Green Transition Depends on The Consumption Rate of The Carbon Budget

Greenhouse gas emissions caused by humans are responsible for the increasing global warming, which threatens our planet’s natural balance. With the rising temperatures, investors and policymakers are turning to carbon budgets as a core factor for analyzing the implications of GHG emissions on our well-being. A carbon budget is a cumulative amount of carbon dioxide (CO2) emissions that are permitted through a period of time to stay within a certain temperature threshold.

At the COP21 or the Paris Climate Conference, world leaders decided to keep global warming at 1.5°C-2°C, as per recommendations of the Intergovernmental Panel on Climate Change (IPCC).

The remaining carbon budget for a 2-degree limit in 2100 is 1150 Gts of CO2, but it is only 400 Gts for 1.5 degrees. CO2 emissions are currently around 42 gigatonnes per annum (Gt/a) and continue to rise.

This carbon budget can be affected by several factors:

Phytoplankton helps the oceans retain CO2, making it a carbon sink. However, rising ocean temperatures are causing a decline in phytoplankton populations. Warmer ocean water absorbs less carbon dioxide from the atmosphere than water that is cooler.

Deforestation, which diminishes the capacity to convert CO2 into carbon-storing biomass is viewed as a serious challenge to the agreed-upon carbon budget. When forests are cut or burned, carbon that has been stored is released into the atmosphere, primarily as carbon dioxide. Carbon sinks such as soil organic matter, dead wood, and living biomass are released into the atmosphere, increasing carbon emissions.

Carbon capture and storage?(CCS) or?carbon capture and sequestration allow power plants or companies to capture the released carbon dioxide (CO2) before it enters the Earth’s atmosphere. It is stored in an underground geological formation. This process is of significance during the latter part of the century where more CO2 is removed than emitted.

Reforestation can also help reduce atmospheric CO2 by removing it from the atmosphere acting as a natural carbon sink.

These factors greatly influence the outcome of the committed carbon budget. Unplanned scenarios like forest fires, loss of oceanic biodiversity, and melting ice caps have forced policymakers to take urgent actions to limit global warming.

The rising GHG emissions are also impacting different industries and businesses that are part of a country’s economy. All of this will have positive and negative implications on business models and, as a result, credit profiles of banks’ customers. Banks are now adopting climate-based scenarios for Risk management advisory services, as companies are increasingly transitioning to greener solutions.

These climate scenarios allow risk departments to see the credit-adjusted impact of this transition. Although this impact will occur later, it does not change the overall cost to banks in terms of funding an increasing ‘Risk-Weighted Asset’ capital charge against facilities granted before various climate regulations come into effect. Impacts in terms of dollar costs can be applied by using the official ‘Net Greening of the Financial System’ (NGFS) estimates against each pathway option.

With this system, banks can:

• Calculate the impact of each scenario on the loan book's regulatory capitalization

• Calculate the cost difference if companies performed proactive, early-stage sustainability actions based on IPCC action recommendations

• Calculate the difference in green loan price per sector

• Use these capital indicators to set long-term business goals

• Track these goals as a part of their day-to-day operations

Banks are now considered agents of change as they are empowered to change their policies to encourage companies or businesses to adopt greener and cleaner solutions that reduce their carbon footprint.