The decarbonization drive

The world is faced with an existential crisis, manifested by undeniable shifts in our planet’s climate system. Since greenhouse gas emissions are largely corporate, we believe that investors can and should play an active role in solving the climate crisis by supporting polluting companies in their green efforts. We believe investing in companies that aggressively transition is a commercial opportunity, well-aligned with our fiduciary duty to deliver returns and manage risk.

Pricing emissions is essential to incentivize green actions. A total of 64 carbon pricing instruments are currently operational around the world, covering over 20% of global emissions¹. EU’s emissions trading system is the oldest and most established scheme. Key high-emissions sectors receive so-called free allowances which can be sold if no longer needed. The market price for EU carbon permits has risen steadily, trading above EUR 60 in September.²

The good news is that substantial emissions abatements are not only possible, but value accretive for the heaviest carbon emitters. We believe this is one of the most misunderstood opportunities in today’s markets, both from an investor and climate point of view.

UBS has developed a framework to assess the valuation impact of mitigation efforts, relying on Marginal Abatement Cost Curves (MACC), sector-relevant collections of green actions and their associated emission abatement potential and costs. Our MACCs are developed in collaboration with Per-Anders Enkvist and his team at Material Economics.

¹www.worldbank.org/en/news/press-release/2021/05/25/carbon-prices-now-apply-to-over-a-fifth-of-global-greenhouse-gases
²https://www.euractiv.com/section/emissions-trading-scheme/news/eu-urges-markets-to-keep-calm-as-carbon-price-hits-e60-record/

The MACCs suggest abatement potential of around 30% by 2030 for most heavy industries. When abatements are achieved, companies reduce their cost of emissions and where applicable, free allowances can be sold and turned into profits.

Financial analysts go to great lengths in forecasting other value-drivers, but rarely account for emissions. We believe this leaves risks and rewards vastly mispriced. At its most simple, our framework allows us to add three extra line items to the discounted cash flow model of valuation: emission cost, green OPEX and green CAPEX. This allows us to model the optimal decarbonization pace maximizing firm value. In many cases, it suggests more aggressive actions than announced by companies.

In addition to supporting companies that provide climate solutions as their core business, we believe it is critical to enable green transitions in emission-intense sectors. By engaging, investors may influence these transition companies in the right direction. We believe this is sound investing, with our clients and the climate as the ultimate beneficiaries.

The views expressed are as of September 2021 and are a general guide to the views of UBS Asset Management. This document is a marketing communication, and the information herein should not be considered investment advice or a recommendation to purchase or sell securities or any particular strategy or fund. Information and opinions have been provided in good faith and are subject to change without notice. © UBS 2021. The key symbol and UBS are among the registered and unregistered trademarks of UBS. All rights reserved.