Fitch Ratings: Corporates' ESG Risk Driven by Policy, not Physical Changes

(The following statement was released by the rating agency) Fitch Ratings-London-15 October 2020: Corporates' credit profiles are far more vulnerable to sudden changes in ESG-related policies and regulation than to the actual physical effects of climate change, Fitch Ratings says. Corporate entities can mitigate physical risks by sufficient investments or relocation of productive capacity. However, societal and regulatory pressures could completely eliminate sectors exposed to policy-driven changes. There are significant differences between sector and sub-sector vulnerabilities not only over time, but also between countries and regions. This is a key finding of a new Fitch report that assesses the vulnerability, every five years from 2025-2050, of the global utilities sectors to ESG factors under a two-degree warming scenario. The scenario underpinning our analysis is the UN Principles or Responsible Investment Inevitable Policy Response, chosen for both its credibility and its focus on policy. Carbon-intensive sub-sectors are much more vulnerable to evolving policies and regulations than to the physical risks of climate change. Our analysis pinpoints coal-fired energy as the most exposed form of electricity generation, with vulnerability already very high in many regions but rising more slowly in Asia, where decarbonisation policy goals have a lower priority than economic growth and electrification targets. Growing environmental consciousness and the resulting societal and regulatory pressures pose an existential threat to coal-fired electricity generation. The trajectory and pace of this pressure could only be mitigated by an unforeseen technological breakthrough, or a collapse of, or reversal in, climate policies. The long-term vulnerabilities of corporate entities related to natural gas sub-sectors are more nuanced. We consider natural gas generation vulnerable to policy-driven phase-outs as the requirement for baseload is reduced by technological developments, such as greater electricity storage capacity. Developed markets with mature demand profiles are likely to introduce phase-outs first, resulting in gas generation reaching a moderate to high level of vulnerability in Europe and North America by 2040, while Asia and Latin America are likely to follow this trajectory but with a 10-year lag. Within the gas sub-sectors gas transmission and distribution (T&D) networks are less vulnerable to policy changes than gas generation. The efficiency of gas transmission networks is comparable to electricity, while demand for gas-transporting infrastructure in the medium term is unlikely to disappear as gas will still be needed to meet peaking energy demand. In the longer term, existing gas networks (with some modification and investments) could also be used for the transportation of hydrogen and other low-carbon gases. This results in only a moderate level of long-term vulnerability for this sub-sector. Water risks are an example where physical climate risks have the potential to massively complicate operations. Clean-water scarcity is already becoming a major global issue. About half of the global population already lives in areas that suffer water scarcity for at least one month each year, while global water demand is forecast to increase by 20%-30% by 2050. This risk issue can be overcome by sufficient investment in water treatment, desalination and distribution, and water-efficiency measures, but achieving this requires governments to incentivise water companies to invest in ensuring sufficient water provision. Risks may rise over time as the water sector's investment needs increase, reflected in higher customer bills. Regulatory regimes may come under pressure and renege on past promises on investment returns in the sector. This could increase the risk of a failure to provide reliable access to water and sanitation services. Nonetheless, its importance to human wellbeing means that we see the water sector as one of the least vulnerable across the corporate universe even out as far as 2050. For more information, see our report Utilities - Long-Term ESG Vulnerability Scores (https://www.fitchratings.com/site/re/10127465). Contact: Alex Griffiths Managing Director, Corporates + 44 20 3530 1709 Fitch Ratings Ltd 30 North Colonnade London E14 5GH Tatiana Kordyukova Senior Director, Fitch Wire +44 20 3530 1954 Media Relations: Adrian Simpson, London, Tel: +44 20 3530 1010, Email: adrian.simpson@thefitchgroup.com The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. 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