COP25 Climate Summit: Companies Must Invest USD 2.5 Trillion to Adapt to Increasingly Stringent Climate Regulations

  • The COP25 summit will be a catalyst for tightening regulations on climate change: we calculate that the total impact on global industry will amount to nearly USD 2.5 trillion over the next ten years.
  • The highest costs will be borne by the energy sector (USD 900 billion), followed by steel (USD 300 billion) and air and maritime transport (USD 55 billion).
  • Companies are not sufficiently prepared for the new wave of regulation: after margins shrink due to rising emission costs and more stringent regulations, the complete loss of value of certain assets or entire companies is a real risk in the near future.

Paris-Warsaw, December 2019 – The COP25 climate conference is ending in Madrid, and greenhouse gas emissions are still rising (+2.0% p.a. in 2018) despite the adoption worldwide of more than 1,500 pieces of legislation on climate change. Efforts to reduce emissions must therefore be increased fivefold in line with the United Nations Environment Programme (UNEP). That is why we expect regulations on environmental change to be tightened and increased in number worldwide.

“To quantify the impact, we grouped the most important indicators into four categories: carbon emission allowance prices; the energy mix and energy efficiency; mobility regulations; and industry-specific taxes, fines and fees. We found that the negative impact on global industry will amount to nearly USD 2.5 trillion over the next ten years,” said Catharina Hillenbrand, Sector Advisor for Energy, Metals, Machinery and Equipment at Euler Hermes.

Which sectors are most exposed?

Which sectors are most exposed?

We believe the new regulations will affect almost the entire global economy, so we calculated their impact by sector (see the full list here), although the burden of regulation will not be distributed evenly and some sectors will feel the changes particularly severely:

  • Climate regulations have already cost the energy sector USD 1.4 trillion over the past ten years, and they are expected to cost a further USD 900 billion in the next decade.
  • The steel sector, as an energy-intensive industry, will be the second most affected sector: USD 300 billion over the next 10 years.
  • Air and maritime transport ranks third (USD 55 billion) due to a combination of carbon emission offset schemes (from USD 16 billion to USD 42 billion), higher taxation and/or CO2 emission charges, as well as global incentives to switch to rail transport. Both segments will also be affected by new regulations on sulphur content in fuel.

How should companies prepare for this wave of regulation?

How should companies prepare?

To prepare, companies must consider both direct and indirect effects:

The direct impact will be a reduction in gross margins due to rising emission costs. This may translate into other costs, such as operating expenses (OPEX) or capital expenditures (CAPEX). But it may also result in lower operating profitability as a result of increased other expenses incurred to switch to cleaner but more costly processes, or greater spending on research and development.

Indirect risks must also be taken into account, from the reshaping of supply chains and the multiplied risk associated with this, to greater exposure to end-customer (expectations). Moreover, each of these issues may have a visible impact on companies’ balance sheets and solvency.

Depending on the speed of adaptation (which is currently insufficient) – in the event of major delays, the most far-reaching but real risk is the complete loss of value of certain assets or entire companies. The coal sector is the first example of an orphaned industry, but many other sectors will also be put to a real test across the entire global economy, potentially leading to their marginalisation.

“An example – perhaps not of the direct impact of the new regulations, but of the changes they will bring about in the supply chain and demand – is the machinery industry, specifically the part that supplies machinery to the extractive sector, including mining,” assesses Tomasz Starus, member of the management board of Euler Hermes responsible for risk assessment. So strong (still) in Poland, which has so far lived on hopes of expansion in markets such as China, still largely based on coal. These hopes are now in question – not only is the scale of extraction the greatest in China, but so are the environmental problems. Rapid, systemically top-down changes aimed at marginalising mining can therefore be expected there, which may already be taking place – there is indeed a real alternative. Gigantic river regulation and mega-hydropower plant construction programmes have been implemented on a scale unimaginable elsewhere. China is also a global powerhouse in the production of renewable energy sources, including photovoltaic panels. A leap from the 19th to the 21st century in terms of electricity generation, at the expense of the industry serving mining. Of course, these changes will also create opportunities for companies that develop products and services supporting the transformation and expansion of the alternative energy sector itself.”

Summary

As the COP25 summit ends in Madrid, greenhouse gas emissions continue to rise, and global industry faces total costs of up to USD 2.5 trillion over the decade due to tightening climate regulations. The most affected will be the energy sector (USD 900 billion), steel (USD 300 billion) and air and maritime transport (USD 55 billion). Euler Hermes experts warn that companies are poorly prepared for the new wave of legislation, and the risk of asset value loss is becoming real — as already exemplified by the coal industry. It will be crucial to take into account both direct costs and the impact on supply chains.