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Harvard Business Review: Carbon Might Be Your Company’s Biggest Financial Liability

29 January, 2022 Through some combination of government intervention and the development of carbon trading markets, it seems inevitable that a price will eventually be put on carbon around the world. ​ At $100 per ton that would represent five percent of the global economy. Five percent of the global economy is a huge number. But where does this liability sit? With the world’s corporations. Every company has an uncovered “Carbon Short” position based on their emissions, and it needs to recognize this hidden liability today. This short position arises from the carbon emissions produced by their own operations (Scope 1 and 2, in the argot of climate accounting), and their products and services (Scope 3). Most companies don’t recognize this liability because these emissions are priced at zero today, were priced at zero last year, and so it seems natural to assume that they will be priced at zero in the future. One could say that companies are engaging in the carbon futures market, assuming that this fundamental “input cost” will never change. Anyone who works in commodity markets knows that uncovered positions can turn from profit to significant loss in the blink of an eye.


To see the implications for one company, consider the example of ExxonMobil. The company recently had three board members replaced by a small activist investor, Engine No. 1, as a result of its failure to recognize that the energy transition requires some fundamental changes in its strategy and capital allocation decisions. Why were investors so incensed? In 2020 ExxonMobil released 112 million metric tons of CO2 “equivalent” (along with carbon, they also released other greenhouse gasses such as methane). At $100/ton, they would owe $11B annually on their own emissions. Since the company has earned only $8 billion on average over the past five years, this means they would rapidly be bankrupt. That surely is a good way to finally get the attention of their board. Add in the company’s share of the annual $60 billion from pricing the roughly 600 million metric tons of its Scope 3 emissions (it’s not clear how much they could pass on to purchasers) and the situation is even more dire.


The price of carbon may be zero in many places today, but it’s unlikely to remain zero for long. A basic approach would be to start with assuming prices of $50 in 2022, $100 in 2024, $200 in 2026, and $300 in 2028. This is one example of a forward price curve; scenario analysis could use several.


This progress each company makes toward managing its “Carbon Short” should be reported on a quarterly basis during the earnings call. Yes, companies must have a long-term plan for covering their carbon short by being net-zero by 2050, but they should provide short-term updates on the risks they face and the progress they’re making on their plan.