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Market News

 February 16, 2007
Carbon Risk in the Canadian Economy

 Toronto, Canada - Projected legislation to curb green house gas (GHG) emissions will have a direct impact on firms that make up 40 per cent of the TSX's market value, finds a new report by CIBC World Markets. The report also finds that the vast majority of these firms will be adversely affected by the implementation of an emissions cap and trading system.

Report author Jeff Rubin, Chief Strategist and Chief Economist at CIBC World Markets, notes that investors will need to recognize carbon liabilities as "as part of a firm's balance sheet", and that "carbon exposure is broader than many investors yet suspect".

"The full extent to which corporate valuations will be impacted by carbon risk will depend on the distribution of permits, the initial severity of the emissions caps and the rate at which they are lowered over time. At the end of the day, legislators will determine those parameters. But investors beware; carbon emissions are very soon going to carry a price in the Canadian economy," he added.

The report notes that the state of California has taken the lead in reducing GHG causing carbon emissions by establishing a state-wide cap and trade system. The state, which is a huge energy consumer, seeks to cut its carbon emission levels back to its 1990 level by 2020.

British Columbia delivered its own climate change plan recently, pledging to reduce current emissions by 33% by 2020, and make all electricity produced in the province carbon-neutral by 2016.

The CIBC report also cites efforts by the states of Connecticut, Delaware, Maine, New Hampshire, New Jersey, New York and Vermont to cap emissions from major electric generating units beginning in 2009, with a 10 per cent cut planned longer term. In addition, a bipartisan bill is before the U.S. Congress seeking to establish a nationwide cap and trade system for GHG emissions.

The report finds that a number of variables will determine an industry's vulnerability to GHG emission caps, such as the ability to pass along the cost of emission credits to customers as opposed to absorbing that cost in profit margins. Another determinant of carbon vulnerability is the industry's energy intensity. To the extent that carbon emission allowances raise the price of energy, those firms that are in more energy-intensive industries will be penalized, even if they themselves are not major purchasers of emission credits.

The ability of firms to abate their emissions through better carbon practices will become increasingly important as the cost of emission allowances rises over time. The report notes that abatement can reduce required allowances that might otherwise have to be bought in the open market or create surplus credits that can be sold in the open market.

The report also shows CIBC's "Carbon Cap Composite Vulnerability Index", based on a weighted average of the four measures of carbon vulnerability: emission intensity; energy intensity; ability to pass along costs; and abatement scope.

The index finds that the coal-fired utilities sector is potentially the most exposed sector of the economy to carbon risk, reflecting extremely high emission intensity per megawatt of power produced. Next to coal-fired utilities, oil sands producers rank the highest on the index. While the oil sands accounted for only 3.5 per cent of Canada's GHG emissions in 2004, some estimates suggest that a virtual doubling in production to 2 million barrels per day will account for over 40 per cent of the growth in national GHG emissions over the balance of the decade.

The full report is available here (PDF).