Measuring the impact of carbon transition risk in the equity performance of energy corporations. January 10, 2023

Abstract

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Energy corporates are heavily exposed to carbon-transition risk as the global system fights to transform the economy from fossil fuels to green energy. We construct a green factor capturing the carbon transition risk premium for the energy related sector based on long-short positions with high versus low polluting corporations within the oil and gas and utilities sectors. While highly polluting companies are identified from the oil and gas sectors, low polluting companies are selected from power utilities based on low-carbon technologies and zero-carbon emitters from renewable energy producers. A carbon intensity measure from Transition Pathway Initiative (TPI) data for North America and Europe is used for this purpose. We find that the green factor delivers positive risk adjusted returns in both geographical areas considered. We also explore the effect of the green factor in explaining returns and find that a) it has a negative and significant effect in explaining returns of the energy sector, including oil and gas corporations b) it exerts a positive and significant effect in explaining returns in the utility sector. An alternative green factor constructed with zero-carbon emitters from renewable energy producers. Reported results show that this contributes to the explanation of returns and delivers a positive alpha. Our findings collaborate the view that investments in low emitting technologies provide a hedge of carbon transition risk.