, tax, depreciation and amortisation that year, based on FT calculations.
Many corporates will not want more expenses heaped upon them. Yet many shareholders should want a better idea of the financial risk they face. Financial directors as well as investors are keen to find some compromise.