Carbon

Carbon is a risk factor that measures an investment opportunity’s reliance on carbon-emitting processes. In light of global action to regulate carbon emissions and manage climate change, businesses with high-carbon exposure may face severe risk to their operations.

Carbon dioxide, an element linked to causes of climate change, is an investment risk factor. Following increased global action against climate change, such as the Paris Agreement signed in 2015, more than 190 countries agreed to reduce carbon-based emissions. Many of these countries even set goals to become carbon neutral by 2050.

Many companies have operating businesses that contribute to carbon emissions. Some produce emissions directly, such as the fossil fuel energy industry, while others may produce carbon emissions as a byproduct of their manufacturing or transportation processes. Global action to manage climate change by reducing carbon emissions will have increasing impacts on the stock market.

Carbon risk, alternatively called transition risk, measures how reliant a company’s business is on carbon emissions. By restricting carbon emissions, carbon-emitting processes will be likewise restricted. Any company that heavily relies on these processes will therefore have its productive capacities cut down severely. Companies that take longer to adapt to new carbon regulations may suffer more consequences. The greater reliance on carbon, the greater those companies’ switching costs will be to preserve their business in a low-carbon economy.

Investors should be aware of the pressures carbon regulations will have on their investments by assessing their carbon risk. Morningstar, by working with ESG leader Sustainalytics, has developed the Morningstar Portfolio Carbon Risk Score to help investors analyze their portfolio for carbon risk. The Morningstar Low Carbon Designation also helps investors recognize if a portfolio has low carbon risk.