A Balance Sheet tells a Net Zero Story

Banks and financial institutions have almost zero emissions. So do most companies in the service industry. Their balance sheet can guide them in their journey towards net zero.

Let us take the case of an insurance company (hypothetical, of course). An insurance company collects money from its policyholders by way of a premium. The company then invests the money in various securities that earn them a return. Out of this, claims against fire, death, floods etc., are paid. The remainder is the profit for the insurance company.

In a simple version, the balance sheet of an insurance company has policyholders’ claims on the liabilities side and the investment in securities on the asset side.

So, what are the implications for net-zero?

Let’s start with the liability side. Policyholders are either individuals or corporate. The bulk of customers tends to be corporates. The composition of corporates and their emission profile indicates a risk to the insurance company. For example, suppose a  significant portion of policyholders are in the business of coal and oil. In that case, the dwindling future of coal and oil companies may impact the insurance company. Thus it needs to track the emission profile of its customers.

The asset side is equally important. To be genuinely net-zero, the insurance company will also need to minimise its investment in high carbon securities. If it holds equity shares of a company, then that company’s carbon emissions count. The same holds for debt securities. Investments in mutual funds would require tracking of emissions of constituent companies.

The shift to net-zero requires companies not asset not only the direct emissions but also indirect emissions. A look at their balance sheet will help.

Green Transition Metals and Net Zero

There are several metals critical to green technologies. Copper and nickel are called established metals. Trading in these metals has been taking place for over a century. Then, there are rising metals like lithium and cobalt where there is no established trading on exchanges.  However, they have become crucial for their role in green transition technologies. There is likely to be a rise in the demand for certain metals (nickel, copper, and manganese) for their role in a wide array of green technologies. Others like cobalt and lithium are limited to batteries.

The IEA’s “Net Zero by 2050” report estimates that the demand for lithium for use in batteries will grow 30‐fold to 2030 and is more than 100‐times higher in 2050 than in 2020. In addition, the total market size of critical minerals like copper,  cobalt, manganese and various rare earth metals grows almost sevenfold between 2020 and  2030 in the net-zero pathway.

The increased demand will need to be matched by supply. A study by IMF shows that many of the metals required for transition, at current production rates, will be inadequate to satisfy future demand. As a result, metals like nickel, vanadium, cobalt and graphite will likely be in short supply. The recent rise in commodity prices is a clear indicator of these shortages.

These metals form a few regions. For instance, the Democratic Republic of the Congo accounts for about 70 per cent of global cobalt output and 50 per cent of reserves.

While the scenario looks difficult, there are two imponderables. First technological change is hard to predict. Second, the speed and direction of the energy transition are likely to be dictated by policy changes.

The road for the shift to net zero will be tough. But it is the only road for the future.

Agriculture and Net Zero

Manufacturing industries have been a focus for reducing carbon emissions. However, agriculture also has its fair share of emissions. Agriculture contributes up to 24% of GHG emissions worldwide. Moreover, the contribution of agriculture in methane emissions is 25-30% — the highest in any human-related activity. Hence reducing emissions in agriculture becomes critical.

49% of emissions come from livestock, mainly through burping and flatulence. In addition, 22% comes from energy use, 16% from rice methane and 13% from soil fertilisation.

Some approaches to reducing emissions in agriculture are:

  • Shift to renewable energy/ biofuels
  • Increased use of biochar
  • Increasing forests and biodiversity
  • Improved farming techniques, including no-till planting, enhancing soils with cover crops, making better use of crop residues
  • Reducing flatulence and burping among cattle through methane reducing feed additives and supplements
  • Reducing stubble burning by incentivising farmers, mechanically cutting stubble and composting stubble.
  • Using drip irrigation to reduce rice methane

The shift to net zero is imperative, and agriculture has a significant role to play.

Cheating Carbon Pricing

Carbon pricing is an efficient mechanism for reducing carbon emissions. Carbon taxes can be a way to force polluters to pay for harming the environment by burning fossil fuel. The World Bank has estimated that 45 countries and 34 subnational jurisdictions have adopted some form of carbon pricing – carbon taxes or emissions trading systems. While these schemes have helped reduce emissions in these countries, they’ve had unintended consequences.

A recent study by Luc Laeven and Alexander Popov of the Centre for Economic Policy Research (CEPR) examined more than 2m loan tranches involving banks doing cross-border lending between 1988 and 2021. This was the period during which time many countries imposed carbon pricing. The study finds that the imposition of carbon taxes at home led banks to reduce lending to coal, oil and gas companies. At the same time, it had a perverse effect of banks increasing lending abroad. The shift was most pronounced for banks with big fossil-fuel-lending portfolios. Thus, the lending simply shifted from countries with carbon taxes to countries with no carbon taxes. Another paper suggests that banks increase cross-border lending in response to stricter climate policies at home. This is a regulatory arbitrage tool to shift dirty loans to countries with relatively lax climate policies. This is akin to companies moving their production facilities to countries with lower compliance requirements, climate or otherwise.

EU’s proposed carbon border adjustment mechanism attempts to level the playing field. However, more countries and blocs need to adopt methods to thwart such actions. The shift to net zero may be in peril without such measures.

Cheating Carbon Pricing

Carbon pricing is an efficient mechanism for reducing carbon emissions. Carbon taxes can be a way to force polluters to pay for harming the environment by burning fossil fuel. The World Bank has estimated that 45 countries and 34 subnational jurisdictions have adopted some form of carbon pricing – carbon taxes or emissions trading systems. While these schemes have helped reduce emissions in these countries, they’ve had unintended consequences.

A recent study by Luc Laeven and Alexander Popov of the Centre for Economic Policy Research (CEPR) examined more than 2m loan tranches involving banks doing cross-border lending between 1988 and 2021. This was the period during which time many countries imposed carbon pricing. The study finds that the imposition of carbon taxes at home led banks to reduce lending to coal, oil and gas companies. At the same time, it had a perverse effect of banks increasing lending abroad. The shift was most pronounced for banks with big fossil-fuel-lending portfolios. Thus, the lending simply shifted from countries with carbon taxes to countries with no carbon taxes. Another paper suggests that banks increase cross-border lending in response to stricter climate policies at home. This is a regulatory arbitrage tool to shift dirty loans to countries with relatively lax climate policies. This is akin to companies moving their production facilities to countries with lower compliance requirements, climate or otherwise.

EU’s proposed carbon border adjustment mechanism attempts to level the playing field. However, more countries and blocs need to adopt methods to thwart such actions. The shift to net zero may be in peril without such measures.