Until a comprehensive global agreement on carbon regulation and pricing is achieved, national and multi-national initiatives will preserve an uneven global carbon market. These disparities have a significant – and unequal – impact on the world economy, especially the carbon-heavy energy sector.

The Climate Risk Management team at RiskMetrics has been tracking national policy commitments regarding carbon emissions. These include regulations that have been enacted into law, such as those in the European Union, as well as policy goals stated at the Copenhagen meeting but not yet legislatively approved, such as those of the US.

Cost Projections for Carbon Regulations

RiskMetrics has assessed companies' level of exposure to carbon-related regulations with a proprietary Weighted Average Country Carbon Reduction Target (WACCRT) model. The WACCRT model enables comparisons of emissions reductions – and associated compliance costs – under existing laws and those intended to come into effect in the 2013-2020 time frame, per declarations under the Copenhagen Accord.

Utilities, Industrials face Greater Exposure than Energy, Materials Sectors

Four major emitting industries that are affected by carbon regulations are energy, materials, industrials, and electric power. For companies in these sectors analyzed by RiskMetrics, the average projected change in emissions in the 2013-2020 timeframe is as follows:

Among these industries, the energy and material sectors face the lowest overall percentage reductions in emissions, because their operations tend to be widely dispersed around the globe, including jurisdictions not likely to enact greenhouse gas (GHG) emission curbs by 2020.

By contrast, the industrials and utility companies analyzed by RiskMetrics have a greater concentration of assets in industrialized countries. Electric utilities, in particular, tend to operate in their home markets only. The concentration of large-emitting utilities in Europe (which are already subject to GHG regulations) and those in the U.S. (likely to be subject to regulations by 2013) accounts for that industry's greatest overall exposure to projected GHG regulations.

Regulatory Exposure Varies Widely within Oil & Gas Sector

More telling are intra-industry comparisons between companies to reveal the extent of their individual regulatory exposure. The table below compares four companies in the integrated oil and gas sector:

Each firm's unique operational footprint is the most significant determinant of its carbon cost risks:

• Hess has more than 75 percent of its emissions concentrated in Malaysia, Algeria and Equatorial Guinea. These countries have not announced any emission targets and all allow flaring of methane gas, a significant contributor of GHG emissions in the oil and gas sector. By contrast, only 20 percent of Hess's emissions are associated with its operations in the U.S. and Europe, giving it relatively little exposure to current or future regulatory controls.
• Total SA, on the other hand, has extensive downstream operations in Europe, where more than half of its emissions occur, giving it substantial current regulatory exposure in RiskMetrics' analytical set of 27 integrated oil & gas companies. Its exposure will continue to grow as Europe tightens its GHG regulations in the coming decade and as Total makes further investments in Canadian oil sands, a high-emissions source in a country that is poised to enact federal GHG controls.
• Occidental Petroleum Corp. faces an even steeper regulatory trajectory. Its emissions are heavily concentrated in North America, where it has large petrochemical operations, accounting for four-fifths of its total GHG emissions. As regulations come into effect in the U.S., Canada and Mexico, Occidental faces a nearly 16-percent reduction in its projected carbon emissions.
• Petrobras, surprisingly, may face the greatest increase in regulatory exposure of all. That is because Petrobras operates almost exclusively in Brazil. As the world's fifth-largest carbon emitter, Brazil enacted a law on Dec. 29 calling for a 39-percent reduction in the country's GHG emissions by 2020. The new law is subject to adjustment as the nation defines responsibilities and regulations for the energy, industrial, farming, and environmental sectors. President Luiz Inacio Lula da Silva is expected to sign the decrees this month after consulting scientists and other experts.

As the new Brazilian law illustrates, how GHG regulations are implemented is as critical as passage of the laws themselves. Accordingly, regulatory developments must be monitored closely.

As negotiations continue this year towards a new global agreement on climate change, investors should not lose sight of smaller national and multi-national deals. The findings of the WACCRT model demonstrate the variance in regulatory exposure according to where operating assets are based. A key question going forward is whether companies will seek to evade stricter regulatory regimes. This could distort the oil and gas sector, and the global energy market as a whole.