Which Industries Are Best Prepared for a Low-Carbon Future?

Telecom and utilities companies stand among the leaders, according to Morningstar Sustainalytics’ Low Carbon Transition Ratings.

Susan Zhou 25 April, 2023 | 4:38AM
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Companies may tout their net-zero commitments, but which ones are truly prepared for a low-carbon future?

The answer: Telecom services, utilities, household products, automobiles, and construction and engineering, according to a report by a team of Morningstar Sustainalytics analysts led by Pustav Joshi about Sustainalytics’ Low Carbon Transition Ratings. But even in those industries, there’s plenty of room for improvement, the report suggests.

In the fight against climate change and its physical consequences, companies are seeking to reduce emissions and establish net-zero commitments (or negating their emissions to virtually zero), in line with a goal of limiting global warming to 1.5 degrees Celsius above preindustrial levels. In turn, this transition to a low-carbon world creates its own risks and opportunities. These transition risks and opportunities represent the costs of socioeconomic changes from decarbonizing the global economy.

Measuring Climate Risk Management
The Low Carbon Transition Rating provides investors with a forward-looking science-based assessment of a company’s current alignment to a net-zero pathway that limits global warming to 1.5 degrees Celsius. The Low Carbon Transition Rating is the combined assessment of two components: a company’s exposure to specific carbon risks and opportunities and its management of those risks.

The Low Carbon Transition Rating management score equally weights a company’s transition preparedness and climate investment plans. Having a high management score doesn’t mean a business is environmentally friendly. Instead, it indicates that the company has the governance structures and management programs in place to address the transition risks. A company with a low management score implies that its governance and plans are inadequate and may lead to higher risk exposure or higher future emissions.

Companies with management scores over 60 have strong management of low-carbon transition risk, Morningstar Sustainalytics says in its report. Most industries scored between 40 and 50, the lower range of average management scores.

Industries With Strong Management of Carbon Transition Risks
Telecom services, utilities, household products, automobiles, and construction and engineering are the industries with the highest proportion of companies with strong management scores for the Low Carbon Transition Rating. Companies in these industries have come furthest in identifying and managing material climate risks, Morningstar Sustainalytics says.

However, despite the strong management performance of some companies, many have room to improve. For example, only 25% of companies in the telecommunications industry have a strong management score. For automobiles, the number is 22%. Poor scores mean companies aren’t managing their material risks.

Strong Managements Disclose Emissions Targets, Use of Carbon Pricing

Overall, climate risk management performance scores are fairly low. The average management score across all industries is around 45. What practices and strategies differentiate top performers? In the industries with the largest percentage of companies with management scores above 60, those companies do particularly well on:

  • Emissions Reduction Targets: Typically, more than half the companies have set an absolute or intensity-based greenhouse gas reduction target, or both. They have set clear timelines for achieving these targets. The leading industries have a higher proportion of companies that have set deep decarbonization targets. Telecommunications and household products do well in disclosing most of the elements assessed under this indicator.
  • Use of Carbon Pricing in Decision-Making: In the five industries with the highest management scores, companies have much higher rates of reporting on utilizing carbon pricing in making decisions. They also publicly disclose the carbon price they use and the source of the carbon price. This highlights their commitment to making transition-compliant investment decisions, Morningstar Sustainalytics says. High-emitting industries like automobiles and utilities have higher rates of disclosure on using carbon pricing for decision-making.
  • Governance Structures to Achieve Net-Zero Targets: Companies with strong management performance also do well by backing up their targets with remuneration and incentives (both monetary and nonmonetary) for the company’s CEO, board members, and senior management, Morningstar Sustainalytics says.

It is important to note that overall management scores across the globe remain low, Morningstar Sustainalytics says. Companies can learn from leaders and do well by setting out clear, ambitious decarbonization targets and plans for decarbonizing their products and processes, clarifying how they use carbon prices to make investment decisions, and adequately linking management incentives with the achievement of the targets.

At the same time, the increasing frequency of extreme weather events, rising fossil fuel prices, and stricter climate regulations in all countries will influence which strategies companies set for themselves and how transparent they are about their climate-related risks. Learn more about Sustainalytics’ Low Carbon Transition Rating.

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Susan Zhou  is a contributor to Morningstar.

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