Adapting portfolios

to climate change
Implications and strategies for all investors

BLACKROCK
INVESTMENT
INSTITUTE
GLOBAL INSIGHTS
SEPTEMBER 2016

Investors can no longer ignore climate change. Some may question the science
behind it, but all are faced with a swelling tide of climate-related regulations
and technological disruption. Drawing on the insights of BlackRocks investment
professionals, we detail how investors can mitigate climate risks, exploit
opportunities or have a positive impact. Climate-aware investing is possible without
Philipp
Hildebrand
BlackRock Vice
Chairman

Deborah
Winshel
Global Head of
Impact Investing

compromising on traditional goals of maximizing investment returns, we conclude.

We then reflect on steps that stakeholders in the climate debate are considering,
including the use of carbon pricing as a cost-effective way to reduce emissions.
Our overall conclusion: We believe all investors should incorporate climate change
awareness into their investment processes.

Summary
We start by detailing how climate change presents market risks and opportunities through four channels:
1) physical: more frequent and severe weather events over the long term; 2) technological: advances in
energy storage, electric vehicles (EVs) or energy efficiency undermining existing business models;
3) regulatory: tightening emissions and energy efficiency standards, and changing subsidies and taxes;
4) social: changing consumer preferences and pressure groups advocating divestment of fossil fuel assets.

These factors can play out immediately (often the regulatory variety), in the medium term as economies
transition to a lower-carbon world (often technological), and in the long run (often physical). Investor time
horizons differ as well and may require different approaches. The longer an asset owners time horizon,
the more climate-related risks compound. Yet even short-term investors can be affected by regulatory and
policy developments, the effect of rapid technological change or an extreme weather event.

We then show how all asset owners can and should take advantage of a growing array of climaterelated investment tools and strategies to manage risk, to seek excess returns or improve their market
exposure. We explain how investors can gradually implement climate considerations into their portfolios
and illustrate the complexities of a one-time portfolio makeover.

We end by detailing what many see as the most cost-effective way for governments to meet emissionsreduction targets: policy frameworks that result in realistic carbon pricing. These could address a market
failure as current fossil fuel prices arguably do not reflect the true costs of their extraction and use. Higher
carbon prices could minimize the economic costs of reducing emissions, incentivize companies to innovate
and help investors quantify climate factors. We see them as a scenario investors should prepare for.

Contents
34
Setting the scene

58
Climate risks

913
Portfolio applications

1415
Next steps

LEF T TO RIGHT

Poppy Allonby Portfolio Manager,

BlackRock Natural Resources Team

Isabelle Mateos y Lago Global Macro

Strategist, BlackRock Investment Institute

Michelle Edkins Global Head,

BlackRocks Investment Stewardship Team

Ashley Schulten Portfolio Manager,

BlackRocks Green Bond Mandates

Ryan LaFond Team Member,

BlackRock Scientific Active Equity

Ewen Cameron Watt Senior Director,

BlackRock Investment Institute

2 A DA P T I N G P O RT FO LIO S TO C LIMAT E C HANGE

Setting the scene

A tide of new regulations to combat climate change is rising. The risks are underappreciated, yet
could soon start to unfold. Significant spending on sustainable infrastructure and government
incentives are needed to meet emissions-reduction targets. These present large investment
risks and opportunities.
Most countries have signed the Paris Agreement to limit
global warming to less than two degrees Celsius (2C) above
pre-industrial levels the threshold where many scientists
see irreversible damage and extreme weather effects kicking
in. The countries have submitted plans to reduce carbon
emissions in so-called intended nationally determined
contributions (INDCs). Yet scientists say these commitments
alone are not enough to keep temperature rises below 2C.
See The Price of Climate Change of October 2015 for details.
There is no one-size-fits-all solution to reducing emissions.
Developed regions such as the European Union (EU) and U.S.
are placing a greater emphasis on improving energy efficiency,
while emerging market (EM) economies such as India and
China are prioritizing low-carbon energy generation such
as wind and solar power. See the chart on the bottom right.
Coordinated action is key, since carbon emissions do not
respect national borders. Emissions are a global problem.

No place to hide
The world is rapidly using up its carbon budget. To keep the
average global temperature rise below 2C, cumulative carbon
dioxide emissions need to be capped at one trillion metric
tons above the levels of the late 1800s, the Intergovernmental
Panel on Climate Change estimated in its latest assessment in
2013. The problem? We have already burned through over half
that amount. To meet the 2C warming cap, three-quarters
of proven coal, oil and gas reserves would have to remain in
the ground, the World Resources Institute estimates. These
assets could be effectively stranded with their owners
exposed to write-downs. See page 6 for details.
The sums at risk are enormous. The damage from climate
change could shave 5%-20% off global GDP annually by 2100,
according to the landmark Stern Review prepared for the UK
government in 2006. The economic impacts are not just in the
distant future. More frequent and more intense extreme
weather events such as hurricanes, flooding and droughts are
already affecting assets and economies.
Even if you are skeptical about the science of climate
change, there is no escaping a swelling tide of climate-related
regulation. Technological changes in areas such as renewables
and batteries are already causing disruption, while pressures
on companies and asset owners to support sustainability are
increasing. We discuss four key climate-related risks in the
next chapter: physical, technological, regulatory and social.

Governments, investors and consumers have been slow to

appreciate climate factors. Why? Scientific uncertainty is one
reason. Behavioral biases also offer some clues:

Risks or opportunities that are unlikely to materialize over

the next few years but could be significant over longer
horizons tend to be underpriced or underappreciated. This
is similar to a consumer who chooses a cheap, high-energy
appliance over an expensive energy-efficient model that
saves money in the long run.

Markets tend to focus on the shark closest to the boat.

Risks we can see, especially visceral ones, occupy most
of our attention. Contentious elections, referenda and
monetary policy decisions dominate headlines. The effects
of climate change are less visible and perceived by many
as distant. This leads to a bias toward inaction.
Bottom line: We believe climate factors have been underappreciated and underpriced. Yet this could change as the
effects of climate change become more visible.

To each his own

Pledged emission reductions by 2030 by category

100%

12% 54% 36% 29% 10%

14% 11% 21% 20%

75

50

25

EU

SA

MX

U.S.

SA Total

(Near) Zero-carbon energy

Fossil fuel shifts

Non-energy

IN

BR

TK

CN

Energy efficiency
Other/unspecified

Sources: BlackRock Investment Institute and the Energy Transitions Commission, April 2016.
Notes: Non-energy measures include changes in land use and forestry. The total emission
reductions in the U.S., EU and South Africa are based on current policy baselines. Chinas and
Indias total reductions show the difference between the business-as-usual mode and what would
happen if the countries were to deploy the listed measures.
BLACK ROCK I NVESTM ENT INST IT U T E 3

Subsidy savings

Green infrastructure
Meeting emissions-reduction targets requires steps such as
retooling energy-inefficient infrastructure and reducing fossil
fuel subsidies. This creates opportunities in areas such as
renewable infrastructure and underscores the importance
of using investment tools that incorporate climate factors.
The global economy will require big investments in
infrastructure as populations and the middle class grow
especially in energy systems and cities. The demand for new
infrastructure could top $90 trillion over 2015-2030, according
to The New Climate Economys 2014 report, Better Growth,
Better Climate. The drive to cut carbon emissions changes the
mix of this spending. Clean energy, efficient power grids and
energy-efficient buildings are on the menu. The energy and
transport sectors make up two-thirds of the needs, a 2016
McKinsey report estimates. Water and waste take up a fifth.
See the chart below. Most of the spending is needed in EMs.
There has arguably never been a better time for governments
to finance sustainable infrastructure. Financing is cheap, with
around one-third of government bonds in the developed world
today yielding below zero. See our Midyear Global Investment
Outlook of July 2016 for details. We expect more public
spending on infrastructure as countries pivot from monetary
to fiscal stimulus. Yet we also see the private sector playing a
key role. The challenge is finding ways to leverage the available
financing. The world is currently spending only half the amount
needed to meet the $90 trillion target by 2030, the New
Climate Economy estimates. Private investors could fill much
of the gap, with the right incentives. See page 13 for details.

Mind the gap

Global infrastructure spending needed vs. planned, 2015-2030
$40
Spending needed
in 2015-2030
30

Trillions

Currently
projected
20

Annual fiscal gains from removing energy subsidies, 2013

Share of revenues
0

10

20

30%

Developing
Asia
Russia & CIS
Middle East &
North Africa
Sub-Saharan
Africa
Latin America
Emerging
Europe
Advanced
economies

Petroleum

Coal

Natural gas

Electricity

Sources: BlackRock Investment Institute and 2015 IMF working paper. Notes: Middle East and North
Africa includes Pakistan. CIS is the Commonwealth of Independent States.

Sustainable subsidies?
Renewable energy handouts attract a lot of headlines.
Yet global fossil fuel subsidies are four times as large, the
International Energy Agency (IEA) estimates. They effectively
pay consumers and companies $15 to emit each metric ton of
carbon, the authors of the 2015 book Climate Shock estimate.
Scrapping energy subsidies could reduce global emissions
and save governments some $3 trillion a year, more than
they collect from corporate taxes, according to the 2015
International Monetary Fund (IMF) working paper How Large
Are Global Energy Subsidies? The study accounts for implicit
revenue losses in the form of taxes that would be collected
if carbon emissions were priced at their true social cost. The
impact would be especially large in developing Asia, Russia
and CIS, and the Middle East and North Africa. Removing
subsidies could boost fiscal balances by 30% or more in
those regions, the IMF estimates. See the chart above.
Reduced subsidies would incentivize companies to innovate,
create more fiscal space for countries to invest in sustainable
infrastructure and disrupt the energy and utility industries.
Cutting subsidies that reduce fuel costs is complex and can
be unpopular. Yet there are emerging success stories, as
detailed in the 2013 IMF study Energy Subsidy Reform:
Lessons and Implications.

10

0
Energy

Transport

Water

Telecoms

Sources: BlackRock Investment Institute and McKinsey Center for Business and Environment,
January 2016. Notes: Currently projected spending is based on an extrapolation of historical data
and the assumption of a continuation of real investment growth. Water includes waste management
systems. All figures are in constant 2010 U.S. dollars.
4 A DA P T I N G P O RT FO LIO S TO C LIMAT E C HANGE

Bottom line: Curbing carbon emissions requires significant

spending on green infrastructure and a reduction in fossil
fuel subsidies. This creates large investment opportunities in
areas that attract capital or industries at risk of disruption.

Climate risks
We see climate change creating risks and opportunities to investment portfolios in
four areas: physical, technological, regulatory and social. The relative importance of
these factors depends on the trajectory of the pathway toward a low-carbon world and
the asset owners time horizon.

Risk 1: Physical

Risk 2: Technological

Climate variability and weather extremes are facts of life.

Yet scientists believe physical climate risks are increasing
due to human activity, and expect them to show up in two
ways: 1) more frequent and extreme weather events such as
storms, flooding, droughts and wildfires; 2) creeping rises in
temperatures and sea levels over time. Consider the following
U.S. examples, which we see playing out elsewhere as well:

Technological advances and cost declines in renewable

power and electric grids, EVs and batteries pose a threat to
incumbent industries and demand for fossil fuels. Imagine,
for example, 25 million EVs on the road in 2025, the equivalent
of 10% of the U.S. passenger car fleet today. This could save
almost 1 million barrels of oil per day, UK consultancy Trusted
Sources estimates. This is roughly equal to the growth in
global oil demand in 2016, according to IEA forecasts.

The frequency of extreme weather events causing

$1 billion or more in losses has risen sharply over the past
decade, data from the National Oceanic and Atmospheric
Administration (NOAA) show. See the chart on the bottom
right. This poses risks to coastal real estate, agriculture
and companies with supply chains in geographically
vulnerable areas.

We could see greater economic losses ahead. Economic

growth in states hit by extreme weather events is 10%
to 15% lower than usual in the month of the event and
remains below trend even 12 months afterward, our
Scientific Active Equity (SAE) teams analysis of NOAA
and Federal Reserve data over the past 35 years shows.

Rising temperatures have clear economic effects,

Greater EV penetration could have a big impact on oil prices.

The oil market is already under pressure from a flood of
new supply in recent years from U.S. shale oil wells itself
the product of technological breakthroughs in fracking.
Technological changes are disruptive and could shorten
investment horizons. Exponential advances in EVs, coupled
with driverless cars and shared rides, could trigger a slide in
demand for traditional cars and gasoline much quicker than
markets may expect.

Costly weather
U.S. billion-dollar disaster events, 1980-2015
$200

even in developed nations with the financial means and

technologies to adapt. Daily productivity typically declines
by 1.7% for each 1C rise in average temperatures above
15C, a 2014 study of U.S. counties by Tatyana Deryugina
and Solomon Hsiang concludes.

Major cities in Southeast Asia below sea level could be

disproportionately exposed to floods and economic damage.
And some cooler regions of the world, such as Canada and
Russia, may actually see economic benefits from warmer
temperatures, according to the Stern Review.
Broad measures such as investing in an impact index or
reducing a portfolios carbon footprint are broad tools to
mitigate these sporadic risks and capture opportunities.
A detailed assessment of geographic risks and advantages
requires more granular modeling.

Total cost

Cost in billions

150

12
Number of
events

100

50

Number of events

The physical effects of climate change are hard to model,

and their impact is likely disparate across geographies. This
means looking at the averages only is of limited use. Example:
Alaska and the upper Midwest are expected to see the largest
temperature increases, according to the U.S. National Climate
Assessment of 2014.

16

1980 1985 1990 1995 2000 2005 2010 2015

Sources: BlackRock Investment Institute and NOAA National Center for Environmental Information
(NCEI), July 2016.
Notes: The line shows the number of climate events with losses exceeding $1 billion. The data
include droughts, flooding, severe storms, tropical cyclones, wildfires, winter storms and freezes.
The bars show the total cost. The data are adjusted for inflation using 2016 dollars.
BLACK ROCK I NVESTM ENT INST IT U T E 5

Dealing with disruption

Stranded assets

Technological disruption driven by efforts to reduce carbon

emissions is happening across industries. Consider:

The term stranded assets has become synonymous

with asset owners divesting their holdings in fossil
fuel-related companies. But what exactly does it
mean? An asset is stranded when it is no longer
usable (submerged real estate) or the cost to use
or extract it exceeds its revenue potential.

Increased use of light-emitting diodes (LEDs) will cut

power consumption from lighting by 40% from 2013-2030,
the U.S. Department of Energy forecasts.

Wind and solar generation could add as much to the global

energy supply in 2015-2020 as U.S. shale oil did in the
previous five-year period, Goldman Sachs estimates.
Renewable power has doubled its share of total global
capacity to 16% since 2007, while making up over half of new
installations. See the chart below. Low-carbon energy has
become cost competitive and less reliant on subsidies. Also,
many companies want to buy power directly from sustainable
sources. Renewables allow buyers to lock in power prices
for 20 years, without exposure to commodity price swings.
This shift creates opportunities, particularly in renewable
infrastructure with stable, long-term income. It may also erode
traditional utilities credit ratings and ability to pay dividends.
Advances in battery technology could help electric grids
better match renewables supply with demand. Widespread
deployment of storage could make financial sense as soon
as 2020, rather than previous estimates of 2045, consultancy
Carbon Tracker estimated in a 2015 report. Many of these
new players are too speculative to be investable yet or need
a catalyst such as carbon pricing or a reduction in fossil fuel
subsidies. Fierce competition, especially from China, also
could drive margins lower. Selectivity, therefore, is key.

Rise of renewables
Renewable power generation and capacity share, 2007-2015
53.6%
50%

Share of new installations

25
Share of global capacity
16.2%
10.3%

Share of global power generation

0
2007

2009

2011

2013

2015

Sources: BlackRock Investment Institute and Bloomberg New Energy Finance, March 2016.
Note: Renewables exclude large hydropower facilities.
6 A DA P T I N G P O RT FO LIO S TO C LIMAT E C HANGE

The cost of extracting resources such as oil has been

dropping due to advances in fracking technologies.
The problem? This notional cost does not reflect the
environmental costs of extracting the resource and
burning it. Governments may tax fossil fuels to an
extent that it is no longer feasible to develop them.
This has implications for the capital allocation of
fossil fuel companies. Such companies typically
spend five times more on seeking new reserves than
they do in returning capital to shareholders, according
to 2013 research from Carbon Tracker and Grantham
Research Institute. Yet much of this capex may make
little sense if the new reserves are incompatible with
a low-carbon pathway, the study argues.
The stranded assets debate today is playing out most
dramatically in electric power generation. Utilities
with outdated nuclear and coal-fired power plants
are under pressure from tougher regulations and
renewables competition. Many utilities that have
adapted to the shift to renewables are thriving. This
illustrates a need to be selective: Not all incumbents
will be losers, and not all renewables will be winners.
Assessing whether an asset is stranded depends
on your view on fossil fuel prices and the speed of
transition to a low-carbon world. We believe market
prices do not yet reflect the effect of rapid changes
in regulations, business models and technology.
Conversely, markets can also overreact to stranded
asset risk and create opportunities. Assets that
may be stranded in the long run can be attractive on
shorter horizons. Price declines could make fossil
fuels more competitive. And underinvestment in
oil or coal exploration today could result in supply
shortages and asset appreciation in the years ahead.
Not all fossil fuels are created equal. Gas, for
example, is relatively clean aside from methane
leaks from wells and pipelines. We see gas as a key
component of the global energy mix for years to come.
Companies with major exposure to this trend should
perform well in the medium term, we believe.

Risk 3: Regulatory
Regulatory risks stemming from efforts to combat climate
change are increasing. We believe many governments will
follow through on their emissions-reduction pledges, and
could see them ratcheting up targets over time. These are
waves in a swelling regulatory tide that also includes carbon
taxes (see page 15) and subsidies for alternative energy or
energy-efficiency measures. New regulations can pop up at
any time, surprising investors. They can upset the status quo,
favoring some industries and companies over others.
Unlike slow-burning and sporadic physical climate events,
regulatory risks are here and now. They can have an immediate
and often negative effect on cash flows by raising the
cost of doing business. More regulations also raise the risk
of compliance failures. Think of the recent spate of scandals
involving auto companies that cheated on emissions standards
tests. Or consider energy companies that violated regulatory
safety or environmental requirements and caused oil spills.
Compliance failures can trigger big fines, legal bills and
sudden implosions in asset prices. Lastly, regulatory risk can
jump unexpectedly across borders. Example: Japans 2011
tsunami resulted in curbs on nuclear power in Germany.

Some policies work better than others. Example: It is more

efficient to raise fuel taxes to encourage the use of lowemissions cars than to set incentives for buying clean cars or
to slap fees on polluting ones, a 2016 study of Swiss cantons
by Anna Alberini and Markus Bareit shows. As policymakers
search for the best solutions, they are pressing asset owners
for better disclosure, measurement and stress testing of
climate factors. High-profile initiatives include:

The Financial Stability Board an international collective

of financial regulators has assembled a task force to
work on new standards for climate reporting by companies.
This dovetails with initiatives by the U.S. Sustainability
Accounting Standards Board and others.

Frances Energy Transition Law requires France-domiciled

asset owners and managers to report climate factors and
carbon emissions footprints by December 2016.

Californias Insurance Commissioner has called upon

insurance companies doing business in the state to divest
from companies that derive 30% or more of their revenues
from thermal coal holdings.

The Dutch central bank has modeled the exposure of the

Netherlands banks, pension funds and insurers to fossil
fuel producers and carbon-intensive sectors in an effort
to pinpoint financial stability risks, a 2016 report shows.

The long-term impact of new regulations or subsidies is not

always immediately obvious. Three examples:

Exhibit C: Regulations can change consumer behavior, spur

business innovation and change the business model of an
entire industry. Take the advent of LED lighting. The mandated
phasing out of energy inefficient incandescent light bulbs
in many countries spurred new investments into LEDs. The
result: LED prices have fallen by 90% since 2010, and todays
lights last 84% longer. See the chart on the right.

The light that never goes out

LED cost and lifetime, 2010-2019
$80

50
Price

Lifetime

60

40

40

30

20

20

10
2010

2012

2014

2016

Lifetime (thousands of hours)

Exhibit B: Subsidies can initially boost cash flows of targeted

industries, but often trigger an influx of capital and capacity.
Spanish solar panel subsidies are a case in point. Government
subsidies led to an unprecedented boom in solar power
deployment in 2008. The industry collapsed when those
subsidies proved to be too generous and the government cut
them, and is only now crawling back. The U.S., German and
Japanese solar markets show similar boom-to-bust dynamics
in the past decade, according to Goldman Sachs research,
against a backdrop of Chinese competition driving margins
ever lower. As a result, these industries do not always make
for great equity investments. The best opportunities are
often less obvious. Example: We like semiconductor makers
benefiting from the structural demand for EVs.

The common thread: Regulators are starting to make climate

awareness a part of good corporate governance. The same is
true for the concept of fiduciary duty for asset owners, as we
show in the next chapter.

Cost per bulb

Exhibit A: Regulations can involve short-term pain but longterm gain. Power utilities in California, for example, face some
of the toughest regulations in the U.S. This may increase their
costs, raise credit risk and curtail dividend payouts and
penalize their investors in the short run. Yet these utilities
could achieve a stronger competitive position in the long term
versus peers in U.S. states where regulation has yet to catch
up. We see the same reasoning applying to countries that take
their climate change medicine now, rather than later.

2019

Sources: BlackRock Investment Institute, Quartz and U.S. Department of Energy (DoE), June 2016.
Notes: Figures are based on the cost and lifetime of general service lamp LED bulbs. 2016 to 2019
are based on DoE forecasts.
BLACK ROCK I NVESTM ENT INST IT U T E 7

Warming paths

Social and corporate awareness of climate change are

increasing amid a recent spike in global temperatures. Last
year was the hottest since records began in the 19th century,
surpassing 2014, according to the U.S. NOAA. The trends
are increasingly driving changes in behavior. Two-thirds of
global consumers today say they are willing to pay more for a
sustainable brand, up from 55% in 2014, a survey from market
research firm Nielsen shows.
Non-governmental organizations (NGOs), shareholders,
activists and consumers are pressuring companies to make
their supply chains more sustainable (using less energy and
water, and producing less waste). The same groups are putting
climate change on the agenda of asset owners, especially
public funds or university endowments. Large investors are
pledging to gradually decarbonize portfolios, divest fossil fuel
companies or disclose carbon footprints. See the table below.

Scenarios for global temperatures, 2010-2100

Greenhouse gas emissions (GtCO2e)

Risk 4: Social

Warming
projected
by 2100

150

Baseline
4.1 4.8C
100
Current policies
3.33.9C
50
Pledges & INDCs
2.42.7C
Below 2C
1.51.7C

0
2010

Rating the risks

The speed of the energy transition is key to assessing climate
risks and opportunities. The less the world does today to curb
carbon emissions, the further away it gets from a 2C warming
path. No action at all or current policies would lock in much
more severe warming. See the chart on the right. Slow action
would mitigate regulatory risk in the short run, but raise the
possibility of extreme weather events. These events, in turn,
could prompt more drastic policy actions down the road. The
bolder the policy action taken today, by contrast, the greater
the transition risk for industries and assets due to fast
technological and other changes.
Investor time horizons play into this. Long-term investors are
likely more exposed to physical risks, stranded assets and the
impact of climate change on economic growth. Yet we also see
them as better positioned to invest in new technologies that
take time to bear fruit. Short-term investors tend to be more
vulnerable to here-and-now regulatory risks.

2030

2050

2070

2100

Sources: BlackRock Investment Institute and Climate Action Tracker Project, July 2016.
Notes: The chart shows the forecast path of emissions in metric gigatons of equivalent carbon
dioxide (GtCO2e) under different scenarios. The baseline area shows the path in the absence of
climate policies; below 2C shows the path needed to keep warming below two degrees Celsius
from pre-industrial levels by 2100. The temperature ranges shown are the median pathways
required to meet targets with 66% certainty. The pledges and INDC area is based on pledges or
promises that governments have made, including in submitted INDCs as of Dec. 7, 2015. The
ranges shown are 10th to 90th percentiles.

Risk for the long-term investor is not short-term portfolio

volatility, but events that could lead to a permanent loss of
capital. The effects of climate change need to be part of that
equation, we believe. This is especially pertinent for pension
funds with rising liabilities at a time when we expect low future
returns across asset classes.
Yet even short-term investors would do well to integrate
climate factors into their portfolios. We discuss various
ways of doing so in the next chapter. This includes climateoptimization of benchmarks, using a climate scoring
framework that aims to generate excess equity returns or
climate-proofing a corporate bond portfolio in one swoop.

Institutional activism
Climate-related actions and pledges by institutional investors

Organization

Goal

Commitments

UN Principles of
Responsible Investing (PRI)

Investors aim to put the UN principles into practice, including recognition of the
materiality of environmental, social and governance (ESG) criteria.

1,500+ signatories
$60+ trillion in assets under
management (AUM)

Montreal Climate Pledge

Signatories commit to measure and publicly disclose the carbon footprint of their
investment portfolios on an annual basis.

120+ signatories
$10+ trillion AUM

Fossil Fuel Divestment

Commitments

An institution or corporation that does not have any investments in fossil fuel
companies (coal, oil or natural gas) and is committed to avoiding any such
investments in the future.

500+ institutions
$3.4 trillion AUM

Portfolio
Decarbonization Coalition

Initiative to reduce emissions by mobilizing institutional investors committed

to gradually decarbonizing their portfolios.

25+ signatories
$600+ billion AUM

Source: BlackRock Investment Institute, July 2016.

8 A DA P T I N G P O RT FO LIO S TO C LIMAT E C HANGE

Portfolio applications
Maximizing returns is the guiding principle of financial fiduciaries. Yet the view of what is
financially relevant is broadening. We describe how investors can incorporate climate factors
to reduce risk and seize opportunities. We give examples of fine-tuning equity exposures,
searching for excess returns, remaking bond portfolios and tapping the green bond market.
Paying heed to environmental, social and governance (ESG)
factors was long thought to be inconsistent with maximizing
financial returns. The first cracks in this view appeared when
the UKs Cadbury Report of 1992 set standards for corporate
governance. We have come to see good governance as
synonymous with operational and financial excellence.
There has been a leap in the quality and quantity of ESG data
in recent years. We believe financial fiduciaries now can and
should integrate relevant ESG factors in their investment
processes or principles. Some investors are starting to pay
special attention to the E component to reduce climate risks,
exploit opportunities and adapt to the transition toward a
lower-carbon economy.
Policy is also moving in this direction. The UN Principles for
Responsible Investment in 2015 called on regulators to ensure
that fiduciary duty requires investors to take account of all
ESG factors in their investment process. Many regulators
have yet to take action, but signs of change are emerging. The
U.S. Department of Labors 2015 guidance for private pension
funds urges fiduciaries to consider ESG factors that could
influence risk and returns. The UK Pension Regulator used
similar language in a July 2016 guide for trustees.

Building better beta

Many asset owners address climate change by adjusting
existing portfolios. This often includes investments in
renewable infrastructure and promising but risky new
technologies, as well as some exclusion of resources or
utility companies. Yet a growing number of tools is available
to more systematically integrate climate factors.
One such approach is to optimize benchmarks for climate
factors. This means overweighting green companies and
underweighting climate offenders, while keeping a portfolios
return profile as close to the benchmark as possible. The
tradeoff? The more climate friendly a portfolio becomes, the
larger the tracking error (the deviation of returns from the
benchmark over time) tends to be. Smallish tweaks can have
a big impact, we found when we tried to optimize the MSCI
World Index to minimize carbon emissions. It is possible, for
example, to cut a portfolios carbon footprint by around 70%
while keeping the tracking error within 0.3%, our simulation
showed. See the chart below.

Small difference, big impact

Carbon emissions of optimized global equity portfolio, 2015

240.5

Necessity, not a choice

Investing with the aim of mitigating climate change may be

a matter of choice for most investors. Yet we see climateaware investing incorporating climate considerations in
the investment process as a necessity. This does not mean
giving up returns, we believe. Benchmarks that take climate
into account have the potential to perform in line with or better
than regular counterparts. The MSCI Low Carbon Target Index,
for example, has modestly outperformed the MSCI ACWI since
2010, MSCI data show. We could see climate-aware portfolios
outperform amid tighter regulations, faster technological
changes or more frequent weather events.
Bottom line: We see climate-proofing portfolios as a key
consideration for all asset owners.

100

Emissions in metric tons

Motivations matter. Is the aim to protect against climate

changes impact on the portfolio? Or is the objective to invest
in companies poised to benefit from the transition to a
lower-carbon economy and/or have a positive impact? Some
investors try to avoid return-adverse outcomes while adding
potential return boosters. Others want to shape outcomes.

50

0
Index 0.3

0.5

0.7
0.9
1.1
Tracking error

1.3

1.5%

Sources: BlackRock Investment Institute and MSCI, July 2016. Notes: The above is a simulation
that aims to minimize a hypothetical portfolios carbon footprint. In constructing the hypothetical
portfolio, BlackRock takes all companies in the MSCI World Index and MSCI emissions data and
performs a standard mean variance optimization for each given tracking error. Emissions data are
measured in metric tons per million U.S. dollars in total capital (total equity and debt). The forwardlooking tracking error is an estimation that uses the BlackRock Fundamental Risk for Equity model.
This does not represent an actual portfolio, fund managed by BlackRock or investable product, nor
is it a recommendation to adopt any particular investment strategy.
BLACK ROCK I NVESTM ENT INST IT U T E 9

Aiming for alpha

Digging for data

Corporate information on climate factors is improving but still

has holes (see Digging for data on the right), and the timing
and intensity of climate-related events are unknowns. These
vagaries create opportunities for generating alpha (returns in
excess of the market) for those willing to do detailed research.

The measurement and disclosure of data to score

companies and climate-optimize portfolios are
far from perfect. Data on climate factors are often
incomplete, self-reported and not comparable. Yet
common standards are developing, and the volume
and quality of data are increasing fast. It now is
possible to incorporate climate factors into the
investment process. We suggest the following menu:

This means asset owners and managers can fulfill their

fiduciary duties under both the old-fashioned interpretation
of maximizing returns and the new view of including climaterelated ESG factors.
Our SAE team started to research climate alpha generation
in 2015 by using simple measures such as companies selfreported Scope 1 and 2 carbon emissions (direct emissions
and those generated by use of energy). The team calculated
emissions as a percentage of sales and focused on year-overyear changes. The thesis was that improving carbon efficiency
may signal operational excellence and could offer the
prospect of outperformance.
Global companies that reduced their carbon footprints the
most have indeed outperformed carbon-cutting laggards in
recent years, the research showed. See the chart below. There
are plenty of caveats, including the small sample size, limited
time period and self-reported nature of the emissions data.
The team has now moved beyond crunching carbon emissions
numbers to developing a holistic climate scoring system that
can be used to climate-proof portfolios. We are using this
evolving concept as a building block in our actively managed
impact investing strategies. See the next page.

Efficiency improvement race

Equity performance by carbon intensity, 2012-2016
6%
Group 1
(most
improved)

4
2
0

Group 2
Group 3
Group 4

-2
-4

Group 5
(least
improved)

-6
-8
2012

2013

2014

2015

2016

Sources: BlackRock Investment Institute, ASSET4 and MSCI, July 2016. Notes: The analysis
above calculates the carbon intensity of all MSCI World companies by dividing their annual carbon
emissions by annual sales. Companies are ranked and bucketed in five quintiles based on their
year-over-year change in carbon intensity. We then analyze each quintiles stock price performance
versus the MSCI World Index. Most improved means the 20% of companies that posted the greatest
annual decline in carbon intensity. Data are from March 2012 through April 2016. The example is
for illustrative purposes only. Past performance is no indication of future results.
1 0 A DA P T I N G P O RT FO LIO S TO C LIMAT E C HANGE

Starter package: ESG data, particularly the

E part, are essential for a first pass. Various
providers now include information on fossil fuel use,
carbon emissions, water consumption and waste
management. The data are becoming more granular
and consistent. This makes it easier to implement
ESG and impact investment strategies. The data are
largely self-reported, however, and need analysis to
track improvement by individual companies.
Climate-friendly indexes: Useful as broad-brush
tools to integrate climate factors and as benchmarks
for custom-made climate portfolios. Drawback is
that they exclude private companies.
Revenue and geographic exposures: Important
for hedging climate risk, for example, by excluding
companies reliant on fossil fuels. The exposures
are static, however, and do not take into account
individual company supply chain risks and initiatives
to improve sustainability and energy efficiency.
Carbon emissions: Good for measuring the carbon
intensity of companies and for adhering to regulatory
reporting requirements. Partial and self-reported
disclosure of the data are drawbacks. Methodologies
are evolving, with a current focus on Scope 3
emissions from sold products and carbon offsets.
This can increase a companys carbon footprint (a car
maker) or reduce it (a wind turbine maker).
Big data: Big data analytics go beyond traditional
sources to uncover corporate risks throughout supply
chains. This is similar to home insurers using external
inputs from real estate websites and crime statistics
with the aim to speed up overall claim adjustments
and focus time-consuming investigations on outliers.
Sovereign risks: Increasing output from rating
agencies and others helps quantify the fiscal,
economic and societal effects of climate events on
countries, as well as the possible impact of stranded
assets on government revenues.

Climate is king

Resource efficiency: The first cut. Companies that generate

more sales with less carbon, water and waste are deploying
resources more efficiently. Companies that recycle, for
example, are rewarded with a higher score while those
contributing to landfills are penalized. Decomposing landfills
produce one-fifth of U.S. human-related methane emissions,
Environmental Protection Agency 2016 estimates show.
Climate risks: Next is estimating risks to companies, ranging
from the effects of possible carbon taxes to the impact of
extreme weather events on labor productivity. To capture the
latter, SAE first measures a companys exposure to each of
the 50 U.S. states. The team then estimates temperatureinduced income shocks. Lastly, it captures how firms perceive
their exposure by counting the absolute number and change in
disclosed climate-related risks.
Climate opportunities: Finally, the team aims to identify
potential winners by tracking filed green patents and disclosed
climate opportunities, and the annual change on these metrics.
This is meant to capture corporate shifts toward alternative
energy and innovations such as cleaner chemicals, new
waste-water treatments and energy storage.

Scoring rules
Framework, categories of BlackRock climate score, July 2016

Resource
efficiency

Climate
risks

Climate
opportunities

Carbon emissions

Carbon tax

Water usage

Temperature
changes

Disclosed
opportunities

Waste disposal

Green patents

Disclosed risks

BlackRock Climate Score

Climate strategy relative performance and emissions, 2012-2015

12

8%
Index emissions

10

6
Climate portfolio
emissions

Relative performance

CO2 emissions in million metric tons

SAEs evolving BlackRock climate score uses 17 measures

that rank U.S. companies in three areas: resource efficiency,
climate risks and climate opportunities. See the graphic
below. We use both absolute levels and the annual rate of
change in these metrics to capture the evolution of climate
factors at companies and their impact on the environment.

Relative performance vs. Russell 3000

Keeping score

0
2012

2013

2014

2015

Sources: BlackRock Investment Institute and Russell Index data, July 2016. Notes: The analysis above
uses a simulated backtested portfolio to illustrate the performance of a strategy optimized for climate
risks. In constructing the hypothetical portfolio, BlackRock takes all companies within the Russell 3000,
ranks each with a climate score (utilizing the measures described on the left) and then applies a risk
weighting. These data points are then used in a standard mean variance optimization. Performance is
net of historical trading costs. This does not represent an actual portfolio, fund managed by BlackRock
or investable product, nor is it a recommendation to adopt any particular investment strategy.

Putting it to the test

Our thesis was that companies that use resources
efficiently, mitigate weather-related risks and exploit climate
opportunities should have stronger fundamentals. And indeed,
SAEs research found that U.S. companies with higher climate
scores tend to be more profitable and generate higher returns
on assets.
How about investment returns? The SAE team tested this by
simulating a portfolio that overweights selected Russell 3000
Index companies with the highest climate score on a monthly
basis while keeping the annualized tracking error within
1% of the index. This limitation meant the simulated portfolio
became climate friendlier only gradually over the period 2012
to 2015. It only becomes clear over time which companies are
most resource efficient. The portfolios weighted average of
CO2 emissions was almost 50% below the benchmarks at the
periods end. See the grey and purple lines in the chart above.
The simulated portfolio would have beaten the Russell
benchmark by seven percentage points over the period after
average historical trading costs. See the charts green line.
An implosion in resource stocks (which have a higher chance
of receiving poor climate scores) helped the outperformance.
The portfolio held 1,600 to 1,800 companies over the period,
versus 3,000 for the benchmark.
Bottom line: Our research suggests there can be little
downside to gradually incorporating climate factors into
the investment process and even potential upside.

Source: BlackRock Investment Institute, July 2016.

BLACK ROCK I NVESTM ENT I N ST IT U T E 1 1

Bond portfolio makeover

Discussing the results with the client, three themes emerged:

We kept close to original benchmarks in our previous

illustrations of how to implement climate factors in investing.
This approach reflects the preference of many asset owners
to stick closely to market gauges. What if an asset owner
wanted to do a one-time portfolio makeover, either because of
regulatory requirements or a desire by stakeholders to do so?
As an experiment, we explored this for an insurance clients
$150 million non-financial corporate bond portfolio. The aim of
the exercise was to reduce climate risks on the portfolio while
maximizing any beneficial effects on the environment.

Small green pipes: We found just a few green securities that

complied with the portfolios mandate. This speaks to a larger
challenge: The green and cleantech credit markets cannot yet
accommodate the money flows needed to hedge against or
halt harmful effects of climate change. Greater incentives to
promote green bond financing are needed to widen the pipes.
See page 13 for details.

We simulated a new portfolio using rules that either excluded

or added issuers, as the table below shows. The exclusions
wiped out 77 bonds, or two-fifths of the portfolios bonds
by value. Why such drastic change? The portfolios narrow
mandate of no financials meant it was overweight oldeconomy sectors. We found nine green and cleantech bonds
that fit into the portfolios mandate, and re-allocated the
remainder to bonds that had survived our exclusionary rules.
The outcome of our simulation? The new portfolio had 70%
less CO2 emissions per invested dollar and an improved
environmental ESG score. The biggest sector changes were in
energy (2% versus 17%), consumer non-cyclical (27% versus
19%) and consumer cyclicals (17% versus 10%). The simulated
portfolios yield was essentially unchanged at 2.17% but its
duration rose to 5.0 years, from 4.6.

Miscarriage of justice? Large energy companies arguably

are part of the solution. They have the technology and capital
to develop clean energy. Yet our exclusion rules ruthlessly
eliminated them. Are we punishing the wrong players?
Possibly: Integrated energy firms could issue green bonds to
fund specific cleantech projects. As a large asset manager, we
generally prefer to work with companies on their climate plans
rather than divesting.
Tradeoffs are complicated: The portfolios narrow mandate
caused a drastic makeover, resulting in a more concentrated
portfolio with a different risk profile. And then there are
trading costs, liquidity challenges and tax implications. The
easiest fix would be to change the portfolios benchmark to a
climate-friendly index. Another solution would be to pursue
climate-proofing objectives gradually over time. An asset
owner, for example, could re-invest maturing bonds in green
and cleantech bonds. This approach would jibe with our earlier
examples of trying to maximize a portfolios climate score
while staying as close as possible to the benchmark.

Climate change rulebook

Rules used to make an insurers corporate bond portfolio climate friendly, July 2016

Exclusions

Rule

Reasoning

Fossil fuel
reserves

Companies reporting fossil fuel reserves as assets unless

25% or more of their revenues are from renewables.

Reduces risks from the transition to a less carbon-intensive

world and from stranded assets.

Carbon emissions
intensity

Energy, materials, utilities and industrial companies with a

carbon intensity greater than their subsector's average.

Screens out the worst performers in four sectors that account

for the majority of CO2 emissions.

Coal revenue or
generation

Companies that receive 30% of revenue from extracting coal or

using it for power generation.

Companies relying on coal face high regulatory, technological

and energy transition risks.

Water withdrawal
intensity

The top 50% most water-intensive companies in the metals

and mining, beverage and utility sectors.

Companies that use the most water are most exposed to

scarcity and regulatory risks.

Toxic emissions

The bottom 50% of companies that have toxic emissions as an

environmental key performance indicator.

Reduces toxic emissions to limit damage to the environment

and air pollution.

Forestry
commitments

Companies failing to address deforestation risks in their

supply chains, including retailers and food producers.

Deforestation and forest degradation contribute to 10%-20%

of global CO2 emissions.

Additions

Rule

Reasoning

Green bonds

Green bonds with similar maturity and risk profiles. They can
be of excluded companies as proceeds are ring-fenced.

Uses debt capital markets to finance projects that have a

positive impact on the environment.

Clean tech or
green companies

Companies deriving 50%-100% of revenues from clean

technologies such as renewables and energy efficiency.

Increases exposure to climate change solutions and

sustainability initiatives.

Source: BlackRock Investment Institute, July 2016. Notes: The example is for illustrative purposes only. It does not represent an investment recommendation, nor a portfolio BlackRock currently manages.
1 2 A DA P T I N G P O RT FO LIO S TO C LIMAT E C HANGE

Green bond game changer?

How can fixed income investors make a positive impact on
climate outcomes? Green bonds are an evolving solution.
The proceeds of green bonds are ring-fenced to fund
eligible climate change mitigation projects, with a focus
on renewables, energy efficiency and transport.
The green bond market has some $130 billion of debt
outstanding as of July 2016 according to Bloomberg data,
or just 0.15% of the total global fixed income market. Yet the
market is growing fast, and we expect to see up to $50 billion
of issuance in the second half of 2016. Highlights:

The universe already includes more than 600 bonds from

24 countries, in 23 currencies. A big chunk is AAA-rated
government issuance, including supranationals. Yet bonds
span the ratings spectrum. See the chart on the right.

Non-government issuers include banks, property

companies, car makers, food producers, conglomerates
and cleantech companies.

Development banks were the first movers and drove

innovation. Yet companies increasingly have been tapping
the market, making up roughly 45% of 2015 green bond
issuance according to Bank of America Merrill Lynch.
We see green bonds becoming their own asset class. Several
index providers have launched green bond indexes; S&P and
Moodys are developing green bond ratings methodologies;
and public bodies are seeking ways to encourage the
development of this nascent market.
Asset managers including BlackRock, issuers and underwriters
have developed a set of green bond principles that include
specifics for the use of proceeds, project evaluation and
impact reporting. Harmonization and toughening of standards
arguably create more work for issuers but are needed to
build a credible and durable foundation for the sector, in our
view. Asset owners, investors, issuers and rating agencies have
adopted the principles, as have public entities such as the
Peoples Bank of China.
Green bond holders do not have to give up liquidity or returns,
in our view. Issuers tend to be big companies or entities
that issue liquid debt securities. We have yet to see pricing
differences with traditional bonds of comparable credit
ratings and maturities. This may change, however. We could
see green bonds starting to trade at a premium to peers.
Asset owners appear to have a big appetite for green bonds,
especially for issuers who provide thorough impact reporting
and have the environmental benefits of their projects rated by
outside sources.
Yet the market cannot yet accommodate large-scale portfolio
allocations. Cheaper and more widespread green bond funding
is needed to drive more investment toward climate-beneficial
projects. Governments have a role to play in facilitating
climate finance; joint efforts such as the G20 Climate Finance
Study Group are leading the debate on how to best do this.

Green bonds
Outstanding green bonds by sector and rating, 2015
Municipal
Utilities
Technology
Industrials
Government
Financials
Energy
Consumer
staples
Consumer
discretionary
AAA

AA

BBB

BB

S&P Rating

No
rating

Sources: BlackRock Investment Institute and Bank of America Merrill Lynch, November 2015.
Note: The size of each bubble reflects the U.S. dollar amount of the outstanding green bonds of
each category and S&P rating. The universe of green bonds reflects the $96 billion of outstanding
issuance as of November 2015.

We see green bonds as part of the solution to finance the

estimated $90 trillion of global infrastructure needed by
2030 to limit climate change. There has been a lot of investor
talk about infrastructure, but little action. Average pension
fund allocations were stuck around 3.5% of assets in the
period 2011-2014, according to a 2015 OECD survey. Legal
frameworks are needed in many countries to enable pension
funds and insurers to lend to infrastructure finance without
diluting lending standards. Illiquidity and long lock-ups also
take infrastructure assets outside many portfolio mandates.
Many potential projects are located in EMs with regulatory
uncertainties and political and currency risks. Tax incentives
and public guarantees may help entice private capital.
Examples: using development banks and export credit
guarantees to lower financing costs and reduce risks.
We also believe creative financing could galvanize the pools
of capital needed. For example, a supranational organization
could first pool EM bank loans to multiple renewable projects
across different countries. This would mitigate project- and
country-specific risks key concerns of many investors. A
second step would be to create different credit tranches. The
supranational would own a junior tranche that would absorb
the first potential losses. This would effectively be a first-loss
cushion for private holders of senior tranches.
We discuss other ways governments can help mobilize private
capital and better align incentives in the next chapter.
Bottom line: Green bonds are a growing investment
opportunity and funding tool for sustainable infrastructure.
BLACK ROCK I NVESTM ENT I N ST IT U T E 1 3

Next steps
What can be done to smooth the transition to a lower-carbon world? We show how the interests
of stakeholders can be aligned. Economists, governments and companies increasingly see
higher carbon prices as a cost-effective way to hit emissions-reduction goals.

Asset owners: new processes

Companies: better data

What can asset owners and investment managers do? Here

are broad strokes:

We see three key steps companies can take to manage

climate-related risks and seize opportunities:

Data: Put the people and tools in place to analyze the fast-

Plan: Incorporate climate factors into strategic planning.

growing pile of ESG data. Nudge data providers to fill holes

and solve inconsistencies.

Integration: Integrate climate factors into the investment

process to identify and manage risks and opportunities.
This helps asset owners and managers provide investment
boards, clients or regulators with portfolio carbon
footprints, screening strategies and detailed reports
that include climate factors for individual securities.

Engagement: As a large asset manager, we prefer dialogue

over divestment. The biggest polluters have the greatest
capacity to move the dial if they modify their behavior. Just
80 companies are responsible for more than half the global
emissions by publicly listed companies, our analysis of
MSCI data shows. Engagement can help nudge some in
the right direction.

Climate action mosaic

Key climate change stakeholders and their actions

Asset owners

Companies

Divestment campaigns
and low-carbon portfolios

Development of
low-carbon technologies

Corporate engagement to
promote sustainability

Greening of supply chains

Commitments to
100% renewable power

Pushing standardization
of climate reporting
Increased disclosure
of portfolios
carbon footprints

Disclosure of
climate-related factors

Climate
Change

Issuance of
green bonds

Governments

Consumers

Country commitments
to reduce emissions

Shift toward energy-efficient

vehicles and appliances

Five-year reviews on
emissions reduction progress

Rising demand for

sustainable brands

Carbon pricing, green

regulations and sustainable
infrastructure

Activism to influence
corporations

Source: BlackRock Investment Institute, July 2016.

1 4 A DA P T I N G P O RT FO LIO S TO C LIMAT E C HANGE

BlackRock has long advocated for corporate executives to

set long-term strategic plans that include consideration
of relevant ESG factors. Consider issuing green bonds.

Engage: Help investors understand how the company is

dealing with climate risks and opportunities and how
these affect the firms long-term value and sustainability.

Disclose: Improve disclosure of climate factors. This

includes making the disclosures more forward looking,
granular and standardized (adapted to the needs of
industries).

Governments: good incentives

Governments can help ensure the transition to a low-carbon
economy is smooth by doing things only governments can do:
making up for market failure or private sector inaction.
Their actions shape the incentives for a mosaic of
stakeholders companies, asset owners and consumers
to modify their behavior. See the graphic on the left.
Most importantly, governments need to provide clarity and
predictability around climate-related policies and regulations.
Key steps that governments are taking include:

Creating policy frameworks that result in higher and more

consistent carbon prices. Economists see this as a costeffective way to achieve emissions-reduction goals. It
could also help reduce investor uncertainty and encourage
corporate innovation to cut greenhouse gases and raise
energy efficiency. See page 15. Reducing subsidies for
fossil fuel extraction and use could also nudge consumers
and businesses toward more efficient energy use.

Mandating higher energy efficiency via rules such as

vehicle emission standards.

Setting standards for consistent measurement and

reporting of climate factors. This is a work in progress.
We see it helping companies and asset owners find better
ways to mitigate risks and capture opportunities.
See Exploring ESG of June 2016 for further details on actions
for governments to consider.

Pricing carbon
The cost of emitting carbon is minimal or even negative for
producers and households. This is because current market
prices arguably do not yet reflect the social costs of burning
fossil fuels. The result is over-consumption. This externality
is at the core of the climate challenge. Higher carbon pricing
would help address this and would be the most cost-effective
way for countries to meet their Paris Agreement pledges, many
economists believe.

Carbon pricing
Range and median of internal carbon prices by sector, 2015

Telecoms
Consumer
discretionary

$357

Utilities

$306

Materials

$122

Governments are pressing ahead with carbon taxes or

emissions-trading schemes (ETSs). See the table below.
Economists believe it is better to employ one tool to tackle
climate challenges across the economy than to use different
sticks and carrots for each sector. But less-efficient
command and control policies such as green car subsidies
are often preferred. The future policy mix in many regions is
still unclear. Yet higher and more consistent carbon pricing is a
scenario that investors should prepare for. It would incentivize
companies to innovate to cut carbon emissions. This, in turn,
could be a key catalyst for investment risks and opportunities
related to technological disruption. It could also help investors
better quantify the carbon risks embedded in their portfolios.
The momentum for carbon pricing is growing. Six major oil
companies in 2015 called for stronger carbon pricing, and
a coalition of 130 investors with more than $13 trillion under
management in 2016 made a similar plea to policymakers.
Some 1,000 global companies are using an internal price on
carbon or plan to do so soon, in an effort to mitigate risks from
future regulation, a 2015 Carbon Disclosure Project (CDP)
survey shows. Yet there is a wide range of prices within
and between industries. See the chart on the right.

$151

Energy

Health care
Financials
Consumer
staples
Industrials

$150

Information
technology

Median
0

50

$100

Price per metric ton

Sources: BlackRock Investment Institute and CDP, September 2015.
Notes: The chart shows internal carbon prices reported by global companies to CDP by sector.
The bars show the range of prices; the dots the median.

What is the correct price of carbon? It is hard to say. A 2015

U.S. government study estimated $36 of economic damages
for each metric ton of carbon emitted. Yet estimates are rising:
A 2015 Stanford University study points to $220 per metric ton.
A single price may not be needed just a sensible floor.
Bottom line: Investors should prepare for higher carbon
prices and their potential impact on portfolios.

Putting a price on carbon

Features of carbon tax vs. emissions trading

Carbon tax

Emissions Trading Scheme (ETS)

Description

A tax on CO2 emissions. Levies fees on emissions from fossil fuel

production, distribution and use.

A market system established to set a price for the right to emit

CO2 above a set level. Caps emissions overall and/or by industry.

Price

The set price level provides certainty. This is desirable because

investment in low-carbon technology requires confidence in
sufficiently high, long-term carbon prices.

Prices are set by trading in the market and, therefore, can be

volatile. Prices swing with economic cycles and restrictions on
the quantity of emissions allowances.

Emissions
reductions

The tax is not directly tied to an emissions reduction target

because it is derived by modeling the cost of cutting emissions.

An ETS delivers emissions reductions by limiting allowances.

Flexibility

Tax rates can be altered to reflect progress in emissions cuts.

They can also target specific groups such as car users.

The supply of emissions allowances can be modified to

influence prices.

Administration

Can build upon existing tax infrastructure. It does require

measuring, reporting and verification. Tweaking tax rates can
raise administrative burden.

Complicated to implement. It requires the creation of emissions

allowances, the allocation of these allowances, a market for
trading them, and needs measuring, reporting and verification.

Examples

Mexico, Japan, Denmark, Finland, France, Norway, Portugal,

Sweden, Canada (to be decided), S. Africa (2017), Chile (2018).

EU, California, Regional Greenhouse Gas Initiative, China

(merging seven regional pilots into a national ETS in 2017).

Sources: BlackRock Investment Institute and Carbon Pricing Watch 2016 by World Bank Group/Ecofys, July 2016.
BLACK ROCK I NVESTM ENT I N ST IT U T E 1 5

Why BlackRock

BlackRock Investment Institute

BlackRock helps millions of people, as well as

the worlds largest institutions and governments,
pursue their investing goals. We offer:

The BlackRock Investment Institute provides connectivity between

BlackRocks portfolio managers, originates research and publishes
insights. Our goals are to help our fund managers become better investors
and to produce thought-provoking content for clients and policy makers.

A comprehensive set of innovative solutions

Global market and investment insights
Sophisticated risk and portfolio analytics

Want to know more?

EXECUTIVE DIRECTOR
Lee Kempler
GLOBAL CHIEF
INVESTMENT STRATEGIST
Richard Turnill

HEAD OF ECONOMIC AND

MARKETS RESEARCH
Jean Boivin
EXECUTIVE EDITOR
Jack Reerink

blackrock.com

This material is prepared by BlackRock and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt
any investment strategy. The opinions expressed are as of August 2016 and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and
nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility
arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain
forward-looking information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass.
Any client examples are hypothetical and meant to illustrate one way that an investor can approach constructing a green portfolio. This is not an investment recommendation for any particular portfolio, nor a
portfolio that BlackRock currently manages. There is no guarantee that any green portfolio will be successful. Reliance upon information in this material is at the sole discretion of the reader. This material is
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Lit. No. BII-CLIMATE-0916

6655A-BII-0916 / BII-0172 /BII-0174