A code red for humanity has been issued, the weather is increasingly erratic, and unprecedented storm destruction are established facts of life for much of the world, and governments across the globe are implementing stricter carbon emission regulations to industries.
But how do the cleaner environmental aspirations impact businesses on a daily basis, particularly the long-term credit realities of financing a new net zero business paradigm? In the financial sector, institutional investors are demanding impactful emissions reductions from the industries they support, and proof of it. The new investor standard is driving much of the change, according to industry professionals who gathered at a Moody’s climate event last week.
Shifting the center of power
Decarbonization has direct credit implications for the utilities sector.
“Current players in the utilities sector have already been working toward de-carbonization. Having the costs come down has helped, but it is something the investors want to see,” Jairo Chung, a vice president and senior analyst in the public project and infrastructure finance group at Moody’s Investors Service said during ‘Road to COP26: Getting Finance Fit for Net Zero.’
Certainly having a strong federal policy that will provide financial assistance and guidance should accelerate decarbonization efforts, Chung said.
Chung looked favorably on more recent developments in U.S. decarbonization policy, specifically how the bipartisan infrastructure investment legislation introduced in August might help modernize the nation’s power infrastructure. The legislation proposes earmarking about $65 billion in what would be the single largest investment in clean energy transmission in U.S. history.
The U.S. Senate’s proposals could be a credit positive to utilities should the legislation pass and funnel funds to the industry, Chung suggested, but she noted that utilities are already pushing to phase out coal-based energy production. Further, the industry is showing strong support for nuclear energy production, Chung said.
Costs for solar power capacity are coming down significantly, to around $20 to $45 per megawatt hour, giving companies further incentive to decarbonize, Chung said.
Changing gears on carbon emissions
Automakers experienced negative credit impacts as they invested large sums in research and development and adopted product offerings to adhere to stricter standards, said Matthias Heck, a vice president and senior credit officer of corporate finance at Moody’s Investors Service during the rating agency’s 6th Annual Climate Week NYC, presented last week.
Autos, a longstanding emblem of the human activity that is contributing to harmful carbon emissions, are also becoming symbols of the sector’s adaptability, and how the financial sector can play a role in encouraging industries to adopt carbon reduction strategies.
While early investments had put pressure on automakers’ operating profit margins, the expenditures have now been factored into corporate credit ratings, Heck said during a panel discussing the credit implications of the energy sector’s transformations.
Building a new energy foundation
Continued access to affordable credit will be especially important to the commercial real estate sector, which has aging property inventories, according to industry executives to also spoke at the Moody’s event.
“Renovating these buildings to meet new regulations will mean a lot of financing,” said Hewson Baltzell, president and COO of Helios Exchange, a commercial real estate database that helps landlords manage the costs of energy retrofits. “Already some are being impeded by issues such as structural problems, who should pay for the renovations and lease structures.”
Overall, Baltzell said, the commercial real estate sector faces three key challenges in mitigating carbon emissions in buildings – clarifying the targets, understanding the property thoroughly as a starting point, and developing a plan to remodel the properties.
Baltzell noted that the credit implications of carbon emissions renovations depend on how extensively the commercial buildings are modified and how the improvements are financed. Helios examined the credit defaults in a sample CRE portfolio of 90 properties across the U.S., which it selected from the Moody’s commercial mortgage-backed securities database.
After running the sample portfolio through the Helios model, applying several assumptions for benefits specific to property types and then revising net operating incomes, Baltzell noted that whole building and deep building retrofits increased credit risks slightly, and only because they tend to be quite efficient and fairly low cost.
Full electrification did increase credit risks, but not severely, especially in the hotel sector. For that sector, electrification only increased the lifetime expected default frequency risk from 27.4% to 28.3%, Baltzell said.
“As long as the building owners are able to benefit from the savings over time, the risks are manageable,” Baltzell said.
Getting ready for COP26
“Road to COP26: Getting finance fit for net zero,” brought together investors, analysts, issuers and climate experts virtually to discuss carbon transition risks, data transparency and how the debt markets can finance net zero strategies.
As the financial sector refines how it tracks emissions commitments, heads of state, industry leaders and the leading voices of climate science and activism will head to Glasgow, Scotland in late October for a separate event COP26, known formally as the 26th UN Climate Change Conference of the Parties. The nearly two-week climate convocation aims to produce a coordinated strategy to engage societies and industries across the globe in new ways of living and doing business.
